Auditing A Practical Approach, 4th Canadian Edition Robyn Moroney Test Bank

Type:

Test Bank

Resource:

Auditing A Practical Approach

Edition:

4th Edition

Author(s):

Robyn Moroney

CHAPTER 1 INTRODUCTION AND OVERVIEW OF AUDIT AND ASSURANCE CHAPTER LEARNING OBJECTIVES 1. Define an assurance engagement.

An assurance engagement involves an assurance provider arriving at an opinion about some information being provided by their client to a third party. A financial statement audit is one type of assurance engagement. This engagement involves an auditor arriving at an opinion about the fair presentation of the financial statements. The audit report is addressed to the shareholders of the company being audited, but other users may read the financial statements. Learning about auditing and assurance requires an understanding of auditing and assurance terminology, including terms such as audit risk, materiality, internal controls, listed entity, and assertions.

2. Explain why there is a demand for audit and assurance services.

Financial statement users include investors (shareholders), suppliers, customers, lenders, employees, governments, and the general public. These groups of users demand audited financial statements because of their remoteness from the entity, accounting complexity, their incentives competing with those of the entity’s managers, and their need for reliable information on which to base decisions. The theories used to describe the demand for audit and assurance services are agency theory, the information hypothesis, and the insurance hypothesis.

3. Differentiate between types of assurance services.

Assurance services include financial statement audits, compliance audits, performance audits, comprehensive audits, internal audits, and assurance on corporate social responsibility (CSR) disclosures.

4. Explain the different levels of assurance.

The different levels of assurance include reasonable assurance, which is the highest level of assurance, limited assurance, and no assurance. Reasonable assurance is provided on an audit of a company’s financial statements. Limited assurance is provided in a review of a company’s financial statements. No assurance is provided in a compilation engagement.

5. Outline different audit opinions An auditor can issue an unmodified opinion, also known as a clean report, or an unmodified opinion with an emphasis of matter paragraph. Alternatively, a modified opinion may be issued as a qualified, an adverse, or a disclaimer of opinion.

6. Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

It is the responsibility of a company’s governing body to ensure that its financial statements are relevant, reliable, comparable, understandable, and true and fair. It is the responsibility of the auditor to form an opinion on the fair presentation of the financial statements. In doing,

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Auditing: A Practical Approach, Fourth Canadian Edition

so the auditor must maintain professional scepticism and utilize professional judgement and due care.

The firms that provide assurance services include the Big-4 international firms, the national firms (with international links), local and regional firms, and consulting firms that tend to specialize in assurance of CSR and environmental disclosures.

7. Identify the different regulators, legislation, and regulations surrounding the assurance process.

Regulators of the assurance process include the Auditing and Assurance Standards Board (AASB), Canadian Securities Administrators (CSA) and the various provincial securities commissions, and the Canadian Public Accountability Board (CPAB). Relevant legislation includes the Canada Business Corporations Act (CBCA). CPA Canada is the professional accounting body in Canada, responsible for the Chartered Professional Accountant (CPA) designation.

8. Describe the audit expectation gap.

The audit expectation gap occurs when there is a difference between the expectations of assurance providers and financial statement or other users. The gap occurs when user beliefs do not align with what an auditor has actually done.

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Introduction and Overview of Audit and Assurance

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TRUE-FALSE STATEMENTS 1. Only current investors (not potential investors) are considered to be users of the financial statements.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services.

Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic

2. Insurance hypothesis is a means whereby the investor can guarantee the success of their investment.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services.

Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic

3. A compliance audit involves gathering evidence to ascertain whether the person or entity under review has followed the rules, policies, procedures, laws, and regulations with which they must conform.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between types of assurance services.

Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic

4. An operational audit is an example of a compliance audit.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between types of assurance services.

Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

5. The most common types of assurance engagements are financial statement audits, confirmation audits, performance audits, comprehensive audits, and assurance on corporate social responsibility (CSR) disclosures.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between types of assurance services.

Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic

6. The nature of audit procedures refers to the reliance on evidence provided by the client and its management.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between types of assurance services.

Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic 7. It is the auditor’s responsibility to prepare the financial statements.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between types of assurance services.

Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic

8. An auditor can provide a reasonable level of assurance on information other than historical financial information.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic

9. A reasonable level of assurance is the highest level of assurance that an auditor can provide.

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Introduction and Overview of Audit and Assurance

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Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic

10. A no assurance engagement is of little use as no assurance is given to the client.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic

11. The Compilation Engagement Report explicitly states that no assurance is being provided.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA: Audit and Assurance CPA: Audit and Assurance AACSB: Analytic

12. When conducting a review engagement, a practitioner must obtain an understanding of the entity and test the effectiveness of the entity’s internal controls.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA: Audit and Assurance AACSB: Analytic

13. A negative expression of opinion is only given when there is a disagreement with management and the auditor.

Answer: False

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Auditing: A Practical Approach, Fourth Canadian Edition

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline different audit opinions.

Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic

14. All modified audit reports are qualified audit opinions.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline different audit opinions.

Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic

15. The expectation gap is caused by unrealistic user expectations such as the auditor providing complete assurance.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the audit expectation gap.

Section Reference: 1.8 The audit expectation gap CPA Competency: Audit and Assurance AACSB: Analytic

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Introduction and Overview of Audit and Assurance

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MULTIPLE CHOICE QUESTIONS 16. Martha Minnati was reviewing the previous year’s audited financial statements of a clothing manufacturer. Her manager explained to her that for a financial statement audit, the clothing company was the accountable party, its shareholders were the users, and the subject matter was the financial statements. What kind of audit engagement was her manager describing? a) consulting engagement b) assurance engagement c) review engagement d) compliance engagement Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define an assurance engagement.

Section Reference: 1.1 Auditing and assurance defined CPA Competency: Audit and Assurance AACSB: Analytic

17. An engagement performed by an auditor or practitioner to enhance the reliability of the subject matter can best be described as a(n) a) compilation engagement. b) review engagement. c) consultancy engagement. d) assurance engagement.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define an assurance engagement.

Section Reference: 1.1 Auditing and assurance defined CPA Competency: Audit and Assurance AACSB: Analytic

18. An example of the three parties in an assurance engagement would be: a) audit client, employee, customer. b) audit client, supplier, auditor. c) auditor, shareholder, general public. d) auditor, general public, employees.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define an assurance engagement.

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Auditing: A Practical Approach, Fourth Canadian Edition

Section Reference: 1.1 Auditing and assurance defined CPA Competency: Audit and Assurance AACSB: Analytic

19. A limitation of an audit is caused by a) the nature of financial reporting. b) the nature of audit procedures. c) the need for the audit to be conducted within a reasonable period of time and at a reasonable cost. d) all of these answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define an assurance engagement.

Section Reference: 1.1 Auditing and assurance defined CPA Competency: Audit and Assurance AACSB: Analytic

20. Which of the following groups would be considered users of the financial statements? a) governments b) current shareholders c) general public d) all of these answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services.

Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic

21. The causes of information risk do not include a) independence. b) complexity. c) reliability. d) competing incentives.

Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services.

Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic

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Introduction and Overview of Audit and Assurance

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22. An audit is one way for investors to insure against at least part of their loss should the company they invest in fail – this is an example of a) agency theory. b) information hypothesis. c) insurance hypothesis. d) competing incentives.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services.

Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic

23. According to the agency theory, demand for audit is due to conflicts between a) managers and owners. b) managers and agents. c) owners and principals. d) auditors and owners.

Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services.

Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic 24. While awaiting a meeting in his firm’s boardroom, the senior partner, Bill Goldsworthy, read the following statement in an article in The Globe & Mail: “The greater the perceived quality of the information contained in the financial statements, the more likely it will be relied upon by the users of that information.” This statement best describes a) the expectations gap. b) agency theory. c) information hypothesis. d) insurance hypothesis.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services.

Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance

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Auditing: A Practical Approach, Fourth Canadian Edition

AACSB: Analytic

25. As users of the financial statements, suppliers would least consider which of the following aspects of the financial statements? a) solvency of the entity b) profitability of the entity c) return on investment of the entity d) corporate social responsibility of the entity Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Explain why there is a demand for audit and assurance services.

Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic

26. Which of the following is incorrect? A government can be considered to be a user of the general purpose financial statements because a) it is the sole basis for the calculation of taxes owed to the government. b) it can determine whether certain regulations have been complied with. c) it can gain a better understanding of the entity’s activities. d) governments need to assess the entity so that they can provide the entity with grants that will benefit society.

Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Explain why there is a demand for audit and assurance services.

Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic

27. Agency theory can be described as the theory of a) hiring an agency to review the work of the management, in this case it is the auditor. b) when the finance function is outsourced to an outside party, and the auditor is required to audit the outside party’s work. c) the relationship between the owner and the management of the business when the owner is not the manager of the business. d) the relationship between the auditor and the management of the business.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services.

Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance

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Introduction and Overview of Audit and Assurance

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AACSB: Analytic

28. Insurance hypothesis tells us that a) investors will demand that financial statements be audited as a way of insuring against some of their loss should their investment fail. b) investors can insure themselves against loss by investing in a diverse investment portfolio should an individual investment fail. c) investors cannot insure themselves against loss when investing in an entity. d) the entity can take out insurance to protect itself from such risks as employee or management fraud which can lead to material misstatements in the financial statements.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services.

Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic 29. Vera Sobczyk spent a week at a client’s wholesale operation determining whether the client’s remittances to the tax authorities were in accordance with tax regulations. This is an example of a(n) a) taxes payable mandate. b) financial audit. c) operational audit. d) compliance audit.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between types of assurance services.

Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic

30. Ming Yao reviewed the operations of a basketball academy. His objectives were to determine how effectively the academy delivered its many programs. What kind of an audit did he perform? a) operational b) compliance c) financial d) comprehensive Answer: a Bloomcode: Comprehension

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Auditing: A Practical Approach, Fourth Canadian Edition

Difficulty: Easy Learning Objective: Differentiate between types of assurance services.

Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic

31. Matt Fuller reports to the board and evaluates how the company can improve risk management practices, internal control procedures, and certain governance issues. Who is he? a) President b) Controller c) Treasurer d) Internal Auditor Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between types of assurance services.

Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic

32. Which of the following is not true about Corporate Social Responsibility assurance? a) reporting is voluntary and is becoming more widespread b) includes both financial and non-financial information c) is required to be performed by an auditor d) disclosures include environmental, employee, and social reporting Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between types of assurance services.

Section Reference: 1.3 Different assurance services CPA Competency: Audit and Assurance AACSB: Analytic 33. Which of the following is a component of the “Other Information” section of the auditor’s report? a) auditor’s responsibilities with respect to the audited financial statements b) management’s responsibility for internal controls as they relate to the financial statements c) responsibility of those charged with governance to oversee the financial reporting process d) management’s responsibility for other information Answer: d Bloomcode: Knowledge Difficulty: Easy

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Introduction and Overview of Audit and Assurance

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Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA: Audit and Assurance AACSB: Analytic

34. Which of the following is not a component of the Review Engagement Report? a) practitioner’s responsibility for the financial statements b) management’s responsibility for the financial statements c) practitioner’s opinion over the reasonableness of the financial statements d) procedures applied to the review engagement and how they differ from an audit engagement Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA: Audit and Assurance AACSB: Analytic

35. Michael Stiller performed work for a client in the real estate business and issued a Compilation Engagement Report. What degree of assurance does a compilation engagement provide to the user of the statements? a) reasonable assurance b) moderate assurance c) no assurance d) complete assurance Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic

36. Theodore Heinrich prepared a set of financial statements based on information provided to him. He checked mathematical accuracy of the data, and the client complimented him on the reasonable cost of the work he performed. Theodore performed a) a compilation engagement. b) a review engagement. c) an audit engagement. d) an operational audit engagement Answer: a Bloomcode: Comprehension

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Auditing: A Practical Approach, Fourth Canadian Edition

Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic

37. Jimmy Bunting, the practitioner at Yanzhou Coal Mining and Minerals, performed the following tasks: he used analytical procedures and he had discussions with management.

These activities were a basis for a conclusion on the financial information. What did Jimmy Bunting perform?

a) a qualified report b) an unmodified opinion c) a compilation engagement d) a review engagement Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic

38. Which of the following would be an example of a reasonable assurance engagement? a) the review of annual financial statements b) the audit of annual financial statements c) the reporting of procedures performed by the auditor as agreed by the client d) the compilation of annual financial statements Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic

39. The wording of a limited assurance engagement expresses a conclusion that generally states a) there is nothing wrong with the subject matter. b) there is something wrong with the subject matter. c) there is nothing that has come to the attention of the auditors that would lead them to believe that the information being assured is not true and fair. d) there is something that has come to the attention of the auditors that would lead them to believe that the information being assured is not true and fair.

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Introduction and Overview of Audit and Assurance

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Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic

40. In a review engagement, which of the following is least likely to occur during the engagement? a) analytical procedures b) inquiries with management and other personnel c) substantive audit procedures d) review of the accounting systems of the entity.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic

41. Maggie Oh performed an audit of a client that had undergone flooding to its operations in St-Jean Sur Richelieu. The client was insured and was able to keep operating.

However, there was material damage to the client’s warehouse and Maggie felt it would be appropriate to inform the users of the financial statements of this fact in the audit report. This form of audit report is called

a) an adverse opinion. b) an unmodified opinion – emphasis of matter. c) a modified opinion. d) a disclaimer of opinion.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline different audit opinions.

Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic

42. Based on the evidence gathered, if an auditor concludes all noted misstatements in the financial statements to be immaterial, individually and collectively, then the auditor would

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Auditing: A Practical Approach, Fourth Canadian Edition

a) resign from the engagement. b) emphasize the errors in the audit report. c) issue an unqualified opinion. d) issue a qualified opinion.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline different audit opinions.

Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic

43. An unqualified opinion is also known as a(n) a) clean opinion. b) adverse opinion. c) unmodified opinion. d) both clean opinion and unmodified opinion.

Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline different audit opinions.

Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic

44. An example of an unmodified audit opinion is a) qualified audit opinion. b) adverse audit opinion. c) unqualified audit opinion with an emphasis of matter. d) denial of audit opinion.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline different audit opinions.

Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic

45. Which of the following is not a type of opinion? a) qualified opinion b) adjusted opinion c) adverse opinion d) disclaimer of opinion

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Introduction and Overview of Audit and Assurance

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Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline different audit opinions.

Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic

46. The following can be said about an emphasis of matter: a) it is included when the auditor’s opinion has changed and the auditor wants to bring the users’ attention to a particular matter. b) it is only used in unqualified audit opinions. c) it is included when the auditor’s opinion has not changed and the auditor wants to bring the users’ attention to a particular matter. d) it cannot be used when expressing an audit opinion that has pervasive misstatements.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline different audit opinions.

Section Reference: 1.5 Different audit opinions CPA Competency: Audit and Assurance AACSB: Analytic

47. A financial statement auditor is required to audit all of the following except a) income statement and balance sheet. b) statement of cash flows. c) management discussion and analysis. d) notes to the financial statements.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

48. For a financial report to be relevant, it must a) be free from material misstatement. b) have an impact on the decisions made by users regarding the performance of the entity. c) be periodically audited by an independent auditor. d) include an audit report

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Auditing: A Practical Approach, Fourth Canadian Edition

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

49. For a financial report to be reliable, it must a) be free from material misstatement. b) have an impact on the decisions made by users regarding the performance of the entity. c) be periodically audited by an independent auditor. d) be reviewed by an internal auditor Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

50. When conducting an audit, an auditor should use a) professional scepticism. b) professional judgement. c) due care. d) all of these answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

51. The top tier of accounting firms is comprised of a) Deloitte, Ernst & Young, PricewaterhouseCoopers (PwC), and KPMG. b) Ernst & Young, PricewaterhouseCoopers (PwC), KPMG, and BDO. c) Deloitte, Ernst & Young, KPMG, and Grant Thornton. d) WHK Group, Deloitte, KPMG, and PricewaterhouseCoopers (PwC).

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Introduction and Overview of Audit and Assurance

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Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

52. Mary Logan was careful to undertake her audits in a most responsible manner. Her audit manager complimented her on her diligence and how well she documented her work at the different stages of the audit process. Which element of responsibility did she display?

a) due care b) professional judgment c) professional scepticism d) professional attitude Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

53. Larry Dibitonto is a partner in his firm and runs management consulting, mergers and acquisitions, insolvency, tax, and accounting services. How are these services referred to collectively? a) audit b) non-assurance services c) reviews d) compilations Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

54. In addition to the preparation of financial statements, it is also the responsibility of those charged with governance to a) identify the financial reporting framework to be used in the preparation and presentation of their financial statements. b) establish and maintain internal controls that are effective in preventing and detecting material misstatements. c) selecting and applying appropriate accounting policies and making reasonable accounting estimates. d) all of these answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

55. Which of the following is not true in relation to comparability? a) able to identify trends that may influence their perception of how well the entity is doing b) able to assess performance of the entity over time and with other entities c) able to be understood d) able to consistently apply accounting principles Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

56. Professional scepticism does not involve a) the professional requirement that all management representations be substantiated with supporting documentation. b) seeking independent evidence to corroborate information provided by their client. c) being suspicious when evidence contradicts documents held by their client or inquiries made of client personnel. d) the attitude adopted by the auditor when conducting the audit.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

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Introduction and Overview of Audit and Assurance

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Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

57. The largest accounting firms in Canada are known collectively as the a) ‘Big-3’. b) ‘Big-4’. c) ‘Big-5’. d) ‘Big-6’.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

58. Auditors of reporting issuers are required to be a member in good standing with a) CPAB. b) CSA. c) CPA Canada. d) OSFI. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different regulators, legislation, and regulations surrounding the assurance process.

Section Reference: 1.7 The role of regulators and regulations CPA Competency: Audit and Assurance AACSB: Analytic

59. Under the Canada Business Corporations Act, the auditor has a responsibility to form an opinion on the company’s a) operations. b) independence. c) financial statements. d) tax calculation.

Answer: c Bloomcode: Knowledge Difficulty: Easy

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Learning Objective: Identify the different regulators, legislation, and regulations surrounding the assurance process.

Section Reference: 1.7 The role of regulators and regulations CPA Competency: Audit and Assurance AACSB: Analytic

60. The expectation gap is caused by a) realistic auditor expectations. b) unrealistic user expectations. c) realistic user expectations. d) unrealistic auditor expectations.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the audit expectation gap.

Section Reference: 1.8 The audit expectation gap CPA Competency: Audit and Assurance AACSB: Analytic

61. The expectation gap cannot be reduced by a) auditors performing their duties properly. b) enhanced reporting to explain what processes have been followed in arriving at an audit or a review opinion. c) assurance providers reporting accurately the level of assurance being provided. d) management preparing the financial statements.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the audit expectation gap.

Section Reference: 1.8 The audit expectation gap CPA Competency: Audit and Assurance AACSB: Analytic

62. The audit expectation gap is the difference in the expectations of the a) assurance providers and the financial statement users. b) assurance providers and the audit client. c) audit client and the financial report or other users. d) audit client and the regulator.

Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the audit expectation gap.

Section Reference: 1.8 The audit expectation gap

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Introduction and Overview of Audit and Assurance

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CPA Competency: Audit and Assurance AACSB: Analytic

SHORT ANSWER QUESTIONS 63. Indicate whether you agree or disagree with the following statements and explain your reasoning. a) Maurice Lecuyer feels that an internal auditor that reports to the chief financial officer of the company can be as independent as an auditor that reports to the audit committee. b) Jillian Humphrey discovered a very material overstatement in the financial statements of Humphrey’s Holistic Medicine. She felt that the misstatement would have an impact on the decisions of users of the financial statements, and indicated to her audit senior that she would be including it as an “emphasis of matter” paragraph in the audit report. c) An auditor is responsible for the preparation and fair presentation of the financial statements in accordance with International Financial Reporting Standards, and for such internal control as is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. d) An assurance engagement involves evaluation or measurement of subject matter against criteria.

Answer: a) Disagree. The internal auditor’s independence is protected best when they report to the highest level of governance, usually the Audit Committee of the Board or to the President of the company. b) Disagree. The pervasiveness of the material misstatement will require an adverse opinion.

In this case, the misstatements affect the financial statements materially and will require disclosures that are vital to a user’s understanding of the financial statements. When statements are pervasively and materially misstated, an adverse opinion is appropriate. c) Disagree. The above statement describes management’s responsibilities. An auditor has the responsibility to express an opinion on financial statements based on an audit. d) Agree. An assurance engagement is an engagement where a practitioner issues a written report and concludes on a subject matter for which the accountable party is responsible.

Therefore, a prerequisite for an assurance engagement is the existence of an accountability relationship, where one party is answerable to another for the subject matter.

Bloomcode: Application Difficulty: Medium Learning Objective: Define an assurance engagement.

Learning Objective: Differentiate between types of assurance services.

Learning Objective: Explain the different levels of assurance.

Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

Section Reference: 1.1 Auditing and assurance defined Section Reference: 1.3 Different assurance services

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Section Reference: 1.4 Different levels of assurance Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

64. Outline the reasons for the demand for assurance services.

Answer: Remoteness – As most users do not have access to the entity under review, this makes it difficult to determine whether the information contained in the report is a fair presentation of the entity and its activities for the relevant period.

Complexity – Most financial statement users do not have the accounting and legal knowledge to enable them to assess the complex accounting and disclosure choices being made by the entity.

Competing incentives – Management may have their own incentives to present the information in a particular light which may help them achieve their own objectives. This may introduce bias in what is being presented.

Reliability – As the information is being depended upon to make important decisions, it is important that the information being presented is reliable Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain why there is a demand for audit and assurance services.

Section Reference: 1.2 Demand for audit and assurance services CPA Competency: Audit and Assurance AACSB: Analytic

65. The main assurance service the general public are familiar with are financial statement audits. Briefly describe the other services that an auditor can provide.

Answer: A compliance audit involves gathering evidence to ascertain whether the person or entity under review has followed the rules, policies, procedures, laws, and regulations with which they must conform.

Performance audits are concerned with the economy, efficiency, and effectiveness of an organization’s activities.

A comprehensive audit may encompass elements of a financial statement audit, a compliance audit, and a performance audit.

Internal audits are conducted to provide assurance about various aspects of an organization’s activities.

Corporate social reporting disclosures include environmental, employee, and social reporting.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between types of assurance services.

Section Reference: 1.3 Different assurance services

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Introduction and Overview of Audit and Assurance

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CPA Competency: Audit and Assurance AACSB: Analytic

66. Identify the three levels of assurance. Identify the three types of engagements relating to each level of assurance and the expression of opinions that would be provided by the assurance provider Answer: Level of Assurance Reasonable Limited None

Type of Engagement Audit Review Agreed-Upon Procedures

Expression of Opinion Positive Negative None

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA Competency: Audit and Assurance AACSB: Analytic

67. Identify the three types of engagements, the level of assurance each engagement provides, and describe the types of procedures that would be performed for each engagement.

Answer: Audit Engagement: Provides a high level of assurance (reasonable assurance). Procedures performed to obtain sufficient appropriate evidence include a combination of inspection, observation, confirmation, recalculation, re-performance, analytical procedures, and inquiry.

Review Engagement: Provides limited assurance. Procedures performed to obtain sufficient appropriate evidence include inquiry and analytical procedures.

Compilation Engagement: Provides no assurance. The practitioner should gain an understanding of the business, systems, and operations, and discuss with management the assumptions made in the preparation of the financial statements. The practitioner would also format the financial statements and verify the mathematical accuracy.

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different levels of assurance.

Section Reference: 1.4 Different levels of assurance CPA: Audit and Assurance AACSB: Analytic

68. What does pervasive mean? What report would an auditor use if financial statements contained a misstatement that was material and pervasive?

Answer: ”Pervasive” refers to misstatements that are not confined to individual accounts or elements of a financial statement, or, if confined, the misstatements impact an extensive portion of a financial statement or are disclosures that are vital to a user’s understanding of the financial statements.

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An auditor would use an audit report that identified material and pervasive misstatements either in a situation that the auditor was either able to identify (adverse) or not able to identify (disclaimer of opinion) through sufficient and appropriate audit procedures.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline different audit opinions.

Section Reference: 1.5 Difference audit opinions CPA Competency: Audit and Assurance AACSB: Analytic

69. How is the expectation gap caused and how can the effects on the expectation gap be reduced?

Answer: In particular, the gap is caused by unrealistic user expectations such as: • the auditor is providing complete assurance • the auditor is guaranteeing the future viability of the entity • an unqualified (clean) audit opinion is an indicator of complete accuracy • the auditor will definitely find any fraud • the auditor has checked all transactions.

The expectation gap can be reduced by: • auditors performing their duties appropriately, complying with auditing standards, and meeting the minimum standards of performance that should be expected of all auditors; • peer reviews of audits to ensure that auditing standards have been applied correctly; • auditing standards being reviewed and updated on a regular basis to enhance the work being done by auditors; • education of the public; • enhanced reporting to explain what processes have been followed in arriving at an audit (reasonable assurance) or a review (limited assurance) opinion (significant improvements have been introduced by standard setters improving assurance reporting); and • assurance providers reporting accurately the level of assurance being provided (reasonable, limited or none).

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the audit expectation gap.

Section Reference: 1.8 The audit expectation gap CPA Competency: Audit and Assurance AACSB: Analytic

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CASE QUESTION 70. Vince Deroy owns Val D’Or Vineyards, a successful winery in the Thousand Islands region. Annual sales are $3,500,000 and he has a $1,200,000 loan with a local bank.

Sales are split between wine sales (88%) and wine tasting and catering (12%).

Vince has excellent personal relationships with his suppliers and has been provided with special contractual terms which allow him delays of up to 120 days to make invoice payments. These arrangements run out this year and he will have 30 days to pay after being invoiced.

The bank has made the $1,200,000 loan to Val D’Or Vineyards based on an understanding that the company will undergo an annual audit of its financial statements.

Vince is an astute entrepreneur and has set up an advisory board which consists of his bank manager, another wine grower in the region, his old high school ethics instructor and track coach, himself, and his accountant.

The board has discussed certain issues including the following: • The need for assurance service providers to audit his financial statements so that users can be provided with assurance that his statements are relevant and reliable.

• Non-audit services that would provide advice on special projects he may be considering in the future.

• A proper accounting firm to conduct an audit mandate.

Required: a) What is the objective of a financial statement audit and how does it relate to Val D’Or Vineyards? b) Vince Deroy’s financial statements must be relevant and reliable. What do these two terms mean in the context of this case? c) What three characteristics should Val D’Or Vineyards’ auditors possess when conducting an audit? Explain them briefly. d) What are non-audit services? Can you describe possible non-audit services that Val D’Or Vineyards might employ?

Answer: a) A financial statement audit provides reasonable assurance about whether the financial statements are prepared in all material respects in accordance with the financial reporting framework.

The Val D’Or Vineyards auditors will use the rules of Canadian GAAP (either IFRS or ASPE) to ensure that the main current users (shareholders, bank, tax authorities) and potential users (suppliers, future investors) are provided with audited statements that will provide them with assurance. The auditors will lend credibility to the information because they are independent. b) Information is relevant if it has an impact on the decisions made by users regarding the performance of the entity. For example, the bank would be interested in evaluating past decisions made by Val D’Or Vineyards management and predicting whether the entity will remain viable (that is, a going concern) into the future. This will give them confidence that the $1,200,000 loan will be repaid. Users like the bank or key suppliers of Val D’Or

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Vineyards can use current information to estimate the future ability of the entity to meet its obligations.

Information is reliable when it is free from material misstatements (errors or fraud). The information must be unbiased; it must not be presented in such a way as to influence the decision-making process of the user. The best way Val D’Or Vineyards can ensure others will perceive that its financial statements are without bias, is through an independent audit of the statements. c) When undertaking an audit, the auditor should use professional scepticism, professional judgement, and due care.

Professional scepticism Professional scepticism is an attitude adopted by the auditor when conducting the audit. It means that the auditor remains independent of the entity, its management, and its staff when completing the audit work. In a practical sense, it means that the auditor maintains a questioning mind and thoroughly investigates all evidence presented by the client. The auditor must seek independent evidence to corroborate information provided by the client and must be suspicious when evidence contradicts documents held by the client or enquiries made of client personnel (including management and those charged with governance).

Professional judgement Professional judgement relates to the level of expertise, knowledge, and training that an auditor uses while conducting an audit. An auditor must utilize their judgement throughout the audit. For example, an auditor must determine the reliability of an information source and decide on the sufficiency and appropriateness of evidence gathered, the procedures to be used in testing, and an appropriate sample size.

Due care Due care refers to being diligent while conducting an audit, applying technical and statutebacked standards, and documenting each stage in the audit process. d) Non-assurance services include management consulting, mergers and acquisitions, insolvency, tax, and accounting services.

Accounting firms are not the only providers of non-assurance services. Val D’Or Vineyards could hire someone to review its plan to expand its vineyard operations, as an example.

Other types of services: corporate social responsibility, employee safety, tax planning, insurance arrangements for key officers of the company, etc.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Differentiate between types of assurance services.

Learning Objective: Differentiate between the roles of the preparer and the auditor, and discuss the different firms that provide assurance services.

Section Reference: 1.3 Differentiate assurance services Section Reference: 1.6 Preparers and auditors CPA Competency: Audit and Assurance AACSB: Analytic

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LEGAL NOTICE Copyright © 2021 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under license and may be used only in accordance with the terms of such license.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 2 ETHICS, LEGAL LIABILITY, AND CLIENT ACCEPTANCE CHAPTER LEARNING OBJECTIVES 1. Describe the fundamental principles of professional ethics.

The fundamental principles of professional ethics include professional behaviour (upholding the reputation of the profession); integrity (being straightforward and honest) and due care (acting diligently and complying with both technical and professional standards); professional competence (maintaining knowledge and skill at an appropriate level); confidentiality (not sharing information that is learned at work); and objectivity (not allowing personal feelings or prejudices to influence professional judgement). There are also specific rules that incorporate the guiding ethical principles and that are enforceable. Some of these rules concern fees and pricing, advertising, contact with predecessor auditors, firm names, and professional contact. Despite principles and rules to guide professional conduct, professional accountants can expect to face ethical dilemmas over their careers. A framework for solving ethical dilemmas includes identifying the ethical issues, determining who is affected by the outcome of the dilemma and how each individual or group is affected, identifying the likely alternatives available to the person who must resolve the dilemma, and deciding on the appropriate action.

2. Describe professional judgement and professional skepticism.

Professional judgement relates to the level of expertise, knowledge, and training that an auditor uses throughout an audit. A framework for professional judgement decision-making includes identifying the problem, gathering the facts, performing the analysis, making a decision, and documenting the decision-making process. Professional skepticism is a component of professional judgement. Professional skepticism means having a questioning mind, being alert to conditions that indicate a misstatement whether due to fraud or error, and critically assessing evidence. While there are qualities associated with professional skepticism, external factors and unconscious biases can impede it. Common biases that can impede auditor professional skepticism are the availability bias, confirmation bias, overconfidence bias, and the anchoring bias.

3. Define and assess auditor independence.

Independence is the ability to make a decision that is free from bias, personal beliefs, and client pressures. An external auditor must not only be independent of their client, they must also appear to be independent of their client. Threats to auditor independence include self-interest, self-review, advocacy, familiarity, and intimidation threats. A self-interest threat can occur when an auditor has a financial interest in a client. A self-review threat can occur when an auditor must form an opinion on their own work or work done by others in their firm. An advocacy threat can occur when an auditor acts on behalf of their client. A familiarity threat can occur when there is a close relationship between the auditor and their client. An intimidation threat can occur when an auditor feels threatened by their client. Safeguards to auditor independence include the code of ethics, legislation, the establishment of audit committees by clients, client acceptance and continuance procedures, partner rotation policies, and education within accounting firms.

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Auditing: A Practical Approach, Fourth Canadian Edition

4. Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement.

Auditors report to their clients’ shareholders. These are the owners who rely on the audited financial statements when evaluating the performance of their company. The board of directors represents the shareholders and oversees the activities of the company and its management.

It is the directors’ responsibility to ensure that the financial statements being audited are fairly presented. The audit committee is responsible for liaising between the external auditor, the internal auditor, and those charged with governance to aid the board of directors in ensuring that the financial statements are fairly presented and that the external auditor has access to all records and other evidence required to form their opinion. The external auditor may use the work performed by the internal auditors after considering the function’s objectivity, technical competence, and due professional care, and the effectiveness of communication between internal and external auditors.

5. Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Contributory negligence is where a client is found to be negligent and to have contributed to the loss suffered by the plaintiff. To successfully sue an auditor, a plaintiff must prove that a duty of care was owed by the auditor, there was a breach of that duty, and a loss was suffered as a result of that breach. Several cases are discussed in the chapter in relation to an auditor’s liability to third parties. To establish that an auditor owes them a duty of care, a third party must now establish that the auditor was aware that the third party was going to use the financial statements and that the users relied on the financial statements for the purpose for which they were prepared.

6. Identify the factors to consider in the client acceptance or continuance decision.

Factors to consider include the integrity of a client, such as the client’s reputation and attitude to risk, accounting policies, and internal controls. An auditor will gain an understanding of the client through communication with the client’s previous auditor (in the case of a client acceptance decision), staff, management, and other relevant parties. The final stage in the client acceptance or continuance decision process involves preparing an engagement letter, which sets out the terms of the audit engagement to avoid any misunderstandings between the auditor and their client.

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Ethics, Legal Liability, and Client Acceptance

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TRUE-FALSE STATEMENTS 1. Compliance with the fundamental ethical principles is mandatory for all members of the accounting profession.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics.

Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Analytic

2. Objectivity refers to the obligation that all members of the professional bodies be Straightforward and honest.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics.

Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Analytic

3. The auditor uses professional skepticism during the decision-making process as an element of professional judgement.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe professional judgement and professional skepticism.

Section Reference: 2.2 Professional judgement and professional skepticism CPA Competency: Audit and Assurance AACSB: Analytic 4. Trusting in management’s ability to make appropriate estimates is a strategy to avoid bias.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe professional judgement and professional skepticism.

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Section Reference: 2.2 Professional judgement and professional skepticism CPA Competency: Audit and Assurance AACSB: Analytic

5. Independence in appearance is the ability to act with integrity, objectivity and professional scepticism.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

6. An example of an advocacy threat is encouraging others to buy shares or bonds being sold by the client.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

7. An effective audit committee will enhance the independence of the external audit function.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

8. When auditors divest themselves of shares owned in a client company, they are eliminating their self-review threat to independence.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

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Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

9. The key difficulty for third parties in successfully claiming against the auditor is establishing that the client's management contributed to the third party's loss.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

10. Ensuring compliance with auditing regulations will not assist auditors in avoiding litigation.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

11. Third parties are anyone other than the client and its shareholders that use the financial statements to make a decision.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

12. Being negligent means not exercising due care.

Answer: True Bloomcode: Comprehension

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Auditing: A Practical Approach, Fourth Canadian Edition

Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

13. Auditors can help avoid litigation by implementing policies and procedures that ensure all work is fully documented.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

14. When assessing client integrity, the auditor will consider the appropriateness of the client's interpretation of accounting rules.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision.

Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

15. An engagement letter sets out the terms of the engagement.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision.

Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

16. An engagement letter does not include an overview of the client's responsibility for the

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preparation of the financial statements.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision.

Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 17. Jim Spence wrote up an advertisement for his firm. In his draft to the local newspaper, he indicated that the firm was able to provide services that he knew it could not deliver. Which part of the profession’s standards or codes of conduct was Jim breaking? a) objectivity b) professional behaviour c) confidentiality d) communication Answer: b Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe the fundamental principles of professional ethics.

Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Ethics

18. Members must attain a level of competence and keep up to date with changes in regulations. To which fundamental principle of the Code of Ethics for Professional Accountants does this refer? a) objectivity b) professional competence and due care c) professional behaviour d) integrity Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics.

Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Analytic

19. All members of professional bodies must be straightforward and honest. To which fundamental principle of the Code of Ethics for Professional Accountants does this refer? a) confidentiality b) objectivity c) integrity d) professional behaviour Answer: c

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics.

Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Analytic

20. The obligation is that all members of the professional bodies are not allowed to let their personal feelings influence their judgment. To which fundamental principle of the Code of Ethics for Professional Accountants does this refer? a) confidentiality b) objectivity c) integrity d) professional behaviour Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics.

Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Analytic

21. Which of the following is not one of the fundamental principles of the Code of Ethics for Professional Accountants? a) confidentiality b) objectivity c) integrity d) intelligence Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics.

Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Analytic

22. Which of the following is a fundamental principle of professional ethics? a) confidentiality b) objectivity c) integrity

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d) all of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics.

Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Ethics

23. Professional behaviour refers to the obligation that all members of the professional bodies a) ensure that they do not harm the reputation of the accounting profession. b) not allow their personal feelings or prejudices to influence their professional judgment. c) refrain from disclosing information to people outside of their workplace that is learned as a result of their employment. d) be straightforward and honest.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics.

Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Ethics

24. Objectivity refers to the obligation that all members of the professional bodies a) be straightforward and honest. b) refrain from disclosing information to people outside of their workplace that is learned as a result of their employment. c) not allow their personal feelings or prejudices to influence their professional judgment. d) ensure that they do not harm the reputation of the accounting profession.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the fundamental principles of professional.

Section Reference: 2.1 The fundamental principles of professional ethic CPA Competency: Audit and Assurance AACSB: Ethics

25. Which of the following is not a common form of bias that may affect an auditor? a) objectivity bias

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b) confirmation bias c) availability bias d) overconfidence bias Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe professional judgement and professional skepticism.

Section Reference: 2.2 Professional judgement and professional skepticism CPA Competency: Audit and Assurance AACSB: Analytic

26. Qualities associated with professional skepticism include all of the following except a) withholding judgement until appropriate evidence is gathered b) trust in management’s ability to make appropriate estimates c) tendency to inquire d) self-confidence to challenge assumptions Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe professional judgement and professional skepticism.

Section Reference: 2.2 Professional judgement and professional skepticism CPA Competency: Audit and Assurance AACSB: Analytic

27. Which of the following are considered qualities associated with professional skepticism? a) withholding judgement until appropriate evidence is gathered b) self-confidence to challenge assumptions c) tendency to inquire d) All of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe professional judgement and professional skepticism.

Section Reference: 2.2 Professional judgement and professional skepticism CPA Competency: Audit and Assurance AACSB: Analytic

28. Faith Goodfellow has been an audit manager at Happy & Gumble LLP, CPA’s the past ten years. Two years ago, she performed human resources and internal audit functions for 9 months while her client underwent a major restructuring. Her firm has a policy of changing audit

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Auditing: A Practical Approach, Fourth Canadian Edition

partners and managers every five to seven years. She is reluctant to take on the audit because she believes there is an independence threat. Which threat is in play? a) integrity threat b) familiarity threat c) self-review threat d) advocacy threat Answer: c Bloomcode: Analysis Difficulty: Medium Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Ethics

29. Jane Lee just joined the firm of Jansen & Dennison LLP (JD). She found out that she owns shares in a client company of JD. She is going to divest herself of these shares.

Which threat to her independence will she be eliminating? a) self-interest threat b) self-review threat c) familiarity threat d) advocacy threat Answer: a Bloomcode: Analysis Difficulty: Medium Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Ethics

30. Moanna Johnson, CPA lives in the same neighbourhood as one of her major clients.

She and her children are involved in the Lower Thames Yacht Club, as are many of her client’s management employees. How would her independence threat best be described? a) self-interest threat b) self-review threat c) advocacy threat d) none of these Answer: d Bloomcode: Analysis Difficulty: Medium Learning Objective: Define and assess auditor independence.

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Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

31. Krista Kirschfield audits a company that has market capitalization of $20,000,000. There is also a requirement that the partners in her firm be rotated every seven years and the audit committee must pre-approve all services provided to the client by Krista’s firm. What kind of client is this? a) small business b) diversified c) reporting issuer d) partnership Answer: c Bloomcode: Analysis Difficulty: Medium Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 32. When Jeffrey Bona, CPA tried to collect last year’s audit fees, he was told that he would receive the fees for the previous year and the current year upon finishing this year’s work and issuing a “clean” audit opinion. This was non-negotiable and he was told that if he did not want to go along with it, the client would get another auditor. When he decided to leave his client, what threat to his independence did he mitigate? a) self-interest threat b) self-review threat c) advocacy threat d) intimidation threat Answer: d Bloomcode: Analysis Difficulty: Medium Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic 33. The firm of McMaster and Martin, CPAs is concerned that its client’s current corporate culture may have an impact on the firm’s independence. What kinds of safeguards can the client introduce or create to reduce the threat to independence?

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Auditing: A Practical Approach, Fourth Canadian Edition

a) introduce appropriate corporate governance mechanisms such as the establishment of an audit committee b) ensure that the responsibility for the appointment and removal of an auditor rests with independent directors on the audit committee or the board c) both a and b d) none of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

34. Auditor independence is a) defined as acting with integrity, objectivity and professional scepticism. b) essential when complying with the ethical principles to act with integrity and objectivity. c) both a and b d) not fundamental to every audit.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

35. Independence in appearance is a) the ability to act with integrity, objectivity and professional scepticism. b) the belief that independence of mind has been achieved. c) the ability to make a decision that is free from bias, personal beliefs and client pressures. d) also referred to as actual independence.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

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36. Threats to the independence of auditors include a) familiarity threats. b) self-interest threats. c) advocacy threats. d) all of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

37. A self-interest threat refers to the threat that can occur when an accounting firm or its staff a) is threatened by the client's staff or directors. b) has a financial interest in an audit client. c) needs to form an opinion on their own work or work performed by others in the firm. d) acts on behalf of its assurance client.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

38. Which of the following is an example of a familiarity threat to independence? a) a bank account held with the client b) performing services for the client that are then assured c) owning shares of the client d) a former partner of the assurance firm holding a senior position with the client Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

39. What type of threat to independence arises when an accounting firm acts on behalf of its assurance client? a) advocacy threat b) self-interest threat c) intimidation threat d) self-review threat Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

40. Intimidation threats to independence include a) the threat that that the client will use a different assurance firm next year. b) a close business relationship with the client. c) representing the client in a legal dispute. d) preparing information for the client that is then assured.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

41. Safeguards to independence are created by a) the general public. b) the profession, legislation or regulation. c) lawyers. d) dependent directors.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

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42. An example of a safeguard to independence created by accounting firms is a) the establishment of a code of ethics. b) legislation that requires that an auditor be independent. c) the existence of client acceptance and continuation procedures. d) the establishment of an audit committee.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

43. Having policies and procedures to ensure the quality of an assurance engagement is an example of a safeguard to independence created by a) the client's audit committee. b) the Canada Business Corporations Act. c) the client's board of directors. d) the accounting firm.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

44. When the external auditors perform work they are responsible for auditing the financial statements. Which users are the auditors least likely to deal with in fulfilling their duties? a) executive directors of the board b) audit committee of the board c) shareholders d) internal auditors Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement.

Section Reference: 2.4 The auditor’s relationships with others

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Auditing: A Practical Approach, Fourth Canadian Edition

CPA Competency: Audit and Assurance AACSB: Analytic

45. What key groups have a professional link with the external auditor? a) client's board of directors, audit committee, and prospective shareholders b) client’s shareholders, the board of directors, audit committee and the internal audit team c) client’s shareholders and prospective shareholders and board of directors d) client’s shareholders only Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement.

Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic

46. The audit committee should a) consist of only non-executive directors of the Board of Directors. b) consist of major shareholders of the client company. c) report to the shareholders at the annual general meeting. d) consist of both executive and non-executive directors of the Board of Directors.

Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement.

Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic

47. The audit committee a) communicates with the auditor regarding any disagreements with management regarding accounting policies and the financial statements. b) has the responsibility to ensure that the financial statements are presented fairly. c) makes decisions regarding the appointment and/or removal of auditors. d) reports directly to the shareholders.

Answer: b Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement.

Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic

48. The relationship between the external and internal auditor can be described as a) the internal audit function is separate and independent of the external audit. b) the external auditor can review the effectiveness of the internal audit function to modify the nature and timing of audit testing. c) the external auditor relies solely on the internal auditor’s reports. d) non-existent. Under no circumstances can the external auditor rely on any work of the internal audit function.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement.

Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic

49. The main recipients of the financial statements and the attached audit report are acknowledged as a) the board of directors. b) the shareholders or members. c) the audit committee. d) the provincial stock exchanges.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement.

Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic

50. Examples of board committees include the a) risk committee. b) nomination committee.

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Auditing: A Practical Approach, Fourth Canadian Edition

c) compensation committee. d) all of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement.

Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic

51. It is the responsibility of the board of directors to a) ensure that the financial statements are fairly presented. b) provide an opinion on the fair presentation of the financial statements. c) direct the auditors to audit specific financial statement accounts. d) determine if shareholders should sell their investment in the company.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement.

Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic

52. Executive directors are a) part of the company's management team. b) full-time employees of the company. c) not members of the company's board of directors. d) both a and b Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement.

Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic

53. Yollande Beauchemin withdrew from a client engagement. The client sued her for not

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fulfilling the understanding in the engagement letter and can establish that Yollande owed him a duty of due care. How can this be done using legal means? a) the client can sue the auditor for breach of contract b) the client can claim that the auditor failed to take reasonable care in the performance of the audit c) both a and b d) none of the above Answer: a Bloomcode: Analysis Difficulty: Medium Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

54. The Kingston Cotton Mill case states that the duty of the auditor is to a) assume that the clients’ statements are not materially misstated. b) approach the audit with professional scepticism. c) approach the audit with suspicion. d) always issue a clean opinion on the client’s financial statements.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

55. The Pacific Acceptance case set the standards of reasonable care and skill required for the conduct of an audit. Which one of the following was not one of the recommendations? a) closely supervise and review the work of junior staff b) properly document procedures used c) duty to use reasonable care and skill d) promptly report material fraud Answer: d Bloomcode: Comprehension Difficulty: Easy

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Auditing: A Practical Approach, Fourth Canadian Edition

Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

56. Contributory negligence means a) the actions of the client as well as the actions of the auditor lead to losses suffered. b) actions by the client and shareholders led to losses suffered. c) actions of the client lead to the losses suffered. d) actions of the auditor lead to losses suffered.

Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic 57. Which of the following statements regarding the auditor’s responsibility to third parties is correct? a) The auditor has no legal responsibility to third parties. b) Third parties can sue the auditor under contract for any losses suffered. c) Third parties can sue the auditor if they were owed a duty of care, suffered a loss, and the auditor was negligent in the conduct of the audit. d) Third parties can sue, whether or not they suffered a loss, as long as they establish that the auditor owed them a duty of care and the auditor was negligent.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

58. An auditor can decrease the possibility of litigation by a) preparing engagement letters. b) complying with ethical principles and pronouncements. c) ensuring all audit staff have the required skills and competence to conduct the audit.

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d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

59. Management failed to put in a system of adequate internal controls. The public accounting firm uncovered the weakness, but did not report it to the Board members of the company. What kind of liability, if any, would the auditors be exposed to? a) breach of contract b) contributory negligence c) both a and b d) no liability Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

60. The principles established by Justice Moffitt in the Pacific Acceptance case do not include a) auditors are watchdogs but not bloodhounds. b) auditors must properly document procedures used. c) auditors have a duty to use reasonable skills and care. d) auditors must audit the whole year.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

61. Under tort law, to prove that an auditor has been negligent the plaintiff must establish a) there was a breach of the duty of care. b) a loss was suffered as a result of the breach of duty of care. c) a duty of care was owed by the auditor. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

62. Auditors can decrease the possibility of litigation by a) ensuring compliance with ethical regulations. b) meeting with the client's nomination committee to discuss any significant audit issues. c) training their staff and regularly updating their knowledge. d) both a and c Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

63. James Taggert has reviewed the engagement letter his firm has prepared for a client. Which of these elements would he be surprised to find? a) unrestricted access to persons within the entity in order to obtain audit evidence b) references to Canadian generally accepted auditing standards c) management’s responsibilities d) previous year’s internal control issues Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision.

Section Reference: 2.6 Client acceptance and continuance decisions

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CPA Competency: Audit and Assurance AACSB: Analytic

64. Which of the following statements is not true regarding engagement letters? a) Engagement letters are prepared by the client and acknowledged by the auditor before commencement of each audit. b) Engagement letters are a form of contract between the auditor and the client. c) Engagement letters are prepared before commencing every audit engagement. d) Engagement letters set out the terms of the audit engagement.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision.

Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

65. If a prospective new audit client does not allow the auditor to contact its existing auditor, a) the auditor should contact the existing auditor anyway because it is the duty. b) the auditor should refuse to take on the prospective new client. c) the existing auditor should contact the new auditor to tell them all about the client. d) the auditor should respect the prospective client’s right to privacy.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision.

Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

66. An auditor's assessment of their client's integrity would not include a) whether the auditor has sufficiently competent staff to complete the audit. b) the client's attitude to audit fees and its willingness to pay a fair amount. c) the client's attitude to risk exposure and management. d) the reputation of the client and its management.

Answer: a Bloomcode: Comprehension

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Auditing: A Practical Approach, Fourth Canadian Edition

Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision.

Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

67. The final stage in the client acceptance and continuance decision process involves a) the auditor obtaining a management representation letter from the client. b) the auditor preparing an independence declaration statement. c) the client's audit committee meeting with the auditor. d) the preparation of an engagement letter.

Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision.

Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

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SHORT ANSWER QUESTIONS 68. Explain the five fundamental principles of professional ethics.

Answer: The fundamental ethical principles that apply to all members of the professional bodies are to act with integrity, objectivity, professional competence and due care, confidentiality and professional behaviour. Integrity refers to the obligation that all members of the professional bodies be straightforward and honest. Objectivity refers to the obligation that all members of the professional bodies not allow their personal feelings or prejudices to influence their professional judgment. Professional competence and due care refers to the obligation that all members of the professional bodies maintain their knowledge and skill at a level required by the professional bodies. Confidentiality refers to the obligation that all members of the professional bodies refrain from disclosing information to people outside of their workplace that is learned as a result of their employment. Professional behaviour refers to the obligation that all members of the professional bodies comply with rules and regulations and ensure that they do not harm the reputation of the profession.

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the fundamental principles of professional ethics.

Section Reference: 2.1 The fundamental principles of professional ethics CPA Competency: Audit and Assurance AACSB: Analytic

69. For the following scenarios, state the violation(s) to the Rules of Professional Conduct: a) Chance Randall, CPA, began a telephone campaign to grow his client base. He began calling companies listed in the telephone directly within a twenty mile radius advising them of his accounting services. After making several phone calls, Chase finally landed a new audit client, Big Bob’s Auto Sales and Leasing Ltd. In order to secure this new business, Chase entered into an agreement with Big Bob whereby Chase would receive a flat fee every time he referred one of his clients to Big Bob’s. He would also earn a 1% percent commission on any vehicle sale or lease that resulted from the referral. As their business relationship grew overtime, Chase asked Big Bob for a loan claiming he wanted to expand his accounting practice. He in fact took the funds for his own personal use without advising his client. b) Anand Lee, CPA, was the CFO of ABC Incorporated. In his role as CFO, he became aware of a material error in the company’s inventory for the annual financial statements in the amount of approximately $1.5 million. Anand brought the matters to the attention of senior management, who casually indicated that year end was already completed and thus they did not want to harm investor confidence by reissuing the financial statements, but Anand did not seek assistance or guidance from either the professional body or the securities commission. c) Sahajpreet Singh, CPA, obtained his designation in 2000. Since that time, he has built up a significant tax practice. In late 2015, a new client approached Sahajpreet and asked him to perform an audit engagement. Believing this could lead to a substantial amount of tax work

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Auditing: A Practical Approach, Fourth Canadian Edition

in the future, Sahajpreet agreed, even though he had not taken any accounting or assurance courses for many years. In performing the audit engagement, Sahajpreet obtained an engagement letter, put the financial statements together based on the clients trial balance, and attached a review engagement report. The financial statements contained a material error.

Answer: a) • By cold calling and implementing a telephone campaign to get new business, Chase violated the rule of no solicitation.

• Chase accepted a referral fee in the form of the flat fee for referring his clients to the car dealership. Referral fees are not permitted.

• Chase accepted a commission in terms of a 1% on auto sales and leases, which is not permitted.

• There is an impairment of independence in that Chase accepted a loan from a client and continued to be the client’s auditor.

• Chase failed to maintain the good reputation of the profession when he accepted the loan to use for his personal use. b) • •

Anand Lee failed to conduct himself in a manner which would maintain the good reputation of the profession and its ability to serve the public interest in that he allowed users to rely on financial statements that were materially misstated.

Anand Lee was associated with false and misleading information in that he knew the financial statements were materially misstated but did not do anything to correct them.

c) • •

•

Sahajpreet failed to maintain his professional competence by keeping himself informed of, and complying with, developments in professional standards in all functions in which he practiced.

Sahajpreet associated himself with financial statements that were false and misleading, and he would have known this had the work been performed in accordance with the standards for review engagements. The procedures required for a review engagement were not performed.

There was no documentation of analytics, discussion and enquiry to establish plausibility.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe the fundamental principles of professional ethics.

Section Reference: 2.1 The fundamental principles of professional ethics CPA Competency: Audit and Assurance AACSB: Analytic

70. Distinguish between independence of mind and independence in appearance.

Answer: Independence is essential when complying with the ethical principles to act with integrity and objectivity. Independence of mind is the ability to act with integrity, objectivity and professional scepticism. It is the ability to make a decision that is free from bias, personal beliefs and client pressures. Independence of mind is also referred to as actual independence.

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Independence in appearance is the belief that independence of mind has been achieved. It is not enough for an auditor to be independent of mind; they must also be seen to be independent.

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

71. Describe the three categories of safeguards to an auditor's independence.

Answer: Safeguards are mechanisms that have been developed by the accounting profession, legislators, regulators, clients and accounting firms. The accounting profession, legislation and regulation have created a range of safeguards including education of accountants about the threats to independence, the establishment of a code of ethics, and legislation that requires that an auditor be independent. Clients can put in place appropriate mechanisms that will reduce the threat to independence. These include having appropriate corporate governance mechanisms, such as the establishment of an audit committee and establishing policies and procedures dedicated to ensuring that the financial statements are true and fair. Accounting firms also have in place a range of safeguards to ensure independence such as policies and procedures to ensure the quality of their service and providing continuing education for their staff regarding these policies and procedures.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

72. For each of the following, indicate if there is a threat to independence. If so, state the threat and a possible safeguard. a)

Ty Tomas, CPA is unaware that his audit client, James Jackets Co. makes up 20% of Ty Tomas firms revenues.

b)

Luca Lobo goes to his assurance client, Joe’s Auto Mart to buy a used car for his daughter.

Due to their business relationship, Joe offers James a vehicle below cost.

c)

Olivia Dazzle has been auditing Fancy Dance Studio for many years. Fancy Dance Studio has been experiencing financial difficulties and has not been able to pay its audit fees for the last three years. Fancy now owes Olivia Dazzle $50,000 in assurance fees.

d)

Robert Razo has three review engagements. One of the review engagements is done for Hugo’s Meatshop Ltd., which is 80% owned by Robert’s father-in-law, Igor Slovlog. The remaining 20% of the Meatshop is owned by Igor’s four children.

Answer:

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a)

There is a self-interest threat in that there is the possibility of client reliance for Ty Tomas. A safeguard against this is to regularly review the assurance fees earned from each client in comparisons to total fees from all clients.

b)

Car dealers are not in the business of selling cars below cost. The discount below cost is similar to a gift and therefore gives rise to a familiarity threat, in that Luca Lobo, the auditor has accepted a “gift” from his client. A safeguard for this is to have a firm policy whereby non trivial gifts from clients are not accepted.

c)

This leads to a self-interest threat as significant fees outstanding are considered to be similar to a loan to the client. It could also lead to an intimidation threat by the client, in that the client could threaten to leave the firm and the auditor would be faced with a large receivable write off. A possible safeguard is to ensure all fees in arrears are collected before performing additional services to prevent any further fee dependence.

d)

This is a familiarity threat in that family members of the auditor own shares of the company under audit. It is also a self-interest threat in that his wife owns shares in the entity. There is no appropriate safeguard in this situation. Robert should resign from the engagement immediately.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

73. The five key threats to auditor independence are self-interest, self-review, advocacy, familiarity, and intimidation threats. Provide an example of each threat and suggest a safeguard against each identified threat.

Answer: This is only a suggested answer and student responses may vary.

Threat Self-interest threat

Example An audit firm relies on the fees from a client.

Self-review threat

An assurance team audits records that were prepared by a colleague in their firm on behalf of the client.

Advocacy Threat

An auditor represents an audit client in a legal case.

Safeguard Regular review of assurance and other fees earned from each client compared with total fees from all assurance clients.

When providing non-audit services, ensuring that the client is responsible for overseeing and guiding that work and making any final decisions regarding the outcomes of that work.

Policies and procedures prohibiting the representation of clients in any disputes or legal matters.

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Ethics, Legal Liability, and Client Acceptance

Familiarity threat

An auditor has a family member involved in the preparation of the accounting information subject to audit.

Intimidation threat

A client threatens to dismiss the audit firm.

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Procedures when assigning staff to assurance clients ensuring no close personal relationships exist between assurance team members and client personnel.

Avoidance of fee dependence.

Bloomcode: Application Difficulty: Medium Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

74. Indicate whether you agree or disagree with the following statements and explain your reasoning. a)

To ensure independence of prospective and continuing clients, an audit firm must review the threats to independence, and make certain that safeguards are put in place to limit or remove those threats.

b)

The final stage in the client acceptance and continuance decision process involves assessing independence threats.

c)

By signing the engagement letter, management is not necessarily considered to be responsible for the financial statements.

d)

To successfully sue an auditor, a plaintiff must only prove that a duty of care was owed by the auditor.

Answer: a) Agree. An audit firm should always assess independence before the client acceptance or continuance decision is made. b)

Disagree. The final stage in the client acceptance and continuance decision process involves the preparation of an engagement letter. An engagement letter is prepared by an auditor and acknowledged by a client before the commencement of an audit.

c)

Disagree. Management is considered to be responsible for the financial statements and acknowledges this responsibility when they sign the engagement letter.

d)

Disagree. To successfully sue an auditor, a plaintiff must prove not only that a duty of care was owed by the auditor, but also that there was a breach of that duty, and a loss was suffered as a result of that breach.

To establish that an auditor owes them a duty of care, a third party must now establish that the auditor was aware that the third party was going to use the financial statements and that the users relied on the financial statements for the purpose they were prepared.

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Bloomcode: Application Difficulty: Medium Learning Objective: Define and assess auditor independence.

Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Learning Objective: Identify the factors to consider in the client acceptance or continuance decision.

Section Reference: 2.3 Independence Section Reference: 2.5 Legal liability Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic 75. Simean & Co, a firm of CPA’s, issued an unqualified audit report for its client, Xiing Manufacturing Corporation, a footwear manufacturer in Asia. Xiing Manufacturing, listed its head office in Toronto, Ontario, and its shares were traded on a Canadian Stock Exchange.

Besides the shareholders, Simean & Co. knew the company was in the process of refinancing a significant bank loan coming due, and the bank was anxious to see the year end results. After an unqualified audit report was issued, the regulator of the stock exchange halted the trading of the shares after allegations of management fraud came to light. As a result, the share price plummeted and the company went out of business.

Required: (a) To whom did Simean & Co. owe a duty of care? (b) What must the bank demonstrate to establish negligence? (c) What are the defences available to Simean & Co? Answer: a) The auditor owes a duty of care to the client, Xiing Manufacturing, as established when the engagement letter is signed.

The auditor also owes a duty of care to third parties. However, this duty is usually limited to fraud or gross negligence unless the auditor has actual knowledge that the third party will rely on the statements. In this case, the bank is a known user and therefore the auditor owes the bank a duty of care. The auditor would not owe a duty of care to all known users unless fraud or gross negligence is established. There is nothing to suggest that this is the case. (b) There are four requirements for negligence to be established: 1. Simean & Co. owed the bank a duty of care.

2. There was a breach of that duty (such as failure to follow generally accepted auditing standards).

3. There must be proof that damage resulted.

4. There must be a reasonably proximate connection between the breach of duty and the resulting damage. (c) The auditor can deny that the plaintiff has established the necessary conditions to recover damages by asserting the following:

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• • • •

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There was no legal duty of care to the plaintiff.

There was no breach of that duty (such as failure to follow generally accepted auditing standards).

No damage resulted.

There was no reasonably proximate connection between the breach of duty and the resulting damage.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

76. Categorize each of the following items as either a factor that relates to contract law or tort law.

1. auditor failed to take reasonable care in the performance of the audit 2. auditor fails to live up to their responsibility implicit in agreeing to act as the auditor and explicit in the engagement letter 3. the work was below the standard that may be reasonably expected from a designated public accountant 4. the injured party must prove that the auditor’s carelessness or unintentional behaviour caused harm and therefore breached the duty of care 5. a client can sue the auditor for breach of contract

Answer: Contract Law 2. auditor fails to live up to their responsibility implicit in agreeing to act as the auditor and explicit in the engagement letter 5. a client can sue the auditor for breach of contract

Tort Law 1. auditor failed to take reasonable care in the performance of the audit 3. the work was below the standard that may be reasonably expected from a designated public accountant 4. the injured party must prove that the auditor’s carelessness or unintentional behaviour caused harm and therefore breached the duty of care

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Section Reference: 2.5 Legal liability CPA Competency: Audit and Assurance AACSB: Analytic

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77. Explain the purpose and major contents of an engagement letter between the auditor and their client.

Answer: The engagement letter is a form of contract between an auditor and their client. Its purpose is to set out the terms of the audit engagement, to avoid any misunderstandings between the auditor and their client. The letter confirms the obligations of the client and the auditor. It also includes an explanation of the scope of the audit, the timing of the completion of various aspects of the audit, an overview of the client's responsibility for the preparation of the financial statements, the requirement that the auditor have access to all information required, independence considerations and fees.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the factors to consider in the client acceptance or continuance decision.

Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 78. Independence is considered one of the key characteristics of auditors. Explain why auditor independence is so important to the effectiveness of an audit and explain the various threats to an auditor's independence.

Answer: Answers may vary.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define and assess auditor independence.

Section Reference: 2.3 Independence CPA Competency: Audit and Assurance AACSB: Analytic

79. Audit committees have been widely recommended as being an important mechanism for enhancing the external auditor's independence. What are the important characteristics of audit committees and discuss why these characteristics are considered so important to a committee's effective and efficient operation.

Answer: Answers may vary.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement.

Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic

80. The key difficulty for third parties in legal action against auditors has been establishing that a duty of care was owed to them by their auditor. Explain the development of the relevant legal principles relating to an auditor's duty of care to third parties with reference to specific case law.

Answer: Answers may vary.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement.

Section Reference: 2.4 The auditor’s relationships with others CPA Competency: Audit and Assurance AACSB: Analytic

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CASE QUESTION

81. Amelia Vadilia is a junior auditor working on the audit of Activia Linens Company. Amelia performed an inventory count where she noticed an unusually large amount of green fabric for use in manufacturing Activia products. When she inquired with the warehouse manager about why the quantity of green fabric was disproportionate with other colors the manager replied by saying “that green fabric products never sells and has been sitting there as long as I can remember”. When Amelia looked over the inventory ledger, she noticed these materials were accounted for and totaled $220,000. Because the materials were recognized in the accounting records and the reasonable explanation provided by the warehouse manager, Amelia did not see a need for further inquiries. She documented her work in the audit file and proceeded to seek the advice of the manager on the audit, Michael Visco. Michael commented, “Activia is long-standing client, always pays their fees on time, and has never had any inventory issues in the past. They will obviously use the green fabric in production at some point, so I would suggest removing any notes of the mater in the audit file and continue working on other audit areas.” Amelia did not feel great about this discussion with her manager and did not know how to proceed knowing there is likely an inventory obsolescence issue.

Required: a) Did Amelia use professional skepticism in her decision-making process? Explain all instances where Amelia did and did not apply professional skepticism during her audit of Activia Linens Company. b) Discuss the ethical dilemma presented to Amelia by identifying each step of the ethical dilemma framework.

Answer: Students responses may vary. a) Amelia used professional skepticism both initially when she saw the green fabric, first noticing that it appeared disproportionate from the rest of the fabric colors, and then when following up by asking the warehouse manager for an explanation. She gathered evidence to support a possible inventory obsolescence issue by tracing the green fabric to the inventory ledger and establishing the $220,000 recorded value. Amelia did a great job exercising her professional skepticism from the onset of her inventory count. b) The application of the framework for ethical dilemmas for Amelia can be summarized as follows: 1. Identify the ethical dilemma: Amelia is being told by her audit manager to remove the evidence of Amelia uncovering the inventory obsolescence issue from the audit file, and forget it ever happened. Amelia feels uneasy about the situation knowing there is likely a misstatement in inventory.

2. Determine who is affected: Activia management and the external users of its financial statements such as banks and investors will be the key parties affected by the possible inventory misstatement. Should the misstatement prove to be material to the users, there can be a significant impact on Amelia, Michael, and their accounting firm.

3. Identify the likely alternatives available: - Amelia can take Michael’s recommendation and remove the documentation from the file and ignore the issue, or - Amelia can highlight the possible impact of the issue to Michael and ask him to reconsider, or

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- Amelia can discuss the issue with the firm’s managing partner in charge, or - Amelia can ask to be removed from the audit entirely.

4. Decide on the appropriate action: Amelia should first request that Michael further investigate the inventory issue by highlighting its impact/importance, and if he does not agree, Amelia should push the matter to the managing partner of the firm.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe the fundamental principles of professional ethics.

Learning Objective: Describe professional judgement and professional skepticism.

Section Reference: 2.1 The fundamental principles of professional ethics Section Reference: 2.2 Professional judgement and professional skepticism CPA Competency: Audit and Assurance AACSB: Analytic

82. The CPL Audit Committee has a policy of changing audit firms every five years to ensure that they receive fresh approaches from different audit firms. Accordingly, the CPL Board has asked Ginger & Paprika LLP to replace its previous audit firm.

CPL is a manufacturer and distributor of wire ropes, industrial cables, and rigging cables and has a reputation for its ability to fill special orders and to ship across Canada from its Thunder Bay facility on time and at competitive prices. They have a reputation among their customers for going the extra mile and have kept a loyal customer base for over a century.

Curtis Sanza, a new partner at Ginger & Paprika LLP, a growing CPA firm in northern Ontario, is excited about CPL becoming a potential new client. The previous week he met with the Canadian President of CPL, Jinyi Gu. Curtis Sanza quickly decided that Jinyi Gu was a man of integrity and his frank and open opinions would make it a pleasure to deal with him. He also appeared to have a competent management team in place.

Curtis also wanted to make an impression on his new firm by bringing in several new clients in the next year or two, as a good portion of his future compensation will be derived from new business.

He is also aware that any negligence on his part during the client acceptance phase would reflect on his professional judgment and open the firm to possible litigation.

The senior partner, Walter Peters, has invited Curtis Sanza to join him in his office to discuss CPL. Required: a) You are Walter Peters, the Senior Partner at Ginger & Paprika LLP. What would be on your “checklist” of client acceptance questions? Prepare an exhaustive inventory of all the questions you would ask Jack before deciding to accept or reject CPL. b) The firm recently lost a lawsuit and has parted ways with the partner-in-charge of the aggrieved client. What can Walter Peters do to avoid litigation?

Answer:

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a)

The first step involves the assessment of client integrity. When assessing client integrity, the auditor will consider the following questions: 1.

2.

3.

4.

What is the reputation of the client, its management, directors, and key stakeholders?

What are the reasons provided for switching audit firms (client acceptance decision)?

What is the client’s attitude to risk exposure and management?

What is the client’s attitude to the implementation and maintenance of adequate internal controls to mitigate (minimize) identified risks?

5. To what extent is the client’s interpretation of accounting rules appropriate?

6. To what extent is the client willing to allow the auditor full access to information required to form their opinion?

7. What is the client’s attitude to audit fees and its willingness to pay a fair amount for the work completed?

Here is a possible checklist of questions with regard to the firm’s possible existing prohibitions that would preclude the firm or any staff member from performing the engagement: 8. We would ask about the prohibitions listed below: A. B. C. D. E. F. G. H. I. J. K. L. M.

Financial interests in entity.

Loans and guarantees to/from client.

Close business relationships with client.

Family and personal relationships with client.

Future or recent employment with entity serving as officer, director, or company secretary of client.

Provision of non-assurance services such as corporate finance or legal services that involve dispute resolution.

Performance of management functions for the client.

Making journal entries or accounting classifications without first obtaining management’s approval.

Acceptance of gifts or hospitality from client (other than clearly insignificant).

Fee quote that is considerably less than market price for the engagement.

Provision of legal services.

Preparation of source documentation.

Provision of corporate finance services.

Are we satisfied there are no significant “threats” to independence? Address each of the following threats in relation to the firm and any member of the engagement team: A. Self-interest (i.e., where loss of client fees would be material).

B. Self-review (i.e., the nature and extent of bookkeeping services required or where a judgment from a previous engagement needs to be evaluated in reaching conclusions).

C. Advocacy (i.e., acting as an advocate on behalf of client in litigation or in share promotion).

D. Familiarity (i.e., being too sympathetic to the client’s interests).

E. Intimidation (i.e., being deterred from acting objectively and exercising professional scepticism).

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Walter Peters would also ask about whether there are any safeguards to reduce the above threat(s) to independence identified to an acceptable level. b)

One of the ways that an auditor can avoid litigation is to follow up on any significant weaknesses in the client’s internal control procedures in a previous year’s audit.

There are a number of ways that an auditor can avoid litigation. These include: A. B. C. D. E.

hiring competent staff training staff and updating their knowledge regularly ensuring compliance with ethical regulations ensuring compliance with auditing regulations implementing policies and procedures that ensure: – appropriate procedures are followed when accepting a new client – appropriate staff are allocated to clients – ethical and independence issues are identified and dealt with on a timely basis – all work is fully documented – adequate and appropriate evidence is gathered before forming an opinion F. meeting with a client’s audit committee to discuss any significant issues identified as part of the audit G. Following up on any significant weaknesses in the client’s internal control procedures in a previous year’s audit.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties.

Learning Objective: Identify the factors to consider in the client acceptance or continuance decision.

Section Reference: 2.5 Legal liability Section Reference: 2.6 Client acceptance and continuance decisions CPA Competency: Audit and Assurance AACSB: Analytic

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LEGAL NOTICE Copyright © 2021 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under license and may be used only in accordance with the terms of such license.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 3 AUDIT PLANNING l CHAPTER LEARNING OBJECTIVES 1. Identify the different phases of an audit.

The phases of an audit include risk assessment, risk response, and reporting. During the risk assessment phase, an auditor will gain an understanding of their client in order to make an informed risk assessment, develop an audit strategy, and set their planning materiality. During the risk response phase, an auditor will execute their detailed testing of account balances and transactions. The final phase of every audit involves reviewing all of the evidence gathered throughout the audit and arriving at a conclusion regarding the fair presentation of the client’s financial statements. The auditor will then write an audit report that reflects their opinion based upon their findings.

2. Explain the process used in gaining an understanding of the client.

An auditor will gain an understanding of their client to aid in the risk identification process. This process involves consideration of issues at the entity level, the industry level, and the broader economic level. At the entity level, an auditor will identify the client’s major customers, suppliers, and stakeholders (that is, banks, shareholders, and employees). The auditor will also determine whether their client is an importer or exporter, who the client’s competitors are, what the client’s capacity is to adapt to changes in technology, and what the nature of any warranties provided to customers is. At the industry level, an auditor is interested in their client’s position within its industry. At the economic level, an auditor will assess how well positioned the client is to cope with current and changing government policy and economic conditions.

3. Explain how related parties can impact risk.

Related parties include parent companies, subsidiaries, joint ventures, associates, company management, and close family members of key management. Since related parties are not independent of each other, these transactions may not be in the normal course of business.

This increases the risk of material misstatement and may impact the overall financial results.

Therefore, related party transactions require some specific consideration throughout the audit and specific procedures should be performed and documented.

4. Evaluate fraud risk.

Fraud is an intentional act through the use of deception to obtain an unjust or illegal advantage.

The two kinds of fraud are financial reporting fraud and misappropriation of assets. There are a number of techniques the auditor uses to assess the risk of fraud. The audit file must document the fraud risk assessment and procedures performed to support that assessment.

5. Explain the going concern assumption.

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The going concern assumption is made when it is believed that a company will remain in business for the foreseeable future. An auditor will consider the appropriateness of this assumption during the risk assessment phase and then throughout the audit.

6. Explain how estimates can impact risk.

Accounting estimates impact the financial statements. Estimates involve estimation uncertainty, which increases with the complexity, subjectivity, and uncertainty of an estimate. The greater the estimation uncertainty, the greater the risk of material misstatement and the more audit effort required. There are a number of risk assessment procedures the auditor must perform with respect to estimates.

7. Appraise corporate governance.

Corporate governance is the rules, systems, and processes used to guide and control within companies. Among other things, governance structures are used to assess the level of risk faced and to design controls to reduce identified risks.

8. Evaluate how a client’s information technology (IT) can affect risk.

There are a number of risks associated with IT. During the risk assessment phase of the audit, the auditor will assess the likelihood that their client’s financial statements are misstated due to limitations in its IT system.

9. Explain how a client’s financial reporting practices and closing procedures can affect reported results.

There are a number of risks associated with a client’s closing procedures. Closing procedures are the processes used by a client at year end to ensure that transactions are recorded in the appropriate accounting period. From an audit perspective, there is a risk that the client’s closing procedures are inadequate.

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TRUE-FALSE STATEMENTS 1. The risk assessment phase of an audit involves the performance of detailed tests of controls and substantive testing of transactions and accounts.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different stages of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

2. The concept of materiality refers to the magnitude of a misstatement or omission that may influence the economic decision of a user.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

3. Auditors must gain an understanding of their client at the outset of every audit.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client CPA Competency: Audit and Assurance AACSB: Analytic

4. The more competitive an audit client's industry, the less pressure is placed on the client's profits.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

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CPA Competency: Audit and Assurance AACSB: Analytic

5. Fraud is an intentional act to obtain an unjust or illegal advantage through the use of deception.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk CPA Competency: Audit and Assurance AACSB: Analytic

6. Misappropriation of assets fraud involves intentionally misstating items or omitting important facts from the financial statements.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk CPA Competency: Audit and Assurance AACSB: Analytic

7. An example of an attitude or rationalization used to justify a fraud is high volume of transactions close to year-end.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk CPA Competency: Audit and Assurance AACSB: Analytic

8. Under the going concern assumption, assets are valued on the basis that they will continue to be used for the purpose of conducting a business.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the going concern assumption.

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Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

9. Mitigating factors that reduce going concern risk include the ability to raise additional funds through the sale of shares.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

10. When an estimate is developed using a simple model and objective data, it is higher in estimation uncertainty than when an estimate is developed using a complex valuation model incorporating subjective, future-looking assumptions.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how estimates can impact risk.

Section Reference: 3.6 Accounting estimates and related disclosures CPA Competency: Audit and Assurance AACSB: Analytic

11. A client's corporate governance structure is assessed when planning an audit.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Appraise corporate governance.

Section Reference: 3.7 Corporate governance CPA Competency: Audit and Assurance AACSB: Analytic

12. Application controls are policies and procedures that relate to many applications.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how a client’s information technology (IT) can affect risk.

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Section Reference: 3.8 Information technology CPA Competency: Audit and Assurance AACSB: Analytic

13. An auditor is not concerned with transactions and events being recorded in the correct accounting period.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how a client’s financial reporting practices and closing procedures can affect reported results.

Section Reference: 3.9 Closing procedures CPA Competency: Audit and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 14. Mathias Mousseau was at a client’s offices and was preparing his work for the following day. He was considering the risk that a material misstatement due to significant error or fraud could occur in the client's financial statements. Which stage of the audit was he performing? a) risk assessment phase b) risk response phase c) reporting phase d) management response phase Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

15. Wilfred Dominic was meeting with his manager to plan audit strategy in order to determine the amount of time to spend testing the client's internal controls and conducting detailed testing of transactions and account balances. Determining the audit strategy occurs during which phase of the audit? a) client acceptance stage b) risk assessment phase c) risk response phase d) reporting phase Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

16. When Parvinder Kaur started the preliminary risk identification process at a local dairy during the risk assessment phase of the audit he endeavoured to gather sufficient appropriate evidence. Which of the following elements were not involved in the preliminary risk identification? a) going concern risk b) client’s corporate governance c) understanding the IT environment d) control testing

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Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

17. During the risk assessment phase of a grocery chain, Seren Dagdeviren tried to determine which procedures would be appropriate. Which of these procedures, if any, would you use in the planning phase of the audit? a) observation and inspection b) analytical procedures c) both a and b d) none of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

18. The risk response phase of an audit involves a) evaluating the results of the detailed testing and forming an opinion on the fair presentation of the client's financial statements. b) the assessment of the audit firm's quality control procedures. c) the performance of detailed tests of controls and substantive testing of transactions and accounts. d) gaining an understanding of the client.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

19. Preliminary risk identification can be affected by

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a) fraud risk. b) corporate governance. c) both a and b d) none of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

20. The purpose of planning an audit is to a) conduct the audit in an efficient and effective manner. b) reduce audit risk to an acceptably low level. c) ensure that sufficient appropriate audit evidence is obtained to reach an appropriate audit opinion. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

21. The reporting phase of an audit involves a) evaluating the results of the detailed testing and forming an opinion on the fair presentation of the client's financial statements. b) the assessment of the audit firm's quality control procedures. c) the performance of detailed tests of controls and substantive testing of transactions and accounts. d) gaining an understanding of the client.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

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22. The risk assessment phase includes a) testing controls. b) substantive testing. c) concluding on the effectiveness of internal controls. d) identifying accounting estimates Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

23. Which of the following terms refers to the quantity and quality of evidence that has been gathered? a) risk assessment. b) audit procedures. c) materiality. d) sufficient appropriate evidence.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

24. Which of the following terms refers to the magnitude of a misstatement or omission that may influence the economic decision of a user? a) risk assessment b) corporate governance c) materiality d) going concern Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance

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AACSB: Analytic

25. Yasser performed several procedures, including observation and inspection of the company’s plans and business strategies. He also made inquiries of those individuals that were involved in the governance of the company, the internal auditors, and operating personnel.

These procedures will help Yasser to a) determine fraud possibilities. b) prepare year-end closing procedures. c) gain an understanding of the client. d) determine control risk.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client CPA Competency: Audit and Assurance AACSB: Analytic

26. When Sheila Copes, CPA audited a new client she asked questions about what the client does, how the client functions, the ownership structure of the client, and its sources of financing.

She was getting an understanding of the client at the a) entity level. b) industry level. c) economy level. d) all of the answers are correct

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client CPA Competency: Audit and Assurance AACSB: Analytic

27. Claudia Martel knows that financial reporting fraud transactions require disclosure. However, she is not sure whether related party transactions require disclosure. You advise her that related party transactions require a) disclosure. b) no disclosure. c) disclosure only if there is risk of fraud. d) auditor judgement.

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Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client CPA Competency: Audit and Assurance AACSB: Analytic

28. When gaining an understanding of their client, at which level do auditors not usually consider the relevant issues? a) audit committee level b) economy level c) entity level d) industry level Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client CPA Competency: Audit and Assurance AACSB: Analytic

29. Which of the following is an example of information used by auditors in gaining an understanding of a client at the entity level? a) the level of competition in the client's industry b) whether the client is an importer or exporter of goods c) the client's ability to withstand currency fluctuations d) the level of government support in the client's industry Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client CPA Competency: Audit and Assurance AACSB: Analytic

30. In assessing the client's relationship with its employees, the auditor will not consider a) the level of unionization among the workforce. b) the attitude of staff to their employer.

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c) how well a client pays its employees. d) the dividend policy.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client CPA Competency: Audit and Assurance AACSB: Analytic

31. Which of the following statements regarding the level of demand for the goods sold or services provided by companies is correct? a) If a client's products or services are seasonal, this will affect revenue flow. b) If a client operates in an industry subject to changing trends, the client does not risk inventory obsolescence. c) If a client's products or services are seasonal, this will not affect revenue flow. d) When a product or process is subject to technological change, there is never a risk that the client will be left behind by its competitors.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client CPA Competency: Audit and Assurance AACSB: Analytic

32. Related parties include a) any investment in another company’s shares. b) all suppliers. c) any employees. d) subsidiaries.

Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how related parties can impact risk.

Section Reference: 3.3 Related parties CPA Competency: Audit and Assurance AACSB: Analytic 33. Georgia Marcelloni’s team has been asked to tackle three ongoing frauds and her partner

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has asked her to follow up only on the financial reporting fraud. Which of the following items will she be pursuing? a) theft of stock by employees or customers b) employees remaining on the payroll after ceasing employment c) recording fictitious sales d) unauthorized refunds to customers Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk CPA Competency: Audit and Assurance AACSB: Analytic

34. Saad Zuberov is a rookie auditor who has asked you about financial reporting frauds and how they differ from misappropriation of assets frauds. Identify for Saad Zuberov which one of the following frauds consists of misappropriation of assets. a) improper asset valuation b) unrecorded liabilities c) theft of inventory d) recording fictitious sales Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk CPA Competency: Audit and Assurance AACSB: Analytic

35. Red flags that auditors can use to alert them to the possibility that a fraud may have occurred include a) strong internal controls. b) routine transactions. c) a high turnover of key employees. d) effective internal auditing staff.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

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CPA Competency: Audit and Assurance AACSB: Analytic

36. When assessing fraud risk, an auditor will adopt an attitude of a) confidentiality. b) professional scepticism. c) belief in management. d) knowledge.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk CPA Competency: Audit and Assurance AACSB: Analytic

37. Which of the following is an example of a misappropriation of assets fraud? a) unauthorized discounts or refunds to customers b) inappropriate application of accounting principles c) unrecorded liabilities d) improper asset valuations Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk CPA Competency: Audit and Assurance AACSB: Analytic

38. When assessing the risk of fraud, an auditor can consider a) attitudes and rationalization to justify a fraud. b) incentives and pressures to commit fraud. c) opportunities to perpetuate a fraud. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk

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CPA Competency: Audit and Assurance AACSB: Analytic

39. Attitudes and rationalization to justify a fraud include a) significant related party transactions. b) an excessive focus on profit maximization. c) a significant decline in demand for the client's products or services. d) a high volume of transactions close to year-end.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk CPA Competency: Audit and Assurance AACSB: Analytic

40. Eva Islam, CPA is auditing a company where it is experiencing strikes regularly, has been under investigation with non-compliance with legislation, and is falling behind competitors.

What kind of risk is being assessed? a) fraud risk b) going concern risk c) both a and b d) none of the above Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

41. William Jones has been asked to review manual or automated procedures that typically operate at a business process level and apply to the processing of transactions by individual applications. What kind of controls is William going to be assessing? a) output controls b) general controls c) both output and general controls d) application controls Answer: d

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

42. The going concern assumption is made when it is believed that a) a company will become insolvent within the next accounting period. b) the board of directors does not believe the company's financial statements are fairly presented. c) a company will remain in business for the foreseeable future. d) a company is a separate legal entity.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

43. If auditors identify risk factors that indicate that the going concern assumption is in doubt, they will a) undertake procedures to gather evidence regarding each risk factor. b) refuse to continue as the auditor of their client. c) report the client to the Canada Revenue Agency. d) reduce the extent of further audit testing that they undertake.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

44. Which of the following is not an example of a mitigating factor that reduces the risk that the going concern assumption may be in doubt? a) the ability to raise additional funds via borrowings b) a letter of guarantee from a parent company c) the ability to sell an unprofitable segment of the business d) significant rapid increase in competition

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Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

45. Risks associated with information technology include a) loss of data. b) errors in programs. c) unauthorized access to computers. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Technology

46. Which statement about the going concern assumption is correct? a) The company will not be able to continue operating in the next accounting period. b) The auditor is responsible for the company to be able to continue operating in the foreseeable future. c) The company will be able to continue operating in the foreseeable future. d) The company cannot make the upcoming debt payments.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Analytic 47. The task of assessing the company’s ability to continue as a going concern is the responsibility of a) the external auditor. b) the internal auditor.

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c) management. d) the audit committee.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

48. Which of the following is an indicator that the company may not be able to continue as a going concern? a) issuing bonus shares to shareholders instead of cash dividends b) ability to increase borrowing c) negative cash flows from operating activities d) introduction of a new product into the market Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

49. Which of the following is considered an accounting estimate? a) accounts receivable b) cash c) allowance for doubtful accounts d) inventory Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how estimates can impact risk.

Section Reference: 3.6 Accounting estimates and related disclosures CPA Competency: Audit and Assurance AACSB: Analytic

50. Which of the following is not a factor that will impact estimation uncertainty? a) materiality b) subjectivity

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c) uncertainty d) complexity Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how estimates can impact risk.

Section Reference: 3.6 Accounting estimates and related disclosures CPA Competency: Audit and Assurance AACSB: Analytic

51. The level of estimation uncertainty for the fair value measurement of a publicly traded equity security would be a) low. b) medium. c) high. d) cannot be determined Answer: a Bloomcode: Analysis Difficulty: Medium Learning Objective: Explain how estimates can impact risk.

Section Reference: 3.6 Accounting estimates and related disclosures CPA Competency: Audit and Assurance AACSB: Analytic

52. The level of estimation uncertainty for the fair value measurement of a derivative instrument that is not publicly traded would be a) low b) medium c) high d) cannot be determined Answer: c Bloomcode: Analysis Difficulty: Medium Learning Objective: Explain how estimates can impact risk.

Section Reference: 3.6 Accounting estimates and related disclosures CPA Competency: Audit and Assurance AACSB: Analytic

53. Corporate governance means a) the viability of a company to remain in business for the foreseeable future.

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b) the rules, systems, and processes within companies used to guide and control them. c) an intentional act through the use of deception to obtain an unjust or illegal advantage. d) the processes used by a client when finalizing the accounts for an accounting period.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Appraise corporate governance.

Section Reference: 3.7 Corporate governance CPA Competency: Audit and Assurance AACSB: Analytic

54. The corporate governance principle of most concern to the auditor is a) safeguarding the integrity in financial reporting. b) making timely and balanced disclosures. c) promoting ethical and responsible decision making. d) respecting the rights of shareholders.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Appraise corporate governance.

Section Reference: 3.7 Corporate governance CPA Competency: Audit and Assurance AACSB: Analytic

55. When gaining an understanding of a client, the auditor will consider the risks associated with information technology. Risks associated with information technology include a) unauthorized access to computers, software, or data. b) errors in programs. c) lack of back-up procedures. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.8 Information technology CPA Competency: Audit and Assurance AACSB: Analytic

56. Which of the following is not a risk associated with the installation of a new IT system?

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a) loss of data in transfer to the new system b) inadequately trained staff c) data not processed correctly d) selection of an inappropriate system for reporting needs Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.8 Information technology CPA Competency: Audit and Assurance AACSB: Analytic

57. Unauthorized access to a company's data can occur when a) inadequate backups of data are maintained. b) there are poor password protection procedures. c) computer programs are tested thoroughly. d) there are sufficient security procedures.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.8 Information technology CPA Competency: Audit and Assurance AACSB: Technology

58. Which of the following is not an example of a risk when a client installs a new IT system? a) Client staff are not adequately trained to use the new system effectively. b) The system may not be appropriate for the client. c) The client has appropriate procedures for selecting new IT systems. d) Data may be lost or corrupted.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.8 Information technology CPA Competency: Audit and Assurance AACSB: Analytic

59. Which of the following statements relating to application controls is correct?

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a) They impact on the procedures used for data entry, data processing, and output. b) They include procedures for purchasing new computers. c) They are not designed to prevent or detect a material misstatement in the financial statements. d) They include the use of passwords and other security measures to minimize the risk of unauthorized access.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.8 Information technology CPA Competency: Audit and Assurance AACSB: Analytic

60. Auditors can assess the adequacy of their client's closing procedures by a) checking the accuracy of accrual calculations around year end. b) looking at earnings trends to assess whether reported income is in line with similar periods in prior years. c) both a and b d) none of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how a client’s financial reporting practices and closing procedures can affect reported results.

Section Reference: 3.9 Closing procedures CPA Competency: Audit and Assurance AACSB: Analytic

61. If auditors believe there is a risk that expenses incurred before year end will be excluded from the current year's expenses, they will

a) send out confirmation requests to a sample of the client's debtors. b) trace transactions recorded close to year end to source documentation. c) perform analytical review analysis on the client's statement of financial position. d) none of the above Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how a client’s financial reporting practices and closing procedures

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can affect reported results.

Section Reference: 3.9 Closing procedures CPA Competency: Audit and Assurance AACSB: Analytic

62. The auditor is concerned about the audit client's closing procedures to ensure a) transactions and events have been recorded in the correct accounting period. b) closing procedures have been correctly applied. c) the financial statements accurately reflect the results of the audit client’s closing procedures. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how a client’s financial reporting practices and closing procedures can affect reported results.

Section Reference: 3.9 Closing procedures CPA Competency: Audit and Assurance AACSB: Analytic

63. In order to report strong results, an audit client may a) include revenue earned in the next income year in the current year’s income. b) bring forward expenses to the current income year. c) defer revenue earned in the current year to the next income year. d) omit closing procedures.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how a client’s financial reporting practices and closing procedures can affect reported results.

Section Reference: 3.9 Closing procedures CPA Competency: Audit and Assurance AACSB: Analytic

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SHORT ANSWER QUESTIONS 64. Explain the three main phases of an audit of financial statements.

Answer: The main phases of an audit are the risk assessment phase, the risk response phase, and the reporting phase. The risk assessment phase involves gaining an understanding of the client, identifying factors that may impact the risk of a material misstatement in the financial statements, performing a risk and materiality assessment, and developing an audit strategy.

The risk of a material misstatement is the risk that the financial statements include a significant error or fraud. The risk response phase (or performing) of the audit involves the performance of detailed tests of controls and substantive testing of transactions and accounts. The reporting phase involves evaluating the results of the detailed testing in light of the auditor's understanding of their client and forming an opinion on the fair presentation of the client's financial statements.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

65. Why must auditors gain an understanding of their client at the start of every audit?

Answer: The purpose of auditors gaining an understanding of their client is to assess the risk that the financial statements contain a material misstatement due to: the nature of the client's business, the industry in which the client operates, the level of competition within that industry, the client's customers and suppliers, and the regulatory environment in which the client operates.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the process used in gaining an understanding of the client.

Section Reference: 3.2 Gaining an understanding of the client CPA Competency: Audit and Assurance AACSB: Analytic

66. Indicate whether you agree or disagree with the following statements and explain your reasoning. a)

Related party transactions require proper identification and consideration when considering risk. However, there is no requirement to disclose related party transactions unless they have an impact on material misstatements.

b)

When assessing fraud risk, auditors should adopt an attitude of professional scepticism to ensure that any indicator of a potential fraud is properly investigated.

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c)

The responsibility for preventing and detecting fraud rests with those charged with governance at the client as well as the auditors.

d)

The auditor should not ask management and those charged with governance if they are aware of a known fraud or suspect there has been fraud.

e)

Elvie Lee explained to her friend how application controls work: “Application controls are designed to prevent and detect a material misstatement in the financial statements.”

Answer: a) Disagree. It is the responsibility of the auditor to ensure that related parties are identified and appropriately disclosed, in line with relevant accounting standards.

According to the CPA Handbook, related parties include parent companies, subsidiaries, joint ventures, associates, company management, and close family members of key management. Since related parties are not independent of each other, these transactions may not be in the normal course of business. This not only increases the susceptibility of the financial statements to material misstatement due to fraud or error, it may also impact the overall financial statement results. Therefore, financial statement users need sufficient information to assess the impact of these transactions on the financial statements overall. b)

Agree. Adopting an attitude of professional scepticism implies that auditors must remain independent of their client, maintain a questioning attitude, and search thoroughly for corroborating evidence to validate information provided by the client. Auditors must not assume that their past experience with client management and staff is indicative of the current risk of fraud.

c)

Disagree. The responsibility for preventing and detecting fraud rests with those charged with governance at the client.

It is the responsibility of the auditor to assess the risk of fraud and the effectiveness of the client's attempts to prevent and detect fraud through their internal control system.

d)

Disagree. The auditor should ask management and those charged with governance these key questions. If the company being audited has an internal audit department, the internal auditors should also be asked this question. The results of these inquiries should be documented.

e)

Agree. These controls are designed to prevent and/or detect a material misstatement in the financial statements by ensuring all transactions are recorded only once and rejected transactions are identified and corrected. Application controls impact on the procedures used for data entry, data processing and output, or reporting. They include reconciliations between input and output data and automated checks on data entered to ensure accuracy.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain how related parties can impact risk.

Learning Objective: Evaluate fraud risk.

Learning Objective: Appraise corporate governance.

Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.3 Related parties Section Reference: 3.4 Fraud risk Section Reference: 3.7 Corporate governance

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Section Reference: 3.8 Information technology CPA Competency: Audit and Assurance AACSB: Analytic

67. What is fraud and what are some of the red flags that can alert auditors to the possibility that a fraud may have occurred?

Answer: Fraud is an intentional act to obtain an unjust or illegal advantage through the use of deception. An auditor can use red flags to alert them to the possibility that a fraud may have occurred. These red flags include: a high turnover of key employees, key finance personnel refusing to take leave, overly dominant management, poor compensation practices, inadequate training programs, a complex business structure, no (or ineffective) internal auditing staff, a high turnover of auditors, unusual transactions, and weak internal controls.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk CPA Competency: Audit and Assurance AACSB: Analytic

68. Bill Dodds was the accounts payable manager of Big Build Property Management Ltd. Bill started with the company as a bookkeeper and worked up to his current management position.

He was promoted due to his dedication to the company and his reliability – he often worked evenings and weekends, rarely called in sick, and he never took holidays. Despite making a good wage, Bill enjoyed living large, and the majority of his paycheque went to pay for his luxury car and designer clothes. As Bill was living paycheque to paycheque he was disappointed he did not have a “nest egg” set aside for retirement or emergency purposes.

Big Build Property Management had a history of profitability. To reward its employees, the company had established a bonus scheme for meeting profit targets. It was a shock to all employees when at the end of 2022, the company announced it had had the worst year in the company’s history. The losses were significant and the company planned significant lay-offs in an attempt to turn this situation around. As a result, the accounting department was reduced by 35%, and the remaining staff was asked to do more. Bill found not only was he managing an unhappy accounts payable group, he was also now signing cheques, processing payables, and reconciling the bank account. This meant Bill was required to work even more without any pay increase or bonus in sight. For the first time in his career at Big Build, Bill was unhappy. While he was fearful further lay-offs may be coming, he also felt unappreciated and after all of his hard work, he was unhappy he was being asked to do more.

Required: Discuss the incentives, opportunities, and rationalizations to commit fraud in this case.

Answers: Incentives and Pressures — While few employees would take the opportunity to commit fraud, adding an element of pressure could sway an honest worker. Pressure may come from the individual’s personal life. In this case, the following incentives/pressures exist: • Management has a focus on the need to reach target profits.

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• There are falling profits at the company.

• Bill also lives paycheque to paycheque and likes to live large. With the fear of losing his job, he may feel pressure to commit fraud to maintain his standard of living.

Opportunity — This is where there is an opportunity to perpetrate a fraud due to weak or nonexistent internal controls.

• Bill rarely called in sick, and never took holidays. This makes it easier to cover up any fraud that could be taking place.

• Lack of segregation of duties. Bill now processes accounts payable, signs cheques, and performs the bank reconciliation. As a result he can make fraudulent payments to himself and cover them up.

• With fewer staff now in place to perform the work required, there is likely less focus on internal controls and more focus on getting the job done. Again there is evidence of this with the lack of segregation of duties in the accounting department. This would make it easier to commit fraud and cover it up.

Rationalization — This is when fraudsters justify their actions to themselves. In this case as Bill is being asked to do more for the same remuneration, he may have an attitude of ”I deserve more money” and “they owe it to me.”

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate fraud risk.

Section Reference: 3.4 Fraud risk CPA Competency: Audit and Assurance AACSB: Analytic

69. What should auditors do if there are risk factors that indicate that the going concern assumption is at risk?

Answer: If the auditor identifies risk factors that indicate that the going concern assumption is in doubt, they will undertake procedures to gather evidence regarding each risk factor.

For example, if a client has lost a number of key, long-standing personnel, an auditor may assess the quality of the remaining staff and the likelihood that the client will be able to hire suitable replacements in the near future. If the auditor believes there is an unresolved going concern issue outstanding, an assessment is made of the appropriateness of management disclosures in the notes to the financial statements regarding that issue. An auditor will assess the process used by management to evaluate the extent of the going concern risk. If a company has a history of losses and difficulties, an auditor will expect management to take a great deal of time and care in their going concern assessment. Once the auditor has an understanding of the process used by management, which may include the careful preparation of detailed cash flow projections and budgets, they will assess the adequacy of that process and conduct additional procedures if necessary.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the going concern assumption.

Section Reference: 3.5 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

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70. CAS 540 indicates that the higher the estimation uncertainty, the higher the risk of material misstatement and the greater the audit effort. What causes the increase in estimation uncertainty? Provide an example of an accounting estimate with high estimation uncertainty and explain why the level of uncertainty in your example is considered to be high.

Answer: An estimate would be considered as having low estimation uncertainty when a simple model and objective data is used to establish the estimate. High estimation uncertainty would exist when a complex valuation model is applied along with subjective and future-looking assumptions. Examples will vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain how estimates can impact risk.

Section Reference: 3.6 Accounting estimates and related disclosures CPA Competency: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 71. CAS 300 Planning an Audit of Financial Statements requires that auditors plan their audits.

Why is planning such an important stage of every audit? Explain the various aspects of the preliminary risk identification process.

Answer: Answers may vary.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different phases of an audit.

Section Reference: 3.1 Phases of an audit CPA Competency: Audit and Assurance AACSB: Analytic

72. When gaining an understanding of their clients, auditors consider the particular information technology risks faced by their clients. Explain the particular risks associated with information technology and discuss the main controls that companies can have in place to mitigate these risks.

Answer: Answers may vary.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the process used in gaining an understanding of the client.

Learning Objective: Evaluate how a client’s information technology (IT) can affect risk.

Section Reference: 3.2 Gaining an understanding of the client Section Reference: 3.8 Information technology CPA Competency: Audit and Assurance AACSB: Analytic

73. Corporate governance is the rules, systems, and processes within companies used to guide and control them. Why are auditors concerned with the corporate governance structures of their clients and what is the current status of corporate governance regulation in Canada?

Answer: Answers may vary.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Appraise corporate governance.

Section Reference: 3.7 Corporate governance CPA Competency: Audit and Assurance AACSB: Analytic

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CASE QUESTION 74. Last year the review of Lethbridge Broadcasting did not go well for Bossy & Bossier CPAs. In an attempt to meet budget, Mike Bossy, the auditor-in-charge, left out the review of closing procedures. His Group Partner’s review notes were professional but his annual review commentary was not as complimentary. Mike was not convinced that he was at fault and felt that according to his firm’s mandate, as spelled out in the engagement letter, it was the client’s responsibility to ensure the adequacy of closing procedures.

This year the firm will be starting the audit of a new broadcasting client and the partner is planning the risk assessment procedures. His partner’s review note reads: “Ensure that Mike Bossy gains a detailed knowledge of the Quebecor Media broadcasting operations at the entity level.”

Required: a) Comment on the partner’s Lethbridge Broadcasting concerns and explain how the closing process is supposed to work. b) Discuss the entity-level audit procedures Mike will have to follow in order to gain an understanding of Quebecor Media operations and why these entity-level procedures are important.

Answer: a) Although the closing procedures are the responsibility of the client, the auditor has a responsibility to ensure that material misstatements do not occur. Reviewing closing procedures is important because from an audit perspective there is a risk that the client's closing procedures are inadequate.

Discussion on Mike Bossy’s and his firm’s responsibilities: (i) Auditors are concerned that transactions and events have been recorded in the correct accounting period. Although this is the responsibility of those charged with governance, it is the responsibility of the auditors to ensure that their client has applied its closing procedures appropriately. (ii) If an auditor determines that the client's closing procedures are weak, an auditor will plan on spending more time conducting detailed testing around year end. (iii) There are a number of ways that Mike Bossy can assess the adequacy of the client's closing procedures. checking the accuracy of accrual calculations around year end. look at earnings trends to assess whether the reported income is in line with similar periods in prior years. trace transactions recorded close to year end to source documentation and confirm that all transactions are recorded in the appropriate accounting period. b)

Knowledge about the entity is gained through interviews with client personnel, including those charged with governance. Mike Bossy will ask questions about what the client does, how the client functions, the ownership structure of the client, and its sources of financing.

Procedures to gain understanding of client: Major customers are identified so that the auditor may consider whether those customers have a good reputation, are on good terms with the client (that is, likely to remain a

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customer in future), and are likely to pay the client on a timely basis. Dissatisfied customers may withhold payment, which affects the allowance for doubtful accounts and the client's cash flow, or decide not to purchase from the client in the future, which can affect the going concern assumption. If a client has only one or a few customers, this risk is increased. The auditor also considers the terms of any long-term contracts between their client and their client's customers.

Major suppliers are identified to determine whether they are reputable and supply quality goods on a timely basis and payment on a timely basis. If the client is having trouble paying its suppliers, it may have trouble sourcing goods as suppliers may refuse to transact with a company that does not pay on time.

The client's capacity to adapt to changes in technology and other trends is assessed. If the client is not well positioned to adjust to such changes, it risks falling behind competitors and losing market share, which in the longer term can affect the going concern assumption.

The nature of any warranties provided to customers is assessed. If the client provides warranties on products sold, the auditor needs to assess the likelihood that goods will be returned and the risk the client has underprovided for that rate of return (adequacy of the warranty provision).

The terms of discounts given by the client to its customers and received by the client from its suppliers are reviewed. An assessment is made of the client's bargaining power with its customers and suppliers to determine whether discounting policies are putting profit margins at risk, which may place the future viability of the client at risk.

An assessment is made of the client's reputation with its customers, suppliers, employees, shareholders, and the wider community. A company with a poor reputation places future profits at risk. It is also not in the best interests of the auditor to be associated with a client that has a poor reputation.

An understanding is gained of client operations. The auditor will note where the client operates, the number of locations it operates in, and the dispersion of these locations. The more spread out the client's operations are, the harder it is for the client to effectively control and coordinate its operations, increasing the risk of errors in the financial statements. The auditor will need to visit locations where the risk of material misstatement is greatest to assess the processes and procedures at each site. If the client has operations interprovincial or overseas, the auditor may plan for a visit to those sites by staff from affiliated offices at those locations where risk is greatest. For example, an auditor is more likely to visit client operations if the client opens a new, large site, or if the business is located in a country where there is a high rate of inflation or where there is a high risk of theft.

An understanding is gained of the nature of employment contracts and the client's relations with its employees. The auditor will consider how a client pays its employees, the mix of wages and bonuses, the level of unionization among the workforce, and the attitude of staff to their employer. The more complex a payroll system, the more likely that errors can occur.

When staff are unhappy, there is greater risk of industrial action, such as strikes, which disrupt client operations.

The client's sources of financing are reviewed. An assessment is made of a client's debt sources, the reliability of future sources of financing, the structure of debt, and the reliance on debt versus equity financing. An auditor assesses whether their client is meeting interest

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payments on funds borrowed and repaying funds raised when they are due. If the client does not meet the conditions of a debt covenant, the borrower may recall the debt, placing the client's liquidity position at risk, and increasing the risk that the client may not be able to continue as a going concern.

The client's ownership structure is assessed. The auditor is interested in the amount of debt funding relative to equity, the use of different forms of shares, and the differing rights of shareholder groups. The client's dividend policy and its ability to meet dividend payments out of operating cash flow are also of interest.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the process used in gaining an understanding of the client.

Learning Objective: Explain how a client’s financial reporting practices and closing procedures can affect reported results.

Section Reference: 3.2 Gaining an understanding of the client Section Reference 3.9 Closing procedures CPA Competency: Audit and Assurance AACSB: Analytic

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LEGAL NOTICE Copyright © 2021 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under license and may be used only in accordance with the terms of such license.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 4 AUDIT PLANNING ll CHAPTER LEARNING OBJECTIVES 1. Evaluate audit risk.

Audit risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. The three components of audit risk are inherent risk, control risk, and detection risk.

2. Explain and apply the concept of materiality.

Information is considered to be material if it impacts the decision-making process of users of the financial statements.

3. Describe how an auditor determines the audit strategy.

The audit strategy is a key component of the risk assessment phase of the audit. It sets the scope, timing, and direction of the audit and provides the basis for developing a detailed audit plan. An audit strategy will depend on the auditor’s preliminary inherent and control risk assessment.

4. Outline how clients measure performance.

By understanding how a client measures its own performance, an auditor can plan the audit to take into consideration areas where the client may be under pressure to achieve certain outcomes.

5. Summarize how an auditor uses analytical procedures when planning an audit.

Analytical procedures are conducted at the risk assessment phase of the audit to identify unusual fluctuations, help identify risks, help when gaining an understanding of a client, identify the accounts at risk of material misstatement, and reduce audit risk by concentrating audit effort where the risk of material misstatement is greatest. There are many processes that can be used when conducting analytical procedures. The processes discussed in this chapter include simple comparisons, trend analysis, common-size analysis, and ratio analysis.

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TRUE-FALSE STATEMENTS 1. Audit risk is the risk that a client's system of internal controls will not prevent or detect a material misstatement.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Evaluate audit risk.

Section Reference: 4.1 Audit risk CPA Competency: Audit and Assurance AACSB: Analytic

2. If inherent risk and control risk are low, the auditor can set detection risk as high.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Evaluate audit risk.

Section Reference: 4.1 Audit risk CPA Competency: Audit and Assurance AACSB: Analytic

3. When classifying risks, significant consideration is given to whether the risk involves simple routine transactions.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate audit risk.

Section Reference: 4.1 Audit risk CPA Competency: Audit and Assurance AACSB: Analytic

4. Materiality is assessed during the risk assessment phase of every audit.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance

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AACSB: Analytic

5. Information is considered quantitatively material if it exceeds an auditor's preliminary materiality assessment.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance AACSB: Analytic

6. By setting a higher planning materiality level, an auditor increases the quality and quantity of evidence that needs to be obtained.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance AACSB: Analytic

7. There is an inverse relationship between the assessed level of inherent and control risk and detection risk as set by the auditor.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

8. A walkthrough involves an auditor tracing a transaction through a client's accounting system.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance

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AACSB: Analytic

9. If the client has one or more appropriate controls in place, the audit strategy is to conduct few or no tests of controls for the identified risk.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

10. Profitability is the ability of a company to pay its debts as they fall due.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline how clients measure performance.

Section Reference: 4.4 Client approaches to measuring performance CPA Competency: Audit and Assurance AACSB: Analytic

11. Companies enter into debt covenants with lenders when taking on significant loans.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline how clients measure performance.

Section Reference: 4.4 Client approaches to measuring performance CPA Competency: Audit and Assurance AACSB: Analytic

12. Key performance indicators used by a client to monitor its performance provide an auditor insight into which accounts are potentially at risk of misstatement.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline how clients measure performance.

Section Reference: 4.4 Client approaches to measuring performance CPA Competency: Audit and Assurance AACSB: Analytic

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13. Trend analysis involves a comparison of account balances to a single line item.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

14. Analytical procedures are conducted at the risk assessment phase of an audit to enhance the understanding of the auditor's client.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

15. Inventory turnover measures how many times a year a company collects cash from its debtors.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 16. Keith Fiorino, a manager at Cox, Durham, & Elliott, CPA’s was given the mandate to deal with the following risks: fraud risks, complex transactions, and significant related party transactions. How would you classify these risks? a) audit risk b) inherent risk c) control risk d) significant risk Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Evaluate audit risk.

Section Reference: 4.1 Audit risk CPA Competency: Audit and Assurance AACSB: Analytic

17. Millie Buenavista made the following two statements concerning inherent risk: (i) Inherent risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. (ii) Inherent risk deals with the susceptibility of the financial statements to material misstatements without considering internal controls. a) both (i) and (ii) are correct b) neither (i) or (ii) are correct c) only (i) is correct d) only (ii) is correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate audit risk.

Section Reference: 4.1 Audit risk CPA Competency: Audit and Assurance AACSB: Analytic

18. Which of the following statements is correct about audit risk? a) It is possible to completely eliminate audit risk. b) Audit risk is the risk that an auditor expresses an inappropriate opinion when the financial statements are materially misstated. c) Audit risk cannot be reduced at the risk assessment phase of an audit by identifying the key risks faced by the client.

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d) The level of audit risk is determined by the client’s management.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate audit risk.

Section Reference: 4.1 Audit risk CPA Competency: Audit and Assurance AACSB: Analytic

19. When classifying risks, significant consideration is not given to whether the risk a) is related to significant economic or accounting developments. b) involves simple transactions. c) involves significant related party transactions. d) involves fraud.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate audit risk.

Section Reference: 4.1 Audit risk CPA Competency: Audit and Assurance AACSB: Analytic

20. If there is a risk that management's assertion that recorded inventory exists is not valid, the auditor will a) spend more time testing for the existence of recorded inventory. b) spend less time testing for the existence of recorded inventory. c) spend more time testing for the completeness of inventory. d) not adjust their audit strategy.

Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Evaluate audit risk.

Section Reference: 4.1 Audit risk CPA Competency: Audit and Assurance AACSB: Analytic

21. Control risk is a) the risk that a client's system of internal controls will prevent or detect a material misstatement.

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b) the susceptibility of an assertion to a material misstatement assuming there are no related controls. c) the risk that a client's system of internal controls will not prevent or detect a material misstatement. d) the risk the auditor will not be able to perform tests of controls.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate audit risk.

Section Reference: 4.1 Audit risk CPA Competency: Audit and Assurance AACSB: Analytic

22. By setting high detection risk, an auditor will a) eliminate the possibility that fraud will be detected. b) reduce the level of reliance placed on their detailed substantive procedures. c) increase the level of reliance placed on their detailed substantive procedures. d) reduce the level of testing of the client's internal control system.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate audit risk.

Section Reference: 4.1 Audit risk CPA Competency: Audit and Assurance AACSB: Analytic

23. When information exceeds an auditor's preliminary materiality assessment, it is deemed to be a) performance materiality. b) specific materiality. c) quantitatively material. d) a control risk.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance AACSB: Analytic

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24. Which of the following statements about materiality is incorrect? a) The preliminary assessment of materiality guides audit planning and testing. b) Materiality is used to guide the validity of information contained in the financial statements. c) Materiality is a key auditing concept that is assessed during the risk assessment phase of every audit. d) Information is considered material if it has no impact on the decision-making process of financial statement users.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance AACSB: Analytic

25. An item that is considered material due to its magnitude is referred to as being a) quantitatively material. b) of no interest to the auditor. c) qualitatively material. d) immaterial.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance AACSB: Analytic

26. Qualitative materiality refers to information that a) impacts a user's decision-making process due to its magnitude. b) impacts a user's decision-making process for a reason other than its magnitude. c) is less than an auditor's preliminary materiality assessment. d) exceeds an auditor's preliminary materiality assessment.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance AACSB: Analytic

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27. Which of the following is an example of an item considered qualitatively material? a) a change in an accounting method b) related party transactions c) being in danger of breaching a debt covenant d) all of the answers are correct Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance AACSB: Analytic

28. By setting a lower planning materiality level, an auditor a) decreases the quality and quantity of evidence that needs to be gathered. b) does not change the audit strategy they use. c) increases the quality and quantity of evidence that needs to be gathered. d) can be certain that they will detect all instances of fraud that have occurred.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance AACSB: Analytic

29. Which of the following statements regarding materiality is correct? a) Materiality is a key auditing concept. b) The preliminary assessment of materiality does not guide audit planning. c) All items are considered material if they are reported incorrectly on the financial statements. d) Once materiality for an audit is determined, it cannot be changed.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance AACSB: Analytic

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30. An example of a qualitative material item is a) an incorrect value reported for an asset. b) a related party transaction. c) interest expenses as being 6% of total sales. d) sales incorrectly recorded twice.

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance AACSB: Analytic

31. Setting the level of planning materiality as low would cause an auditor to a) increase the quality and quantity of evidence to be collected. b) reduce the quality and quantity of evidence to be collected. c) revise the acceptable level of audit risk. d) none of the above Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance AACSB: Analytic

32. An auditor has gained a detailed understanding of the client's system of internal controls and has conducted extensive tests of those controls. She later assesses control risk as low.

What is she planning to perform? a) a combined audit strategy b) an audit of financial controls c) a substantive audit strategy d) a modified audit strategy Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy

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CPA Competency: Audit and Assurance AACSB: Analytic

33. When a control is effective, the next step is to a) identify what could go wrong. b) test the control. c) perform a walkthrough. d) reduce reliance on detailed substantive procedures.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

34. When Brenda discovered she had a low risk client with low inherent risk and low control risk, how did she set her detection risk? a) low b) high c) medium d) detection risk is not related to inherent risk and control risk Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic 35. Zain Hakim’s client does not have in place appropriate controls for a risk he has identified.

What should Zain do? a) conduct few or no tests of controls b) report the weaknesses to those charged with governance c) increase his reliance on substantive tests d) all of the answers are correct Answer: d Bloomcode: Application Difficulty: Medium

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Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

36. Moises Alou has reviewed internal controls at a spring training facility in Florida and has deemed control risk to be high. Which kind of audit strategy may be appropriate for Moises? a) combined audit strategy b) substantive audit strategy c) both a and b d) none of the above Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

37. An audit strategy a) is determined by the client. b) involves determining the amount of time to be spent testing the client's internal controls and conducting detailed substantive testing. c) sets the scope, timing, and direction of the audit. d) both b and c Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

38. The audit strategy for a client with high inherent risk and high control risk will include a) no or very limited tests of controls. b) decreased reliance on substantive tests. c) increased testing of controls. d) increased reliance on controls.

Answer: a

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

39. A transaction walkthrough involves a) taking a tour of the client's manufacturing facility. b) vouching recorded transactions back to the source documents. c) tracing a transaction through a client's accounting system. d) observing an inventory count Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

40. An audit strategy will include increased reliance on tests of controls when a) inherent risk and control are high. b) inherent risk and control risk are low. c) the auditor believes there is a high risk that their client's internal controls will not prevent or detect material misstatements. d) there is a high susceptibility of assertions to material misstatements.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

41. By assessing control risk as high, an auditor has determined that their client's system of internal controls a) is unlikely to be effective in mitigating inherent risks identified. b) is very effective at preventing or detecting material misstatements. c) is very strong. d) will eliminate the possibility of material fraud or error.

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Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

42. Which of the following statements regarding key performance indicators (KPIs) is incorrect? a) They reflect the success factors of an organization. b) They can be quantified. c) Some KPIs are common to many clients, including return on assets. d) The auditors determine the KPIs for a company.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline how clients measure performance.

Section Reference: 4.4 Client approaches to measuring performance CPA Competency: Audit and Assurance AACSB: Analytic

43. Common measures of a company's profitability include a) price-earnings ratio. b) earnings per share. c) both a and b d) quick ratio.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline how clients measure performance.

Section Reference: 4.4 Client approaches to measuring performance CPA Competency: Audit and Assurance AACSB: Analytic

44. Which of the following statements relating to debt covenants is incorrect? a) Covenants are written into loan contracts. b) If a company breaches a debt covenant it will not need to renegotiate or repay the loan. c) Covenants restrict a company's activities. d) Companies typically enter into debt covenants with banks when they borrow a significant amount.

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Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline how clients measure performance.

Section Reference: 4.4 Client approaches to measuring performance CPA Competency: Audit and Assurance AACSB: Analytic

45. Liquidity refers to a) the ability of a company to earn a profit. b) a comparison of account balances to a single line item. c) the ability of a company to pay its debts when they fall due. d) the ability of a company to use its assets efficiently.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline how clients measure performance.

Section Reference: 4.4 Client approaches to measuring performance CPA Competency: Audit and Assurance AACSB: Analytic

46. Gaining an understanding of how an audit client measures and assesses its performance, assists the auditor to a) assess audit risk. b) evaluate the profitability of the audit client. c) gain an understanding of accounts that may be at risk. d) determine the overall audit strategy.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline how clients measure performance.

Section Reference: 4.4 Client approaches to measuring performance CPA Competency: Audit and Assurance AACSB: Analytic

47. Which of the following is not a reason for using profitability measures? a) to assess performance of key staff b) to compare performance against competitors c) to measure the ability to meet its debts as they fall due

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d) to track revenue and expenses over time Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline how clients measure performance.

Section Reference: 4.4 Client approaches to measuring performance CPA Competency: Audit and Assurance AACSB: Analytic

48. Francesca Prez was explaining the importance of analytical procedures to her staff. She made two statements: (i) Analytical procedures are conducted throughout an audit. (ii) Analytical procedures are an efficient method for estimating account balances. a) both (i) and (ii) are correct b) neither (i) nor (ii) are correct c) only (i) is correct d) only (ii) is correct Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

49. Matthias Holewsky was explaining how important it was for his staff to use analytical procedures in order to cut down on substantive testing. He mentioned two factors that he felt were important when conducting analytical procedures: (i) reliability of client data (ii) the ability to make comparisons over time Which of these two factors can help him achieve his objective? a) (i) only b) (ii) only c) both (i) and (ii) d) neither (i) nor (ii) Answer: c Bloomcode: Comprehension Difficulty: Easy

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Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

50. Analytical procedures are a) always based only on available financial statement data. b) expected to be efficient and effective. c) relevant to achieving audit objectives. d) conducted throughout the audit.

Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

51. Analytical procedures are undertaken to a) prove the client is profitable. b) determine the correct cash balance. c) identify fluctuations in accounts inconsistent with the auditor’s expectations. d) identify non-compliance with internal control procedures.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

52. Which of the following is not an example of an analytical procedure? a) comparison of financial data to invoices b) comparison of financial data to industry averages c) comparison of financial data to budgets d) comparison of financial data to non-financial data Answer: a

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Bloomcode: Application Difficulty: Medium Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

53. Ratio analysis is used to a) assess the relationship between various financial statement balances. b) compare account balances over time. c) compare account balances with a single line item. d) assess the effectiveness of internal controls.

Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

54. In conducting analytical procedures, which of the following sources of information is considered to be most reliable? a) information generated using consistent accounting methods b) information from external sources c) information generated by an accounting system that has effective internal controls d) information provided by the client Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

55. Analytical procedures are conducted at the risk assessment phase of the audit to a) aid in the identification of risk. b) identify where fraud has occurred.

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c) determine if account balances are accurate. d) evaluate the work performed by the auditors.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

56. Analytical procedures are used at which of the following stages of an audit? a) final review b) planning c) execution d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

57. Which of the following is not an example of a profitability ratio? a) current ratio b) gross profit margin c) return on assets d) profit margin Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

58. Which of the following is an example of a liquidity ratio?

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a) gross profit divided by net sales b) profit divided by average assets c) cost of sales divided by average inventory d) current assets divided by current liabilities Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

59. In conducting analytical procedures, which of the following information sources are not generally considered to be reliable? a) audited information b) information generated by an accounting system with ineffective internal controls c) information generated using consistent accounting methods d) information generated by an accounting system with effective internal controls Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

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SHORT ANSWER QUESTIONS 60. Explain audit risk and the three components of the audit risk model.

Answer: Audit risk is the risk that an auditor expresses an inappropriate audit opinion when financial statements are materially misstated. This means that an auditor reports that in their opinion the financial statements are fairly presented when in fact, they contain a significant error or fraud. While it is impossible to eliminate audit risk, an auditor will aim to reduce it to an acceptably low level. Inherent risk is the susceptibility of an assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, assuming there are no related controls. Control risk is the risk that a client's system of internal controls will not prevent or detect a material misstatement. Detection risk is the risk that the auditor's testing procedures will not be effective in detecting a material misstatement should there be one.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate audit risk.

Section Reference: 4.1 Audit risk CPA Competency: Audit and Assurance AACSB: Analytic

61. Indicate whether you agree or disagree with the following statements and explain your reasoning. a)

Monica Callahan, the in-charge auditor, was explaining to her junior auditors why she was setting inherent risk high. “It is appropriate to set higher inherent risk for this company as our client is in an industry that is very competitive.”

b)

In selecting an appropriate materiality base, an auditor can choose an item from the balance sheet or income statement.

c)

Randy Roberts has mentioned to his staff auditors that audit risk is based on factors that relate to the entity, while materiality is based on the user needs. As a result, materiality and audit risk are two concepts that need to be considered separately when considering material misstatements.

d)

Shareep Kaur has determined control risk at a biochem company to be high. She plans to use a combined audit strategy.

Answer: a) Agree. An organization in a highly competitive environment will have a higher inherent risk than an entity in an industry with few competitors. By the same token, a geographically dispersed company will have a higher inherent risk than an organization with a single location. b)

Agree. Balance sheet bases are generally total assets or equity. Income statement bases are profit before tax, revenue, or gross profit. An auditor will select an appropriate base

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using their professional judgement based on their knowledge of the client and the needs of financial statement users for their decision making. c)

Disagree. Materiality and audit risk both require consideration in identifying and assessing the risk of a material misstatement. They both have to be considered when determining the nature, timing, and extent of the audit work performed, and they are both considered when evaluating the effect of uncorrected misstatements on the financial statements and in forming the opinion in the auditor's report.

d)

Disagree. When control risk is high, the audit strategy most likely to be adopted will be that of substantive testing.

When assessing control risk as low, an auditor will generally plan to perform a combined audit strategy where a detailed understanding of their client's system of internal controls is obtained as the auditor plans to rely on that system to identify, prevent, and detect material misstatements.

Bloomcode: Application Difficulty: Medium Learning Objective: Evaluate audit risk.

Learning Objective: Explain and apply the concept of materiality.

Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.1 Audit risk Section Reference: 4.2 Materiality Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

62. What is the relationship between materiality and audit risk?

Answer: Audit risk is the risk the financial statements may be materiality misstated. Information is material if it impacts the decision of a user, therefore materiality is based on users. When assessing materiality, the auditor does not consider audit risk, however, both concepts impact the quantity and quality of evidence. The greater the risk of material misstatement, the greater the need for the auditor to gather more evidence that is of a high quality. By setting a lower planning materiality level, an auditor also increases the quality and quantity of evidence that needs to be gathered. When gathering evidence, one of the criteria may be to test material items. The lower the materiality level set, the more items will fall into this definition. Also, by setting a lower materiality level, an auditor increases their sensitivity to a potential misstatement.

When analyzing test results, an auditor will assess potential misstatements in aggregate with reference to their planning materiality. The lower the materiality, the more likely the auditor will conclude that misstatements are material and further testing is required.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain and apply the concept of materiality.

Section Reference: 4.2 Materiality CPA Competency: Audit and Assurance AACSB: Analytic

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63. Explain the audit approach used by an auditor when they assess control risk as high.

Answer: By assessing control risk as high, an auditor will adopt a substantive approach.

When this audit strategy is adopted, an auditor will gain the minimum necessary knowledge of the client's system of internal controls as required by the auditing standards, but generally conduct no tests of those controls. If a client's system of internal controls is non-existent, very poor, or unlikely to be effective in mitigating an identified inherent risk, there is generally no point testing the internal controls as the auditor will not be planning on relying on them. Instead, an auditor will increase their level of reliance on detailed substantive procedures, which involves intensive testing of year-end account balances and transactions from throughout the year.

An exception is where an auditor has identified a significant risk. In this case, an auditor will gain an understanding of their client's controls relevant to that risk. For example, if a client has significant transactions that involve estimation, an auditor will review the processes used by management to make those estimations. If a client does not have adequate controls to address significant risks, this is considered a noteworthy deficiency in a client's system of internal controls.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

64. Direct Home Builders was incorporated in December of 2019 and started operating in January of 2020. The company operates a retail web site that sells home building products to contractors in Canada. The business is owned and managed by two brothers, Buster and Dave Jameson. Despite a slowdown in the very competitive construction sector, the brothers have developed several unique interactive on-line shopping features that have led to significant revenue growth. As a result of this revenue growth, the owners have had to hire more sales, customer service, IT, and accounting staff. This has increased the payroll costs to the extent the company is now experiencing cash flow difficulties. The local bank has provided interim financing, but a new cash injection is required. Buster and Dave are considering making a public share offering to raise further capital.

The brothers have approached a CPA firm to determine what may be involved with an initial public offering. They have been advised that one requirement is annual audited financial statements. They have discussed this requirement with their Controller, who believes they may have some challenges obtaining an unqualified audit opinion. She has expressed this concern due to the issues she has had with the new accounting hires and the turnover within the accounting area. She has had to let a couple of the staff go as they made several material accounting errors. She has since implemented stronger controls over the accounting processes, but she is still uncertain whether material errors remain.

Required: Discuss the factors that will increase the inherent risk of Direct Home Builders.

Answer: Factors that increase risk: • new business

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• first time audit • rapid growth • turnover in accounting staff • competitive industry • cash flow problems • possible share offering.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.3 Audit Strategy CPA Competency: Audit and Assurance AACSB: Analytic

65. Describe the profitability and liquidity approaches to measuring a client's performance.

Answer: It is common for companies to use profitability measures to assess their performance and that of their senior staff. Companies will track their revenue and expenses over time and assess any variability. They will compare their revenue and expenses with close competitors and assess their ability to compete, as well as provide valuable insights to management as to whether results are matching expectations based on known factors such as seasonality or economic downturns. This also provides the auditor with valuable insights into the expectations of management. Liquidity is the ability of a company to meet its needs for cash in the short and long term. It is vital for a company to have access to cash to pay its debts when they fall due. If it cannot meet these obligations, a company may go into liquidation. Companies require cash to pay their employees' wages, utility bills, supplier bills, interest payments on money lent, dividends to shareholders and so on. In the longer term, companies need cash to repay longterm debt and undertake capital investment.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline how clients measure performance.

Section Reference: 4.4 Client approaches to measuring performance CPA Competency: Audit and Assurance AACSB: Analytic

66. Discuss the purpose and some common examples of profitability ratios.

Answer: Profitability ratios reflect a company's ability to generate earnings and ultimately the cash flow required to pay debts, meet other obligations, and fund future expansion. Common profitability ratios include the gross profit margin, profit margin, return on assets, and return of shareholders' equity. The gross profit margin indicates whether a seller of goods has a sufficient mark-up on goods sold to pay for other expenses. The profit margin indicates the profitability of a company after taking into account all operating expenses. The return on assets (ROA) indicates the ability of a company to generate income from its average investment in total assets. The return on shareholders' equity (ROE) indicates the ability of a company to generate income from the funds invested by its common (ordinary) shareholders.

Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Outline how clients measure performance.

Section Reference: 4.4 Client approaches to measuring performance CPA Competency: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 67. Audit risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially stated. Why is the concept of audit risk so important to auditors and what can they do to reduce it to an acceptably low level?

Answer: Answers may vary.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate audit risk.

Section Reference: 4.1 Audit risk CPA Competency: Audit and Assurance AACSB: Analytic

68. Gaining an understanding of a client includes auditors learning how their clients measure their performance. How is this information used by auditors in audit planning and what are examples of non-financial performance measures commonly used by auditors?

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Outline how clients measure performance.

Section Reference: 4.4 Client approaches to measuring performance CPA Competency: Audit and Assurance AACSB: Analytic

69. Analytical procedures are used by auditors to evaluate their clients' financial information by studying plausible relationships among both financial and non-financial data. Explain how analytical procedures are used at different stages of an audit.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

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CASE QUESTIONS 70. (Reproduced with permission from CICA UFE Question 1996 — Paper 4 — Question 2) Allentown Credit Union (ACU) is located in a rural community in Canada. Membership is open to people in the community and the surrounding area. The local economy, which is predominantly agricultural, has been harmed by droughts in recent years and by declines in commodity prices, leading to a decline in ACU’s profitability.

ACU has always had an external audit and has always prepared its financial statements in accordance with International Financial Reporting Standards. Ellino & Co. has audited ACU for the last several years. You, CPA, a senior with Ellino & Co., have been appointed to the audit of ACU for the year ended December 31, 2022. It is now early January 2023, and you are at the client’s premises reviewing the information gathered to date.

ACU was founded in 1942, and it has always maintained a philosophy of serving the community. This has resulted in liberal lending practices and investment in the local community whenever possible. This stance has distinguished it from other financial institutions, which are primarily branches of national banks, and has given ACU a 75% share of the market.

ACU has been headed by the general manager, Ted Richards, for the past ten years. Ted reports directly to the Board of Directors, which is comprised of local people, some of whom have no formal financial training. Ted has always been accessible to members of the credit union and, on occasion, he has intervened in favour of the customer over the staff. He maintains that this flexibility is crucial to generating revenue, which is an important objective of the Board.

The loan manager, Sheila Meigs, joined ACU in the past year. She is responsible for the entire lending function, which includes authorization of loans, appraisal of collateral, and assessment of the collectibility of outstanding loans. The loan portfolio is the largest asset on the balance sheet, representing 75% of total assets.

The accountant, Vivian Larson, and the head teller, Joanne Blake, both have 15 years of experience at ACU. Both are married to farmers and work to supplement their income. Both families are members of ACU, and all their personal and business transactions are conducted through the credit union.

As you read through your notes, Ted Richards interrupts you to tell you about some of the events that have occurred at ACU during the year.

•

ACU foreclosed on a large loan and sold the land held as collateral. One effect of this sale was to depress the land prices in the surrounding area. ACU still maintains a high inventory of land received from past foreclosures but has decided to hold onto this land for fear of depressing land prices further.

•

As a result of the depressed state of the local economy, provisions have recently been made to allow some customers to repay their loans with grains (i.e., oats and barley) instead of cash. Although such payments are not a common practice, Ted has approved these transactions on an exception basis.

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Even though the economy is depressed, Ted believes this will turn around and loans will be collected over the long term. Therefore, he has instructed to Sheila Meigs, Loan Manager, not to write off any significant loans as loan balances.

Required: a) Define inherent risk and perform an inherent risk assessment for ACU. b) Perform a control risk assessment. c) Conclude on the overall risk of material misstatement. d) How will your audit risk conclusion impact the audit strategy?

Answer: a) The inherent risk has increased for several reasons.

• First, there has been a downturn in the local economy and ACU’s performance is very sensitive to economic conditions.

• The tough economic conditions increase the likelihood of uncollectible loans. There is a management bias to maximize asset values and income as demonstrated by Ted who advised the loans officer not to write off significant balances due to the belief that the economy will pick up over the long term.

• The loans are a significant account on the balance sheet and the valuation of the loans and the loss provision requires professional judgement. As a result, there is considerable scope for error in evaluating the judgement exercised by management.

• Also, the presence of unusual transactions such as allowing some customers to repay their loans with grains instead of cash increases the inherent risk. b)

Control risk is also a potential problem.

• A new person is handling the lending function, which means there is a greater chance that internal controls will not be observed because of unfamiliarity.

• Also, the experience of the new loan manager is not known, and her job requires the exercise of judgement. Until we have gained confidence in her ability as a loan manager, the control risk has definitely increased.

• In addition, Ted Richards seems to override internal controls. For example, he has accepted grain in lieu of payment on loans, which is an unusual way of running the business.

c)

The overall risk associated with the ACU engagement is high. Duties are poorly segregated, and there is an independence problem with the staff. Also, the board of directors appears to be very unsophisticated.

d)

As a result, we will have to do more audit work than in previous years to attain the necessary audit assurance.

Source: Question 2, Paper 4, UFE 1996. ©2015 CPA Canada. This item is reproduced here for your use with the permission of the Chartered Professional Accountants of Canada. It should not be copied or distributed in any form as this would cause an infringement of Chartered Professional Accountants of Canada's copyright.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Evaluate audit risk.

Learning Objective: Describe how an auditor determines the audit strategy.

Section Reference: 4.1 Audit risk

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Section Reference: 4.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

71. Ron Yates, the senior auditor at Delahanty, Forbes, CPAs was planning for the audit of Winnipeg Lighting Showcase (WLS) and decided to use benchmarking as an analytical procedure.

His manager agreed with Ron’s approach and suggested information sources that would ensure the reliability of the data for his benchmarking exercise.

As Ron walked out of the office he ran into Irene Balla, a newly hired auditor. He congratulated her on her decision to use a substantive approach to her accounts receivable section of the audit program.

Irene was also going to be reviewing certain internal controls in the WLS audit program. She asked him to whom she should report weaknesses in the client’s internal controls.

Required: a) Which information sources are generally considered to be reliable when conducting benchmarking exercises? b) What circumstances would have made Irene use a substantive approach? c) To whom will Irene report weaknesses in a client's system of internal controls?

Answer: a) In conducting analytical procedures, the following information sources are generally considered to be reliable: • information generated by an accounting system that has effective internal controls • information generated by an independent reputable external source • audited information • information generated using consistent accounting methods • information from a source internal to the client that has proven to be accurate in the past (for example, when preparing budgets). b)

By assessing control risk as high, Irene will adopt a substantive audit approach.

When this audit strategy is adopted, it is implied that Irene has gained the minimum necessary knowledge of the client's system of internal controls as required by the auditing standards, but generally she will not have conducted tests of those controls.

If WLS's system of internal controls is non-existent, very poor, or unlikely to be effective in mitigating an identified inherent risk, there is generally no point testing the internal controls as Irene will not be planning on relying on them. Instead, Irene will increase her level of reliance on detailed substantive procedures, which involves intensive testing of year-end account balances and transactions from throughout the year.

c)

If the auditor tests the controls and believes them to be ineffective, the auditor cannot rely on the controls. In this case, the auditor reports the weaknesses identified to those charged with governance, makes recommendations on improving the controls, and increases the reliance placed on detailed substantive procedures.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe how an auditor determines the audit strategy.

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Learning Objective: Summarize how an auditor uses analytical procedures when planning an audit.

Section Reference: 4.3 Audit strategy Section Reference: 4.5 Analytical procedures CPA Competency: Audit and Assurance AACSB: Analytic

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LEGAL NOTICE Copyright © 2021by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under license and may be used only in accordance with the terms of such license.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 5 AUDIT EVIDENCE CHAPTER LEARNING OBJECTIVES 1. Explain the audit assertions.

When preparing the financial statements, management will make assertions about each account and related disclosures in the notes. Auditors use these assertions to assess the risk of material misstatement and design audit procedures. The assertions used when testing transactions and events and related disclosures, including income statement items, are occurrence, completeness, accuracy, cut-off, classification, and presentation. The assertions used when testing balance sheet items and related disclosures are existence, rights and obligations, completeness, and accuracy, valuation and allocation, classification and presentation.

2. Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

The different types of audit evidence include external confirmations, documentary evidence, representations, verbal evidence, computational evidence, physical evidence, and electronic evidence. External confirmations are sent directly by an auditor to a third party. Documentary evidence may be generated internally by the client or externally by third parties. Representation letters are requested from a client’s lawyers or management. Verbal evidence is the discussions between the auditor and client personnel or third parties. Computational evidence is gathered when an auditor checks the mathematical accuracy of figures included in the financial statements. Physical evidence involves the inspection of tangible assets. Electronic evidence includes data held on a client’s computer, files sent by email to the auditor, and items scanned and faxed.

Sufficiency refers to the quantity of evidence gathered. Appropriateness refers to the relevance and reliability of audit evidence gathered.

3. Determine the persuasiveness of audit evidence.

The persuasiveness of evidence used to corroborate the details included in a client’s accounts varies. Internally generated evidence held by the client is the least persuasive, as the client can alter or hide this evidence. Externally generated evidence held by the client is more persuasive, as it is created by an independent third party. Externally generated evidence sent directly to the auditor is the most persuasive, as the client does not handle this evidence.

4. Explain the issues to consider when using the work of an expert.

When an auditor decides to use the work of an expert, the report produced by the expert forms part of the evidence used by an auditor when forming their audit opinion. An expert is someone with the skills, knowledge, and experience required to help an auditor. The auditor determines the scope of the work to be carried out, and assesses the capability of the expert, the objectivity of the expert, and the expert’s report.

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5. Explain the issues to consider when using the work of another auditor.

An auditor may need to use the work of another auditor when their client operates in a number of locations, has divisions or subsidiaries spread around the country or the globe, or has significant assets in other places. When this is the case, the principal auditor may need to rely on evidence provided by another auditor for certain components of the client’s financial statements.

6. Describe the evidence-gathering procedures most often used by auditors.

An auditor will inspect records, documentation, and tangible assets. They will observe client staff undertaking various procedures. An auditor will make inquiries of client personnel and third parties.

Confirmations are sent to third parties, including banks, lawyers, lenders, and debtors. An auditor will recalculate numbers appearing in client files and records to check mathematical accuracy. They will re-perform some processes used by the client to check the effectiveness of internal controls and the validity of amounts estimated by client personnel. Analytical procedures are used throughout the audit to appraise the relationships between financial and non-financial information.

7. Explain how auditors arrive at a conclusion based upon the evidence gathered.

The final audit procedure is to assess the evidence gathered throughout the audit and draw a conclusion on the fair presentation of a client’s financial statements.

8. Describe how auditors document the details of evidence gathered in working papers.

Audit evidence is documented in an auditor’s working papers. Audit working papers include the client’s name, the period under audit, a title describing the contents of the working paper, a file reference indicating where the working paper fits in the audit file, the initials of the preparer of the working paper together with the date the working paper was prepared, the initials of the reviewer(s) of the working paper together with the date(s) the working paper was reviewed, and cross-referencing between working papers indicating where further work and evidence are summarized elsewhere. Working papers are stored in either the permanent file or the current file. The permanent file includes client information and documentation that apply to more than one audit. The current file includes client information and documentation that apply to the current audit.

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TRUE-FALSE STATEMENTS 1. When preparing the financial statements, auditors make assertions about each account and the related disclosures.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the audit assertions.

Section Reference: 5.1 Assertions CPA Competency: Audit and Assurance AACSB: Analytic

2. The cut-off assertion means that the entity holds or controls the rights to assets and liabilities are the obligations of the entity.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the audit assertions.

Section Reference: 5.1 Assertions CPA Competency: Audit and Assurance AACSB: Analytic

3. Audit evidence is the information that an auditor uses when arriving at their opinion on the fair presentation of their client's financial statements.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

4. Negative confirmations ask the recipient to reply only if they disagree with the information provided.

Answer: True Bloomcode: Knowledge Difficulty: Easy

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Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

5. Internally generated evidence is considered the most persuasive when the source of the evidence is considered to be reliable, trustworthy, and independent of the client.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Determine the persuasiveness of audit evidence.

Section Reference: 5.3 Persuasiveness of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

6. Correspondence with the client's lawyers is an example of externally generated evidence sent directly to the auditor.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Determine the persuasiveness of audit evidence.

Section Reference: 5.3 Persuasiveness of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

7. The greater the risk of material misstatement of the item under consideration, the more likely an auditor will turn to an expert for their advice.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the issues to consider when using the work of an expert.

Section Reference: 5.4 Using the work of an expert CPA Competency: Audit and Assurance AACSB: Analytic

8. An expert is expected to be less objective if they are not associated with the client.

Answer: False Bloomcode: Knowledge

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Difficulty: Easy Learning Objective: Explain the issues to consider when using the work of an expert.

Section Reference: 5.4 Using the work of an expert CPA Competency: Audit and Assurance AACSB: Analytic

9. A component auditor is an auditor who, at the request of the group engagement team, performs work on financial information related to a component for the group audit.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the issues to consider when using the work of an expert.

Section Reference: 5.4 Using the work of an expert CPA Competency: Audit and Assurance AACSB: Analytic

10. The component partner sets out the work to be conducted by the group engagement partner.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the issues to consider when using the work of another auditor.

Section Reference: 5.5 Using the work of another auditor CPA Competency: Audit and Assurance AACSB: Analytic

11. Observation is an evidence-gathering procedure that involves checking the mathematical accuracy of client records.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the evidence-gathering procedures most often used by auditors.

Section Reference: 5.6 Evidence-gathering procedures CPA Competency: Audit and Assurance AACSB: Analytic

12. Analytical procedures involve an evaluation of financial information by studying plausible relationships among both financial and non-financial data.

Answer: True

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the evidence-gathering procedures most often used by auditors.

Section Reference: 5.6 Evidence-gathering procedures CPA Competency: Audit and Assurance AACSB: Analytic

13. The decision of what constitutes sufficient appropriate audit evidence is a matter for professional judgement.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how auditors arrive at a conclusion based upon the evidence gathered.

Section Reference: 5.7 Drawing conclusions CPA Competency: Audit and Assurance AACSB: Analytic

14. The permanent file includes client information and documentation that apply to more than one audit.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe how auditors document the details of evidence gathered in working papers.

Section Reference: 5.8 Documentation—audit working papers CPA Competency: Audit and Assurance AACSB: Analytic

15. The permanent file includes detailed descriptions of evidence gathered for a particular year's audit.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe how auditors document the details of evidence gathered in working papers.

Section Reference: 5.8 Documentation—audit working papers CPA Competency: Audit and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 16. Omar Gallardo, the audit manager, was explaining to his new audit team how management assertions work when assessing the risk of material misstatements. He made two statements to his audit team: (i) Auditors use assertions for account balances and related disclosures. (ii) Auditors use assertions for transactions and related disclosures.

Which of these statements were true? a) (i) only b) (ii) only c) both (i) and (ii) d) neither (i) nor (ii) Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the audit assertions.

Section Reference: 5.1 Assertions CPA Competency: Audit and Assurance AACSB: Analytic

17. Olga Chevalier, CPA was reviewing account balance assertions for Athabasca Oil Sands. Which one of the following would not be an account balance assertion? a) completeness b) rights and obligations c) accuracy, valuation, and allocation d) occurrence Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Explain the audit assertions.

Section Reference: 5.1 Assertions CPA Competency: Audit and Assurance AACSB: Analytic

18. Delaney Humphrey was explaining the importance of documentary evidence. Which assertion was she referring to when she obtained details of the price paid for inventory and traced it to the supplier’s invoice to verify the amount recorded? a) completeness b) accuracy

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c) classification d) cut-off Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Explain the audit assertions.

Section Reference: 5.1 Assertions CPA Competency: Audit and Assurance AACSB: Analytic

19. Lilia Hussey made two statements to Sami Moneymaker about cut-off procedures: (i) Testing cut-off transactions is particularly important for transactions close to year end. (ii) Cut-off procedures help determine whether transactions have been recorded in the correct accounting period.

Which of these statements were true? a) (i) only b) (ii) only c) both (i) and (ii) d) neither (i) nor (ii) Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the audit assertions.

Section Reference: 5.1 Assertions CPA Competency: Audit and Assurance AACSB: Analytic 20. Lucy Wong’s work at Axcan Pharma consisted of reading lease agreements to ensure that leases were disclosed accurately in the notes to the financial statements. Which assertion was she fulfilling? a) completeness b) persuasiveness c) accuracy d) presentation Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Explain the audit assertions.

Section Reference: 5.1 Assertions

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CPA Competency: Audit and Assurance AACSB: Analytic

21. Which of the following is not an assertion used for transactions and events? a) cut-off b) existence c) classification d) occurrence Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the audit assertions.

Section Reference: 5.1 Assertions CPA Competency: Audit and Assurance AACSB: Analytic

22. When testing for accuracy, an auditor searches for evidence a) to verify that a recorded transaction or event took place and relates to the entity. b) that all disclosures that should have been included in the financial statements have been included. c) that transactions and events have been recorded at appropriate amounts. d) to verify that recorded assets are owned by the entity.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the audit assertions.

Section Reference: 5.1 Assertions CPA Competency: Audit and Assurance AACSB: Analytic

23. Completeness is an assertion used a) when testing balance sheet items. b) for transactions and events. c) that relates to disclosure. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the audit assertions.

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Section Reference: 5.1 Assertions CPA Competency: Audit and Assurance AACSB: Analytic

24. Which assertion do auditors test when they test for the adequacy of the allowance for doubtful accounts? a) accuracy, valuation, and allocation b) rights and obligations c) classification d) occurrence Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Explain the audit assertions.

Section Reference: 5.1 Assertions CPA Competency: Audit and Assurance AACSB: Analytic

25. The first stage when an auditor considers the use of an expert is a) assessing the objectivity of the expert. b) assessing the need to use an expert. c) assessing the expert's report. d) determining the scope of the work to be carried out.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the audit assertions.

Section Reference: 5.1 Assertions CPA Competency: Audit and Assurance AACSB: Analytic

26. Mike Noseworthy, CPA was excited to see his audit manager and blurted out (i) “It is our responsibility as auditors to arrive at an audit opinion by gathering sufficient appropriate evidence.” (ii) “Appropriateness is the quantity and sufficiency is the quality of audit evidence gathered.”

Which of these statements were true? a) (i) only b) (ii) only c) both (i) and (ii)

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d) neither (i) nor (ii) Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

27. Iqbal Saleem was training junior audit staff and mentioned the importance of third party documentation. Which of the following are not external confirmations? a) supplier invoices b) bank confirmations c) payable confirmations d) receivable confirmations Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

28. Irvin Schatz, CPA had his client Brown Boveri, send out a legal letter to their lawyers. The legal letter would have contained requests for a) the lawyer’s opinion on the client’s legal matters. b) legal matters that the lawyer is in disagreement with the client. c) both a and b d) none of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

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29. Nicholas Doulas, the partner-in-charge of the Fairfax Financial Holdings audit, wrote a management representation letter. It would have included a) written details of verbal representations made by management during the audit. b) a representation that there have been no material frauds and errors. c) both a and b d) none of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

30. Abe Freed, a struggling public accountant was being coached by his father. His father told him that he was using a poor form of evidence as a basis for his conclusions. What type of evidence was he referring to? a) computational evidence b) verbal evidence c) physical evidence through inspection d) external confirmations Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

31. Evan Contador was reviewing ways of obtaining electronic evidence at Enbridge Inc. He was considering the different sources of evidence that might qualify and be defined as electronic evidence. Which elements are considered electronic evidence? a) physical evidence gathered through inspection b) computational evidence c) files sent via email to the auditor d) confirmations from suppliers Answer: c Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

32. Marianne Gilespie, the senior auditor at Manulife Financial was sorting out several sources of internally generated evidence. Which one of the following would not qualify as internally generated evidence? a) minutes of meetings b) journals and ledgers c) the annual operating plan presented to the Board of Directors d) bank confirmations Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

33. External confirmations can be sent to a) third parties holding the client's inventory. b) the client's audit committee. c) the client's lawyers. d) both a and c Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

34. Which of the following statements regarding a legal representation letter is incorrect? a) The letter can include a request to provide details of any legal matters that the lawyer is in disagreement with the client.

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b) The letter is sent by the auditor to its lawyers asking them to complete the letter and send it directly to the client. c) The letter is sent by the client to its lawyers asking them to complete the letter and send it directly to the auditor. d) The letter can include any legal matters involving the client.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

35. Which of the following forms of evidence is used when gaining an understanding of the client and its internal control systems? a) verbal b) computational c) physical d) external confirmations Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

36. Internally generated evidence held by the client includes a) bank statements. b) correspondence with the client's lawyers. c) copies of invoices sent to customers. d) expert valuations.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance

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AACSB: Analytic

37. An auditor verifies amounts recorded in their client's records using a) electronic evidence. b) verbal evidence. c) confirmations. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

38. Fran Zora has been auditing Manitoba Telecom Services for the past five years. She has gathered a lot of externally generated evidence because of its persuasiveness and reliability as evidence. Which one of the following evidences lacks trustworthiness and independence from the client? a) purchase requisitions b) bank confirmations c) correspondence with the client’s lawyers d) receivable confirmations Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Determine the persuasiveness of audit evidence.

Section Reference: 5.3 Persuasiveness of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

39. When there is a significant risk that an account will be misstated and the client's system of internal controls is not considered effective at reducing that risk, a) less high-quality evidence is gathered when conducting substantive tests. b) detection risk is set as high. c) detection risk is set as low. d) only control testing is required.

Answer: c

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Auditing: A Practical Approach, Fourth Canadian Edition

Bloomcode: Application Difficulty: Medium Learning Objective: Determine the persuasiveness of audit evidence.

Section Reference: 5.3 Persuasiveness of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

40. Which broad category of corroborating evidence is the least persuasive to an auditor? a) externally generated evidence sent directly to the auditor b) internally generated evidence c) externally generated evidence held by the client d) original documents Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Determine the persuasiveness of audit evidence.

Section Reference: 5.3 Persuasiveness of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

41. The auditor searches for evidence to a) ensure the absence of fraud. b) maintain their independence. c) prove that management representations are not accurate. d) prove that recorded amounts are accurate.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Determine the persuasiveness of audit evidence.

Section Reference: 5.3 Persuasiveness of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

42. Which of the following is not a category of corroborating evidence? a) externally generated evidence sent directly to the auditor b) internally generated evidence c) externally generated evidence held by the client d) client control testing evidence Answer: d

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Determine the persuasiveness of audit evidence.

Section Reference: 5.3 Persuasiveness of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

43. Which of the following provides the least reliable audit evidence? a) internally generated audit evidence b) original documents c) externally generated documentary evidence held by the client d) externally generated evidence held by the auditor Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Determine the persuasiveness of audit evidence.

Section Reference: 5.3 Persuasiveness of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

44. When an auditor uses the work of an expert, who has the responsibility for arriving at an overall conclusion regarding the fair presentation of a client's financial statements? a) the auditor b) the expert c) the client's management d) the client's audit committee Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the issues to consider when using the work of an expert.

Section Reference: 5.4 Using the work of an expert CPA Competency: Audit and Assurance AACSB: Analytic

45. Which of the following is an example of a situation where an auditor may use the work of an expert? a) a geologist engaged to evaluate the quantity and quality of mineral deposits b) an actuary engaged to verify insurance premiums c) both a and b d) none of the above

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Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the issues to consider when using the work of an expert.

Section Reference: 5.4 Using the work of an expert CPA Competency: Audit and Assurance AACSB: Analytic

46. Assessing an expert's report involves the auditor a) setting the nature, timing, and extent of work to be completed by the expert. b) assessing the consistency of information included in the expert's report with their understanding of the client. c) evaluating the expert's qualifications as a member of a relevant professional body. d) deciding that they do not have the expertise necessary to test and evaluate the accuracy of reported information.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the issues to consider when using the work of an expert.

Section Reference: 5.4 Using the work of an expert CPA Competency: Audit and Assurance AACSB: Analytic

47. The services of an expert may be engaged a) to check the accuracy of the auditor’s valuation of an account. b) when the auditor does not have the required skills and knowledge to assess the validity of an account. c) to provide an opinion on the fair presentation of the financial statements. d) to provide assistance to the auditor to prove the validity of an account.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the issues to consider when using the work of an expert.

Section Reference: 5.4 Using the work of an expert CPA Competency: Audit and Assurance AACSB: Analytic

48. Steven Marinaro, CPA is performing complex calculations to help him determine reserves in the Alberta Oil Sands. Which of the following evidence-gathering procedures will Steve use when using the work of another auditor?

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a) recalculation b) observation c) confirmations d) all of the answers are correct Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Explain the issues to consider when using the work of another auditor.

Section Reference: 5.5 Using the work of another auditor CPA Competency: Audit and Assurance AACSB: Analytic

49. The auditor may use the work of another auditor a) when there is insufficient time to complete the audit engagement. b) when the client operates from a number of locations. c) to assist in forming an opinion in circumstances where there are large volumes of audit evidence. d) when the auditor is not independent Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the issues to consider when using the work of another auditor.

Section Reference: 5.5 Using the work of another auditor CPA Competency: Audit and Assurance AACSB: Analytic

50. The group engagement partner is a) requested by the component auditor to perform certain audit work on behalf of the group engagement team. b) not responsible for providing an opinion on the fair presentation of the client's financial statements. c) not the auditor responsible for signing the audit report. d) the auditor responsible for signing the audit report.

Answer: d Bloomcode: Comprehension Difficulty: Medium Learning Objective: Explain the issues to consider when using the work of another auditor.

Section Reference: 5.5 Using the work of another auditor CPA Competency: Audit and Assurance AACSB: Analytic

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51. Which of the following statements regarding using the work of another auditor is correct? a) The group engagement partner will spend more time reviewing the component auditor's work when the component is at risk of material misstatement. b) The group engagement partner will spend more time reviewing the component auditor's work if the component auditor has a good reputation. c) The group engagement partner will spend less time reviewing the component auditor's work when the component is at risk of material misstatement. d) The component auditor sets out the work to be conducted by the group engagement partner.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the issues to consider when using the work of another auditor.

Section Reference: 5.5 Using the work of another auditor CPA Competency: Audit and Assurance AACSB: Analytic

52. If the component auditor cannot access sufficient evidence, the engagement partner will a) consider issuing an adverse audit opinion. b) always issue an unqualified audit opinion. c) consider issuing a modified audit opinion due to a scope limitation. d) only add an emphasis of matter paragraph to the clean audit report.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the issues to consider when using the work of another auditor.

Section Reference: 5.5 Using the work of another auditor CPA Competency: Audit and Assurance AACSB: Analytic

53. Auditors use a re-performance procedure a) only when testing controls. b) only during the risk assessment phase. c) only when conducting substantive testing. d) when testing controls and when conducting substantive testing.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the evidence-gathering procedures most often used by auditors.

Section Reference: 5.6 Evidence-gathering procedures

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CPA Competency: Audit and Assurance AACSB: Analytic

54. Observation involves an auditor a) asking questions to gain an understanding of various matters throughout the audit. b) watching a procedure being carried out by another party. c) checking the mathematical accuracy of client records. d) redoing processes conducted by the client.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the evidence-gathering procedures most often used by auditors.

Section Reference: 5.6 Evidence-gathering procedures CPA Competency: Audit and Assurance AACSB: Analytic

55. Why do auditors inspect records and documents? a) to check the dates of transactions b) for evidence that management have authorized significant purchases c) to check that a transaction occurred d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the evidence-gathering procedures most often used by auditors.

Section Reference: 5.6 Evidence-gathering procedures CPA Competency: Audit and Assurance AACSB: Analytic

56. Which of the following is not a method of collecting audit evidence? a) observation b) inquiry c) disclosure d) analytical procedures Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the evidence-gathering procedures most often used by auditors.

Section Reference: 5.6 Evidence-gathering procedures

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CPA Competency: Audit and Assurance AACSB: Analytic

57. An audit gathering procedure undertaken by an auditor to verify the balance of inventory on hand is a) observation. b) inquiry. c) re-performance. d) analytical procedures.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the evidence-gathering procedures most often used by auditors.

Section Reference: 5.6 Evidence-gathering procedures CPA Competency: Audit and Assurance AACSB: Analytic

58. What type of audit evidence is used when the auditor calculates the expected balance in the allowance for doubtful accounts? a) re-calculation b) analytical procedures c) re-performance d) inquiry Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the evidence-gathering procedures most often used by auditors.

Section Reference: 5.6 Evidence-gathering procedures CPA Competency: Audit and Assurance AACSB: Analytic 59. If an auditor believes that the audit client’s internal controls are effective, the approach she/he would take in the conduct of the audit is a) to place emphasis on testing account balances. b) to place her/his focus on tests of controls and further tests of transactions and balances. c) a substantive approach. d) to only test controls.

Answer: b Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Explain how auditors arrive at a conclusion based upon the evidence gathered.

Section Reference: 5.7 Drawing conclusions CPA Competency: Audit and Assurance AACSB: Analytic

60. If an auditor decides that a client has internal controls that can reduce the likelihood of material misstatement for an identified risk, the auditor will a) test those controls. b) qualify the audit report. c) adopt a substantive approach. d) not test those controls.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how auditors arrive at a conclusion based upon the evidence gathered.

Section Reference: 5.7 Drawing conclusions CPA Competency: Audit and Assurance AACSB: Analytic

61. An audit working paper generally includes a) the client's name. b) cross-referencing between working papers. c) a file reference. d) all of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe how auditors document the details of evidence gathered in working papers.

Section Reference: 5.8 Documentation—audit working papers CPA Competency: Audit and Assurance AACSB: Analytic

62. Which of the following would not be included in an auditor's permanent file? a) the client's organizational chart b) copies of long-term contracts c) copies of accounts receivable confirmation letters d) prior years' audit reports

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Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe how auditors document the details of evidence gathered in working papers.

Section Reference: 5.8 Documentation—audit working papers CPA Competency: Audit and Assurance AACSB: Analytic

63. During the risk response phase of the audit, an auditor will document a) details of audit tests undertaken. b) their understanding of their client. c) related parties identified. d) analytical procedures used to aid in risk identification.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe how auditors document the details of evidence gathered in working papers.

Section Reference: 5.8 Documentation—audit working papers CPA Competency: Audit and Assurance AACSB: Analytic

64. Which statement regarding audit working papers is correct? a) Working papers are used to document some of the details of each audit. b) Working papers may be in paper or electronic format. c) Working papers provide only the conclusion of the auditor, not all of the evidence of the work completed. d) All working papers from the year’s audit are kept in the permanent file.

Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe how auditors document the details of evidence gathered in working papers.

Section Reference: 5.8 Documentation—audit working papers CPA Competency: Audit and Assurance AACSB: Analytic 65. The current file of the auditor’s working papers does not include

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a) management letters detailing weaknesses in internal controls identified in the previous audit. b) extracts from the Board of Directors meetings. c) documentation of testing of subsequent events. d) details of the audit process.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe how auditors document the details of evidence gathered in working papers.

Section Reference: 5.8 Documentation—audit working papers CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

SHORT ANSWER QUESTIONS 66. Identify and explain the key assertions used for transactions and events, including income statement items, for an accounting period.

Answer: The key assertions for transactions and events are occurrence, completeness, accuracy, cut-off, classification, and presentation. When testing for occurrence, an auditor searches for evidence to verify that a recorded transaction or event, such as revenue or an expense item, took place and relates to the entity. When testing for completeness, an auditor searches for transactions or events and makes sure these have been recorded. When testing for accuracy, an auditor searches for evidence that transactions and events have been recorded at appropriate amounts. When testing for cut-off, an auditor searches for evidence that transactions have been recorded in the correct accounting period. When testing for classification, an auditor ensures that transactions and events have been recorded in the proper accounts. When testing for presentation, an auditor ensures that transactions and events are appropriately aggregated or disaggregated, clearly described, and related disclosures are relevant and understandable.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the audit assertions.

Section Reference: 5.1 Assertions CPA Competency: Audit and Assurance AACSB: Analytic

67. Indicate whether you agree or disagree with the following statements and explain your reasoning. a)

Paula Faconi has just completed a risk assessment and has identified key risk factors at Darwin Industries. When asked by one of her staff members “What’s next?”, she replies: “Now that we have identified the risks, its time to perform some planning in order to obtain sufficient appropriate audit evidence.”

b)

Roni Khali was assigned to the Inglis Glass Company audit. She was ensuring that when recognizing revenues, all transactions and events that should have been recorded have been recorded. She was testing the occurrence assertion.

c)

Harvey Jarvis, the group partner was reviewing the work of Jacob Barnes on the Bazzle Gold account. Jacob asked Harvey for an explanation on how audit risk would affect his work. Harvey answered: “Audit risk affects the quantity and quality of evidence gathering.”

d)

Benoit Chausson, CPA made the following true statement: “The appropriateness of audit evidence refers to its relevance and reliability.” He then added: (i) “Reliable information is logically connected to an assertion” (ii) “Relevant information reflects the true state of the information”

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Answer: a) Agree. Once an auditor has identified the key risk factors for their client, they will plan their audit to obtain sufficient appropriate audit evidence to ensure that relevant accounts and related disclosures are reported accurately. b)

Disagree. When testing for completeness (not occurrence), an auditor searches for transactions or events and makes sure these have been recorded. This assertion is particularly important when the auditor believes there is a risk of understatement and that some transactions or events that should have been recorded have not been recorded; for example, expenses incurred but not recorded to understate expenses and overstate profit.

c)

Agree. Audit risk affects the quantity and quality of evidence gathered by an auditor during the execution stage of the audit. When there is a significant risk that an account will be misstated, and the client's system of internal controls is not considered to be effective at reducing that risk, detection risk is set as low and more high-quality evidence is gathered when conducting substantive tests of that account.

d)

Disagree. Benoit mixed up his definitions of reliable and relevant information, as relevant information is logically connected to an assertion, and reliable information reflects the true state of the information.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the audit assertions.

Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Learning Objective: Describe the evidence-gathering procedures most often used by auditors.

Section Reference: 5.1 Assertions Section Reference: 5.2 Types of audit evidence Section Reference: 5.6 Evidence-gathering procedures CPA Competency: Audit and Assurance AACSB: Analytic

68. Describe the purpose and examples of external confirmations.

Answer: An external confirmation is sent directly by an auditor to a third party, who is asked to respond to the auditor on the matter(s) included in the confirmation letter. There are two broad types of external confirmations: positive and negative confirmations. Positive confirmations ask the recipient to reply in all circumstances. Negative confirmations ask the recipient to reply only if they disagree with the information provided. External confirmations can be sent to the client's bank, lawyers, lenders and debtors, and third parties holding the client's inventory. A bank confirmation letter is a request for information about the amount of cash held in the bank or in overdraft, details of any loans with the bank, details of any pledges of assets made to guarantee loans and interest rates charged. An external confirmation may be sent to a client's lawyer (legal confirmation) if the lawyer holds documents on behalf of the client that are of relevance to the audit. While rare, an external confirmation may be sent to a client's suppliers and lenders (payable confirmation) to confirm the details of amounts owed to creditors and significant loans.

External confirmations can be sent to debtors (receivable confirmation) to verify the receivables balance.

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Bloomcode: Application Difficulty: Medium Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

69. Explain the three broad categories of corroborating evidence.

Answer: There are three broad categories of corroborating evidence. The categories are internally generated evidence, externally generated evidence held by the client, and externally generated evidence sent directly to the auditor. Internally generated evidence held by the client includes records of cheques sent, copies of invoices and statements sent to customers, purchase orders, company documentation regarding policies and procedures, contracts, minutes of meetings, journals, ledgers, trial balances, spreadsheets, worksheets, reconciliations, calculations, and computations. Internally generated evidence is the least persuasive as it can only be used to verify that a client has accurately converted this information into the financial statements. Externally generated evidence held by the client includes supplier invoices and statements, customer orders, bank statements, contracts, lease agreements, and tax assessments. These sources of evidence are quite persuasive as they are produced by third parties, however it is possible that the client can manipulate these documents, which reduces their reliability to the auditor. Externally generated evidence sent directly to the auditor includes bank confirmations, accounts receivable confirmations, correspondence with the client's lawyers, including confirmations and representations, and expert valuations. These sources of evidence are considered to be the most reliable and best quality as they are independent of the client.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

70. Describe the major evidence-gathering procedures most often used by auditors.

Answer: The major evidence-gathering procedures are observation, enquiry, recalculation, reperformance, and analytical procedures. Observation involves watching a procedure being carried out by another party. Enquiry involves asking questions, verbally or in written form, to gain an understanding of various matters throughout the audit. Recalculation involves checking the mathematical accuracy of client records. Re-performance involves redoing processes conducted by the client. Analytical procedures are an evaluation of financial information by studying plausible relationships among both financial and non-financial data.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the evidence-gathering procedures most often used by auditors.

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Section Reference: 5.6 Evidence-gathering procedures CPA Competency: Audit and Assurance AACSB: Analytic

71. Explain the purpose of working papers and the difference between the permanent file and current file.

Answer: Working papers provide a record of the audit work completed and evidence gathered in forming their audit opinion. Working papers are used to document the details of each audit. The two main files held for each client are the permanent file and the current file. The permanent file includes documents that pertain to a client for more than one audit. These will include copies of long-term contracts and agreements, a client's organizational chart, and details of the client's board directors and its subcommittees.

The current file includes the details of work completed and evidence gathered that relate to the current audit. This includes correspondence between the auditor and their client, and their client's bankers and lawyers that pertain to the current audit period, as well as extracts from the minutes of meetings, such as the board of directors' meetings, which pertain to the current audit.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe how auditors document the details of evidence gathered in working papers.

Section Reference: 5.8 Documentation—audit working papers CPA Competency: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 72. Audit evidence is the information that an auditor uses when arriving at their opinion on the fair presentation of their client's financial statements. Why is evidence so important to a financial statement audit?

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

73. CAS 501 Audit Evidence - Specific Considerations for Specific Items requires an auditor to gather sufficient appropriate audit evidence regarding any legal matters involving their client.

How can auditors gather such evidence and what impact can legal matters have on the client's financial statements?

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify and describe different types of audit evidence and assess sufficient appropriate audit evidence.

Section Reference: 5.2 Types of audit evidence CPA Competency: Audit and Assurance AACSB: Analytic

74. CAS 620 Using the Work of an Auditor's Expert provides guidelines for auditors when using the work of an expert. Identify examples of situations where auditors may use experts and evaluate the benefits and risks associated in each situation.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the issues to consider when using the work of an expert.

Section Reference: 5.4 Using the work of an expert CPA Competency: Audit and Assurance AACSB: Analytic

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CASE QUESTION 75. Nazim Kali, the auditor-in-charge of Valo, a Brazilian mining company, was reviewing the expert’s report on the valuation of reserves for the world’s largest bauxite deposits. The mining plans of Valo have met with strong criticism from scientists, environmentalists, and the Brazilian population.

The bauxite operations had required the use of local auditors of another international public accounting firm. The group engagement partner, Lori Lake, met with Nazim to discuss the reliance their firm would be placing on the component auditors. She was concerned that the component auditor’s conclusions were not based on adequate evidence. The bauxite operations being audited by the component auditors are a material part of the consolidated statements of Valo.

Required: a) What role does Nazim have in assessing the expert’s report on the bauxite deposits? b) What role does Nazim and his firm have before they make a decision to use the work of another auditor? c) What is the engagement partner’s role once her firm has assigned the work to a component auditor?

Answer: a) It is important that an expert's report be written in such a way that an auditor, who is not an expert in the field being reported on, can understand the technical content of the report.

The report should detail each stage of the process used in arriving at the overall opinion or conclusion of the report. It should include information about the data sources or estimation models used, or calculations conducted. The auditor assesses the appropriateness of the data sources used — it is essential that the expert uses data sources that are reputable and reliable. The auditor assesses the consistency of any assumptions made with those made in prior years and with other known information. The auditor assesses the consistency of information included in the expert's report with their understanding of the client. Finally, the auditor assesses the consistency of the conclusions drawn with corroborating evidence gathered by the audit team. b)

When making a client acceptance or continuance decision, an auditor such as Nazim will consider their capacity to undertake the audit. The primary auditors should also consider the proportion of the financial statements for which they will have to rely on another auditor (component auditor). The group engagement partner's firm should audit the majority of a client's financial statements and be knowledgeable about the components of the financial statements that they do not audit themselves. If this is not the case, the firm should not accept or continue to audit the client.

When assigning work to a component auditor, the group engagement partner will consider the capacity of the other auditor to undertake the work. The group engagement partner will also consider the reputation of the component auditor and ensure that they are a member of a reputable professional body. It is the responsibility of the group engagement partner to ensure that the work completed by a component auditor meets the group engagement partner's requirements and standards.

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Auditing: A Practical Approach, Fourth Canadian Edition

CAS 600 sets out the responsibilities of the group engagement partner when using the work of a component auditor. The group engagement partner sets out the work to be conducted by a component auditor. The two auditors may discuss the detailed procedures to be used and the group engagement partner then reviews the main conclusions drawn in the working papers of the component auditor. The extent of review of the component auditor's work depends on a number of factors. The group engagement partner will have to spend more time because the component of the client's financial statements being audited by a component auditor is material and/or at risk of material misstatement. The group engagement partner will spend less time if the component auditor has a good reputation and/or has done audit work for the group engagement partner in the past.

The group engagement partner uses the evidence provided by a component auditor when drawing a final conclusion on the fair presentation of a client's financial statements. The findings of a component auditor on a component of the financial statements will be placed in the context of the audit as a whole. If the group engagement partner is concerned about the conclusions arrived at by a component auditor, they will discuss the findings with the component auditor. They may also discuss the implications of those findings with those charged with governance at the client to gain a more complete understanding of the component of the financial statements audited by the component auditor. If the group engagement partner decides that the conclusions arrived at by the component auditor indicate a material misstatement in the component audited, the group engagement partner will consider issuing a modified audit opinion if the impact of the misstatement is material to the financial statements taken as a whole.

Because the group engagement partner, Lori Lake is concerned that the component auditor has not been able to gather sufficient appropriate audit evidence regarding the component of the financial statements audited, she will ask that further evidence be gathered. If the component auditor cannot access sufficient evidence, Lori Lake will consider issuing a modified audit opinion due to a scope limitation. This will occur when the group engagement partner is unable to obtain additional evidence on the elements of the component audited by a component auditor.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Explain the issues to consider when using the work of an expert.

Learning Objective: Explain the issues to consider when using the work of another auditor.

Section Reference: 5.4 Using the work of an expert Section Reference: 5.5 Using the work of another auditor CPA Competency: Audit and Assurance AACSB: Analytic

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LEGAL NOTICE Copyright © 2021 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under license and may be used only in accordance with the terms of such license.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 6 SAMPLING AND OVERVIEW OF THE RISK RESPONSE PHASE OF THE AUDIT CHAPTER LEARNING OBJECTIVES 1. Explain how audit sampling is used in an audit.

When creating an audit plan and designing audit procedures, an auditor also decides how to select appropriate items for testing. When there are numerous transactions or items within an account balance available for testing, an auditor must decide how best to select a sample that is representative of the entire population of items available for testing.

2. Understand the difference between sampling and non-sampling risk.

Sampling risk is the risk that the sample chosen by the auditor is not representative of the population of transactions or items within an account balance available for testing and, as a consequence, the auditor arrives at an inappropriate conclusion. Non-sampling risk is the risk that an auditor arrives at an inappropriate conclusion for a reason unrelated to sampling issues, such as using an inappropriate audit procedure.

3. Differentiate between statistical and non-statistical sampling.

Statistical sampling involves random selection and probability theory to evaluate the results.

Non-statistical sampling is any sample selection method that does not have these characteristics.

4. Describe sampling methods and the factors to be considered when choosing a sample.

Sampling methods include random selection, systematic selection, haphazard selection, block selection, and judgemental selection. Before selecting a sample, an auditor will set parameters pertaining to control and detection risk, planning materiality, population, tolerable error rate, and the required level of confidence. Once these parameters are set, an auditor may select a sample using a statistical or non-statistical sampling technique.

5. Determine the factors that influence the sample size when testing controls.

When testing controls, the factors that influence the sample size include the extent to which the risk of material misstatement is reduced by the operating effectiveness of controls, the rate of deviation from the prescribed control activity that the auditor is willing to accept, the rate of deviation from the prescribed control activity that the auditor expects to find in the population, the auditor’s required confidence level, and the number of sampling units in the population.

6. Determine the factors that influence the sample size when doing substantive testing and consider techniques used to perform substantive tests.

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Auditing: A Practical Approach, Fourth Canadian Edition

When conducting substantive testing of transactions and balances, the factors that influence the sample size include the auditor’s assessment of the risk of material misstatement, the use of other substantive procedures directed at the same assertion, the auditor’s required confidence level, the tolerable error, the amount of error the auditor expects to find in the population, the stratification of the population, and the number of sampling units in the population.

Two main techniques are applied when the auditor is performing substantive tests and deciding how much of a balance to test. These are (1) key item testing, and (2) representative sampling.

7. Outline how to evaluate the results of tests conducted on a sample.

When testing controls, the auditor will compare the rate of deviation with the tolerable rate of deviation and determine whether they believe that the control tested is effective in preventing and/or detecting a material misstatement. When testing transactions and balances, the error in the sample will be projected onto the population and then compared to the tolerable error rate.

The auditor will then determine whether the class of transactions or account balance being tested appears to be materially misstated.

8. Understand the difference between tests of controls and substantive tests.

The purpose of tests of controls is to assess the effectiveness of a client’s system of internal controls throughout the accounting period being audited. The purpose of substantive testing is to gather direct evidence that the financial statements are free from material misstatement.

9. Explain the factors that impact the nature, timing, and extent of audit testing.

The nature of audit testing refers to the purpose of the test and the procedure used. The timing of audit testing refers to the stage of the audit when procedures are performed and the date, such as within or outside the accounting period, that audit evidence relates to. The extent of audit testing refers to the amount of audit evidence gathered when testing controls and conducting detailed substantive procedures.

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TRUE-FALSE STATEMENTS 1. Sampling is required when an audit procedure is tested on an entire group of transactions or all items within an account balance.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how audit sampling is used in an audit.

Section Reference: 6.1 Audit sampling CPA Competency: Audit and Assurance AACSB: Analytic

2. Sampling risk is the risk that the sample chosen by the auditor is not representative of the population available for testing.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between sampling and non-sampling risk.

Section Reference: 6.2 Sampling and non-sampling risk CPA Competency: Audit and Assurance AACSB: Analytic

3. The risk that the auditor concludes that a material misstatement exists when it does not is likely to result in an increase in audit effort when it is not required.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between sampling and non-sampling risk.

Section Reference: 6.2 Sampling and non-sampling risk CPA Competency: Audit and Assurance AACSB: Analytic

4. Non-statistical sampling involves random selection and probability theory to evaluate the results.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Differentiate between statistical and non-statistical sampling.

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Section Reference: 6.3 Statistical and non-statistical sampling CPA Competency: Audit and Assurance AACSB: Analytic

5. Stratification is when an auditor selects a sample for testing by dividing the number of population items by the sample size, resulting in the sampling interval.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.4 Sampling techniques and factors affecting sampling CPA Competency: Audit and Assurance AACSB: Analytic

6. Block selection involves the selection of items that are grouped together within the population of items available.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.4 Sampling techniques and factors affecting sampling CPA Competency: Audit and Assurance AACSB: Analytic

7. Tolerable error is the minimum error an auditor is willing to accept within the population tested.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.4 Sampling techniques and factors affecting sampling CPA Competency: Audit and Assurance AACSB: Analytic

8. Stratification of the population will result in less efficient sampling and increase the sample size required.

Answer: False

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.4 Sampling techniques and factors affecting sampling CPA Competency: Audit and Assurance AACSB: Analytic

9. An increase in the number of sampling units in the population will result in a decrease in the sample size.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Determine the factors that influence the sample size when testing controls.

Section Reference: 6.5 Factors that influence the sample size—testing controls CPA Competency: Audit and Assurance AACSB: Analytic

10. When auditors conclude that an internal control is effective, they will rely on the control to prevent and detect a material misstatement and reduce their detailed substantive procedures.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Determine the factors that influence the sample size when substantive testing and consider techniques used to perform substantive tests.

Section Reference: 6.6 Factors that influence the sample size—substantive testing CPA Competency: Audit and Assurance AACSB: Analytic

11. When conducting substantive testing, an increase in the auditor's assessment of the risk of material misstatement will result in an increase in the size of the sample.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Determine the factors that influence the sample size when substantive testing and consider techniques used to perform substantive tests.

Section Reference: 6.6 Factors that influence the sample size—substantive testing CPA Competency: Audit and Assurance AACSB: Analytic

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12. Projected error refers to the extrapolation of the errors detected when testing a sample to the population from which the sample was drawn.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Outline how to evaluate the results of tests conducted on a sample.

Section Reference: 6.7 Evaluating sample test results CPA Competency: Audit and Assurance AACSB: Analytic

13. An audit plan includes the audit procedures to be used when testing controls and when conducting detailed substantive audit procedures.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

14. Tests of controls are audit procedures designed to evaluate the operating effectiveness in detecting detect material misstatements at the assertion level.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

15. The timing of audit testing refers to the stage of the audit when procedures are performed and the date that audit evidence relates to.

Answer: True Bloomcode: Knowledge Difficulty: Medium Learning Objective: Explain the factors that impact the nature, timing, and extent of audit testing.

Section Reference: 6.9 Nature, timing, and extent of audit testing CPA Competency: Audit and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 16. Sampling is not required when a) it is the first year that the auditor has done the audit for a client. b) the auditor is conducting tests of controls. c) an audit procedure is conducted on an entire group of transactions. d) the client requests the auditor not to collect samples of certain transactions.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how audit sampling is used in an audit.

Section Reference: 6.1 Audit sampling CPA Competency: Audit and Assurance AACSB: Analytic

17. Christian Hardy was explaining to his junior staff the implications of sampling risk when conducting substantive testing. He made the following two statements: (i) “If we conclude that a material misstatement does not exist when it does, then we have an increased control risk.” (ii) “If we conclude that a material misstatement exists when it does not we have an inefficient audit.”

Which statements, if any, were true? a) (i) only b) (ii) only c) both (i) and (ii) d) neither (i) or (ii) Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between sampling and non-sampling risk.

Section Reference: 6.2 Sampling and non-sampling risk CPA Competency: Audit and Assurance AACSB: Analytic

18. Non-sampling risk arises when an auditor a) does not use sampling. b) uses an inappropriate audit procedure. c) tests all of the items in a population. d) spends too much time testing the accounts most at risk of material misstatement.

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Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between sampling and non-sampling risk.

Section Reference: 6.2 Sampling and non-sampling risk CPA Competency: Audit and Assurance AACSB: Analytic

19. Sampling risk for tests of controls is when a) audit risk is reduced. b) an auditor concludes that the audit client’s internal control system is effective when it is not. c) an auditor concludes that material misstatements exist when they do not. d) audit risk is increased.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between sampling and non-sampling risk.

Section Reference: 6.2 Sampling and non-sampling risk CPA Competency: Audit and Assurance AACSB: Analytic

20. Non-sampling risk is the risk that a) an auditor selects an appropriate method to select a sample. b) an auditor reaches an inappropriate conclusion for any reason not related to sampling risk. c) the sample chosen is not representative of the whole population. d) none of the above Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between sampling and non-sampling risk.

Section Reference: 6.2 Sampling and non-sampling risk CPA Competency: Audit and Assurance AACSB: Analytic

21. The risk that an auditor concludes that a material misstatement does not exist when it does will result in a(n) a) increased risk that the audit will not be effective. b) increased risk that the audit will be inefficient. c) increase in the auditor’s assessment of the risk of material misstatement.

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d) decreased reliance on internal controls.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between sampling and non-sampling risk.

Section Reference: 6.2 Sampling and non-sampling risk CPA Competency: Audit and Assurance AACSB: Analytic

22. When testing controls, non-sampling risk is the risk that an auditor a) designs tests that are ineffective. b) does not select a sample. c) both a and b d) none of the above Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between sampling and non-sampling risk.

Section Reference: 6.2 Sampling and non-sampling risk CPA Competency: Audit and Assurance AACSB: Analytic

23. When testing controls, sampling risk is the risk that the auditor a) concludes that their client's internal controls are ineffective when they are effective. b) concludes that their client's internal controls are effective when they are ineffective. c) both a and b d) none of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between sampling and non-sampling risk.

Section Reference: 6.2 Sampling and non-sampling risk CPA Competency: Audit and Assurance AACSB: Analytic

24. Which of the following statements regarding statistical sampling is correct? a) It is easier to use than non-statistical sampling. b) It involves haphazard selection. c) It is generally used for low-risk accounts.

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d) It involves random selection.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between statistical and non-statistical sampling.

Section Reference: 6.3 Statistical and non-statistical sampling CPA Competency: Audit and Assurance AACSB: Analytic

25. Which of the following is not an advantage of non-statistical sampling? a) It allows an auditor to select a sample that they believe is appropriate. b) It allows an auditor to measure sampling risk. c) It is lower cost than statistical sampling. d) It requires less staff training.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between statistical and non-statistical sampling.

Section Reference: 6.3 Statistical and non-statistical sampling CPA Competency: Audit and Assurance AACSB: Analytic

26. Which of the following statements about statistical sampling is incorrect? a) Statistical sampling involves the use of random selection. b) Statistical sampling uses probability theory to evaluate results. c) Statistical sampling allows for the measurement of sampling risk. d) Statistical sampling is simple to use.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between statistical and non-statistical sampling.

Section Reference: 6.3 Statistical and non-statistical sampling CPA Competency: Audit and Assurance AACSB: Analytic

27. Which of the following best describes the concept of key item testing? a) the selection of items that are grouped together within the population of items available b) the proportion of items tested that did not conform to the client’s prescribed control procedure c) focus is on selecting the largest transactions within a balance to obtain coverage of the total

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d) the selection of items that an auditor believes should be included in the sample for testing Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Differentiate between statistical and non-statistical sampling.

Section Reference: 6.3 Statistical and non-statistical sampling CPA Competency: Audit and Assurance AACSB: Analytic

28. Olivier Beauchemain did not perform a true sample when he went to his client to examine sales invoices. He did not use any specific method for choosing the invoices. He let his eye catch the items he thought might make up his sample. What technique did he use? a) random selection b) block selection c) haphazard selection d) stratified sample selection Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.4 Sampling techniques and factors affecting sampling CPA Competency: Audit and Assurance AACSB: Analytic

29. George Melkonian wanted to determine whether his auditing class knew how different factors influence sample size. He made two statements: (i) “An increase in the expected rate of deviation of the population to be tested will decrease sample size.” (ii) “An increase in the tolerable rate of deviation will decrease sample size.”

George asked his class to indicate which of the statements, if any, were false. a) (i) only b) (ii) only c) both (i) and (ii) d) neither (i) nor (ii) Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

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Auditing: A Practical Approach, Fourth Canadian Edition

Section Reference: 6.4 Sampling techniques and factors affecting sampling CPA Competency: Audit and Assurance AACSB: Analytic

30. Random selection involves a) dividing a population into groups of sampling units with similar characteristics. b) the selection of a sample without the use of a methodical technique. c) the selection of a sample that is free from bias and where each item in a population has an equal chance of selection. d) the selection of items that an auditor believes should be included in their sample for testing.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.4 Sampling techniques and factors affecting sampling CPA Competency: Audit and Assurance AACSB: Analytic

31. Which sampling method involves the selection of items that are grouped together within the population of items available? a) systematic selection b) haphazard selection c) random selection d) block selection Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.4 Sampling techniques and factors affecting sampling CPA Competency: Audit and Assurance AACSB: Analytic

32. When testing controls, the tolerable error is a) the tolerable rate of deviation that an auditor will accept before concluding that a control is effective. b) the minimum rate of deviation that an auditor will accept. c) the tolerable rate of deviation that an auditor will accept before concluding that a control is ineffective.

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d) the maximum amount of error in an account balance that an auditor will accept before concluding that an account is materially misstated.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.4 Sampling techniques and factors affecting sampling CPA Competency: Audit and Assurance AACSB: Analytic

33. Which of the following statements is incorrect? a) When detection risk is set as high, an auditor will require a high level of confidence that the transactions and accounts are not materially misstated. b) An auditor may decide to stratify the population before selecting a sample from it. c) An auditor will use professional judgement to determine the tolerable error and required level of confidence. d) An auditor will use professional judgement when considering what would be considered an error within the population tested.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.4 Sampling techniques and factors affecting sampling CPA Competency: Audit and Assurance AACSB: Analytic

34. Before selecting a sample, an auditor will use professional judgement to a) set the required level of confidence. b) set the tolerable error rate. c) select an appropriate population for testing. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.4 Sampling techniques and factors affecting sampling CPA Competency: Audit and Assurance AACSB: Analytic

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35. Which of the following is a factor that influences the sample size when testing controls? a) an increase in the auditor's assessment of the risk of material misstatement b) an increase in the tolerable rate of deviation c) stratification of the population when appropriate d) an increase in tolerable misstatement Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Determine the factors that influence the sample size when testing controls.

Section Reference: 6.5 Factors that influence the sample size—testing controls CPA Competency: Audit and Assurance AACSB: Analytic

36. When testing controls, a decrease in the sample size will occur when there is a) an increase in the tolerable rate of deviation. b) a decrease in the tolerable rate of deviation. c) an increase in the extent to which the auditor's risk assessment takes into account relevant controls. d) an increase in the number of sampling units in the population.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Determine the factors that influence the sample size when testing controls.

Section Reference: 6.5 Factors that influence the sample size—testing controls CPA Competency: Audit and Assurance AACSB: Analytic

37. What impact will there be on sample size when there is an increase in the number of sampling units in the population? a) increase b) decrease c) negligible d) may increase or decrease depending on the total dollar value Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Determine the factors that influence the sample size when testing controls.

Section Reference: 6.5 Factors that influence the sample size—testing controls

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CPA Competency: Audit and Assurance AACSB: Analytic

38. Which of the following factors decreases sample size in tests of controls? a) an increase in the expected deviation rate in the population b) an increase in the extent to which an auditor’s risk assessment takes into account internal controls c) an increase in the number of sampling units in the population d) an increase in the tolerable deviation rate Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Determine the factors that influence the sample size when testing controls.

Section Reference: 6.5 Factors that influence the sample size—testing controls CPA Competency: Audit and Assurance AACSB: Analytic

39. When conducting substantive testing, which of the following is not a factor that influences the sample size? a) an increase in the tolerable rate of deviation b) an increase in the auditor's assessment of the risk of material misstatement c) stratification of the population when appropriate d) an increase in tolerable misstatement Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Determine the factors that influence the sample size when substantive testing and consider techniques used to perform substantive tests.

Section Reference: 6.6 Factors that influence the sample size—substantive testing CPA Competency: Audit and Assurance AACSB: Analytic

40. What impact will there be on sample size for substantive testing when there is an increase in the tolerable misstatement? a) decrease b) negligible c) increase d) no impact as the level of tolerable misstatement refers to the sample size for testing controls Answer: a

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Determine the factors that influence the sample size when substantive testing and consider techniques used to perform substantive tests.

Section Reference: 6.6 Factors that influence the sample size—substantive testing CPA Competency: Audit and Assurance AACSB: Analytic

41. An account is at a higher risk of misstatement when it requires a) complex calculations. b) estimation. c) both a and b d) simple valuation techniques.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline how to evaluate the results of tests conducted on a sample.

Section Reference: 6.7 Evaluating sample test results CPA Competency: Audit and Assurance AACSB: Analytic

42. When evaluating sample test results, which of the following statements is incorrect? a) If an auditor discovers errors when testing transactions or account balances, they will need to project the error to the population being tested. b) An auditor will not consider whether the population was stratified before being sampled. c) If an error is considered to be unique, it will be removed before projecting remaining errors to the population. d) If the rate of deviation exceeds the tolerable rate, the auditor will extend their testing.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline how to evaluate the results of tests conducted on a sample.

Section Reference: 6.7 Evaluating sample test results CPA Competency: Audit and Assurance AACSB: Analytic

43. If the total projected error in an account balance was $3,248 and the tolerable error was set at $10,000, the auditor would a) conclude that the errors uncovered are material. b) decide that further audit work was required. c) conclude that the errors detected are not material.

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d) conduct other tests aimed at the assertion being tested.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Outline how to evaluate the results of tests conducted on a sample.

Section Reference: 6.7 Evaluating sample test results CPA Competency: Audit and Assurance AACSB: Analytic 44. Where an auditor concludes that the audit client’s systems of internal controls are ineffective, he/she will a) conclude that the client’s system of internal controls can be relied upon to detect potential material misstatements. b) conclude that the client’s system of internal controls cannot be relied upon to detect potential material misstatements. c) reduce the amount of reliance to be placed on substantive tests. d) project the misstatements to the entire population.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline how to evaluate the results of tests conducted on a sample.

Section Reference: 6.7 Evaluating sample test results CPA Competency: Audit and Assurance AACSB: Analytic

45. When errors are discovered upon testing transactions or account balances, the auditor will a) project the error to the entire population, if possible. b) assess if the errors constitute an isolated event. c) consider the impact of the errors. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline how to evaluate the results of tests conducted on a sample.

Section Reference: 6.7 Evaluating sample test results CPA Competency: Audit and Assurance AACSB: Analytic

46. Gisele James, the senior on the audit of Magna International, was explaining how audit strategy and audit plans have an impact on tests of controls and substantive procedures. She

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made two statements: (i) Audit strategy details the audit procedures to be used when testing controls and when conducting detailed substantive audit procedures. (ii) The audit plan provides the basis for developing an audit strategy.

Which statements were true, if any? a) (i) only b) (ii) only c) both (i) and (ii) d) neither (i) or (ii) Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

47. Henrietta Lombardi assessed control risk to be low. What is the appropriate audit strategy to adopt? a) substantive audit approach b) control testing strategy c) combined audit strategy d) substantive year-end testing Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

48. Anthony DiPietro was testing the controls of Blue Coast Wholesale Fish Market. When testing controls, which one of the following evidence-gathering procedures is used?

a) vouching of transactions for proper valuation b) confirmations of accounts receivable c) tracing of transactions to source documents to ensure existence d) inquiry of client personnel Answer: d

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

49. Michael Fernandez has decided to perform substantive procedures at a major retailer.

Which one of the following is not a substantive procedure? a) re-performing control procedures to test their effectiveness b) inspecting documents to verify the dates of the transactions c) bank confirmations regarding interest rates on borrowings by client d) recalculating an interest expense using confirmed interest rates Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

50. Kenneth Beach wanted to ensure that all the transactions at his client were recorded.

For which assertion was he conducting these detailed substantive procedures? a) occurrence b) completeness c) cut-off d) accuracy Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

51. Jasmeet Kaur, who was representing her CPA firm at a conference, made the following statement about assertions: When our auditors conduct substantive procedures, we search for evidence that recorded accounts exist and that all accounts that should have been recorded, indeed have been recorded. Which assertions was she talking about? a) rights and obligations b) accuracy, valuation, and allocation

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c) occurrence and completeness d) presentation and completeness Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

52. Corey Hill used analytical procedures at his client, Ultimate Vacations. Which one of these is not an analytical procedure? a) Send confirmations to major customers. b) Estimate revenue for Ultimate Vacations by multiplying trips sold by average price of vacation packages. c) Discuss unusual fluctuations with client personnel. d) Compare wages month by month for this year and last year.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

53. David Killbear has been involved in testing controls at Highbridge Falls. Which of these control tests would be deemed ineffective? a) reading a client’s policy manual b) entering invalid passwords to see whether access is denied c) inspecting documents for proper authorization d) observing an employee performing a bank deposit Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

54. Olivia Peralta was training a team of new auditors and delivered some interesting rules of

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thumb about control risk and detection risk: (i) “The required level of confidence is a function of control risk when testing controls and detection risk when conducting substantive tests.” (ii) “When detection risk is determined to be low, an auditor will require a low level of confidence that the transactions and accounts are not materially misstated.”

Which of the above two statements are true? a) (i) only b) (ii) only c) both (i) and (ii) d) neither (i) nor (ii) Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

55. Control risk is the risk that: a) an auditor expresses an inappropriate audit opinion when a financial statement is materially misstated. b) an auditor's substantive procedures will not detect material misstatements. c) a client's system of internal controls will not prevent or detect a material misstatement. d) the client’s transactions are at a high risk of material misstatement Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

56. Tests of controls are conducted to establish that a) controls operate consistently throughout the period. b) there are no material misstatements in the financial statements. c) controls operate effectively. d) both a and c Answer: d Bloomcode: Comprehension

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Auditing: A Practical Approach, Fourth Canadian Edition

Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

57. When conducting detailed substantive procedures, auditors search for evidence that a) the client's internal control system is operating effectively. b) all transactions have been recorded in the correct accounts. c) no fraud has occurred during the year. d) they have remained independent of their clients.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

58. Substantive audit procedures do not include a) detailed tests of balances. b) analytical procedures. c) detailed tests of transactions. d) tests of controls.

Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

59. When control risk is high, the audit strategy is to a) do little or no tests of controls and increase reliance on substantive testing of transactions and account balances. b) assume the client's management is dishonest and immediately report them to the Canada Revenue Agency (CRA). c) increase reliance on tests of controls and reduce reliance on substantive testing of transactions and account balances. d) refuse to continue with the remainder of the audit due to the high risk of fraud.

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Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

60. Tests of controls are conducted to a) make an assessment of detection risk. b) assess if controls are operating effectively and efficiently throughout the year. c) determine how the internal controls operate. d) gain knowledge of the methods and procedures the entity uses to record transactions.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

61. Which assertion does the objective that transactions and events have been recorded in the correct accounting period relate to? a) cut-off b) completeness c) accuracy d) classification Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

62. Which audit objective does the recalculation of the wages payable amount address? a) rights and obligations b) completeness c) accuracy, valuation, and allocation d) classification

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Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

63. Which audit assertion does the audit procedure of obtaining a confirmation from selected accounts receivable of amounts owed to the audit client relate to? a) existence b) classification c) accuracy d) completeness Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

64. Substantive procedures or tests can be described as a) procedures to detect all errors in the accounts. b) audit procedures to detect material misstatements at the assertion level. c) procedures to assess audit risk. d) audit procedures to evaluate the operating effectiveness of internal controls.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

65. For high-risk accounts, the timing of most audit procedures will be a) whenever the client says it is most convenient for them to be conducted. b) at, or after, year-end. c) before year end.

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d) during the interim audit testing stage.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the factors that impact the nature, timing, and extent of audit testing.

Section Reference: 6.9 Nature, timing, and extent of audit testing CPA Competency: Audit and Assurance AACSB: Analytic

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SHORT ANSWER QUESTIONS 66. Explain sampling risk as it relates to both tests of controls and substantive procedures.

Answer: Sampling risk is the risk that the sample chosen by the auditor is not representative of the population of transactions or items within an account balance available for testing and, as a consequence, the auditor arrives at an inappropriate conclusion. When testing controls, sampling risk is the risk that an auditor relies on their client's system of internal controls when they should not do so (that is, the auditor concludes that their client's internal controls are effective when they are ineffective), and the risk that an auditor concludes that their client's internal controls are less reliable than they really are (that is, the auditor concludes that their client's internal controls are ineffective when they are effective). When conducting substantive tests, sampling risk is the risk that an auditor concludes that a material misstatement does not exist when it does or an auditor concludes that a material misstatement exists when it does not.

Bloomcode: Application Difficulty: Medium Learning Objective: Understand the difference between sampling and non-sampling risk.

Section Reference: 6.2 Sampling and non-sampling risk CPA Competency: Audit and Assurance AACSB: Analytic

67. Indicate whether you agree or disagree with the following statements and explain your reasoning. a)

Helen Holt was explaining to her group partner that the completeness assertion implies that transactions and events that have been recorded have occurred and pertain to the entity.

b)

Keith Lake was explaining to Ben Fitz how sampling risk works for the audit team: “Sampling risk is the risk that as auditors we will arrive at a conclusion that has nothing to do with sampling issues.”

c)

Larry Baneiro was vehemently arguing about the benefits of using non-statistical versus statistical sampling methods for a client in the excavation business. Here is what he had to say about non-statistical sampling: “Non-statistical sampling is easier to use than statistical sampling, it requires less staff training, it has lower cost, and it allows an auditor to make a sample choice that they believe is appropriate.”

d)

Georgia Walters has started her sample selection of sales transactions for a gemstone conglomerate. She believes that she can improve audit efficiency by stratifying the sample.

Answer: a) Disagree. The occurrence assertion implies that transactions and events that have been recorded have occurred and pertain to the entity. The completeness objective infers that all transactions that should have been recorded, indeed have been recorded. b)

Disagree. Keith Lake was describing non-sampling risk. Sampling risk is the risk that the sample chosen is not suitable and the auditor arrives at an inappropriate conclusion.

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c)

Agree. All the elements Larry brings up are generally true. Statistical sampling can have the disadvantage of the cost involved in using it. Most audit firms use a combination of statistical and non-statistical sampling as both methods provide appropriate audit evidence and allow the auditor to form a conclusion on the items being tested.

d)

Agree. Stratification can be used ahead of random selection to improve audit efficiency.

This means that an auditor partitions a population ahead of sampling, by identifying sub populations with similar characteristics. For example, for accounts receivable, the auditor may stratify high dollar items or balances that are overdue. After stratifying a population, items can be randomly selected within each stratum. Thus, stratification can be used to ensure the sample includes items that have the characteristics required by the auditor, such as the inclusion of material or risky items in the sample, while remaining a statistical sampling technique, when items are randomly selected.

Bloomcode: Application Difficulty: Medium Learning Objective: Understand the difference between sampling and non-sampling risk.

Learning Objective: Differentiate between statistical and non-statistical sampling.

Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.2 Sampling and non-sampling risk Section Reference: 6.3 Statistical and non-statistical sampling Section Reference: 6.4 Sampling techniques and factors affecting sampling Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

68. Describe the major types of sampling techniques available to auditors.

Answer: There are a range of sampling techniques available to auditors which include random selection, systematic selection, haphazard selection, block selection, and judgement selection.

Random selection requires that the person selecting the sample does not influence the choice of items selected. The resulting sample is then free from bias and each item within the population has an equal chance of being selected for testing. Random number generators can be used to select a sample. Systematic selection involves the selection of a sample for testing by dividing the number of items in a population by the sample size, resulting in the sampling interval (n). Once the sampling interval has been determined, a starting point is selected, which is an item in the population below the sampling interval, and then the sample is selected by selecting the first item and then every nth item after that. Haphazard selection involves the selection of a sample by an auditor without using a methodical technique. Block selection involves the selection of items that are grouped together within the population of items available.

Judgemental selection involves the selection of items that an auditor believes should be included in their sample for testing. For example, when testing controls, judgement may be used to ensure that transactions processed when a new computer is installed are included in the sample. When conducting substantive testing, judgement may be used to include in the sample large or unusual items.

Bloomcode: Application

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Difficulty: Medium Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.4 Sampling techniques and factors affecting sampling CPA Competency: Audit and Assurance AACSB: Analytic

69. Identify and explain the factors that influence the sample size for tests of controls.

Answer: There are a number of factors that will influence the sample size when testing controls.

The first factor is an increase in the extent to which the risk of material misstatement is reduced by the operating effectiveness of controls. If an auditor believes that a control will be effective in reducing an identified risk of material misstatement, their audit strategy will be to increase testing of that control to ensure it is effective. When concluding that a control is effective, an auditor will rely on that control to prevent and detect a material misstatement, and reduce their detailed substantive procedures. The second factor is an increase in the rate of deviation from the prescribed control activity that the auditor is willing to accept. There is an inverse relationship between the tolerable rate of deviation and sample size. If an auditor intends to rely on a control to prevent and detect a material misstatement, a lower tolerable error rate will be set and the sample size will be increased to provide the auditor with the evidence required to demonstrate that the control is effective. If an auditor expects to place relatively more reliance on their substantive procedures and reduce their reliance on an internal control, they will increase the tolerable rate of deviation and reduce the sample size when testing the control.

The third factor is an increase in the rate of deviation from the prescribed control activity that the auditor expects to find in the population. If an auditor believes that the rate of deviation has increased when compared to prior audits, they will increase the sample size to accurately evaluate the impact of the changed circumstances. The fourth factor is an increase in the auditor's required confidence level. When control risk is assessed as low for a risk factor, an auditor's required level of confidence in the effectiveness of their client's internal control is higher than when control risk is assessed as medium to high. If an auditor is to rely on their client's internal control procedures to prevent or detect an identified material misstatement, their required confidence level in that control increases and they will increase the sample size when testing that control. The fifth and final factor is an increase in the number of sampling units in the population. When a population is large and fairly homogenous, there is little benefit from continuing to increase the sample size as the results from continued testing should confirm early findings.

Bloomcode: Application Difficulty: Medium Learning Objective: Determine the factors that influence the sample size when testing controls.

Section Reference: 6.5 Factors that influence the sample size—testing controls CPA Competency: Audit and Assurance AACSB: Analytic

70. Explain how auditors evaluate the results of tests of controls conducted on a sample.

Answer: After an auditor has completed their audit testing, the next stage is to evaluate the results. When testing controls, an auditor will consider whether the results of their tests applied to a sample provide evidence that the control tested is effective within the entire population. If

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an auditor discovers departures from prescribed controls when testing controls, a deviation rate will be calculated. The deviation rate is the proportion of departures within the sample. If the sample is representative of the population, the auditor will compare this deviation rate with their tolerable rate of deviation. If the rate of deviation exceeds the tolerable rate, the auditor will extend their testing and gather further evidence of other controls that may be aimed at reducing the identified risk of material misstatement. If after conducting more testing the auditor finds that the rate of deviation remains consistent with their initial findings and other controls are similarly ineffective, the auditor will conclude that the client's system of internal controls cannot be relied upon to prevent or detect a potential material misstatement and the auditor will increase their reliance on their substantive tests of the account tested.

Bloomcode: Application Difficulty: Medium Learning Objective: Outline how to evaluate the results of tests conducted on a sample.

Section Reference: 6.7 Evaluating sample test results CPA Competency: Audit and Assurance AACSB: Analytic

71. Explain the differences between the main objectives of tests of controls and substantive procedures.

Answer: Tests of controls are conducted to establish that controls operate effectively, meaning that the rate of deviation from prescribed control procedures are minimized and controls effectively prevent and detect material misstatements, and operate consistently throughout the accounting period.

When conducting detailed substantive procedures, an auditor searches for evidence that recorded transactions occurred and relate to the client (occurrence assertion), that all transactions have been recorded (completeness assertion), that all transactions have been recorded at appropriate carrying amounts (accuracy assertion), that all transactions have been recorded in the correct accounting period (cut-off assertion), and that all transactions have been recorded in the correct accounts (classification assertion). Detailed substantive procedures also involve an auditor searching for evidence that recorded accounts such as assets, liabilities, and equity accounts exist (existence assertion), that all accounts that should have been recorded have been recorded (completeness assertion), that recorded accounts represent items owned by the client or amounts owed by the client to third parties (rights and obligations assertion), and that recorded accounts appear at appropriate carrying amounts (accuracy, valuation, and allocation assertion).

Bloomcode: Application Difficulty: Medium Learning Objective: Understand the difference between tests of controls and substantive tests.

Section Reference: 6.8 Tests of controls and substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic 72. CGA-CANADA AUDITING 1 EXAMINATION Dec 2001 — Question 2

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Explain the differences between attribute sampling and sampling for substantive testing purposes, in terms of the auditor’s purpose, the definition of exceptions, and the relevance of materiality to the techniques.

Answer: Attribute Sampling

Substantive Testing Sampling

Auditor purpose

It confirms whether or not control objectives are met in order to assess control risk, but provides no direct evidence about financial statements

It provides direct substantive evidence for financial statement assertions

Definition of exceptions

An error is the failure to apply a control procedure. It is a “yes or no” determination that results in an exception rate.

An error is where a transaction is recorded in the wrong amount or to the wrong account. It can be quantified in monetary terms.

It is often described with reference to materiality.

Materiality

Materiality is not relevant. It is the tolerable deviation rate that is used to evaluate results.

The aggregate and projected monetary errors must be considered in light of materiality (as both quantitatively and qualitatively defined). They may be quantified as a “tolerable misstatement.”

Source: Question 2, CGA-CANADA AUDITING 1 EXAMINATION, Dec 2001. ©2015 CPA Canada. This item is reproduced here for your use with the permission of the Chartered Professional Accountants of Canada. It should not be copied or distributed in any form as this would cause an infringement of Chartered Professional Accountants of Canada's copyright.

Bloomcode: Application Difficulty: Medium Learning Objective: Determine the factors that influence the sample size when substantive testing and consider techniques used to perform substantive tests.

Section Reference: 6.6 Factors that influence the sample size—substantive testing CPA Competency: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 73. A range of sampling techniques are available to auditors. Evaluate the advantages and disadvantages of the major techniques.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.3 Statistical and non-statistical sampling CPA Competency: Audit and Assurance AACSB: Analytic

74. The most common statistical sample selection method according to the study by Hall et al (2002) is dollar-unit sampling. Explain in detail how this method operates and evaluate the advantages and disadvantages of using it.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Section Reference: 6.3 Statistical and non-statistical sampling CPA Competency: Audit and Assurance AACSB: Analytic

75. An auditor uses professional judgement when determining the nature, timing, and extent of audit procedures to use for each audit. Explain why the nature, timing, and extent of audit testing are crucial factors in every audit.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the factors that impact the nature, timing, and extent of audit testing.

Section Reference: 6.9 Nature, timing, and extent of audit testing CPA Competency: Audit and Assurance AACSB: Analytic

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CASE QUESTION 76. Joe Jones walked out of the Old Rock Bakery operation and chewed on a Cheese Danish.

He had chosen random selection to test for proper authorization of purchasing transactions. He had just completed the initial audit testing of the purchasing transactions and had evaluated the results. His conclusion was that the deviation rate of 12 exceptions in a sample of 80 transactions was relatively high.

In addition, Joe was preparing to start the audit of another client, Rohr Industries, an airplane component manufacturer. He had discussed sampling methodology with his audit team and it had been determined that the Rohr Industries systems did not lend themselves easily to statistical sampling techniques. The audit team would have to employ non-statistical sampling.

Required: a) What is the procedure that Joe Jones would follow when his initial testing showed a relatively high deviation rate for the Old Rock Bakery transactions? b) What is non-statistical sampling? c) Describe the non-statistical sampling methods that were open to Joe and his team for the Rohr Industries audit. d) Which of Joe’s two clients’ systems would lend themselves to stratification?

Answer: a) After discovering the high deviation rate, Joe would perform the following: 1. Compare the deviation rate with the tolerable rate of deviation.

2. If the rate of deviation exceeds the tolerable rate, then Joe would extend testing and gather further evidence of other controls that may be aimed at reducing the identified risk of material misstatement.

3. If after conducting more testing Joe finds that the rate of deviation remains consistent with his initial findings and other controls are similarly ineffective, Joe would conclude that the client's system of internal controls cannot be relied upon to prevent or detect a potential material misstatement.

4. Joe would then increase his reliance on substantive tests of the account being tested. b)

Non-statistical sampling is any sample selection method that does not have the characteristics of statistical sampling. It is generally easier to use, and requires less resources and training.

c)

Haphazard selection involves the selection of a sample by an auditor without using a methodical technique. There is a risk that an auditor will avoid selecting some items or ensure other items are included in the sample. For example, an item that is going to be difficult to test because the documentation is held in another location may be deliberately excluded by the auditor, while an item that looks large or unusual and catches the auditor's eye may be included. This is a non-statistical technique as human bias may impact the sample selected, and therefore prevent the sample from being a true random sample.

Block selection involves the selection of items that are grouped together within the population of items available. This is a non-statistical technique as many populations of items are sorted in a sequence, which makes the selection of groups of items in a block inappropriate. For example, transactions are generally grouped in date order; by using block

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selection the items selected will not be representative of transactions made throughout the year.

Judgemental selection involves the selection of items that an auditor believes should be included in their sample for testing. When testing controls, judgement may be used to ensure that transactions processed when a new computer is installed are included in the sample. When conducting substantive testing, judgement may be used to include in the sample large or unusual items. This is a non-statistical sampling technique. d)

Stratification consists of the process of dividing a population into groups of sampling units with similar characteristics.

This means that if Joe’s audit team can partition a population of transactions into sub populations that have similar characteristics, such as high dollar values, there will be audit efficiencies.

Stratification is usually performed ahead of random selection. There is an indication that the Rohr Industries systems do not lend themselves easily to statistical sampling techniques and that the audit team has decided to employ non-statistical sampling. Hence, stratification will be more practicable for the Old Rock Bakery audit as it is already using random sampling techniques.

Bloomcode: Application Difficulty: Medium Learning Objective: Differentiate between statistical and non-statistical sampling.

Learning Objective: Describe sampling methods and the factors to be considered when choosing a sample.

Learning Objective: Outline how to evaluate the results of tests conducted on a sample.

Section Reference: 6.3 Statistical and non-statistical sampling Section Reference: 6.4 Sampling techniques and factors affecting sampling Section Reference: 6.7 Evaluating sample test results CPA Competency: Audit and Assurance AACSB: Analytic

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LEGAL NOTICE Copyright © 2021 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under license and may be used only in accordance with the terms of such license.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 7 UNDERSTANDING AND TESTING THE CLIENT’S SYSTEM OF INTERNAL CONTROLS CHAPTER LEARNING OBJECTIVES 1. Define internal control.

Internal control is the process designed, implemented, and maintained by those charged with governance, management, and other personnel to provide reasonable assurance about the achievement of the entity’s objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations, and compliance with applicable laws and regulations.

The term “controls” refers to any aspects of one or more of the components of internal control.

Controls include entity-level controls and transaction-level controls.

2. State the seven generally accepted objectives of internal control activities.

Internal controls are designed and implemented to ensure that transactions are real; recorded; correctly valued, classified, summarized, and posted; and timely.

3. Describe the elements of the system of internal control at the entity level.

The system of internal control at the entity level are the control environment, the entity’s risk assessment process, the entity’s information system and communications, control activities, and monitoring. Internal control also includes how the controls are implemented, such as through appropriate segregation of duties.

4. Identify the different types of controls.

There are four different types of controls: manual, automated (otherwise known as application controls), IT general controls (ITGCs), or a combination of control types referred to as ITdependent manual controls. Each of these types can be described as either a preventive control or a detective control. Preventive controls, as the name suggests, prevent errors from occurring.

Detective controls detect the error after it has occurred and rectify the error on a timely basis.

5. Explain how to select and design tests of controls.

The selection of which controls to test is a matter of professional judgement. Deciding which controls to test will be influenced by the control objective, the type of control, the frequency at which the control is performed, and the level of assurance the auditor plans to gain from determining whether the control is designed and implemented effectively. As a general rule, the best controls to test are those that address the WCGWs most effectively with the least amount of testing required. The extent of testing of controls (that is, deciding how many to test) is also a matter of professional judgement, although there are sampling techniques available. The extent of testing is affected by many factors, including how often the control is performed, the degree to which reliance will be placed on the control as part of the audit, the persuasiveness of the evidence produced by the control, the need to be satisfied that the control operated as intended throughout the period of reliance, the existence of a combination of controls that may reduce the

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level of assurance that might be needed from any one control, the relative importance of the WCGW questions or statements being considered, and any other factors such as the competence of the person carrying out the control, the quality of the control environment, and any changes in the accounting system.

6. Explain the different techniques used to document and test internal controls.

The most common forms of documentation are narratives, flowcharts, combinations of narratives and flowcharts, and checklists and preformatted questionnaires. There are four key techniques used for testing controls: inquiry (questions are asked regarding the operation of the control), observation (the operation of the control is observed to be occurring), inspection (physical evidence resulting from the performance of the control is examined), and reperformance (the control is re-performed to test its effectiveness).

7. Understand how to interpret the results of testing of controls.

If the controls tested are considered to be effective and can be relied on for the purposes of reducing overall audit risk for a particular significant account and assertion, the level of additional substantive testing required is reduced. If the controls tested are considered to be ineffective and are not able to provide any audit evidence that reduces overall audit risk for a particular significant account and assertion, the level of additional substantive testing that is required is increased.

8. Explain how to document tests of controls.

The purpose of the test of controls, the selection of controls to test, the results of the control testing performed, and the conclusion regarding the design and implementation of the controls are all documented in the audit working papers. The working papers are then reviewed by more experienced auditors to determine if sufficient work was performed and if the appropriate conclusion was reached.

9. Describe the importance of identifying strengths and weaknesses in a system of internal controls.

An important outcome of understanding a client’s system of internal controls is the ability to make observations, draw conclusions, and offer recommendations regarding the strengths and weaknesses observed. CAS 260 and CAS 265 require auditors to provide those charged with governance with timely observations arising from the audit. This is generally done through a management letter.

10. Explain how to communicate internal control strengths and weaknesses to those charged with governance.

A management letter is a deliverable prepared by the audit team and provided to the client (including those charged with governance). It informs the client of the auditor’s recommendations for improving its internal controls.

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TRUE-FALSE STATEMENTS 1. Internal control is intended to provide reasonable assurance about the achievement of an entity's objectives.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define internal control.

Section Reference: 7.1 Internal control defined CPA Competency: Audit and Assurance AACSB: Analytic

2. Audit risk is the risk that an entity's internal control system will not prevent or detect material misstatements.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define internal control.

Section Reference: 7.1 Internal control defined CPA Competency: Audit and Assurance AACSB: Analytic

3. The inherent limitations of internal control include the possibility of collusion by two or more individuals to circumvent a control.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: State the seven generally accepted objectives of internal control activities.

Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

4. The internal control objective of 'valued' refers to controls in place to ensure that transactions are recorded in the correct accounting period.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: State the seven generally accepted objectives of internal control activities.

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Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

5. The internal control objective of 'real' refers to controls in place to ensure that fictitious or duplicate transactions are not included in the books and records of the organization.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: State the seven generally accepted objectives of internal control activities.

Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

6. One of the elements of an entity's control environment is management's philosophy and operating style.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

7. Control risk refers to the risk that the auditor's testing procedures will not be effective in detecting a material misstatement.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

8. The concept that no one employee should be in a position both to perpetrate and hide errors or fraud in the normal course of their duties is known as segregation of incompatible duties.

Answer: True Bloomcode: Knowledge Difficulty: Easy

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Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

9. In larger entities, there are often limitations surrounding the entity's ability to put effective internal controls in place.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

10. Transaction-level controls are implemented by businesses to reduce the risk of misstatements due to error or fraud and to ensure that processes are operating effectively.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

11. The purpose of preventive controls is to discover fraud or errors that may have occurred during transaction processing and to rectify those errors.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

12. An example of a purely manual control is a locked inventory stock cage for high dollar-value items.

Answer: True Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

13. IT general controls are driven by the particular software application being used.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

14. To improve efficiency, auditors test only those controls that they believe are critical to their opinion.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to select and design tests of controls.

Section Reference: 7.5 Selecting and designing tests of controls CPA Competency: Audit and Assurance AACSB: Analytic

15. The greater the degree of reliance on an internal control, the less they test the control to provide the required assurance.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to select and design tests of controls.

Section Reference: 7.5 Selecting and designing tests of controls CPA Competency: Audit and Assurance AACSB: Analytic

16. Attribute sampling is a sampling technique used to reach a conclusion about the total dollar amount of misstatement in an account balance.

Answer: False Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Explain how to select and design tests of controls.

Section Reference: 7.5 Selecting and designing tests of controls CPA Competency: Audit and Assurance AACSB: Analytic

17. Narratives involve the auditor describing in words each step of the flow of transactions from start to finish.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different techniques used to document and test internal controls.

Section Reference: 7.6 Documenting and testing internal controls CPA Competency: Audit and Assurance AACSB: Analytic

18. Checklists and preformatted questionnaires are particularly helpful in industries that the auditor may not personally be familiar with auditing.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different techniques used to document and test internal controls.

Section Reference: 7.6 Documenting and testing internal controls CPA Competency: Audit and Assurance AACSB: Analytic

19. Tests of account balances can often provide evidence about the continued functioning of controls.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand how to interpret the results of testing of controls.

Section Reference: 7.7 Results of the auditor’s testing CPA Competency: Audit and Assurance AACSB: Analytic

20. If the tests of controls confirm the auditor's preliminary evaluation of controls, the planned substantive audit procedures are not modified.

Answer: True

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Bloomcode: Application Difficulty: Medium Learning Objective: Understand how to interpret the results of testing of controls.

Section Reference: 7.7 Results of the auditor’s testing CPA Competency: Audit and Assurance AACSB: Analytic

21. The more complex the client's operations and its internal controls, the less experienced the auditor who performs the work needs to be.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to document tests of controls.

Section Reference: 7.8 Documenting conclusions CPA Competency: Audit and Assurance AACSB: Analytic

22. If inherent risk is low and a reasonable level of assurance has been gained from controls testing, extensive substantive procedures need to be performed to estimate the dollar value of any error in an account balance.

Answer: False Bloomcode: Application Difficulty: Medium Learning Objective: Explain how to document tests of controls.

Section Reference: 7.8 Documenting conclusions CPA Competency: Audit and Assurance AACSB: Analytic

23. Internal control weaknesses decrease the risk of material misstatements being undetected by management's processes and controls.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the importance of identifying strengths and weaknesses in a system of internal controls.

Section Reference: 7.9 Identifying strengths and weaknesses in a system of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

24. An internal control exception is an observed condition that provides evidence that the control

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being tested did not operate as intended.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to select and design tests of.

Section Reference: 7.5 Selecting and designing tests of controls CPA Competency: Audit and Assurance AACSB: Analytic

25. The purpose of an auditor's management letter is to inform the client of the auditor's recommendations for improving its internal controls.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how to communicate internal control strengths and weaknesses to those charged with governance.

Section Reference: 7.10 Management letters CPA Competency: Audit and Assurance AACSB: Analytic

26. Significant professional judgement is never required to decide whether an identified internal control weakness is significant enough to warrant communicating to management.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to communicate internal control strengths and weaknesses to those charged with governance.

Section Reference: 7.10 Management letters CPA Competency: Audit and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 27. A partner and his team performed an audit and issued an unmodified audit report. A year later his firm was sued when a shareholder found out the financial statements were misstated.

This situation best describes a) poor internal controls. b) human error. c) unethical behaviour. d) audit risk.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define internal control.

Section Reference: 7.1 Internal control defined CPA Competency: Audit and Assurance AACSB: Analytic

28. When internal controls are effective, a) there will be an increased reliance on substantive tests of transactions and account balances. b) control risk will also be high. c) the organization is more likely to achieve its strategic and operating objectives. d) the organization is less likely to achieve its strategic and operating objectives.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define internal control.

Section Reference: 7.1 Internal control defined CPA Competency: Audit and Assurance AACSB: Analytic

29. Internal control encompasses which of the following elements of an organization? a) processes b) culture c) systems d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy

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Learning Objective: Define internal control.

Section Reference: 7.1 Internal control defined CPA Competency: Audit and Assurance AACSB: Analytic

30. Which of the following statements about internal control is incorrect? a) Internal control is a very broad concept. b) Internal control eliminates the possibility of fraud and error. c) Internal control encompasses all of the elements of an organization. d) Internal control provides reasonable assurance about the achievement of the entity's objectives.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define internal control.

Section Reference: 7.1 Internal control defined CPA Competency: Audit and Assurance AACSB: Analytic

31. Which statement about internal controls is incorrect? a) Internal controls encompass all of the elements of an organization. b) Internal controls support the achievement of an organization's objectives. c) Internal controls only have to be understood if a combined audit approach is adopted. d) Internal controls comprise a key component of audit risk assessment.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define internal control.

Section Reference: 7.1 Internal control defined CPA Competency: Audit and Assurance AACSB: Analytic 32. As part of her annual review Roma Lazor reviews her client’s draft financial statements to assess that transactions appear to be charged and recorded in the correct account.

This best describes which control objective(s)? a) posting b) classification c) valuation d) timeliness

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Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: State the seven generally accepted objectives of internal control activities.

Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

33. Internal controls in large and medium sized entities can only provide an entity with reasonable assurance in achieving its financial reporting objectives. Which of the following is not an inherent limitation of internal control? a) human error that results in a breakdown in internal control b) collusion by two or more individuals to circumvent a control c) a control within a software program being overridden or disabled d) changing audit risk parameters Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: State the seven generally accepted objectives of internal control activities.

Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

34. The generally accepted objectives of internal control do not include a) efficiency. b) classified. c) recorded. d) timely.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: State the seven generally accepted objectives of internal control activities.

Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

35. The internal control objective of 'classified' means there are controls in place to ensure that a) fictitious or duplicate transactions are not included in the books of an organization. b) correct amounts are assigned to transactions. c) transactions are recorded in the correct accounting period.

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d) transactions are charged and allocated to the correct general ledger account.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: State the seven generally accepted objectives of internal control activities.

Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

36. Which assertion is not specifically addressed by internal control objectives? a) cut-off b) presentation c) completeness d) existence Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: State the seven generally accepted objectives of internal control activities.

Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

37. If controls are in place to ensure that transactions are recorded in the correct accounting period, this satisfies which internal control objective? a) timely b) real c) valued d) posted Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: State the seven generally accepted objectives of internal control activities.

Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

38. Which of the following is an inherent limitation of internal control? a) a control within a software program being overridden or disabled b) human error that results in a breakdown in internal control

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c) collusion by two or more individuals to circumvent a control d) all of the answers are correct Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: State the seven generally accepted objectives of internal control activities.

Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

39. Which audit assertion is not addressed by the internal control objectives? a) valuation b) allocation c) classification d) presentation Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: State the seven generally accepted objectives of internal control activities.

Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

40. Which of the following is not an inherent limitation of internal controls? a) human error b) collusion between two or more employees c) lack of knowledge of internal controls d) overriding of a control within a software program Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: State the seven generally accepted objectives of internal control activities.

Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic 41. Aaron Packham has learned that it is important to be aware of the attitude and actions of management and those charged with governance concerning the entity's internal control and its importance in the entity. This best describes dealing with a) a key control objective.

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b) the control environment. c) mitigation of audit risk. d) financial statement assertions.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

42. Vayda Badilia decided to list several questions for herself about factors that influence management's attitudes towards internal control so as to assure herself that she could have more confidence in management’s abilities and integrity. When she was finished, which control environment element did she tick off on her working papers? a) management’s philosophy and operating style b) communication and enforcement of integrity and ethical values c) commitment to competence d) participation by those charged with governance Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

43. As part of her yearly audit plan activities, Jenna Ryan reviews audit working papers of previous years to determine the risk that a client's system of internal controls will not prevent or detect a material misstatement. This review refers to a) audit risk. b) inherent risk. c) control risk. d) detection risk.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

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44. Emile Mayer was concerned when she reviewed the operations of her client and noticed that many of the employees had incompatible duties over the recording of transactions and custody of assets. This best refers to which desired control? a) information processing controls b) physical controls c) authorization controls d) segregation of incompatible duties Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

45. When Melissa Lee, a senior auditor, performed an audit of an electronics firm, she reviewed the control environment, performed a risk assessment, and reviewed the key business processes and control activities. These activities are part of a) a review of entity-level controls. b) a review of the internal control system. c) establishing audit risk. d) none of the above Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

46. When Tessa Tessier reviewed the different key activities in the marketing department of a wholesaler of jewellery, she was performing an entity level review of a) monitoring controls. b) the control environment. c) internal controls. d) the risk assessment process.

Answer: c Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic 47. Harry Karas was involved in getting a big picture of his client’s entity controls. He went about finding out whether periodic evaluations of internal control are made and determining the extent to which personnel, in carrying out their regular duties, obtain evidence as to whether the system of internal controls continues to function. These activities are part of a) internal control activities. b) documentation controls. c) monitoring of controls. d) the inherent risk assessment.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

48. Rina Glickstein is unsure about the best way to evaluate her audit staff. She decides to look at their professional characteristics such as their expertise, experience, knowledge, and training.

What best describes what she is looking for? a) their independence b) their professional judgement c) their due care d) their professional scepticism Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

49. All of the following are components of internal control, except for a) monitoring of controls. b) the control environment. c) audit committees.

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d) the information system.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

50. Which of the following is not an element of the control environment? a) participation by those charged with governance b) commitment to competence c) segregation of duties d) hiring and retaining competent employees Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

51. The control environment does not a) set the tone of an entity. b) set the foundation for all other components of internal control. c) refer to the policies and procedures that help make sure management's directives are carried out. d) influence the control consciousness of employees.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

52. For identified risks, management a) assesses the likelihood of their occurrence. b) decides upon actions to manage them.

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c) estimates their significance. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

53. Detection risk refers to a) the susceptibility of an assertion to a material misstatement, assuming there are no related controls. b) the risk that the auditor's testing procedures will not be effective in detecting a material misstatement. c) the risk that a client's system of internal controls will not prevent or detect a material misstatement. d) the entity’s process for identifying and responding to business risks Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

54. Which of the following statements relating to control activities is incorrect? a) They include management's philosophy and operating style. b) They are policies and procedures that help make sure management's directives are carried out. c) They help guarantee that necessary actions are taken to address risks impacting the achievement of the organization's objectives. d) They have various objectives and are applied at various organizational and functional levels.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

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55. Performance reviews are control activities that include a) authorization for access to computer programs. b) segregating incompatible duties. c) reviews of actual performance versus budgets. d) periodic counting and comparison with amounts shown on control records.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

56. In understanding the client's control activities at the entity level, consideration is given to factors such as a) the extent to which performance of control activities relies on IT. b) the extent to which controls included in the organization's policies are being applied. c) whether adequate safeguards are in place to prevent unauthorized access to or destruction of documents, records and assets. d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

57. When gaining an understanding of the client's monitoring processes at the entity level, factors ordinarily considered include a) evaluations or observations made by the external auditors. b) management's approach to correcting known significant deficiencies on a timely basis. c) both a and b d) none of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls

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CPA Competency: Audit and Assurance AACSB: Analytic

58. Edward Fancy is planning to visit an airline company to review the collective assessment of the client’s control environment, risk assessment process, information system, control activities, and monitoring of controls. What does this mandate describe? a) entity-level controls b) transaction-level controls c) detective controls d) industry-level controls Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

59. Susan Struthers will be reviewing those controls that stop fraud or errors from occurring.

This is an example of a review of a) detective controls. b) preventive controls. c) entity-level controls. d) transaction-level controls.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

60. Sam Fenton wants to ensure that sales in a retail outlet are not recorded at the wrong amount. Which preventive control will help him ensure his objective? a) the signature of the goods by the warehouse receiver on a receiving report or a bill of lading b) a credit check by the credit manager c) automatic pricing of sales invoices using a master price file d) review of sales invoices at month end Answer: c

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Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

61. Millicent Vonareva was reviewing her IT General Controls program for her client visit. She noticed an item that she thought did not belong in her “Controls to prevent unauthorized access to data” section of the program. Which item did not belong there? a) Data files and critical applications are regularly backed up in offsite locations. b) Program changes are subject to formal change management procedures. c) Policies exist to ensure departing employees are denied access to software programs and databases. d) Procedures exist to protect against computer viruses.

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic 62. Boca Chino, a public accountant, is testing whether his client’s account coding on each purchase order is checked by the computer to a table of valid account numbers, and that various logic tests are performed by the computer. He is trying to mitigate the following from going wrong: a) detective controls not being in place. b) amounts being posted to the wrong accounting period. c) transactions being classified and coded to incorrect accounts. d) incorrect amounts being posted to the accounts.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

63) Maya Lacasta spent the past week designing audit procedures to evaluate the operating

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effectiveness of controls in preventing, or detecting and correcting, material misstatements of a major bookstore operation at the assertion level. What types of audit procedures did she employ? a) entity-level controls b) detective controls c) tests of controls d) preventive controls Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

64. The senior auditor has no physical evidence that a control was performed, who performed it, or how effectively it was performed. What is the nature of this control? a) internal control b) entity-level control c) detective control d) preventive control Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

65. The auditor had the following procedures in his audit program for a client: (i) Review performance versus forecasts (ii) Review performance indicators (iii) Review exception reports What are these instructions related to? a) detective controls b) physical controls c) internal controls d) entity-wide controls Answer: a

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

66. Jane Toms, an audit senior, performed a review of certain application controls at a clothing manufacturing client. Which one of these controls is an input control? a) Reconciliation of totals where input totals are compared to the output totals. b) Output is printed to a secure printer where access is limited. c) Reasonable checks: actual data is compared to expected data for reasonableness. d) Ensuring all required data is entered.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

67. Theo Lillis performs the following application control procedures: (i) Control totals: Input totals are balanced and reconciled (ii) Reasonable checks: Actual data is compared to expected data for reasonableness (iii) Sequence tests: Sequential data is reviewed and exception reports are produced for missing numbers.

Which of the above application controls do these procedures apply to? a) processing controls b) output controls c) input controls d) general controls Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

68. One of the main objectives of internal controls is

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a) to support the assessment of business risk. b) to prevent or detect misstatements in the financial statements. c) to enable the auditor to assess the audit risk. d) to protect management from all legal liability.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

69. Controls can be classified as a) information technology general controls. b) automated controls. c) manual controls. d) all of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

70. Which of the following statements is correct? a) Preventing errors during processing should not be an important objective of every accounting system. b) Preventive controls can be applied to each transaction during normal processing to avoid errors occurring. c) To be effective, controls over transactions should only include detective controls. d) The purpose of preventive controls is to discover fraud or errors that may have occurred during transaction processing.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

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71. Which of the following is an example of a preventive control? a) management level reviews of actual performance versus budgets b) credit manager following up on an exception report showing sales made to a customer who has exceeded their credit limit c) sales invoices are automatically priced using the information in the price master file d) a bank reconciliation Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

72. A computer program that will not allow a sale to be processed if a customer has exceeded its credit limit is an example of a a) preventive control. b) test of controls. c) detect control. d) substantive procedure.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

73. It is important that detective controls a) identify only materially significant errors. b) completely and accurately capture some of the relevant data. c) are performed on a consistent and regular basis. d) include correction for any material errors identified.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance

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AACSB: Analytic

74. Which of the following is an example of a detective control? a) account coding on purchase orders being checked by the computer to a table of valid account numbers b) quarterly reviews of credit balances in accounts receivable to determine their causes c) amounts are not able to be paid to employees without first matching a valid tax file number to the employee master file d) sales invoices are automatically priced using a master pricing file Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

75. Manual controls a) generally rely on the client's IT applications in some way. b) support the ongoing functioning of the programmed aspects of preventive and detective controls. c) can be classified as program change controls or logical access controls. d) do not rely on the client's IT environment for their operation.

Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

76. An example of a program change control is a) the accounts receivable clerk does not have access to the cash payments application. b) regular and timely back-ups of data. c) program change forms must be authorized by the IT manager. d) test attempts to log on to terminals using unauthorized user IDs. Answer: c Bloomcode: Comprehension Difficulty: Easy

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Auditing: A Practical Approach, Fourth Canadian Edition

Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

77. When the auditor decides to include controls testing in their audit strategy, they select those controls that a) are the easiest to test. b) provide the most efficient and effective audit evidence. c) provide no assurance that the controls operated effectively throughout the period of reliance. d) provide the least efficient and effective audit evidence.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to select and design tests of controls.

Section Reference: 7.5 Selecting and designing tests of controls CPA Competency: Audit and Assurance AACSB: Analytic

78. The factors to consider when deciding the extent of testing of controls include which of the following? a) the persuasiveness of the evidence produced by the control b) the degree to which the auditors intend to rely on the control as a basis for limiting their substantive tests c) how often the control is performed d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to select and design tests of controls.

Section Reference: 7.5 Selecting and designing tests of controls CPA Competency: Audit and Assurance AACSB: Analytic

79. Which of the following statements is incorrect? a) The less frequently a control is performed, the more testing the auditor needs to perform to be satisfied the control is operating effectively. b) When other controls related to a particular objective are also in place and are tested, the level of assurance that might be needed from any one control is not as high as if the auditor were relying solely on a single control.

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c) The less frequently a control is performed, the less testing the auditor needs to perform to be satisfied the control is operating effectively. d) The results of the tests in prior audits and the current audit to date affect the perception of risk.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to select and design tests of controls.

Section Reference: 7.5 Selecting and designing tests of controls CPA Competency: Audit and Assurance AACSB: Analytic

80. A sampling technique used to reach a conclusion about a population in terms of a rate of occurrence is known as a) dollar unit sampling. b) random sampling. c) attribute sampling. d) haphazard sampling.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to select and design tests of controls.

Section Reference: 7.5 Selecting and designing tests of controls CPA Competency: Audit and Assurance AACSB: Analytic

81. Tests of controls will usually be carried out a) at an interim date. b) only after year end. c) only by the audit engagement partner. d) by the client's board of directors.

Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain how to select and design tests of controls.

Section Reference: 7.5 Selecting and designing tests of controls CPA Competency: Audit and Assurance AACSB: Analytic

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82. Anwar Maris is considering whether to use a checklist or narrative approach to describe the purchasing system of an environmental engineering company. What part of the audit process is he involved in? a) documenting internal controls b) risk assessment of company c) review of control environment d) assessment of detection risk Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different techniques used to document and test internal controls.

Section Reference: 7.6 Documenting and testing internal controls CPA Competency: Audit and Assurance AACSB: Analytic

83. The most common ways of auditors documenting their understanding of internal controls include a) flowcharts. b) narratives. c) preformatted questionnaires. d) all of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different techniques used to document and test internal controls.

Section Reference: 7.6 Documenting and testing internal controls CPA Competency: Audit and Assurance AACSB: Analytic

84. Flowcharts involve a) the auditor summarizing in boxes each step of a transaction from start to finish. b) the auditor describing in words each step of the flow of transactions from start to finish. c) an internal control checklist. d) a questionnaire that is used to systematically identify the most common types of control procedures.

Answer: a Bloomcode: Comprehension Difficulty: Easy

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Learning Objective: Explain the different techniques used to document and test internal controls.

Section Reference: 7.6 Documenting and testing internal controls CPA Competency: Audit and Assurance AACSB: Analytic

85. Checklists and preformatted questionnaires are particularly helpful a) in industries that the auditor may not personally be familiar with auditing. b) when control risk is high. c) when more experienced auditors find it difficult to identify which are the critical controls. d) in providing a visual representation of the flow of transactions.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different techniques used to document and test internal controls.

Section Reference: 7.6 Documenting and testing internal controls CPA Competency: Audit and Assurance AACSB: Analytic 86. Which of the following is not a method of recording an audit client’s internal control system? a) narratives b) organizational charts c) flowcharts d) questionnaires Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different techniques used to document and test internal controls.

Section Reference: 7.6 Documenting and testing internal controls CPA Competency: Audit and Assurance AACSB: Analytic 87. Flowcharts are used by an auditor to a) document the generalized computer audit programs. b) document the audit client’s accounting controls. c) provide a checklist of internal controls. d) provide a description of the audit client’s accounting controls.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the different techniques used to document and test internal controls.

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Section Reference: 7.6 Documenting and testing internal controls CPA Competency: Audit and Assurance AACSB: Analytic 88. One of the factors considered by the auditor in determining if there is a need for additional detailed tests of controls is a) evaluation of substantive tests. b) evidence provided by other tests. c) timing of audit tests. d) availability of qualitative and quantitative audit evidence.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand how to interpret the results of testing of controls.

Section Reference: 7.7 Results of the auditor’s testing CPA Competency: Audit and Assurance AACSB: Analytic 89. If tests of controls indicate that internal controls are not as effective as originally assessed, the auditor will a) increase assessment of control risk. b) increase assessment of detection risk. c) place less reliance on substantive procedures. d) increase level of audit risk.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand how to interpret the results of testing of controls.

Section Reference: 7.7 Results of the auditor’s testing CPA Competency: Audit and Assurance AACSB: Analytic 90. If the tests of controls confirm the auditor's preliminary evaluation of controls, the planned substantive audit procedures are a) increased. b) not modified. c) reduced. d) verified by management.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand how to interpret the results of testing of controls.

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Section Reference: 7.7 Results of the auditor’s testing CPA Competency: Audit and Assurance AACSB: Analytic

91. In trying to determine whether there is a need for additional detailed tests of controls, which of the following factors are considered? a) evidence provided by other tests b) changes in the overall control environment c) results of inquiries and observations d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand how to interpret the results of testing of controls.

Section Reference: 7.7 Results of the auditor’s testing CPA Competency: Audit and Assurance AACSB: Analytic

92. Which of the following statements is correct? a) Tests of account balances can often provide evidence about the continued functioning of controls. b) An ineffective entity-level control environment may allow the auditor to limit their tests of controls to inquiry and observation. c) Auditors do not need to investigate any control exceptions identified during their testing. d) Tests of account balances never provide evidence about the continued functioning of controls.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand how to interpret the results of testing of controls.

Section Reference: 7.7 Results of the auditor’s testing CPA Competency: Audit and Assurance AACSB: Analytic

93. If inherent risk is high and no assurance has been obtained from controls testing, a) only overall analytical review procedures need to be performed to reduce detection risk to an acceptable level. b) no further substantive testing needs to be performed. c) extensive substantive procedures need to be performed to estimate the dollar value of any error in the account balance. d) the risk of material misstatement is assessed as low.

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Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to document tests of controls.

Section Reference: 7.8 Documenting conclusions CPA Competency: Audit and Assurance AACSB: Analytic

94. Which of the following would not be included in a test of a control working paper? a) the purpose of the test b) a conclusion about whether the account balance is materially misstated c) the work performed d) the findings/results of the testing Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to document tests of controls.

Section Reference: 7.8 Documenting conclusions CPA Competency: Audit and Assurance AACSB: Analytic

95. The working papers to document tests of controls a) detail the audit plan. b) set out the purpose of the tests of controls identified. c) provide instructions of details of tests to be conducted. d) identify the amount of material misstatement.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to document tests of controls.

Section Reference: 7.8 Documenting conclusions CPA Competency: Audit and Assurance AACSB: Analytic

96. Internal control weaknesses identified by an auditor a) decrease the level of substantive tests to be implemented by the auditor. b) increase the risk of material misstatements being undetected by the auditor’s testing procedures.

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c) increase the risk of material misstatement being undetected by management’s processes and controls. d) decrease the risk of material misstatements being undetected by the auditor's testing procedures.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the importance of identifying strengths and weaknesses in a system of internal controls.

Section Reference: 7.9 Identifying strengths and weaknesses in a system of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

97. An internal control exception is a) only expected to exist when internal controls are effective. b) an observed condition that provides evidence that the control being tested did not operate as indicated. c) both a and b d) an observed condition that provides evidence that the control being tested operated as indicated.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the importance of identifying strengths and weaknesses in a system of internal controls.

Section Reference: 7.9 Identifying strengths and weaknesses in a system of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

98. The purpose of the management letter is to inform a) the auditor with concerns held by the client's management about the audit fee. b) the client's management of the auditor's opinion on the company's financial statements. c) the client's audit committee’s disagreements with management. d) the client of the auditor's recommendations for improving its internal controls.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to communicate internal control strengths and weaknesses to those charged with governance.

Section Reference: 7.10 Management letters CPA Competency: Audit and Assurance

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AACSB: Analytic

99. Which of the following statements is correct? a) Significant professional judgement is not necessary in deciding whether a weakness identified is significant enough to warrant communicating to management. b) A management letter is prepared by management. c) Significant professional judgement is necessary in deciding whether a weakness identified is significant enough to warrant communicating to management. d) The purpose of a management letter is to inform management of the risk assessment process.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to communicate internal control strengths and weaknesses to those charged with governance.

Section Reference: 7.10 Management letters CPA Competency: Audit and Assurance AACSB: Analytic

100. The purpose of management letters is to a) confirm the terms of the audit engagement. b) set out the responsibilities of management and the auditor in regards to the audit. c) discuss weaknesses in internal control and other matters discovered in the audit. d) make recommendations of substantive procedures to be conducted.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain how to communicate internal control strengths and weaknesses to those charged with governance.

Section Reference: 7.10 Management letters CPA Competency: Audit and Assurance AACSB: Analytic

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SHORT ANSWER QUESTIONS 101. Explain the seven generally accepted objectives of internal control activities and identify the relevant assertions.

Answer: The internal control objectives are matched with the relevant assertions as follows: Real — there are controls in place to ensure that fictitious or duplicate transactions are not included in the books and records of the organization (occurrence, rights and obligations, and existence assertions).

Recorded — there are controls in place that will prevent or detect the omission of transactions from the books and records of the organization (accuracy, completeness, and accuracy, valuation, and allocation assertions).

Valued — there are controls in place to ensure that the correct amounts are assigned to the transactions (accuracy, and accuracy, valuation, and allocation assertions).

Classified — there are controls in place to ensure that transactions are charged and allocated to the correct general ledger account (accuracy, classification, and accuracy, valuation, and allocation assertions).

Summarized — there are controls in place to ensure that the transactions in the books and records are summarized and totalled correctly (accuracy, and accuracy, valuation, and allocation assertions).

Posted — there are controls in place to ensure that the accumulated totals in the transaction file are correctly transferred to the general ledger and subsidiary ledgers (accuracy, classification, and accuracy, valuation, and allocation assertions).

Timely — there are controls in place to ensure that transactions are recorded in the correct accounting period (cut-off and completeness assertions).

Bloomcode: Application Difficulty: Medium Learning Objective: State the seven generally accepted objectives of internal control activities.

Section Reference: 7.2 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

102. Indicate whether you agree or disagree with the following statements and explain your reasoning. a)

During her career as a public accountant, Faye Teller has performed audits of large and medium sized clients. When she visited a small business client, a food wholesaler that has a history of poor controls, she gave a lot of thought to performing her planned audit approach. She decided to use the combined audit approach.

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b)

Lea Konczynski was discussing with her audit manager how she could assess whether controls are being monitored. Her audit manager mentioned that the internal audit function is a primary source of assessing and monitoring control activities.

c)

The audit senior has been reviewing the key controls in the purchasing and payables process. She has been asked by a junior auditor: “When should the client set up the payable?” She answers: “The company can set up the payable when the goods are received in good order and then the client can make the payment when the invoice is received.”

d)

The auditor decided to perform all substantive testing at the interim audit and to review transaction-level controls at year end.

Answer: a) Disagree. When a client’s internal controls are weak, substantive testing is warranted.

Faye would probably perform a very brief overview of the control system to assure herself that control weaknesses still exist and then move to a substantive audit approach. The combined approach would be inappropriate given the control weaknesses that exist.

Performing tests of controls on a weak control system would be a poor use of the audit staff’s time. b)

Agree. Usually the company relies on auditors or independent managers to monitor control activities. The importance that a company places on its internal audit function provides evidence about its overall commitment to internal control. The internal audit activities most relevant to the audit include those that provide evidence about the design and effectiveness of internal control or that provide substantive evidence about potential material misstatements in the financial statements.

c)

Agree. Many companies will set up the accounts payable when the goods are received.

The receiving report gets matched up with the purchasing document and the payment is made upon receipt of the invoice. Many suppliers are also paid through electronic transfer of funds, without any paper or electronic invoice, based on the receipt of goods. In effect, there is no accounts payable ever set up. There is a debit to Goods/Inventory and a credit to cash.

d)

Disagree. Tests of controls at the transaction level are usually performed during the interim audit. Year-end work focuses on tests of balances.

Bloomcode: Application Difficulty: Medium Learning Objective: State the seven generally accepted objectives of internal control activities.

Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.2 Objectives of internal controls Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

103. Explain the key elements of the control environment.

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Answer: The control environment sets the foundation for effective internal control, provides discipline and structure, and includes the following elements: Communication and enforcement of integrity and ethical values — Integrity and ethical values are essential elements of the control environment, affecting the design, administration, and monitoring of key processes.

Commitment to competence — Management's commitment to competence refers to considering the skill levels required for particular jobs within the organization and making sure that staff with the required skills are hired and matched to the right jobs.

Participation by those charged with governance — The organization's control environment is influenced significantly by its board of directors and others charged with governance of the entity; for example, the audit committee members or the CEO. Management's philosophy and operating style — Obtaining an understanding of management's philosophy and operating style is necessary to identify the factors that influence management's attitudes towards internal control.

Organizational structure — The client's organizational structure provides the framework within which its activities for achieving entity-wide objectives are planned, executed, controlled, and monitored.

Human resource policies and practices — Human resource policies and practices relate to hiring, inducting, training, evaluating, counselling, promoting, and compensating employees.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

104. What are control activities? Explain the major categories of control activities.

Answer: Control activities are policies and procedures that help make sure management's directives are carried out. They help guarantee that necessary actions are taken to address risks impacting the achievement of the organization's objectives. Generally, control activities that may be relevant to an audit may be categorized as policies and procedures pertaining to the following: Performance reviews (sometimes referred to as 'performance indicators') — These control activities include reviews of actual performance versus budgets, forecasts and prior-period performance and relating different sets of data (operating or financial) to one another, together with analyses of the relationships and investigative and corrective actions.

Information processing — A variety of controls are performed to check accuracy, completeness, and authorization of transactions within information processing environments.

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Physical controls — These activities encompass the physical security of assets, including adequate safeguards over access to assets and records (such as secured facilities and authorization for access to computer programs and data files) and periodic counting and comparison with amounts shown on control records.

Segregation of incompatible duties — The concept that no one employee or group of employees should be in a position to perpetrate and hide errors or fraud in the normal course of their duties.

In general, the principle duties that are incompatible and should be segregated are: - authorization or approval of transactions affecting assets - custody of assets - recording or reporting of transactions.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 System of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

105. Explain the differences between preventive controls and detective controls.

Answer: Tests of controls (or controls testing) are the audit procedures performed to test the operating effectiveness of controls in preventing or detecting and correcting material misstatements at the assertion level. Preventive controls can be applied to each transaction during normal processing to avoid errors occurring. Preventing errors during processing is an important objective of every accounting system. An example of a preventive control is a computer program that will not allow a sale to be processed if a customer has exceeded their credit limit. An absence of effective preventive controls increases the risk that errors will occur or fraud may occur and therefore increases the need for controls that are sensitive enough to detect these errors should they occur.

The purpose of detective controls is to discover fraud or errors that may have occurred during transaction processing (in spite of any preventive controls) and to rectify those errors. Generally, detective controls are not applied to each transaction during the normal flow of processing.

Instead, they are applied outside the normal flow of individual transactions to groups of transactions that have been fully or partially processed. It is important that detective controls: 1.

2.

3.

4.

completely and accurately capture all relevant data, identify all potentially significant errors, are performed on a consistent and regular basis, include follow-up and correction on a timely basis for any misstatements or issues detected.

Examples of detective controls include management level reviews made of actual performance versus budgets, forecasts, prior periods, competitors (if available), and industry averages (if available).

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls

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CPA Competency: Audit and Assurance AACSB: Analytic

106. Indicate whether you agree or disagree with the following statements and explain your reasoning. a)

The audit senior was explaining how different controls work: “Detective controls can be applied to each transaction during normal processing to avoid errors occurring.”

b)

The public accountant was reviewing the audit program and was convinced that the following item did not belong in the IT General Controls (ITGC) part of her audit program: “Program change controls — only appropriately authorized, tested, and approved changes are made to applications, interfaces, databases, and operating systems. All changes are documented so systems documentation is up to date.”

c)

The techniques for control testing are made up of inquiry, observation, inspection of physical evidence, and re-performance. Inspection of physical evidence relies on the auditor testing the physical evidence to verify that a control has been performed properly.

d)

The manager of a large client realizes that when testing controls, either statistically based sampling techniques or professional judgement can be used to determine the extent of testing. One of the factors to consider when deciding the extent of testing should include the competence of the person who performs the control.

Answer: a) Disagree. The audit senior is describing preventive controls which are designed to avoid errors before the transaction gets processed. Detective controls, on the other hand are designed to discover fraud or errors that may have occurred during transaction processing activities. b)

Disagree. This is one of three key ITGC controls we test for. The other is logical access controls and a third item – other ITGCs – is a catch-all for key ongoing operating controls.

c)

Agree. Inspection of physical evidence is a technique that relies on the auditor testing the physical evidence to verify that a control has been performed properly. Usually, the objective is to gain evidence that the procedures were properly performed.

d)

Agree. The competence and integrity of the employee performing the control, the employee's independence from the related processing procedures, the degree to which the employee is supervised, and the extent of employee turnover all contribute to the perception as to whether the control is operating as intended.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different types of controls.

Learning Objective: Explain how to select and design tests of controls.

Section Reference: 7.4 Types of controls Section Reference: 7.5 Selecting and designing tests of controls CPA Competency: Audit and Assurance AACSB: Analytic

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107. Discuss the factors that relate to the likelihood that an internal control operates as intended.

Answer: Several factors affect the perception of the likelihood that a control operated as intended throughout the period of reliance. The competence and integrity of the employee performing the control, the employee's independence from the related processing procedures, the degree to which the employee is supervised, and the extent of employee turnover all contribute to the perception as to whether the control is operating as intended. The extent of testing is also impacted by the quality of the control environment with consideration being given to: the likelihood that a control is bypassed during peak processing periods, the potential for management to override a control, the extent to which the internal auditors have performed similar or related tests during the year, and the likelihood in a good control environment that a control will continue to operate as intended throughout the period of reliance.

Where there have been changes in the accounting system, the auditor considers whether a control may have been less effective during the period when the changes were being implemented and whether the control is still applicable to the new accounting system. When the client cannot provide satisfactory explanations for fluctuations (or the absence of expected fluctuations) in the related account balances, the auditor considers whether they need to revise the extent of their tests of controls. The results of the tests in prior audits and the current audit to date affect the perception of risk. If tests in prior audits indicated that a particular control was ineffective, without improvements in the control, tests of that control in the current audit are not likely to be useful. Similarly, if in prior audits the tests showed that the control was effective, the expectation of errors would be reduced and, therefore, the tests of controls might be less extensive. The auditor also considers whether the changes in the types or volume of transactions could affect the auditor's expectations.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain how to select and design tests of controls.

Section Reference: 7.5 Selecting and designing tests of controls CPA Competency: Audit and Assurance AACSB: Analytic

108. What are the most common forms of documentation used by auditors to document their understanding of internal controls?

Answer: The most common forms of documentation include the following: Narratives - this is the most common form of documentation, particularly in smaller environments where accounting and internal control activities are simple or where a particular flow of a transaction is relatively simple and straightforward. It involves the auditor describing (in words) each step of the flow of transaction from start to finish.

Flowcharts — this form of documentation is used in larger and more complex environments. It involves the auditor summarizing (in flowcharts/boxes) each step of the flow of a transaction from start to finish (that is, from initiation to reporting in the general ledger).

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Combinations of narratives and flowcharts — this form of documenting internal controls is typically a page divided into two sections with the process flowchart on the left-hand side, and the narrative describing each step in the flow on the right-hand side.

Checklists and preformatted questionnaires — an internal control checklist or questionnaire is another technique used to systematically identify the most common types of internal control procedures that should be present.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the different techniques used to document and test internal controls.

Section Reference: 7.6 Documenting and testing internal controls CPA Competency: Audit and Assurance AACSB: Analytic

109. What are the factors considered by auditors in determining whether there is a need for additional detailed tests of controls?

Answer: In determining whether there is a need for additional detailed tests of controls, the following factors are considered: Results of inquiries and observations. If, during their inquiries or observations later in the audit process, the auditors identify that significant changes to processes and controls have occurred, their previous tests of controls may no longer provide a basis for relying on those controls.

Therefore, they may need to identify and test other controls, perform additional tests of controls or increase the level of substantive testing performed at year end. Changes to processes or controls are only significant if they have implications for the continued functioning and effectiveness of controls on which the auditor is relying in the first place.

Evidence provided by other tests. Tests of account balances (substantive testing) can often provide evidence about the continued functioning of controls. For example, when the auditor examines vendors' invoices in support of year-end accounts payable and expense account balances, they learn whether controls relating to the recording of these transactions continue to function. To the extent that their other audit procedures provide evidence of the effectiveness of controls from the date of interim work to the end of the period under audit, additional tests that otherwise might be necessary can be reduced.

Changes in the overall control environment. An effective entity-level control environment may allow the auditor to limit their tests of controls to inquiry and observation during the period between when they tested the controls (interim) and year end. If they become aware of adverse changes in the overall control environment of the entity, such as a loss of employees and key management who perform key controls and who provide evidence as to the effectiveness of the overall entity control environment, additional tests of controls may be necessary.

Bloomcode: Application Difficulty: Medium Learning Objective: Understand how to interpret the results of testing of controls.

Section Reference: 7.7 Results of the auditor’s testing CPA Competency: Audit and Assurance AACSB: Analytic

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110. What are the main items commonly included in tests of controls working papers?

Answer: In tests of controls working papers, the auditor would ordinarily set out the purpose of the tests of the controls identified. This assists in carrying out the testing by reminding the auditor of the overall purpose in testing the controls. If the auditors identify any exceptions or issues, they are able to decide if there is an impact on their testing strategy by considering whether the control exception means that the control no longer meets the objective of the test.

The auditor also documents the test performed, the actual controls selected for testing, and the results of the testing. There needs to be enough detail regarding the controls selected to allow another auditor to review the working paper, re-perform the steps (if necessary), and reach the same conclusion as the auditor who prepared the working paper. The results are often set out in a table to make it easier to review and identify quickly what (if any) exceptions were identified during the testing. Prior to an overall conclusion being reached for each section of work performed, the results table also assists the person reviewing the working paper to determine if enough work has been performed and if the right conclusion regarding the controls testing has been reached. The working paper should also include a conclusion specific to whether the test results support the overall purpose of the test.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain how to document tests of controls.

Section Reference: 7.8 Documenting conclusions CPA Competency: Audit and Assurance AACSB: Analytic

111. What is a management letter and what are its major purposes?

Answer: A management letter (sometimes referred to as a letter of recommendations) is a deliverable prepared by the audit team and provided to those charged with governance. The management letter discusses internal control weaknesses and other matters discovered during the course of the audit. The purpose of the management letter is to inform the client of the auditor's recommendations for improving its internal controls. Significant professional judgement is necessary in deciding whether a weakness identified is significant enough to warrant communicating to management and those charged with governance. When the auditor identifies risks of material misstatement that the entity has not controlled (or has not adequately controlled), or if in the auditor's judgement there is a material weakness in the entity's design or implementation of internal control, they are required to communicate these weaknesses as soon as practicable to those charged with governance. While it is not mandatory to provide feedback regarding internal control weaknesses in writing, the auditor ordinarily prefers to provide their recommendations in the form of a letter or report to avoid any ambiguity or confusion as to what observations, conclusions, and recommendations they have made.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain how to communicate internal control strengths and weaknesses to those charged with governance.

Section Reference: 7.10 Management letters CPA Competency: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 112. Why are internal controls so important to companies? What are the implications for companies if their internal controls are not operating effectively?

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Define internal control.

Section Reference: 7.1 Internal control defined CPA Competency: Audit and Assurance AACSB: Analytic

113. The Committee of Sponsoring Organisations (COSO) of the Treadway Commission has produced guidance for designing and implementing effective internal controls, as well as the effective monitoring of a system of internal controls. Explain the various aspects of this guidance and critically evaluate its impact at enhancing internal controls within companies.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the different types of controls.

Section Reference: 7.4 Types of controls CPA Competency: Audit and Assurance AACSB: Analytic

114. CAS 230 Audit Documentation requires auditors to document each stage of the audit in their working papers. Regarding the contents of working papers, what are the specific requirements in CAS 230? Explain the importance of auditors effectively documenting the tests of controls they have performed.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Hard Learning Objective: Explain how to document tests of controls.

Section Reference: 7.8 Documenting conclusions CPA Competency: Audit and Assurance AACSB: Analytic

115. CAS 260 Communication with Those Charged with Governance requires auditors to communicate audit matters of governance interest arising from the audit of the financial report with those charged with governance of an entity. What are some examples of these matters and why is it important for auditors to communicate them?

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Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the importance of identifying strengths and weaknesses in a system of internal controls.

Section Reference: 7.9 Identifying strengths and weaknesses in a system of internal controls CPA Competency: Audit and Assurance AACSB: Analytic

116. In the United States, what have been the major impacts on companies and auditors of section 404 of the Sarbanes-Oxley Act (2002)? Has this section improved the quality of companies' internal controls?

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain how to communicate internal control strengths and weaknesses to those charged with governance.

Section Reference: 7.10 Management letters CPA Competency: Audit and Assurance AACSB: Analytic

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CASE QUESTIONS 117. In July 2011, Rupert Murdoch, his son, James, and ex-News International chief executive, Rebekah Brooks faced questions from British MPs over a phone hacking scandal at the former News of the World.

It had originally appeared that the News of the World had only hacked the phones of celebrities, politicians and members of the British Royal Family. However, revelations in July 2011, that victims included murdered schoolgirl Milly Dowler, relatives of deceased British soldiers, and victims of the 7/7 London bombings generated widespread public outrage and revulsion.

Advertiser boycotts contributed to the closure of the News of the World.

Reacting to the revelation, Prime Minister David Cameron said that the alleged hacking, if true, was "truly dreadful". He added that police ought to pursue a "vigorous" investigation to ascertain what had taken place. Interestingly, the Prime Minister himself came under fire for hiring a former News of the World editor, Andy Coulson. Prime Minister David Cameron called his decision a "catastrophic error of judgment" in hiring the former editor of Rupert Murdoch's News of the World as a spokesman.

Sean Hoare, 47, the journalist who had accused his former News of the World editor, Andy Coulson of complicity in the illegal activity, was found at home dead, days after he had made fresh allegations against executives under whom he had worked.

On 18 July, News Corp announced that its UK management standards committee would be removed from News International. It will now be housed in a separate building, under the chairmanship of Lord Grabiner, and reporting to News Corp director, Joel Klein.

In an analysis of the culture of the Murdoch empire in Newsweek in July 2011, one of Murdoch's former top executives was quoted as saying: "This scandal and all its implications could not have happened anywhere else. Only in Murdoch's orbit. The hacking at News of the World was done on an industrial scale. More than anyone, Murdoch invented and established this culture in the newsroom, where you do whatever it takes to get the story, take no prisoners, destroy the competition, and the end will justify the means." This same executive went on to say, "In the end, what you sow is what you reap. Now Murdoch is a victim of the culture that he created. It is a logical conclusion, and it is his people at the top who encouraged lawbreaking and hacking phones and condoned it."

In 2010, it was also suggested that the journalistic approach of newspapers such as the News of the World had brought into public focus that there had been a shift away from the traditional ethics of journalism, raising serious questions about privacy, freedom of speech, and confidentiality. There were also observations in the North American Press about the ethics employed by the News of the World. NBC New York noted that the old journalistic maxim, "Get it first. But, first, get it right," although speaking for accurate reporting does not address the situation where in the case of the News of the World information was allegedly obtained in an unethical way or by illegal means. The approach was also criticized by Stephen B. Shepard, dean of the CUNY Graduate School of Journalism, who commenting on the phone hacking scandal, said: "It's wrong. It's not a gray area. What they did was illegal and, even if it weren't, it's just plain wrong. There's no defense for it. Even the government needs a warrant to get into a house or a computer. You can't break into something like this and get away with it."

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Required: Discuss the underpinnings of a proper control environment and where appropriate, comment on deficiencies at the former News of the World operations, or in Prime Minister Cameron’s operations, assuming the press reports are correct.

Answer: The control environment sets the tone of an entity and influences the control consciousness of its people. It is the foundation for all other components of internal control and is often thought of as a combination of the culture, structure and discipline of an organization. It reflects the overall attitude, awareness and actions of management, the board of directors, any others charged with governance, and owners concerning the importance of controls and the emphasis given to controls in determining the organization's policies, processes and organizational structure. This is sometimes referred to as the “tone at the top.” a)

Communication and enforcement of integrity and ethical values. Integrity and ethical values are essential elements of the control environment, affecting the design, administration and monitoring of key processes. It is also important that management is seen to comply with its own policies.

In the case of News of the World operations, Murdoch had previously been criticized for building a media empire that lacked any ethical base and substituting responsible journalism with "gossip, sensationalism, and manufactured controversy." Karl Grossman, a professor of journalism at State University of New York College at Old Westbury, accused Murdoch of building the most "dishonest, unprincipled and corrupt" media empire in history and of "making a travesty of what journalism is supposed to be about." Grossman also claims that News Corporation changes the culture of their newly-acquired news outlets, using them to promote Murdoch's political and financial interests. Once-acclaimed newspapers such as the New York Post and The Times of London have been accused of becoming an "instrument" to aide politicians that Murdoch favours.

b)

Commitment to competence. Management's commitment to competence refers to considering the skill levels required for particular jobs within the organization and making sure that staff with the required skills are hired and matched to the right jobs.

c)

Participation by those charged with governance. The organization's control environment is influenced significantly by its board of directors and others charged with governance of the entity; for example, the audit committee members or the CEO (if they are charged with responsibility for governance as well as being a member of management). Those charged with governance are responsible for overseeing the entity's accounting and financial reporting policies and procedures. As a result, those charged with governance have an obligation to be concerned with the entity's financial reporting to shareholders and the investing public, and to monitor the entity's accounting policies and the internal and independent (external) audit processes.

The News Corp announcement that its UK management standards committee would be removed from News International appears to be a first cosmetic attempt to provide an indication of participation by those charged with governance.

d)

Management's philosophy and operating style. Obtaining an understanding of management's philosophy and operating style is necessary to identify the factors that influence management's attitudes towards internal control. This understanding affects the auditor's assessment of how management makes judgements and accounting estimates,

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as well as providing an insight into the competence and motivations of management. The more confidence an auditor gains regarding management's abilities and integrity, the more reliance placed on the information, explanations and representations provided by management. Alternatively, doubts about management's ability and integrity will increase the level of corroborating evidence required for representations made by management. An understanding of management's operating style is therefore a fundamental input into assessing audit risk.

The effect of the phone hacking scandal originating with the News of the World also raised wider questions about the ethics employed by companies under Murdoch's ownership, and the ethics employed specifically by print journalists and to some extent the wider world of journalism. e)

Organizational structure. The client's organizational structure provides the framework within which its activities for achieving entity-wide objectives are planned, executed, controlled and monitored. Establishing an organizational structure includes considering the key areas of authority and responsibility as well as the appropriateness of lines of reporting.

1.

Assignment of authority and responsibility. Assignment of authority and responsibility includes how authority and responsibility for operating activities are assigned, and how reporting relationships and authorization hierarchies are established. It includes policies relating to appropriate business practices, knowledge and experience of key personnel, and resources provided for carrying out duties. It also includes policies and communications directed towards ensuring all employees understand the organization's objectives, know how their individual roles and actions contribute to those objectives, and recognize how they will be held accountable for their actions.

Somebody had to assign authority at News of the World and someone has to be held responsible. It starts with the tone at the top.

The Guardian reported that the News of the World had made payments in excess of £1 million to three people subject to phone hacking, including Professional Footballers' Association chairman Gordon Taylor, with the out-of-court settlements subject to secrecy clauses. Around the same time, Private Eye revealed that The Guardian had, in order to avoid "all out war" with the News of the World, chosen not to tell the same Culture, Media and Sport Committee that the £700,000 payment to Taylor was signed off in June 2008 by the directors of News Group Newspapers, the News International subsidiary owning the News of the World - thus showing awareness of the matter at the highest levels. The reports led the Press Complaints Commission to reopen its inquiry into the matter, leading The Guardian's editor Alan Rusbridger to resign from the PCC.

2.

Human resource policies and practices. Human resource policies and practices relate to hiring, inducting, training, evaluating, counselling, promoting and compensating employees. As discussed above, the competence and integrity of an entity's employees are essential elements of its control environment. The organization's ability to recruit and retain competent and responsible employees is therefore dependent to a large extent on its human resource policies and practices.

Having resigned in 2007 as editor of the News of the World in the aftermath of the royal hacking affair, Andy Coulson quit his position as David Cameron's communications director on 21 January 2011, citing "continued coverage of events connected to my old

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job at the News of the World". British Prime Minister Cameron had hired the former editor of News of the World, without performing a high level of due diligence in hiring Coulson.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe the elements of the system of internal control at the entity level.

Section Reference: 7.3 Objectives of internal controls CPA Competency: Audit and Assurance AACSB: Analytic 118. (Reproduced from: CICA UFE Question 2009 — Paper 2 — Question 3) Bazaar buys computers, parts, and related equipment and resells them at a mark-up to a loyal base of corporate customers. Competition is growing, but the market is favourable, and Bazaar offers excellent customer service, giving it a competitive advantage. The owner is very involved in most of the important operating decisions. His capable assistant steps in when necessary.

The owner plans to implement a code of ethics at some point and also wishes to improve certain controls.

Bazaar is a medium-sized private company that operates multiple warehouses, each carrying a mix of inventory items. The first type of inventory, which can be quite costly, consists of specialized computer hardware, desktop computers, and laptop computers. The turnover rate for this inventory is high since new technology is always emerging. Because the company orders months in advance, Bazaar occasionally overestimates demand. After three or four months, products are difficult to sell, but they are kept because most cannot be returned to the supplier, and Bazaar is reluctant to hold liquidation sales for fear they would negatively affect the sales at regular prices. The second type of inventory, parts and peripherals, generates a significant portion of Bazaar’s sales. This category includes items such as monitors, printers, and toner cartridges. The third type of inventory includes software packages ranging from sophisticated operating systems to games. This inventory can be returned to suppliers if unsold after a certain period.

This year, Bazaar implemented an integrated computer system to manage the general ledger as well as inventory, purchases, and sales. Sales representatives enter orders into the sales database, and can modify the information, including quantities and selling prices. Any changes are usually made to orders before shipping. Problems result if representatives make changes after shipping, since they should issue credits instead. The timing differences create reconciliation problems for both customers and Bazaar when settling invoices. Also, sometimes credits have been issued in error. For example, the owner described one example where a credit was issued for a price adjustment made by a sales representative. The supporting paperwork stated that the credit had been issued in error (which seems to happen often) and the refund cheque was cancelled. However, the details of the refund cheque could not be located. When asked, the clerk said he left the cheque copies on his desk and the next morning they were gone. He gave up looking for them.

Electronic purchase orders require authorization from either the owner or his assistant through the use of a personal identification number (PIN). Each user has a specific PIN. Orders greater than $5,000 require the owner’s authorization. Occasionally, the owner is not available. He has given one of the accounting clerks he trusts his PIN to be used for emergency situations. Before

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making a payment, the accounting department matches the invoice to the authorized purchase order and the receiving slip.

Other Information: The owner noted that Bazaar’s costs seem higher than expected, particularly since this year he decided to pay suppliers faster in order to benefit from discounts. According to his calculation, the cost of goods sold should have decreased by around 2% over last year, since most suppliers offer discounts and did not increase prices. Instead, he noted a 3% increase in costs.

The sales mix has not changed significantly from previous years. Purchases increased and were distributed across the inventory types in amounts similar to the overall sales mix. To help retain the sales team, stock options were given this year for the first time as an added form of compensation. The options are available if Bazaar’s net income after tax is at least $5 million per year.

Customers have 30 days to pay invoices, but most take advantage of a 2% discount offered for payment within 10 days. Customers make payments in full payments and discounts are reimbursed later by system-generated cheques. Cheques may be issued with or without supporting documentation.

The owner noted he just received a memo from a clerk at one of the warehouses. It says the amount of damaged inventory has been gradually increasing over the past eight months. The clerk suggests this is because the forklift is not operating properly and items are being dropped as they are loaded for shipment. He wants the forklift replaced. He asks what he should do with the damaged inventory that has been piling up in a corner of the warehouse. He suggests holding a liquidation sale to get rid of it.

Required: a) Assess and conclude on inherent risk. Be sure to discuss items that both increase and decrease risk for a balanced discussion. b) Assess and conclude on the control risk. c) Based on your inherent and control risk assessment, conclude on detection risk. d) Based on the risk assessment, what type of audit strategy should be implemented? e) Identify five control weaknesses at Bazaar. For each weakness, indicate the implication and make a specific recommendation how Bazaar can fix it. f) What is the auditor’s responsibility with respect to fraud when performing a financial statement audit? Assess the fraud risk at Bazaar and indicate what should be done when planning the audit.

Answer: a) Items reducing inherent risk: • Bazaar has been operating for many years and has a good reputation.

• Bazaar has a loyal customer base.

• Owner has many years of experience in the industry.

• Market is favourable.

• Activities are simple (buying and reselling at a markup).

• The nature of the business appears to be non-complex (except for the specialized orders): there do not appear to be complex or non-routine transactions to contend with.

Items increasing inherent risk: • Competition is strong, increasing the possibility of a decline in sales.

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• Multiple warehouse locations increase the complexity of the engagement.

• Bazaar deals with computers and related equipment, and new technology is always emerging, so the risk of inventory obsolescence • Inventory items are computer-related, which may increase the risk of asset misappropriation since they could be considered high-demand products.

• The volume of transactions appears to be high • The distribution of stock options for the first time is an added risk factor because employees may be inclined to manipulate net income in order to obtain their options.

Therefore, the stock options may increase the risk of fraud.

Conclusion: Inherent risk is high. b)

Control risk (internal control components) Items increasing control risk: • Owner says controls could be improved.

• The purchase authorization mechanism seems weak since the assistant was able to authorize a purchase over his limit without much trouble.

• Conversion took place during the year; new system is now in place.

• No code of ethics in place, which shows a lack of clear policies and poor tone at the top.

• Owner has given another employee his PIN number.

• Sales employees can modify all information – can change pricing or quantities without authorization (before or after shipping).

• There appears to be a problem with the issuance of credit notes. One that had been issued by a sales representative was apparently issued in error.

• Appears to be a lack of policies or procedures over documentation – documentation for refund cheque missing.

Conclusion: Control risk is assessed as high.

c)

Detection risk The detection risk should be derived from the assessed inherent risk (IR) and control risk (CR) and should be used to determine the amount of audit work required to reduce the overall risk to an acceptable level. As IR and CR are high, meaning there is a high risk of material misstatement, detection risk should be set at “Low”, therefore, more work is required to reduce the audit risk to an acceptable level.

d)

Audit Strategy (Approach) The overall audit risk is high. This increases the amount of audit work to be performed, and a substantive audit strategy should be planned. Although some controls exist, they appear to be easily circumvented or to not be functioning properly, therefore it does not seem likely we can rely on the controls in place. This means the auditor will plan to do more substantive testing.

e)

System Controls 1. Weakness: Inventory- manual changes to the inventory price list occurred.

2. Implication: The price list may not be reliable. Inventory items may be valued at less (or greater) than their original amounts, impacting the gross margin realized on sales. Since prices can easily be changed, this can lead to improper valuation of inventory and cost of goods sold. These inventory pricing changes may be a factor in the rise of cost of sales, which has increased 3% over the previous year.

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3. Recommendation: Limit access in the computer system so inventory pricing changes may be made by only authorized employees (for instance, by implementing authorization levels within the computer system), with proper backup.

Purchases — PINs 1. Weakness: a situation occurred in which the assistant authorized a purchase that was over his limit. To do so, he would have had to use the owner’s PIN. 2. Implication: The use of PINs for approvals over a specified amount are not functioning as intended. This could lead to improper purchases being made, resulting in losses to the company. This may explain the increase in the cost of sales that is bothering the owner.

3. Recommendation: The PINs used to authorize purchase orders should not be shared among staff. They should be locked away and changed on a regular basis to ensure their security.

Sales 1. Weakness: The database used for sales is shared by all representatives.

2. Implication: Sales orders can be modified after a deal is concluded with a client, and changes may be made to these orders both before and after shipping occurs. The fact that no authorization is required to modify sales orders, and that no controls seem to be in place to restrict access or changes leads to the inability to reconcile sales orders and invoices.

3. Recommendation: Additional controls should be put in place to lock the data once it has been entered into the system. Sales order change request screens should be used to restrict access and track changes. This would allow for proper authorization and verification to be performed before the changes are completed and recorded in the database.

Discount refunds 1. Weakness: When customers pay within the discount period, they often make full payments. A system-generated cheque is then issued to refund the discount, often without backup documentation.

2. Implication: As a result, it is difficult to determine whether the discount was legitimately refunded to the proper customer or whether something suspicious happened.

3. Recommendation: In order to ensure that discount refund cheques are appropriately prepared and are legitimate, adequate supporting documentation approving the issuance of the refund cheque should be in place prior to cheque preparation, and the refund should be approved prior to issuance.

Credit notes 1. Weakness: A refund cheque issued for a price adjustment credit made by a sales representative was cancelled, but the details of the refund cheque could not be located.

The clerk says he left the cheque copies on his desk and the next morning they were gone, and he is no longer looking for them.

2. Implication: Price adjustments may not be in accordance with agreements or contracts and may be prepared for illegitimate purposes.

3. Recommendation: Copies of cheques, along with their supporting documentation, should be kept locked away at all times to ensure that documentation is kept secure and that items can be subsequently reviewed. f)

Fraud

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Although a financial statements audit is not designed to specifically detect fraud, the auditor should still demonstrate professional scepticism when examining information. Examples of suspicious activities were described by the owner. For example, two instances seemed suspicious: the discount refunds and the missing refund cheque. These items (and the fact that the supporting documentation seemed to be nonexistent or had gone astray) may indicate that fraud has occurred. Therefore, additional work is required to investigate further. With respect to the discount refunds and the missing refund cheque, sales representatives may have taken advantage of the ability to change information in the system and made changes to sales contracts in order to obtain payment of the discounts for themselves. It is too early to draw conclusions, but the auditor must remain sceptical of this strange situation.

Difficulty: Hard Bloomcode: Analysis CPA Competency: Audit and Assurance AACSB: Analytic Learning Objective 1: Describe the elements of internal control at the entity level Section Reference: 7.3 System of internal controls

119. Jorge Yulia was anxious to start the selection and testing of controls at Walley Real Estate Group, a company that specializes in unique coastal properties nestled along the Nova Scotia coastline. A charming collection of coastal communities dots the rocks along the Bay of Fundy. Chaz Walley brings years of talent and experience from being an executive in the marketing, technology and finance world to personally owning, renovating, aggregating and subdividing property. Along with investment analysis and extensive contract negotiation experience, clients are expertly represented in every transaction. Chaz imparts a sense of ease and joy to finding the perfect property for each client, making owning beach and coastal property a dream! Jorge had two main “big picture” objectives: to prevent or detect misstatements in the financial statements.

Jorge was concerned about the following issues: 1. Revenue recognition was the trickiest as many of the transactions took over a year to complete. Partial payments and deposits are being made and have to be matched up with proper revenue recognition criteria.

2. The entertainment and promotional expenses were high and he was not sure how they compared to industry standards, although they appeared to be consistent with the Walley Real Estate Group’s profile and the deep pockets of its clientele.

Required: a) What are detective and preventive controls? b) Can Jorge use these preventive and detective controls to help him resolve the two issues he is concerned about? c) Which factors will Jorge have to consider when determining the “extent” of tests to be performed? d) When would Jorge perform substantive testing of revenue?

Answer: a) Preventive controls Preventive controls can be applied to each transaction during normal processing to avoid errors occurring. When designing controls, consideration is given to what can go wrong

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with the transaction (the risk of material misstatement), which would result in an error.

These are sometimes referred to as WCGWs (what can go wrongs). Effective controls should prevent the WCGWs from occurring (preventive controls), or, if they do occur, that the errors are detected and corrected as quickly as possible (detective controls).

An absence of effective preventive controls increases the risk that errors or fraud will occur and, therefore, increases the need for controls that are sensitive enough to detect these errors should they occur.

Detective controls The purpose of detective controls is to discover fraud or errors that may have occurred during transaction processing (in spite of any preventive controls) and to rectify those errors. As discussed above, companies put detective controls in place to assist management in ensuring WCGWs do not occur and that the business is functioning as planned through the design and implementation of its business processes.

Detective controls are often 'unofficial' procedures that client personnel perform to make sure that the information for which they are responsible is accurate. b)

Jorge could integrate preventive and detective controls into the revenue recognition audit program. For example, he could check whether revenue transactions were allowed if customers exceeded their credit limits (preventive control) or if the accounting system had captured all the relevant data of a closed sales transaction.

Jorge would be hard pressed to use preventive or detective controls over the reasonableness of promotional expenses unless he had standards or benchmarks, such as budgeted amounts that he could compare actual expenses to.

c)

The factors to consider when deciding the extent of testing include the following: 1. How often the control is performed.

2. The degree to which the auditor intends to rely on the control as a basis for limiting their substantive tests.

3. The persuasiveness of the evidence produced by the control.

4. The need to be satisfied that the control operated as intended throughout the period of reliance.

5. The existence of a combination of controls that may reduce the level of assurance that might be needed from any one of the controls.

6. The relative importance of the 'what can go wrong' questions or statement being considered.

7. Other factors that relate to the likelihood that a control operated as intended during the period of reliance, including: – The competence of the person who performs the control – The quality of the control environment – Changes in the accounting system – Unexplained changes in related account balances – The auditor's prior-period experiences with the engagement Even though the above factors may reduce the expectation of errors, the auditor's tests of a control need to be sufficiently extensive to provide reasonable assurance that the control operated effectively throughout the period of reliance.

d)

Substantive procedures or substantive tests would be performed at year end. The tests of controls would be performed during the interim audit.

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Bloomcode: Analysis Difficulty: Medium Learning Objective: Identify the different types of controls.

Learning Objective: Explain how to select and design tests of controls.

Section Reference: 7.4 Types of controls Section Reference: 7.5 Selecting and designing tests of controls CPA Competency: Audit and Assurance AACSB: Analytic 120. (Reproduced from ICAO — 2006 — Practice Test 2 — Question 3) Definition Electronics (Definition) is one of Canada’s leading retailers of home video and audio equipment. Ten years ago, Definition began as a local electronics store. It has rapidly grown and it now operates 11 stores across the country and it employs over 200 people. You, CPA, recently joined as a financial analyst in January 2020. It is your first day on the job and you meet with John Gomery, Definition’s controller. John explains that because of the rapid growth, he believes there are significant control weaknesses. Part of the issue is they are using an old proprietary software system called “eDef”. He goes on to tell you how the system works and you note the following: eDef is used to manage inventory and record sales and purchases. The primary activities used on a daily basis include: •

Recording of sale transactions. Definition does not use cash registers. Salespeople use networked PCs to record sales in eDef. eDef calculates sales taxes and generates invoices. It updates the inventory on hand at the same time.

•

Recording returns. A merchandise return results in a refund issued to the customer.

However, the item is not added back into inventory as the owner feels very strongly about not selling opened packages. Returned inventory is tracked manually in a spreadsheet on the server and periodically sold through a clearance sale or on eBay. There is no separate return module. Returns are recorded as negative sales transactions and the system has been programmed not to update inventory quantities for such transactions.

•

Recording inventory purchases. eDef automatically generates a purchase order when the on-hand quantity for any given SKU falls below a preset limit. When the inventory is received, the quantity on hand can be updated only if an open purchase order exists.

•

Calculation of commissions. On a monthly basis, eDef calculates sales staff’s commissions. Definition’s salespeople earn a low base salary and a 5% commission on their net sales.

At month-end, Definition’s accounting staff download sales and inventory transactions from eDef into Quicken, a small business accounting system. They prepare financial statements which are required by the bank within 15 days of month-end.

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eDef and the hardware it runs on have lately been unable to cope with the volume of transactions recorded in multiple locations. It has crashed 4 times last month, each time for at least 3 hours.

The controller goes on to discuss the policies currently in place. They are as follows: 1. All merchandise may be returned within 30 days of sale. Whenever possible, the return should be processed by the salesperson that made the original sale in order to maintain the customer relationship.

2. The store manager counts all inventory weekly. An eDef report is generated and the manager then counts the items in the store based on the report. Any discrepancies should be reported to George.

3. Salespeople may, based on their judgement, reduce prices by up to 10% for repeat customers.

4. Daily sales journal by salesperson is generated by eDef and reconciled to the daily cash receipts (or credit card slips) by the store manager. The journal reflects both sales and returns.

5. Salespeople can edit sales records from the same day (in case they make a mistake they discover after the invoice is printed). At the end of the day, once the sales journal is reconciled, the store manager “locks” the day’s records. Subsequent changes must be processed as either additional sales or returns.

6. If the system is temporarily down, salespeople are instructed to prepare invoices using a Microsoft Word template (which to the customer looks like a regular Definition invoice) and keep a copy of it. When the system is back up, the store manager enters these manual invoices into eDef using the normal sales module.

7. Salesperson commission (based on net sales) is paid monthly. Store manager bonus (based on store net sales) is paid quarterly.

Required: Identify the control weaknesses at Definition. For each item, address the implication of the weakness and make a recommendation.

Answer: Manual Invoices Weakness: When the system crashes (which has been a frequent issue lately), salespeople prepare manual invoices in Word. These are later input into eDef when it is back on line.

Implication: There is a significant risk of an error or fraud. Salespeople could simply not give the invoices to the store manager and keep the cash. This would be discovered during the inventory count, but it would be difficult to trace the fraud to a specific salesperson. More likely, salespeople could easily alter the amount of the invoice in Word, hand the invoice with the lower amount to the store manager, and steal the difference. This fraud would be difficult to detect since salespeople have the discretion to reduce list prices by up to 10%. There is also the possibility of

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inadvertent error – salespeople could misplace invoices or the store managers could enter them incorrectly. As a result, the accounting records would be incorrect which would result in errors in the financial statements and bad purchasing decisions (since the system drives purchase orders).

Offsetting control: The head office should prepare duplicate pre-numbered invoices with safety features (such as colour logo or something else difficult to reproduce), which could be used during outages. All carbon copies of manual invoices should be sent back to head office once filled out, and the corporate controller should reconcile them to the entries in eDef. A search for missing manual invoice numbers should be made regularly. As an added control, all manual invoices over a certain threshold should be reviewed and signed by the store manager before given to the customer and should be logged in a register, later reconciled to eDef. Ability to edit invoices Weakness: A major control weakness is the ability of salespeople to edit invoices the same day.

Implication: This creates several opportunities for fraud. A salesperson could wait until the customer leaves the store and could then reduce the selling price in eDef and steal the difference.

This would not be suspicious since salespeople have the discretion to reduce prices for repeat customers. Furthermore, salespeople could alter other salespersons’ records since there are no access controls. They might change the salesperson ID for a transaction (replace another salesperson’s ID with their own to embezzle their commission).

Offsetting control: It would be best if George can turn this feature off right away. Salespeople should not be able to edit the invoice once it is issued. Corrections could be made through credit memos, which should be tracked and reviewed by the store managers on a daily basis and by the corporate office on a test basis.

Processing of returns Weakness: The system does not update inventory on hand for a return and returns are processed as negative sales.

Implication: As the returned merchandise is tracked in a manual spreadsheet the salesperson only needs to forget to enter the return in the spreadsheet and the loss may not be detected.

There is also a risk that a salesperson might steal the returned merchandise.

Offsetting control: Until a better automated system can be implemented, Definition could require salespeople to fill out a duplicate pre-numbered return form. The original invoice number and date should be entered on the form by the salesperson. All forms would need to be approved and checked for compliance by the store manager before a refund is issued (the manager can check the invoice date against the original transaction in eDef to make sure it is correct). The store manager can then process the return in the system, ensuring it is charged against the correct salesperson for commission purposes. The store manager should also be the one updating the inventory sheet.

Controls over cash and inventory Weakness: Definition does not use cash registers that would create clear accountability for cash and as mentioned above there are other weaknesses over the processing of sales and returns and over returned merchandise.

Implication: There appears to be a significant risk of cash embezzlement and there is a high risk of inventory defalcation as the inventory is high value (expensive equipment).

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Offsetting control: Until a better system is installed, we could centralize cash and inventory handling to create clear responsibilities. Instead of salespeople accepting cash, we could have one cashier in each location handle all cash transactions directly with customers. This would reduce some of the risks mentioned above. Similarly, there should be a designated inventory manager at each store who should accept all returns (initialling the return form), keep the inventory in a secure area and ultimately be responsible for it.

Inventory Counts / Inventory Shortages Weakness: For new merchandise, the onus is on store managers to report inventory shortages to George.

Implication: New store managers might neglect to report inventory shortages to cover up shortages, whether caused by them or others.

Offsetting control: The corporate office should consider conducting “surprise” inventory checks at all locations, either personally or hire an independent third party to do so.

Controls over purchasing Weakness: Currently, purchase orders are generated automatically by the system.

Implication: Given the numerous control weaknesses, there is a significant risk that the inventory quantities in eDef may be incorrect or that unauthorized or incorrect program changes might lead to wrong purchasing decisions by eDef. This could result in Definition ordering too much inventory (and risk loss if it has to be sold at clearance prices) or running out of inventory.

Offsetting control: George, the controller or at minimum the store manager should review and approve all purchase orders to ensure the quantities being ordered appear reasonable. In addition, the store managers should survey inventory daily (probably just walk through) to make sure the store is not at risk of running out of critical items.

Financial reporting Weakness: The bank relies on Definition’s financial statements. Weaknesses in the system may result in incorrect sales, returns, purchases or inventory balances which may in turn lead to material misstatements in our financial statements.

Implication: Such misstatements, when discovered, would have an adverse impact on our relationship with the bank and might even cause the bank to demand repayment. This would likely impact our ability to continue as a going concern.

Offsetting control: George and the controller should carefully review the financial statements before they go to the bank. We should also consider engaging an independent accounting firm to provide some limited assurance (review would likely be more economical than an audit) on at least a quarterly basis.

Bloomcode: Analysis Difficulty: Hard Learning Objective: Describe the importance of identifying strengths and weaknesses in a system of internal controls.

Learning Objective: Explain how to communicate internal control strengths and weaknesses to those charged with governance.

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Section Reference: 7.9 Identifying strengths and weaknesses in a system of internal controls Section Reference: 7.5 Management letters CPA Competency: Audit and Assurance AACSB: Analytic

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The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 8 EXECUTION OF THE AUDIT—PERFORMING SUBSTANTIVE PROCEDURES CHAPTER LEARNING OBJECTIVES 1. Define substantive audit procedures.

Substantive audit procedures are procedures designed to obtain direct evidence of the completeness, accuracy, and validity of data, and the reasonableness of estimates and other information contained in the financial statements. Substantive procedures include inspection, observation, enquiry, confirmation, recalculation, re-performance, analyses of many types, and analytical reviews.

2. Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

The combination of inherent risk and control risk determines the level of detection risk the auditor is willing to accept that will still allow them to conclude that the financial statements are not materially misstated. Detection risk is reduced or increased in direct proportion to the amount of substantive testing performed. There are several factors that influence how much substantive testing must be performed, including the nature of the test, the level of assurance necessary, the type of evidence required, and the complexity of the client’s data-capturing systems. The timing of substantive procedures is most flexible when controls have been tested and assessed as effective. In that case, the procedures can be performed up to six months before year end. When controls are not tested or are not assessed as effective, the timing of substantive procedures is at or near year end.

3. Provide examples of different substantive audit procedures.

The different types of substantive procedures are tests of transactions/underlying data, and analytical procedures. Different analytical procedures include absolute data comparisons, ratio analysis, trend analysis, common-size financial statements, break-even analysis, and pattern and regression analysis. Substantive analytical procedures are different from those analytical procedures used during the planning phase of the audit.

4. Explain the different levels of audit evidence obtained when performing substantive procedures.

The different levels of audit evidence obtained when performing substantive procedures include persuasive, corroborative, minimal, and general audit evidence.

5. Design an audit plan to audit accounting estimates.

After an auditor identifies and assesses the risk of misstatement relating to accounting estimates, the auditor plans the audit response. Procedures may include obtaining evidence after year end but before the audit report date, developing an estimate and comparing with management’s, and testing how management made the estimate. Additional work is required if a risk is assessed as a

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significant risk. The auditor should also “stand back” to assess the audit evidence gathered in an unbiased fashion.

6. Describe the documentation of the conclusions reached as a result of performing substantive procedures.

Conclusion statements are documented for each significant account (including the execution of the relevant audit program steps), the results, and any significant findings, including any misstatements. The auditor also documents that the financial statements reconcile to the underlying accounting records. Overall conclusions are usually prepared for each audit program step completed, as well as for each significant account and significant assertion.

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`TRUE-FALSE STATEMENTS 1. A significant account is one that could contain material misstatements based upon their materiality and/or relationship to identified inherent and financial statement risks.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

2. Control risk is assessed to be low when there are no internal controls tested or relied upon by the auditor.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

3. Normally, it is more efficient to carry out substantive procedures than to test and rely on controls.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

4. The timing of substantive procedures is directly influenced by the level of control risk.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

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Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

5. Roll-forward procedures are performed during the period between the end of the financial year and the date of the audit report.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

6. Key item testing is an example of a technique used when conducting substantive procedures.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

7. Vouching involves tracking a source document back to the underlying accounting records.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

8. Audit sampling is the application of audit procedures to less than 100 per cent of items within a population.

Answer: True Bloomcode: Knowledge

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Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

9. Analytical procedures may not be useful when they are used on a company with significantly diverse operations and geographical segments.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

10. Analytical procedures that provide persuasive or corroborative evidence contribute minimal support for the audit conclusion.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of audit evidence obtained when performing substantive procedures.

Section Reference: 8.4 Levels of Evidence CPA: Audit and Assurance AACSB: Analytic

11. Comparing the number of days purchases in trade payables with prior years would provide persuasive evidence of accounts payable.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of audit evidence obtained when performing substantive procedures.

Section Reference: 8.4 Levels of Evidence CPA: Audit and Assurance AACSB: Analytic

12. Corroborative evidence confirms audit findings from other procedures.

Answer: True

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of audit evidence obtained when performing substantive procedures.

Section Reference: 8.4 Levels of Evidence CPA: Audit and Assurance AACSB: Analytic

13. Estimates include estimation uncertainty, which will have no impact on the risk of material misstatement.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design an audit plan to audit accounting estimates.

Section Reference: 8.5 Auditing Accounting Estimates CPA: Audit and Assurance AACSB: Analytic

14. When considering the impact of accounting estimates on the audit, the greater the estimation uncertainty, the greater the audit effort required.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design an audit plan to audit accounting estimates.

Section Reference: 8.5 Auditing Accounting Estimates CPA: Audit and Assurance AACSB: Analytic 15. When auditing accounting estimates, the auditor can develop a point of estimate and compare against management’s estimate to ensure the amount is reasonable.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design an audit plan to audit accounting estimates.

Section Reference: 8.5 Auditing Accounting Estimates CPA: Audit and Assurance AACSB: Analytic

16. The lack of significant change in an account balance from one year to the next does not necessarily mean that the auditor can assume the balance is reasonable.

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Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the documentation of the conclusions reached as a result of performing substantive procedures.

Section Reference: 8.6 Evaluating and Documenting Substantive Analytical Procedures’ Results CPA: Audit and Assurance AACSB: Analytic

17. Misstatements can only arise from fraud.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the documentation of the conclusions reached as a result of performing substantive procedures.

Section Reference: 8.6 Evaluating and Documenting Substantive Analytical Procedures’ Results CPA: Audit and Assurance AACSB: Analytic

18. The audit program serves as the instructions for the audit team members to complete the required testing.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the documentation of the conclusions reached as a result of performing substantive procedures.

Section Reference: 8.6 Evaluating and Documenting Substantive Analytical Procedures’ Results CPA: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

MULTIPLE CHOICE QUESTIONS 19. Matilda Papas has been asked to lead her audit team in the audit of the Toronto Raptors basketball team. She performed a review of their risks and found that the team’s risks tend to be driven by the nature of certain significant accounts or business activities that the Raptors pursue. This risk is a) audit risk. b) inherent risk. c) control risk. d) detection risk.

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

20. Manny Regimbald is concerned about the audit of a high-risk client, the Lewiston Stampeders. He believes that there is a high likelihood that because his audit team is inexperienced, the testing procedures will not detect a material misstatement. This is a(n) a) audit risk. b) control risk. c) detection risk. d) none of the above Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

21. Kelton Kittle is ready to undertake substantive procedures at an educational institution.

Which of the following factors will influence his substantive tests? a) the nature of the test b) the type of evidence required c) the complexity of the client's data-capturing systems d) all of the above

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Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

22. After performing a risk assessment of a food processing company, Abrar Singh has come to the conclusion that he will require more evidence to be obtained by his audit team from substantive procedures. Which of the factors below led him to this conclusion? a) the level of assurance necessary b) the type of evidence required c) the nature of the test d) the complexity of the client's data capturing systems Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

23. Ying Ye believes that she will have to employ sophisticated substantive audit procedures for her client. What contributes to this decision? a) the nature of the client’s accounting system b) the availability of an internal auditor to assist in the testing c) the complexity of the client's data capturing systems d) none of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

24. Inherent risk is a) assessed as high when there are no internal controls tested or relied upon by the auditor. b) assessed as low when there are good internal controls in place.

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c) the risk of a misstatement occurring irrespective of any internal controls put in place by management. d) the risk that the auditor's testing procedures will not detect a material misstatement.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

25. Which of the following statements is correct? a) If detection risk is high, few substantive procedures are necessary to reduce the detection risk. b) There is an inverse relation between the auditor's assessed risk of material misstatement and detection risk. c) There is no relation between the auditor's assessed risk of material misstatement and detection risk. d) If detection risk is low, significant substantive procedures are necessary to reduce the detection risk.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

26. The purpose of substantive procedures includes obtaining direct evidence as to a) the reasonableness of the estimates and other information in the financial statements. b) the completeness, accuracy, and validity of data. c) both a and b d) none of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

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27. Substantive testing can be conducted using which of the following procedures? a) enquiry b) confirmation c) analytical review d) all of the above Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

28. Which of the following factors do not influence the extent and timing of substantive procedures to be undertaken? a) the audit risk assessment b) the nature of the procedures c) complexity of the audit client’s data-capturing system d) the level of assistance received from the internal auditor who responds directly to management Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Define substantive audit procedures Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

29. Uber Levin has performed a test of controls of a flower shop. He has concluded that the controls are very effective and that the inherent risk is low. He is trying to determine the timing of substantive procedures at year end. Which factor will determine the timing of his audit procedures? a) timing of the year-end work b) audit risk c) inherent risk d) control risk Answer: a Bloomcode: Comprehension Difficulty: Easy

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Auditing: A Practical Approach, Fourth Canadian Edition

Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

30. Olaf Kuzino is trying to determine the extent of testing his team will have to perform in order to determine whether controls are working. How will he decide how much testing to perform? a) He will utilize statistical sampling. b) He will use his professional judgement. c) He will use last year’s results as a basis for this year’s tests. d) none of the above Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

31. Which of the following factors should not influence the extent and timing of when substantive procedures are performed? a) the type of audit opinion that the client would like the auditor to issue b) the complexity of the client's data capturing systems c) the level of assurance necessary d) the type of evidence required Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

32. Typically, substantive testing tends to be performed a) at the start of the financial year.

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b) at or near year end. c) half way through the financial year. d) only when the client's management allows the auditor to conduct the tests.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

33. Roll-forward procedures are performed a) to update the audit findings from the time of the interim procedures through to year end. b) to detect fraud in various balance sheet accounts. c) before the end of the financial year. d) none of the above Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

34. Which of the following examples of substantive procedures would often be performed prior to year end? a) confirming the client's bank balance b) attending the client's annual inventory count c) testing additions and disposals to the fixed asset register d) performing confirmations of accounts receivable Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures

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CPA: Audit and Assurance AACSB: Analytic

35. Performing substantive procedures prior to year end, in the absence of specific effective controls, may be acceptable when a) the auditor is able to conclude overall that the client's control environment is effective. b) the likelihood of errors or fraud is high. c) the likelihood of errors or fraud is low. d) both a and c Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic 36. An auditor’s ability to perform substantive procedures at an interim date is dependent on a) the evaluation of audit risk. b) convenience. c) the materiality of the account to be tested. d) an effective control environment.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

37. Which of the following substantive tests would an auditor most likely conduct at year end? a) testing the proper authorization of purchase orders. b) review of the audit client’s credit procedures. c) testing the mathematical accuracy of invoices. d) confirmation of accounts receivable.

Answer: d

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Execution of the Audit—Performing Substantive Procedures

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Bloomcode: Application Difficulty: Medium Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

38. Roll-forward procedures are conducted to a) update findings from the previous year’s audit to the current year. b) update findings from an interim date to year end. c) adjust accounts at year end for prepayments. d) none of the above Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

39. Which of the following factors would most likely influence an auditor's consideration of the reliability of data when performing analytical procedures? a) if the data were developed in a computerized accounting system b) if the data were prepared in conformity with GAAP c) if the data were developed under a system with adequate controls d) if the data were processed in an online system Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

40. Sherry Galo is performing procedures and has decided to vouch the balance in the fixed

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Auditing: A Practical Approach, Fourth Canadian Edition

assets ledger of a furniture manufacturing company back to supporting documentation. She is performing a a) test of details. b) test of controls. c) risk assessment. d) none of the above Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

41. Daniel Morency has performed evaluations of financial information and determined whether the fluctuations of his client’s sales figures are consistent with other data he has gathered. He has used this information to predict year-end amounts of sales. This is an example of substantive procedures called a) tests of details. b) computer-assisted audit techniques. c) analytical procedures. d) none of the above Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

42. Tobias Appel is trying to ensure that he can review controls over purchasing transactions. In addition, he would like to substantiate the dollar amounts he is reviewing. What type of procedures can he perform that will provide evidence as to whether a control is effective as well as if an item is being recorded properly? a) statistical sampling b) dual purpose tests c) test of balances d) test of controls Answer: b Bloomcode: Application

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Execution of the Audit—Performing Substantive Procedures

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Difficulty: Medium Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

43. Stella Zhang has been performing analytical procedures techniques as a substantive test.

The techniques that can be used to perform analytical procedures are a) preparation of common-sized financial statements. b) break-even analysis. c) ratio analysis. d) all of the above Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

44. The nature of substantive procedures normally consists of one or a combination of techniques. Which of the following is not one of these techniques? a) analytical procedures b) representative sampling c) key item testing d) testing proper authorization of invoicing Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

45. Vouching involves a) tracking a source document through to the underlying accounting records. b) agreeing the details of a transaction to supporting evidence outside of the company's accounting records. c) the application of audit procedures to less than 100 per cent of items within a population. d) none of the above

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Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

46. Tracing is primarily directed towards verifying which of the following assertions? a) completeness b) existence c) occurrence d) accuracy, valuation, and allocation Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

47. The primary purpose of vouching is to ensure that a) the balances or transactions are not understated. b) sufficient information is disclosed in the notes to the financial statements. c) the balances or transactions are not overstated. d) all transactions have been recorded.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic 48. Common examples of substantive procedures related to key items testing and representative sampling include a) tests of income statement accounts for account classification. b) tests of client-prepared schedules. c) tests of underlying data to be used as part of the analytical procedures. d) all of the above

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Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

49. Analytical procedures may not be used a) as primary tests of an account balance. b) in testing internal controls. c) to provide at least some minimal level of support for the conclusion. d) as corroborative tests in combination with other procedures.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

50. Which of the following is not a type of analytical procedure? a) confirmation analysis b) ratio analysis c) break-even analysis d) trend analysis Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

51. Which of the following is the first step an auditor performs when performing analytical procedures? a) determine appropriate procedures for investigating the reasons for differences if they are significant b) draw conclusions c) identify the computation, comparison, or relationship to be made or investigated

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Auditing: A Practical Approach, Fourth Canadian Edition

d) assess the reliability of any data to be used Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

52. Using computer-assisted audit techniques (CAATs) makes the audit a) more comprehensive. b) more expensive. c) more efficient. d) both a and c Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

53. Jacqueline Martineau was told by her audit senior to ensure that the evidence she provided through analytical procedures was both persuasive and corroborative. Which of the following evidences are persuasive? a) When reviewing accruals for commissions, refer to terms of agreements and payment dates. b) When reviewing trade receivables or sales, review the volatility of the customer base and compare with expectations. c) When reviewing sales and commissions expense, compare sales commissions or bonuses with related sales. d) When reviewing payroll expense, compare payroll tax expenses to the annual payroll times the statutory tax rates.

Answer: a Bloomcode: Evaluation Difficulty: Hard Learning Objective: Explain the different levels of audit evidence obtained when performing substantive procedures.

Section Reference: 8.4 Levels of Evidence CPA: Audit and Assurance AACSB: Analytic

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54. Analytical procedures that provide persuasive evidence include a) reviewing the cash accounts in the general ledger for unusual items. b) relating average amounts invested to an average interest rate. c) comparing the number of days purchases in trade payables with prior years. d) reviewing the property, plant, and equipment account in the general ledger for unusual items.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of audit evidence obtained when performing substantive procedures.

Section Reference: 8.4 Levels of Evidence CPA: Audit and Assurance AACSB: Analytic

55. Comparing sales commissions or bonuses with related sales provides what level of evidence? a) corroborative b) absolute c) minimal d) persuasive Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Explain the different levels of audit evidence obtained when performing substantive procedures.

Section Reference: 8.4 Levels of Evidence CPA: Audit and Assurance AACSB: Analytic

56. The levels of evidence that can be obtained when performing substantive procedures includes a) minimal. b) persuasive. c) general. d) all of the above Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of audit evidence obtained when performing

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substantive procedures.

Section Reference: 8.4 Levels of Evidence CPA: Audit and Assurance AACSB: Analytic

57. Corroborative evidence a) supplements the results from analytical procedures. b) confirms audit findings from other procedures. c) confirms the auditor’s evaluation of internal controls. d) none of the above Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of audit evidence obtained when performing substantive procedures.

Section Reference: 8.4 Levels of Evidence CPA: Audit and Assurance AACSB: Analytic

58. Which of following procedures provides an example of minimal support for conclusions? a) comparison of sales commissions with related sales b) comparison of direct labour costs and the number of employees with prior periods c) comparison of selling prices less selling costs to normal gross margins d) none of the above Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Explain the different levels of audit evidence obtained when performing substantive procedures.

Section Reference: 8.4 Levels of Evidence CPA: Audit and Assurance AACSB: Analytic

59. An example of an analytical procedure which provides persuasive evidence is a) calculating commissions paid as a percentage of sales. b) comparing sales commissions and bonuses paid with related sales. c) reviewing cash accounts in the general ledger for unusual items. d) comparing the debtor’s turnover in the current year to the previous year.

Answer: a

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Bloomcode: Application Difficulty: Medium Learning Objective: Explain the different levels of audit evidence obtained when performing substantive procedures.

Section Reference: 8.4 Levels of Evidence CPA: Audit and Assurance AACSB: Analytic

60. Analytical procedures may be used a) as primary tests of a balance. b) as corroborative tests in combination with other procedures. c) to provide at least some minimal level of support for the conclusion. d) all of the above Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of audit evidence obtained when performing substantive procedures.

Section Reference: 8.4 Levels of Evidence CPA: Audit and Assurance AACSB: Analytic

61. Which of the following tests of details should be considered when significant risk exists in accounting estimates? a) examining documents to corroborate terms b) verifying mathematical accuracy c) agreeing assumptions to supporting documents d) all of these are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Design an audit plan to audit accounting estimates.

Section Reference: 8.5 Auditing Accounting Estimates CPA: Audit and Assurance AACSB: Analytic

62. When the documentation pertaining to auditing an estimate is complete, the auditor should a) always discuss their findings with management. b) stand back and assess whether the estimate is reasonable. c) repeat the tests performed to ensure they were accurate.

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d) the audit requirements of the estimate is complete and no further work is required.

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Design an audit plan to audit accounting estimates.

Section Reference: 8.5 Auditing Accounting Estimates CPA: Audit and Assurance AACSB: Analytic

63. Which of the following is not an event which causes a fluctuation in the accounting data? a) changes in the payroll rates b) the introduction of a new sales item c) changes to the organizational chart of the entity d) increased costs of inventory Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the documentation of the conclusions reached as a result of performing substantive procedures.

Section Reference: 8.6 Evaluating and Documenting Substantive Analytical Procedures’ Results CPA: Audit and Assurance AACSB: Analytic

64. Judgmental misstatements can arise from a) the auditor conducting substantive tests inappropriate to the account being tested. b) differences in the interpretation or application of accounting policies. c) selecting a sample that is not representative of the population. d) none of the above Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the documentation of the conclusions reached as a result of performing substantive procedures.

Section Reference: 8.6 Evaluating and Documenting Substantive Analytical Procedures’ Results CPA: Audit and Assurance AACSB: Analytic

65. When an auditor identifies unexpected misstatements or errors, he/she will a) re-evaluate the effectiveness of internal controls and overall assessment of risk.

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Execution of the Audit—Performing Substantive Procedures

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b) plan to conduct predominately substantive tests. c) increase the level of tests of internal controls. d) none of the above Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Describe the documentation of the conclusions reached as a result of performing substantive procedures.

Section Reference: 8.6 Evaluating and Documenting Substantive Analytical Procedures’ Results CPA: Audit and Assurance AACSB: Analytic

66. Fluctuations in financial data identified by the auditor when planning the audit may be caused by a) dependent relationships. b) seasonal patterns. c) external decisions directly impacting the business. d) all of the above Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the documentation of the conclusions reached as a result of performing substantive procedures.

Section Reference: 8.6 Evaluating and Documenting Substantive Analytical Procedures’ Results CPA: Audit and Assurance AACSB: Analytic

67. Which of the following statements is correct? a) Misstatements can only arise from fraud. b) Misstatements can only arise from error. c) Misstatements can arise from error or fraud. d) none of the above Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the documentation of the conclusions reached as a result of performing substantive procedures.

Section Reference: 8.6 Evaluating and Documenting Substantive Analytical Procedures’ Results CPA: Audit and Assurance AACSB: Analytic

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68. Overall significant account conclusion statements are captured on a) audit programs. b) lead sheets. c) confirmation requests. d) minutes of board of directors' meetings.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the documentation of the conclusions reached as a result of performing substantive procedures.

Section Reference: 8.6 Evaluating and Documenting Substantive Analytical Procedures’ Results CPA: Audit and Assurance AACSB: Analytic

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SHORT ANSWER QUESTIONS 69. Indicate whether you agree or disagree with the following statements and explain your reasoning. a)

Svetlana Petrova was reviewing the risk profile of Gaz Prom Industries in order to determine detection risk. She concluded: “Both my inherent and control risks are low. I guess I should be willing to accept high detection risk.”

b)

Boris Ivanov had performed an assessment of the accounts payable system at Magnitogirsk Iron and Steel Works Operations in the Urals. His focus was on the completeness assertion for accounts payable balances. Inherent risk and control risk were both high. He decided that because the overall risk assessment was high he would have to set his detection risk high.

c)

Jana Novotna, the auditor in charge of the Mosenergo petroleum giant, was explaining to Valentin Titov the importance of the timing of substantive procedures: “Although we associate examinations of internal controls with interim work and substantive procedures with year-end work, we can perform substantive procedures before year end if there exists an effective control environment.”

d)

Susan Martin, the audit senior at Canadian National Railways, was explaining to the junior auditor how vouching works: “We take a balance or a transaction from the underlying accounting records and agree it to the supporting evidence inside the accounting records of the company.”

e)

Larisa McCarthy, the auditor in charge of the Firestone audit, feels that the large population of sales transactions warrants the use of representative sampling. She mentions to her staff: “Representative sampling using audit risk tables is especially useful when a lot of errors exist in an accounting system and the auditor perceives the risk of understatement to be high.”

Answer: a) Agree. There is an inverse relation between the auditor's assessed risk of material misstatement and detection risk.

Detection risk is reduced or increased in direct proportion to the amount of substantive testing performed.

If the combined inherent risk and control risk are low, as it is in this case (the client is in a low-risk industry and the account has a lower chance of being materially misstated if there are controls put in place), the amount of detection risk the auditor is willing to accept is high and therefore only a small number of substantive procedures are necessary to reduce the detection risk. b)

Disagree. There is an inverse relation between the auditor's assessed risk of material misstatement and detection risk.

Detection risk is reduced or increased in direct proportion to the amount of substantive testing performed.

If the combined inherent risk and control risk is high this indicates that the client is in a highrisk industry. As a result, the account has a higher chance of being materially misstated if

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there are no controls put in place and no controls have been tested. Therefore, the amount of detection risk the auditor is willing to accept is low and therefore significant substantive procedures are necessary to reduce the detection risk. c)

Agree. The auditor's ability to perform substantive audit procedures at an interim date is generally dependent on the existence of an effective control environment and the effectiveness of controls.

When the control environment is ineffective or there are specific ineffective controls, the auditor considers whether or not it is appropriate to perform substantive procedures at an interim date.

The timing of the substantive procedures is most flexible when controls have been assessed as effective and tested to confirm this assessment. In these circumstances, the substantive procedures may be performed earlier in the year. When controls are assessed as effective but not tested, the substantive procedures may still be performed at an interim date.

d)

Disagree. Vouching is when a balance or transaction is taken from the underlying accounting records and verified by agreeing the details to supporting evidence outside of the accounting records of the company. Typically, the details are agreed to external thirdparty information such as a supplier invoice or delivery documentation.

e)

Disagree. The auditor uses this technique when they do not expect errors or they expect a low number of errors. Auditors use representative sampling when the risk of material misstatement has been assessed as low, and their primary concern is with the overstatement in an account balance.

Bloomcode: Evaluation Difficulty: Hard Learning Objective: Define substantive audit procedures.

Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Learning Objective: Provide examples of different substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

70. Discuss the factors that influence the extent and timing of substantive procedures.

Answer: How much substantive testing is performed and when it is performed are influenced by several factors. The most important factor is the overall risk assessment for the item being tested. Prior to making this assessment, the auditor will have performed planning procedures and controls testing (including testing of any controls identified that the auditor intends to place reliance on). The results of these planning and interim procedures allow the auditor to make an overall assessment as to how much detection risk still exists prior to any substantive testing being performed. The auditor then designs what they believe are appropriate substantive audit procedures that will allow material errors and exceptions to be identified and rectified before an overall conclusion is made.

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There are several other factors (over and above the audit risk assessment) that influence how much (extent) and when (timing) substantive procedures are performed. These include the following: a)

The nature of the test. Some tests lend themselves more easily to testing during the yearend visit as opposed to during the interim audit visit(s). For example, vouching prepayment amounts to their supporting documentation (the invoices that were paid during the year) is easy to perform prior to year end; verifying the calculation of the split between the amount to be recognized as a prepayment and the amount to be expensed in the income statement is easiest to perform at or after year end.

b)

The level of assurance necessary (reasonable assurance requires more evidence to be obtained from substantive procedures than limited assurance in order to reach a conclusion).

c)

The type of evidence required (for example, are the procedures designed to provide persuasive, corroborative, or minimal audit evidence?).

d)

The complexity of the client's data-capturing systems (the more complex the systems, the more complex and sophisticated the substantive audit procedures need to be).

Bloomcode: Application Difficulty: Medium Learning Objective: Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures.

Section Reference: 8.2 Relationship between Risk Assessment and the Nature, Timing, and Extent of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

71. Explain the difference between vouching and tracing.

Answer: Vouching is when a balance or transaction is taken from the underlying accounting records and verified by agreeing the details to supporting evidence outside of the accounting records of the company (typically the details are agreed to external third-party information such as a supplier invoice or delivery documentation). Because vouching involves testing and verifying information already recorded in the accounting records, the primary purpose of the testing is to ensure the balances or transactions are not overstated (for example, existence and occurrence assertions).

Tracing is when a source document is traced back to the underlying accounting records.

Because tracing involves testing and verifying information outside of the accounting records that is not necessarily recorded (for instance, on a source document such as an invoice), the primary purpose of the testing is to ensure the balances are not understated (for example, completeness assertion).

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures.

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Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

72. Explain the three common sampling strategies that can be applied when the auditor applies representative sampling.

Answer: When the auditor applies representative sampling, there are three common sampling strategies applied, depending on the auditor's expectations of error and their overall audit objective (overstatement or understatement of the amount being audited).

1.

Representative sampling using audit risk tables – The auditor uses this technique when they do not expect errors or they expect a low number of errors; that is, the risk of material misstatement has been assessed as low, and their primary concern is with the overstatement in an account balance. This is a common technique used to obtain 'coverage' of a total balance as at year end and can be used to calculate errors that can then be extrapolated across a total balance.

2.

Variables estimation sampling – The auditor uses this technique if they expect more than a few errors in an account balance. This technique can be used when the concern is both understatement and overstatement, and is therefore different to representative sampling.

Variables estimation sampling is usually applied to detect misstatements of the book values (carrying amounts or recorded values) of populations.

3.

Attribute sampling – The auditor uses this technique to supplement other substantive procedures to obtain audit assurance related to tests of transactions when they do not expect errors (or they expect a low number of errors). Discovery sampling is used to obtain a level of confidence, based on a statistically valid sample of transactions, that key attributes in existence for the sample tested can be inferred to be in existence for the entire population.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures.

Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

73. Identify the steps used by the auditor when performing analytical procedures.

Answer: When performing analytical procedures, the steps the auditor performs can be summarized as follows: 1.

2.

3.

4.

Identify the computation, comparison, or relationship to be made or to be investigated.

Assess the reliability of any data to be used.

Estimate the probable balance in the account or the probable outcome of the computation.

Make whatever computations are needed using data in the client's records or data from reliable outside sources.

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Execution of the Audit—Performing Substantive Procedures

5.

6.

7.

8.

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Compare the estimated amount with the computed or recorded amount and evaluate whether the difference, if any, is significant.

Determine appropriate procedures for investigating the reasons for the difference if it is significant.

Perform the procedures.

Draw conclusions.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures.

Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

74. Explain the four different levels of evidence obtained when performing substantive procedures.

Answer: Several different levels of evidence are obtained when performing substantive procedures, depending on the type of substantive procedure performed. Evidence can be persuasive, corroborative, minimal, or general.

Persuasive: Analytical procedures can be the primary test of a balance (that is, the primary basis for the conclusion) if they provide persuasive evidence. This would be the case when the procedures generate an amount that the auditor believes is a reasonable estimate of what the balance should be, thus enabling them to conclude whether or not the account balance is free from material errors. The effect of classifying an analytical review procedure as persuasive means that no further substantive procedures need to be performed on the related account balance, even in moderate risk situations.

Corroborative: An analytical procedure provides corroborative evidence if it (1) confirms audit findings from other procedures and (2) supports management representations or otherwise decreases the level of audit scepticism. A corroborative analytical procedure includes comparisons of account balances to expectations developed and documented earlier in the audit. These comparisons generally provide corroborative evidence about an account balance and enable the auditor to limit the extent of other procedures in that area.

Minimal: Analytical procedures that do not provide persuasive or corroborative evidence contribute minimal support for the conclusion. In deciding whether a particular analytical procedure or combination of procedures provides corroborative evidence or only minimal support for the conclusion, the auditor evaluates both the extent of their analytical procedures and the quality of the evidence they expect to obtain.

General: Analytical procedures might provide persuasive evidence in one circumstance but not in another. To illustrate, the risk assessment related to investments might indicate a low likelihood of material misstatement related to recording investment income. If a client has a relatively stable investment portfolio, a comparison of the average amount invested to an average market rate of interest or yield may provide the auditor with persuasive evidence to conclude that the amount of investment income recorded for the year is free from material misstatement. On the other hand, another client's portfolio might be more diversified and turn

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over quite rapidly. In that case, the auditor may need to expand the analytical review by segmenting the client's portfolio and applying the average yield test to the various segments.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the different levels of audit evidence obtained when performing substantive procedures.

Section Reference: 8.4 Levels of Evidence CPA: Audit and Assurance AACSB: Analytic 75. Explain the auditor’s responsibility over accounting estimates.

Answer: An auditor must assess the inherent and control risk with respect to the client’s accounting estimates, and plan to address those risks using one or more of the following approaches: 1. Obtain evidence from year end to the date of the audit report. This may reduce estimation uncertainty.

2. Develop an estimated value or range of values to gauge the reasonability of management’s estimate.

3. Test how management made the estimate by assessing the judgements, assumptions, and data used, and verifying the mathematical accuracy of the estimate.

When a significant risk exists, the auditor should evaluate whether management considered alternative amounts and assumptions throughout the estimation process and how the final estimate was selected.

When the audit documentation is complete, the auditor would also need to “stand back” and assess whether the estimates and disclosures are reasonable given the evidence collected.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design an audit plan to audit accounting estimates.

Section Reference: 8.5 Auditing Accounting Estimates CPA: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 76. There are certain audit procedures that are required to be performed according to various auditing standards. Identify specific examples of such procedures and explain why the procedures are mandatory.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Define substantive audit procedures.

Section Reference: 8.1 Overview of Substantive Procedures CPA: Audit and Assurance AACSB: Analytic

77. Analytical procedures are evaluations of financial information made by a study of plausible relationships among both financial and non-financial data. Discuss why analytical procedures are used by an auditor and explain several of the common types of analytical procedures.

Answer: Answers may vary.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Provide examples of different substantive audit procedures.

Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

78. Before they can complete an audit, auditors need to evaluate the causes of any unexpected fluctuations in a client’s financial statements detected by the use of analytical procedures.

Explain how auditors interpret the results of analytical procedures and why it is done.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the documentation of the conclusions reached as a result of performing substantive procedures.

Section Reference: 8.6 Evaluating and Documenting Substantive Analytical Procedures’ Results CPA: Audit and Assurance AACSB: Analytic

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CASE QUESTION 79. Raisa Alexseev was getting ready to perform analytical procedures at Vulcan Spice Mills.

She had made the following notes in her audit file: 1.

2.

3.

4.

Review allowance for doubtful accounts.

Don’t forget to bring calculator to work.

Figure out the probability of $5,000,000 sales commissions threshold of last year.

Perform variance analysis.

Instructions Can you summarize the steps Raisa will have to go through using analytical procedures before she can draw any conclusions about the subject matter?

Answer: When performing analytical procedures, the steps Raisa will perform can be summarized as follows: 1.

Identify the computation, comparison, or relationship to be made or to be investigated.

Raisa would compare the allowance or commissions amounts in the current year’s accounts and compare them to the methods and outcomes of previous years.

2.

Assess the reliability of any data to be used. Raisa will ensure that the accounts receivable controls over transactions have been tested and that substantive procedures such as accounts receivable confirmations have been carried out.

3.

Estimate the probable balance in the account or the probable outcome of the computation.

If the client uses percentage of receivables or aging percentages, Raisa will estimate this year’s anticipated balance using the data available.

4.

Make whatever computations are needed using data in the client's records or data from reliable outside sources. Raisa will use her calculator or software to perform computations on the allowance for doubtful account amount or the reasonableness of the commission expense.

5.

Compare the estimated amount with the computed or recorded amount and evaluate whether the difference, if any, is significant.

6.

Determine appropriate procedures for investigating the reasons for the difference if it is significant. Raisa will have discussions with the client’s personnel such as the credit manager and sales vice president.

7.

Perform the procedures.

8.

Draw conclusions. Based on the procedures applied and her conclusions, Raisa may have to perform more substantive work in order to be satisfied with the reliability of underlying data.

Bloomcode: Application Difficulty: Medium

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Learning Objective: Provide examples of different substantive audit procedures.

Section Reference: 8.3 Substantive Audit Procedures CPA: Audit and Assurance AACSB: Analytic

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LEGAL NOTICE Copyright © 2021 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under license and may be used only in accordance with the terms of such license.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 9 AUDIT DATA ANALYTICS CHAPTER LEARNING OBJECTIVES 1. Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Audit data analytics (ADAs) involve examining large datasets, usually using computer software, to look for trends, exceptions, and outliers. Often the test results are presented as visualizations. ADAs can be used at any stage of an audit. They can be used at the beginning of the audit during the risk assessment stage when the focus is on audit planning. They can be used during the risk response stage of the audit, as they can be used to conduct tests of controls, substantive analytical procedures, and tests of details. Lastly, ADAs can be used at the end of the audit as the auditor looks to complete the audit and performs analytical procedures to support the overall audit conclusion. Common techniques for ADAs include visualizations, matching, clustering, and statistical techniques.

2. Explain the key considerations related to data when performing audit data analytics.

Most ADAs involve structured data, which are in a fixed field or cell such as general ledger data.

For an auditor to gain efficiencies, it is important that an ADA is well planned. This includes obtaining a read-only copy of the data from the client, understanding what data are available, and understanding the size of the data set. Data quality must be considered before performing an ADA. It is important that the data are in a consistent format, complete, and accurate, otherwise the data need to be cleaned before they can be used. The auditor should also consider the relevance and reliability of the data.

As with all audit work, documentation should be in sufficient detail to allow an experienced auditor to reperform the test and come up with the same results. As the auditor obtains, prepares, uses, maintains, and destroys the data, the data move through the data life cycle.

3. Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

It is important the auditor spend adequate time planning an ADA. A five-step process, including planning the test, preparing the data, assessing the relevance and reliability of the data, performing the test, and evaluating the test results, ensures an ADA is planned well. When performing an ADA, the auditor likely identifies notable items. When there are too many notable items to examine each one individually, the auditor should assess if there was an issue with the test design resulting in false positives. Once the auditor determines the notable items are not false positives, the auditor can then cluster and group the exceptions to identify those with similar characteristics and then perform more audit work on the clusters.

4. Illustrate how audit data analytics can be used as a substantive analytical procedure.

ADAs can be used to perform substantive analytical procedures. Regression analysis is an example. This is a predictive analytic technique that allows the auditor to use a mathematical formula to determine an expected amount to compare with the actual amount or account

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Auditing: A Practical Approach, Fourth Canadian Edition

balance for reasonableness. When using regression analysis, the auditor needs to identify the dependent and independent variables. The dependent variable is the item to be predicted or the account being audited, and the independent variable is the predictor. The auditor needs to determine an acceptable difference, which is usually an amount less than performance materiality.

5. Illustrate how audit data analytics can be used as a substantive test.

ADAs can be used as a substantive test to corroborate transactions and balances in the accounting records. An advantage of using an ADA as a test of details is that it may allow the auditor to test 100 percent of a population quickly. This provides the auditor a higher level of assurance regarding the risk of material misstatement while reducing the time needed to perform the test. Substantive testing includes matching cash receipts to invoiced amounts and matching payroll transactions and balances.

6. Describe the features of a good data visualization.

Visualizations are often used to communicate the results of an ADA. In deciding the best visualization, the auditor needs to understand what the visualization is trying to communicate. A good visualization stands alone and conveys its message without any additional information.

Preparing an effective visual also involves including the appropriate level of detail, colour, and axis scaling.

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Audit Evidence/Audit Data Analytics

9-3

TRUE-FALSE STATEMENTS 1. Audit data analytics are the examination of large datasets, usually using computer software, to identify patterns, trends, and outliers as a means of gathering sufficient appropriate audit evidence.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Section Reference: 9.1.1 How Audit Data Analytics are Used CPA Competency: Audit and Assurance AACSB: Analytic

2. Audit data analytics can only be used in the risk response phase of the audit.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Section Reference: 9.1.2 When Audit Data Analytics are Used CPA Competency: Audit and Assurance AACSB: Analytic

3. Data visualizations search for items that should or should not match and help prevent fraud.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Section Reference: 9.1.3 Techniques Used for Audit Data Analytics CPA Competency: Audit and Assurance AACSB: Analytic

4. Data quality includes data consistency, data completeness, and data cleansing.

Answer: True Bloomcode: Knowledge Difficulty: Easy

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Learning Objective: Explain the key considerations related to data when performing audit data analytics.

Section Reference: 9.2 Data Considerations CPA Competency: Audit and Assurance AACSB: Analytic

5. Unstructured data are most commonly used in audit data analytics.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the key considerations related to data when performing audit data analytics.

Section Reference: 9.2.1 Types of Data CPA Competency: Audit and Assurance AACSB: Analytic

6. Audit efficiencies are always realized when using ADA techniques and tools.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the key considerations related to data when performing audit data analytics.

Section Reference: 9.2.2 Data Access CPA Competency: Audit and Assurance AACSB: Analytic

7. The five-step process from the CPA Canada Guide to Audit Data Analytics is required by auditing standards.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3 The Audit Data Analytic (ADA) Five-Step Process CPA Competency: Audit and Assurance AACSB: Analytic

8. When performing an ADA, notable items are considered unexpected trends, outliers, and exceptions that do not require follow-up.

Answer: False

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Audit Evidence/Audit Data Analytics

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.4 Perform the ADA CPA Competency: Audit and Assurance AACSB: Analytic

9. If a large number of notable items is found, it may indicate there is an issue with the test, and the test may need to be revised and reperformed.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.5 Evaluate the Results CPA Competency: Audit and Assurance AACSB: Analytic

10. Reviewing both the correlation coefficient and the standard error of the model will help the auditor assess the quality of the regression.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4.1: Regression Analysis CPA Competency: Audit and Assurance AACSB: Analytic

11. A regression analysis is more helpful when auditing clients with a low volume of repetitive transactions.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4.1: Regression Analysis CPA Competency: Audit and Assurance AACSB: Analytic

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12. A regression analysis is a predictive analytic technique that allows the auditor to use a mathematical formula to determine the actual amount of an account.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4: Data Analytics as a Substantive Analytical Procedure CPA Competency: Audit and Assurance AACSB: Analytic

13. Using an ADA as a test of details may allow the auditor to test 100 percent of a population.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Illustrate how audit data analytics can be used as a substantive test.

Section Reference: 9.5.1: Substantive Testing CPA Competency: Audit and Assurance AACSB: Analytic

14. ADAs can be used as risk assessment procedures, substantive analytical procedures, or as substantive tests.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Illustrate how audit data analytics can be used as a substantive test.

Section Reference: 9.5.1: Substantive Testing CPA Competency: Audit and Assurance AACSB: Analytic 15. Even a good visualization requires some additional information in order for the user to completely understand the data.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance AACSB: Analytic

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Audit Evidence/Audit Data Analytics

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16. A visualization of data can be interpreted more quickly than a data table.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance AACSB: Analytic

17. In visualizations, it is always best to include as many details and as much information as possible.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance AACSB: Analytic

18. An effective visual minimizes the use of colour.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 19. A data analytic performed to understand past data is called a a) descriptive analytic. b) diagnostic analytic. c) predictive analytic. d) prescriptive analytic.

Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Section Reference: 9.1 What Are Data Analytics CPA Competency: Audit and Assurance AACSB: Analytic 20. A data analytic performed to examine a variety of solutions to determine the best outcome is called a a) descriptive analytic. b) diagnostic analytic. c) predictive analytic. d) prescriptive analytic.

Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Section Reference: 9.1 What Are Data Analytics CPA Competency: Audit and Assurance AACSB: Analytic 21. Which of the following accurately describes audit data analytics? a) examination of small datasets to identify patterns, trends, and outliers b) use of manual techniques to examine large datasets to gather audit evidence c) method of expanding audit testing to guarantee financial statements are properly presented d) examination of large datasets to identify patterns, trends, and outliers Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe audit data analytics, when they can be used during an audit, and

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some of the approaches available to perform these procedures.

Section Reference: 9.1.1 How Audit Data Analytics Are Used CPA Competency: Audit and Assurance AACSB: Analytic 22. Yulia Sanchez conducted a test on purchases and used audit data analytics to compare purchase orders with supplier invoices. Any exceptions were noted and Yulia examined each exception to determine if there was a misstatement. The audit data analytic technique she used is called a) visualization. b) matching. c) clustering. d) statistical technique.

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Section Reference: 9.1.3 Techniques Used for Audit Data Analytics CPA Competency: Audit and Assurance AACSB: Analytic

23. Ivan Goldberg used audit data analytics to identify specific accounts causing a significant increase in accounts payable. This ADA was performed during the a) risk assessment phase. b) reporting phase. c) risk response phase. d) client acceptance phase.

Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Section Reference: 9.1.2 When Audit Data Analytics Are Used CPA Competency: Audit and Assurance AACSB: Analytic

24. Kelton Kittle is planning on preparing a bar chart showing the aging of the accounts receivable balance. This bar chart will a) be prepared using the data analytic technique called matching. b) identify any fraud. c) be helpful during the audit completion phase.

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d) identify trends in the aging of accounts.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Section Reference: 9.1.2 When Audit Data Analytics Are Used, 9.1.3 Techniques Used for Data Analytics CPA Competency: Audit and Assurance AACSB: Analytic

25. During the audit of a manufacturing company, the auditor performed audit data analytics.

Which of the following ADAs were used as a substantive test? a) identifying payments made after year end b) creating a visualization of ratio analysis c) performing a quantity and price analysis for inventory d) analyzing the general ledger for large unusual transactions Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Section Reference: 9.1.2 When Audit Data Analytics Are Used CPA Competency: Audit and Assurance AACSB: Analytic

26. During the audit of a retail clothing store company, the auditor performed audit data analytics. Which of the following ADAs were used to assess risk? a) identifying payments made after year end b) identifying credit entries in accounts receivable c) testing the net realizable value of inventory d) analyzing the general ledger for large unusual transactions Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Section Reference: 9.1.2 When Audit Data Analytics Are Used CPA Competency: Audit and Assurance AACSB: Analytic

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27. Kim Wilson is planning on performing audit data analytics using structured data. Which of the following would be considered structured data? a) emails b) accounts receivable sub-ledger c) texts d) statistics posted on various websites Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the key considerations related to data when performing audit data analytics.

Section Reference: 9.2.1 Types of Data CPA Competency: Audit and Assurance AACSB: Analytic

28. Jaques is using ADAs in the audit of JKJ Company, a company with 20 different stores.

When considering the data quality, he discovers that each store uses different software and captures the data differently. Data will need to be manipulated to ensure the data are a) consistent. b) complete. c) clean. d) clustered.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the key considerations related to data when performing audit data analytics.

Section Reference: 9.2.3 Data Quality CPA Competency: Audit and Assurance AACSB: Analytic

29. Sue Young is using ADAs to verify the amount of purchases recorded in the financial statements. Which of the following steps would help ensure the data is clean? a) agreeing the total purchases figure from the dataset to the total in the general ledger b) ensuring the dates entered from two different systems are formatted in the same manner c) verifying that the purchase orders are in sequential number d) removing duplicate purchase invoices from the dataset Answer: d Bloomcode: Application

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Difficulty: Medium Learning Objective: Explain the key considerations related to data when performing audit data analytics.

Section Reference: 9.2.3 Data Quality CPA Competency: Audit and Assurance AACSB: Analytic

30. Auditors should always consider the relevance and reliability of the information to be used as audit evidence. Which of the following characteristics would decrease the reliability of data? a) strong internal controls b) data available from multiple sources c) numerical data d) unstructured data Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the key considerations related to data when performing audit data analytics.

Section Reference: 9.2.4 Data Relevance and Reliability CPA Competency: Audit and Assurance AACSB: Analytic

31. Jennifer is creating a visualization comparing key profit ratios of JKJ Ltd. both to profit ratios from previous years as well as to its industry. The company has strong internal controls and information can be obtained from a variety of sources and in a variety of formats. Which of the following characteristics would most increase the relevance or reliability of the data being used to create the visualization? a) internal data on the valuation of inventory b) financial data created under a strong internal control system c) publicly available audited financial data d) email from the CFO giving the ratios that are common in the industry Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Explain the key considerations related to data when performing audit data analytics.

Section Reference: 9.2.4 Data Relevance and Reliability CPA Competency: Audit and Assurance AACSB: Analytic

32. At what stage of the data life cycle does the auditor consider the accuracy, completeness, and timeliness of the data and clean the data errors?

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a) Data collection b) Data processing c) Data usage d) Data maintenance Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the key considerations related to data when performing audit data analytics.

Section Reference: 9.2.6 The Data Life Cycle CPA Competency: Audit and Assurance AACSB: Analytic

33. Olaf has taken prepared data and is now using the data to perform the test. What stage of the data life cycle is he working on? a) Data collection b) Data processing c) Data usage d) Data maintenance Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3 The Data Life Cycle CPA Competency: Audit and Assurance AACSB: Analytic

34. Which of the following would be considered by an auditor during the planning of an ADA? a) availability of data b) complexity of the client's data capturing systems c) format of the data d) consistency of the data Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.1 Plan the ADA CPA Competency: Audit and Assurance AACSB: Analytic

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35. Which of the following would be considered by an auditor during the accessing and preparing of data for an ADA? a) availability of data b) software to be used to conduct test c) account and assertion to be tested d) consistency of the data Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.2 Access and Prepare the Data CPA Competency: Audit and Assurance AACSB: Analytic 36. Jason is auditing a company’s professional expenses over a three-year period. Which of the following characteristics would make the data less reliable? a) Data are produced under a system of effective internal controls b) Data are unstructured c) Data are in general ledger format d) Data are controlled by the accounting department Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.3 Consider the Data’s Relevance and Reliability CPA Competency: Audit and Assurance AACSB: Analytic 37. Jason is auditing a company’s professional expenses over a three-year period. He decides to perform an ADA to determine if there is a higher risk of misstatement in this area. Which of the following questions would be considered when determining the relevance of the data to be used? a) Are the data structured? b) Will the data provide information regarding the trend of professional expenses? c) Can the data that will be used be easily overridden by management? d) Will the data be provided by management or gathered directly by Jason?

Answer: b

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Bloomcode: Application Difficulty: Medium Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.3 Consider the Data’s Relevance and Reliability CPA Competency: Audit and Assurance AACSB: Analytic

38. Which of the following statements is accurate regarding notable items? a) if a large number of notable items are found, the original risk assessment is determined to be accurate b) notable items are exceptions that do not require follow-up c) unexpected trends requiring follow-up would be notable items d) all data points are considered notable items Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.4 Perform the ADA CPA Competency: Audit and Assurance AACSB: Analytic 39. Jason is auditing a company’s accounts receivable balance and has used an ADA test to provide evidence regarding valuation. Which of the following steps occurred during the performing of the ADA? a) Jason determined controls over receivables were strong and data could be relied on b) All duplicate data receivable entries were removed c) A visualization was created to show aging of receivables d) Jason concluded the test provided evidence regarding valuation Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3 The Audit Data Analytic (ADA) Five-Step Process CPA Competency: Audit and Assurance AACSB: Analytic 40. Which of the following is not a consideration when the auditor evaluates the results of an ADA?

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a) How many notable items were found? b) Do test results indicate more testing is required? c) How will the exceptions be documented in the audit file? d) Whether to use the data analytic technique of matching or visualization Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.5 Evaluate the Results CPA Competency: Audit and Assurance AACSB: Analytic

41. Why would an auditor use an ADA to analyze and test the journal entries in the general ledger? a) to ensure no fraud occurred during the period b) to determine the financial statements are properly presented c) to identify entries that may indicate a higher risk of misstatement d) to identify false positives Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.6 Additional Issues to Consider when Performing an ADA as a Risk Assessment Procedure CPA Competency: Audit and Assurance AACSB: Analytic

42. Sherry Galo has performed an ADA and has documented the notable items. Which of the following statements accurately describes how the CPA guidelines suggest addressing notable items? a) When few exceptions are identified, the auditor may be able to examine each one to determine the impact on the original risk assessment. b) When a great number of notable items are identified, the auditor must conclude the test was ineffective. c) When no exceptions are identified, the auditor should assume the test has not been performed correctly and should reperform the test. d) When few exceptions are identified, reduce the exceptions by using clustering.

Answer: a Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.6 Additional Issues to Consider when Performing an ADA as a Risk Assessment Procedure CPA Competency: Audit and Assurance AACSB: Analytic

43. Daniel Morency has decided to test the journal entries posted in the miscellaneous expense account for the year under audit. Daniel is looking for large credit entries in order to identify possible areas of misstatement. Which of the following steps will help ensure the completeness of the dataset? a) Daniel compares total activity from this year to last year. b) Daniel totals the debits in the miscellaneous expense account and compares them to the level of materiality. c) Daniel reviews the sequential ordering of the entries posted in the miscellaneous expense account. d) Daniel removes any duplicate entries from the dataset.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.6 Additional Issues to Consider when Performing an ADA as a Risk Assessment Procedure CPA Competency: Audit and Assurance AACSB: Analytic

44. When auditing the general ledger to identify inappropriate entries, the review of entries posted by unauthorized users would test the assertions of a) completeness and occurrence. b) existence and occurrence. c) accuracy and valuation. d) classification and cut-off.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.6 Additional Issues to Consider when Performing an ADA as a Risk Assessment Procedure CPA Competency: Audit and Assurance AACSB: Analytic

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45. When auditing the general ledger to identify inappropriate entries, the review of significant value journal entries would test the assertion of a) completeness. b) existence. c) accuracy. d) classification.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.6 Additional Issues to Consider when Performing an ADA as a Risk Assessment Procedure CPA Competency: Audit and Assurance AACSB: Analytic

46. What is a false positive as it relates to an ADA? a) items identified as an exception b) unexpected trending of items c) items erroneously identified as an exception d) items correctly excluded from the test population Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.6 Additional Issues to Consider when Performing an ADA as a Risk Assessment Procedure CPA Competency: Audit and Assurance AACSB: Analytic

47. A predictive analytic technique that would allow the auditor to calculate the expected amount of payroll expense by using the average rate of pay and the number of employees would be a a) visualization analysis. b) matching analysis. c) regression analysis. d) cluster analysis.

Answer: c

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4 Data Analytics as a Substantive Analytical Procedure CPA Competency: Audit and Assurance AACSB: Analytic

48. In a regression analysis, the dependent variable is a) information gathered internally. b) the predictor. c) the item or account being predicted. d) determined after the test is performed.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4.1 Regression Analysis CPA Competency: Audit and Assurance AACSB: Analytic

49. Sue is conducting a regression analysis to predict the amount of salaries expense using the number of employees and the average rate of pay. Which of the following would be considered the dependent variable? a) number of employees b) amount of salaries expense c) average rate of pay d) age of employees Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4.1 Regression Analysis CPA Competency: Audit and Assurance AACSB: Analytic

50. Sue is conducting a regression analysis to predict the amount of salaries expense using the number of employees and the average rate of pay. The average rate of pay would be considered to be an

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a) internal financial predictor. b) internal non-financial predictor. c) external financial predictor. d) external non-financial predictor.

Answer: a Bloomcode: Comprehension Difficulty: Medium Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4.1 Regression Analysis CPA Competency: Audit and Assurance AACSB: Analytic

51. Sue is conducting a regression analysis to predict the amount of salaries expense using the number of employees and the average rate of pay. This type of regression analysis is called a(n) a) linear regression. b) dependent regression. c) multiple regression. d) independent regression, Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4.1 Regression Analysis CPA Competency: Audit and Assurance AACSB: Analytic

52. Paul has decided to perform a regression analysis as a substantive analytical procedure to forecast the amount of rental revenue based on the average number of apartments rented per year and the average amount of rent charged. What are the related assertions? a) occurrence, completeness, and accuracy b) existence and completeness c) completeness, presentation, and accuracy d) classification, existence, and accuracy Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

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Section Reference: 9.4.1 Regression Analysis CPA Competency: Audit and Assurance AACSB: Analytic

53. Paul has decided to perform a regression analysis as a substantive analytical procedure to forecast the amount of rental revenue based on the average number of apartments rented per year and the average amount of rent charged. Which of the following should be determined during the planning of the ADA? a) difference between the predicted amount of revenue and the actual amount of revenue b) the amount of acceptable audit risk c) the number of apartments rented for the year d) whether the average amount of rent received from the client is reliable Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4.1 Regression Analysis CPA Competency: Audit and Assurance AACSB: Analytic

54. Paul has decided to perform a regression analysis as a substantive analytical procedure to forecast the amount of rental revenue based on the average number of apartments rented per year and the average amount of rent charged. What type of procedure would this be? a) risk assessment b) substantive analytical c) test of control d) test of detail Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4 Audit Data Analytics as a Substantive Analytical Procedure CPA Competency: Audit and Assurance AACSB: Analytic

55. Stacey Vino was told by her audit senior to ensure that the data she was using for the regression analysis was clean and complete. In which phase of the ADA would this step be performed? a) planning the ADA

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b) accessing and preparing the data c) assessing the data’s relevance and reliability d) performing the ADA Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4.1 Regression Analysis CPA Competency: Audit and Assurance AACSB: Analytic

56. When performing a regression analysis, the auditor will assess the quality of the model.

Which of the following would indicate a higher level of confidence in the regression? a) correlation coefficient of .2 b) standard error is greater than performance materiality c) expected results are less than actual results d) correlation coefficient of .85 Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4.1 Regression Analysis CPA Competency: Audit and Assurance AACSB: Analytic

57. Paul performs a regression analysis as a substantive analytical test on total rental revenue.

He uses the average number of apartments rented for the month and the average monthly rent to determine an expected monthly revenue amount. He calculates the difference between the expected and actual for each month. Which months will require further examination? a) months with a difference between expected and actual results over $0 b) months where expected and actual results are exactly the same c) the months with the highest and the lowest difference d) months with a difference between expected and actual results over performance materiality Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4.1 Regression Analysis

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CPA Competency: Audit and Assurance AACSB: Analytic

58. Paul decides to perform an ADA and test accounts payable and compare purchase orders with invoices received and booked. This comparison will provide evidence as to the existence of accounts payable at year end. What type of procedure is this? a) risk assessment b) substantive analytical c) test of control d) test of details Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.5.1 Substantive Testing CPA Competency: Audit and Assurance AACSB: Analytic

59. Peter is going to use an ADA to compare the invoices issued by a company to the cash they have received during the year. The purpose of this is to substantiate both the accounts receivable at year end and the amount of revenue during the year. For accounts receivable, what assertion will this test provide evidence for? a) completeness b) rights and obligations c) existence d) cut-off Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.5.2 ADA Example of Accounts Receivable and Revenue CPA Competency: Audit and Assurance AACSB: Analytic

60. Which of the following would be considered an advantage of using an ADA as a substantive procedure? a) ability to test 100 percent of a population b) time needed to perform the test c) level of assurance that can be provided from the test

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d) all of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.5.1 Substantive Testing CPA Competency: Audit and Assurance AACSB: Analytic

61. Peter is going to use an ADA to compare the invoices issued by a company to the cash they have received during the year. The purpose of this is to substantiate both the accounts receivable at year end and the amount of revenue during the year. For the sales account, what assertion will this test provide evidence for? a) completeness b) rights and obligations c) occurrence d) cut-off Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.5.2 ADA Example of Accounts Receivable and Revenue CPA Competency: Audit and Assurance AACSB: Analytic

62. Peter is going to use an ADA to match the hours worked according to time sheets to the hours paid according to the payroll register files. What type of procedure is this? a) risk assessment b) substantive analytical c) test of control d) test of details Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.5.3 ADA Example of Payroll CPA Competency: Audit and Assurance AACSB: Analytic

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63. Determining which type of visualization will best summarize the results of an ADA would be part of a) planning of an ADA. b) preparing the data. c) assessing the data’s relevance and reliability. d) performing the ADA. Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance AACSB: Analytic

64. The best visualization for a regression analysis would be a a) bar chart. b) scatterchart. c) line chart. d) pie chart.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance AACSB: Analytic

65. The best visualization for showing part of a miscellaneous expense account would be a a) bar chart. b) scatterchart. c) line chart. d) pie chart.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance

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AACSB: Analytic

66. How much detail should be provided in a good visualization? a) as much detail as possible b) only a title and labelling of both axes c) enough detail for the user to understand the data presented d) no words should be included on visualizations Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance AACSB: Analytic

67. In a bar chart visualization, if axis scaling is too large, a) small fluctuations will appear significant b) large fluctuations will appear insignificant c) small fluctuations will not be noticeable d) neither small or large fluctuations will be noticeable Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance AACSB: Analytic

68. In a bar chart visualization, which of the following will happen if axis scaling is inappropriate? a) if axis scaling is too small, small fluctuations will appear significant b) if axis scaling is too large, small fluctuations will appear significant c) axis scaling is not important in a visualization d) if axis scaling is too large, significant fluctuations may remain hidden Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance

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AACSB: Analytic

69. In a visualization, what is the best use of colour? a) Use only red colour b) No colour should be used c) Use as many colours as possible d) Use one or two colours Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance AACSB: Analytic

70. Overall, when deciding on a good visualization, the auditor should a) understand the goal of the visualization. b) use five or six colours. c) use as much detail as possible. d) always use bar charts.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance AACSB: Analytic

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SHORT ANSWER QUESTIONS 71. Indicate whether you agree or disagree with the following statements and explain your reasoning. a)

Svetlana Petrova was reviewing the risk profile of Gaz Prom Industries in order to identify areas where there was a risk of material misstatement. She concluded: “In order to determine where there is an increased risk of material misstatement, I will use a prescriptive analysis.”

b)

Boris and Jana were performing an assessment of the accounts payable system at Magnitogirsk Iron and Steel Works Operations. Their focus was on the completeness assertion for accounts payable balances. Boris stated “In order to gather evidence on the completeness of accounts payable, we should analyze the general ledger for unusual transactions and create a visualization of the Days in Accounts Payable and the Accounts Payable Turnover ratios.”

c)

Jana Novotna, the auditor in charge of the Mosenergo petroleum giant, was explaining to Valentin Titov the importance of visualizations. “This data analytic technique allows us to present our information visually and can assist us in identifying risk and trends; however, it is important that we ensure data are consistent, complete, and clean.”

d)

Susan Martin, the audit senior at Canadian National Railways, was explaining to the junior auditor the difference between structured and unstructured data: “Structured data are more reliable and include emails and texts or information that is posted on social media.

Unstructured data includes data captured, processed, and maintained in an accounting system.”

e)

Larisa McCarthy, the auditor in charge of the Loblaw audit, feels that the use of ADAs will significantly reduce the time required in auditing large population of sales transactions. After performing the ADA, there were two large notable items. Larisa mentions to her staff “The ADA is not useful as we have discovered some notable items. The fact that there were any notable items means that the ADA was not appropriately planned and performed.”

Answer: a) Disagree. A descriptive analysis will help gather evidence to support the risk assessment for the overall entity and to identify the significant accounts and related assertions. A prescriptive analysis analyzes a variety of solutions in order to determine the best outcome. b)

Disagree. Analyzing the general ledger for unusual transactions or creating a visualization of ratios will help in the risk assessment phase of the audit. Testing completeness is in the risk response phase of the audit. Boris and Jana need to create a substantive test and test to ensure all invoices that should be included in accounts payable are included. For example, they could perform an ADA and focus on the dates around year end to ensure that any purchase orders that were matched to a receiving report and invoice were included in accounts payable.

c)

Agree. A visualization is a good technique when using ADAs as risk assessment procedures or when examining exceptions. Trends and finding outliers or exceptions can be

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seen quickly when information is presented visually. The audit should also consider data quality. The results of an ADA are only as good as the data being used to perform the ADA. Data consistency, data completeness, and data cleansing should all be considered when determining the data quality. d)

Disagree. Although structured data are typically more reliable, they do not include emails and texts or information that is posted on social media. They include data captured, processed, and maintained in an accounting system. Unstructured data includes emails, texts, and information posted on social media. It is less common in audits today but the use of unstructured data will likely grow as technology evolves.

e)

Disagree. With only two large notable items, the auditor will likely be able to examine both to determine if there is any impact on the original risk assessment. The auditor needs to consider if there was an issue with the population and whether the test needs to be revised and reperformed if there is a large number of notable items.

Bloomcode: Evaluation Difficulty: Hard Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Learning Objective: Explain the key considerations related to data when performing audit data analytics.

Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.1.1 How Audit Data Analytics are Used Section Reference: 9.1.2 When Audit Data Analytics are Used Section Reference: 9.1.3 Techniques Used for Audit Data Analytics Section Reference: 9.2.1 Types of Data Section Reference: 9.3.6 Additional Issues to Consider when Performing an ADA as a Risk Assessment Procedure CPA Competency: Audit and Assurance AACSB: Analytic

72. The following is a list of different audit data analytics performed by an auditor. Indicate whether the ADA is a risk assessment procedure, a test of control, a substantive analytical procedure, or a substantive test.

Scenario 1: Analyzing the miscellaneous expense account for large unusual transactions Scenario 2: Testing purchase order authorization limits by comparing purchase orders to the pre-authorized limits for various suppliers Scenario 3: Calculating expected rental revenue by using average rent and number of units rented to actual rental revenue Scenario 4: Testing outstanding cheques on the bank reconciliation to determine if cheques were cashed after the end of the period Scenario 5: Testing the balance in accounts receivable by matching invoices to cash received Answer:

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Scenario

Type of Procedure/Test

1

Risk Assessment Procedure

2 3

Test of Control Substantive Analytical Procedure

4 5

Test of Control Substantive Test

Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Learning Objective: Illustrate how audit data analytics can be used as a substantive test.

Section Reference: 9.1.2 When Audit Data Analytics are Used Section Reference: 9.4 Audit Data Analytics as a Substantive Analytical Procedure Section Reference: 9.5.1 Substantive Testing CPA Competency: Audit and Assurance AACSB: Analytic 73. Discuss the factors that influence the quality of data when an auditor is planning an ADA. Why is the quality of data important?

Answer: It is important for auditors to consider the quality of data in order to assess its usability when planning an ADA. This starts with considering the consistency, completeness, and cleansing of the data. a) Consistency takes into account the following: Does the business use more than one computer system/software? Are the data fields the same between the different software?

Are the data captured in a consistent format? b) Completeness is critical to ensure meaningful analysis. If an ADA is performed with incomplete data, it will not provide a complete picture and an inappropriate conclusion can be reached. The auditor needs to understand how the client ensures data are not lost or altered during data movement. c) Cleansing of the data involves identifying and correcting missing, incorrect, and duplicate fields, as well as reformatting the data so they are in a consistent format.

Software programs help with data cleansing. The CPA guideline indicates it is important to consider the extent of the errors and the usability of the data. If there are too many errors, there may be an issue with the controls over collecting the data.

The reliability and relevance of data being used is also important. If data are not relevant or reliable, the conclusion drawn from the data analysis may be incorrect.

Overall, the quality of data, along with the reliability and relevance of data, is extremely important when performing audit data analytics as the conclusions drawn are only as good as

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the data used in the analysis. If data quality is poor, the conclusions drawn may be inappropriate and could result in an ineffective audit.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the key considerations related to data when performing audit data analytics.

Section Reference: 9.2.3 Data Quality CPA Competency: Audit and Assurance AACSB: Analytic

74. What is the data life cycle? Explain the different stages of the data life cycle.

Answer: The data life cycle is the movement of data from when they are collected, maintained, used, stored, and then finally destroyed.

1. Data Collection - When the auditor obtains a copy of the client’s data, this is the data collection or creation stage. Usually the auditor acquires a copy of the client’s data, but data can also be collected by data entry, such as when a customer completes a customer order or enters information on a website or by scan, such as scanning bar codes.

2. Data Processing - After the data are collected, the auditor considers the accuracy, completeness, and timeliness of the data, and data errors are cleaned. This is the processing stage of the data life cycle.

3. Data Usage - Once the data are prepared, the auditor performs the test and interprets the results, thereby using the data. This is the data usage stage.

4. Data Maintenance - Once the audit is complete, the audit file is archived. This means while the file is not active, it is still kept for peer review purposes and in case the audit file is needed in the future. This includes any data used to support the audit opinion.

These data are then in the maintenance stage.

5. Data Deletion - After a period of time, the audit file and the data in it are no longer needed and can be deleted. For an auditor, this is usually determined by the firm’s quality assurance manual. This is the deletion stage of the data life cycle.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the key considerations related to data when performing audit data analytics Section Reference: 9.2.6 The Data Life Cycle CPA Competency: Audit and Assurance AACSB: Analytic

75. Describe the four different data analytic techniques and state how they are helpful to an audit.

Answer: 1.

Visualization – Information is presented visually. This technique is helpful in assessing risk and identifying trends.

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2.

Matching – This technique searches for items that should or should not match. It is helpful in identifying instances of fraud and noting any exceptions.

3.

Attribute sampling (clustering) – This technique groups items with similar characteristics together and is helpful for exception identification and exception reduction. It is helpful to organize large amounts of data and to identify outliers that require examination.

4.

Statistical techniques – These techniques include regression analysis and data distribution.

Regression analysis can be used as a predictive substantive analytical procedure by taking past data and developing a mathematical formula to represent that data. This formula develops an expected amount that can then be compared to the actual amount for reasonableness. The auditor can also examine the distribution of data to identify outliers.

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe audit data analytics, when they can be used during an audit, and some of the approaches available to perform these procedures.

Section Reference: 9.1.3 Techniques Used for Audit Data Analytics CPA Competency: Audit and Assurance AACSB: Analytic

76. Identify the five steps for Audit Data Analytics suggested by the CPA Canada Guide to plan, perform, and evaluate ADAs. Answer: The CPA Canada Guide to Audit Data Analytics suggests a five-step process for planning, performing, and evaluating ADAs. This process involves: 1.

2.

3.

4.

5.

Planning the ADA Preparing the data Assessing the relevance and reliability of the data Performing the test Evaluating the test results

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3 The Audit Data Analytic Five-Step Process CPA Competency: Audit and Assurance AACSB: Analytic

77. The auditor may choose to use ADAs to perform substantive analytical procedures.

Formulate a substantive analytical procedure that will assist in corroborating the balance in the Sales Revenue account for a golf course.

Answer: The following is a suggested procedure; however, student answers may vary.

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Sales Revenue – Determine the number of golfers each month and multiple it by the average golf fee. Once this number is calculated, compare this to the actual revenue recorded for each month. Consider the reasonableness of the estimate as compared to actual to determine if the balance in the revenue account is accurate.

Bloomcode: Synthesis Difficulty: Hard Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4 Audit Data Analytics as a Substantive Analytical Procedure CPA Competency: Audit and Assurance AACSB: Analytic 78. The auditor may choose to use ADAs to perform substantive tests. Formulate a substantive test that will assist in corroborating the balance in the Accounts Payable account for a manufacturing company.

Answer: The following is a suggested procedure; however, student answers may vary.

Accounts Payable – Match subsequent cash disbursements with invoices received from suppliers with the purchase orders and receiving reports. Ensure all purchases orders are matched to receiving reports and invoices for the period selected.

Bloomcode: Synthesis Difficulty: Hard Learning Objective: Illustrate how audit data analytics can be used as a substantive test.

Section Reference: 9.5.1 Substantive Testing CPA Competency: Audit and Assurance AACSB: Analytic 79. Explain the features of a good data visualization.

Answer: In deciding on the best visualization, the auditor needs to understand what the visualization is trying to communicate. This will determine what type of visualization is most appropriate (e.g., bar chart, line chart, scatterchart). All visualizations should consider the following: An appropriate level of detail: An effective visual has the right level of detail. It provides only the details needed, in an easy-to-read manner.

Appropriate axis scaling: The axis for an effective visual allows the user to correctly interpret the data. If the scaling is too small, significant fluctuations may remain hidden and if it is too large, small fluctuations may appear significant.

A balanced use of colour: An effective visual minimizes the use of colour except to draw the user’s attention to significant items. Colour should be used to highlight key information and red and green should be avoided, as users may be colour blind. Good visualization tends to use a maximum of two colours.

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Auditing: A Practical Approach, Fourth Canadian Edition

Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the features of a good data visualization.

Section Reference: 9.6 Features of a Good Visualization CPA Competency: Audit and Assurance AACSB: Analytic

80. Describe what must be considered by the auditor when forming a conclusion on the results of audit data analytics. How do auditors determine what results need follow-up?

Answer: The auditor must consider the following when evaluating the results: - Has the test met its objectives?

- Do the test results indicate more testing may be required or the test needs to be revised and reperformed?

- How will the exceptions be documented in the audit file?

The auditor will look at notable items and follow-up on these items. The follow-up will depend on the type of procedure/test being performed.

Risk assessment procedure - When few exceptions are identified, the auditor may be able to examine each to determine the impact on the original risk assessment - Where a great number of notable items are identified, the auditor should consider if there was an issue with the population and whether the test may need to be revised and reperformed Test of control - Notable items should be summarized and categorized by type of exception - Identify any themes for exceptions and consider potential causes to determine if controls are effective or ineffective Substantive analytical procedure - Differences greater than performance materiality require follow-up to determine if the difference is justified or if it is due to a misstatement - Additional testing may be required to ensure the difference is not due to misstatement Substantive test - All exceptions are reported and noted - Any immaterial exceptions should be carried to the schedule of unadjusted errors - Material exceptions should be adjusted by management Bloomcode: Application Difficulty: Medium Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Learning Objective: Illustrate how audit data analytics can be used as a substantive test.

Section Reference: 9.3.5 Evaluate the Results Section Reference: 9.3.6 Additional Issues to Consider when Performing an ADA as a Risk

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Section Reference: 9.4.1 Regression Analysis Section Reference: 9.5.2 ADA Example of Accounts Receivable and Revenue CPA Competency: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 81. CAS 240 requires the auditor to assess the risk of fraud. Auditors will commonly use ADAs to analyze the general ledger to identify any areas of risk. Identify specific examples of such procedures and explain how the procedures help identify potential fraud.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3.6 Additional Issues to Consider when Performing an ADA as a Risk Assessment Procedure CPA Competency: Audit and Assurance AACSB: Analytic

82. Regression analysis allows the auditor to express a relationship between variables as a mathematical formula. This formula can then be used to develop an expected account balance that can then be compared with the actual account balance for reasonableness. Formulate a regression analysis for payroll expense. Discuss whether the regression is a linear regression or a multiple regression analysis and identify the dependent and independent variables. Be sure to include whether the independent variable is internal or external, and financial or non-financial.

Answer: Answers may vary.

Bloomcode: Synthesis Difficulty: Hard Learning Objective: Illustrate how audit data analytics can be used as a substantive analytical procedure.

Section Reference: 9.4.1 Regression Analysis CPA Competency: Audit and Assurance AACSB: Analytic

83. Using the five-step process, explain how auditors perform an audit data analytic for risk assessment.

Answer: Answers may vary.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the five-step process for performing an audit data analytic and apply this process when using audit data analytics as a risk assessment procedure.

Section Reference: 9.3 The Audit Data Analytic (ADA) Five-Step Process CPA Competency: Audit and Assurance AACSB: Analytic

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CASE QUESTION 84. Raisa Alexseev was assigned to perform the year end audit at Vulcan Spice Mills. She had already made a preliminary risk assessment analysis and determined that the potential for fraud was high due to the significant volume of employee expenses. The controls surrounding the employee expenses were weak due to the ability of management to override the controls.

Raisa decided to design an ADA to perform a substantive test on the reimbursement of employee expenses.

Instructions Using the five-step process, formulate a substantive test for employee expenses.

Be sure to include: The main assertions related to the employee expense account.

The data Raisa will require to perform the substantive test.

The technique Raisa should use to perform this substantive test.

Answer: When performing the substantive test, the steps Raisa will perform can be summarized as follows: 1.

Plan the ADA – the purpose of the ADA is to perform a test of details on the employee reimbursed expense account. The test will provide evidence over occurrence, accuracy, and cut-off. There is a risk that the expenses are overstated and that employees are being reimbursed for expenses that did not occur or that were not business expenses. The following data is required: a listing of all expenses in the account from the general ledger, corporate credit card data broken down by employee, location and vendor, and payroll records with amounts of reimbursement and dates of non-work days. A matching technique will be performed as follows: Occurrence – match dates of charges with non-work dates or charges just before or after end dates to identify potential personal or unauthorized expenses Accuracy – match credit card data of expenses with expense entries in the general ledger to ensure amounts are the same Cut-off – match credit card expense dates with dates in the journal entries in the general ledger to ensure expenses are recorded in the correct period

2.

Access and prepare the data – obtain the data from Vulcan Spice Mills and test for accuracy by testing for any duplicate payments. Agree the total of the data file to the total from the general ledger. Agree total amounts on corporate credit card statements to amounts recorded in the general ledger.

3.

Assess the data’s relevance and reliability – Some of the data are generated externally (corporate credit card information) and some are generated internally.

4.

Perform the ADA.

5.

Evaluate the results. Raisa will look at any unmatched items and perform follow-up on all items. Since Raisa is looking at the risk of fraud, all exceptions should be noted, investigated, and discussed with management.

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Auditing: A Practical Approach, Fourth Canadian Edition

Bloomcode: Synthesis Difficulty: Hard Learning Objective: Illustrate how audit data analytics can be used as a substantive test.

Section Reference: 9.5.1 Substantive Testing CPA Competency: Audit and Assurance AACSB: Analytic

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LEGAL NOTICE Copyright © 2021 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

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The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 10 AUDITING SALES AND RECEIVABLES CHAPTER LEARNING OBJECTIVES 1. Identify the audit objectives applicable to sales and receivables.

When auditing sales and receivables, the auditor’s objective is to obtain sufficient appropriate evidence about each significant assertion for the applicable classes of transactions and balances. Significant assertions for sales, cash receipts, and sales adjustments include occurrence, completeness, accuracy, cut-off, classification, and presentation. Significant assertions for accounts receivable and allowance for doubtful accounts include existence, completeness, accuracy, valuation, and allocation, classification and presentation. Evidence may be obtained by tests of controls or substantive testing depending on the audit strategy chosen.

2. Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

When auditing sales and receivables, the auditor’s objective is to obtain sufficient appropriate evidence about each significant assertion for the applicable classes of transactions and balances. Significant assertions for sales, cash receipts, and sales adjustments include occurrence, completeness, accuracy, cut-off, classification, and presentation. Significant assertions for accounts receivable and allowance for doubtful accounts include existence, completeness, accuracy, valuation, and allocation, classification and presentation. Evidence may be obtained by tests of controls or substantive testing depending on the audit strategy chosen. receipts, while sales adjustments include granting cash discounts, processing sales returns and allowances, and determining bad debts.

Control procedures such as appropriate segregation of duties, authorizations, and use of documents and records should be interwoven into each process to reduce the risk of misstatement in the financial statements.

3. Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

To determine the appropriate audit strategy, the auditor starts with obtaining an understanding of the entity. This is necessary for the auditor to assess the inherent and control risks. For audit purposes, the most significant inherent risk is that of overstatement |of sales transactions and receivables balances to boost reported profits and assets.

For the entity, the greatest inherent risk is that of misappropriation of cash arising from sales transactions. The auditor assesses control risk by evaluating the design effectiveness of internal controls. The auditor drafts the audit program based on the preliminary assessment of control risk, identifying both tests of the operating effectiveness of controls and the reduced level of substantive procedures relevant to the control risk assessment. The auditor confirms the control risk assessment on completion of the tests of operating effectiveness.

4. Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Before designing substantive procedures, the auditor must determine the acceptable level of detection risk for each significant related assertion. This level of detection risk will be used by the auditor to determine the nature, timing, and extent of substantive procedures that need to be performed.

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Auditing: A Practical Approach, Fourth Canadian Edition

5. Design a substantive audit program for sales and receivables.

It is usually cost-effective to perform substantive tests on the balance of receivables rather than the transactions making up that balance. The most important test of transactions is that of cut-off at the year end. The major test of balances is the confirmation of accounts receivable. Given that customers are third parties, such evidence is highly reliable. If no response is received, the auditor performs alternative procedures, such as examining subsequent collections and vouching unpaid invoices and supporting documentation constituting customer balances. The auditor must also verify the estimate of the allowance for doubtful accounts.

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TRUE-FALSE STATEMENTS 1. One of the key objectives in auditing sales and receivables is that the customer is satisfied with the goods or services provided by the company.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to sales and receivables.

Section Reference: 10.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic

2. The key issues relating to auditing sales and receivables are that the receivables do actually exist and are collectible with adequate allowances for doubtful accounts, and that the sales are genuine and neither overstated or understated.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to sales and receivables.

Section Reference: 10.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic

3. Credit checks should be performed for all customers after sending the customer order to the warehouse for processing, pickup, and delivery.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

4. A significant risk over cash receipts is that cash paid by customers is stolen before it is recorded.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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AACSB: Analytic

5. Sales transactions are the main source of operating revenue for most business enterprises, and thus, the accounts receivable produced by credit sales transactions are material to the balance sheet for all businesses except where cash receipts are predominant.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

6. A substantive test for sales may include a sample of invoices from the sales journal which would be vouched back to sales orders or shipping documents in order to test occurrence.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

7. In terms of the accounts receivable, the main consideration is the gross amount due from customers on credit sales and the related allowance for doubtful accounts.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

8. Accounts receivable can be verified without any consideration being given to sales on the income statement.

Answer: False Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

9. A substantive test for accounts receivable could include verifying accounts receivable and the related allowance account by tracing the current period’s opening balances to the closing audited balances in the previous year’s working papers.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

10. The cut-off tests for sales are designed to ensure that both sales and receivables are recorded in the correct accounting period and that inventories and accounts payable are recorded in the same accounting period.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 11. The account balance audit objective, “Accounts receivable presents gross claims on customers at balance date and agree with the sum of the accounts receivable subsidiary ledger”, is derived from the assertion category of a) existence or occurrence. b) completeness. c) rights and obligations. d) accuracy, valuation, and allocation.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to sales and receivables.

Section Reference: 10.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic

12. Which of these is not a specific audit objective for sales and receivables? a) existence or occurrence b) completeness c) representation d) presentation Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to sales and receivables.

Section Reference: 10.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic 13. Which assertion category does the following audit objective relate to? “Accounts receivable include all claims on customers at the balance sheet date.” a) valuation b) rights and obligations c) disclosure d) completeness Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to sales and receivables.

Section Reference: 10.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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14. Verifying the accuracy of the accounts receivable trial balance relates to the a) existence or occurrence assertion. b) completeness assertion. c) accuracy, valuation, and allocation assertion. d) rights and obligations assertion.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to sales and receivables.

Section Reference: 10.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic

15. In a credit sales environment, the document that usually initiates the activity in the sales cycle is a) customer order. b) sales order. c) dispatch note. d) sales invoice.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

16. Which of the following is not normally considered a step in the credit sales functions? a) accepting customer orders b) approving credit c) acquiring goods to fill the order d) billing customers Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

17. In a credit sales environment, the document that serves as the basis for internal processing of an order is a) customer order. b) sales order. c) dispatch note. d) sales invoice.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

18. In a credit sales environment, the best place to vest credit approval is in a) accounts receivable. b) the sales department. c) the cashier area where receipts will eventually be sent. d) an independent credit department.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

19. Controls over approving credit relate to the a) existence or occurrence assertion. b) completeness assertion. c) accuracy, valuation, and allocation assertion. d) rights and obligations assertion.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

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20. To enhance controls in the credit sales area, the warehouse should be instructed not to release (or dispatch) goods until a) they received a faxed copy of the sales requisition. b) they have a completed sales invoice. c) they receive an approved sales order. d) the shipping department requests the goods.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

21. Accounting for the numerical sequence of dispatch notes used in tracing will primarily meet the a) existence or occurrence assertion. b) completeness assertion. c) accuracy, valuation, and allocation assertion. d) presentation assertion.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

22. From the following which would not be an appropriate control procedure for the invoicing of customers? a) checking the existence of a dispatch note matching the approved sales order before an invoice is prepared b) using an authorized price list when preparing the invoice c) comparing totals for dispatch notes with totals for invoices d) segregating filling and dispatching sales orders Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

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Auditing: A Practical Approach, Fourth Canadian Edition

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

23. Use of an authorized price list in preparing the sales invoices meets primarily the a) existence or occurrence assertion. b) completeness assertion. c) accuracy, valuation, and allocation assertion. d) rights and obligations assertion.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

24. The main control objective of the recording of sales function is a) that only actual deliveries are invoiced. b) that sales are recorded accurately and in the proper period. c) that cash will be received for the sale. d) to produce a monthly customer statement.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

25. Which of these is not an example of a sales adjustment transaction? a) cash discount b) sales return or allowance c) short payment of customer account d) bad debt write-off Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions

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CPA Competency: Audit and Assurance AACSB: Analytic

26. A cash register or point-of-sale terminal provides a) an immediate visual display for the customer of the amount of the cash sale and the cash tendered. b) a printed receipt for the customer and an internal record of the transaction. c) a printed control totals of the day’s receipts. d) all of the above Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

27. For entities involved in the business of selling goods and services which of the following function(s) will apply? a) sales b) sales and cash receipts c) cash receipts d) sales, cash receipts, and sales adjustments Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

28. Information processing controls specific to credit sales transactions include a) proper authorization. b) documents and records. c) independent checks. d) all of the above Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

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Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

29. In recording sales, the primary control objective is to a) ensure sales invoices are recorded. b) ensure sales invoices are recorded accurately and in the right period. c) ensure cash receipts are recorded accurately and in the right period. d) both b and c Answer: b Bloomcode: Comprehension Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

30. When an entity receives mail receipts, it is preferable to have at least two clerks responsible for opening the mail. This control a) ensures both clerks are punctual. b) reduces the risk of cash receipts received in the mail being misappropriated. c) ensures receipts are processed to the appropriate general ledger account. d) ensures all cheques received are accompanied by a remittance advice.

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic 31. ‘Depositing receipts intact’ means a) all receipts are deposited, that is, not used to make payments. b) all receipts are placed in a security envelope prior to banking. c) both mail receipts and over-the-counter receipts are banked together. d) mail receipts are banked separately to receipts received over-the-counter.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

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Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

32. Controls useful in reducing the risk of fraud associated with sales adjustment transactions include a) proper authorization of all sales adjustment transactions. b) proper authorization of credit for returned or damaged goods. c) proper authorization for the writing off of bad debts. d) all of the above Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

33. Access controls should permit read-only access to transaction and master files except for authorized individuals. Which of the following illustrates such an exception? a) credit controller can override marginal breaches of a customer’s credit limit. b) sales manager can amend a price for a sales transaction. c) sales manager can amend a discount for a customer. d) any of the above Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

34. Which of the following is not an example of a programmed application control? a) numerical continuity of documents is assured b) unreasonable quantities, amounts, and dates are queried c) only orders for goods in the entity’s product range are accepted d) duplicate document numbers are accepted Answer: d Bloomcode: Application Difficulty: Medium

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Auditing: A Practical Approach, Fourth Canadian Edition

Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

35. Use of point-of-sale terminals to record over-the-counter cash sales provides all of the following except a) assurance that all cash sales are processed through the system. b) an immediate visual display for the customer to verify the accuracy of price and cash tendered. c) a printed receipt for the customer. d) printed control totals of the day’s receipts processed on the device.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

36. Standard control procedures over customer remittances received through the mail include having the mailroom personnel a) forward the remittances, unopened, directly to the accounts receivable clerk. b) open the mail, restrictively endorse the cheques, and then forward the remittances directly to the cashier. c) open the mail, restrictively endorse the cheques, and then forward the remittances directly to the accounts receivable clerk. d) open the mail, restrictively endorse the cheques, and then list each remittance on a prelist.

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

37. After making the deposit, the daily cash summary should be forwarded by the cashier directly to

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a) the chief financial officer. b) the accounts receivable clerk. c) general accounting. d) the cash receipts clerk.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

38. When undertaking tests of controls for revenues, auditors are more concerned with controls associated with the occurrence assertion than they are with the completeness assertion because a) clients are more likely to overstate than understate revenues. b) clients are more likely to understate than overstate revenues. c) it is difficult to determine when services have been performed. d) the allowance for doubtful accounts often is understated.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

39. The control an entity should have in place in order to ensure all credit sales have proper credit approval is a) an approved sales order for all goods released to dispatch. b) a check on customer’s credit limit prior to each sale and a credit department credit check on all new customers. c) determination that customer is on an approved customer list. d) both a and c Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy

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Auditing: A Practical Approach, Fourth Canadian Edition

CPA Competency: Audit and Assurance AACSB: Analytic

40. When testing the operating effectiveness of controls pertaining to the function of the recording of sales, the auditor may vouch recorded sales to supporting documents. The vouching of recorded sales to supporting documents pertains to the audit objective of a) existence or occurrence. b) rights and obligations. c) accuracy, valuation, and allocation. d) all of the above Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

41. In most credit sales audits, the auditor's concern over sales adjustment transactions is based upon the a) sheer number and value of these transactions. b) lack of proper authorization for these transactions. c) potential use of these transactions to conceal a theft of cash. d) poor controls normally found over these transactions and the inherent lack of documentation.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

42. The write-off of accounts receivable should be authorized by the a) cashier b) controller. c) accounts receivable clerk. d) chief financial officer.

Answer: d Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

43. After completing the testing of controls over cash receipts and sales adjustments, the auditor assesses the level of control risk to be higher than expected. How would this affect the auditor’s substantive audit work on accounts receivable? a) More work would need to be performed to ensure that the allowance for doubtful debts is fairly stated. b) Less work would need to be performed on following up non-responses from the auditor’s customers’ circularization. c) The auditor may consider changing the date of the customers’ circularization from one month before the year-end, to the actual year-end date. d) More analytical review tests could be performed on debtors as a substitute for other substantive tests.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

44. An inherent risk for sales and receivables is a) promising large bonuses for meeting sales targets. b) the susceptibility of cash to misappropriation. c) not requiring employees to take regular annual leave. d) all of the above Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

45. The type of computer assisted audit technique (CAAT) that would be least suitable for testing controls where credit sales transactions are processed using real time systems is a) systems control and audit file. b) integrated test facility.

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Auditing: A Practical Approach, Fourth Canadian Edition

c) embedded audit facility. d) test data approach.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

46. When examining sales transactions, which of the following would not be possible using generalized audit software? a) inquiring about segregation of duties for invoicing customers b) selecting a sample of invoices for inspection c) re-performing invoice pricing and reporting differences d) ensuring the sales journal is correctly totalled Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

47. A key control environment factor in reducing the risk of fraudulent financial reporting through the overstatement of sales and accounts receivable is a) management’s adoption and adherence to high standards of integrity and ethical values. b) reducing the emphasis on sales targets. c) establishing an effective audit committee. d) all of the above Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

48. A potential misstatement for the function of approving credit is a) goods may be released from the warehouse for unauthorized orders.

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b) goods dispatched may not agree with goods ordered. c) sales may be made without credit approval. d) all of the above Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

49. A potential misstatement for the function of filling sales orders is a) goods may be released from the warehouse for unauthorized orders. b) sales may be made without credit approval. c) sales may be made to unauthorized customers. d) all of the above Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

50. Which of these is not a potential misstatement for the function of recording cash receipts? a) cash may not be deposited intact daily b) some receipts may not be recorded c) errors may be made in journalizing receipts d) receipts may be posted to the wrong customer account Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

51. The best procedure for dealing with a non-response to a third positive request for confirmation of an accounts receivable is

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Auditing: A Practical Approach, Fourth Canadian Edition

a) assume that the debtor’s value is correct. b) write-off the balance as a bad debt. c) examine subsequent cash collections. d) involve the client in chasing up the debtor.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

52. For accounts receivables and sales, analytical procedures provide evidence that relates to a) existence or occurrence assertion. b) completeness assertion. c) valuation or measurement assertion. d) all of the above Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

53. An unusual feature of cut-off tests is that they a) are always performed at year-end to verify a recorded balance even though they are tests of transactions. b) are never performed at year-end to verify a recorded balance because they are tests of transactions. c) are always performed at year-end to verify transactions even though they are tests of details of balances. d) none of the above Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

54. Confirming accounts receivable is an accepted audit procedure whenever

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a) they are material in amount. b) it is reasonable to presume debtors will respond. c) they are material and it is reasonable to presume debtors will respond. d) a large number of small balances is involved.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

55. When detection risk is high, the timing of the receivables confirmations would be expected to be a) at balance date. b) prior to balance date. c) prior to balance date provided analytical procedures are performed between the confirmations and balance date. d) prior to balance date provided analytical procedures and tests of control are performed between the confirmations and balance date.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

56. In the processing of accounts receivable confirmations, the auditor would not normally be expected to a) personally prepare the confirmations. b) personally post the requests. c) include his/her own return address envelope. d) maintain custody of the confirmations until they are mailed.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

57. When the positive form of accounts receivable confirmation is used and no response is received, the auditor should normally

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Auditing: A Practical Approach, Fourth Canadian Edition

a) assume the account is in error. b) send a second positive request. c) assume the account is correct. d) send a negative confirmation.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

58. The summary of the results from confirming accounts receivable contained in the auditor’s working papers would not normally provide statistical data on the a) market value of the confirmation sample. b) number of confirmations sent and responses received. c) proportion of the population total covered by the sample. d) relationship between the audited and book values of items included in the sample.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

59. Which of these is not an approach that might be adopted by an auditor in evaluating the adequacy of an allowance for bad debts? a) reviewing subsequent events b) reviewing and testing the process used by management c) use the percentages adopted by the client d) use an independent estimate Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

60. When reviewing and testing the process used by management in determining the allowance for bad debts, which of the following would not be involved?

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a) reviewing projected allowances for future periods b) ascertaining management’s procedures for determining the estimate and considering their reliability c) ensuring that the procedures have been properly followed d) identifying the assumptions underlying the estimate and considering their reasonableness Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

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SHORT ANSWER QUESTIONS 61. Identify the assertion relating to classes of transactions that corresponds with the following descriptions.

1. All sales, cash receipts, and sales adjustment transactions are recorded in the correct accounts.

2. Sales recorded represent goods that were shipped to customers during the period.

3. Particularly relevant to transactions around the year end; all sales, cash receipts, and sales adjustment transactions arising before the period end are recorded in the current period and those arising after the period end are included in the next accounting period.

4. All goods shipped to customers during the period are recorded.

5. All sales, cash receipts, and sales adjustment transactions are properly recorded.

6. Cash receipts represent cash received from customers during the period.

Answer: Assertion Classification Occurrence Cut-off

Completeness Accuracy Occurrence

Audit Objective All sales, cash receipts, and sales adjustment transactions are recorded in the correct accounts.

Sales recorded represent goods that were shipped to customers during the period.

Particularly relevant to transactions around the year end; all sales, cash receipts, and sales adjustment transactions arising before the period end are recorded in the current period and those arising after the period end are included in the next accounting period.

All goods shipped to customers during the period are recorded.

All sales, cash receipts, and sales adjustment transactions are properly recorded.

Cash receipts represent cash received from customers during the period.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to sales and receivables Section Reference: 10.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic

62. Identify the assertion relating to account balances that corresponds with the following descriptions.

1. Accounts receivable represent gross claims on customers at the end of the reporting period and agree with the sum of the accounts receivable subsidiary ledger.

2. All amounts owed by customers at the end of the reporting period are included in accounts receivable.

3. Accounts receivable at the end of the sales reporting period represent legal claims of the entity on customers for payment.

4. Accounts receivable represent amounts owed by customers at the end of the reporting period.

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5. The allowance for doubtful accounts represents a reasonable estimate of the difference between gross accounts receivable and their net realizable value.

Answer: Assertion Valuation and allocation

Completeness Rights and obligations

Existence Valuation and allocation

Audit Objective Accounts receivable represent gross claims on customers at the end of the reporting period and agree with the sum of the accounts receivable subsidiary ledger.

All amounts owed by customers at the end of the reporting period are included in accounts receivable.

Accounts receivable at the end of the sales reporting period represent legal claims of the entity on customers for payment.

Accounts receivable represent amounts owed by customers at the end of the reporting period.

The allowance for doubtful accounts represents a reasonable estimate of the difference between gross accounts receivable and their net realizable value.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to sales and receivables Section Reference: 10.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic

63. Provide an appropriate control procedure that relates to the audit assertions and objectives provided in the table below.

Audit Objective Sales recorded represent goods that were shipped to customers during the period.

All goods shipped to customers during the period are recorded.

All sales, cash receipts, and sales adjustment transactions are properly (accurately) recorded.

Control Procedure

Assertion Occurrence

Audit Objective Sales recorded represent goods that were shipped to customers during the period.

Completeness

All goods shipped to customers during the period are recorded.

All sales, cash receipts, and sales adjustment transactions are properly (accurately) recorded.

Control Procedure checking the existence of a shipping document and matching it to the approved sales order before each invoice is prepared segregating invoicing from the foregoing functions using an authorized price list in preparing the sales invoices

Assertion Occurrence

Completeness Accuracy

Answer:

Accuracy

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Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

64. Identify the five functions in the processing of credit sales transactions and any documents and records that are used in these functions.

Answer: Accepting customer orders: orders are recorded in writing as customer orders or, if written orders are not submitted, an order number can be used. Once accepted, the order is recorded on a multicopy sales order, which is a form showing the description of the goods, the quantity ordered, and other relevant data.

Approving credit: A credit check is made of any new customer and, if accepted, an appropriate credit limit is determined. This is recorded on a newly created customer record.

Filling and dispatching sales orders: When the warehouse receives a copy of the sales order then this is authorization to fill the order and release the goods to the shipping department (or dispatch area). The dispatch function then involves preparing a multicopy dispatch note which provides evidence that the goods were shipped.

Invoicing customers: The invoicing function involves preparing and sending sales invoices to customers. Invoices should be prepared after checking the existence of a dispatch note matching the approved sales order.

Recording the sales: sales are entered in a sales journal and posted to the accounts receivable ledger and general ledger. Accuracy is facilitated by the use of prelists to check the total of sales invoices in the sales journal is checked against the total in the receivables ledger. A monthly customer statement is also used to give the customer the opportunity to identify errors.

Bloomcode: Application Difficulty: Medium Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

65. Identify the three functions in the processing of cash receipts transactions and any documents and records that are used in these functions.

Answer: Receiving cash: Over-the-counter receipts of cash should be processed using a cash register or point-of-sale terminal that produces a receipt for the customer, and an internal record of the transaction on a computer file or a tape locked inside the register. Receipts through the mail should be recorded on a prelist and any cash should be recorded in a rough

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cash book. Cheques may also be received with remittance advices, which should be forwarded to accounts receivable for posting.

Depositing cash in the bank: Deposits should be checked against the register total for overthe-counter receipts, and against the prelist for mail receipts. Details of cash receipts are then entered on a daily cash summary and the bank deposit slip is prepared in duplicate.

Once receipts are banked, the copy of the deposit slip is receipted by the bank and retained by the cashier.

Recording the receipts: The daily cash summary is used to enter the cash receipts journal, distinguishing between receipts from cash sales and from credit sales. The credit sales receipts are then posted to the accounts receivable ledger using remittance advices, and cash receipts are posted to the general ledger.

Bloomcode: Application Difficulty: Medium Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

66. Provide three relevant analytical procedures related to the audit of sales and receivables.

Answer: -

sales turnover ratio (sales/total assets) gross margin analysis trends in sales levels accounts receivable turnover ratio (credit sales/receivables) comparison of bad debts to sales revenue and total receivables

Bloomcode: Application Difficulty: Medium Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustment transactions Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

67. Identify factors that ought to be considered in the assessment of inherent and control risks for sales and accounts receivable.

Answer: Factors considered in the assessment of inherent and control risk.

Pervasive factors include: - Pressure to overstate sales in order to report announced sales or profitability targets - Pressure to overstate cash and accounts receivable or understate the allowance for bad debts due to liquidity or going concern problems.

Other factors include:

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- A high volume of transactions result in numerous opportunities for errors to occur.

- The timing of revenue recognition may be contentious.

- Classification of factored accounts with recourse.

- Cash is susceptible to misappropriation.

- Sales adjustment transactions may be used to conceal irregularities.

Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

68. Identify a necessary control for each of the following potential misstatements in relation to credit sales transactions: 1. Sales may be made to unauthorized customers.

2. Sales may be made without credit approval.

3. Goods may be released from the warehouse for unauthorized orders.

4. Unauthorized shipments may be made.

5. Some shipments may not be invoiced.

6. Invoices may not be journalized or posted to customer accounts.

7. Invoices may be posted to the wrong customer account.

Answer: Only one necessary control required.

Potential Misstatement Necessary Control 1. Sales may be made to unauthorized customers.

• Determination that customer is on approved customer list.

- Approved sales order for each cash sale 2. Sales may be made without credit approval.

• Credit department credit check on all new customers.

- Check on customer’s credit limit before each sale.

3. Goods may be released from the warehouse for unauthorized orders.

• Approved sales invoice for all goods released to dispatch.

4. Unauthorized shipments may be made.

• Segregation of duties for filling and dispatching orders.

- Preparation of dispatch note for each shipment.

5. Some shipments may not be invoiced.

• Matching of sales invoice with each dispatch note.

- Periodic accounting for all dispatch notes.

6. Invoices may not be journalized or posted to customer accounts.

• Independent check of agreement of sales journal entries and amounts posted to customer accounts with control totals of invoices.

- Periodic accounting for all sales invoices.

7. Invoices may be posted to the wrong customer account.

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• Chart of accounts and supervisory review.

- Mailing of monthly statements to customers, with independent follow-up of customer complaints.

Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

69. For each of the following functions of cash receipts, identify a potential misstatement and a necessary control: 1. Receiving cash receipts.

2. Depositing cash in the bank.

3. Recording the receipts.

Answer: 1. Receiving cash receipts: Cash sales may not be registered. Use of cash registers or pointof-sale devices. Mail receipts may be lost or misappropriated after receipt. Restrictive endorsement of cheques. Preparation of a rough cash book or prelist of mail receipts.

2. Depositing cash in the bank: Amounts may not agree with the cash count list or prelist.

Independent check of agreement of cash and cheques with register totals and prelist.

Cash may not be deposited intact daily. Independent check of agreement of validated deposit slip with daily cash summary.

3. Recording the receipts: Some receipts may not be recorded. Independent check of agreement of amounts journalized and posted with the daily cash summary.

Errors may be made in journalizing receipts. Preparation of periodic bank reconciliations.

Receipts may be posted to the wrong customer account. Mailing of monthly statements to customers.

Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables.

Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

70. Provide three inherent risks related to the audit of sales and receivables.

Answer: -

pressure to overstate sales to achieve profitability targets pressure to overstate cash and accounts receivable to avoid going concern doubts adjusts to sales or receivables as a result of errors contentious issues relating to the timing of revenue recognition susceptibility to misappropriation of liquid assets generated by cash receipts the use of sales adjustment transactions to conceal the theft of cash received from

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customers Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

71. Describe a preventative control for each of the WCGW (what can go wrong) provided in the table below.

WCGW Sales may be made to unauthorized customers.

Sales may be made without credit approval.

Goods may be released from the warehouse for unauthorized orders.

Goods shipped may not agree with goods ordered.

Unauthorized shipments may be made.

Preventative Control

Answer: WCGW Sales may be made to unauthorized customers.

Sales may be made without credit approval.

Goods may be released from the warehouse for unauthorized orders.

Goods shipped may not agree with goods ordered.

Unauthorized shipments may be made.

Preventative Control Determination that the customer is on the approved customer list.

Credit department performs a credit check on all new customers.

Approved sales order is required for all goods released to shipping.

Independent check by shipping clerk to agree goods shipped from warehouse with approved sales order.

Segregation of duties for filling and shipping orders

Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of sales and receivables Section Reference: 10.4 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

72. There are three stages in applying analytical procedures to sales and receivables in the final audit. Briefly explain each stage.

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Answer: The first stage in applying analytical procedures is to review the understanding of the entity, obtained during the planning phase, as to whether any changes to sales and receivables are to be expected.

The second stage is to identify absolute changes in amounts between this year and previous years. This is normally done in the course of preparing the lead schedule for sales and accounts receivable. On this schedule, previous and current year ledger balances making up the financial statement disclosures are recorded side by side, making any differences readily apparent.

The third stage involves the use of more sophisticated relationships such as ratios and trends. This procedure can be performed on accounting data held on computer files, using computer audit software. Wherever a change in relationships cannot be readily explained, the auditor must seek an explanation from management and corroborate that explanation, usually by performing more tests of details.

Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

73. Confirmations are considered to be the most efficient procedure for obtaining sufficient appropriate audit evidence to support the existence and rights assertions of accounts receivable. However, there are still circumstances under which other procedures may be more effective. List four situations in which confirmations are unlikely to be effective.

Answer: Any four of the following: - When customers are small businesses or private individuals, they are less likely to maintain sufficiently accurate accounts payable ledger records to provide a reliable response.

-.

- Customers are unlikely to admit to owing more than is shown on the monthly statement.

- Many trivial differences are likely to be reported as a result of goods and cash in transit.

- The non-response rate may be high.

- Previous audits may have shown responses to be unreliable.

- Customers may not be able to confirm total balances if they use a voucher system.

Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

74. Differentiate between the two different forms of confirmation of accounts receivable balances and explain the conditions for which each would be used.

Answer: The two different forms are the positive and negative confirmation requests. The positive form asks a debtor to respond that the balance shown is incorrect or correct. The negative form only requires the debtor to respond when the amount shown is incorrect.

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The positive form of confirmation is used when detection risk is low or individual customer balances are relatively large. The negative form should be used when detection risk is moderate or high, that there are a large number of small balances in the population, or the auditor has no reason to believe that the respondents are unlikely to give the request due consideration.

Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

75. List the steps involved when the auditor reviews and tests the process used by management to estimate the bad debts and the allowance for doubtful accounts.

Answer: - The auditor must ascertain management’s procedures for determining the estimate and considering their reliability.

- They must ensure that the procedures have been properly followed and that the estimate has been approved.

- They must identify the assumptions underlying the estimate and consider their reasonableness.

- They must verify the reliability of the data on which the estimate is based.

- They must check the calculations in determining the general allowance.

- Finally, they must consider the reliability of previous year allowances.

Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

76.

1. What is the initial starting point for auditing accounts receivables?

2. Identify and describe three tests of details of transactions that would be performed in auditing accounts receivable.

3. Identify and describe the two most important tests of details of balances in relation to accounts receivable.

Answer: 1. The initial starting point is to trace the opening balances to the previous year’s working papers.

2.

- Vouching recorded accounts receivable to supporting documentation: this involves vouching a sample of debits in customers’ accounts to supporting invoices, and vouching a sample of credits to remittance advices and sales adjustment authorizations.

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- The sales cut-off test: the auditor compares the last issued dispatch note with the cut-off established for inventory purposes on balance date.

- The cash receipts cut-off test: the auditor personally observes collections are recorded or they review the entity’s records and a validated deposit slip at balance date.

3.

- Confirmations: direct written communication by the auditor with individual customers to confirm the customer’s accounts receivable balance.

- Evaluate the adequacy of the allowance for bad debts: the auditor must review and test management’s procedure for determining the allowance. They may also use an independent estimate and review subsequent events.

Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for sales and receivables.

Section Reference: 10.5 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 77. Describe the process that a company should follow when granting credit sales transactions to a new customer.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for processing sales, cash receipts, and sales adjustment transactions.

Section Reference: 10.2 The process for credit sales transactions CPA Competency: Audit and Assurance AACSB: Analytic

78. Explain why sales adjustment transactions attract the attention of auditors and list the audit risks associated with sales adjustments.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Outline audit strategy considerations including the risk of material misstatement and tests of controls for sales, cash receipts, and sales adjustments transactions.

Section Reference: 10.3 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

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LEGAL NOTICE Copyright © 2021 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under license and may be used only in accordance with the terms of such license.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 11 AUDITING PURCHASES, PAYABLES, AND PAYROLL CHAPTER LEARNING OBJECTIVES 1. Identify the audit objectives applicable to purchases, payables, and payroll.

In the auditing of purchases, the key issue is often to ensure that the purchases are all recorded and are not understated; therefore, the focus is on completeness, accuracy, and cut-off assertions. For payables that are derived from the purchases, the key issue is to ensure they are all fully recorded in the accounts as liabilities; therefore, the focus is on the completeness and accuracy, valuation and allocation assertions. Lastly, the focus of the payroll expense is to ensure the expense has been properly recorded and the associated deductions for income tax, employee benefits, and related liabilities are properly recorded as liabilities. This means the focus is on the completeness, occurrence, and accuracy assertions as well as assertions related to balances of completeness, existence, and accuracy, valuation and allocation.

2. Describe the functions and control procedures normally found in information systems for processing purchase, payment, and purchase adjustment transactions.

The processing of purchase transactions involves the following functions: requisitioning goods and services, preparing purchase orders, receiving the goods, storing goods received in inventory, checking and approving the supplier’s invoice, and recording the liability.

Control procedures such as using pre-numbered cheques, approval of purchases by authorized personnel, and segregation of duties should be interwoven into each process to reduce the risk of material misstatement.

3. Describe the functions and control procedures normally found in information systems for payroll transactions.

The processing of payroll transactions involves the following functions: hiring employees, authorizing payroll changes, preparing attendance and timekeeping data, preparing the payroll, recording the payroll, paying the payroll, and protecting unclaimed wages. Control procedures such as limiting access to payroll records, independently reviewing the payroll, and making payments by direct deposit should be included in each process to reduce the risk of material misstatements.

4. Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

The audit process starts with obtaining an understanding of the purchases, payables, and payroll systems to help assess the inherent and control risks. For audit purposes, the most significant inherent risk is usually that of understatement of purchase transactions and accounts payable balances in order to boost reported profits and enhance liquidity. For the entity, the greatest inherent risk is that of improper purchasing and payments to fictitious employees. Next, the auditor assesses the control risk. Based on the effectiveness of the internal controls, the auditor then drafts the audit program based on the preliminary assessment of control risk. The assessed level of control risk is confirmed on completion of the tests of operating effectiveness, which leads to the final determination of an audit strategy. For purchases and payroll, the audit strategy is likely to be one based on a combined approach.

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5. Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll.

Once the auditor assesses the inherent and control risks, detection risk is set to achieve the required audit risk. This detection risk will be used by the auditor to determine the nature, timing, and extent of substantive procedures that need to be performed. The level and detail of substantive procedures performed is a matter of professional judgement. If detection risk is set as low, the auditor will be required to perform extensive substantive testing. If the detection risk is set as high, the auditor may perform a combined audit.

6. Design a substantive audit program for purchases, payables, and payroll.

The final stage of the audit is the performance of substantive procedures. It is usually more cost-effective to test the balance of accounts payable than to test the transactions making up that balance. The most important test of transactions is that of cut-off at the year end.

The major test of balances is the examination of suppliers’ statements. Because these are documentary evidence received from third parties, they are moderately reliable; however, the auditor needs to be alert to the possibility that such statements may be forged or altered by the entity. Finally, the auditor must also verify directors’ and officers’ salaries.

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TRUE-FALSE STATEMENTS 1. In the audit of payroll, one of the key issues is to ensure that the payroll expense has been properly recorded and the associated deductions for income tax, employee benefits, and related liabilities are properly recorded as liabilities.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to purchases, payables, and payroll.

Section Reference: 11.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic

2. The occurrence objective for purchases, payables, and payroll requires that accounts payable and payroll liabilities include all amounts owed by the entity to suppliers of goods and services at the end of the reporting period.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to purchases, payables, and payroll.

Section Reference: 11.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic

3. A purchase order is a form issued by the supplier detailing the goods or services supplied and the amount owing.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing purchase, payment, and purchase adjustment transactions.

Section Reference: 11.2 The process for purchase transactions CPA Competency: Audit and Assurance AACSB: Analytic

4. The segregation of receiving goods from the requisitioning and purchasing of those goods prevents those making requisitions from ordering goods directly from suppliers and also prevents the purchasing department from gaining access to goods improperly ordered.

Answer: True Bloomcode: Comprehension Difficulty: Easy Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Learning Objective: Describe the functions and control procedures normally found in information systems for processing purchase, payment, and purchase adjustment transactions.

Section Reference: 11.2 The process for purchase transactions CPA Competency: Audit and Assurance AACSB: Analytic 5. Employees are generally hired by the company’s purchasing department.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic 6. Even though an employee’s supervisor may initiate a request for payroll change, such as a change in job classification or wage rate increase, all changes should be authorized in writing by the personnel department before being entered into the personnel data master file.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

7. Purchase and payroll transactions account for the major expenses incurred by a business, and so are a major component in the determination of profit, and also relate to the acquisition of major classes of assets including inventories and capital assets.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

8. The auditor knows that overstatements of payroll may result from unintentional errors or fraud through payments to fictitious employees, payments to actual employees for hours not worked, and payments to actual employees at higher than authorized rates.

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Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

9. Accounts payable is usually the smallest current liability on the balance sheet and a insignificant factor in the evaluation of an entity’s short-term solvency, especially when the accounts payable is affected by a high volume of transactions and thus is susceptible to misstatements.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll.

Section Reference: 11.5 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

10. Accounts payable is affected by purchase transactions that increase the account balance and payment transactions that decrease the balance, thus, detection risk for payables assertions is affected by the control and inherent risk factors related to both these transaction classes.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll.

Section Reference: 11.5 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

11. A substantive audit procedure for verifying accounts payable should include tracing the opening balance to the previous year’s working papers.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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12. A proper cut-off of payment transactions at the year end, such as verifying and examining the date of cheques outstanding as at the end of the reporting period, is essential to the correct presentation of cash and accounts payable at the end of the reporting period.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 13. Which of these is not directly affected by purchases and payments transactions? a) plant assets b) work-in-process inventory c) accounts payable d) prepaid expenses Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to purchases, payables, and payroll.

Section Reference: 11.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic 14. The specific audit objective “accounts payable are liabilities of the entity at the balance date” is derived from the: a) completeness assertion. b) valuation assertion. c) presentation assertion. d) rights and obligations assertion.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing purchase, payment, and purchase adjustment transactions.

Section Reference: 11.2 The process for purchase transactions CPA Competency: Audit and Assurance AACSB: Analytic

15. On delivery of the goods to stores or other requisitioning departments, receiving clerks should obtain a) a signed receipt on the copy of the receiving report retained by the receiving department. b) an original copy of the receiving report released by the receiving department. c) a copy of the receiving report retained by the receiving department. d) an authority for receiving report retained by the receiving department.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing purchase, payment, and purchase adjustment transactions.

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Section Reference: 11.2 The process for purchase transactions CPA Competency: Audit and Assurance AACSB: Analytic

16. The control related to the completeness assertion is a) determining the mathematical accuracy of the suppliers’ invoices. b) serially numbering suppliers’ invoices on receipt so that subsequent checks of numerical continuity can confirm that all invoices are recorded. c) preparing a daily prelist of suppliers’ invoices approved for payment. d) coding the account distributions on the suppliers’ invoices.

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for processing purchase, payment, and purchase adjustment transactions.

Section Reference: 11.2 The process for purchase transactions CPA Competency: Audit and Assurance AACSB: Analytic

17. Purchases transactions relate a) solely to the purchase of inventory held for sale. b) to the purchase of inventory, plant and equipment, and supplies. c) to the purchase of all goods and services. d) to the purchase of all goods and services and the payroll function.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing purchase, payment, and purchase adjustment transactions.

Section Reference: 11.2 The process for purchase transactions CPA Competency: Audit and Assurance AACSB: Analytic

18. Which of the following is least likely to be a function of the processing of purchase transactions? a) storing goods received for inventory b) checking and approving the supplier’s invoice c) return to customers d) receiving the goods Answer: c Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing purchase, payment, and purchase adjustment transactions.

Section Reference: 11.2 The process for purchase transactions CPA Competency: Audit and Assurance AACSB: Analytic

19. The correct statement in relation to purchase requisitions is: a) all purchase requisitions in the organization should originate from the warehouse. b) all managers in the organization should be able to sign a requisition order. c) the purchase requisition represents the start of the trail of documentary evidence in support of management’s assertion as to the occurrence of the purchase transaction. d) all of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for processing purchase, payment, and purchase adjustment transactions.

Section Reference: 11.2 The process for purchase transactions CPA Competency: Audit and Assurance AACSB: Analytic

20. Purchase requisitions may originate from a) personnel manager, for plant and equipment. b) the warehouse, for inventory. c) purchases for a delivery vehicle. d) both b and c Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

21. Purchase orders become part of the transaction trail of documentary evidence that directly supports which assertion for purchase transactions? a) existence or occurrence b) rights and obligations c) accuracy and valuation d) presentation Answer: a Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

22. The quantity ordered may not be displayed on the copy of the purchase order sent directly to the a) requesting department. b) vouchers payable department. c) receiving department. d) accounts receivable department.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

23. The receiving department should be instructed to accept no goods without having on file a properly authorized a) purchase requisition. b) invoice. c) receiving report. d) purchase order.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

24. A copy of the receiving report should be sent directly by the receiving department to the a) accounts (receivable) department. b) chief financial controller. c) purchasing department. d) accounts (payable) department.

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Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

25. A check by the auditor on the numeric sequence of prenumbered receiving reports to determine that a supplier’s invoice was recorded for each relates to the a) existence or occurrence assertion. b) completeness assertion. c) presentation assertion. d) rights and obligations assertion.

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

26. A responsibility not normally assigned to receiving department personnel is to a) compare goods received with description of goods ordered. b) prepare a prenumbered receiving report for every order received. c) enter cheque requisition data and verify the batch total. d) file the purchase order copy pending arrival of goods.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

27. Prior to recording purchases transactions, supplier’s invoices are checked and approved in the accounting department. Controls over this function include all of the following except a) marking all supporting documentation as “paid”. b) approving the supplier’s invoice for payment by having an authorized person sign the invoice. c) agreeing the details of the supplier’s invoice with the related receiving report and purchase order.

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Auditing: A Practical Approach, Third Canadian Edition

d) determining the mathematical accuracy of the supplier’s invoice.

Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

28. For the purchasing firm the processing of purchases and payment transactions requires all of the following functions except: a) requisitioning goods and services. b) preparing purchase invoices. c) preparing the cheque requisition. d) All of the above functions are required.

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

29. Responsibility for determining that unpaid supplier’s invoices are processed for payment on their due dates generally lies with the a) warehouse department. b) accounts payable department. c) purchasing department. d) internal audit department.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

30. Segregation of the functions of payroll and personnel do all of the following, except a) reduce the risk of payments to fictitious employees. b) reduce the risk of payments to terminated employees.

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c) restrict the recording of new employee data to the payroll department. d) restrict the payment of wages to the payroll department.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

31. Controls over the preparation and signing of cheques include all of the following except a) authorized personnel in the accounting department should be responsible for signing the cheques. b) the cheque requisition and supporting documents should be cancelled (stamped) when the cheque is signed. c) the signed cheque and the supporting documents should be returned to the accounts payable clerk for review and mailing. d) prenumbered cheques should be used.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

32. Controls specific to the recording of cash payments include which of the following? a) an independent check by the accounting supervisor of the agreement of the amounts authorized and posted to accounts payable with the cheque summary received from the general accounting department b) an independent check of the agreement of the total of cheques issued with a batch total of the vouchers processed for payment. c) limits on access to blank cheques d) all of the above Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

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33. Payroll functions include all of the following except a) hiring employees. b) deciding on the number of workers required to work on a particular day. c) preparing the payroll. d) protecting unclaimed wages.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

34. Payroll functions include all of the following except a) preparing attendance and timekeeping data. b) authorized payroll changes. c) terminating employees. d) hiring employees.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic 35. A special supervisor’s password is required in order to add a new employee to the personnel data master file. This control relates primarily to the a) existence or occurrence assertion. b) completeness assertion. c) presentation assertion. d) accuracy, valuation, and allocation assertion.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

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36. Responsibility for updating of the personnel data master file should rest with authorized employees in the a) personnel department. b) payroll department. c) controller’s department. d) employee’s operating department.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

37. In most modern organizations, employee timekeeping data is recorded via a) employee badges. b) time-clock cards. c) security identification cards. d) sign-in/sign-off book.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

38. Wage rate increases should be authorized in writing by the a) payroll department. b) personnel department. c) finance department. d) data entry department.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

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39. A programmed routine in the edit run for payroll lists all employees who worked more than 50 hours during the week for review. This is an example of a a) reasonableness test. b) validity test. c) sequence test. d) self-checking test.

Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

40. For proper control, unclaimed payroll cheques should be stored by the a) finance department. b) payroll department. c) personnel department. d) timekeeping department.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic 41. Controls applicable to paying the payroll and protecting unclaimed wages include all of the following except a) payroll cheques and bank transfers should be signed or authorized by finance office personnel involved in preparing or recording the payroll. b) payroll cheques, where used should be distributed to employees by finance office personnel not involved in preparing or recording the payroll. c) any unclaimed payroll cheques should be stored in a safe or vault in the finance office. d) finance office personnel should check the agreement of the names and amounts on cheques or bank transfers with payroll register entries.

Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy

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CPA Competency: Audit and Assurance AACSB: Analytic

42. The batching of payroll documents is normally done in the a) timekeeping department. b) payroll department. c) data entry department. d) personnel department.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll.

Section Reference: 11.5 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

43. An important consideration in assessing inherent risk for purchase transactions is any motivation management may have to misstate expenditure. Which of the following is not a factor that may contribute to misstatement? a) the need to achieve announced profitability targets. b) the need to disclose concern over control problems. c) temptations for employees to make unauthorized purchases. d) temptations for employees to misappropriate purchased assets.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll.

Section Reference: 11.5 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

44. Which of the following is not a factor that tends to increase the inherent risk for purchases and payables? a) the number of directors b) a high volume of transactions c) issues over costs being capitalized versus being expensed d) the complexity of payroll calculations.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll.

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Section Reference: 11.5 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

45. Test data may be used to test application controls over accepting and recording data for unpaid suppliers’ invoices. Which of the following conditions would not be relevant? a) numeric characters in an alphanumeric field b) missing or invalid supplier numbers c) missing due date or payment terms d) alphabetical characters in a numeric field Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll.

Section Reference: 11.5 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

46. In witnessing a payroll distribution, the auditor would not be expected to observe that a) the segregation of duties exist between the preparation and payment of payroll. b) the correct payroll entries are made in the firm’s ledger and journal c) there is proper control and disposal of unclaimed cheques. d) each employee receives only one cheque or pay envelope.

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll.

Section Reference: 11.5 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic 47. Factors relating to the internal control environment that the auditor needs to consider when assessing control risk for purchase, payment, and payroll transactions include all of these except a) integrity and ethical values. b) management’s commitment to competence. c) design of substantive procedures. d) assignment of authority and responsibility.

Answer: c Bloomcode: Comprehension Difficulty: Easy

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Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll.

Section Reference: 11.5 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

48. Which of these is not a source of potential misstatement for the function of recording a payment? a) a cheque may be issued for unauthorised purchases b) a cheque may not be recorded promptly c) errors may be made in recording cheques d) All of the above are sources of potential misstatement for the function of recording a payment.

Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll.

Section Reference: 11.5 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

49. Which of these is the least likely risk factor for payroll? a) payments to fictitious employees b) payments to actual employees for hours less than they worked c) payment to actual employees for hours not worked d) payments to actual employees at higher than authorized rates Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll.

Section Reference: 11.5 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

50. Which of the following is not an initial procedure for verifying accounts payable? a) trace the opening balance to the prior year’s working papers (if applicable) b) review activity in the general ledger account for any unusual entries c) reconcile accounts to monthly supplier’s statements d) obtain a listing of amounts owed at the balance sheet date Answer: c Bloomcode: Application Difficulty: Medium Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

51. Confirmation of accounts payable will provide the least amount of evidence for the a) existence or occurrence assertion. b) completeness assertion. c) accuracy and valuation assertion. d) rights and obligations assertion.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

52. Which of these is not a procedure for identifying unrecorded liabilities? a) examination of the subsequent period’s purchase and payment transactions b) analytical procedures for expense and liability balances c) examination of contractual commitments d) confirmation of accounts payable Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

53. Tests of details of transactions for payables balances include a) vouching recorded payables to supporting documentation. b) confirming payables with major suppliers by reviewing the accounts payable ledger or accounts payable master file. c) comparing financial statement presentation with applicable regulations and accounting standards. d) verifying directors’ and executive officers’ remuneration.

Answer: a Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

54. Tests of details of balances for payables include all of the following except a) reconciling payables with monthly statements received by the entity from suppliers. b) confirming accounts payable. c) searching for unrecorded liabilities. d) verifying directors’ and executive officers’ remuneration.

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

55. The third stage of applying analytical procedures is to a) identify absolute changes in amounts between the current year and the prior year. b) use ratios and trends. c) make an objective assessment regarding usability of analytical procedures. d) document expected and unexpected changes.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

56. Which of these tests would be the least useful when using analytical procedures on expenses? a) comparing prior year amounts with current year amounts b) comparing current year amounts as a percentage of sales with prior year c) comparing relationships between related expenses d) comparing total expenses to the bank balance at balance date Answer: d Bloomcode: Application Difficulty: Medium Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

57. A purchases cut-off test would satisfy the audit objective assertion of a) classification. b) rights and obligations. c) completeness d) none of the above Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

58. A confirmation is performed less frequently for accounts payable than it is for accounts receivable because a) only a negative confirmation can be sent. b) confirmation offers no assurance that unrecorded liabilities will be discovered. c) it is only performed when detection risk is high. d) it specifies the amount due to the supplier.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

59. Each major class of creditors and borrowings must be disclosed in the balance sheet.

Which of these would not be shown as a class of creditors and borrowings? a) taxation liabilities b) revenue owing c) employee benefits d) lease liabilities Answer: b Bloomcode: Comprehension

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Difficulty: Easy Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

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SHORT ANSWER QUESTIONS 60. Identify the assertion relating to classes of transactions that corresponds with the following descriptions.

1. All purchases, payments, and payroll transactions are recorded in the correct accounts.

2. Particularly relevant to transactions around the year end; all purchases, cash payments, purchase adjustments, and payroll transactions arising before the period end are recorded in the current period and those arising after the period end are included in the next accounting period.

3. Recorded payroll expenses relate to employee services received in the period.

4. All payments that occurred during the period and that should have been recorded have been recorded.

5. Purchase, payment, and payroll transactions are properly (accurately) recorded.

Answer: Assertion Classification Cut-off

Occurrence Completeness Accuracy

Audit Objective All purchases, payments, and payroll transactions are recorded in the correct accounts.

Particularly relevant to transactions around the year end; all purchases, cash payments, purchase adjustments, and payroll transactions arising before the period end are recorded in the current period and those arising after the period end are included in the next accounting period.

Recorded payroll expenses relate to employee services received in the period.

All payments that occurred during the period and that should have been recorded have been recorded.

Purchase, payment, and payroll transactions are properly (accurately) recorded.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to purchases, payments, and payroll Section Reference: 11.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic

61. Identify the assertion relating to account balances that corresponds with the following descriptions.

1. Accounts payable represent gross amounts due to suppliers and agree with the sum of the accounts payable in the accounts payable subsidiary ledger.

2. Accounts payable include all amounts owed by the entity to suppliers of goods and services at the end of the reporting period.

3. Accounts payable and accrued payroll liabilities are liabilities of the entity at the end of the reporting period.

4. Accrued payroll liabilities include all amounts owed in respect of payroll and deductions at the end of the reporting period.

5. Recorded accounts payable represent amounts owed by the entity at the end of the reporting period.

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Answer: Assertion Accuracy, valuation, and allocation Completeness

Rights and obligations Completeness

Existence

Audit Objective Accounts payable represent gross amounts due to suppliers and agree with the sum of the accounts payable in the accounts payable subsidiary ledger.

Accounts payable include all amounts owed by the entity to suppliers of goods and services at the end of the reporting period.

Accounts payable and accrued payroll liabilities are liabilities of the entity at the end of the reporting period.

Accrued payroll liabilities include all amounts owed in respect of payroll and deductions at the end of the reporting period.

Recorded accounts payable represent amounts owed by the entity at the end of the reporting period.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to purchases, payments, and payroll Section Reference: 11.1 Audit objectives CPA Competency: Audit and Assurance AACSB: Analytic

62. Describe a control procedure over the preparation and signing of cheques and electronic fund transfers.

Answer: Control procedure over the preparation and signing of cheques and electronic fund transfers include the following: - Authorized personnel in the finance department who otherwise have no responsibility for initiating or processing purchase transactions should be responsible for signing the cheques or controlling the use of electronic signatures.

- Authorized cheque signers should determine that each cheque or bank transfer is accompanied by properly approved suppliers’ invoices, and that the name of the payee and amount on the payment agree with details on the invoice.

- The suppliers’ invoices and supporting documents should be cancelled to prevent resubmission for duplicate payment.

- The cheque signer should control the mailing of the cheques or initiation of the bank transfers to reduce the risk of theft or alterations.

- Where cheques are used, none should be made payable to “cash” or “bearer” and no blank cheques should be issued.

- Pre-numbered cheques should be used.

- Access to blank cheques and to electronic signatures should be limited to authorized personnel.

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Section Reference: 11.2 The process for purchase transactions CPA Competency: Audit and Assurance AACSB: Analytic

63. Identify and describe three key issues relevant to the audit of purchases, payables and payroll.

Answer: 1. That purchases are all recorded and are not understated: Recorded purchase transactions represent goods and services received during the period under audit, and the auditor needs to ensure that such purchases are properly recorded in the accounts. Purchases may be understated to inflate performance data.

2. The payables that are derived from the purchases are all fully recorded in the accounts as a liability: Purchase transactions relate to the purchase of goods and services. The auditor must ensure that the transactions in the purchases accounts are an accurate representation of activity during the period.

3. The payroll expense has been properly recorded and the associated deductions for income tax, pension, and related liabilities are properly recorded as liabilities.

Tests of controls over payroll are an important part of the audit process. Misstatement can occur due to errors or fraud. Of particular concern are overstatements due to fictitious payments, payments for hours not worked, and payments at higher than authorized rates.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for processing purchase, payment, and purchase adjustment transactions.

Section Reference: 11.2 The process for purchase transactions CPA Competency: Audit and Assurance AACSB: Analytic

64. Identify key controls that ought to be in place for the preparation and signing of cheques.

Answer: • Authorized finance department personnel, with no responsibility for initiating or processing purchase transactions, should be responsible for signing the cheques.

• Authorized cheque signers need to determine that each cheque is accompanied by a properly approved supplier's invoice, and the name of the payee and amount on the cheque agree with details on the invoice.

• The supplier's invoice and supporting documents should be stamped (or otherwise cancelled) with the date or the cheque number when the cheque is signed to prevent resubmission for the duplicate payment.

• The cheque signer should control the mailing of the cheques to reduce the risk of theft or alterations.

• No cheques should be made payable to 'cash' or 'bearer' and no blank cheques should be issued.

• Cheques should be pre-numbered.

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Blank cheques and signature plates should only be accessible to authorized personnel.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic 65. Following is a description of Out of Control corporations’ inventory purchases process for skateboard wheels. Identify the weaknesses in the controls and suggest possible improvements.

When stock falls below 100 the computer automatically produces a purchase requisition for more stock from the supplier. If there is a special promotion coming up, Tony, the marketing manager, might put in an extra purchase requisition for promotional stock. The computer numbers the dockets in sequence and sends them to the purchasing department.

The purchasing department issues a purchase order with their standard supplier when they receive an authorized purchase requisition. Tony used to work in purchasing, and is good friends with Mika who now manages the purchasing department. Tony sometimes covers a shift for Mika when he has a day off.

When the order arrives at the warehouse receiving dock, the purchase order is compared to the goods received: The personnel check that the right types of wheels are included, the right number of wheels is included, and that they are undamaged. They then prepare a prenumbered receiving report and forward it to accounting along with the supplier invoice.

Accounting then enters the amounts from the supplier invoices into the system.

Solution: Purchase requisitions: The authority to order promotional stock should be allocated to a specific manager in the warehouse division.

Purchase orders: Tony covering Mika’ shifts will cause a situation where there is no separation of requisitioning from ordering, leaving an opening for fraudulent orders.

Receiving dock: It would be a better control to have a special copy of the purchase order produced for the receiving personnel that does not include the number of wheels ordered.

This will ensure a more accurate count is performed.

The supplier should forward the suppliers’ invoice separately to accounting so that accounting can check them off against delivery counts. If they go through the dock there is an opportunity for fraud.

Checking and approving the suppliers’ invoice: the invoice is not checked, but just entered directly. Some checks may include: • serially numbering suppliers’ invoices on receipt.

• checking supplier invoices with the related receiving reports and purchase orders.

• determining the mathematical accuracy of the suppliers’ invoices • coding account distributions on the invoices.

• approving for payment, with an authorized individual’s signature.

• preparing daily prelist of suppliers’ invoices approved for payment.

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Recording the liability: the accounting software could be set up to do a lot of the checks in the previous point automatically; for example, by comparing invoices to orders and checking for valid suppliers.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic 66. What could motivate management to misstate expenditures? What other factors may lead to misstatements?

Answer: • They may understate expenses in order to falsely report the achievement of announced profitability targets or to match industry norms.

• They may understate payables in order to report a higher level of working capital in the face of liquidity problems or going-concern doubts.

Other factors may include: • A high volume of transactions, affecting all assertions.

• Temptations for employees to make unauthorized purchases and payments, or to misappropriate assets.

• Contentious accounting issues.

• The complexity of payroll calculations especially where bonuses and overtime come into play.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic 67. Identify the need for controls over hiring employees, authorising payroll changes, and preparing attendance and timekeeping data.

Solution: Hiring employees: controls are needed to prevent the creation of fictitious employees through which wages can be redirected to the perpetrator of the fraud.

Authorizing payroll changes: changes such as promotions and pay rate increases provide a fraud threat through the overpayment of wages.

Preparing attendance and timekeeping data: employees need to clock on and off in a way that ensures they are only paid for hours actually worked. The payroll may be prepared straight from this data.

Bloomcode: Application Difficulty: Medium

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Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

68. Explain the nature and use of an imprest payroll account.

Answer: It is an account that only has payroll transactions credited and debited to it. The account is funded with the net amount of pay and all pays are issued out of it. Any discrepancies will indicate that there are errors or deliberate falsifications somewhere in the process.

Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

69. Provide three relevant analytical procedures related to the audit of purchases, payments, and payroll.

Answer: -

days in accounts payable (payables/credit purchases x 365) gross margin analysis expected staff costs based on average pay rate and average number of staff

Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

70. Provide three inherent risks related to the audit of purchases, payables, and payroll.

Answer: -

pressures to understate expenses in order to falsely report the achievement of announced profitability targets or industry norms pressures to understate payables in order to report a higher level of working capital in the face of liquidity problems or going concern doubts temptations for employees to make unauthorized purchases and payments, or to misappropriate purchased assets contentious accounting issues such as whether a cost should be capitalized or expensed complexity of payroll calculations for factory workers whose gross earnings may be based on time and/or productivity, affecting the accuracy of payroll costs

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Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

71. Describe a preventative control for each of the WCGW (what can go wrong) provided in the table below.

WCGW Goods may be requisitioned for unauthorized purposes.

Purchases may be made for unauthorized purposes.

Goods received may not have been ordered.

Invoices may be recorded incorrectly or not recorded.

Invoices may be recorded for goods not ordered or received.

Preventative Control

Answer: WCGW Goods may be requisitioned for unauthorized purposes.

Purchases may be made for unauthorized purposes.

Goods received may not have been ordered.

Invoices may be recorded incorrectly or not recorded.

Invoices may be recorded for goods not ordered or received.

Preventative Control General and specific authorization procedures.

Approved purchase requisition for each order.

Approved purchase order for each shipment.

Periodic accounting for pre-numbered receiving reports and purchase orders.

Matching of purchase order and receiving report with the supplier’s invoice.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.3 The process for payroll transactions Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

72. Describe a preventative control for each of the WCGW (what can go wrong) provided in the table below.

WCGW

Preventative Control

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A cheque may not be recorded.

Errors may be made in recording a cheque.

A cheque may be altered after being signed.

Cheques may not be recorded promptly.

Cheques may be issued for unauthorized purchases.

Answer: WCGW A cheque may not be recorded.

Errors may be made in recording a cheque.

A cheque may be altered after being signed.

Cheques may not be recorded promptly.

Cheques may be issued for unauthorized purchases.

Preventative Control Use of, and accounting for, pre-numbered cheques.

Independent check of agreement of amounts journalized and posted with the cheque register.

Cheque signers to mail cheques.

Independent check of dates on cheques with dates recorded.

Cheque signers to review supporting documentation for completeness and approval.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Learning Objective: Discuss considerations relevant to determining the audit strategy for purchases, payables, and payroll.

Section Reference: 11.3 The process for payroll transactions Section Reference: 11.4 Audit strategy CPA Competency: Audit and Assurance AACSB: Analytic

73. With regards to control risk assessment for purchase transactions, align the potential misstatements in the following chart with their possible tests of operating effectiveness.

Potential Misstatement Goods may be requisitioned for unauthorized purposes.

Purchases may be made for unauthorized purposes.

Goods received may not have been ordered.

Stores clerks may deny taking custody of purchased goods.

Possible Tests of Operating Effectiveness Inspect signed inventory receipts.

Examine supporting documentation for invoices.

Examine receiving report for matching purchase order.

Examine purchase orders for approved requisitions.

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Invoices may be recorded for goods not ordered.

Invoices may be recorded incorrectly or not recorded.

Answer: Potential Misstatement Goods may be requisitioned for unauthorized purposes.

Purchases may be made for unauthorized purposes.

Goods received may not have been ordered.

Stores clerks may deny taking custody of purchased goods.

Invoices may be recorded for goods not ordered.

Invoices may be recorded incorrectly or not recorded.

Examine evidence of independent check, or re-perform independent check.

Inquire about procedures.

Possible Tests of Operating Effectiveness Inquire about procedures.

Examine purchase orders for approved requisitions.

Examine receiving report for matching purchase order.

Inspect signed inventory receipts.

Examine supporting documentation for invoices.

Examine evidence of independent check, or re-perform independent check.

Bloomcode: Application Difficulty: Medium Learning Objective: Indicate the factors relevant to determining an acceptable level of detection risk for the audit of purchases, payables, and payroll.

Section Reference: 11.5 Determining an acceptable level of detection risk CPA Competency: Audit and Assurance AACSB: Analytic

74. List three tests of details of balances for accounts payable and two tests for payroll balances.

Answer: Accounts Payable • Reconciling accounts payable to monthly statements received by the entity from suppliers.

• Confirming accounts payable.

• Searching for unrecorded liabilities.

Payroll Balances • Recalculating payroll liabilities.

• Verifying directors' and executive officers' remuneration.

Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

75.

1. On what basis are the tests of details of balances planned?

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2. What are the stages in applying analytical procedures to payables?

Answer: 1. They are planned on the basis that the analytical procedures confirm expectations.

2. The first stage is to review the understanding of the entity obtained during the planning phase as to whether any changes to payables balances are to be expected. The second stage is to identify absolute changes in amounts between the current year and previous years. The third stage involves the use of more sophisticated relationships such as ratios and trends.

Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic 76. Why are directors’ and executive officers’ remuneration considered to be audit sensitive?

What procedure could be used to check directors’ and executive officers’ remuneration?

Answer: Directors’ and executive officers’ remuneration is audit sensitive because all companies under the corporations act must disclose it in the financial statements. Also, directors and executive officers may be able to override controls, due to their position of power, and alter their payments.

For these reasons, the auditor compares the authorizations for directors’ and executive officers’ compensation with recorded amounts paid.

Reference: Section 15.6 Substantive procedures Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for purchases, payables, and payroll.

Section Reference: 11.6 Designing substantive procedures CPA Competency: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 77. Describe the audit process for purchase transactions. Indicate the audit risks that need to be addressed and the mitigating controls that can be implemented.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for processing purchase, payment, and purchase adjustment transactions.

Section Reference: 11.2 The process for purchase transactions CPA Competency: Audit and Assurance AACSB: Analytic

78. Describe the audit process for payroll transactions. Indicate the audit risks that need to be addressed and the mitigating controls that can be implemented.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found in information systems for payroll transactions.

Section Reference: 11.3 The process for payroll transactions CPA Competency: Audit and Assurance AACSB: Analytic

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LEGAL NOTICE Copyright © 2021 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under license and may be used only in accordance with the terms of such license.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 12 AUDITING INVENTORIES AND PROPERTY, PLANT, AND EQUIPMENT CHAPTER LEARNING OBJECTIVES 1. Identify the audit objectives applicable to inventories.

The key issues in auditing inventory are usually to ensure the inventories actually exist, are owned, and are properly valued. The auditor’s objective is to gather sufficient and appropriate evidence about each key assertion.

2. Describe the functions and control procedures normally found for the custody of inventory and maintenance of inventory records.

The key control over the maintenance of inventory is the segregation of duties. The duty of recording inventory movements should be segregated from the physical custody of inventory as goods move in and out of inventory and are transferred between areas.

A key control over the custody of the inventory is the performance of the cyclical and annual inventory counts. Inventory counts are the responsibility of management and they should be well planned to ensure count results are reliable. A comparison of the count results to the accounting records indicates whether the controls over inventory are effective.

3. Discuss considerations relevant to determining the audit strategy for inventories.

Inventories and cost of sales are usually significant to most entities’ financial position and the results of their operations. The main inherent risks for inventory are the existence or occurrence assertion and the accuracy, valuation and allocation assertions. Numerous factors contribute to the inherent risk of misstatements, including the high volume of transactions, contentious valuation issues, and the high risk of theft and obsolescence.

Assessment of control risk is important where the entity does not plan to perform an inventory count at year end and for the cost of inventory for manufacturing entities. If test counts do not support an assessment of control risk as low, or if it is not an efficient audit strategy, the auditor will adopt a substantive audit strategy.

4. Design a substantive audit program for inventory.

Except where perpetual records are used as the basis for determining inventory at the end of the reporting period, and for costing records in manufacturing entities, the audit for inventories is based mainly on substantive procedures applied to the account balance at the end of the reporting period.

The emphasis is on the assertions of existence and valuation, because the inherent risk of their misstatement is always high. In verifying the existence of inventories, the auditor relies on physical inspection, whether through observation of cyclical counts verifying perpetual inventory records or through attendance at annual inventory counts. For valuation, the auditor verifies the cost of inventory against invoice prices or costing records.

The auditor also needs to ensure that the accounting basis adopted complies with applicable accounting standards and that required disclosures are properly made in the financial statements.

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5. Identify the audit objectives applicable to property, plant, and equipment.

The key issues in auditing property, plant, and equipment are usually to gather sufficient and appropriate evidence as to the existence of the assets as well as whether the assets are owned and are properly valued with adequate provision for depreciation. Furthermore, a key focus in the audit of property, plant, and equipment relates to the purchasing of new assets and disposing of old assets, including any profits or losses on sale. In addition, consideration is required in relation to depreciation charges, the treatment of leased assets, and asset revaluations.

6. Discuss considerations relevant to determining the audit strategy for property, plant, and equipment.

There may be significant variations in the inherent risk assessments for assertions relating to different property, plant, and equipment accounts and the type of industry. For example, inherent risk for the existence assertion may be low in a merchandising entity because the plant and equipment are not normally vulnerable to theft.

Because transactions relating to property, plant, and equipment are few and usually individually material, assessment of control risk relating to these transactions is rarely necessary.

7. Design a substantive audit program for property, plant, and equipment.

In verifying property, plant, and equipment, the auditor relies on verifying changes in the recorded balance, including an inspection of additions. The auditor rarely inspects assets making up the balance, reflecting the incidence of transactions that are frequent for inventories, being a current asset, but infrequent for property, plant, and equipment.

Accuracy and valuation is determined by the application of accounting procedures involving a high degree of judgement. For property, plant, and equipment, this involves estimating useful economic lives, residual value, and the basis of depreciation. The auditor needs to determine the appropriateness of the judgements made and the accuracy of the resulting calculations. The auditor also needs to ensure that the accounting basis adopted complies with applicable accounting standards and that required disclosures are properly made in the financial statements.

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TRUE-FALSE STATEMENTS 1. The key issue in auditing inventories is to ensure the inventories actually exist, are owned, and are properly valued.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to inventories.

Section Reference: 12.1 Audit objectives: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

2. Ensuring that inventory transactions are recorded in the correct accounts is an example of the completeness assertion.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to inventories.

Section Reference: 12.1 Audit objectives: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

3. All companies are required by Canadian Auditing Standards to maintain a perpetual inventory system.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found for the custody of inventory and maintenance of inventory records.

Section Reference: 12.2 Custody of inventory and maintenance of inventory records CPA Competency: Auditing and Assurance AACSB: Analytic

4. Perpetual inventory records need to be compared with actual inventory at regular intervals.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found for the custody of inventory and maintenance of inventory records.

Section Reference: 12.2 Custody of inventory and maintenance of inventory records CPA Competency: Auditing and Assurance AACSB: Analytic Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Auditing: A Practical Approach, Fourth Canadian Edition

5. Specialized inventories may require the assistance of experts in determining either the quantity (as in the case of aerial measurement of stockpiles) or value (as in the case of antiques).

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for inventories.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

6. Close to the end of the reporting period, the auditor needs to consider the extent of test counts relative to total inventory and needs to review the recorded differences between test counts and inventory records over the year as well as the explanations of those differences.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for inventories.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

7. In tracing opening inventory balances to working papers for the previous year, the auditor should make certain that any audit adjustments, agreed on in the previous year, were recorded.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

8. The application of analytical procedures to inventories is not used very extensively since each company has its own inventory policies and procedures which make industry comparison somewhat useless.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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CPA Competency: Auditing and Assurance AACSB: Analytic

9. The key issues in auditing property, plant, and equipment are ensuring that the property, plant, and equipment actually exist, are owned, and are properly valued with adequate provision for depreciation.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to property, plant, and equipment.

Section Reference: 12.5 Audit objectives: property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

10. Ensuring that additions and disposals of property, plant, and equipment before the period end are recorded in the current period and those after the period end are included in the next accounting period is an example of the classification assertion.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to property, plant, and equipment.

Section Reference: 12.5 Audit objectives: property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

11. The transactions relating to property, plant, and equipment are quite often few and each usually material.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for property, plant, and equipment.

Section Reference: 12.6 Audit strategy CPA Competency: Auditing and Assurance AACSB: Analytic

12. A capital asset sub-ledger details individual items of plant and equipment and records the cost of each asset and of any additions or alterations, and the accumulated depreciation charged against it.

Answer: True Bloomcode: Comprehension Difficulty: Easy

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Learning Objective: Discuss considerations relevant to determining the audit strategy for property, plant, and equipment.

Section Reference: 12.6 Audit strategy CPA Competency: Auditing and Assurance AACSB: Analytic

13. With respect to property, plant, and equipment, in the first audit engagement, evidence must be obtained as to the fairness of the opening balances and the ownership of the assets making up the balances, whereas in a recurring engagement, the auditor concentrates on the current year’s transactions.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

14. As existence of property, plant, and equipment is the key audit assertion, the auditor does not need to obtain evidence of sales, disposals, and trade-ins.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 15. If the auditor was testing inventory pricing the audit objective being fulfilled would be a) completeness. b) rights and obligations. c) existence. d) accuracy, valuation, and allocation.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to inventories.

Section Reference: 12.1 Audit objectives: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

16. Reviewing data pertaining to inventory quality relates primarily to the a) occurrence assertion. b) completeness assertion. c) rights and obligations assertion. d) accuracy, valuation, and allocation assertion Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to inventories.

Section Reference: 12.1 Audit objectives: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

17. Inventories received before the period end are recorded as current purchases and those received after the period end are included in the next period. What assertion is being described? a) cut-off b) checking c) counting d) preparation Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to inventories.

Section Reference: 12.1 Audit objectives: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

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18. Which of the following is not a function of maintaining inventory records? a) physically comparing inventory with inventory records b) recording the movement of goods into inventory c) ordering goods d) recording the movement of goods from inventory Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found for the custody of inventory and maintenance of inventory records.

Section Reference: 12.2 Custody of inventory and maintenance of inventory records CPA Competency: Auditing and Assurance AACSB: Analytic

19. An important procedure for the conduct of a physical inventory count is to maintain control over the count systems. Which of the following is not a common count system? a) use of pre-printed inventory count sheets b) use of blank inventory tags c) use of blank, pre-numbered inventory count sheets d) use of pre-numbered, three-part inventory tags Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found for the custody of inventory and maintenance of inventory records.

Section Reference: 12.2 Custody of inventory and maintenance of inventory records CPA Competency: Auditing and Assurance AACSB: Analytic

20. When costing manufactured inventory all of the following procedures are necessary except a) determining the cost of materials entered into raw materials. b) determining the cost of raw materials transferred to work in process. c) recording costs of direct labour applied to work in process. d) determine the cost of purchases.

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found for the custody of inventory and maintenance of inventory records.

Section Reference: 12.2 Custody of inventory and maintenance of inventory records CPA Competency: Auditing and Assurance AACSB: Analytic

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21. Cyclical inventory counts differ from full inventory counts in which way? a) cyclical inventory counts are performed at the balance sheet date b) cyclical inventory counts are only performed by internal audit c) cyclical inventory counts may involve counting only a portion of inventory items d) They differ in all of the above ways.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the functions and control procedures normally found for the custody of inventory and maintenance of inventory records.

Section Reference: 12.2 Custody of inventory and maintenance of inventory records CPA Competency: Auditing and Assurance AACSB: Analytic

22. ABC Ltd. is a retailer who is planning to undertake a full inventory count at year end.

Control risk over inventory records for this entity is deemed to be a) important due to the timing of the inventory count. b) important due to the nature of the business. c) unimportant due to the timing of the inventory count. d) none of the above Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found for the custody of inventory and maintenance of inventory records.

Section Reference: 12.2 Custody of inventory and maintenance of inventory records CPA Competency: Auditing and Assurance AACSB: Analytic

23. Which of these factors contributes least to the risk of misstatement of inventories? a) the volume of transactions b) location at a large single site c) vulnerability to spoilage or damage d) unusual items requiring geometric volume measurement.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for inventories.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

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24. The audit strategy that would be the most appropriate when an auditor has decided on a predominantly substantive approach is to determine inventory quantity by a) physical count at or within a few days of balance sheet date. b) physical count near balance sheet date, adjusted by reference to perpetual records. c) reference to perpetual records, without a physical count at or near balance sheet date. d) none of the above Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for inventories.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

25. Observation of inventory counts is a required audit procedure whenever a) inventories are material. b) it is practicable to do so. c) inventories are material and it is practicable to do so. d) inventories are material and the auditor considers it to be necessary.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for inventories.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

26. During the observation of the inventory count, the auditor has no responsibility to a) watch for damaged and obsolete inventory items. b) make some test counts of inventory quantities. c) supervise the taking of the inventory. d) record cut-off data.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for inventories.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

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27. When the client engages an inventory specialist to take the inventory, the impact on the audit in this area is a) to eliminate the need to perform test counts. b) to eliminate the need to observe the inventory. c) minimal because the specialists are considered independent auditors. d) minimal because the specialists are considered audit employees.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for inventories.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic 28. In companies where inventories are at multiple locations, the auditor’s observations ordinarily should include a) all inventory locations. b) a variation of locations attended each year. c) a five minute visit to each location. d) all significant inventory locations.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for inventories.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic 29. The auditor’s strategy in performing test counts during the inventory observation is to a) test all large-dollar items. b) randomly select all test items. c) concentrate tests on high dollar items with random selection of other items. d) concentrate tests in areas where employees seem to be disregarding the inventory instructions.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for inventories.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

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30. Confirmation of inventories in public warehouses cannot provide evidence concerning the a) existence assertion. b) completeness assertion. c) accuracy, valuation, and allocation assertion. d) it cannot provide evidence concerning any of the listed assertions.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

31. Ensuring inventories include all materials, products, and supplies on hand at the end of the reporting period derives from the audit assertion of a) completeness. b) accuracy, valuation, and allocation. c) existence. d) rights and obligations.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

32. The action that is not part of verifying the valuation of inventory is a) observing the inventory count. b) determining which items need to be written down in price. c) checking the cost of inventory. d) All of the above are part of verifying the value of inventory.

Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

33. Which statement is most correct?

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a) In observing physical inventory, the auditor has a responsibility to both take and supervise the taking of inventory. b) In observing physical inventory, the auditor has no responsibility to take or supervise the taking of inventory. c) In observing physical inventory, the auditor is only responsible for supervising the taking of inventory. d) In observing physical inventory, the auditor is responsible for the taking of inventory.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

34. The timing of a physical count of inventory is negotiated between the auditor and management. If the assessed level of control risk is high, an auditor would probably a) insist that the entity performs physical counts of inventory several times during the year. b) apply gross profit tests to ascertain the reasonableness of the physical counts. c) increase the extent of tests of control of the inventory cycle. d) request the entity to schedule the physical count at the end of the year.

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

35. In the event that the audit client has multiple locations and the auditor is not able to be present at all of them on the date of the physical inventory count, the auditor can rely a) totally on the internal auditor to observe the physical inventory count. b) on the internal auditor subject to the requirements of CAS 610. c) totally on the records prepared as part of the client periodic inventory system. d) none of the above Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

36. Verifying the accuracy and valuation assertion for inventory involves which of the following? a) verifying the cost of inventory b) verifying the net realizable value of inventory c) verifying the basis used by management in determining the value of each item of inventory d) all of the above Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

37. Which of these procedures would not be appropriate for an auditor in discharging his or her responsibilities concerning the entity’s physical inventories, assuming that the inventory is held at one location? a) obtaining written representation from the entity as to the existence, quality, and dollar amount of the inventory b) relying on the internal auditor to observe the total inventory count c) confirming the goods in the hands of public warehouses d) observing cut-off procedures are being performed Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

38. What should an auditor do to ensure that inventory is stated at the lower of cost and net realizable value? a) select a sample of inventory purchases made during the year and check the associated invoice to ensure they are not recorded at more than that value b) review and test the process used by management, use an independent estimate, and review subsequent events c) ensure that all inventory items on hand at year end have been properly recorded at cost when purchased. d) ensure that inventory that is not saleable is disclosed separately in the financial report Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for inventory.

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Auditing Inventories and Property, Plant, and Equipment

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CPA Competency: Auditing and Assurance AACSB: Analytic

39. Which of these would not cause the net realizable value of inventory to be below its cost? a) a rise in the selling price b) physical deterioration c) a decision to sell at a loss d) obsolescence.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

40. Goods held on consignment are a) goods held at locations outside the entity. b) goods held by the firm but belonging to customers. c) goods sent to an entity by the seller where the seller is only paid when the goods are sold. d) goods pledged as security for a loan.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

41. The application of analytical procedures to the audit of inventories is often a) not very useful. b) the only procedure necessary. c) a requirement of the standards. d) used extensively.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

42. Matters that should be considered by the auditor before reaching a conclusion about the reliability of an inventory count include all of the following except a) the type of accounting package used by the firm. b) the general condition of the inventory. c) departures from the entity’s inventory count. d) All of the above should be considered.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

43. Which of the following is not an income statement account related to property, plant, and equipment? a) depreciation b) accumulated depreciation c) loss on disposal of plant d) rent on operating leases Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the audit objectives applicable to property, plant, and equipment.

Section Reference: 12.5 Audit objectives: property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic 44. The auditor identifies the specific audit objective: “determine that property, plant and equipment (PPE) assets represent productive assets that are in use at balance sheet date”.

This objective is derived from the a) existence assertion. b) completeness assertion. c) presentation assertion. d) rights and obligations assertion.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to property, plant, and equipment.

Section Reference: 12.5 Audit objectives: property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

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45. The statement about inherent risk assessments for property, plant, and equipment that is inaccurate is a) inherent risk is normally low for the classification and presentation assertions for PPE assets acquired under finance leases. b) inherent risk is normally low for the existence assertion in a merchandising entity because PPE assets are not generally vulnerable to theft. c) inherent risk is normally moderate to high for the existence assertion in a manufacturing entity because scrapped or retired PPE assets may not be written off the books. d) inherent risk is normally low for the accuracy, valuation, and allocation assertion when PPE assets are purchased for cash.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to property, plant, and equipment.

Section Reference: 12.5 Audit objectives: property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

46. In the audit of property, plant, and equipment, the principal accuracy and valuation assertion is that a) they should be stated at cost or a valuation less accumulated depreciation. b) the entity has rights to all recorded property, plant, and equipment. c) all additions that have occurred during the period have been recorded. d) both a and c Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to property, plant, and equipment.

Section Reference: 12.5 Audit objectives: property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

47. The statement about audit strategy for property, plant, and equipment that is inaccurate is a) for depreciation and accumulated depreciation inherent risk is affected by the difficulty in estimating both useful lives and residual value. b) although material, verification of PPE typically involves significantly less time and cost than verification of current assets. c) unlike current asset accounts, control risk assessments for PPE asset balances are less dependent on controls over major transaction classes. d) None of the above statements is inaccurate.

Answer: d Bloomcode: Comprehension Difficulty: Easy

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Auditing: A Practical Approach, Fourth Canadian Edition

Learning Objective: Identify the audit objectives applicable to property, plant, and equipment.

Section Reference: 12.5 Audit objectives: property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

48. Entities frequently maintain a capital asset register as a subsidiary ledger detailing individual items of PPE. Which of the following would an auditor not expect to find in a capital asset register? a) cost and accumulated depreciation b) the date of previous audit inspections c) serial number and supplier d) insurance cover Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for property, plant, and equipment.

Section Reference: 12.6 Audit strategy CPA Competency: Auditing and Assurance AACSB: Analytic

49. When equipment items are purchased for cash a) the inherent risk in the accuracy, valuation, and allocation assertions are not affected. b) the inherent risk in the existence and occurrence and allocation assertions is high. c) the inherent risk in the accuracy, valuation, and allocation assertions objectivity is low. d) the inherent risk in the accuracy, valuation, and allocation assertions is zero.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for property, plant, and equipment.

Section Reference: 12.6 Audit strategy CPA Competency: Auditing and Assurance AACSB: Analytic

50. In auditing property, plant, and equipment (PPE), why might the auditor decide to assess control risk at the maximum and perform predominantly substantive testing? a) The number of additions to/disposals of PPE is usually not a material number. Therefore, it is not of concern to the auditor. b) PPE in total is material. All material balances should be tested using a substantive approach. c) The controls over PPE for most companies are usually poor. d) Because transactions relating to property, plant, and equipment are few and usually individually material, assessment of control risk relating to these transactions is usually assumed to be the maximum.

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Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for property, plant, and equipment.

Section Reference: 12.6 Audit strategy CPA Competency: Auditing and Assurance AACSB: Analytic

51. Which of these is not true regarding substantive procedures for property, plant, and equipment in an initial audit a) the auditor concentrates on the current year’s transactions only. b) evidence must be obtained as to the fairness of the opening balances. c) evidence must be obtained as to the ownership of the assets. d) All of the above are untrue.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

52. When the auditor receives the client-prepared schedules for property, plant, and equipment assets, in order to determine that they booked the adjustments proposed by the auditor at the conclusion of the prior audit, the auditor should a) inquire of management. b) examine the general journal for the first month of the current year. c) inquire of accounting personnel. d) compare beginning balances with prior year's working papers.

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

53. Analytical procedures are not widely used in the audit of property, plant, and equipment.

Which of the following is not a valid comment about the use of analytical procedures in the audit of PPE?

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Auditing: A Practical Approach, Fourth Canadian Edition

a) compare the annual depreciation charge with the cost of an asset to approximate the depreciation rate b) a substantial asset balance variation can be caused by one or a few transactions of which the auditor is likely to already be aware c) comparison of repairs expense with prior years may indicate capitalization in error d) None of the above is invalid.

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

54. When substantiating disposals of property, plant, and equipment, the auditor should be able to find evidence using all of the following except a) cash remittance advices. b) written authorizations. c) supplier invoices. d) sales agreements.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

55. The auditor is least likely to discover unrecorded retirements of property, plant, and equipment assets by a) analyzing the miscellaneous revenue account. b) investigating the disposition of facilities associated with discontinued product lines. c) selecting retirement work orders from the accounting records and verifying their accuracy. d) reviewing insurance policies for termination or reductions of coverage.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

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56. Substantiating asset disposals with supporting documentation is a test of details of transactions. Which assertion is most likely satisfied? a) existence b) completeness c) accuracy, valuation, and allocation d) all of the above Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

57. The auditor is concerned that the client has committed a number of errors in the capital/repair expenditures distinction. In selecting items from the repairs expense account for investigation, the most appropriate audit procedure would involve a) random selection. b) systematic selection. c) tracing. d) scanning.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

58. In a typical audit, verification of the ownership of plant and equipment is least likely to involve examination of a) the physical characteristics of the items. b) “paid invoices”. c) registration certificates. d) property tax bills.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance

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Auditing: A Practical Approach, Fourth Canadian Edition

AACSB: Analytic

59. When reviewing accumulated depreciation, the auditor seeks evidence as to the reasonableness, consistency, and accuracy of depreciation charges. The substantive procedures performed seek to provide evidence for which assertion? a) accuracy and valuation b) completeness c) rights and obligations d) presentation Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

60. When an asset is shown on the financial statements other than at cost, which of the following is not required to be disclosed? a) the evidence gathered to support the valuation b) the year and basis of valuation c) whether it is an internal or independent valuation d) the name of the valuer Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

61. Evidence concerning the pledging of property, plant, and equipment assets is likely to be obtained through a) review of the board minutes. b) confirmation of debt agreements. c) inquiries of management. d) all of the above Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design a substantive audit program for property, plant, and equipment.

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Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

SHORT ANSWER QUESTIONS 62. Identify the appropriate account balance audit objectives applicable to inventories for the assertion categories of: • existence • completeness • rights and obligations • accuracy, valuation, and allocation • presentation.

Answer: • existence – inventories included in the balance sheet physically exist.

• completeness – inventories include all materials, products and supplies on hand at balance sheet date.

• rights and obligations – the entity has rights to the inventories included in the balance sheet.

• accuracy, valuation, and allocation – inventories are properly stated at the lower of cost and net realizable value, determined in accordance with applicable accounting standards.

• presentation– disclosures relating to the classification, basis of valuation, and the pledging of inventories are adequate, relevant, and understandable.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to inventories.

Section Reference: 12.1 Audit objectives: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

63. Identify the assertion relating to classes of transactions that corresponds with the following descriptions.

1.

2.

3.

4.

5.

Inventory transactions are recorded in the correct accounts.

Recorded sale transactions represent inventories sold during the period.

All inventory receipts during the period have been recorded as purchases.

Inventory transactions are accurately recorded.

Inventories received before the period end are recorded as purchases in the current period and those received after the period end are included in the next accounting period.

6. Purchase and inventory transactions and events are appropriately aggregated and disaggregated, clearly described, and the related disclosures are relevant and understandable.

Answer:

Assertion Classification Occurrence Completeness

Audit Objective Inventory transactions are recorded in the correct accounts.

Recorded sale transactions represent inventories sold during the period.

All inventory receipts during the period have been recorded as purchases.

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Auditing Inventories and Property, Plant, and Equipment

Accuracy

Inventory transactions are accurately recorded.

Cut-off

Inventories received before the period end are recorded as purchases in the current period and those received after the period end are included in the next accounting period.

Purchase and inventory transactions and events are appropriately aggregated and disaggregated, clearly described, and the related disclosures are relevant and understandable.

Presentation

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Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to inventories Section Reference: 12.1 Audit objectives CPA Competency: Auditing and Assurance AACSB: Analytic

64. Identify the assertion relating to account balances that corresponds with the following descriptions.

1. Inventories recorded represent items on hand at the end of the reporting period.

2. The entity has rights to the inventories included in the balance sheet.

3. Inventories include all materials, products, and supplies on hand at the end of the reporting period.

4. Inventories are properly identified and classified in the financial statements.

5. All inventory disclosures that should have been included in the financial statements have been included.

6. Inventories are appropriately aggregated or disaggregated, clearly described, and the related disclosures are relevant and understandable.

Answer:

Assertion Existence Rights and obligations Completeness Classification Completeness Presentation

Audit Objective Inventories recorded represent items on hand at the end of the reporting period.

The entity has rights to the inventories included in the balance sheet.

Inventories include all materials, products, and supplies on hand at the end of the reporting period.

Inventories are properly identified and classified in the financial statements.

All inventory disclosures that should have been included in the financial statements have been included.

Inventories are appropriately aggregated or disaggregated, clearly described, and the related disclosures are relevant and understandable.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to inventories Section Reference: 12.1 Audit objectives CPA Competency: Auditing and Assurance AACSB: Analytic Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Auditing: A Practical Approach, Fourth Canadian Edition

65. List the procedures that should be adopted in a physical inventory count.

Answer: • Assigning and communicating responsibility for the count.

• Preparation of the area to be counted, including cut-off procedures.

• Clear identification of the inventory to be counted.

• Procedures for the actual count, ideally conducted in pairs.

• Checking procedures for the accuracy of the count.

• Progressive clearing of counted areas by a supervisor.

• Recording the inventory count tags onto the inventory count sheets.

• Follow-up of cut-off procedures to ensure accurate count.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found for the custody of inventory and maintenance of inventory records.

Section Reference: 12.2 Custody of inventory and maintenance of inventory records CPA Competency: Auditing and Assurance AACSB: Analytic

66. List the four separate functions of maintaining inventory records.

Identify the documentation used in each function to prevent inventory records from being manipulated.

Answer: Recording the movement of goods into inventory: receipt of goods is acknowledged by the warehouse person initialling a copy of the receiving report which then provides the source for the inventory record of the cost and quantity.

Movement of goods from inventory: a dispatch note is used to authorize the release of goods from inventory and this movement is recorded on the inventory record.

Transfers of inventory: In manufacturing entities, inventory transfer requisitions control the movement from raw materials through work in process and to finished goods. Retailing entities use similar procedures for transferring inventory.

Physical comparison of inventory with inventory records: count sheets are used to record the physical count of inventory during a stock taking.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found for the custody of inventory and maintenance of inventory records.

Section Reference: 12.2 Custody of inventory and maintenance of inventory records CPA Competency: Auditing and Assurance AACSB: Analytic

67. Describe a substantive procedure relating to observing a physical inventory count.

Answer:

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Substantive procedure relating to observing a physical inventory count include the following: - Evaluate the adequacy of the entity’s inventory-taking plans.

- Review industry experience and trends.

- Recalculate totals and extensions of quantities times unit prices.

- Observe physical inventory count and test compliance with prescribed procedures.

- Compare physical counts with perpetual inventory records.

- Make test counts.

- Look for indications of slow-moving, damaged, or obsolete inventory.

- Account for all inventory tags and count sheets used in the physical count.

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the functions and control procedures normally found for the custody of inventory and maintenance of inventory records Section Reference: 12.2 Custody of Inventory and Maintenance of Inventory Records CPA Competency: Auditing and Assurance AACSB: Analytic

68. What are the three audit strategy options that an auditor has for verifying the existence (and completeness) of inventories and what is the implication of each strategy for control risk?

Answer: 1. Determine inventory quantity by perpetual inventory records where the entity does not intend to count inventory at or close to balance sheet date. This audit strategy requires assessing control risk over inventory records as being low.

2. Determine inventory quantities by a physical count at or near reporting date, adjusted to balance sheet quantities by reference to perpetual inventory records. This strategy requires assessing control risk over inventory records, or of purchases and sales, as being less than high.

3. Determine inventory quantities by a physical count at or within a few days of reporting date. This is a predominantly substantive approach in which the auditor does not test control over inventory records, which may not even exist. As such, control risk is considered to be unimportant.

Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for inventories.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

69. For each of the following potential misstatements for inventories, identify a necessary control: 1.

2.

3.

4.

5.

Failure to record goods received Unreliable count procedures during a physical inventory count Inappropriate basis for determining inventory costs Unauthorized removal of goods from inventory Insufficient extent of comparison between physical inventory count and inventory records

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Auditing: A Practical Approach, Fourth Canadian Edition

6. Inadequate investigation and correction of differences between inventory count and inventory records Answer: 1. Failure to record goods received - Use of prenumbered receiving reports and inventory transfer requisitions - Independent reconciliation of inventory records with control account in general ledger 2. Unreliable count procedures during a physical inventory count - Responsibility independent from maintenance of inventory records and custodianship of inventory - Adequate instructions properly issued and carried out 3. Inappropriate basis for determining inventory costs - Basis must be approved by finance director 4. Unauthorized removal of goods from inventory - Custodian required to acknowledge responsibility for receipt of goods into store - Custodian required to obtain receipt for all deliveries from store - Physical comparison of inventory with inventory records 5. Insufficient extent of comparison between physical inventory count and inventory records - Prescribed procedures for systematic counts 6. Inadequate investigation and correction of differences between inventory count and inventory records - Maintain a proper record of all differences and their corrections Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for inventories.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

70. Describe a preventative control for each of the WCGW (what can go wrong) provided in the table below.

WCGW Failure to record goods.

Unauthorized removal of goods.

Unreliable count procedures.

Inadequate investigation and correction of inventory errors.

Insufficient extent of physical comparison of inventory with inventory records.

Preventative Control

Answer: WCGW Failure to record goods.

Unauthorized removal of goods.

Unreliable count procedures.

Inadequate investigation and correction of

Preventative Control Independent reconciliation of inventory records with control account in general ledger.

Physical comparison of inventory with inventory records.

Adequate instructions properly issued and followed.

Proper record maintained of differences and

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Auditing Inventories and Property, Plant, and Equipment

inventory errors.

Insufficient extent of physical comparison of inventory with inventory records.

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their correction.

Prescribed procedures for systematic counts.

Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for inventory.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

71. There are numerous factors that contribute to the risk of misstatement in the assertions for inventories and cost of sales. List four of these factors.

Answer: Any four of the following: • The volume of purchase, manufacturing, and sale transactions that affect these accounts is generally high, increasing the opportunities for misstatements to occur.

• There are often contentious valuation and allocation issues such as: - the identification, measurement, and allocation of indirect materials, labour, and manufacturing overhead - joint product costs - the disposition of cost variances - accounting for scrap and wastage • Special procedures are sometimes required to determine inventory quantity or value.

• Inventories are often stored at multiple sites, leading to difficulties in maintaining physical control over theft and damage, and in accounting for goods in transit between sites.

• Inventories are vulnerable to spoilage, obsolescence, and general economic conditions that may affect demand and saleability, and thus their valuation.

Inventories may be returned.

Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for inventory.

Section Reference: 12.4 Substantive procedures for inventories CPA Competency: Auditing and Assurance AACSB: Analytic

72. From the list of substantive procedures provided below, classify each as either a procedure relating to inventory or a procedure relating to property, plant, and equipment.

List of substantive procedures: 1. Trace opening balances for plant assets and related accumulated depreciation accounts to and from the previous year’s working papers.

2. Review activity in the general ledger, accumulated depreciation, and depreciation expense accounts, and investigate entries that appear unusual in amount or source.

3. Compare asset additions and disposals with supporting documentation.

4. Review depreciation expense.

5. Trace opening inventory balances to the previous year’s working papers.

6. Test the cut-off of purchases, inventory transfers, and sales.

7. Review activity in inventory accounts and investigate entries that appear unusual in amount or source.

8. Look for indications of slow-moving, damaged, or obsolete inventory.

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Auditing: A Practical Approach, Fourth Canadian Edition

Answer: Inventory Trace opening inventory balances to the previous year’s working papers.

Test the cut-off of purchases, inventory transfers, and sales.

Review activity in inventory accounts and investigate entries that appear unusual in amount or source.

Look for indications of slow-moving, damaged, or obsolete inventory.

Property, Plant, and Equipment Trace opening balances for plant assets and related accumulated depreciation accounts to and from the previous year’s working papers.

Review activity in the general ledger, accumulated depreciation, and depreciation expense accounts, and investigate entries that appear unusual in amount or source.

Compare asset additions and disposals with supporting documentation.

Review depreciation expense.

Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for inventory Learning Objective: Design a substantive audit program for property, plant, and equipment Section Reference: 12.4 Substantive procedures for inventories Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

73. Identify the assertion relating to classes of transactions that corresponds with the following descriptions.

1. Recorded additions represent property, plant, and equipment acquired during the period under audit.

2. All additions that occurred during the period have been recorded.

3. Additions are correctly journalized and posted.

4. Additions and disposals of property, plant, and equipment before the period end are recorded in the current period and those after the period end are included in the next accounting period.

5. Recorded disposals represent property, plant, and equipment sold or scrapped during the period under audit.

6. Additions and disposals of property, plant, and equipment are recorded in the correct accounts.

7. Property, plant, and equipment transactions and events are appropriately aggregated or disaggregated, clearly described, and the related disclosures are relevant and understandable.

8. Disclosed property, plant, and equipment transactions have occurred and pertain to the entity.

9. Property, plant, and equipment transactions are disclosed accurately and at appropriate amounts.

10. All disposals that occurred during the period have been recorded.

Answer:

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Auditing Inventories and Property, Plant, and Equipment

Assertion Occurrence Completeness Accuracy Cut-off

Occurrence Classification Presentation

Occurrence Accuracy Completeness

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Audit Objective Recorded additions represent property, plant, and equipment acquired during the period under audit.

All additions that occurred during the period have been recorded.

Additions are correctly journalized and posted.

Additions and disposals of property, plant, and equipment before the period end are recorded in the current period and those after the period end are included in the next accounting period.

Recorded disposals represent property, plant, and equipment sold or scrapped during the period under audit.

Additions and disposals of property, plant, and equipment are recorded in the correct accounts.

Property, plant, and equipment transactions and events are appropriately aggregated or disaggregated, clearly described, and the related disclosures are relevant and understandable.

Disclosed property, plant, and equipment transactions have occurred and pertain to the entity.

Property, plant, and equipment transactions are disclosed accurately and at appropriate amounts.

All disposals that occurred during the period have been recorded.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to property, plant and equipment Section Reference: 12.5 Audit objectives: property, plant and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

74. Identify the assertion relating to account balances that corresponds with the following descriptions.

1. Property, plant, and equipment are stated at cost or a valuation less accumulated depreciation.

2. Non-current asset balances include all applicable assets used in operations at the end of the reporting period.

3. The entity owns or has rights to all recorded property, plant, and equipment assets at the end of the reporting period.

4. Recorded property, plant, and equipment assets represent productive assets that are in use at the end of the reporting period.

5. The details of additions and disposals of property, plant, and equipment support their classification in the financial statements.

6. Property, plant, and equipment are appropriately aggregated and disaggregated, clearly described, and the related disclosures are relevant and understandable.

Answer:

Assertion

Audit Objective

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Valuation and allocation Completeness Rights and obligations

Existence

Classification

Presentation

Property, plant, and equipment are stated at cost or a valuation less accumulated depreciation.

Non-current asset balances include all applicable assets used in operations at the end of the reporting period.

The entity owns or has rights to all recorded property, plant, and equipment assets at the end of the reporting period.

Recorded property, plant, and equipment assets represent productive assets that are in use at the end of the reporting period.

The details of additions and disposals of property, plant, and equipment support their classification in the financial statements.

Property, plant and equipment are appropriately aggregated and disaggregated, clearly described and the related disclosures are relevant and understandable.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to property, plant and equipment Section Reference: 12.5 Audit objectives: property, plant and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

75.

1 2 3

Generally, what is the assessment of control risk for transactions relating to property, plant, and equipment?

Generally, what is the assessment of materiality in relation to property, plant, and equipment?

Briefly discuss the assessment of inherent risk in relation to property, plant, and equipment.

Answer: 1. Because transactions relating to property, plant, and equipment are few and usually individually material, assessment of control risk relating to these transactions is rarely necessary.

2. Property, plant, and equipment is often the largest category of assets on the balance sheet and therefore expenses associated with this account are material factors in the determination of profit.

3. There may be significant variation in the inherent risk assessments for assertions relating to different property, plant, and equipment accounts. Inherent risk may be assessed as low under one assertion but high under another. Factors that impact on the assessment of inherent risk include the nature of the business and the form of purchase or lease of the asset.

Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for property, plant, and equipment.

Section Reference: 12.6 Audit strategy CPA Competency: Auditing and Assurance AACSB: Analytic

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76.

1

What procedures might be useful to the auditor in determining if all disposals of property, plant, and equipment have been recorded?

2

What procedures would be adopted by the auditor to gather evidence on the reasonableness, consistency, and accuracy of depreciation charges (expense)?

Answer: 1. Disposals • Analyze miscellaneous income (revenue) account for proceeds from the sale of PPE. • Investigate disposition of any facilities associated with discontinued product lines and operations.

• Trace disposal work orders and authorizations of any disposals to accounting records.

• Review insurance policies for termination or reduction (or any change) of coverage.

• Inquire of management about any disposals.

2. Depreciation • Reasonableness: consider the entity's history in estimating useful lives of existing PPE; ensure management has reviewed depreciation rates for current year.

• Consistency: identify methods by reviewing client-prepared depreciation schedules and inquiries of management; determine if methods are consistent with preceding year (on recurring engagements this is possible by reviewing last year's working papers).

• Accuracy: by recalculation on major items and any additions and/or disposals during the year.

Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

77. When performing tests of details of balances for property, plant, and equipment, it is necessary for the auditor to review accumulated depreciation. Discuss what this review entails.

Answer: In this test, the auditor seeks evidence as to the reasonableness, consistency, and accuracy of depreciation charges. Reasonableness is determined by considering such factors as the entity’s past history in estimating useful lives and the remaining useful lives of existing assets. The auditor must ensure that management has reviewed the depreciation rates during the year and adjusted the rates as necessary. Consistency is ascertained by the auditor reviewing depreciation schedules and by inquiring of management. The auditor must then determine whether the methods in use are consistent with those used in the preceding year.

On a recurring audit, this can be established by a review of the previous year’s working papers.

Accuracy is verified through recalculation. Ordinarily, the auditor does this on a selective basis by recalculating the depreciation on major assets and testing depreciation taken on additions and disposals during the year.

Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for property, plant, and equipment.

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Auditing: A Practical Approach, Fourth Canadian Edition

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

78. When conducting tests of details of transactions for property, plant, and equipment, there are three types of transactions that need to be substantiated. These transactions are additions, disposals, and repairs and maintenance. Briefly describe what is involved with substantiating each of these types of transactions.

Answer: Substantiating additions: The auditor needs to ensure that additions are properly capitalized in accordance with management’s policy and that this policy is consistent. Recorded amounts for additions are then vouched to supporting documentation and the amounts checked to ensure they exclude expenses. A physical inspection of major items is necessary to check that the documentation is correct. The auditor should also examine lease contracts to determine that leases are properly recognized and recorded.

Substantiating disposals: The auditor must examine documentation to support any sales, disposals, and trade-ins. This is necessary to determine the accuracy and propriety of the accounting records, including the recognition of any gain or loss incurred. The auditor should also inspect the results of any inventory count for further evidence that all disposals have been recorded.

Reviewing repairs and maintenance and rental expenses: The auditor should scan the individual charges in excess of the entity’s cut-off value for capitalization to ensure that they are properly expensed. Rental expenses are also reviewed to ensure that such rents relate to assets under operating leases. Documentary evidence needs to be tested for evidence of leases that should be accounted for as finance leases.

Bloomcode: Application Difficulty: Medium Learning Objective: Design a substantive audit program for property, plant, and equipment.

Section Reference: 12.7 Designing substantive procedures for property, plant, and equipment CPA Competency: Auditing and Assurance AACSB: Analytic

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Auditing Inventories and Property, Plant, and Equipment

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ESSAY QUESTIONS 79. Describe the audit process for inventory transactions, indicating the audit risks that need to addressed and the mitigating controls that can be implemented.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for inventories.

Section Reference: 12.3 Audit strategy: inventory CPA Competency: Auditing and Assurance AACSB: Analytic

80. Describe the audit process for property, plant, and equipment transactions, indicating the audit risks that need to addressed and the mitigating controls that can be implemented.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for property, plant, and equipment.

Section Reference: 12.6 Audit strategy CPA Competency: Auditing and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

LEGAL NOTICE Copyright © 2021 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under license and may be used only in accordance with the terms of such license.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 13 AUDITING CASH AND INVESTMENTS CHAPTER LEARNING OBJECTIVES 1. Identify the audit objectives applicable to cash.

Cash normally includes cash balances at the bank or similar institutions, cash on hand, and cash equivalents. In the auditing of cash, the key issues are to ensure that the cash exists and is owned by the client and that all cash transactions at the end of the reporting period are complete and properly disclosed.

2. Discuss considerations relevant to determining the audit strategy for cash.

The verification of cash balances is an important part of the financial statement audit. Even though the balances at the end of the reporting period may appear immaterial, the amount of cash flowing through the accounts can be very material. The high volume of transactions contributes to a significant level of inherent risk for cash balance assertions, particularly existence and completeness. While the audit approach to cash is usually substantive, the auditor should understand the procedures the client uses for maintaining accountability over cash. This often includes independently performed bank reconciliations and the use of imprest accounts.

3. Design and execute an audit program for cash balances.

Several types of substantive procedures to test cash balances are performed during most audits, including conducting cash cut-off tests, tracing bank transfers, counting cash on hand, confirming certain balances and other arrangements with banks, reviewing bank reconciliations, obtaining and using subsequent period bank statements, and determining the adequacy of management’s disclosures for cash balances.

4. Describe special considerations when auditing cash balances, including lapping, petty cash funds, and imprest bank accounts.

Lapping is an irregularity that results in the misappropriation of cash receipts for personal use. The auditor should assess the likelihood of lapping in obtaining an understanding about the segregation of duties in the receiving and recording of collections from customers. Three procedures that should detect lapping include confirming accounts receivable on a surprise basis at an interim date, making surprise cash counts, and comparing details of cash receipts journal entries with the details of corresponding daily deposit slips.

The balance of petty cash is rarely material and for this reason the majority of audits do not involve an audit of petty cash. Generally, the only time this part of the audit is performed is when the company expects or requests petty cash to be audited. When auditing petty cash, the auditor performs tests of details of transactions and tests of balances. The auditor tests a number of replenishing transactions.

An entity may use an imprest bank account for payroll and dividends. Substantive tests should include confirming the balance with the bank, reviewing the bank reconciliations, and using the subsequent period’s bank statement.

5. Identify the audit objectives applicable to investments.

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Auditing: A Practical Approach, Fourth Canadian Edition

In the auditing of investments, the key issues are to ensure that the investments exist, are owned, are properly recorded (including profits or losses on any sales) and disclosed, and are properly valued at the end of the reporting period.

6. Discuss considerations relevant to determining the audit strategy for investments.

Investing transactions occur infrequently and internal control over the processing of transactions is generally good. However, because transactions are infrequent and usually individually significant, it is common for the auditor to use a substantive approach.

7. Design and execute an audit program for investments.

Auditors usually vouch purchases and sales of investments by examining brokers’ advices and evidence of appropriate approval. Tests of details of balances involve inspecting or confirming recorded investments, verifying income from investments, and checking their market value.

8. Explain the special considerations applicable to the audit of investments in subsidiaries, associates, and joint ventures.

Where a company controls another company, consolidated financial statements must be prepared. The auditor generally uses a substantive approach in verifying the consolidation of investments in group entities in the consolidated financial statements of the economic entity.

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TRUE-FALSE STATEMENTS 1. In the auditing of cash, the key issues are to ensure that the cash exists and is owned by the client and that all cash transactions at the end of the reporting period are complete and properly disclosed.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the audit objectives applicable to cash.

Section Reference: 13.1 Audit objectives for cash CPA Competency: Audit and Assurance AACSB: Analytic

2. In the auditing of investments, the key issues are to ensure that the investments exist, are owned, are properly recorded (including profits or losses on any sales) and disclosed, and are properly valued at the end of the reporting period.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the audit objectives applicable to cash.

Section Reference: 13.1 Audit objectives for cash CPA Competency: Audit and Assurance AACSB: Analytic

3. For many entities, cash balances represent a large proportion of assets. However, the amount of cash flowing through the accounts over a period of time is usually smaller than for any other account in the financial statements.

Answer: False Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for cash.

Section Reference: 13.2 Audit strategy for cash CPA Competency: Audit and Assurance AACSB: Analytic

4. An imprest petty cash fund is a cash fund maintained at a constant level via replenishment with the value of receipts paid out of the fund.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for cash.

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Auditing: A Practical Approach, Fourth Canadian Edition

Section Reference: 13.2 Audit strategy for cash CPA Competency: Audit and Assurance AACSB: Analytic 5. The significance of cash to the entity’s liquidity and the fact that the balance is relatively small mean that the acceptable level of detection risk in verifying cash balances is invariably set as low.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

6. Cash balances do not normally show a stable or predictable relationship with other current or historical financial or operating data. As a result, the auditor will often not perform any analytical review procedures in this part of the audit.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

7. Lapping is an irregularity that results in the deliberate misappropriation of cash receipts, either temporarily or permanently, for the personal use of the individual perpetrating the unauthorized act.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe special considerations when auditing cash balances, including lapping, petty cash funds, and imprest bank accounts.

Section Reference: 13.4 Special considerations for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

8. The balance of petty cash is generally material and for this reason the majority of audits involve a significant audit of petty cash.

Answer: False Bloomcode: Comprehension Difficulty: Easy Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Learning Objective: Identify the audit objectives applicable to investments.

Section Reference: 13.5 Audit objectives for investments CPA Competency: Audit and Assurance AACSB: Analytic

9. Entities commonly invest in other entities, and these investments take a variety of forms including equity securities such as preference or ordinary shares, or debt securities such as corporate debentures or government bonds.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the audit objectives applicable to investments.

Section Reference: 13.5 Audit objectives for investments CPA Competency: Audit and Assurance

AACSB: Analytic 10. Ensuring that investment transactions are recorded in the correct accounts is an example of testing the accuracy audit objective.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the audit objectives applicable to investments.

Section Reference: 13.5 Audit objectives for investments CPA Competency: Audit and Assurance

AACSB: Analytic 11. Often the purchase and sale of investments are processed separately from other purchases and sales, especially for entities holding substantial investment portfolios where specific control procedures over investments are likely implemented.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for investments.

Section Reference: 13.6 Audit strategy for investments CPA Competency: Audit and Assurance

AACSB: Analytic 12. Where substantial investments are held, a separate investment subsidiary ledger or investment register may be maintained. This records details of acquisitions and disposals, the receipt of interest and dividends, and market values.

Answer: True Bloomcode: Knowledge Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Auditing: A Practical Approach, Fourth Canadian Edition

Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for investments.

Section Reference: 13.6 Audit strategy for investments CPA Competency: Audit and Assurance

AACSB: Analytic 13. Investment transactions rarely present cut-off problems, so the auditor may perform many substantive procedures before or after the end of the reporting period. Income statement account balances relating to investments are usually verified at the same time.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance

AACSB: Analytic 14. Auditors usually vouch purchases and sales of investments by examining brokers’ advices and evidence of appropriate approval. Purchases and sales of non-current investments, for example, should be vouched to authorizations in the minutes of directors’ meetings.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance

AACSB: Analytic 15. When a company (or other entity) controls another company (or other entity), under IFRS, consolidated financial statements must be prepared for the economic entity.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the special considerations applicable to the audit of investments in subsidiaries, associates, and joint ventures.

Section Reference: 13.8 Auditing consolidated financial statements CPA Competency: Audit and Assurance

AACSB: Analytic 16. To verify the amounts included in the consolidated financial statements, the auditor must obtain and verify the financial statements of each group entity. Where the auditor is not also the auditor of another group entity, consideration must be given to the extent of reliance that may be placed on the work of the other auditor.

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Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the special considerations applicable to the audit of investments in subsidiaries, associates, and joint ventures.

Section Reference: 13.8 Auditing consolidated financial statements CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

MULTIPLE CHOICE QUESTIONS 17. The account balance audit objective, “Year-end transfers of cash between banks are recorded in the proper period”, is derived from the a) occurrence assertion. b) cut-off assertion. c) completeness assertion. d) classification assertion.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the audit objectives applicable to cash.

Section Reference: 13.1 Audit objectives for cash CPA Competency: Audit and Assurance AACSB: Analytic

18. Which of following assertions are key concerns for cash? a) classification and presentation b) existence and classification c) completeness and rights and obligations d) existence and completeness Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the audit objectives applicable to cash.

Section Reference: 13.1 Audit objectives for cash CPA Competency: Audit and Assurance AACSB: Analytic

19. Cash should be correctly identified and classified in the balance sheet. The classification that is correct is a) cash on deposit is always a non-current asset. b) cash on deposit is always a current asset. c) fixed-term deposits are always non-current assets. d) fixed-term deposits are always current assets.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to cash.

Section Reference: 13.1 Audit objectives for cash CPA Competency: Audit and Assurance AACSB: Analytic

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20. Which of these statements is the most correct? In the bank reconciliation, a) the difference between the balance on the entity’s bank statement and the balance recorded in the entity’s records will be due to outstanding cheques and bank charges. b) the difference between the balance on the entity’s bank statement and the balance recorded in the entity’s records will be due to outstanding cheques and direct debits and credits on the bank statement. c) the difference between the balance on the entity’s bank statement and the balance recorded in the entity’s records will be due to deposits in transit and outstanding cheques. d) the difference between the balance on the entity’s bank statement and the balance recorded in the entity’s records will be due to bank charges and direct debits and credits on the bank statement.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for cash.

Section Reference: 13.2 Audit strategy for cash CPA Competency: Audit and Assurance AACSB: Analytic

21. Which of these statements is the most correct? a) A high volume of transactions flowing through an entity’s cash account contributes to a significant level of inherent risk for cash balance assertions. b) A high volume of transactions flowing through an entity’s cash account contributes to a significant level of detection risk for cash balance assertions. c) A high volume of transactions flowing through an entity’s cash account contributes to a significant level of risk particularly for the disclosure assertion. d) A high volume of transactions flowing through an entity’s cash account contributes to a significant level of risk particularly for the rights and obligations assertion.

Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for cash.

Section Reference: 13.2 Audit strategy for cash CPA Competency: Audit and Assurance AACSB: Analytic

22. In the planning of an audit, it was decided that cash would not be audited because it comprised only 1 per cent of total assets. How would you respond to this decision? a) Whether or not this was acceptable would depend on the company and the type of industry. b) Cash is always going to be material, no matter what amount it is. c) An amount of 1 per cent of total assets is likely to be immaterial.

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d) It is probable that this amount would still be considered material, due to the nature of cash.

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for cash.

Section Reference: 13.2 Audit strategy for cash CPA Competency: Audit and Assurance AACSB: Analytic

23. A bank confirmation request provides information to the auditor about a) account balances. b) loan documents. c) the client’s securities. d) all of the answers are correct Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

24. Which of these is a substantive test of details of balances used for cash balances? a) verifying the bank reconciliation b) obtaining and using the subsequent period’s bank statement c) confirming bank balances d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

25. In performing analytical procedures in the cash area, the auditor will usually a) compare this year’s balance(s) to the operating profit. b) compare this year’s balance(s) to total assets. c) compare this year’s balance(s) to the level of sales as a percentage. d) often won’t perform any analytical review.

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Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

26. The auditor should trace bank transfers using a bank transfer schedule primarily to determine if a) cash has been understated due to kiting. b) cash has been understated due to lapping. c) cash has been overstated due to kiting. d) cash has been overstated due to lapping.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

27. During the count of cash on hand, it is not necessary for the auditor to a) insist on the presence of an internal auditor throughout the count. b) insist on the presence of the custodian of the cash throughout the count. c) obtain a signed receipt from the custodian on return of the funds. d) ascertain that all undeposited funds are payable to the order of the client, either directly or through endorsement.

Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

28. The control of all funds during the count of cash on hand is meant primarily to prevent a) any chance of double counting. b) transfers by the entity’s personnel of counted to uncounted funds. c) unauthorized disbursements. d) unrecorded cash.

Answer: b

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Auditing: A Practical Approach, Fourth Canadian Edition

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

29. Since the custodian may have substituted personal cash to cover a cash shortage, the count of cash on hand provides weak evidence for the a) existence assertion. b) completeness assertion. c) rights and obligations assertion. d) accuracy and valuation assertion.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

30. The standard bank confirmation requests information about all of the following except a) account balances. b) loan balances. c) other arrangements that the client may have with the bank. d) secondary endorsements.

Answer: d Bloomcode: Knowledge Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic 31. Information concerning ‘other arrangements’ with banks is obtained from the client’s banks, in the bank confirmation form. This information is likely to include a) compensating liabilities. b) cash on hand. c) unused facilities. d) average daily balances.

Answer: c Bloomcode: Knowledge Difficulty: Easy Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

32. The practice where a cheque is paid into a bank account of an entity in a group of companies before balance sheet date but recorded by the payer as a disbursement that occurred after balance sheet date is known as a) kiting. b) lapping. c) low-balling. d) cash control.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

33. Kiting is possible when a) one person handles cash receipts and another maintains the accounts receivable ledger. b) one person handles cash receipts and maintains the accounts receivable ledger. c) one person issues cheques and another records them. d) one person issues cheques and records them.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

34. Initial substantive procedures for cash balance assertions may include all of the following except a) trace opening balances for cash on hand and in bank to the previous year’s working papers. b) review activity in general ledger accounts for cash and investigate entries that appear unusual in amount or source. c) obtain entity-prepared summaries of cash on hand and in bank, verify mathematical accuracy, and determine agreement with general ledger. d) count undeposited cash on hand.

Answer: d

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Auditing: A Practical Approach, Fourth Canadian Edition

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

35. Unlike other balance sheet accounts, cash account balances a) are not liquid. b) may be an asset or a liability. c) cannot have a credit balance. d) cannot have a debit balance.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

36. The starting point for verifying cash balances is to a) review the current period’s activity in the general ledger cash accounts for any significant entries that are unusual. b) determine the mathematical accuracy of cash balances in the general ledger. c) trace the current period’s opening balances to the closing audited balances in the previous year’s working papers. d) obtain any schedules that might have been prepared by the entity showing undeposited cash receipt summaries.

Answer: c Bloomcode: Knowledge Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

37. Which of the following would not normally be done by the auditor in connection with the subsequent period’s bank statement? a) use a bank statement for a period ending at least 7 days after year end b) trace deposits in transit on the bank reconciliation to deposits on the bank statement. c) scan the cut-off statement for unusual items d) agree ending balance on the subsequent period’s bank statement to the general ledger.

Answer: d

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Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

38. In working with the bank reconciliation and the subsequent period’s bank statement, the auditor finds that a prior-period cheque was not on the reconciliation as an outstanding cheque. This may be an indication of a) lapping. b) kiting. c) window dressing. d) an attempt to conceal a cash shortage.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic 39. In working with the bank reconciliation and the subsequent period’s bank statement, the auditor finds that many of the cheques on the outstanding cheque list did not clear during the cut-off period. This may be an indication of a) lapping. b) kiting. c) window dressing. d) an attempt to conceal a cash shortage.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

40. Audit tests to detect lapping involve which of the following? a) confirm accounts payable b) compare details of cash payments journal entries with the details of corresponding daily deposit slips c) use a bank cut-off statement d) make a surprise cash count of currency and customers cheques on hand and oversee the banking of these amounts

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Auditing: A Practical Approach, Fourth Canadian Edition

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Describe special considerations when auditing cash balances, including lapping, petty cash funds, and imprest bank accounts.

Section Reference: 13.4 Special considerations for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

41. If the petty cash account is tested in detail by the auditor, it is usually because a) it is always material. b) it is quickly and easily tested. c) of the possibility of unrecorded disbursements. d) the company requested a petty cash audit.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe special considerations when auditing cash balances, including lapping, petty cash funds, and imprest bank accounts.

Section Reference: 13.4 Special considerations for cash balances CPA Competency: Audit and Assurance AACSB: Analytic 42. A procedure the auditor can employ to detect ‘lapping’ is a) confirming accounts on a surprise basis at an interim date. b) making a surprise cash count. c) comparing details of cash receipts journal entries with the details of corresponding daily deposit slips. d) all of the answers are correct Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Describe special considerations when auditing cash balances, including lapping, petty cash funds, and imprest bank accounts.

Section Reference: 13.4 Special considerations for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

43. Which of the following would be the best protection for an entity that wishes to prevent the ‘lapping’ of trade accounts receivable? a) Request that customers’ payment cheques be made payable to the entity and addressed to the chief financial officer. b) Have customers send payments directly to the entity’s bank.

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c) Segregate duties so that no employee has access to both the cheques from customers and currency from daily cash receipts. d) Make sure that the same person always deals with cash receipts.

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Describe special considerations when auditing cash balances, including lapping, petty cash funds, and imprest bank accounts.

Section Reference: 13.4 Special considerations for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

44. Which statement is the most correct? a) The imprest petty cash fund should be in the custody of no more than two individuals. b) The imprest petty cash fund should be maintained at the imprest amount. c) The balance of the petty cash fund should always be audited. d) Use of an imprest petty cash fund enables small items to be purchased with no documentation required.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe special considerations when auditing cash balances, including lapping, petty cash funds, and imprest bank accounts.

Section Reference: 13.4 Special considerations for cash balances CPA Competency: Audit and Assurance AACSB: Analytic 45. One ‘red flag’ that may indicate fraud in relation to cash register operations is a) unusually low inventory shrinkage. b) increasing cash sales, relative to credit card sales. c) cashiers who cannot issue refunds without supervision. d) multiple refunds or voids just under the review limit.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe special considerations when auditing cash balances, including lapping, petty cash funds, and imprest bank accounts.

Section Reference: 13.4 Special considerations for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

46. Audit evidence for share holdings on the investment brokerage register is normally the a) debenture certificate.

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Auditing: A Practical Approach, Fourth Canadian Edition

b) company’s investment register. c) brokerage account holdings statement. d) cancelled (or presented) cheque.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the audit objectives applicable to investments.

Section Reference: 13.5 Audit objectives for investments CPA Competency: Audit and Assurance AACSB: Analytic

47. The correct statement concerning the materiality of securities is: a) short-term investments may be immaterial to the solvency position but material to the income statement. b) long-term investments may be immaterial to both the financial position and the income statement. c) long-term investments may be immaterial to the financial position but material to the income statement. d) short-term investments may be material to the solvency position but immaterial to the income statement.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Discuss considerations relevant to determining the audit strategy for investments.

Section Reference: 13.6 Audit strategy for investments CPA Competency: Audit and Assurance AACSB: Analytic

48. Which of these controls would be the most effective in assuring that the proper custody of assets in the investing cycle is maintained? a) The purchase and sale of investments are executed on the specific authorization of the board of directors. b) The recorded balances in the investment subsidiary ledger are periodically compared with the contents of the safety deposit box by independent personnel. c) Direct access to securities in the safety deposit box is limited to only one corporate officer. d) Personnel who post investment transactions to the general ledger are not permitted to update the investment subsidiary ledger.

Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for investments.

Section Reference: 13.6 Audit strategy for investments CPA Competency: Audit and Assurance Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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AACSB: Analytic

49. The substantive approach is generally used for investing transactions because of a) infrequent transactions. b) high volume of transactions. c) ineffective controls. d) effective controls.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

50. Analytical procedures applied to investment balance sheet accounts provide a) evidence for the existence assertion. b) evidence for the completeness assertion. c) evidence for the presentation assertion. d) little or no evidence.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic 51. In auditing tests of details of balances for investments, the auditor’s procedures may include all of the following except a) inspecting and confirming banking records. b) inspecting and counting securities on hand. c) recalculating investment revenue earned. d) vouching purchases and sales of investments to brokers’ advices.

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

52. The inspecting and counting of securities on hand is ordinarily performed simultaneously with the auditor’s a) counting of cash. b) observing of the inventory counting. c) conducting analytical procedures. d) checking the bank reconciliation.

Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

53. Which of the following is correct concerning the inspecting and counting of securities on hand? a) a receipt should be provided by the auditor to the custodian when the securities are returned b) the auditor should observe the broker’s advice number on the document c) all securities should be controlled by the auditor until the count is completed d) confirmation of securities should be sent to the internal auditors Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

54. The statement that is not true concerning the confirmation of securities held by outsiders for safekeeping is a) either positive or negative confirmations can be used. b) confirmations should be requested as of the date other securities are counted. c) the auditor should receive responses directly from the custodian. d) the data confirmed are the same as the data that should be noted when the auditor is able to inspect the securities.

Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

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55. Verification procedures for investment income are least likely to include a) recalculation by the auditor. b) direct confirmation with the investee. c) inspection of debenture certificates. d) inspection of dividend record books.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

56. When inspecting securities on hand the auditor needs to record all these matters except a) the name of the owner. b) the certificate number of the document c) the description of the security d) All of the above need to be recorded.

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

57. For infrequently traded securities, which are material in amount, the auditor should ordinarily a) estimate the market price themselves. b) require the security to be classified as a long-term investment. c) obtain direct confirmation from an independent broker. d) inspect the books of the investee directly.

Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

58. Tests of details of balances for investment balance assertions include all of these except

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Auditing: A Practical Approach, Fourth Canadian Edition

a) inspect and count securities on hand. b) confirm securities held by others. c) vouch entries in investment and related income and equity accounts. d) recalculate investment revenue earned.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

59. For most entities investment transactions are a) infrequent, but individual transactions can be substantial. b) frequent, but individual transactions are usually substantial. c) infrequent, but individual transactions are usually small. d) frequent, but individual transactions are usually small.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

60. Which of these procedures do auditors usually perform as a test of details of transactions to verify all management assertions relating to investments? a) trace purchases of investments to brokers’ advices b) vouch purchases and sales of investments to brokers’ advices c) inspect the minutes of directors meetings d) both b and c Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

61. Which check could not be carried out for securities held by a client? a) check of paper certificate of legal title for securities held in listed companies b) check with the bank of securities held in safety deposit boxes c) check against records in the investment register Copyright © 2021 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

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d) check with confirmation for securities held by outsiders Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

62. CAS 600 recommends that in the audit of group entities, where the auditor is not also the auditor of another group entity, the principal auditor may a) be able to rely solely on the work and conclusions of the other auditor. b) ask the other auditor about the independence requirements, and offer representations as to compliance. c) send a detailed questionnaire to the other auditor. d) ignore the findings of the other auditor.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the special considerations applicable to the audit of investments in subsidiaries, associates, and joint ventures.

Section Reference: 13.8 Auditing consolidated financial statements CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

SHORT ANSWER QUESTIONS 63. Identify the assertion relating to classes of transactions that corresponds with the following audit objectives for cash.

1. Payments and receipts are recorded in the correct accounts.

2. Recorded receipt and payment transactions represent cash inflows and outflows during the period.

3. All cash inflows and outflows made during the period have been recorded.

4. Payments and receipts are accurately recorded.

5. Year-end transfers of cash between banks and bank accounts are recorded in the proper period.

Answer:

Assertion Classification Occurrence Completeness Accuracy Cut-off

Audit Objective Payments and receipts are recorded in the correct accounts.

Recorded receipt and payment transactions represent cash inflows and outflows during the period.

All cash inflows and outflows made during the period have been recorded.

Payments and receipts are accurately recorded.

Year-end transfers of cash between banks and bank accounts are recorded in the proper period.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to cash Section Reference: 13.1 Audit objectives for cash CPA Competency: Audit and Assurance AACSB: Analytic

64. Identify the assertion relating to account balances that corresponds with the following audit objectives for cash.

1. Recorded cash balances are realizable at the amounts stated on the balance sheet and agree with supporting schedules.

2. Recorded cash balances include the effects of all cash transactions that have occurred.

3. The entity has legal title to all cash balances shown at the end of the reporting period.

4. Recorded cash balances exist at the end of the reporting period.

5. Cash balances are appropriately presented and information disclosed is clearly expressed.

Answer:

Assertion Accuracy, valuation, and allocation

Audit Objective Recorded cash balances are realizable at the amounts stated on the balance sheet and agree with supporting

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schedules.

Completeness Rights and obligations Existence Classification

Recorded cash balances include the effects of all cash transactions that have occurred.

The entity has legal title to all cash balances shown at the end of the reporting period.

Recorded cash balances exist at the end of the reporting period.

Cash balances are appropriately presented and information disclosed is clearly expressed.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to cash Section Reference: 13.1 Audit objectives for cash CPA Competency: Audit and Assurance AACSB: Analytic

65. Describe two internal control features applied to the management of an imprest petty cash fund.

Answer: Internal controls features applied to an imprest petty cash fund include the following: - The fund should be maintained at the imprest level; that is, cash in the fund plus vouchers for payments should always equal the imprest amount.

- The fund should be in the custody of one person.

- The fund should be kept secure and stored in the safe when not in use.

- Payments from the fund should be for small amounts, and documentation should support each payment.

- The fund should not be mingled with other cash.

- Replenishment of the fund should be based on a review of supporting documentation.

- Upon payment, supporting documents should be stamped “paid” to prevent their reuse.

Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for cash Section Reference: 13.2 Audit strategy for cash CPA Competency: Audit and Assurance AACSB: Analytic

66. Are there any issues that may arise with the valuation of cash balances?

Answer: At first it would seem easy to value cash, as it is cash. It has a set value. Cash balances may not be easily valued if they are held in a foreign currency. Exchange risks will need to be examined.

There may also be restrictions on the transfer of cash, such as cash balances held in foreign countries. They may have restrictions on the transfer of cash overseas leading to a difficulty with the measurement of its actual value to the business.

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Auditing: A Practical Approach, Fourth Canadian Edition

Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for cash.

Section Reference: 13.2 Audit strategy for cash CPA Competency: Audit and Assurance AACSB: Analytic

67. Although the auditor primarily adopts a substantive approach to the audit of cash balances, an understanding of procedures for maintaining accountability over cash is necessary for the design of substantive tests of details. Name and describe the two main procedures for internal control of cash.

Answer: Bank reconciliations: This involves an independent (internal) comparison of the balance shown on the bank statement with the balance recorded in the entity’s records. The difference between the two is reconciled by listing outstanding deposits and unpresented cheques.

Verifying the reconciliation of the bank account at reporting date is an important substantive procedure.

Imprest accounts: Students could describe an imprest petty cash fund, or an imprest bank account.

An imprest petty cash fund should include the following controls: • Balance should be maintained at the imprest level. Cash plus receipts should equal the opening balance.

• One person has custody of the fund.

• The fund should be kept secure, and in the safe when not in use.

• Small payments only with supporting documents for every payment.

• Never mingled with other cash.

• Replenished only on review of supporting documents.

• On replenishment, supporting documents should be stamped ‘paid’ to prevent reuse.

Internal controls over an imprest bank account should include the following: • One person only is authorized to transact on the account.

• Only transactions of the specified types are to be processed against the account (payroll, dividend, etc.).

• Each period a cheque for the total net amount payable should be deposited in the imprest bank account.

• The account should be independently reconciled each month.

Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for cash.

Section Reference: 13.2 Audit strategy for cash CPA Competency: Audit and Assurance AACSB: Analytic

68. Why is detection risk for verifying cash balances invariably low? Why does the auditor not often use analytical procedures for the audit of cash balances?

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Answer: The entity’s liquidity relies on the cash account: it is vital to the survival of the business as a going concern. Also, the quantity of cash flowing through the account is higher than its actual balance at any one time. It has a materiality that is greater, relative to its balance, than any other account balance. It is material in a qualitative way even if it does not appear to be material in a quantitative way.

Cash balances do not normally show a stable or predictable relationship with other operating or financial data. Procedures would usually be limited to comparisons with previous periods or budgeted amounts.

Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

69. One of the commonly used substantive tests for cash balances is to confirm the bank balance directly with the bank Name five categories of information requested on a standard bank confirmation request.

Answer: In practice bank confirmation requests are usually sent on every audit. It would be considered highly unusual not to send one. Things included in the request include: The student could name any five of the following: • Credit account balances, • Debit account balances, • Promissory notes/bills of exchange held for collection on behalf of the customer, • Customer’s other liabilities to the bank, • Items held as security for customer’s liabilities to the bank, • Accounts opened/closed, • Sealed packets, locked boxes, security packets, etc., • Unused limits/facilities, or • Other information.

Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

70. One of the commonly used substantive tests for cash balances is to verify bank reconciliations performed by the entity. Name the five steps in verifying the bank reconciliation. Are there circumstances under which auditors might perform the bank reconciliation for themselves? If not, why not? If so, what are they?

Answer: • Check the mathematical accuracy and compare with the general ledger.

• Verify the bank balance per the bank confirmation with the bank balance per the reconciliation.

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Auditing: A Practical Approach, Fourth Canadian Edition

Trace unpresented cheques on the bank reconciliation to the subsequent period’s bank statement.

Trace deposits in transit on the bank reconciliation to the subsequent period’s bank statement.

Verify any bank charges or errors on the reconciliation with the bank statement or other supporting documentation.

The auditors may perform the bank reconciliation for themselves if the client has not prepared one, the client’s reconciliation has some significant unreconciled items, or the auditor has concerns that there is a lack of segregation of duties in the preparation of the bank reconciliation.

Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic 71. What is the purpose of ‘window dressing’? How would it be perpetrated? What is the main indicator of window dressing, and why does the indicator work?

Answer: ‘Window dressing’ is a deliberate attempt to enhance a company’s appearance of short-term solvency. It is normally perpetrated by writing cheques on the last day of the financial year but not mailing them until several weeks later, when cleared funds are available at the bank to meet the cheques. This boosts apparent current ratios.

If none of a sequence of cheques is presented for payment on the bank statement for more than two weeks after the reporting date, this may indicate window dressing. This will work because payees do not normally delay banking cheques once received, and it is normal for most cheques to clear the bank statement within a week of issue.

Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

72. What should the auditor do to perform cash counts properly? Why are they important to the audit of cash on hand? Why is a cash count often not performed?

Answer: The auditor should: • Control all cash and negotiable instruments held by the entity until all funds have been counted. This will prevent entity personnel transferring counted funds to uncounted funds.

• Insist that the custodian of the cash be present throughout the count, and get their signature on return of the funds. This minimizes the possibility, in the event of a shortage, of the custodian claiming that all cash was intact when released to the auditor for counting.

• Ascertain that all undeposited cheques are payable to the order of the entity. If they are not payable to the entity, the amount should not be included in cash.

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A cash count is often not performed because companies usually try to keep cash on hand to a minimum and so cash on hand is often immaterial.

Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic 73. Describe three procedures an auditor would perform when verifying a client’s bank reconciliation.

Answer: 1. Check the mathematical accuracy and compare with the general ledger.

2. Verify the bank balance per the bank confirmation with the bank balance per the reconciliation.

3. Trace outstanding cheques on the bank reconciliation to the subsequent period’s bank statement.

4. Trace deposits in transit on the bank reconciliation to the subsequent period’s bank statement.

5. Verify any bank charges or errors on the reconciliation with the bank statement or other supporting documentation.

Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for inventory.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

74. Identify the assertion relating to classes of transactions that corresponds with the following audit objectives for investments.

1. Investment revenues, gains, and losses resulted from transactions and events that occurred during the period.

2. All purchases of investments during the period have been recorded as additions.

3. Investment transactions are recorded in the correct accounts.

4. Investment revenues, gains, and losses are reported at proper amounts.

Answer:

Assertion Occurrence Completeness Classification

Audit Objective Investment revenues, gains, and losses resulted from transactions and events that occurred during the period.

All purchases of investments during the period have been recorded as additions.

Investment transactions are recorded in the correct accounts.

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Auditing: A Practical Approach, Fourth Canadian Edition

Accuracy

Investment revenues, gains, and losses are reported at proper amounts.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to investments Section Reference: 13.5 Audit objectives for investments CPA Competency: Audit and Assurance AACSB: Analytic

75. Identify the assertion relating to account balances that corresponds with the following audit objectives for investments.

1. Recorded cash balances are realizable at the amounts stated on the balance sheet and agree with supporting schedules.

2. The income statement includes the effects of all investment transactions and events during the period.

3. All recorded investments are owned by the reporting entity.

4. Recorded investment balances represent investments that exist at the end of the reporting period.

5. Investment balances are properly identified and classified in the financial statements.

Answer:

Assertion Accuracy, valuation, and allocation Completeness Rights and obligations Existence Classification

Audit Objective Recorded cash balances are realizable at the amounts stated on the balance sheet and agree with supporting schedules.

The income statement includes the effects of all investment transactions and events during the period.

All recorded investments are owned by the reporting entity.

Recorded investment balances represent investments that exist at the end of the reporting period.

Investment balances are properly identified and classified in the financial statements.

Bloomcode: Application Difficulty: Medium Learning Objective: Identify the audit objectives applicable to investments Section Reference: 13.5 Audit objectives for investments CPA Competency: Audit and Assurance AACSB: Analytic

76. Name and describe five possible internal controls related to the investment function.

Answer: Students could name five of the following: • Purchases and sales should be made in accordance with management’s authorizations.

The purchase and sale of investments intended to be retained as non-current assets should require board approval.

• Dividend and interest cheques must be promptly deposited intact, and the completeness of recorded investment income must be independently verified.

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Transactions should be recorded on the basis of appropriate supporting documentation, and the duties of recording of transactions and custody of the securities should be segregated.

Securities should be stored in safes or vaults, with access restricted to authorized personnel. Periodically, relevant documents should be independently compared with recorded balances.

Changes in value and in circumstances relating to the appropriate classification of investments should be periodically analyzed.

Management should undertake performance reviews to detect poor investment performance and/or erroneous reporting.

Periodically, the classification of individual investments should be reviewed.

Bloomcode: Application Difficulty: Medium Learning Objective: Discuss considerations relevant to determining the audit strategy for investments.

Section Reference: 13.6 Audit strategy for investments CPA Competency: Audit and Assurance AACSB: Analytic

77.

1. Identify the matters the auditor should observe when inspecting securities.

2. List the requirements for the presentation of investments in securities that would conform to the disclosure requirements of accounting standards.

Answer: 1. Inspection of securities • The certificate number on the document; • The name of the owner (which should be the entity, either directly or by endorsement); • The description of the security; • The number of shares (or debentures); • The value of the shares (or debentures); • The name of the issuer.

2. Disclosure of investments in securities • Classification between current and non-current; • Classification into government and semi-government stocks and bonds, debentures, shares, and share options; • Recognition of dividends, interest, and realized gains and losses in the income statement; • Recognition of impairment write-offs in the income statement; • Disclosure of the basis and methods of accounting; • Disclosure of the market value of quoted investments; • Disclosure of any liens.

Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

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78. Why is a substantive approach used for most entities in the audit of investment balances? Why is it rarely possible to obtain much evidence from analytical procedures in the audit of investment balances?

Answer: The substantive approach is used for most entities in the audit of investment balances because the volume of transactions is quite low. Also, there is a heightened risk of fraud due to the complexity of accounting for some transactions.

Analytical procedures are rarely of much use as current investment assets tend not to have any predictable relationship with other balances, and non-current investment assets are subject to so few transactions that it is easier to proceed directly to tests of details.

Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

79. From the list of substantive procedures provided below, classify each as either a procedure relating to cash or a procedure relating to investments.

List of substantive procedures: 1. Trace opening balances for investment accounts to the previous year’s working papers.

2. Review activity in all investment-related balance sheet and income statement accounts, and investigate entries that appear unusual in amount or source.

3. Trace opening balances for cash on hand and in the bank to previous year’s working papers.

4. Review activity in general ledger accounts for cash and investigate entries that appear unusual in amount or source.

5. Perform analytical procedures by comparing cash balances with expected amounts.

6. Vouch entries in investment and related income and equity accounts.

7. Recalculate investment revenue earned.

8. Obtain entity-prepared summaries of cash on hand and in the bank, verify mathematical accuracy, and determine agreement with general ledger.

Answer: Cash Trace opening balances for cash on hand and in the bank to previous year’s working papers.

Investments Trace opening balances for investment accounts to the previous year’s working papers.

Review activity in general ledger accounts for cash and investigate entries that appear unusual in amount or source.

Review activity in all investment-related balance sheet and income statement accounts, and investigate entries that appear unusual in amount or source.

Vouch entries in investment and related income and equity accounts.

Obtain entity-prepared summaries of cash on hand and in the bank, verify mathematical accuracy, and determine agreement with general ledger.

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Auditing Cash and Investments

Perform analytical procedures by comparing cash balances with expected amounts.

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Recalculate investment revenue earned.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Design and execute an audit program for cash Learning Objective: Design and execute an audit program for investments Section Reference: 13.4 Special considerations for cash balances Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

80. From the list of substantive procedures provided below, classify each as either a procedure relating to cash or a procedure relating to investments.

List of substantive procedures: 1. Confirm securities held by others.

2. Observe that all cash received by the close of business on the last day of the financial year is included in cash and that no receipts of the subsequent period are included.

3. Inspect and count securities on hand.

4. Observe the last cheque issued and mailed on the last day of the financial year and trace to the accounting records to determine the accuracy of the cash payments cutoff.

5. Confirm bank balances.

6. Obtain and use the subsequent period’s statements to verify bank reconciliation items and look for evidence of window dressing.

7. Obtain entity-prepared schedules of investments and determine that they accurately represent the underlying accounting records from which they are prepareevaluating the conclusd by adding and cross-adding the schedules.

8. Perform analytical procedures by analyzing interest and dividend yields relative to expectations.

Answer: Cash Observe that all cash received by the close of business on the last day of the financial year is included in cash and that no receipts of the subsequent period are included.

Investments Confirm securities held by others.

Observe the last cheque issued and mailed on the last day of the financial year and trace to the accounting records to determine the accuracy of the cash payments cut-off.

Inspect and count securities on hand.

Confirm bank balances.

Obtain entity-prepared schedules of investments and determine that they accurately represent the underlying accounting records from which they are prepared by adding and cross-adding the

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schedules.

Obtain and use the subsequent period’s statements to verify bank reconciliation items and look for evidence of window dressing.

Perform analytical procedures by analyzing interest and dividend yields relative to expectations.

Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for cash Learning Objective: Design and execute an audit program for investments Section Reference: 13.4 Special considerations for cash balances Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing Cash and Investments

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ESSAY QUESTIONS 81. Describe the audit process for cash transactions, indicating the audit risks that need to be addressed and the mitigating controls that can be implemented.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for cash balances.

Section Reference: 13.3 Substantive procedures for cash balances CPA Competency: Audit and Assurance AACSB: Analytic

82. Describe the audit process for investment transactions, indicating the audit risks that need to be addressed and the mitigating controls that can be implemented.

Answer: Answers may vary.

Bloomcode: Application Difficulty: Medium Learning Objective: Design and execute an audit program for investments.

Section Reference: 13.7 Substantive procedures for investments CPA Competency: Audit and Assurance AACSB: Analytic

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LEGAL NOTICE Copyright © 2021 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under license and may be used only in accordance with the terms of such license.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

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CHAPTER 14 COMPLETING AND REPORTING ON THE AUDIT CHAPTER LEARNING OBJECTIVES 1. Explain the procedures performed as part of the engagement wrap-up, including gathering and evaluating audit evidence.

During the engagement wrap-up, the auditor reviews planned audit procedures to ensure they are completed, finalizes any open items (including review notes and to-do items), ensures that all necessary documentation is in the working paper files and removes any unnecessary documentation, reconsiders their risk assessment and fraud risk, reconsiders materiality, performs analytical procedures, assesses misstatements, and performs subsequent events procedures.

2. Understand the considerations when assessing the going concern assumption used in the preparation of the financial statements.

The auditor is required to consider whether the going concern assumption is the correct basis upon which the financial statements have been prepared. That is, is the entity viewed by the auditor, management, and those charged with governance as continuing into the foreseeable future with neither the intention nor the need to liquidate, to cease trading, or to seek protection from creditors?

3. Understand the purpose of and the procedures performed in the review for contingent liabilities and commitments.

It is the auditor’s responsibility to perform procedures to verify that there are no unrecorded or undisclosed lawsuits or claims that could result in the financial statements being materially misstated.

4. Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

There are two types of subsequent events. Type 1 subsequent events are those that provide additional evidence with respect to conditions that existed at year end. These are required to be adjusted for in the financial statements. Type 2 subsequent events are those that provide evidence with respect to conditions that developed subsequent to year end; these are not required to be recorded in the financial statements, but are considered for inclusion as a disclosure note.

5. Analyze misstatements and explain the difference between quantitative and qualitative considerations when evaluating misstatements.

Quantitative and qualitative considerations of misstatements include the risk of undetected errors remaining, the effect of the misstatements on compliance with covenants or agreements, whether the misstatements are errors or judgemental misstatements, whether any prior-period unadjusted misstatements exist and could affect the current period’s results, the likelihood that

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these differences will become material in the future, the sensitivity of the misstatements, the significance of the misstatements for the known users of the financial statements, the effect of offsetting differences in financial statement captions, and the dollar amount (quantity) of the misstatements.

6. Evaluate conclusions obtained during the performance of the audit and explain how these conclusions link to the overall opinion formed on the financial statements.

The final phase of the audit is to assess all of the audit evidence obtained and determine whether it is sufficient and appropriate to reduce the risk of material misstatement in the financial statements to an acceptably low level. Based on the evidence gathered, the audit opinion on the financial statements will be determined.

7. Describe the components of an audit report.

The audit report includes a title, an addressee, an audit opinion, a basis of opinion, possibly key audit matters, other matters, management’s and the auditor’s responsibility for the financial statements, the name of the engagement partner, the auditor’s signature, the date of the report, and the auditor’s address. KAMs are the matters that, in the auditor’s professional judgement, were of most significance in the audit of the financial statements.

8. Identify the types of modifications to an audit report.

The overall conclusion reached at the end of the audit can be unmodified, unmodified with an emphasis of matter, modified with a qualification, modified with an adverse opinion, or modified with a disclaimer of opinion.

9. Explain what reporting is required to management and those charged with governance.

All audit matters of governance interest—that is, items that are important and relevant to those charged with governance in overseeing the financial reporting and disclosure process—should be reported to management and those charged with governance by the auditor. This is a required communication that can be provided verbally or in writing, with written communications (or evidence of such communications) preferred.

10. Understand the various types of other engagements that auditors may be asked to perform.

A practitioner may be asked to perform engagements other than those involving financial information and tax engagements. These other engagements include reports prepared in accordance with a special purpose framework or a basis of accounting other than GAAP; reports on a single financial statement line item, such as inventory or gross sales; assurance reports; reports on compliance with contractual agreements, such as covenants; reviews of interim financial statements, such as for companies listed on a stock exchange in the United States; reports on applying specified procedures to financial information other than financial statements, such as reports on the accuracy of expenditures; and reports on the application of accounting principles either to a specific, actual transaction or to the financial statements overall as well as reports on supplementary matters.

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TRUE-FALSE STATEMENTS 1. Subsequent events procedures are normally performed through to and including the date of the auditor's report.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the procedures performed as part of the engagement wrap-up, including gathering and evaluating audit evidence.

Section Reference: 14.1 Engagement wrap-up CPA Competency: Audit and Assurance AACSB: Analytic

2. Sufficiency relates to the quality of audit evidence gathered.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Explain the procedures performed as part of the engagement wrap-up, including gathering and evaluating audit evidence.

Section Reference: 14.1 Engagement wrap-up CPA Competency: Audit and Assurance AACSB: Analytic

3. Generally, the further into the future an event is likely to take place, the greater the uncertainty surrounding the event.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the considerations when assessing the going concern assumption used in the preparation of the financial statements.

Section Reference: 14.2 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

4. A type 1 subsequent event provides evidence with respect to conditions that developed subsequent to year end.

Answer: False

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Bloomcode: Knowledge Difficulty: Easy Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic

5. The uninsured loss of inventory as a result of fire subsequent to year end is an example of a type 2 subsequent event.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic

6. An error is an intentional misstatement in the client's financial statements.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Analyze misstatements and explain the difference between quantitative and qualitative considerations when evaluating misstatements.

Section Reference: 14.5 Misstatements CPA Competency: Audit and Assurance AACSB: Analytic

7. The client's compliance with contractual requirements of operating agreements is an example of a qualitative factor that may cause misstatements of quantitatively immaterial amounts to be considered material.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Analyze misstatements and explain the difference between quantitative and qualitative considerations when evaluating misstatements.

Section Reference: 14.5 Misstatements CPA Competency: Audit and Assurance AACSB: Analytic

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8. The final phase of an audit is to assess all of the audit evidence obtained and determine whether it is sufficient and appropriate.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Evaluate conclusions obtained during the performance of the audit and explain how these conclusions link to the overall opinion formed on the financial statements.

Section Reference: 14.6 Evaluating the conclusions and forming an opinion CPA Competency: Audit and Assurance AACSB: Analytic

9. The auditor's responsibility for the financial statements includes selecting and applying appropriate accounting policies.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Describe the components of an audit report.

Section Reference: 14.7 Components of the audit report CPA Competency: Audit and Assurance AACSB: Analytic

10. A limitation on the scope of the auditor's work could result from an inability to perform procedures or an imposition by the entity.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance AACSB: Analytic

11. An unqualified audit report with an emphasis of matter should be issued if a subsequent event has occurred that has resulted in a new audit report being prepared on a revised financial statement.

Answer: True Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance

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AACSB: Analytic

12. Matters of governance that the auditor may wish to discuss with those charged with governance include any practical difficulties encountered in performing the audit.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain what reporting is required to management and those charged with governance.

Section Reference: 14.9 Communication with those charged with governance CPA Competency: Audit and Assurance AACSB: Analytic

13. As soon as practicable, the auditor should communicate weaknesses in internal controls to management or those charged with governance.

Answer: True Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain what reporting is required to management and those charged with governance.

Section Reference: 14.9 Communication with those charged with governance CPA Competency: Audit and Assurance AACSB: Analytic

14. A public auditor in practice can only perform audits and reviews and is prohibited from completing non-assurance engagements such as compilations of financial information and tax engagements.

Answer: False Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the various types of other engagements that auditors may be asked to perform.

Section Reference: 14.10 Other engagements CPA Competency: Audit and Assurance AACSB: Analytic

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MULTIPLE CHOICE QUESTIONS 15. Mostafa Torabi, the partner on the Tory, Jimenez LLP audit called a meeting of his senior staff during the engagement wrap-up. Which of the following areas would be the least likely to be covered during the wrap up? a) consideration of the amount used for materiality b) removal of all unnecessary documentation from the engagement files c) performing analytical procedures on the adjusted financial statements d) preparation of budgets for the following year’s audit Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the procedures performed as part of the engagement wrap-up, including gathering and evaluating audit evidence.

Section Reference: 14.1 Engagement wrap-up CPA Competency: Audit and Assurance AACSB: Analytic

16. Ron Nucci is trying to gather sufficient appropriate evidence. Which of these are factors to consider in evaluating the sufficiency and appropriateness of audit evidence? a) audit risk b) control risk c) quality of information obtained d) business risk Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the procedures performed as part of the engagement wrap-up, including gathering and evaluating audit evidence.

Section Reference: 14.1 Engagement wrap-up CPA Competency: Audit and Assurance AACSB: Analytic

17. Which of the following are areas are not normally covered during the wrap-up of an audit engagement? a) Perform subsequent events procedures. b) Consider the amount used for materiality. c) Reconsider the assessments of internal control at the entity level and the risk of fraud. d) Preliminary analytical procedures.

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Auditing: A Practical Approach, Fourth Canadian Edition

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the procedures performed as part of the engagement wrap-up, including gathering and evaluating audit evidence.

Section Reference: 14.1 Engagement wrap-up CPA Competency: Audit and Assurance AACSB: Analytic

18. When misstatements or deviations from controls are found in planned procedures, consideration should always be given to: a) the need to modify or perform further audit procedures. b) the reason for the misstatement or deviation. c) both a and b. d) none of the above.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the procedures performed as part of the engagement wrap-up, including gathering and evaluating audit evidence.

Section Reference: 14.1 Engagement wrap-up CPA Competency: Audit and Assurance AACSB: Analytic

19. The going concern assumption means the viability of a business to a) remain in business for the foreseeable future. b) maintain the current level of sales. c) the viability of the business to operate in its current market. d) increase the level of sales.

Answer: a Bloomcode: Knowledge Difficulty: Easy Learning Objective: Understand the considerations when assessing the going concern assumption used in the preparation of the financial statements.

Section Reference: 14.2 Going concern CPA Competency: Audit and Assurance AACSB: Analytic 20. An auditor’s consideration of the going concern assumption does not include considering a) knowledge of conditions and events obtained during planning and performing the audit.

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b) any material uncertainties about the entity’s ability to meet obligations as they fall due. c) changes in the industry in which the entity operates which could affect future operations. d) the auditor’s final assessment of audit risk.

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Understand the considerations when assessing the going concern assumption used in the preparation of the financial statements.

Section Reference: 14.2 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

21. Under the going concern assumption: a) an entity is viewed as not likely to continue in operation for the foreseeable future. b) an entity's assets and liabilities are recorded at liquidation values. c) an entity is viewed as continuing in business for the foreseeable future. d) an entity is considered to be a separate legal entity from its owners.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the considerations when assessing the going concern assumption used in the preparation of the financial statements.

Section Reference: 14.2 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

22. Which of the following factors is not relevant when management is assessing the going concern assumption? a) whether the auditor specializes in the client's industry b) the time into the future that an event is likely to take place c) the nature and condition of the entity's business d) the size and complexity of the entity Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the considerations when assessing the going concern assumption used in the preparation of the financial statements.

Section Reference: 14.2 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

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23. When Jussi Hallonen was reviewing existing or possible obligations on the balance sheet, he was told that the outcome for these obligations was uncertain and that the company was awaiting a future event. Jussi Hallonen was reviewing a) accruals. b) going concern. c) materiality. d) contingent liabilities.

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Understand the purpose of and the procedures performed in the review for contingent liabilities and commitments.

Section Reference: 14.3 Contingent liabilities CPA Competency: Audit and Assurance AACSB: Analytic

24. For contingent liabilities, an auditor is not required to review which of the following? a) legal expense accounts for unexpected fluctuations b) minutes of meetings of those charged with governance c) correspondence with taxation authorities d) correspondence with suppliers Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the purpose of and the procedures performed in the review for contingent liabilities and commitments.

Section Reference: 14.3 Contingent liabilities CPA Competency: Audit and Assurance AACSB: Analytic

25. At year-end Faie Bialis sent out accounts receivable confirmations. One of the major customers of her client confirmed the amount of the receivable. After year end, but prior to the issuance of the audit report, the client declared bankruptcy and an aggrieved shareholder of Faie’s client sued her firm. What type of subsequent event was this? a) Type 1 b) Type 2 c) Type 1 and 2 d) this was not a subsequent event Answer: a

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Bloomcode: Application Difficulty: Medium Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic

26. When Nicholas Walker released the audit report of Imperial Corp., he did not anticipate that there would follow an announcement two days later that several days after year end his client’s foreign subsidiary had been nationalized by Libya for non-compliance to environmental laws of the country. What type of subsequent event was this? a) Type 1 b) Type 2 c) Type 1 and 2 d) this was not a subsequent event Answer: b Bloomcode: Application Difficulty: Medium Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic 27. When Kelly Lake was training her staff about the auditor’s responsibility for subsequent events she made the two following statements: (i) Type 2 subsequent events are those events that do not result in changes to financial statements. (ii) Type 1 subsequent events do not require adjustments to financial statements.

Which of the above statements, if any, is true? a) (i) only b) (ii) only c) both (i) and (ii) d) neither (i) nor (ii) Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events

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CPA Competency: Audit and Assurance AACSB: Analytic

28. A subsequent event occurs: a) before the end of the financial year. b) between the client's financial year end and the date of the auditor's report. c) after the auditor completes the tests of controls. d) after the auditor signs the audit engagement letter.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic

29. Which of the following statements is correct regarding a type 1 subsequent event? a) They are events that do not result in changes to amounts in the financial statements. b) They occur before the end of the client's financial year. c) They may be of such significance as to require disclosure in the financial statements. d) The financial statements are adjusted for any material changes in estimates from these types of events.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic

30. Procedures used by an auditor when conducting a subsequent events review include: a) assessing continued compliance with borrowing limits and loan covenants. b) enquiring of those charged with governance as to whether any subsequent events have occurred that may affect the financial statements. c) reading minutes of the meetings of the board of directors. d) all of the answers are correct.

Answer: d

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic

31. Which of the following dates is least relevant when considering subsequent events? a) the date on which the financial statements are approved b) the audit report date c) the date on which the financial statements are issued d) the date the auditor completes the fieldwork Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic

32. Type 1 subsequent events are events that a) occur before the balance sheet date. b) require changes to amounts in the financial statements. c) do not require changes to amounts in the financial statements. d) occur after the end of the financial year and do not affect the financial statements.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic

33. Which of the following is not an example of a type 2 subsequent event? a) the loss of inventory after year end b) the issuance of shares c) the bankruptcy of a credit customer subsequent to year end d) the purchase of a business

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Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic

34. Which of the following is not a procedure used to identify subsequent events? a) obtaining evidence from the entity’s legal representative concerning litigation and claims b) assessing continued compliance with borrowing limits and loan covenants c) performing analytical procedures up to the date of the audit report d) performing preliminary analytical procedures Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic

35. When an error or exception is identified during substantive testing, the first response is to a) qualify the audit report. b) understand why the error or exception has arisen. c) increase the sample size. d) report the error or exception to the audit committee.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Analyze misstatements and explain the difference between quantitative and qualitative considerations when evaluating misstatements.

Section Reference: 14.5 Misstatements CPA Competency: Audit and Assurance AACSB: Analytic

36. Which of the following statements regarding judgemental misstatements is incorrect? a) They are the same as errors.

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b) They can arise as a result of a difference in underlying assumptions by the client and the auditor. c) They are not the same as errors. d) They can arise as a result of a difference in the application of judgment by the client and the auditor.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Analyze misstatements and explain the difference between quantitative and qualitative considerations when evaluating misstatements.

Section Reference: 14.5 Misstatements CPA Competency: Audit and Assurance AACSB: Analytic

37. Which of the following are examples of qualitative considerations that may cause misstatements of quantitatively immaterial amounts to be considered material? a) the client's compliance with contractual requirements of operating or other agreements b) key ratios monitored by analysts or other key users of the financial statements c) both a and b d) error in the amount of contingent liabilities recorded by the client Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Analyze misstatements and explain the difference between quantitative and qualitative considerations when evaluating misstatements.

Section Reference: 14.5 Misstatements CPA Competency: Audit and Assurance AACSB: Analytic

38. The final phase of an audit includes which of the following? a) performing substantive tests of account balances b) gaining an understanding of the client's internal control system c) confirming the terms of the audit engagement with the auditor d) determining whether the audit evidence obtained is sufficient and appropriate to reduce the risk of material misstatements in the financial statements to an acceptably low level Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate conclusions obtained during the performance of the audit and explain how these conclusions link to the overall opinion formed on the financial statements.

Section Reference: 14.6 Evaluating the conclusions and forming an opinion

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CPA Competency: Audit and Assurance AACSB: Analytic

39. Which of the following is not a step in forming an opinion on the financial statements? a) evaluation of the audit evidence obtained b) evaluation of the effects of unrecorded misstatements c) evaluating the fair presentation of the financial statements d) obtaining a signed engagement letter Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Evaluate conclusions obtained during the performance of the audit and explain how these conclusions link to the overall opinion formed on the financial statements.

Section Reference: 14.6 Evaluating the conclusions and forming an opinion CPA Competency: Audit and Assurance AACSB: Analytic

40. When an auditor expresses an unqualified audit opinion, it indicates the a) entity has complied with the reporting obligations as required by CPAB. b) internal controls of the entity are operating efficiently and effectively. c) financial statements are accurate in all respects. d) financial statements have been prepared in accordance with an applicable accounting framework.

Answer: d Bloomcode: Application Difficulty: Medium Learning Objective: Evaluate conclusions obtained during the performance of the audit and explain how these conclusions link to the overall opinion formed on the financial statements.

Section Reference: 14.6 Evaluating the conclusions and forming an opinion CPA Competency: Audit and Assurance AACSB: Analytic

41. The components of an audit report include all of the following except a) title, address, and introductory paragraph. b) management’s responsibility for the financial statements. c) a statement that accounting estimates are reasonable. d)basis for opinion.

Answer: c Bloomcode: Knowledge

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Difficulty: Easy Learning Objective: Describe the components of an audit report.

Section Reference: 14.7 Components of the audit report CPA Competency: Audit and Assurance AACSB: Analytic

42. Management's responsibilities for the financial statements do not include which of the following? a) selecting and applying appropriate accounting policies b) expressing an opinion on the financial statements c) establishing and maintaining internal controls d) making reasonable accounting estimates Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the components of an audit report.

Section Reference: 14.7 Components of the audit report CPA Competency: Audit and Assurance AACSB: Analytic

43. Which of the following are included in the components of the auditor's report? a) management's responsibility for the financial statements b) the client’s opinion on whether the financial statements are fairly presented c) the date of the completion of the fieldwork d) any internal control deficiencies Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the components of an audit report.

Section Reference: 14.7 Components of the audit report CPA Competency: Audit and Assurance AACSB: Analytic

44. Which of the following would not be included in an audit report? a) The auditor's address b) Opinion paragraph c) The audit fee charged to the client d) Management’s responsibility for the financial statements Answer: c

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Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the components of an audit report.

Section Reference: 14.7 Components of the audit report CPA Competency: Audit and Assurance AACSB: Analytic 45. When May Flower was unable to perform work on inventory because of a client’s insistence that she not perform an inventory taking, what kind of audit opinion would she most likely consider? a) adverse opinion b) emphasis of matter c) limitation of scope d) disclaimer of opinion Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance AACSB: Analytic

46. When Olga Shapiro mentioned that the financial statements were materially misstated, what kind of opinion was this? a) disclaimer b) emphasis of matter c) adverse d) limitation of scope Answer: c Bloomcode: Application Difficulty: Medium Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance AACSB: Analytic 47. Joshua Hanson knew that his client’s financial statements were misstated but the misstatement was not pervasive. What kind of audit report was he considering? a) qualified opinion b) emphasis of matter c) compilation

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d) unqualified opinion Answer: a Bloomcode: Application Difficulty: Medium Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance AACSB: Analytic

48. If it is not possible to obtain sufficient appropriate audit evidence, the auditor should: a) express an adverse opinion. b) express a qualified or disclaimer of opinion. c) report the client to CPA Canada. d) express an unqualified opinion with an emphasis of matter.

Answer: b Bloomcode: Knowledge Difficulty: Easy Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance AACSB: Analytic

49. If the auditor is not able to obtain sufficient appropriate audit evidence, the appropriate audit opinion will either be: a) a qualified opinion or an unqualified opinion. b) a disclaimer of opinion or an emphasis of matter. c) a qualified opinion or disclaimer of opinion. d) an emphasis of matter or a qualified opinion.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance AACSB: Analytic

50. A limitation on the scope of the auditor's work may result from: a) damage to accounting records. b) lack of access to key personnel.

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c) absence of adequate accounting records. d) all of the answers are correct.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance AACSB: Analytic

51. Material disagreements with management will result in either: a) a qualified opinion or adverse opinion. b) an emphasis of matter or adverse opinion. c) an adverse opinion or an unqualified opinion. d) an unqualified opinion or a qualified opinion.

Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance AACSB: Analytic

52. Which of the following is not an area of disagreement with those charged with governance that may result in a modified audit opinion? a) the acceptability of accounting policies selected b) the terms of the audit engagement c) the method of application of accounting policies d) the adequacy of disclosures in the financial statements Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance AACSB: Analytic

53. A key audit matter is: a) a qualified report.

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b) specific to the entity and highlight matters that, in the auditor’s professional judgement, were of most significance in the audit of the financial statements of the current period. c) never permitted in Canada. d) a key performance indicator.

Answer: b Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance AACSB: Analytic

54. The auditor's report will not require a modified opinion where: a) there is a disagreement with those charged with governance. b) a limitation of scope of the engagement exists. c) a significant uncertainty exists. d) the financial statements are presented fairly.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance AACSB: Analytic

55. Which items are matters of governance interest that an auditor would wish to discuss with those charged with governance? a) the general approach and overall scope of the audit b) the potential effect on the financial statements of any material risks and exposures c) material uncertainties related to events and conditions that may cast significant doubt on the entity’s ability to continue as a going concern d) all of the answers are correct Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain what reporting is required to management and those charged with governance.

Section Reference: 14.9 Communication with those charged with governance CPA Competency: Audit and Assurance AACSB: Analytic

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56. Those charged with governance are accountable for ensuring that the entity achieves its objectives with regard to which of the following? a) compliance with applicable laws b) the level of inventory held c) the amount of cash in the bank d) their fiduciary duties Answer: a Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain what reporting is required to management and those charged with governance.

Section Reference: 14.9 Communication with those charged with governance CPA Competency: Audit and Assurance AACSB: Analytic

57. Matters of governance interest that the auditor may wish to discuss with those charged with governance include: a) any practical difficulties encountered in performing the audit. b) the potential effect on the financial statements of any material risks and exposures. c) expected modifications to the audit report. d) all of the answers are correct.

Answer: d Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain what reporting is required to management and those charged with governance.

Section Reference: 14.9 Communication with those charged with governance CPA Competency: Audit and Assurance AACSB: Analytic

58. Governance relates to a) the responsibility of the audit committee and its relationship to the auditor. b) the responsibility of those charged with governance regarding compliance with GAAP. c) responsibilities ensuring that the entity achieves its objectives regarding reliability of financial statements, effectiveness and efficiency of operations, and compliance with laws. d) the day-to-day operating activities of the entity.

Answer: c Bloomcode: Knowledge

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Difficulty: Easy Learning Objective: Explain what reporting is required to management and those charged with governance.

Section Reference: 14.9 Communication with those charged with governance CPA Competency: Audit and Assurance AACSB: Analytic

59. An auditor may prepare or provide an opinion on information other than general purpose financial statement information, on all the following engagements except a) reports prepared in accordance with a special purpose framework. b) reports on a component of the financial statements. c) reports on the expected market value of the share price for the following five years. d) reports on compliance with contractual agreements.

Answer: c Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the various types of other engagements that auditors may be asked to perform.

Section Reference: 14.10 Other engagements CPA Competency: Audit and Assurance AACSB: Analytic

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SHORT ANSWER QUESTIONS 60. Indicate whether you agree or disagree with the following statements and explain your reasoning. a)

Kyle Harris, the senior auditor at James & Juniper LLP made the following statement to his audit team: “What constitutes sufficient appropriate audit evidence is a matter of judgement.”

b)

Pompei Foods Company operates as a specialty food distributor. Jacques Vincent, auditor, has told his staff that the bankruptcy of a credit customer at year end should not be considered a type 1 event.

c)

Winnipeg Ice Wolves auditor Lise Parenteau found an omission of a disclosure in the financial statements of the hockey team. She called this an error.

d)

Eileen Keen was told by the client that a limitation in the scope of her work would require a modification to the audit report.

Answer: a) Agree. What constitutes sufficient appropriate evidence is ultimately a matter of professional judgement. It will be based on the satisfactory performance of audit procedures designed to address the assessed risk of material misstatement. b)

Disagree. Type 1 subsequent events require changes of amounts in the financial statements. This includes bankruptcies of credit customers subsequent to year end, which would be considered when evaluating the adequacy of the allowance for doubtful accounts.

c)

Agree. An error is an unintentional misstatement in the financial misstatements, including the omission of an amount or a disclosure.

d)

Agree. The opinion paragraph requires modification under different circumstances.

A limitation in the scope of the engagement is one valid reason for qualifying the audit report.

Bloomcode: Application Difficulty: Medium Learning Objective: Explain the procedures performed as part of the engagement wrap-up, including gathering and evaluating audit evidence.

Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Learning Objective: Analyze misstatements and explain the difference between quantitative and qualitative considerations when evaluating misstatements.

Learning Objective: Identify the types of modifications to an audit report.

Section Reference: 14.1 Engagement wrap-up Section Reference: 14.4 Subsequent events Section Reference: 14.5 Misstatements Section Reference: 14.8 Identification of the types of modifications to an audit report CPA Competency: Audit and Assurance

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AACSB: Analytic

61. Discuss the factors that are relevant when management is assessing the going concern assumption.

Answer: The following factors are relevant when management is assessing the going concern assumption: a)

Generally, the further into the future an event is likely to take place, the greater the uncertainty surrounding that event. For that reason, most financial reporting frameworks specify the period management is required to assess all available information when making their going concern assessment. In Canada, this is typically 12 months from the date of the directors' report and audit opinion.

b)

Any judgement about the future is based on information available at the time at which the judgement is made. Subsequent events can contradict a judgement that was reasonable at the time it was made. Management of clients in industries subject to frequent change face more difficulty when assessing the going concern assumption.

c)

The size and complexity of the entity, the nature and condition of its business, and the degree to which it is affected by external factors all affect judgement regarding the outcome of events or conditions.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the considerations when assessing the going concern assumption used in the preparation of the financial statements.

Section Reference: 14.2 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

62. Describe two procedures that are necessary for the auditor to perform with respect to contingent liabilities.

Answer: Procedures necessary for the auditor to perform with respect to contingent liabilities include the following: - Inquire of management and others within the entity, including in-house legal counsel, if there are any unreported contingent liabilities.

- Review minutes of meetings of those charged with governance and correspondence between the entity and its external legal counsel.

- Review correspondence with taxation authorities.

- Review legal expense accounts for unexpected fluctuations.

- Include in the management representation letter the fact that all contingent liabilities have been disclosed to the auditor.

Bloomcode: Application Difficulty: Medium

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Learning Objective: Understand the purpose of and the procedures performed in the review for contingent liabilities and commitments Section Reference: 14.3 Contingent liabilities CPA Competency: Audit and Assurance AACSB: Analytic

63. Describe two procedures used by the auditor in conducting a review for subsequent events.

Answer: Procedures used by the auditor in conducting a review for subsequent events include the following: - Gaining an understanding of and evaluating processes that management has established to determine that subsequent events are identified and dealt with.

- Inquiring of those charged with governance as to whether any subsequent events have occurred that might affect the financial statements.

- Inquiring of management whether new commitments, borrowings, or guarantees have been entered into or any other factors have changed the classification of any liabilities.

- Assessing continued compliance with borrowing limits and loan covenants.

- Inquiring of management whether any assets have been seized (or appropriated) by the government or destroyed - for example, by flood or fire Bloomcode: Application Difficulty: Medium Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any) Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic

64. Explain the difference between type 1 and type 2 subsequent events and provide examples of each type of event.

Answer: Type 1 subsequent events are events that can affect the estimates inherent in the financial statements or indicate that the going concern assumption in relation to the whole or a part of the entity is not appropriate. The financial statements are adjusted for any material changes in estimates resulting from these types of events up to the date of the auditor's report.

Examples of type 1 subsequent events (that require changes of amounts in the financial statements) include: a)

the bankruptcy of a customer subsequent to year end, which would be considered when evaluating the adequacy of the provision for uncollectible trade receivables,

b)

an amount received in respect of an insurance claim that was in the course of negotiation as at year end,

c)

deterioration in operating results and financial position after year end that is so significant that it may indicate the going concern assumption is not appropriate to use in the preparation of the financial statements.

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Type 2 subsequent events are those events that do not result in changes to amounts in the financial statements. However, these events may be of such significance as to require disclosure in the financial statements. Examples of type 2 subsequent events (that do not require adjustment but may require disclosure in the financial statements) include: a)

the uninsured (or underinsured) loss of plant or inventory as a result of a fire or flood subsequent to year end,

b)

the purchase of a business,

c)

the issuance of shares or debt securities.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Compare the two types of (material) subsequent events to determine what effect they have on the financial statements (if any).

Section Reference: 14.4 Subsequent events CPA Competency: Audit and Assurance AACSB: Analytic

65. Identify quantitative and qualitative considerations that are taken into account when the auditor evaluates whether misstatements cause financial statements to be materially misstated or if they require additional disclosure.

Answer: Examples of quantitative and qualitative considerations to be taken into account include: a) the risk of additional misstatements remaining undetected b)

the effects of identified misstatements on the client's compliance with covenants under debt or similar agreements

c)

whether the proposed corrections result from an error or are the result of a judgemental misstatement between the client's and the auditor's application of accounting policies

d)

the turnaround effect on the current year's financial statements of uncorrected misstatements identified in the prior year

e)

the likelihood that recurring differences, which currently are immaterial, will have a material effect in the future

f)

the sensitivity of the circumstances surrounding the misstatements, for example, the implications of differences involving fraud and possible illegal acts, or violations of contractual provisions

g)

the significance of the financial statement elements affected by the misstatements

h)

the significance of the misstatements relative to known user needs, for example, the magnifying effects of the misstatements on the calculation of a purchase price in a transfer of interests (buy/sell agreement)

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i)

the effect of the misstatements on segment information or on another portion of the client's business that has been identified as playing a significant role in the client's operations or profitability

j)

the effects of offsetting misstatements in different financial statement captions (or balance sheet names within the financial statements, for example, cash at bank, prepayments, payables)

Bloomcode: Application Difficulty: Medium Learning Objective: Analyze misstatements and explain the difference between quantitative and qualitative considerations when evaluating misstatements.

Section Reference: 14.5 Misstatements CPA Competency: Audit and Assurance AACSB: Analytic

66. Describe the four steps involved in forming an opinion of the financial statements.

Answer: 1. evaluating the audit evidence obtained 2. evaluating the effects of unrecorded misstatements identified and the qualitative aspects of the entity’s accounting practices 3. evaluating whether the financial statements have been properly prepared and presented in accordance with the applicable reporting framework 4. evaluating the fair presentation of the financial statements Bloomcode: Application Difficulty: Medium Learning Objective: Evaluate conclusions obtained during the performance of the audit and explain how these conclusions link to the overall opinion formed on the financial statements Section Reference: 13.6 Evaluating the Conclusions and Forming an Opinion CPA Competency: Audit and Assurance AACSB: Analytic

67. From the list of responsibilities provided below, classify each as either a responsibility of management or a responsibility of the auditor.

List of responsibilities: 1. expressing an opinion on the financial statements based on the audit 2. establishing and maintaining internal controls relevant to the preparation and fair presentation of the financial statements that are free from material misstatements, whether due to fraud or error 3. selecting and applying appropriate accounting policies 4. stating that the audit was conducted in accordance with auditing standards (including compliance with relevant ethical requirements) 5. describing the audit

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6. making accounting estimates that are reasonable in the circumstances 7. stating that the auditor believes that the audit evidence obtained is sufficient and appropriate to provide a basis for the auditor’s opinion Answer: Responsibility of Management establishing and maintaining internal controls relevant to the preparation and fair presentation of the financial statements that are free from material misstatements, whether due to fraud or error selecting and applying appropriate accounting policies making accounting estimates that are reasonable in the circumstances

Responsibility of the Auditor expressing an opinion on the financial statements based on the audit

stating that the audit was conducted in accordance with auditing standards (including compliance with relevant ethical requirements) describing the audit stating that the auditor believes that the audit evidence obtained is sufficient and appropriate to provide a basis for the auditor’s opinion

Bloomcode: Application Difficulty: Medium Learning Objective: Describe the components of an audit report Section Reference: 13.7 Components of the Audit Report CPA Competency: Audit and Assurance AACSB: Analytic

68. Explain the difference between management's and the auditor's responsibility for the financial statements.

Answer: Management's responsibility includes establishing and maintaining internal controls relevant to the preparation and fair presentation of financial statements that are free from material misstatements, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances.

The auditor must state that the responsibility of the auditor is to express an opinion on the financial statements based on the audit, state that the audit was conducted in accordance with auditing standards (including compliance with relevant ethical requirements), describe the audit and state that the auditor believes that the audit evidence obtained is sufficient and appropriate to provide a basis for the auditor's opinion.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Describe the components of an audit report.

Section Reference: 14.7 Components of the audit report CPA Competency: Audit and Assurance AACSB: Analytic

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69. List five examples of matters of governance interest that the auditor may wish to discuss with those charged with governance.

Answer: Matters of governance interest that the auditor may wish to discuss with those charged with governance include: a) the general approach and overall scope of the audit, including any expected limitations thereon, or any additional requirements b)

the selection of, or changes in, significant accounting policies and practices that have, or could have, a material effect on the entity's financial statements.

c)

the potential effect on the financial statements of any material risks and exposures, such as pending litigation, that are required to be disclosed in the financial statements

d)

misstatements, whether or not recorded by the entity that have, or could have, a material effect on the entity's financial statements

e)

material uncertainties related to events and conditions that may cast significant doubt on the entity's ability to continue as a going concern

f)

disagreements with management about matters that, individually or in aggregate, could be significant to the entity's financial statements or the audit report. These communications include consideration of whether the matter has, or has not, been resolved and the significance of the matter

g)

expected modifications to the audit report

h)

any practical difficulties encountered in performing the audit

i)

any irregularities or suspected non-compliance with laws and regulations that came to the auditor's attention during the audit

j)

comments on the design and operation of the internal controls and suggestions for their improvement, particularly if the auditor has identified material weaknesses in internal control during the audit

k)

any other matters agreed upon in the terms of the audit engagement

Bloomcode: Application Difficulty: Medium Learning Objective: Explain what reporting is required to management and those charged with governance.

Section Reference: 14.9 Communication with those charged with governance CPA Competency: Audit and Assurance AACSB: Analytic

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ESSAY QUESTIONS 70. Explain why the global financial crisis has resulted in the number of potential and actual legal liability insurance claims and explain how auditors can deal with the risk of litigation in tough economic times.

Answer: Answers may vary.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Explain the procedures performed as part of the engagement wrap-up, including gathering and evaluating audit evidence.

Section Reference: 14.1 Engagement wrap-up CPA Competency: Audit and Assurance AACSB: Analytic

71. Explain the potential threats to independence relating to review engagements and how an auditor can safeguard against these threats.

Answer: Answers may vary.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Understand the various types of other engagements that auditors may be asked to perform.

Section Reference: 14.10 Other Engagements CPA Competency: Audit and Assurance AACSB: Analytic

72. Demand for forensic accounting has grown following the collapses of Enron and WorldCom. Explain the important characteristics of forensic accountants and the main techniques they use to investigate fraud.

Answer: Answers may vary.

Bloomcode: Comprehension Difficulty: Easy Learning Objective: Analyze misstatements and explain the difference between quantitative and qualitative considerations when evaluating misstatements.

Section Reference: 14.5 Misstatements CPA Competency: Audit and Assurance AACSB: Analytic

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CASE QUESTION 73. David Davidson, the partner in charge of the Bombardier Aerospace audit, was reviewing the work his team had completed.

Bombardier is a Canadian company. They used to be involved in recreational equipment such as Ski-Doo snowmobiles and Sea-Doo watercraft. Their Aerospace division, however, is probably their best known operating segment and is known as a leading manufacturer of commuter jets containing 50-100 seats.

Bombardier’s operations were by far the largest of the aerospace companies in Montreal and several of the new programs were very ambitious and very risky. It seemed to David that every review he performed had material misstatement possibilities.

David was thinking that an audit of this magnitude was challenging his abilities in evaluating what was sufficient and appropriate audit evidence.

When David started the audit of the current year’s operations, he was surprised with the events that took place in 2015 at the Bourget and Farnborough air shows. The anticipation for Bombardier’s new CSeries aircraft turned out to be less than positive as other manufacturers seemed to pile up the orders. Airbus executives had also been claiming for months that their company’s introduction of a new engine option (NEO) for the A320 narrowbody voided the business case for the CSeries.

Although Bombardier has been able to get commitments up to 100 aircraft, the company is only one-third of the way to its goal of 300 orders for the CSeries scheduled service entry in late 2017. This also still leaves Bombardier 350 aircraft short of the sales required for the project to break even.

As Bombardier attempts to expand its aircraft product line into medium-sized aircraft (100-149 seats), it is entering a space that is getting very close to the market segment dominated by industry giants, Boeing and Airbus. While those companies tend to focus on even larger aircraft, they may want to protect themselves by defending against Bombardier in the mediumsized aircraft segment because Bombardier could later expand into the lucrative large-aircraft segment. Bombardier’s $3.4-billion bet on the market for narrow-bodied aircraft faces a potential threat: a price war instigated by Boeing Co. and Airbus SAS. David Davidson had an uneasy feeling about the viability of the Aerospace sector of the company’s operations.

Required: a) Describe the factors that David Davidson and his firm will have to consider in evaluating the sufficiency and appropriateness of audit evidence at Bombardier Aerospace. b) What factors are relevant when management assesses the going concern issue at Bombardier?

Answer: a) Some of the factors to consider in evaluating sufficiency and appropriateness of audit evidence at Bombardier Aerospace include: • materiality of misstatements • management responses

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previous experience results of audit procedures performed quality of information obtained persuasiveness of the audit evidence whether the evidence obtained supports or contradicts the results of the risk assessment procedures.

If it is not possible to obtain sufficient appropriate audit evidence, David Davidson will have to express a qualified opinion, adverse opinion, or disclaimer of opinion. b)

The following factors are relevant when management is assessing the going concern assumption: • Generally, the further into the future an event is likely to take place, the greater the uncertainty surrounding that event. For that reason, most financial reporting frameworks specify the period management is required to assess all available information when making their going concern assessment. In Canada, this is typically 12 months from the date of the directors' report and audit opinion.

• Any judgement about the future is based on information available at the time at which the judgement is made. Subsequent events can contradict a judgement that was reasonable at the time it was made. Management of clients in industries subject to frequent change face more difficulty when assessing the going concern assumption.

• The size and complexity of the entity, the nature and condition of its business, and the degree to which it is affected by external factors all affect judgement regarding the outcome of events or conditions.

CAS 570 Going Concern requires that the auditor considers the appropriateness of management's use of the going concern assumption in the preparation of the financial statements.

Consideration of management's use of the going concern assumption is based on knowledge of conditions or events obtained through planning and performing the audit.

The auditor considers whether their procedures identify conditions and events that, when considered in the aggregate, indicate there could be substantial doubt about the entity's ability to continue as a going concern.

They also consider whether there are material uncertainties about the entity's ability to continue as a going concern that need to be disclosed in the financial statements.

Usually, material uncertainties relate to an entity's inability to meet obligations as they become due without substantial disposals of assets outside the ordinary course of business, restructuring of debt or equity, or major operational improvements.

Bloomcode: Analysis Difficulty: Medium Learning Objective: Explain the procedures performed as part of the engagement wrap-up, including gathering and evaluating audit evidence.

Learning Objective: Understand the considerations when assessing the going concern assumption used in the preparation of the financial statements.

Section Reference: 14.1 Engagement wrap-up Section Reference: 14.2 Going concern CPA Competency: Audit and Assurance AACSB: Analytic

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Auditing: A Practical Approach, Fourth Canadian Edition

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