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Auditing: accounts payable, inventory, subsequent events, evidence

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1. Discuss the auditors' approach to the verification of liabilities and assets.

2. Which do you consider the more significant step in establishing strong internal control over accounts payable transactions: the approval of an invoice for payment or the issuance of check in payment of an invoice? Discuss.

3. Discuss how the auditors coordinate the year-end cutoff of accounts payable with their observation of the year-end physical inventory.

4. Discuss the purpose of the auditors' review of cash payments subsequent to the balance sheet date.

5. Discuss what kind of documentary evidence created outside the client's organization is particularly important to the auditors in verifying accrued property taxes.

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1. Discuss the auditors' approach to the verification of liabilities and assets.

The auditors' approach to the verification of liabilities and assets in an audit is said to substantially TEST existence, ownership, and valuation of liabilities and assets. Examples of the approach as referenced by C.M. Chartered Accountants are:

1. Obtaining evidence
The auditor's job, in short, is to provide a professional opinion on the relationship between the assertions in the financial statements and those embodied by generally accepted accounting principles. The auditor must obtain evidence to support his or her opinion on these financial statement assertions. Evidence can come in many forms including:

Evidence Example
? physical evidence ? bank statements and cheques
? testing of calculations to ensure accuracy ? checking of payroll withholding tax calculations
? internal documentary evidence ? minutes of meetings
? accounting records and reports ? general ledger and trial balance
? statements and representations by management and employees ? the letter of representation
? external documentary evidence ? confirmation of accounts receivable with debtors
? statements and representations by third parties ? documents from lawyers
? consistency with other evidence ? ratios and comparisons with industry norms

An auditor does not obtain all of these types of evidence for every financial statement assertion. For example, when attempting to verify an amount receivable the auditor may rely on direct confirmation from the debtor and evidence of payment made after the year end to provide assurance that the receivable both existed and was collectable. The auditor might decide that additional evidence would not be required to prove the assertions.

An auditor's goal is to reduce the risk of audit failure to an appropriately low level. Auditors must use professional judgment in selecting appropriate verification techniques to reach their goal all within an acceptable level of risk. Auditing procedures are designed to minimize three types of risk:

1. Inherent risk
Inherent risk relates to the nature of the transactions, assets and liabilities being audited. Some financial statement items are inherently more susceptible to error or fraud. For example, cash is more susceptible to theft than prepaid expenses or goodwill. Inherent risk is generally identified during the planning process by obtaining or updating knowledge of the organization's business and industry and significant events and transactions occurring during the year under audit.

2. Control risk
Control risk relates to the effectiveness of the organization's internal controls and financial reporting. The organization has the responsibility for establishing sufficient internal control to prevent or detect, on a timely basis, errors resulting from problems in the processing of transactions and the maintenance of accounting records. If the auditor identifies effective internal controls and performs tests to provide evidence of the effectiveness of those controls then he or she can reduce the amount of verification on detailed balances and transactions. The auditor will typically only test internal controls where doing so would reduce the cost of performing the audit or where testing of detailed transactions and balances is not feasible.

3. Detection risk
Detection risk is the risk that the auditor will not identify misstatements in the financial statements. An auditor only reviews a sample of transactions and balances as to test all would be both impractical and prohibitively expensive. ...

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Multiple Choice Auditing questions (annual vacations, misstatements in the expenditure cycle, and more...)

I need help with these multiple choice on Auditing...


1. The audit objective, "The accounts receivable balance represents gross claims on customers and agrees with the sum of the accounts receivable subsidiary ledger" is derived from the assertion of:
a. existence or occurrence.
b. completeness.
c. rights and obligations.
d. valuation or allocation.
e. presentation or disclosure.

2. A company policy states that annual vacations are mandatory for all employees. This policy is most important for employees who:
a. are not bonded.
b. handle cash receipts.
c. maintain the detailed accounting records.
d. have access to the general ledger.
e. serve as inventory clerks.

3. When the positive form of accounts receivable confirmation is used and no response is received, the auditor should normally:
a. assume the account is in error.
b. assume the account is correct.
c. send a second request.
d. send a negative confirmation.
e. contact the customer by telephone.

4. Factors that may contribute to misstatements in the expenditure cycle assertions include all of the following except:
a. there is usually a high volume of transactions.
b. unauthorized purchases and cash disbursements may be made.
c. purchased assets may be appropriated.
d. there may be duplicate payment of vendor's invoices.
e. contentious accounting issues may arise concerning whether a cost should be capitalized or expensed.

5. A trace of the beginning balance for accounts payable to prior year's working papers is a substantive test for:
a. initial procedures.
b. analytical procedures.
c. test of details of transactions.
d. tests of details of balances.
e. presentation and disclosure.

6. In the confirmation of accounts payable, which of the following accounts would be least likely to be selected by the auditor for confirmation?
a. an account with high activity during the year, but a low balance at year end.
b. an account with a vendor who sends a monthly statement.
c. an account with a zero balance.
d. a major vendor used in the prior year, but not in the current year.
e. an account with a debit balance.

7. Observation of inventories is a required audit procedure whenever:
a. inventories are material.
b. inventories are material and it is practicable and reasonable.
c. it is practicable and reasonable.
d. the auditor considers it to be necessary.
e. inventories are material and the auditor considers it to be necessary.

8. During the observation of the inventory, the auditor has no responsibility to:
a. observe the taking of the inventory by client personnel.
b. make some test counts of inventory quantities.
c. supervise the taking of the inventory.
d. make inquiries of the client concerning the inventories.
e. watch for damaged and obsolete inventory items.

9. In companies where inventories are at multiple locations, the auditor's observations ordinarily should include:
a. all inventory locations.
b. a random sample of locations.
c. several inventory locations picked by the auditor.
d. a representative sample of locations.
e. all significant inventory locations.

10. When inventories are material and the auditor does not observe the inventory at or near the year-end, professional standards require the auditor to:
a. thoroughly test the accounting records.
b. observe some physical counts of the inventory.
c. disclaim an opinion on the financial statements.
d. resign from the engagement.
e. re-perform the entire inventory count.

11. A company has a policy that all terminated employees must have an "exit interview" with a member of the personnel department, who documents the discussion. This control relates to the:
a. valuation or allocation assertion.
b. completeness assertion.
c. rights and obligations assertion.
d. presentation or disclosure assertion.
e. existence or occurrence assertion.

12. Completed time tickets and clock cards are sent by:
a. personnel to timekeeping.
b. payroll to timekeeping.
c. timekeeping to payroll.
d. timekeeping to personnel, which forwards them to payroll.
e. timekeeping to payroll, which forwards them to personnel.

13. In assessing control risk in the personnel services cycle, of least concern to the auditor is:
a. payments to fictitious employees.
b. payments to actual employees for hours not worked.
c. failure to pay actual employees for hours worked.
d. payment to actual employees at higher than authorized rates.
e. payments to actual employees for hours worked.

14. Which one of the following is an investing activity?
a. acquiring debt
b. capital leases
c. selling land
d. issuing bonds
e. issuing preferred stock

15. The auditor will normally find evidence concerning the proper authorization of
transactions in the financing cycle by:
a. direct confirmation by the investors.
b. inquiring of the audit committee.
c. inquiring of management.
d. reading the copies of the contracts.
e. reading the minutes of the board of directors meetings.

16. The company officer who is assigned the authority and responsibility for investing transactions should have all of the following characteristics except:
a. is of unquestioned integrity.
b. possesses the knowledge and skills required of a person charged with executing such transactions.
c. has the ability to understand the auditor's procedures relating to investing transactions.
d. realizes the importance of observing all prescribed control procedures.
e. can assist other participating members of management in making initial and ongoing assessments of risks associated with individual investments.

17. Which of the following is correct concerning the inspecting and counting of securities on hand?
a. All securities should be controlled by the auditor until the count is completed.
b. The custodian need not be present during the count.
c. A receipt should be provided by the auditor to the custodian when the securities are returned.
d. The auditor should observe the broker's advice number on the document.
e. The auditor should observe the name of the broker.

18. The control of all funds during the count of cash on hand is meant primarily to prevent:
a. transfers by the client.
b. any chance of double counting.
c. unauthorized disbursements.
d. client personnel from viewing the count procedure.
e. lapping or kiting by the client.

19. In confirming bank deposits, the auditor need not:
a. send two copies of the standard confirmation to the bank.
b. send requests for accounts with zero balances at the end of the year.
c. have the bank return the original to the client.
d. personally mail the requests.
e. make sure the bank returns the response to him or her directly.

20. The auditor may obtain the year-end bank statement directly from the bank and prepare the reconciliation personally. This step is most likely when:
a. the auditor suspects possible material misstatements.
b. it is impracticable to obtain confirmations.
c. detection risk is set at high.
d. detection risk is set at moderate.
e. detection risk is set at low.

21. When material in amount, a bank overdraft should be treated as a:
a. current asset.
b. current liability.
c. current contra-asset.
d. reduction in current assets.
e. reduction in current liabilities.

22. Which of the following is not among the specific auditing procedures the auditor performs to obtain additional audit evidence?
a. making subsequent events review
b. reading minutes of meetings
c. reviewing evidence concerning litigation, claims, and assessments
d. obtaining client representation letter
e. performing analytical procedures

23. By definition, subsequent events occur between:
a. the interim and balance sheet date.
b. the balance sheet date and the report date.
c. the report date and the date the report is issued.
d. the date the report is approved and the date the report is issued.
e. the balance sheet date and the date the report is issued.

24. Which of the following events in a subsequent period is an example of a type 1 subsequent event?
a. issuance of long-term bonds
b. settlement of warranties in excess of recorded amounts
c. purchase of a business
d. issuance of preferred stock
e. casualty loss resulting from a flood

25. Which of the following events in the subsequent period is an example of a Type 2 subsequent event?
a. realization of recorded year-end receivables at a different amount than recorded
b. settlement of recorded year-end estimated product warranty liabilities at a different amount than recorded
c. purchase of a machine
d. purchase of a business
e. sale of equipment

26. Ordinarily, type 1 subsequent events require:
a. adjustment.
b. adjustment and disclosure.
c. a disclaimer.
d. inclusion as a reportable condition.
e. Disclosure.

27. Ordinarily, type 2 subsequent events require:
a. adjustment.
b. adjustment and disclosure.
c. a disclaimer.
d. inclusion as a reportable condition.
e. disclosure.

28. Which of the following subsequent events is least likely to be discovered by reading the minutes of meetings?
a. a new bond issue authorization
b. the payment of a cash dividend.
c. a treasury stock purchase.
d. the discontinuance of a product line.
e. a major increase in the write-off of receivables.

29. The primary source of information about litigation, claims, and assessments is:
a. the board of directors.
b. the client's attorneys.
c. management.
d. direct confirmation with the other party involved.
e. the audit committee.

30. A lawyer's refusal to respond to a letter of audit inquiry normally requires the auditor to:
a. issue a qualified opinion or a disclaimer of opinion.
b. issue an unqualified opinion with an explanatory paragraph.
c. issue a qualified or adverse opinion.
d. issue a standard three-paragraph unqualified opinion.
e. contact the client's in-house attorney for the relevant information.

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