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  1. CHAPTER 13      
  2.  
  3.  
  4. Multiple-Choice Questions
  5.  
  6. 1.
  7. easy    A listing of all the things which the auditor will do to gather sufficient, competent evidence is the:
  8. b       a.      audit strategy.
  9.         b.      audit program.
  10.         c.      audit procedure.
  11.         d.      audit risk model.
  12.        
  13. 2.
  14. easy    Shown below (1 through 5) are the five types of tests which auditors use to determine whether financial statements are fairly stated. Which three are substantive tests?
  15. b       1.      procedures to obtain an understanding of internal control
  16.         2.      tests of controls
  17.         3.      tests of transactions
  18.         4.      analytical procedures
  19.         5.      tests of details of balances
  20.         a.      1, 2, and 3.
  21.         b.      3, 4, and 5.
  22.         c.      2, 3, and 5.
  23.         d.      2, 3, and 4.
  24.        
  25. 3.
  26. easy    Collectively, procedures performed to obtain an understanding of the entity and its environment, including internal controls, represent the auditor’s:
  27. c       a.      audit strategy.
  28.         b.      tests of controls.
  29.         c.      risk assessment procedures.
  30.         d.      tests of transactions.
  31.        
  32. 4.      For efficiency, tests of controls are frequently done at the same time as:
  33. easy    a.      analytical procedures.
  34. c       b.      compliance tests.
  35.         c.      tests of transactions.
  36.         d.      tests of details of balances.
  37.        
  38. 5.
  39. easy    Which of the following procedures are frequently performed in response to the auditor’s assessment of the risk of material misstatement?
  40. d       a.      Analytical procedures
  41.         b.      Tests of transactions
  42.         c.      Tests of details of balances
  43.         d.      All of the above
  44.        
  45. 6.      In which stage(s) of an audit can analytical procedures be performed?
  46. easy    a.      In the planning stage.
  47. d       b.      In conjunction with tests of transactions and tests of details of balances.
  48.         c.      In the completion stage.
  49.         d.      During all three stages.
  50.        
  51.  
  52.  
  53. 7.      Tests of controls may include which of the following types of evidence?
  54. easy    a.      Observation
  55. d       b.      Reperformance
  56.         c.      Observation
  57.         d.      All of the above
  58.        
  59. 8.      The purpose of tests of controls is to provide reasonable assurance that the:
  60. easy    a.      accounting treatment of transactions and balances is valid and proper.
  61. b       b.      internal control procedures are functioning as intended.
  62.         c.      entity has complied with GAAP disclosure requirements.
  63.         d.      entity has complied with requirements of quality control.
  64.        
  65. 9.      In the context of an audit of financial statements, substantive tests are audit procedures that:
  66. easy    a.      may be eliminated under certain conditions.
  67. c       b.      are designed to discover significant subsequent events.
  68.         c.      may be either tests of transactions, tests of balances, or analytical tests.
  69.         d.      will increase proportionately with the auditor’s reliance on internal control.
  70.        
  71. 10.     Which of the following is not useful for obtaining an understanding of internal controls?
  72. medium  a.      Make inquiries of the client’s personnel.
  73. c       b.      Examine documents and records.
  74.         c.      Read industry trade magazines.
  75.         d.      Observe client activities and operations.
  76.        
  77. 11.     A system walkthrough is used to:
  78. medium  a.      test balances.
  79. c       b.      test details of transactions.
  80.         c.      gain an understanding of internal controls.
  81.         d.      achieve all of the above.
  82.        
  83. 12. (Public)    PCAOB Standard 2 _______ the auditor to perform walkthroughs of significant processes.
  84. medium  a.      encourages
  85. b       b.      requires
  86.         c.      does not allow
  87.         d.      permits
  88.        
  89. 13.     The most important consideration in developing the audit plan and audit program is the:
  90. medium  a.      client’s size.
  91. d       b.      client’s industry.
  92.         c.      audit firm’s available personnel.
  93.         d.      the audit risk model used in its planning form.
  94.        
  95. 14.     Tests of controls are directed toward the control’s:
  96. medium  a.      efficiency.
  97. b       b.      effectiveness.
  98.         c.      efficiency and effectiveness.
  99.         d.      cost benefit ratio.
  100.        
  101.  
  102.  
  103. 15.
  104. medium  When the auditor finds that there are missing controls in an area of the accounting system, the audit program in that area would be modified in such a way as to:
  105. d       a.      increase the amount of tests of controls.
  106.         b.      increase the reliance on tests of controls.
  107.         c.      cause the issuance of a qualified or adverse opinion.
  108.         d.      eliminate the need for a test of controls.
  109.        
  110. 16.
  111. medium  A procedure designed to test for monetary misstatements directly affecting the correctness of financial statement balances is a:
  112. b       a.      test of controls.
  113.         b.      substantive test.
  114.         c.      test of attributes.
  115.         d.      monetary-unit sampling test.
  116.        
  117. 17.     Which of the following is not appropriate for purposes of testing the effectiveness of controls?
  118. medium  a.      Make inquiries of client personnel.
  119. b       b.      Evaluate prior experience with the client.
  120.         c.      Observe control-related activities.
  121.         d.      Reperform client procedures.
  122.        
  123. 18.     Which of the following is not a direct result of performing analytical procedures?
  124. medium  a.      Identify areas of potential misstatements.
  125. d       b.      Reduce detailed audit tests.
  126.         c.      Understand the client’s business.
  127.         d.      Identify specific errors in the accounts.
  128.        
  129. 19.
  130. medium  If no material differences are found using analytical procedures and the auditor concludes that misstatements are not likely to have occurred:
  131. a       a.      other tests may be reduced.
  132.         b.      it will be necessary to increase the tests of balances.
  133.         c.      it will not be necessary to perform tests of balances.
  134.         d.      it will be necessary to increase the tests of transactions.
  135.        
  136. 20.     The primary emphasis in most tests of details of balances is on the:
  137. medium  a.      balance sheet accounts.
  138. a       b.      income statement accounts.
  139.         c.      cash flow statement account.
  140.         d.      all of the above.
  141.        
  142. 21.     Analytical procedures are defined in the auditing standards as:
  143. medium  a.      compliance tests.
  144. b       b.      substantive tests.
  145.         c.      tests of controls.
  146.         d.      helpful procedures not possessing the validity of other tests available to the auditor.
  147.        
  148. 22.     Tests of transactions are used to determine whether ___________ have been satisfied.
  149. medium  a.      compliance test requirements.
  150. c       b.      balance coverage requirements.
  151.         c.      transaction-related audit objectives.
  152.         d.      any of the above
  153.        
  154.  
  155.  
  156. 23.     Which of the following statements is not true?
  157. medium  a.      Analytical procedures emphasize the overall reasonableness of transactions and balances.
  158. b       b.      Tests of controls are concerned with evaluating whether controls are sufficiently effective to justify reducing control risk and thereby reducing analytical review procedures.
  159.         c.      Substantive tests of transactions emphasize the verification of transactions recorded in the journals and then posted in the general ledger.
  160.         d.      Tests of details of balances emphasize the ending balances in the general ledger.
  161.        
  162. 24.     Which of the following audit tests is usually the least costly to perform?
  163. medium  a.      Analytical procedures.
  164. a       b.      Tests of controls.
  165.         c.      Tests of balances.
  166.         d.      Substantive tests of transactions.
  167.        
  168. 25.     Which of the following audit tests is usually the most costly to perform?
  169. medium  a.      Analytical procedures.
  170. c       b.      Tests of controls.
  171.         c.      Tests of balances.
  172.         d.      Substantive tests of transactions.
  173.        
  174. 26.     Analytical procedures must be performed in:
  175. medium  a.      the planning and testing stages.
  176. c       b.      conjunction with tests of transactions and tests of details of balances.
  177.         c.      the planning and completion stages.
  178.         d.      the planning, testing and completion stages.
  179.        
  180. 27.     Which of the following tests commonly occur together?
  181. medium  a.      Substantive tests of transactions and tests of controls.
  182. a       b.      Substantive tests of transactions and obtaining an understanding of internal controls.
  183.         c.      Analytical procedures and tests of controls.
  184.         d.      All of the above commonly occur together.
  185.        
  186. 28.     Which of the following relationships between types of tests and audit evidence is not correct?
  187. medium  a.      Tests of details and documentation.
  188. c       b.      Tests of controls and observation.
  189.         c.      Tests of details and observation.
  190.         d.      Substantive tests of transactions and reperformance
  191.        
  192. 29.
  193. medium  Tests of controls are generally viewed as less expensive than tests of details. Which of the following is not a reason that tests of controls are less expensive?
  194. d       a.      Auditors generally make inquiries and observations of the client resulting in little auditor time being invested.
  195.         b.      Tests of controls are often done on a large number of items in a very short period of time.
  196.         c.      Audit software often makes testing controls very easy and fast.
  197.         d.      All of the above are reasons that tests of controls are less expensive than tests of details.
  198.        
  199.  
  200.  
  201. 30.     An increased extent of tests of controls is most likely to occur when:
  202. medium  a.      it is a first-year audit.
  203. c       b.      the auditor is doing a “fraud audit.”
  204.         c.      controls are effective and the preliminary control risk assessment is low.
  205.         d.      controls are ineffective and the preliminary control risk assessment is high.
  206.        
  207. 31.     Many auditors perform extensive analytical procedures on audits because:
  208. medium  a.      they are required by GAAS.
  209. c       b.      they pinpoint errors in accounts.
  210.         c.      they indicate areas of potential risk and misstatement.
  211.         d.      all of the above.
  212.        
  213. 32. (Public)
  214. medium  Which of the following types of procedures will be performed in an audit of internal control over financial reporting?
  215. c       a.      Procedures to obtain an understanding of internal control
  216.         b.      Tests of controls
  217.         c.      Both a and b
  218.         d.      Either a or b, but not both
  219.        
  220. 33.     Tests of details of balances focus on:
  221. medium  a.      beginning of the year balances.
  222. b       b.      end of the year balances.
  223.         c.      transaction details for the period under audit.
  224.         d.      all of the above.
  225.        
  226. 34.     Auditors who test manual controls that rely on IT-generated reports must consider:
  227. medium  a.      the benefits of relying on IT-generated reports.
  228. d       b.      the effectiveness of management’s review.
  229.         c.      the controls related to the accuracy of the information in the report.
  230.         d.      both b and c.
  231.        
  232. 35.
  233. medium  When an auditor believes that analytical procedures indicate a reasonable possibility of misstatement, the auditor may:
  234. c       a.      perform additional analytical procedures.
  235.         b.      decide to modify tests of details of balances.
  236.         c.      either a or b.
  237.         d.      neither a nor b.
  238.        
  239. 36.
  240. medium  If the results of the tests of controls, substantive tests of transactions, and analytical procedures are not consistent with the predictions, tests of details of balances will be:
  241. d       a.      eliminated.
  242.         b.      increased.
  243.         c.      unaffected.
  244.         d.      changed.
  245.        
  246. 37.
  247. medium  When controls are deemed ineffective and assessed control risk is high for a private company, there will be ______ emphasis placed on tests of controls.
  248. a       a.      no
  249.         b.      relatively little
  250.         c.      moderate
  251.         d.      heavy
  252.        
  253.  
  254.  
  255. 38.     Tests of controls address each of the following questions except:
  256. medium  a.      How were the procedures performed?
  257. b       b.      Why were the procedures performed?
  258.         c.      Were the necessary procedures performed?
  259.         d.      Who performed the procedures?
  260.        
  261. 39.     Which of the following audit tests would be regarded as a test of controls?
  262. medium  a.      Comparison of the inventory pricing to vendors’ invoices.
  263. b       b.      Tests of the signatures on canceled checks to board of directors’ authorizations.
  264.         c.      Tests of the additions to property, plant, and equipment by physical inspections.
  265.         d.      Review of the specific items making up the balance in a given general ledger account.
  266.        
  267. 40. (Public)
  268. medium  Which of the following tests form the basis for an auditor’s report on internal control over financial reporting?
  269. c       a.      Analytical procedures
  270.         b.      Tests of transactions
  271.         c.      Tests of controls
  272.         d.      Tests of details of balances
  273.        
  274. 41.
  275. medium  After finishing the review phase of the study and evaluation of internal control in an audit, the auditor should perform tests of controls on:
  276. a       a.      those controls that the auditor wants and plans to rely upon.
  277.         b.      those controls in which material weaknesses were identified.
  278.         c.      those controls that have a material effect upon the financial statement balances.
  279.         d.      a random sample of the controls that were reviewed.
  280.        
  281. 42.     At what point in the audit are tests of details most appropriately designed?
  282. medium  a.      Engagement evaluation.
  283. b       b.      Planning.
  284.         c.      Testing.
  285.         d.      Any of the above.
  286.        
  287. 43. (Public)    Which of the following is/are performed in an audit of internal control over financial reporting?
  288. medium  a.      Procedures to obtain an understanding of internal control
  289. c       b.      Tests of controls
  290.         c.      Both a and b
  291.         d.      Either a or b, but not both
  292.        
  293. 44.
  294. medium  The reliance placed on substantive tests in relation to the reliance placed on internal control varies in a relationship that is ordinarily:
  295. b       a.      parallel.
  296.         b.      inverse.
  297.         c.      direct.
  298.         d.      equal.
  299.        
  300. 45.
  301. medium  Which of the following is ordinarily designed to detect possible material dollar errors on the financial statements?
  302. b       a.      Tests of controls.
  303.         b.      Analytical review procedures.
  304.         c.      Computer controls.
  305.         d.      None of the above.
  306.        
  307.  
  308.  
  309. 46.     What type of test is used to more types of evidence than any other?
  310. challenging     a.      Substantive tests of transactions.
  311. d       b.      Tests of controls.
  312.         c.      Analytical procedures.
  313.         d.      Tests of details.
  314.        
  315. 47.     Only _______ involve physical examination and confirmation.
  316. challenging     a.      tests of controls
  317. c       b.      tests of transactions
  318.         c.      tests of balances
  319.         d.      analytical procedures
  320.        
  321. 48.     Documentation is used in every type of test except ________.
  322. challenging     a.      tests of controls
  323. c       b.      tests of transactions
  324.         c.      analytical procedures
  325.         d.      tests of details
  326.        
  327. 49.
  328. challenging     Procedures to obtain an understanding of internal control do not generally provide sufficient evidence that a control is operating effectively, except in the case of:
  329. c       a.      well-defined controls in low risk cycles.
  330.         b.      cycles that contain no significant deficiencies or material weaknesses.
  331.         c.      automated controls.
  332.         d.      all of the above.
  333.        
  334. 50.
  335. challenging     Which of the following types of evidence is not available when using substantive tests of transactions?
  336. b       a.      Documentation.
  337.         b.      Confirmation.
  338.         c.      Inquiries of the client.
  339.         d.      Reperformance.
  340.        
  341. 51.     An exception in a test of control indicates the _______ of misstatements.
  342. challenging     a.      amount
  343. b       b.      likelihood
  344.         c.      amount and likelihood
  345.         d.      neither the amount nor the likelihood
  346.        
  347. 52.     Which of the following is not a valid basis for omitting an audit test?
  348. challenging     a.      the difficulty and expense involved in testing a particular item.
  349. a       b.      the relative risk involved.
  350.         c.      the degree of reliance on the relevant internal controls.
  351.         d.      the relationship between the cost of obtaining evidence and its usefulness.
  352.        
  353. 53.
  354. challenging     Which of the following ultimately determines the specific audit procedures necessary to provide an independent auditor with a reasonable basis for the expression of an opinion?
  355. b       a.      The audit program.
  356.         b.      The auditor’s judgment.
  357.         c.      Generally accepted auditing standards.
  358.         d.      The auditor’s working papers.
  359.        
  360.  
  361. Essay Questions
  362.  
  363. 54.
  364. easy    Contrast the circumstances in which the auditor would choose not to test controls with those in which he or she would perform tests of controls.
  365.  
  366.         Answer:
  367.         If the auditor believes that controls have not been operating effectively during the period under audit, or that it would not be cost-effective to test controls, then he or she would choose not to test controls. In contrast, if the auditor believes that controls have been operating effectively during the period under audit, and that it would be cost-effective to test controls, the auditor will perform tests of controls.
  368.  
  369.  
  370. 55.
  371. easy    Three factors the auditor considers when assessing control risk are: the auditor’s belief concerning the effectiveness of internal controls, the results of tests of controls, and the cost-effectiveness of a reduced assessed control risk. Identify the combination of conditions for these three factors that is required before a reduction in substantive testing is permitted.
  372.  
  373.         Answer:
  374.         A reduction in substantive testing is permitted when (1) the auditor identifies specific controls he or she believes have been operating effectively during the period under audit, (2) the auditor believes it will be cost-effective to test those controls, and (3) the results of tests of controls indicate that the controls have indeed been operating effectively.
  375.  
  376.  
  377. 56.
  378. medium  List each of the five types of audit tests and list at least two types of evidence that may be obtained from each type of test.
  379.  
  380.         Answer:
  381. •     Procedures to obtain an understanding of internal control - documentation, observation, inquiries of the client, and reperformance.
  382. •     Tests of controls - documentation, observation, inquiries of the client, and reperformance.
  383. •     Substantive tests of transactions - documentation, inquiries of the client, and reperformance.
  384. •     Analytical procedures - inquiries of the client and analytical procedures.
  385. •     Tests of details of balances - physical examination, confirmation, documentation, inquires of the client, and reperformance.
  386.  
  387.  
  388. 57.
  389. medium  Must auditors always perform tests of controls?
  390.         Answer:
  391. Auditors only need to perform tests of controls in the audit of a private company if they intend to rely on them. Auditors must always perform tests of controls in the audit of a public company.
  392.  
  393.  
  394.  
  395.  
  396. 58.
  397. medium  Describe the five types of audit tests. Identify which of the five types are substantive tests, and which are used to reduce assessed control risk.
  398.  
  399.         Answer:
  400.         The five types of audit tests used to determine whether financial statements are fairly stated are: procedures to obtain an understanding of internal control, tests of controls, substantive tests of transactions, analytical procedures, and tests of details of balances. Substantive tests of transactions, analytical procedures, and tests of details of balances are substantive tests, whereas procedures to obtain an understanding of internal control and tests of controls are used to reduce assessed control risk.
  401.  
  402.  
  403. 59.
  404. medium  Consider the audit risk model and the five types of audit tests. Which tests provide evidence pertinent to the various elements of the audit risk model?
  405.  
  406.         Answer:
  407.         Evidence can be obtained about control risk via procedures to obtain an understanding of internal controls, tests of controls, and substantive tests of transactions. Evidence can be obtained about planned detection risk via substantive tests of transactions, analytical procedures, and tests of details of balances.
  408.  
  409.  
  410. 60.
  411. medium  Discuss the purposes of (1) substantive tests of transactions, (2) tests of controls, and (3) tests of details of balances. Give an example of each.
  412.  
  413.         Answer:
  414.         The purpose of substantive tests of transactions is to determine whether all six transaction-related audit objectives have been satisfied for each class of transactions. For example, as part of the auditor’s test of the accuracy objective for sales, the auditor would compare the amount recorded in the sales journal for a sample of sales transactions with the total on the corresponding sales invoices.
  415.         The purpose of tests of controls is to determine the effectiveness of both the design and operations of specific internal controls. For example, the auditor might observe for a month whether statements are mailed to all customers.
  416.         The purpose of tests of details of balances is to determine the monetary correctness of the accounts to which they relate. The confirmation of accounts receivable is an example.
  417.  
  418. 61.
  419. medium  There are three stages of the audit in which analytical procedures are performed. Identify each of these three stages and, for each stage, discuss the purpose of performing analytical procedures in that stage. Also indicate in which stage(s) analytical procedures are required by current professional auditing standards.
  420.  
  421.         Answer:
  422.         Analytical procedures are performed in the audit planning stage to help the auditor decide the other evidence needed to satisfy sufficient competent evidence requirements. Analytical procedures can also be performed as substantive tests in the testing phase of the audit. Analytical procedures are performed in the audit completion phase as a final test of reasonableness. Auditing standards require that analytical procedures be performed in the planning and completion phases of every audit.
  423.  
  424.  
  425.  
  426.  
  427. 62.
  428. medium  Discuss the major determinants of the extent of tests of details of balances.
  429.  
  430.         Answer:
  431.         Major determinants of the extent of tests of details of balances include: the results of tests of controls, substantive tests of transactions, and analytical procedures; the amount of tolerable misstatement; and the levels of inherent risk and acceptable audit risk.
  432.  
  433.  
  434. 63.
  435. challenging     What are the four steps auditors follow when they plan to reduce assessed control risk?
  436.         Answer:
  437.         The steps are as follows:
  438. 1.      Apply transaction-related audit objectives to the class of transaction being tested.
  439. 2.      Identify key controls that should reduce control risk for each transaction-related audit objective.
  440. 3.      Develop appropriate tests of controls for all internal controls used to reduce the preliminary assessment of control risk below maximum.
  441. 4.      For potential types of misstatements related to each transaction-related audit objectives, design appropriate substantive tests of transactions, considering deficiencies in internal control and expected results of the tests of controls.
  442.  
  443. 64.
  444. challenging     Discuss the relationship of each of the following to the extent of planned tests of details of balances: (1) tolerable misstatement, (2) inherent risk, (3) control risk, and (4) acceptable audit risk.
  445.  
  446.         Answer:
  447.         Inherent risk and control risk are directly related to the extent of planned tests of details of balances; that is, as inherent risk and/or control risk increase, the extent of planned tests of details of balances also increases. Tolerable misstatement and acceptable audit risk are inversely related to the extent of planned tests of details of balances; that is, as tolerable misstatement and/or acceptable audit risk increase, the extent of planned tests of details of balances decreases.
  448.  
  449.  
  450. 65.
  451. challenging     There are seven types of audit evidence: physical examination, confirmation, documentation, observation, inquiries of the client, reperformance, and analytical procedures. For each of the following types of audit tests, indicate the type(s) of evidence that can be obtained through the test: (1) tests of controls, (2) substantive tests of transactions, (3) analytical procedures, and (4) tests of details of balances.
  452.  
  453.         Answer:
  454. 1.      Tests of controls. Documentation, observation, inquiries of the client, reperformance.
  455. 2.      Substantive tests of transactions. Documentation, inquiries of the client, reperformance.
  456. 3.      Analytical procedures. Inquiries of the client, analytical procedures.
  457. 4.      Tests of details of balances. Physical examination, confirmation, documentation, inquiries of the client, reperformance.
  458.  
  459.  
  460.  
  461.  
  462. 66.
  463. challenging     Discuss the major activities and procedures performed by the auditor in each of the four phases of an audit.
  464.  
  465.         Answer:
  466.         The major activities performed in the planning and design phase (Phase I) are: preplan the engagement; obtain background information about the client; obtain information about the client’s legal obligations; perform preliminary analytical procedures; set materiality, and assess acceptable audit risk and inherent risk; obtain an understanding of internal control, and assess control risk; and develop an overall audit plan and audit program.
  467.         Phase II involves tests of controls, substantive tests of transactions, and an assessment of the likelihood of misstatements in the financial statements.
  468.         Phase III involves analytical procedures and tests of details of balances.
  469.         In Phase IV, the auditor performs the review for contingent liabilities, the review for subsequent events, accumulates final evidence, evaluates results, issues the audit report, and communicates with the client’s audit committee and management.
  470.  
  471.  
  472.  
  473. Other Objective Answer Format Questions
  474.  
  475. 67.
  476. easy
  477. a       One difference between procedures used to obtain an understanding of internal control and procedures used to test controls is that tests of controls are more extensive.
  478. a.      True
  479. b.      False
  480.  
  481. 68.
  482. easy
  483. b       Tests of controls are generally less expensive to perform than analytical procedures.
  484. a.      True
  485. b.      False
  486.  
  487. 69.
  488. easy
  489. a       Tests of controls provide evidence about the potential for misstatements in a client’s accounting system.
  490. a.      True
  491. b.      False
  492.  
  493. 70.
  494. easy
  495. b       Auditing standards encourage, but do not require, a written audit program.
  496. a.      True
  497. b.      False
  498.  
  499. 71.
  500. easy
  501. b       Substantive tests of transactions are the most expensive type of audit test to perform.
  502. a.      True
  503. b.      False
  504.  
  505. 72.
  506. easy
  507. a       An exception in a test of control provides only an indication of the likelihood of monetary misstatements in the financial statements because tests of controls do not reveal whether monetary misstatements have actually occurred.
  508. a.      True
  509. b.      False
  510.  
  511.  
  512.  
  513. 73.
  514. easy
  515. b       An exception in a substantive test of transactions provides only an indication of the likelihood of monetary misstatements in the financial statements because substantive tests of transactions do not reveal whether monetary misstatements have actually occurred.
  516. a.      True
  517. b.      False
  518.  
  519. 74.
  520. easy
  521. a       Analytical procedures are the least expensive type of audit test.
  522. a.      True
  523. b.      False
  524.  
  525. 75.
  526. easy
  527. a       If inherent risk is decreased from medium to low, tests of details of balances can be reduced.
  528. a.      True
  529. b.      False
  530.  
  531. 76.
  532. easy
  533. a       When designing an audit program for tests of details of balances, the auditor should make assumptions about inherent risk and control risk, and predictions concerning the outcome of tests of controls, substantive tests of transactions, and analytical procedures.
  534. a.      True
  535. b.      False
  536.  
  537. 77.
  538. easy
  539. a       The extent of tests of details of balances can be reduced when transaction-related audit objectives have been satisfied by tests of controls or substantive tests of transactions.
  540. a.      True
  541. b.      False
  542.  
  543. 78.
  544. easy
  545. b       Tests of controls and substantive tests of transactions are rarely, if ever, conducted simultaneously on the same transactions.
  546. a.      True
  547. b.      False
  548.  
  549. 79.
  550. easy
  551. b       Under normal circumstances, there should be no variation in the audit evidence mix from cycle to cycle for a given audit engagement.
  552. a.      True
  553. b.      False
  554.  
  555. 80.
  556. medium
  557. a       Auditing standards recognize that in instances where a significant amount of audit evidence is in electronic form, it may not be possible to reduce detection risk to an acceptable level by performing only substantive tests.
  558. a.      True
  559. b.      False
  560. 81.
  561. medium
  562. a       When analytical procedures are performed during substantive testing, they are typically more focused and extensive than when performed as part of audit planning.
  563. a.      True
  564. b.      False
  565. 82.
  566. medium
  567. a       Tests of controls may be performed prior to substantive tests of transactions.
  568. a.      True
  569. b.      False
  570.  
  571.  
  572.  
  573. 83.
  574. medium
  575. b       Tests of details of balances focus on beginning and ending of the year balances.
  576. a.      True
  577. b.      False
  578.  
  579. 84.
  580. medium
  581. a       If tests of controls reveal that controls are sufficiently effective to justify reducing control risk, the auditor is justified in reducing substantive audit tests.
  582. a.      True
  583. b.      False
  584.  
  585. 85.
  586. medium
  587. b       Analytical procedures are the most expensive type of audit test to perform because of the expertise and training required to properly use them.
  588. a.      True
  589. b.      False
  590.  
  591. 86. (Public)
  592. medium
  593. b       PCAOB Standard 2 requires auditors to test controls every three years.
  594. a.      True
  595. b.      False
  596.  
  597. 87.
  598. medium
  599. b       The auditor must communicate significant deficiencies in internal control only after the entire audit is complete to ensure the auditor has a sufficient understanding of the circumstances surrounding the deficiency.
  600. a.      True
  601. b.      False
  602.  
  603. 88.
  604. medium
  605. b       The results of tests of controls and tests of details of balances affect the design of substantive tests of transactions.
  606. a.      True
  607. b.      False
  608.  
  609. 89.
  610. medium
  611. b       If the auditor’s preliminary assessment of control risk is decreased from high to medium, tests of controls can be reduced.
  612. a.      True
  613. b.      False
  614.  
  615. 90.
  616. medium
  617. b       When testing details of balances, most audit procedures satisfy only one balance-related objective, but more than one audit procedure should be used to test each objective.
  618. a.      True
  619. b.      False
  620.  
  621. 91.
  622. medium
  623. b       Substantive tests of transactions and substantive tests of details of balances are often conducted simultaneously.
  624. a.      True
  625. b.      False
  626.  
  627. 92.
  628. medium
  629. b       Auditing standards require that tests of controls be performed on every audit engagement.
  630. a.      True
  631. b.      False
  632.  
  633. 93. (Public)
  634. challenging
  635. a       In the audit of a public company, computer controls must be tested if they are considered to be key controls for reducing the likelihood of material misstatements in the financial statements.
  636. a.      True
  637. b.      False
  638.  
  639.  
  640.  
  641. 94.
  642. challenging
  643. a       Procedures to obtain an understanding of internal control may suffice for tests of controls when the auditor is assessing automated controls.
  644. a.      True
  645. b.      False
  646.  
  647. 95.
  648. challenging
  649. a       Analytical procedures are normally designed at the account level, whereas tests of controls and substantive tests of transactions are normally designed at the transaction-related objective level.
  650. a.      True
  651. b.      False
  652.  
  653. 96.
  654. challenging
  655. b       Procedures to obtain an understanding of internal control may suffice for tests of controls when the auditor is assessing control risk in a well defined transaction cycle that has not contained material misstatements in prior audits.
  656. a.      True
  657. b.      False
  658.  
  659. 97.
  660. challenging
  661. a       Analytical procedures provide fewer types of evidence than any other type of audit test.
  662. a.      True
  663. b.      False
  664.  
  665.  
  666.  
  667.  
  668. CHAPTER 14      
  669.  
  670.  
  671. Multiple-Choice Questions
  672.  
  673. 1.      Which of the following is not an account affected by the sales and collection cycle?
  674. easy    a.      Cash
  675. d       b.      Accounts receivable
  676.         c.      Allowance for doubtful accounts
  677.         d.      Gross margin
  678.        
  679. 2.
  680. easy    Which of the following is not one of the five classes of transactions included in the sales and collection cycle?
  681. d       a.      Sales returns and allowances
  682.         b.      Charge-off of uncollectible accounts
  683.         c.      Bad debt expense
  684.         d.      Depreciation expense
  685.        
  686. 3.      What event initiates a transaction in the sales and collection cycle?
  687. easy    a.      Receipt of cash.
  688. d       b.      Delivery of product to a customer.
  689.         c.      Identification of a new customer.
  690.         d.      Customer request for goods.
  691.        
  692. 4.      A _________ is a document that indicates a request for merchandise by a customer.
  693. easy    a.      sales invoice
  694. c       b.      vendor invoice
  695.         c.      customer order
  696.         d.      sales order
  697.        
  698. 5.
  699. easy    A _________ is a document that communicates the description, quantity, and related information for goods ordered by a customer.
  700. a       a.      sales order
  701.         b.      customer order
  702.         c.      vendor invoice
  703.         d.      sales invoice
  704.        
  705. 6.      What critical event must take place before goods can be shipped?
  706. easy    a.      Determination of correct delivery address
  707. b       b.      Credit approval
  708.         c.      Receipt of cash
  709.         d.      Receipt of sales order from the customer
  710.        
  711. 7.      Before goods are shipped on account, a properly authorized person must:
  712. easy    a.      prepare the sales invoice.
  713. c       b.      approve the journal entry.
  714.         c.      approve the customer’s credit.
  715.         d.      verify that the unit price is accurate.
  716.        
  717.  
  718.  
  719. 8.      A document prepared to initiate shipment of the goods sold is the:
  720. easy    a.      sales order.
  721. b       b.      bill of lading.
  722.         c.      sales invoice.
  723.         d.      customer order.
  724.  
  725. 9.
  726. The document used to indicate to the customer the amount of a sale and payment due date is the:
  727. easy    a.      sales invoice.
  728. a       b.      bill of lading.
  729.         c.      purchase order.
  730.         d.      sales order.
  731.        
  732. 10.     At what point in the sales and collection cycle does the company first give up assets?
  733. easy    a.      Sales approval
  734. d       b.      Credit approval
  735.         c.      Cash collection
  736.         d.      Shipment of goods
  737.        
  738. 11.     Most companies recognize sales revenue when:
  739. easy    a.      sales are invoiced.
  740. c       b.      customer orders are received.
  741.         c.      goods are shipped.
  742.         d.      customer orders are approved.
  743.        
  744. 12.     Which of the following is not a business function within the “Sales” class of transactions?
  745. easy    a.      Processing customer orders.
  746. c       b.      Granting credit.
  747.         c.      Processing and recording sales returns and allowances.
  748.         d.      Shipping goods.
  749.        
  750. 13.     The total of the individual account balances in the accounts receivable master file equals the:
  751. easy    a.      total sales for the period.
  752. d       b.      balance of the sales account in the general ledger.
  753.         c.      total sales less the total cash received for the period.
  754.         d.      balance of the accounts receivable account in the general ledger.
  755.        
  756. 14.
  757. easy    A listing of amounts owed by customer which shows how long each component part has been due is the:
  758. d       a.      trial balance.
  759.         b.      working trial balance.
  760.         c.      accounts receivable trial balance.
  761.         d.      aged accounts receivable trial balance.
  762.        
  763. 15.
  764. easy
  765. b       A document sent to each customer showing his or her beginning accounts receivable balance and the amount and date of each sale, cash payment received, any debit or credit memo issued, and the ending balance is the:
  766.         a.      accounts receivable subsidiary ledger.
  767.         b.      monthly statement.
  768.         c.      remittance advice.
  769.         d.      sales invoice.
  770.        
  771.  
  772.  
  773. 16.     The document that accompanies the customer’s payment is the:
  774. easy    a.      credit memo.
  775. b       b.      remittance advice.
  776.         c.      vendor invoice.
  777.         d.      monthly statement.
  778.        
  779. 17.     The document that supports reductions in accounts receivable is the:
  780. easy    a.      bill of lading.
  781. c       b.      sales invoice.
  782.         c.      credit memo.
  783.         d.      monthly statement.
  784.  
  785. 18.
  786. easy   
  787. A document that initiates shipment of goods and indicates the description of the merchandise, the quantity shipped, and customer name and address is the:
  788. a       a.      bill of lading.
  789.         b.      sales invoice.
  790.         c.      picking ticket.
  791.         d.      vendor invoice.
  792.        
  793. 19.     When designing audit procedures, the direction of tests is a crucial step in satisfying the:
  794. easy    a.      valuation objective.
  795. c       b.      cutoff objective.
  796.         c.      completeness objective.
  797.         d.      classification objective.
  798.        
  799. 20.
  800. easy    Which of the following documents is not commonly associated with the “cash receipts” class of transactions?
  801. b       a.      Remittance advice.
  802.         b.      Sales order.
  803.         c.      Prelisting of cash receipts.
  804.         d.      Cash receipts journal or listing.
  805.        
  806. 21.
  807. easy    The process which postpones entries for the collection of receivables to conceal an existing cash shortage is referred to as:
  808. b       a.      kiting.
  809.         b.      lapping.
  810.         c.      floating.
  811.         d.      shorting.
  812.        
  813. 22.
  814. easy    When sales invoices are automatically calculated and posted by a computer, the auditor may be able to reduce substantive tests of transactions for which, if any, objective?
  815. a       a.      Accuracy
  816.         b.      Existence
  817.         c.      Completeness
  818.         d.      None of the above
  819.        
  820. 23.
  821. easy    The ____________ is a contract between a carrier (e.g., a trucking company) and the seller of goods that dictates the details surrounding the shipment of goods.
  822. a       a.      bill of lading
  823.         b.      sales invoice
  824.         c.      picking ticket
  825.         d.      remittance advice
  826.        
  827.  
  828. 24.
  829. easy    Some companies have customers send payments directly to an address maintained by a bank. This is called a(n) _______ system.
  830. c       a.      direct deposit
  831.         b.      funds transfer
  832.         c.      lockbox
  833.         d.      interbank transfer
  834.        
  835. 25.
  836. medium  In many audits, no substantive tests of transactions are made for the ________ objective on the grounds that understatement of sales is not a concern.
  837. c       a.      accuracy
  838.         b.      existence
  839.         c.      completeness
  840.         d.      none of the above
  841.        
  842. 26.     The most important aspects of the billing function include all but which of the following?
  843. medium  a.      Making sure that all shipments have been billed.
  844. b       b.      Making sure that no shipment has been billed more than twice.
  845.         c.      Making sure that each shipment is billed at the correct amount.
  846.         d.      All of the above are correct.
  847.        
  848. 27.     For the most part, the audit of the sales and collection cycle:
  849. medium  a.      cannot be performed until the audit of cash is completed.
  850. c       b.      must be performed first so that the audit of the other cycles can rely on the data.
  851.         c.      can be performed independently of the audit of other cycles.
  852.         d.      must be performed simultaneously with the audit of the purchases and disbursements cycle.
  853.        
  854. 28.
  855. medium
  856. b       An audit procedure that compares the name, amount, and dates shown on remittance advices with cash receipts journal entries and with related duplicate deposit slips would be effective in detecting:
  857.         a.      kiting.
  858.         b.      lapping.
  859.         c.      illicit write-offs of customers as uncollectible accounts.
  860.         d.      sales without proper credit authorization.
  861.        
  862. 29.     In which of the following will sales return and allowances not be recorded?
  863. medium  a.      Sales returns and allowances transaction file
  864. c       b.      Accounts receivable master file
  865.         c.      Cash receipts journal
  866.         d.      Sales returns and allowances will be recorded in all of the above
  867.        
  868. 30.     For most firms, the function of indicating credit approval is recorded on the:
  869. medium  a.      sales order.
  870. a       b.      sales invoice.
  871.         c.      customer order.
  872.         d.      remittance advice.
  873.        
  874. 31.
  875. medium  The document used as the basis for recording sales transactions and updating the accounts receivable master file is the:
  876. d       a.      sales order.
  877.         b.      bill of lading.
  878.         c.      sales journal.
  879.         d.      sales invoice.
  880.        
  881.  
  882.  
  883. 32.
  884. medium  When posting the sales journal, details of the journal are posted to “x” and journal totals are posted to “y.”
  885. c       a.      x = the sales account. y = the general ledger.
  886.         b.      x = the sales account.  y = the accounts receivable subsidiary ledger.
  887.         c.      x = the accounts receivable master file.  y = the general ledger.
  888.         d.      x = the accounts receivable account in the general ledger.  y = the sales account in the general ledger.
  889.        
  890. 33.     Credit memos are normally issued for what purpose(s)?
  891. medium  a.      To maintain control of returned merchandise.
  892. d       b.      To facilitate record keeping.
  893.         c.      To reduce customer frustration and sales losses.
  894.         d.      Both a and b.
  895.        
  896. 34.     Proper auditing requires that an account receivable must be charged off by the client when:
  897. medium  a.      the customer files for bankruptcy.
  898. d       b.      the account is at least six months old.
  899.         c.      a collection agency cannot inspire customer to pay the debt.
  900.         d.      the client company concludes that an amount is no longer collectible.
  901.        
  902. 35.
  903. medium  Who is generally responsible for opening receipts when a company uses a lockbox to speed the handling of cash receipts?
  904. c       a.      Company personnel.
  905.         b.      Temporary employees in the town where the lockbox is located.
  906.         c.      Bank employees.
  907.         d.      None of the above.
  908.        
  909. 36.     A document used to indicate authority to write an account receivable off as uncollectible is the:
  910. medium  a.      credit memo.
  911. b       b.      uncollectible account authorization form.
  912.         c.      debit memo.
  913.         d.      none of the above.
  914.        
  915. 37.
  916. medium  After the auditor has identified the key internal controls and deficiencies and assessed control risk for a private company, it is appropriate to decide whether:
  917. a       a.      substantive tests will be reduced sufficiently to justify costs of performing tests of controls.
  918.         b.      substantive tests will be increased sufficiently to justify costs of performing tests of controls.
  919.         c.      tests of controls will be increased sufficiently to justify costs of performing substantive tests.
  920.         d.      tests of controls will be reduced sufficiently to justify costs of performing substantive tests.
  921.        
  922. 38.
  923. medium  Management’s assertions for sales and collection activities are _____ when sales are generated via e-commerce activities.
  924. a       a.      unchanged
  925.         b.      expanded
  926.         c.      mitigated
  927.         d.      decreased
  928.        
  929.  
  930.  
  931. 39.     To prevent fraud, management should deny cash access to anyone responsible for:
  932. medium  a.      entering sales transactions.
  933. c       b.      entering cash receipts transactions.
  934.         c.      both a and b.
  935.         d.      neither a nor b.
  936.        
  937. 40.     One key internal control to prevent fictitious transactions in the sales and collection cycle is:
  938. medium  a.      to include a list of customer numbers in the computer files.
  939. a       b.      to account for the integrity of the numerical sequence of sales orders.
  940.         c.      to include the sales price list of all products in the computer files.
  941.         d.      having bank reconciliations prepared by one who is independent of the treasury function.
  942.        
  943. 41.     The credit-granting function should be separated from which of the following?
  944. medium  a.      Purchasing function
  945. c       b.      Manufacturing function
  946.         c.      Sales function
  947.         d.      None of the above
  948.        
  949. 42.     Which one of the following statements is true? In deciding on substantive tests of transactions:
  950. medium  a.      some procedures are commonly employed on every audit regardless of the circumstances.
  951. a       b.      all procedures are dependent on the adequacy of the controls and the results of the tests of controls.
  952.         c.      results obtained in the prior year’s audit will not affect the procedures used this year.
  953.         d.      the materiality of the item will not influence the choice of procedures used.
  954.        
  955. 43.     To test for recorded sales for which there were no actual shipments, the auditor traces from the:
  956. medium  a.      bill of lading to the sales journal.
  957. b       b.      sales journal to the bill of lading.
  958.         c.      sales journal to the accounts receivable subsidiary ledger.
  959.         d.      bill of lading to the supporting customer order and sales order.
  960.        
  961. 44.     An effective procedure to test for unbilled shipments is to trace from the:
  962. medium  a.      sales journal to the shipping documents.
  963. b       b.      shipping documents to the sales journal.
  964.         c.      sales journal to the accounts receivable ledger.
  965.         d.      sales journal to the general ledger sales account.
  966.        
  967. 45.     The auditor traces items from the source documents to the journals to satisfy the:
  968. medium  a.      existence objective.
  969. b       b.      completeness objective.
  970.         c.      ownership objective.
  971.         d.      valuation objective.
  972.        
  973. 46.
  974. medium  In many audits of sales transactions, no substantive tests of transactions are performed for the completeness objective because:
  975. b       a.      understatements of assets and income are a greater concern than overstatements.
  976.         b.      overstatements of assets and income are a greater concern than understatements.
  977.         c.      it doesn’t matter if income is understated because the savings on income tax offsets the reduced revenue and net income is correct.
  978.         d.      the unrecorded sales cause a reduction of accounts receivable; therefore, the ratios of the two financial statements will not be misleading.
  979.        
  980.  
  981.  
  982. 47.
  983. medium  To determine that sales are accurately recorded, the unit prices on the duplicate sales invoices are normally compared with:
  984. b       a.      the original invoices.
  985.         b.      an approved price list.
  986.         c.      the amounts recorded in the sales journal for that transaction.
  987.         d.      the amounts posted to the customer’s account in the accounts receivable master file.
  988.        
  989. 48.     Which of the following is not a point at which the auditor deems authorization to be critical?
  990. medium  a.      Authorization of credit.
  991. d       b.      Price authorization.
  992.         c.      Shipment of goods.
  993.         d.      Each of the above is an important point for authorization.
  994.        
  995. 49.     With respect to sales, prenumbered documents are intended to:
  996. medium  a.      prevent the failure to bill or record sales.
  997. c       b.      prevent duplicate billings or recordings of sales.
  998.         c.      both a and b.
  999.         d.      neither a nor b.
  1000.        
  1001. 50.     Prenumbered documents will only be useful for control purposes if:
  1002. medium  a.      a different numerical sequence is used for each company.
  1003. b       b.      the sequence is accounted for periodically.
  1004.         c.      employees do not have access to the complete sequence.
  1005.         d.      all of the above are true.
  1006.        
  1007. 51.     It is important that sales be billed and recorded in the journal as soon as possible after:
  1008. medium  a.      the order is received.
  1009. d       b.      the order is received and credit is approved.
  1010.         c.      credit is approved and it is verified that there is enough inventory to fill the order.
  1011.         d.      the shipment takes place.
  1012.        
  1013. 52.     _______ tests for omitted transactions, while _____ tests for nonexistent transactions.
  1014. medium  a.      Tracing, vouching
  1015. a       b.      Vouching, tracing
  1016.         c.      Verifying, tracking
  1017.         d.      Tracking, verifying
  1018.        
  1019. 53.     The audit procedure referred to as proof of cash receipts is useful to test:
  1020. medium  a.      time lags in making deposits.
  1021. b       b.      whether all recorded cash receipts have been deposited in the bank.
  1022.         c.      whether there are cash receipts that have not been recorded in the journals.
  1023.         d.      all three of the above.
  1024.        
  1025. 54.     Which of the following procedures would ordinarily be best expected to find unrecorded sales?
  1026. medium  a.      Compare shipping documents with sales records.
  1027. a       b.      Apply gross profit rates to inventory disposed of during the period.
  1028.         c.      Trace payments received subsequent to the balance sheet date.
  1029.         d.      Send accounts receivable confirmation requests.
  1030.        
  1031.  
  1032.  
  1033. 55.
  1034. medium  At which point in an ordinary sales transaction would a lack of specific authorization be of least concern to the auditor?
  1035. d       a.      Granting of credit.
  1036.         b.      Shipment of goods.
  1037.         c.      Determination of discounts.
  1038.         d.      Selling of goods for cash.
  1039.        
  1040. 56.
  1041. medium
  1042. b       Smith Manufacturing Company’s accounts receivable clerk has a friend who is also a Smith’s customer. The accounts receivable clerk has issued fictitious credit memos to his friend for goods supposedly returned. The most effective procedure for preventing this activity is to:
  1043.         a.      prenumber and account for all credit memorandums.
  1044.         b.      require receiving reports to support all credit memorandums before they are approved.
  1045.         c.      have independent sales and accounts receivable departments.
  1046.         d.      mail monthly statements to customers.
  1047.        
  1048. 57.
  1049. challenging     Generally, audit evidence gathered from the sales and collection cycle is combined with evidence from other parts of the audit:
  1050. a       a.      as the evidence accumulation process proceeds.
  1051.         b.      only when all fieldwork processes of the engagement are completed.
  1052.         c.      only after the audit of the sales and collection cycle is concluded.
  1053.         d.      after the conclusion of both the cash cycle and the sales and collection cycle.
  1054.        
  1055. 58.
  1056. challenging     Proper separation of duties is useful to prevent various types of misstatements. Which of the following is not an essential separation of duties?
  1057. a       a.      Persons having access to cash should not have access to marketable securities.
  1058.         b.      Separate the credit-granting function from the sales function.
  1059.         c.      Personnel doing internal comparisons should be independent of those entering the original data.
  1060.         d.      Anyone responsible for inputting sales and cash receipts transactions information into the computer should be denied access to cash.
  1061.        
  1062. 59.
  1063. challenging     Which one of the following is not an auditor’s concern about a key authorization point in the sales/collection cycle?
  1064. a       a.      The receiving room must have authorization before releasing items to inventory control.
  1065.         b.      Credit must be authorized before the sale.
  1066.         c.      Goods must be shipped after the authorization.
  1067.         d.      Prices must be authorized.
  1068.        
  1069. 60.
  1070. challenging     Transaction-related audit objectives are essentially the same for processing credit memos as for sales with certain differences. Which of the following are two key differences?
  1071. d       a.      Risk and emphasis on the completeness objective.
  1072.         b.      Materiality and emphasis on the accuracy objective.
  1073.         c.      Risk and emphasis on the classification objective.
  1074.         d.      Materiality and emphasis on the occurrence objective.
  1075.        
  1076. 61.
  1077. challenging     Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this defalcation and be least likely to be detected by an auditor?
  1078. a       a.      Understating the sales journal.
  1079.         b.      Overstating the accounts receivable control account.
  1080.         c.      Overstating the accounts receivable subsidiary ledger.
  1081.         d.      Understating the cash receipts journal.
  1082.        
  1083.  
  1084.  
  1085. 62.
  1086. challenging     Which of the following would be the best protection for a company that wishes to prevent the “lapping” of trade accounts receivable?
  1087. c       a.      Segregate duties so that the bookkeeper in charge of the general ledger has no access to incoming mail.
  1088.         b.      Segregate duties so that no employee has access to both checks from customers and currency from daily cash receipts.
  1089.         c.      Have customers send payments directly to the company’s depository bank.
  1090.         d.      Request that customer’s payment checks be made payable to the company and addressed to the treasurer.
  1091.        
  1092. 63.
  1093. challenging     A proof of cash is not useful in discovering differences in the actual and reported cash balances due to:
  1094. c       a.      deposits in transit.
  1095.         b.      collections on the company’s behalf by the bank which are deposited directly to the   company’s account.
  1096.         c.      cash receipts that were not recorded in the relevant journals.
  1097.         d.      any of the above reasons.
  1098.        
  1099. 64.
  1100. challenging
  1101. b       When designing substantive tests of transactions for sales, the auditor is concerned with the possibility of several types of misstatements. Which of the following is not one of the types of these misstatements?
  1102.         a.      Sales being included in the journal for which no shipment was made.
  1103.         b.      Sales to related parties, such as officers and subsidiaries.
  1104.         c.      Sales recorded more than once.
  1105.         d.      Shipments being made to nonexistent customers and recorded as sales.
  1106.  
  1107. 65.
  1108. challenging    
  1109. An auditor needs to determine whether all customers of an electric utility company are being billed. The auditor should test from the:
  1110. d       a.      sales register to the accounts receivable ledger.
  1111.         b.      sales register to the meter department records.
  1112.         c.      accounts receivable ledger to the sales register.
  1113.         d.      meter department records to the sales register.
  1114.        
  1115. 66.
  1116. challenging     Which one of the following would the auditor consider to be an incompatible operation if the cashier receives remittances from the mailroom?
  1117. c       a.      The cashier prepares the daily deposit.
  1118.         b.      The cashier makes the daily deposit at a local bank.
  1119.         c.      The cashier posts the receipts to the accounts receivable subsidiary ledger cards.
  1120.         d.      The cashier endorses the checks.
  1121.        
  1122.  
  1123.  
  1124. Essay Questions
  1125.  
  1126. 67.
  1127. easy    Explain each of the following types of documents and indicate the class of transactions in which they are commonly used.
  1128. 1.      Customer order
  1129. 2.      Shipping document
  1130. 3.      Remittance advice
  1131. 4.      Sales returns and allowance journal
  1132. 5.      Uncollectible account authorization form
  1133.         Answer:
  1134. 1.      Customer order – request for merchandise by a customer. Appears in the Sales class of transactions.
  1135. 2.      Shipping document – document prepared to initiate shipment of goods, indicating the description of the merchandise, the quantity shipped, and other relevant data. Appears in the Sales class of transactions.
  1136. 3.      Remittance advice – document that accompanies the sales invoice mailed to the customer and can be returned to the seller with payment. Appears in the Cash receipts class of transactions.
  1137. 4.      Sales returns and allowance journal – journal used to record all sales returns and allowances, analogous to the sales journal. Appears in the Sales returns and allowance class of transactions.
  1138. 5.      Uncollectible account authorization form – document used internally to indicate authority to write off an account receivable. Appears in the charge off of Uncollectible accounts class of transactions.
  1139.  
  1140.  
  1141. 68.
  1142. medium  State the five classes of transactions that comprise the sales and collection cycle.
  1143.  
  1144.         Answer:
  1145.         The five classes of transactions that comprise the sales and collection cycle are:
  1146. •     Sales (cash and sales on account)
  1147. •     Cash receipts
  1148. •     Sales returns and allowances
  1149. •     Charge-off of uncollectible accounts
  1150. •     Bad debt expense.
  1151.  
  1152. 69.
  1153. medium  Customer billing is a critical process which auditors must understand. What are the most important aspects of billing and what are the related objectives?
  1154.  
  1155.         Answer:
  1156.         The most important aspects of billing are:
  1157. •     To make sure that all shipments made have been billed (completeness),
  1158. •     That no shipment has been billed more than once (occurrence), and
  1159. •     That each shipment is billed for the proper amount (accuracy).
  1160.  
  1161.  
  1162.  
  1163. 70.
  1164. medium  When assessing planned control risk for sales, the auditor is concerned about proper authorization at three key points. Discuss each of these three points.
  1165.  
  1166.         Answer:
  1167.         Credit should be properly authorized before a sale takes place; goods should be shipped only after proper authorization; and prices, base terms, freight, and discounts must be properly authorized.
  1168.  
  1169.  
  1170. 71.
  1171. medium  When testing the occurrence objective for sales, the auditor is concerned with the possibility of three types of misstatements. One type is sales being included in the journal for which no shipment was made. Discuss the other two types of misstatements.
  1172.  
  1173.         Answer:
  1174.         The auditor is also concerned with the possibility of (1) shipments being made to nonexistent customers and recorded as sales, and (2) sales being recorded more than once.
  1175.  
  1176.  
  1177. 72.
  1178. medium  Explain what lapping means, and discuss the internal control deficiency that allows it to occur. Also discuss the procedures the auditor can perform to detect lapping.
  1179.  
  1180.         Answer:
  1181.         Lapping, which is a common type of defalcation, is the postponement of entries for the collection of receivables to conceal an existing cash shortage. It involves deferring recording the cash receipts from one customer and covering the shortages with subsequent receipts from another customer. Improper segregation of duties in which a person who handles cash receipts is allowed to enter those receipts into the accounting records allows lapping to occur. The auditor can detect lapping by comparing the name, amount, and dates shown on remittance advices with cash receipts journal entries and related deposit slips.
  1182.  
  1183.  
  1184. 73.
  1185. challenging     Discuss the four business functions that result in sales transactions in a typical sales and collection cycle and, for each function, state the key documents and records involved.
  1186.  
  1187.  
  1188. Answer:
  1189.         The four business functions that result in sales transactions, and related documents and records, are:
  1190. •     Processing customer orders. Key documents include customer order and sales order.
  1191. •     Granting credit. Customer order or sales order.
  1192. •     Shipping goods. Shipping document (bill of lading).
  1193. •     Billing customers and recording sales. Sales invoice, sales journal, summary sales report, accounts receivable master file, accounts receivable trial balance, and monthly statements.
  1194.  
  1195.  
  1196.  
  1197. 74.
  1198. challenging     When designing substantive tests of transaction for Sales, the auditor is concerned with several types of misstatements. What are these types of misstatements and are they intentional or unintentional?
  1199.  
  1200.         Answer:
  1201. The auditor is concerned with sales being included in the journals for which no shipment was made, sales recorded more than once, and shipments being made to nonexistent customers and recorded as sales. The first two types of misstatements can be intentional or unintentional, but the third type is always intentional.
  1202.  
  1203.  
  1204. 75.
  1205. challenging     For each of the following potential misstatements, provide one potential audit test that could be used to detect the misstatement.
  1206. •     Recorded sale for which there was no shipment
  1207. •     Sale recorded more than once
  1208. •     Shipment made to nonexistent customers
  1209.         Answer:
  1210.         The potential audit tests include the following:
  1211. •     Recorded sale for which there was no shipment. Vouch selected entries in the sales journal to related copies of shipping and other supporting documents.
  1212. •     Sale recorded more than once. Review a numerically sorted list of recorded sales transactions for duplicate numbers. The auditor may also test for proper cancellation of shipping documents.
  1213. •     Shipment made to nonexistent customers. Trace customer information on sales invoices to the customer master file.
  1214.  
  1215.  
  1216. 76.
  1217. challenging     If sales invoices are automatically calculated and posted by a company’s computer system, can the auditor reduce substantive tests of transactions for the accuracy objective?
  1218.  
  1219.         Answer:
  1220.         If the auditor determines that the computer is programmed accurately and the price list master file is authorized and correct, detailed invoice computations can be reduced or eliminated. The auditor would then focus on determining that effective computer controls exist to ensure that the computer system is properly programmed and has not been altered since it was last tested by the auditor.
  1221.  
  1222.  
  1223. 77.
  1224. challenging     The transaction-related audit objectives and the client’s methods of controlling misstatements are essentially the same for credit memos as for sales with the exception of two differences. What are the two differences from the auditor’s perspective?
  1225.  
  1226.         Answer:
  1227. The first difference is materiality. In many instances, sales returns and allowances are so immaterial that auditors ignore them. The second difference is the emphasis on the occurrence objective. For sales returns and allowances, auditors usually emphasize testing recorded transactions to uncovering any theft of cash from the collection of accounts receivable that was covered up by fictitious sales returns and allowances.
  1228.  
  1229.  
  1230.  
  1231.  
  1232. 78.
  1233. challenging     Describe the three basic steps an auditor should follow when designing tests of controls and substantive tests of transactions.
  1234.  
  1235.         Answer:
  1236.         The three basic steps in designing tests of controls and substantive tests of transactions are:
  1237. •     Determine key internal controls for each audit objective.
  1238. •     Design tests of controls for each control used to support a reduced control risk.
  1239. •     Design substantive tests of transactions to test for monetary misstatements for each objective.
  1240.  
  1241.  
  1242.  
  1243. Other Objective Answer Format Questions
  1244.  
  1245. 79.
  1246. medium  Match seven of the terms for documents and records (a-k) with the descriptions provided below (1-7):
  1247.  
  1248.         a.      Customer order form
  1249.         b.      Sales order
  1250.         c.      Bill of lading
  1251.         d.      Sales invoice
  1252.         e.      Summary sales report
  1253.         f.      Accounts receivable master file
  1254.         g.      Monthly statement
  1255.         h.      Remittance advice
  1256.         i.      Prelisting of cash receipts
  1257.         j.      Credit memo
  1258.         k.      Uncollectible account authorization form
  1259.        
  1260. i                 1.    A schedule prepared by an independent person when cash is received. It is used to verify whether cash received was recorded and deposited at the correct amounts and on a timely basis.
  1261.  
  1262. j                 2.    A document indicating a reduction in the amount due from a customer because of returned goods or an allowance granted.
  1263.  
  1264. c
  1265.           3.    A document prepared to initiate shipment of goods, indicating the description of the merchandise, the quantity shipped, and other relevant data. It is a written contract between the carrier and seller of the receipt and shipment of goods.
  1266.  
  1267. b                 4.    An internal document for communicating the description, quantity, and related information for goods ordered by a customer. This is frequently used to indicate credit approval and authorization for shipment.
  1268.  
  1269. h                 5.    A document that accompanies the sales invoice mailed to the customer and which can be returned to the seller with the cash payment.
  1270.  
  1271. k                 6.    A document used internally to indicate authority to write-off an account receivable as uncollectible.
  1272.  
  1273. d                 7.    A document indicating the description and quantity of goods sold, the price, freight charges, insurance, terms, and other relevant data.
  1274.  
  1275.  
  1276. 80.
  1277. easy
  1278. b       A sales invoice is a document that usually indicates credit approval.
  1279. a.      True
  1280. b.      False
  1281.  
  1282. 81.
  1283. easy
  1284. b       Credit should be approved before a customer’s order is received.
  1285. a.      True
  1286. b.      False
  1287.  
  1288. 82.
  1289. easy
  1290. a       Credit should be approved before goods are shipped to a customer.
  1291. a.      True
  1292. b.      False
  1293.  
  1294. 83.
  1295. easy
  1296. a       The receipt of a customer order from a customer is the starting point for the entire sales and collection cycle.
  1297. a.      True
  1298. b.      False
  1299.  
  1300. 84.
  1301. easy
  1302. b       The preparation of a sales invoice is the final step in the sales and collection cycle.
  1303. a.      True
  1304. b.      False
  1305.  
  1306. 85.
  1307. easy
  1308. a       When auditors evaluate sales returns and allowances, a primary emphasis is on the objective of occurrence.
  1309. a.      True
  1310. b.      False
  1311.  
  1312. 86.
  1313. easy
  1314. b       A bill of lading is a special type of sales invoice used when goods are shipped interstate.
  1315. a.      True
  1316. b.      False
  1317.  
  1318. 87.
  1319. easy
  1320. b       The overall objective in the audit of the sales and collection cycle is to evaluate whether the account balances affected by the cycle are fairly presented in accordance with GAAS.
  1321. a.      True
  1322. b.      False
  1323.  
  1324. 88.
  1325. easy
  1326. a       For good internal control, the credit-granting function should be separate from the sales function.
  1327. a.      True
  1328. b.      False
  1329.  
  1330. 89.
  1331. medium
  1332. b       The sales and collection cycle involves the transfer of ownership of goods to customers but does not involve the conversion of services into accounts receivable.
  1333. a.      True
  1334. b.      False
  1335.  
  1336. 90.
  1337. medium
  1338. a       The shipping point is critical because it is the first point at which company assets are released to another party.
  1339. a.      True
  1340. b.      False
  1341.  
  1342.  
  1343.  
  1344. 91.
  1345. medium
  1346. a       Sales returns and allowances are often ignored by auditors because they are often immaterial.
  1347. a.      True
  1348. b.      False
  1349.  
  1350. 92.
  1351. medium
  1352. b       A bill of lading is a written contract between the seller and the buyer.
  1353. a.      True
  1354. b.      False
  1355.  
  1356. 93.
  1357. medium
  1358. a       In a lockbox system, bank employees are responsible for opening cash receipts and maintaining records of all payments made by customers at the lockbox address.
  1359. a.      True
  1360. b.      False
  1361.  
  1362. 94.
  1363. medium
  1364. a       The most difficult type of cash embezzlement to detect is when it occurs before the cash is recorded in the cash receipts journal.
  1365. a.      True
  1366. b.      False
  1367.  
  1368. 95.
  1369. medium
  1370. a       Sales transactions are the result of the following four functions in the sales and collection cycle: processing customer orders, granting credit, shipping goods, billing customers, and recording sales.
  1371. a.      True
  1372. b.      False
  1373.  
  1374. 96.
  1375. medium
  1376. a       The most important concern in the processing and recording cash receipts function is the possibility of theft.
  1377. a.      True
  1378. b.      False
  1379.  
  1380. 97.
  1381. medium
  1382. b       The prelisting of cash receipts should be prepared by the individual who has primary responsibility for the recording of cash receipts.
  1383. a.      True
  1384. b.      False
  1385.  
  1386. 98.
  1387. medium
  1388. b       A credit memo is a document used internally that indicates authority to write-off an account receivable as uncollectible.
  1389. a.      True
  1390. b.      False
  1391.  
  1392. 99.
  1393. medium
  1394. b       Testing from source documents to the journal is useful for testing nonexistent transactions.
  1395. a.      True
  1396. b.      False
  1397.  
  1398. 100.
  1399. medium
  1400. b       When a company prepares multi-copy, prenumbered sales invoices at the time customer orders are received, there is a higher likelihood of failure to bill the customers than when sales invoices are prepared only after goods have been shipped.
  1401. a.      True
  1402. b.      False
  1403.  
  1404.  
  1405.  
  1406. 101.
  1407. medium
  1408. b       Tests of controls should never be performed using the client’s computer system; that is, all tests of control should be performed either using the auditor’s computers or performed manually by the auditor.
  1409. a.      True
  1410. b.      False
  1411.  
  1412. 102.
  1413. medium
  1414. a       Management’s assertions for sales and collection activities remain the same whether sales are generated through traditional or e-commerce activities.
  1415. a.      True
  1416. b.      False
  1417.  
  1418. 103.
  1419. medium
  1420. b      
  1421. Misstatements involving the completeness objective for sales lead to overstatements of assets and income.
  1422. a.      True
  1423. b.      False
  1424.  
  1425. 104.
  1426. medium
  1427. a       Violations of the existence objective for sales are of greater concern to the auditor than violations of the completeness objective.
  1428. a.      True
  1429. b.      False
  1430.  
  1431. 105.
  1432. medium
  1433. b       An effective procedure to test the completeness objective for sales is to trace sales journal entries to copies of sales orders, shipping documents, and sales invoices.
  1434. a.      True
  1435. b.      False
  1436.  
  1437. 106.
  1438. medium
  1439. b       The auditor’s primary concern about authorization centers on shipment of goods to customers.
  1440. a.      True
  1441. b.      False
  1442.  
  1443. 107.
  1444. medium
  1445. b       When auditing sales returns and allowances, the emphasis is normally on testing the completeness objective.
  1446. a.      True
  1447. b.      False
  1448.  
  1449. 108.
  1450. challenging
  1451. b       For each internal control deficiency identified by the auditor, he or she should design one or more tests of controls to assess the extent of the deficiency and its effect on the financial statements.
  1452. a.      True
  1453. b.      False
  1454.  
  1455. 109.
  1456. challenging
  1457. b       For effective internal control, it is important that sales be recorded as soon after the customer order is received as possible to prevent the unintentional omission of transactions from the records and to make sure that sales are recorded in the proper period.
  1458. a.      True
  1459. b.      False
  1460.  
  1461. 110.
  1462. challenging
  1463. b       Footing the sales journal and tracing the totals to the general ledger are tests relating to the accuracy objective for sales.
  1464. a.      True
  1465. b.      False
  1466.  
  1467. CHAPTER 15      
  1468.  
  1469.  
  1470. Multiple-Choice Questions
  1471.  
  1472. 1.
  1473. easy    A sample in which the characteristics of the sample are the same as those of the population is a(n):
  1474. b       a.      variables sample.
  1475.         b.      representative sample.
  1476.         c.      attributes sample.
  1477.         d.      random sample.
  1478.        
  1479. 2.
  1480. easy    When the auditor decides to select less than 100 percent of the population for testing, the auditor is said to use:
  1481. a       a.      audit sampling.
  1482.         b.      representative sampling.
  1483.         c.      poor judgment.
  1484.         d.      none of the above.
  1485.        
  1486. 3.      In practice, auditors _________ know if a sample is truly a representative one.
  1487. easy    a.      sometimes
  1488. d       b.      often
  1489.         c.      routinely
  1490.         d.      never
  1491.        
  1492. 4.      To determine if a sample is truly representative, an auditor must:
  1493. easy    a.      conduct multiple samples of the same population.
  1494. c       b.      never use sampling because of the expense involved.
  1495.         c.      audit the entire population.
  1496.         d.      perform none of the above.
  1497.        
  1498. 5.      One of the ways to eliminate nonsampling risk is through:
  1499. easy    a.      proper supervision and instruction of the client’s employees.
  1500. b       b.      proper supervision and instruction of the audit team.
  1501.         c.      the use of attributes sampling rather than variables sampling.
  1502.         d.      controls which ensure that the sample drawn is random and representative.
  1503.        
  1504. 6.      One cause of nonsampling risk is:
  1505. easy    a.      ineffective use of audit procedures.
  1506. a       b.      testing less than the entire population.
  1507.         c.      use of extensive tests of controls.
  1508.         d.      any of the above.
  1509.        
  1510. 7.      An auditor can increase the likelihood that a sample is representative by using care in:
  1511. easy    a.      designing the sampling process.
  1512. d       b.      designing the sample selection.
  1513.         c.      evaluating the sample results.
  1514.         d.      performing all of the above.
  1515.        
  1516.  
  1517.  
  1518. 8.
  1519. easy    When the auditor goes through a population and selects items for the sample without regard to their size, source, or other distinguishing characteristics, it is called:
  1520. b       a.      block sample selection.
  1521.         b.      haphazard selection.
  1522.         c.      systematic sample selection.
  1523.         d.      statistical selection.
  1524.        
  1525. 9.      When auditors wish to evaluate a sample statistically, the only acceptable selection method is:
  1526. easy    a.      probabilistic selection.
  1527. a       b.      judgmental selection.
  1528.         c.      haphazard selection.
  1529.         d.      block sample selection.
  1530.        
  1531. 10.
  1532. easy    A sample in which every possible combination of items in the population has an equal chance of constituting the sample is a:
  1533. a       a.      random sample.
  1534.         b.      statistical sample.
  1535.         c.      judgment sample.
  1536.         d.      representative sample.
  1537.        
  1538. 11.
  1539. easy    The process which requires the calculation of an interval and then selects the items based on the size of the interval is:
  1540. c       a.      statistical sampling.
  1541.         b.      random sample selection.
  1542.         c.      systematic sample selection.
  1543.         d.      computerized sample selection.
  1544.        
  1545. 12.     ________ is the risk that audit tests will not uncover existing exceptions in a sample.
  1546. easy    a.      Sampling risk.
  1547. b       b.      Nonsampling risk.
  1548.         c.      Audit risk.
  1549.         d.      Detection risk.
  1550.        
  1551. 13.
  1552. easy    ________ is the risk that an auditor will reach an incorrect conclusion because a sample is not representative of the population.
  1553. a       a.      Sampling risk
  1554.         b.      Nonsampling risk
  1555.         c.      Audit risk
  1556.         d.      Detection risk
  1557.        
  1558. 14.
  1559. easy    In systematic