The Third Standard of Field Work -- Evidence
1. (c) Analytical review procedures are designed to discover unusual relationships. Answers (a), (b) and (d) are examples of analytical review procedures.
2. (b) Positive confirmation requests ask for a reply whether or not the balance is correct. A negative request asks for a reply only if the balance is incorrect. With a large number of accounts, positive requests are used with large balances and negative requests are used for small balances.
3. (c) The competency (reliability) of evidence depends upon the degree of control exercised over the evidence by the client. The client does not have any control in answers (a), (b) and (d). The client does have control over sales invoices and, thus, it is the least competent.
4. (c) Analytical review procedures are substantive tests. Answer (a) is incorrect because substantive tests do not evaluate a system of internal control, the auditor does. Answers (b) and (d) are incorrect because analytical review procedures are not compliance tests.
5. (a) Trace from source documents to records to ensure all items have been billed.
6. (c) Source document to accounting records.
7. (d) Comparison, trend and ratios are analytical tools used by the auditor to detect unusual transactions.
8. (c) In this case, no one account has a material effect on the balance; thus, negative confirms are in order.
9. (b) The client is not inflating sales or accounts receivable by making fictitious entries.
10. (d) Shipments made after year end were included in customers' year end accounts receivable balances.
Consequently, customers' accounts payable balances at year end were smaller than confirmed.
11. (a) The review of corporate minutes is a standard part of work done in the subsequent period.
12. (b) Verification from an independent third party as to the validity of an account balance.
13. (c) Normally, the auditor would expect most checks to clear during the period from year end to the date of his cut-off bank statement.
14. (b) It is not the auditor's responsibility to supervise the inventory taking, but rather to observe the physical inventory.
15. (c) Client representations in any form (written or oral) must be supported by other audit evidence.
16. (b) Purchase cutoff procedures are designed to determine that items actually received in inventory have been included in the proper period.
17. (b) The question deals with fixed asset disposals. The auditor examines repairs and maintenance accounts to find unrecorded fixed asset additions.
18. (b) The physical inventory was higher than the perpetual record which indicates that inventory was not booked as received or that returns to suppliers were not recorded. Answer (b) meets the criteria for the answer.
19. (a) Cutoff tests are used to determine whether items have been recorded in the proper period. By coordinating cutoff tests with the physical inventory, auditors can determine if the items are physically present.
20. (d) Analytical review procedures are designed to detect unusual fluctuations in financial statement account balances. They are not conclusive evidence in the same respect as confirmation or documentation. The results of these analytical procedures should be investigated, however, if unusual relationships are revealed.
21. (c) Substantive audit procedures include test of balances and analytical procedures. The objectives of analytical procedures is to gather evidence concerning the completeness of the items included in the financial statements, and to indicate unusual fluctuations in account balances that may require more detailed substantive audit procedures.
22. (d) In planning an audit, an auditor is required to prepare written audit programs. These programs should set forth in reasonable detail the audit procedures that the auditor believes are necessary to accomplish the objectives of the audit. Those objectives are to determine whether or not the financial statements are fairly presented in accordance with GAAP. That is, whether or not the financial statement assertions embodied in the financial statement components are fairly stated, in all material respects. The timing and cost-benefit issues presented in answers (a) and (b) have a bearing on audit procedures and audit programs but are not related to establishing audit objectives. Answer (c) is incorrect because audit techniques are selected to meet auditor objectives, not to establish those objectives.
23. (b) There should be a rational relationship between the cost of obtaining evidence and the usefulness of the information obtained. However, when considering competency of evidence, time and cost are not relevant. The three presumptions made about the competency of evidence are presented in answers (a), (c) and (d). (a) The more effective the internal control structure, the more assurance it provides about the reliability of accounting data and financial statements. (c) When evidential matter can be obtained from independent sources outside the entity, it is more competent than evidential matter secured solely within the entity. (d) The independent auditor's direct personal knowledge, obtained through examination, observation, computation, and inspection, is more persuasive than information obtained indirectly.
24. (a) Analytical procedures are required by GAAS in the planning and review stages of an audit. Analytical procedures are substantive audit tests, but as a substantive test they are used to plan the audit and in the final review.
25. (c) The auditor is concerned with unrecorded liabilities as of the balance sheet date (completeness assertion), thus audit procedures performed to identify unrecorded liabilities before the balance sheet date would be meaningless. Accounts receivable may be confirmed prior to the balance sheet date if the auditor concludes internal controls surrounding accounts receivable are effective [answer (b)]. Inventory counts may be observed prior to year if the client maintains perpetual inventory records and the controls surrounding those records are effective [answer (d)].
26. (b) GAAS requires that the auditor must obtain an attorney's letter date as of the last day of field work (audit report date). Information received from the client's attorney may be the basis for an adjustment of the financial statement as of year end or the basis for financial statement disclosures of events occurring during the subsequent period.
27. (c) Before undertaking any audit procedures, the auditor would determine whether omitted procedures constitute the ability to issue an opinion. If the omitted procedures were deemed to be necessary to support the opinion issued, the auditor would attempt to perform such procedures.
28. (a) If transactions are not supported by proper documentation, it may indicate that the transactions are fictitious.
IF so, the financial statements would be materially misstated.
29. (c) The objective of analytical procedures used in the overall review stage of the audit is to assist the auditor in assessing the conclusions reached and in the evaluation of the overall financial statement presentation. Answer (a) refers to substantive tests of details, not analytical procedures. Answer (b) is an objective of analytical procedures used in planning the audit. Answer (d) involves the auditor obtaining information about management's plans and assessing the likelihood that such plans can be implemented; these are not analytical procedures.
30. (a) The purpose of applying analytical procedures in planning the audit is to assist in planning the nature, timing, and extent of auditing procedures that will be used to obtain evidential matter for specific account balances or classes of transactions. To accomplish this, the analytical procedures used in planning the audit should focus on enhancing the auditor's understanding of the client's business and the transactions and events that have occurred since the last audit date, and identifying areas that may represent specific risks relevant to the audit. Answer (b) refers to analytical procedures used as substantive tests.
31. (a) Confirmation of receivables is a generally accepted auditing procedure. The use of positive confirmation requests is preferable when individual account balances are relatively large or when there is reason to believe that there may be a substantial number of accounts in dispute or with inaccuracies or irregularities. The negative form is useful when internal control surrounding accounts receivable is considered to be effective. In this case, although the individual accounts may not be relatively large, the internal control structure is weak and the balances, since they are delinquent, may be in dispute. Answer (c) would be an appropriate procedure but these balances are delinquent, suggesting that there will be limited receipts subsequent to year end. Answer (d) is incorrect because internal evidence is not as competent as external evidence.
32. (c) The amount of interest earned is based on face amount, interest rate, and time period. Since this is a bond investment, the auditor can examine the actual bond instrument and recompute the interest earned. Such evidence, obtained directly by the auditor's recalculation, is very competent. Answers (a) and (d) relate to cash received, not interest earned. Answer (b) would only provide evidence about the interest rate, not the face amount and time period.
33. (a) An auditor reviews a client's sales cut-off to determine if year-end sales are being recorded in the correct period. Sales records are compared with shipping documents. If, assuming title passes at time of shipment, goods were shipped before year end and no sale was recorded as of year end, the auditor will have detected unrecorded sales. Similarly, if a sale was recorded as of year end, but goods were not shipped until the following year, sales would be overstated.
34. (b) A letter of audit inquiry to the client's lawyer is the auditor's primary means of obtaining corroboration of the information furnished by management concerning litigation, claims, and assessments. The matters included in answers (a), (c) and (d) could be covered in a letter of audit inquiry but the primary reason for the request is to provide corroborative evidential matter.
35. (d) In some cases, the corroborating information that can be obtained by the application of auditing procedures other than inquiry is limited. When a client plans to discontinue a line of business, for example, the auditor may not be able to obtain information through other auditing procedures to corroborate the plan or intent. Accordingly, the auditor should obtain a written representation to provide confirmation of management's intent. The client's plans included in the other answers, in comparison to the plans to discontinue a line of business, could be more readily corroborated by other evidence.
36. (b) A primary objective when auditing liabilities is to determine that they are all properly included. Accordingly, the auditor has to search for liabilities that exist as of balance sheet date. In searching for contingent liabilities, the auditor will typically review bank confirmation letters for any indication of direct or contingent liabilities, examine invoices for professional services especially from attorneys who may be working on pending litigation, and read minutes of the board of directors for indications of lawsuits or other contingencies. Answer (b) refers to customer confirmations which are typically used to provide evidence about recorded amounts, not to search for unrecorded items.
37. (d) In determining the scope of work to be performed with respect to possible transactions with related parties, the auditor should obtain an understanding of management responsibilities and the relationship of each component to the total entity. Normally, the business structure is based on the abilities of management, tax and legal considerations, product diversification, and geographical location. Experience has shown, however, that business structure may be deliberately designed to obscure related party transactions. Therefore, when searching for related party transactions the auditor should obtain an understanding of each subsidiary's relationship to the total entity.
38. (b) When an auditor concludes that an auditing procedure considered necessary at the time of the examination was omitted from his examination of financial statements, he should assess the importance of the omitted procedure to his present ability to support his previously expressed opinion. A review of his working papers, discussion of the circumstances, and a reevaluation of the overall scope of the examination may be helpful in making this assessment.
For example, the results of other procedures that were applied may tend to compensate for the one omitted or make its omission less important. Also, subsequent examinations may provide audit evidence in support of the previously expressed opinion. This last comment is not the same as answer (d) which refers to tests of controls in subsequent periods, not audit evidence.
39. (a) The auditor's objective is to obtain sufficient competent evidential matter to provide him with a reasonable basis for forming an opinion. There should be a rational relationship between the cost of obtaining that evidence and the usefulness of the information obtained. In determining the usefulness of evidence, relative risk may properly be given consideration. Also, the auditor's understanding and evaluation of the internal control structure affects the nature, timing, and extent of testing. The matter of difficulty and expense involved in testing a particular item is not in itself a valid basis for omitting the test.
40. (c) If the auditor becomes aware of facts that existed at the report date, he should determine whether the facts would have affected the audit report. If they would have affected his report and people are currently relying on the report, the auditor should advise the client to make appropriate disclosures of the facts and their impact. Answer (a) does not address what the auditor should do regarding the current year's audit. Answers (b) and (d) would be considered only after the auditor determined that the lack of footnote disclosure affected his report.
41. (c) If the auditor decides to give an adverse opinion as a result of the report or findings of a specialist, reference to and identification of the specialist may be made if it will facilitate an understanding of the reason for the modified opinion. When expressing an unqualified opinion, the auditor should not refer to the work or findings of a specialist—regardless of whether or not the specialist's work provided reliable evidence [answer (b)] or the specialist is independent of the client [answer (d)]. Such a reference might be misunderstood to be a qualification of the auditor's opinion or a division of responsibility [answer (a)], neither of which is intended.
42. (c) A negative confirmation requests a response only if the debtor disagrees with the information given; thus, the auditor infers from a nonresponse that the balance is correct. The auditor cannot, however, infer that all nonrespondents have verified their account information. This is not a verification by the debtor because many debtors simply do not respond for reasons other than agreeing with the balance. A positive confirmation requests a response whether or not the debtor is in agreement with the client. The balance is verified only when the debtor responds or the auditor is satisfied by performing other audit procedures. Answers (a) and (b) could apply to positive or negative confirmations. Answer (d) is incorrect because the auditor can statistically quantify the result of either confirmation approach.
43. (a) When auditing notes payable and long-term debt, the auditor should obtain copies of agreements and determine if provisions are being adhered to. If the debt is in the form of bonds, the agreement is the bond trust indenture. Answer (b) does not relate to long-term debt, but short-term payables. Answer (c) refers to interest income, rather than interest expense. Answer (d) deals with existence of bondholders; the auditor is concerned with existence of the debt.