Chapter 4 Audit Evidence and Audit Audit Programs
36
Audit Evidence and Audit Audit Programs MULTIPLE CHOICE:
1.
The The perm perman anen ent t fil file e sec sectio tion n of of the the work workin ing g pap paper ers s tha that t is is kept for each audit client most likely contains a. Review notes pertaining to questions and comments regarding the audit work performed. b. A schedule of time spent on the engagement by each individual auditor. c. Correspondence with the client's legal counsel concerning pending litigation. d. arrative descriptions of the client's internal control policies and procedures A!"#R$
&.
f the the foll follow owin ing g pro proce cedur dures es( ( whi which ch is not not cons consid ider ered ed part part of of )obtaining an understanding of the client*s environment+, a. #-am #-amin inin ing g tra trade de publ public icat atio ions ns to gain gain a bet bette ter r understanding of the client's industry. b. Confi Confirm rmin ing g cus custo tome mer r acc accou ount nts s rec recei eivab vable le for for e-i e-ist sten ence ce and valuation. c. Tour Tourin ing g the the clie client nt's 's man manuf ufac actu turi ring ng and and war wareh ehou ousi sing ng facilities to gain a clearer understanding of operations. d. !tudy !tudyin ing g the the inte interna rnal l con contr trol ols s ove over r cas cash h rec recei eipt pts s and and disbursements. A!"#R$
/.
%
0f worki working ng pape papers rs are are to to have have the the cha chara racte cteri rist stic ics s tha that t will will ensure that they achieve their primary purposes( which of the following is the most important+ a. "orking papers must be of standard format and standard content. b. "orking papers must be properly inde-ed and cross referenced to the draft audit report. c. "orking papers must provide sufficient( competent( and useful information to support the audit report. d. "orking papers must be arranged in logical order following the audit program sequence. A!"#R$
C
37
2.
Chapter 4 Audit Evidence and Audit Audit Programs
"hic "hich h of of the the foll follow owin ing g is is not not an e-am e-ampl ple e of of ana analy lyti tica cal l evidence+ a. Comp Compar ared ed inv inven ento tory ry tur turno nove ver r by ma3 ma3or or cla class ss wit with h the the prior year on a monthly and quarterly basis. b. Comp Compar ared ed gro gross ss pro profi fit t perc percen enta tage ges s by ma3 ma3or or pro produ duct ct classes with the prior year. c. #-am #-amin ined ed invo invoic ices es for for pla plant nt asse asset t add addit itio ions ns to determine whether the client had erroneously recorded ordinary repairs as plant assets. d. #-ami #-amine ned d mon month thly ly perfo perform rman ance ce repo report rts s and and inve invest stig igat ated ed significant variations from budgeted amounts. A!"#R$
4.
Choo Choose se the the bes best t ill illus ustr trati ation on of ob3e ob3ect ctiv ive e aud audit it evid eviden ence ce from the following The paid invoice file containing invoices matched with a. receiving reports and purchase orders. b. 5anagement's assertion that payment procedures require matching of invoice with receiving report and purchase order. c. Clerical staff assurances that management policy regarding payment of invoicesmatching of invoice with receiving report and purchase orderis always followed. d. The treasurer's statement of not remembering any e-ceptions in which an invoice was submitted for payment that was not accompanied by a matching receiving report and purchase order. A!"#R$
6.
C
A
An initi initial al 7fir 7first stt tim ime8 e8 audi audit t req requi uire res s more more audi audit t tim time e to to complete than a recurring audit. ne of the reasons for this is that a. ew audi audito tors rs are are usua usuall lly y ass assig igne ned d to to an an ini initi tial al audi audit. t. b. 9red 9redec eces esso sor r audi audito tors rs need need to be cons consul ulte ted. d. c. The clie client nt's 's busi busines ness( s( indu indust stry ry( ( and and inte intern rnal al cont contro rol l are unfamiliar to the auditor and need to be carefully studied. d. A lar large ger r prop propor orti tion on of cust custom omer er accou account nts s rece receiv ivab able le need to be confirmed on an initial audit. A!"#R$
C
Chapter 4 Audit Evidence and Audit Programs
:.
"hich of the following is a basic tool used by the auditor to control the audit work and review the progress of the audit+ a. Time and e-pense summary. b. #ngagement letter. c. 9rogress flowchart. d. Audit program. A!"#R$
;.
C
f the following audit procedures( which best supports the valuation ob3ective+ a. 9erforming a lower of cost or market test of the client's inventories. b. Reviewing a contingent liability footnote for proper wording. c. !earching for unrecorded liabilities. d. bserving the client's yearend physical inventory taking. A!"#R$
11.
%
As part of audit planning( C9As should design audit programs for each individual audit and should include audit steps and procedures to a. %etect and eliminate fraud. b. 0ncrease the amount of management information available. c. 9rovide assurances that the ob3ectives of the audit are met. d. #nsure that only material items are audited. A!"#R$
1>.
%
An auditor wants to develop an audit test to evaluate the reasonableness of the quantity of scrap material resulting from a certain production process compared to industry standards. "hich would be the most competent type of evidence available to satisfy this ob3ective+ a. %ocumentary. b.
=.
38
A
An assumption underlying analytical procedures is that
39
Chapter 4 Audit Evidence and Audit Programs
a. b.
c.
d.
These procedures cannot replace tests of balances and transactions. !tatistical tests of financial information may lead to the discovery of material errors in the financial statements. The study of financial ratios is an acceptable alternative to the investigation of unusual fluctuations. Relationships among data may reasonably be e-pected to e-ist and continue in the absence of known conditions to the contrary.
A!"#R$ 1&.
An auditor is e-amining accounts receivable. "hat is the most competent type of evidence in this situation+ a. 0nterviewing the personnel who record accounts receivable. b. ?erifying that postings to the receivable account from 3ournals have been made. c. Receipt by the auditor of a positive confirmation. d. o response received for a request for a negative confirmation. A!"#R$
1/.
C
"ith respect to the auditor's planning of a yearend e-amination( which of the following statements is always true+ a. An engagement should not be accepted after the fiscal yearend. b. An inventory count must be observed at the balance sheet date. c. The client's audit committee should not be told of the specific audit procedures that will be performed. d. 0t is an acceptable practice to carry out substantial parts of the e-amination at interim dates. A!"#R$
12.
%
%
A letter to the auditor in response to an inquiry is an e-ample of 9hysical evidence. a. Confirmation evidence. b. %ocumentary evidence. c. d. Analytical evidence.
Chapter 4 Audit Evidence and Audit Programs
A!"#R$ 14.
40
"hich of the following statements about working papers is correct+ "orking papers are not permitted to be used as a a. reference source by the client. The auditor should document the understanding of the b. client's internal control obtained to plan the audit "orking papers may be regarded as a substitute for c. the client's accounting records. "hen reporting on comparative financial statements( d. the independent auditor may discard working papers after two years. A!"#R$
16.
"hich of the following factors is most important in determining the competence of audit evidence+ a. The reliability of the evidence in meeting the audit ob3ective. b. The ob3ectivity of the auditor gathering the evidence. c. The quantity of the evidence obtained. d. The independence of the source of evidence. A!"#R$
1:.
A
The procedures specifically outlined in an audit program are primarily designed to a. 9rotect the auditor in the event of litigation. b. %etect errors or fraud. c. Test internal evidence. d. @ather evidence. A!"#R$
1;.
%
"hen reviewing audit working papers( the primary responsibility of an audit supervisor is to determine
that$ a. b.
c. d.
#ach worksheet is properly identified with a descriptive heading. "orking papers are properly referenced and kept in logical groupings. !tandard departmental procedures are adhered to with regard to work paper preparation and technique. "orking papers adequately support the audit findings( conclusions( and report.
41
Chapter 4 Audit Evidence and Audit Programs
A!"#R$ 1=.
Auditors apply analytical procedures to the client's operations in order to identify a. 0mproper separation of accounting and other financial duties. b. "eaknesses of a material nature in the client's internal control. c. nusual transactions. d. oncompliance with prescribed control procedures. A!"#R$
&>.
A
The incharge auditor decides that work papers are complete a. "hen satisfied that the audit ob3ectives have been met and the working papers support the conclusions. b. "hen working papers make reference to the steps outlined in the audit program. c. nly after the auditor who prepared the working papers has signed and dated them. d. "hen proper crossreferences to other working papers are noted. A!"#R$
&&.
C
"hich of the following workpapers would one normally e-pect to find in the permanent file+ a. A copy of a longterm bond indenture. b. The working trial balance. c. An analysis of additions and disposals relating to marketable securities. d. A workpaper analyBing customer replies to confirmation requests. A!"#R$
&1.
%
A
f the following procedures( which does not produce analytical evidence+ a. Compare revenue( cost of sales( and gross profit with the prior year and investigate significant variations. b. #-amine monthly performance reports and investigate significant revenue and e-pense variances. c. Confirm customers' accounts receivable and clear all material e-ceptions. d. Compare sales trends and profit margins with industry averages and investigate significant differences.
42
Chapter 4 Audit Evidence and Audit Programs
A!"#R$ &/.
Audit evidence can come in different forms with different degrees of persuasiveness. "hich of the following is the least persuasive type of evidence+ a. %ocuments mailed by outsiders to the auditor. b. Correspondence between the auditor and vendors. c. !ales invoices inspected by the auditor. d. Computations made by the auditor. A!"#R$
&2.
C
Analytical procedures are !ubstantive tests designed to evaluate a system of a. internal control. b. Tests of control procedures designed to evaluate the validity of management's representation letter. c. !ubstantive tests designed to evaluate the reasonableness of financial information. d. Tests of control procedures designed to detect errors in reported financial information. A!"#R$
25.
C
C
"hich of the following statements relating to the competence of evidential matter is always true+ #vidential matter gathered by an auditor from a. outside an enterprise is reliable. b. Accounting data developed under satisfactory conditions of internal control are more relevant than data developed under unsatisfactory internal control conditions. c. ral representations made by management are not valid evidence. d. #vidence gathered by auditors must be both valid and relevant to be considered competent. A!"#R$
&6.
%
An auditor test counted a batch of inventory. e-ample of what kind of evidence+ a. Analytical. b. %ocumentary. c. 9hysical. d.
C
This is an
43
&:.
Chapter 4 Audit Evidence and Audit Programs
0n evaluating the reasonableness of advertising e-pense( which of the following would be the best evidence+ ral evidence obtained through discussions with company a. marketing e-ecutives and representatives of the advertising agency retained. b. %ocumentary evidence obtained by vouching charges to the account and by retracing charges from source documents to the account. c. Analytical evidence developed by comparing the ratio of advertising e-penses to sales with historical data for the company and industry. d. Arithmetical evidence developed by recomputing charges submitted by the advertising agency and paid by the company. A!"#R$
&;.
"hich of the following is not a consideration in the development of audit programs+ a. 0nternal control over the recording of plant asset additions and repairs and maintenance e-penditures is found to be weak. b. The client constructed a ma3or addition to its central manufacturing facility during the year under audit. c. The client is a private university located in the 5idwest. d. The client's board or directors is elected by the stockholders at the annual meeting. A!"#R$
&=.
C
%
Audit working papers are used to record the results of the auditor's evidencegathering procedures. "hen preparing working papers( the auditor should remember that working papers should be a. ept on the client's premises so that the client can have access to them for reference purposes. b. The primary support for the financial statements being e-amined. c. Considered as a part of the client's accounting records that are retained by the auditor. d. %esigned to meet the circumstances and the auditor's needs on each engagement. A!"#R$
%
Chapter 4 Audit Evidence and Audit Programs
/>.
The main advantage of properly inde-ed working papers is to a. Reduce the siBe of the file. b. etter organiBe the working papers. c. Allow division of labor within the audit team. d. Dacilitate the efficient use of audit staff. A!"#R$
/1.
"hich of the following is not a typical analytical procedure+ a. !tudy of relationships of financial information with relevant nonfinancial information. b. Comparison of financial information with similar information regarding the industry in which the entity operates. c. Comparison of recorded amounts of ma3or disbursements with appropriate invoices. d. Comparison of recorded amounts of ma3or disbursements with budgeted amounts. A!"#R$
/&.
44
C
"hich of the following is an e-ample of inferential evidence+ a. The auditor observes the taking of the client's physical inventory and performs test counts. b. The auditor inspects marketable securities for e-istence. c. An auditor( who notes that customer accounts receivable have increased significantly in the current year as a percentage of sales( suspects that a larger proportion of the accounts will prove uncollectible. d. The auditor counts cash on hand at yearend. A!"#R$
C
//.
"hich of the following would be least likely to be comparable between similar corporations in the same industry line of business+ a. #arnings per share. b. Return on total assets before interest and ta-es. c. Accounts receivable turnover. d. perating cycle. A!"#R$
A
45
/2.
Chapter 4 Audit Evidence and Audit Programs
"hich of the following is not an e-ample of confirmation evidence+ a. Requesting the client's outside legal counsel to evaluate the possible outcome of pending litigation. b. Euestioning the client's employees about e-isting internal control policies and procedures. c. Requesting the client's customers to verify yearend accounts receivable balances. d. Requesting payees to respond in writing to the terms contained in notes payable appearing in the client's ledger. A!"#R$
/4.
A C9A( in performing an independent audit( would most likely use recalculation as a substantive test for which of the following e-penserelated accounts+ 9urchases of supplies. a. 0nterest e-pense. b. c. Advertising e-pense. d. Repairs and maintenance e-pense. A!"#R$
/6.
%uring the course of an audit engagement( an auditor prepares and accumulates audit working papers. The primary purpose of the audit working papers is to a. Aid the auditor in adequately planning his work. b. 9rovide a point of reference for future audit engagements. c. !upport the underlying concepts included in the preparation of the basic financial statements. d. !upport the auditor's opinion. A!"#R$ /:.
%
"hich of the following is not an appropriate auditing procedure supporting fairness of financial presentation+ a. 0nspecting plant asset additions for e-istence. b. Recalculating accrued interest on notes payable. c. #-amining invoices in support of legal fees recorded during the fiscal year. d. Reviewing the client's production quality control program. A!"#R$
%
Chapter 4 Audit Evidence and Audit Programs
/;.
!ales commissions as a percentage of sales declined significantly during the year under audit. f the following possible causes( the most likely is a. !ales increased during the year. b. The sales force was reduced at the end of the year. c. !ales commission rates were increased at the beginning of the year. d. Dictitious sales were recorded at yearend to inflate earnings. Commissions were not recorded on these sales. A!"#R$
/=.
A
An audit program provides proof that a. !ufficient competent evidential matter was obtained. b. The work was adequately planned. c. There was compliance with generally accepted standards of reporting. d. There was a proper study and evaluation of internal control. A!"#R$
41.
%
"hich of the following is responsible for the fairness of the representations made in financial statements+ a. Client's management. 0ndependent auditor. b. Audit committee. c. d. A0C9A. A!"#R$
2>.
46
"hich of the following ultimately determines the specific audit procedures necessary to provide an independent auditor with a reasonable basis for the e-pression of an opinion+ The audit program. a. The auditor's 3udgment. b. c. @enerally accepted auditing standards. d. The auditor's working papers. A!"#R$
2&.
%uring the working paper review( an audit supervisor finds that the auditor's reported findings are not adequately crossreferenced to supporting documentation. The
47
Chapter 4 Audit Evidence and Audit Programs
supervisor will most likely instruct the auditor to a.
b.
c. d.
9repare a working paper to indicate that the full scope of the audit was carried out. DamiliariBe himFherself with the sequence of working papers so that he7she8 will be able to answer questions about the conclusions stated in the report. #liminate any crossreferences to other working papers since the system is unclear. 9rovide a workpaper inde-ing system that shows the relationship between findings( conclusions( and the related facts.
A!"#R$ 2/.
"hich of the following would be the most relevant form of evidence to evaluate the reasonableness of account balances+ a. Analytical. b. %ocumentary. c. 9hysical. d.
22.
A
5ost of the independent auditor's work in formulating an opinion on the financial statements consists of !tudying and evaluating internal control. a. btaining and e-amining evidential matter. b. c. #-amining cash transactions. d. Comparing recorded accountability with assets. A!"#R$
26.
A
@enerally( what source of evidence should most impact audit conclusions+ a. #-ternal b. 0nquiry. c. ral. d. 0nformal. A!"#R$
24.
%
%uring an audit of the accounts receivable function( you found that the accounts receivable turnover rate had fallen from :./ to 2./ over the last three years. "hat is the most likely cause of the decrease in the turnover rate+
Chapter 4 Audit Evidence and Audit Programs
a. b. c. d.
An increase in the discount offered for early payment. A more liberal credit policy. A change from net /> to net &4. @reater cash sales.
A!"#R$ 2:.
A
"hich of the following does not describe one of the functions of audit workpapers+ a. Dacilitates thirdparty reviews. b. Aids in the planning( performance( and review of audits. c. 9rovides the principal evidential support for the auditor's report. d. Aids in the professional development of the operating staff. A!"#R$
4>.
%
To test for unsupported entries in the ledger( the direction of audit testing should be from the a. Gedger entries. b. Hournal entries. c. #-ternally generated documents. d. riginal source documents. A!"#R$
2=.
"hich of the following is generally included or shown in the auditor's working papers+ The procedures used by the auditor to verify the a. personal financial status of members of the client's management team. b. Analyses that are designed to be a part of( or a substitute for( the client's accounting records. c. #-cerpts from authoritative pronouncements that support the underlying generally accepted accounting principles used in preparing the financial statements. d. The manner in which e-ceptions and unusual matters disclosed by the auditor's procedures were resolved or treated. A!"#R$
2;.
48
%
The principal reason for developing a written audit program is to help assure that the a. Audit work is properly supervised.
49
Chapter 4 Audit Evidence and Audit Programs
b. c. d.
Audit work is properly planned and documented. Audit report contains only significant findings. "ork of different auditors is properly coordinated.
A!"#R$ 41.
ne of the primary roles of an audit program is to$ a. !erve as a tool for planning( directing( and controlling audit work. b. %ocument an auditor's understanding of the internal control. c. 9rovide for a standardiBed approach to the audit engagement. d. %elineate the audit risk accepted by the auditor. A!"#R$
4&.
%
Audit information is generally considered relevant when it is$ a. %erived through valid statistical sampling. b. b3ective and unbiased. c. Dactual( adequate( and convincing. d. Consistent with the audit ob3ectives. A!"#R$
42.
A
The principal purpose for crossinde-ing audit working papers is to a. @ive the working papers a professional appearance. b. #-plain the use of tick marks. c. 9rovide e-planation of the audit steps performed. d. 9rovide a trail for the auditor and the reviewer. A!"#R$
4/.
%
#-ternal auditors often confirm assertions contained in the organiBation's financial statements and accounting records with third parties. "hich of the following best e-plains why confirmation produces evidence of high quality+ a. "ritten assertions from knowledgeable third parties provide sufficient evidence to achieve most audit ob3ectives. b. Confirmation by knowledgeable third parties is usually the most relevant evidence available. c. Confirmation by knowledgeable third parties is usually the least costly evidence available.
Chapter 4 Audit Evidence and Audit Programs
d.
50
Confirmation by knowledgeable third parties is highly competent because of its independent source.
A!"#R$
%
44.
As a category of evidence( documents may be e-ternal or internal. As an auditor reviewing your client's accounts receivable( which of the following is an e-ample of internal documentary evidence+ a. The carrier's bill of lading. b. !ales invoice copies. c. A customer's purchase order. d. A vendor's monthend statement. A!"#R$
COMPLETION: 56.
Audit programs can be developed only after the auditor has completed the audit IIIIIIIIIIIIIII process. A!"#R$
4:.
9GA0@
An auditor who gathers increased quantities of evidence for larger account balances is observing the standard relating to of audit evidence. A!"#R$ !DD0C0#CJ
4;.
An auditor who gathers increased amounts of e-ternal evidence under conditions of weak internal control is observing the standard of of audit evidence. A!"#R$
4=.
0n performing substantive audit tests( focusing on the e-istence or occurrence ob3ective helps locate misstatements due to while the completeness ob3ective directs audit attention to misstatements due to . A!"#R$
6>.
C59#T#C# 7?AG0%0TJ8
C550!!0( 50!!0
#vidence consisting of everything that can be counted( e-amined( observed( or inspected is referred to as IIIIIIIIIIIII evidence.
51
Chapter 4 Audit Evidence and Audit Programs
A!"#R$ 61.
The audit trail consists of that stream of evidence that enables the auditor to trace a transaction or event forward from its inception to the appropriate ledger account( or conversely( vouch a transaction backward from the ledger account to the inception of the transaction or event. Dor the audit trail to e-ist( transactions must be . A!"#R$
6&.
of evidence that auditors' are often first procedures.
C59G#T##!!
5AT<#5AT0CAG
A group of related transactions affecting essentially the same set of general ledger accounts is referred to as a IIIIIIIIIIIIIIIII . A!"#R$
65.
evidence may be the best form the ob3ective( in concerning errors of omission the application of analytical
An auditorprepared bank reconciliation is an e-ample of IIIIIIIIIIIIIII evidence. A!"#R$
62.
%C5#T#%
Analytical supporting suspicions aroused by A!"#R$
6/.
9
TRA!ACT0 CJCG#
The focal point of the current file is the IIIIIIIIIIII IIIIIIIIIIIIIII IIIIIIIIIIIIII often referred to as a table of contents. A!"#R$
"R0@ TR0AG AGAC#
MATCHING:
66. Dor each of the listed auditing procedures( indicate( by letter( the type of evidence it represents. a. b. c. d. e. f.
9hysical evidence Confirmation evidence %ocumentary evidence Analytical evidence 5athematical evidence
52
Chapter 4 Audit Evidence and Audit Programs
IIII 1. Audited clientprepared bank reconciliation IIII &. ?ouched debits to repairs accounts by e-amining invoices
vendors*
IIII /. bserved the client*s yearend physical inventory IIII 2. Compared accounts receivable turnover with industry average IIII 4. 9repared tenyear income summary e-pressing all components as a percentage of sales IIII 6. btained letter from client*s outside legal counsel regarding pending litigation IIII :. 0nquired of corporate treasurer as to reason7s8 for acquiring marketable securities IIII ;. Calculated yearend interest accrual and compared with general ledger balance IIII =. btained replies directly from customers concerning the correctness of client*s recorded yearend accounts receivable balances IIII 1>.#-amined securities purportedly owned by the client and held by local brokers IIII 11.Compared operating cash flows with net income and identified causes of significant disparities. !GT0$ 1. &. /. 2. 4. 6. :. ;. =. 1>. 11. 6:.
e c a d d b f e b a d
Dor each of the listed procedures( indicate( by letter( the
53
Chapter 4 Audit Evidence and Audit Programs
assertion7s8 being tested. a. b. c. d. e.
#-istence or occurrence Completeness Rights and obligations ?aluation or allocation 9resentation and disclosure
IIII 1. Confirmed customer accounts receivable IIII &. ?ouched property additions to underlying documentation consisting of vendors* invoices and work orders IIII /. 0nquired of corporate treasurer as to reasons for buying and holding securities IIII 2.
!elected a sample of bills of lading representing shipments to customers and traced to sales invoices to determine that all shipments have been billed to customers
IIII 4.
#-amined vendors* invoices recorded after yearend to determine whether any of these invoices represent liabilities of the client as of yearend
IIII 6.
btained confirmation of marketable securities from client*s brokers
IIII :.
#valuated the reasonableness of the client*s depreciation policy
IIII ;.
btained letter from client*s outside legal counsel regarding pending litigation
IIII =.
0nspected recorded addition to client materials handling facilities
IIII 1>. 0nvestigated decrease in revenue from scrap sales as revealed by the application of analytical procedures !GT0$ 1. &. /.
a(d d e
Chapter 4 Audit Evidence and Audit Programs
2. 4. 6. :. ;. =. 1>.
54
b b(c a(c(d d e a b
PROBLEME!!A"
6;. Dor each of the following ledger accounts( give an e-ample of substance underlying the account balance$ 1. &. /. 2. 4. 6. :. ;. =. 1>.
Cash in bank !ales revenue 0nventories Accounts payable otes payable Capital stock 5arketable securities perating e-penses "ages and salaries e-pense 9roperty( plant( and equipment
!GT0$ 1. &. /. 2. 4. 6. :. ;.
=. 1>.
ank statement( canceled checks( deposit tickets !ales invoices( shipping documents( cash register tapes @oods in warehouses( goods out on consignment ?endors* records of accounts receivable( vendors* invoices 9ayees* confirmation of amounts owed to them( copy of note in client*s files Records maintained by registrar and transfer agent !ecurities in vault or in safekeeping( brokers* advices( brokers* confirmations ?endors* invoices( canceled checks( client*s workpapers supporting such charges as depreciation( amortiBation( and product warranty 9ayroll summaries( time cards( clock cards( canceled checks( human resources records 9lant assets at various locations( vendors* invoices
6=. Audit evidence must be sufficient and competent. To be competent( the evidence must be both valid and relevant. Required$
55
Chapter 4 Audit Evidence and Audit Programs
a. b.
"hat is meant by )sufficient audit evidence+, %efine the concepts of validity and relevance as they relate to audit evidence.
!GT0$ a. !ufficient audit evidence is evidence that is adequate to support the auditor*s opinion on the financial statements. A matter of audit 3udgment( sufficiency is usually based on materiality and the adequacy of e-isting internal control. b. ?alidity of audit evidence is a function of three qualities$ 18 The independence and competence of the source of the evidence 7e.g.( e-ternal evidence possesses greater validity than internal evidence8K &8 The conditions under which the evidence was obtained 7e.g.( evidence produced by strong internal control possesses greater validity than evidence gathered under weak internal control8K and /8 The manner in which the evidence was obtained 7e.g.( evidence obtained directly by the auditor possesses greater validity than evidence obtained indirectly8. Relevance means that the evidence pertains to specific audit ob3ectives. bserving the taking of the inventory( for e-ample( provides evidence concerning e-istence of the inventory( but is not relevant to determining ownership. :>. The following operating data has been provided to #rica ChaveB by her audit client( @rimes
>& !ales M1;(>>> Cost of sales 1>(>>> !ales commissions 1(>;> @ross profit 6(=&> perating e-penses /(&>> 0ncome before ta-es /(:&> 0ncome ta-es 1(&>> et income M&(4&> NNNNN Required$
L 1>>L
&>>/
L
&&(>>> 11(>>> 1 1>> =(=>> /(6>> 6(/>> &(>>> 2(/>> NNNNN
1>>L
Change 7L8 &&L
56
Chapter 4 Audit Evidence and Audit Programs
a. Complete the vertical and horiBontal analysis by calculating the correct percentages. b. "hy are both vertical and horiBontal analysis important inputs to analytical procedures+ c. Assuming sales commissions have been accurately computed based on &>>/ sales( what are the possible e-planations for any abnormalities produced by your percentage calculations+
!GT0$ a. &>>& !ales M1;(>>> Cost of sales 1>(>>> !ales commissions 1(>;> @ross profit 6(=&> perating e-penses /(&>> 0ncome before ta-es /(:&> 0ncome ta-es 1(&>> et income M&(4&> NNNNN
L 1>>L 46 6 /; 1: &1 : 12 NN
&>>/
L
&&(>>> 11(>>> 1(1>> =(=>> /(6>> 6(/>> &(>>> 2(/>> NNNNN
1>>L 4> 4 24 16 &= = &> NN
Change 7L8 &&L 1> & 2/ 1/ 6= 6: :1
b. Trend analysis 7the )Change, column8 e-amines changes in data over time. @iven the assumption that past trends may be e-pected to continue into the future( significant changes warrant further investigation. ?ertical analysis 7the first two percentage columns8( by e-pressing all components as percentages of a common base 7sales in this case8( permits the auditors to compare percentages with previously developed auditor e-pectations. 0f( for e-ample( the auditor has previously determined that commissions average 6L of sales( heFshe may wish to investigate the lower rate reflected in &>>/ results. c. 0f sales commissions are accurate and represent 6 percent of sales( the sales base must be overstated in order to produce a commission rate of only 4 percent. !ales may have been fabricated( or &>>2 sales may have been recorded in &>>/. The material decline in cost of sales as a percentage of sales
57
Chapter 4 Audit Evidence and Audit Programs
suggests that recorded sales transactions were not accompanied by cost of sales entries. :1. The following financial data have been e-tracted from the records of lackwell "holesale Tires$ &>>/
&>>&
!ales M14(66> Cost of sales :(;>> #nding inventory 6(&>> Accounts receivabletrade &(&>> Total current assets 1&(/>> Total current liabilities :(/>> Customer payment terms$ &F1>KnF/> 0ndustry averages$ @ross margin 41L Current ratio &$1 0nventory turnover &.4 Accounts receivable turnover 11.>
12(=;> :(2>> 2(/>> 1(/>> 1>(1>> 2(=;>
Required$ ased on the above data( in which areas do you recommend concentrating audit resources for the &>>/ audit+ !upport your answer by citing the relevant data. !GT0$ &>>/ !ales Cost of sales @ross margin
M14(66> :(;>> :(;6>
&>>&
4>L
12(=;> :(2>> 4(4;>
2=L
0nventory and accounts receivable appear to warrant emphasis for lackwell "holesale Tires. Although the gross margin has not changed materially in &>>/ relative to &>>& and appro-imates the industry average for both years( inventory turnover has declined significantly and is well below the industry average 71.&4 v. &.48. This suggests the possibility of inflated inventory quantities( incorrect inventory prices( obsolete inventory( or some combination of these. Accounts receivable turnover for &>>&
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Chapter 4 Audit Evidence and Audit Programs
was appro-imately equal to the industry averageK but for &>>/ turnover has declined to appro-imately : times versus 11 times for the industry. @iven payment terms of &F1>KnF/>( one would e-pect a turnover between 11 and 1& times( or appro-imately /> days sales in accounts receivable. A turnover of : times equates with appro-imately 4> days sales in accounts receivable. Dailure to properly investigate customer credit( or weak collection procedures( or inflated accounts receivable are possible e-planations for the decline in turnover. Although the current ratio appears adequate when compared with the preceding year and with the industry average( the quick ratio 7current assets minus inventory divided by current liabilities8 has declined from 1.16 in &>>& to .;2 in &>>/. This suggests a shortterm liquidity problem( especially if inventories are overstated andFor customer accounts receivable are delinquent.
:1.
0dentify the deficiencies in the following audit workpaper$
TRA5"AJ #T#R9R0!#! ank Reconciliation 1&F/1F&>>/ alance per bank Add deposit in transit %educt outstanding checks$
Ad3usted balance
M4(::2 O 1(&&/ P 6(==:
2244
M6: P
22:: 22:; 22:=
1;> P 1(>&/ P // P 1(/>/ M4(4=2
59
Chapter 4 Audit Evidence and Audit Programs
alance per ledger Ad3ustment to correct Ad3usted balance as above
NNNNN M6(/>> 7:>68 M4(4=2 NNNNNN
!GT0$ 1. &. /. 2. 4.
0nitials of preparer and reviewer and dates of preparation and review are missing. ame of bank account being reconciled is omitted. !ubtraction error. Ad3usted balance should be M4(6=2 rather than M4(4=2. Audit ad3ustment of M:>6 not e-plained. Audit legends not e-plained.
