CH 07

Audit Planning: Assessment of Control Risk
MULTIPLE CHOICE:
1. Which of the following is ordinarily considered a test of

internal control procedures?
a. Send confirmation letters to banks.
b. Count and list cash on hand.
c. Examine signatures on checks.
d. Obtain or prepare reconciliations of bank accounts as
of the balance sheet date.
ANSWER: C
2. When obtaining an understanding of an entity's control

environment, an auditor should concentrate on the substance
of management's policies and procedures rather than their
form because
a. The auditor may believe that the policies and
procedures are inappropriate for that particular
entity.
b. The board of directors may not be aware of
management's attitude toward the control environment.
c. Management may establish appropriate policies and
procedures but not act on them.
d. The policies and procedures may be so weak that no
reliance is contemplated by the auditor.
ANSWER: C
3. After the study and evaluation of a client's internal

control policies and procedures has been completed, an
auditor might decide to
a. Increase the extent of substantive testing in areas
where the internal control policies and procedures are
strong.
b. Reduce the extent of control testing in areas where the
internal control policies and procedures are strong.
c. Reduce the extent of both substantive and control
testing in areas where the internal control policies
and procedures are strong.
d. Increase the extent of substantive testing in areas
where the internal controls are weak.
ANSWER: D
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97 Chapter 7 Audit Planning: Assessment of Control Risk
4. A conceptually logical approach to the auditor's evaluation

of internal accounting control consists of the following
four steps:
I. Determine whether the necessary procedures are
prescribed and are being followed satisfactorily.
II. Consider the types of errors and fraud that could
occur.
III. Determine the internal control policies and procedures
that should prevent or detect errors and fraud.
IV. Evaluate any weakness to determine its effect on the
nature, timing, or extent of auditing procedures to be
applied and suggestions to be made to the client.
What should be the order in which these four steps are

performed?
a. III, IV, I, II
b. III, I, II, IV
c. II, III, I, IV
d. II, I, III, IV
ANSWER: C
5. An auditor evaluates the existing internal control

in order to
a. Determine the extent of substantive tests which must be
performed.
b. Determine the extent of control tests which must be
performed.
c. Ascertain whether irregularities are probable.
d. Ascertain whether any employees have incompatible
functions.
ANSWER: A
6. The auditor is studying internal control policies and

procedures within the sales, shipping, and billing subset of
the revenue cycle. Which of the following conditions
suggests a need for additional testing of controls?
a. Internal control is found to be weak with regard to
shipping and billing.
b. Internal control over sales, billing, and shipping
appears strong, but 80% of sales revenue is
attributable to three major customers.
c. Internal control over billing and shipping is thought
to be strong and the auditor considers additional
testing of selected controls will result in a major
reduction in substantive testing.
Chapter 7 Audit Planning: Assessment of Control Risk 98
d. Internal control over the recording of sales is found

to be weak and the sales are evenly divided among a
large number of customers.
ANSWER: C
7. A secondary objective of the auditor's study and evaluation

of internal control is that the study and evaluation provide
a. A basis for constructive suggestions concerning
improvements in internal control.
b. A basis for reducing the auditor's assessed level of
control risk below the maximum level.
c. An assurance that the records and documents have been
maintained in accordance with existing company policies
and procedures.
d. A basis for determination of the resultant extent of
the tests to which auditing procedures are to be
restricted.
ANSWER: A
8. In studying the design and implementation of a client's

internal controls, the auditor needs to identify necessary
control points. Controls existing at these points may be
classified as "accuracy" controls and "safeguard" controls.
Which of the following controls may be regarded as a
safeguard control?
a. In processing sales orders, the computer is programmed

to compare the customer's credit limit minus the prior
balance with the current sales order amount.
b. Sales prices are stored in computer memory and are
automatically applied as stock numbers are entered from
customer orders.
c. Although the payroll is prepared manually, a second
employee recalculates gross pay, withholdings, and net
pay.
d. Negotiable securities are kept in a locked vault and
are accessible only by the treasurer accompanied by one
of her assistants.
ANSWER: D
9. The auditor's review of the client's internal control is

documented in order to substantiate
a. Conformity of the accounting records with generally
accepted accounting principles.
b. Representation as to adherence to requirements of

management.
c. Representation as to compliance with generally accepted
auditing standards.
d. The fairness of the financial statement presentation.
ANSWER: C
10. An internal control questionnaire indicates that an approved

receiving report is required to accompany every check
request for payment of merchandise. Which of the following
procedures provides the greatest assurance that this control
is operating effectively?
a. Select and examine canceled checks and ascertain that
the related receiving reports are dated no earlier than
the checks.
b. Select and examine canceled checks and ascertain that
the related receiving reports are dated no later than
the checks.
c. Select and examine receiving reports and ascertain that
the related canceled checks are dated no earlier than
the receiving reports.
d. Select and examine receiving reports and ascertain that
the related canceled checks are dated no later than the
receiving reports.
ANSWER: B
11. When considering internal control, an auditor must be aware

of the concept of reasonable assurance which recognizes that
a. The employment of competent personnel provides
assurance that the objectives of internal control will
be achieved.
b. The establishment and maintenance of a system of
internal control is an important responsibility of the
management and not of the auditor.
c. The cost of internal control should not exceed the
benefits expected to be derived from internal control.
d. The segregation of incompatible functions is necessary
to obtain assurance that the internal control is
effective.
ANSWER: C
12. Statement on Auditing Standards No. 60 requires the auditor

to communicate "reportable conditions" to the audit
committee of the board of directors or, in the absence of an
audit committee, to a body having similar oversight

authority. Of the following, which does not represent a
reportable condition?
a. Bank accounts have not been reconciled in the last nine
months, including the last month of the fiscal year.
b. The corporate controller, unknown to the board of
directors, has submitted her resignation effective two
months from now.
c. Perpetual inventory records contain numerous errors and
can no longer be relied upon to reflect proper
inventory levels.
d. Although documents are prenumbered, they are not
safeguarded and are not being used in numerical
sequence.
ANSWER: B
13. In connection with the examination of financial statements

by an independent auditor, the client suggests that members
of the internal audit staff be utilized to minimize audit
costs. Which of the following tasks could most
appropriately be delegated to the internal audit staff?
a. Selection of accounts receivable for confirmation,
based upon the internal auditor's judgment as to how
many accounts and which accounts will provide
sufficient coverage.
b. Preparation of schedules for negative accounts
receivable responses.
c. Evaluation of the internal control for accounts
receivable and sales.
d. Determination of the adequacy of the allowance for
doubtful accounts.
ANSWER: B
14. An auditor uses the knowledge provided by the understanding

of internal control and the final assessed level of control
risk primarily to determine the nature, timing, and extent
of the
a. Attribute tests.
b. Compliance tests.
c. Tests of controls.
d. Substantive tests.
ANSWER: D
15. Flowcharting as a means of internal control evaluation

provides the following advantage over the use of
questionnaires and descriptive narratives:
a. Ease of preparation.
b. Comprehensive coverage of controls.
c. Simplicity.
d. Ease in following information flow.
ANSWER: D
16. Which of the following factors most likely affects the

auditor's judgment about the quantity, type, and content of
working papers?
a. The effectiveness of the existing internal control.
b. The content of the client's representation letter.
c. The timing of substantive tests completed prior to the
balance sheet date.
d. The usefulness of the working papers as a reference
source for the client.
ANSWER: A
17. If the independent auditors decide that the work performed

by the internal auditor may have a bearing on their own
procedures, they should consider the internal auditor's
a. Competence and objectivity.
b. Efficiency and experience.
c. Independence and review skills.
d. Training and supervisory skills.
ANSWER: A
18. An auditor's purpose for further testing of internal control

procedures is to
a. Provide a basis for reducing the assessed level of
control risk below that which resulted from the
auditor's initial understanding of internal control.
b. Reduce the risk that errors or fraud which are not
prevented or detected by internal control are not
detected by the independent audit.
c. Provide assurance that transactions are executed in
accordance with management's authorization and accessed
to assets is limited by a segregation of functions.
d. Provide assurance that transactions are recorded as
necessary to permit the preparation of the financial
statements in conformity with GAAP.
ANSWER: A
19. Control testing is performed in order to determine whether

or not
a. The assessed level of control risk can be reduced.
b. Necessary controls are absent.
c. Incompatible functions exist.
d. Material dollar errors exist.
ANSWER: A
20. The independent auditor should acquire an understanding of

the internal audit function as it relates to the independent
auditor's study and evaluation of internal control because
a. The audit programs, working papers, and reports of
internal auditors can often be used as a substitute for
the work of the independent auditor's staff.
b. The procedures performed by the internal audit staff
may eliminate the independent auditor's need for an
extensive study and evaluation of internal control.
c. The work performed by internal auditors may be a factor
in determining the nature, timing, and extent of the
independent auditor's procedures.
d. The understanding of the internal audit function is an
important substantive test to be performed by the
independent auditor.
ANSWER: C
21. In the assessment of control risk, the auditor is basically

concerned that the client's internal control provides
reasonable assurance that
a. Management cannot override the system.

b. Operational efficiency has been achieved in accordance
with management plans.
c. Errors and fraud have been prevented or detected.
d. Controls have not been circumvented by collusion.
ANSWER: C
22. Which of the following may be considered an appropriate

means for further testing controls over vendor payments?
a. Confirm year-end balances with vendors.
b. Search for unrecorded invoices at year-end.
c. Develop a set of hypothetical transactions designed to
test existing controls over vendor payments (e.g.,
introduce into the system, a voucher containing an

invoice for raw materials but lacking a purchase order
and/or receiving report.)
d. Construct an internal control flowchart covering the
payment processing function.
ANSWER: C
23. Which of the following statements concerning the independent

auditor's required communication of material weaknesses in
internal control is correct?
a. Weaknesses reported at interim dates must be repeated
in the final communication.
b. If the auditor does not become aware of any material
weaknesses during the examination, that fact must be
communicated.
c. Weaknesses that had been reported in prior years'
communications and have not been corrected need not be
repeated in the current year's communication.
d. Although written communication is preferable, the
auditor may communicate the findings orally.
ANSWER: D
24. Which of the following would be the best procedure to

determine whether purchases were properly authorized?
a. Discuss authorization procedures with personnel in the
controller's and purchasing functions.
b. Review and evaluate a flowchart of purchasing
procedures.
c. Determine whether a sample of entries in the purchase
journal is supported by properly executed purchase
orders.
d. Vouch payments for selected purchases to supporting
receiving reports.
ANSWER: C
25. After studying and evaluating a client's existing internal

control, an auditor has concluded that the policies and
procedures are well designed and functioning as intended.
Under these circumstances, the auditor would most likely
a. Perform further control tests to the extent outlined in
the audit program.
b. Determine the control policies and procedures that
should prevent or detect errors and fraud.
c. Set detection risk at a higher level than would be set

under conditions of weak internal control.
d. Set detection risk at a lower level than would be set
under conditions of weak internal control.
ANSWER: C
26. An auditor is required to obtain a basic understanding of

the client's internal control to plan the audit. The
auditor may then decide to perform tests of controls on all
internal control procedures
a. That would aid in preventing fraud.
b. Documented in the flowchart.
c. Considered to be weaknesses that might allow errors to
enter the accounting system.
d. Considered to be strengths for which the auditor
desires further reduction in the assessed level of
control risk.
ANSWER: D
27. The auditor's understanding of the client's internal control

is documented in order to substantiate
a. Conformity of the accounting records with generally
accepted accounting principles.
b. Compliance with generally accepted auditing standards.
c. Adherence to requirements of management.
d. The fairness of the financial statement presentation.
ANSWER: B
28. To determine whether the client's system of internal control

operated effectively to minimize errors of failure to
invoice a shipment, the auditor would select a sample of
transactions from the population represented by the
a. Customer order file.
b. Bill of lading file.
c. Open invoice file.
d. Sales invoice file.
ANSWER: B
29. When evaluating a client's system of internal control to

determine whether the necessary procedures are prescribed
and have been implemented satisfactorily, an auditor must
a. Develop questionnaires and checklists.
b. Obtain an understanding of internal control.
c. Perform tests of internal control procedures.

d. Evaluate administrative policies.
ANSWER: B
30. Of the following internal control policies or procedures,

which would most likely allow for a reduction in the scope
of the auditor's tests of depreciation expense?
a. Review and approval of the periodic equipment
depreciation entry by a supervisor who does not
actively participate in its preparation.
b. Comparison of equipment account balances for the
current year with the current-year budget and prior-
year actual balances.
c. Review of the miscellaneous income account for salvage
credits and scrap sales of partially depreciated
equipment.
d. Authorization of payment of vendors' invoices by a
designated employee who is independent of the equipment
receiving function.
ANSWER: A
31. Tracing copies of sales invoices to shipping documents will

provide evidence that all
a. Shipments to customers were recorded as receivables.
b. Billed sales were shipped.
c. Debits to the subsidiary accounts receivable ledger are
for sales shipped.
d. Shipments to customers were billed.
ANSWER: B
32. In assessing control risk, the auditor must, as a minimum

a. Perform tests of all significant controls.
b. Obtain an understanding of the design and
implementation of the client's internal control.
c. Obtain an understanding of the design of the client's
internal control.
d. Obtain an understanding of the design, implementation,
and operating effectiveness of the client's internal
control.
ANSWER: B
33. An independent auditor has concluded that the client's

records, procedures and representations can be relied upon
based on tests made during the year when internal control

was found to be effective. The auditor should test the
records, procedures, and representations again at year-end
if
a. Inquiries and observations lead the auditor to believe
that conditions have changed significantly.
b. Comparisons of year-end balances with like balances at
prior dates revealed significant fluctuations.
c. Unusual transactions occurred subsequent to the
completion of the interim audit work.
d. Client records are in a condition that facilitate
effective and efficient testing.
ANSWER: A
34. An auditor is least likely to further test control

procedures by examining documents with respect to controls
relating to
a. Segregation of the functions of recording disbursements
and reconciling the bank account.
b. Comparison of receiving reports and vendors' invoices
with purchase orders.
c. Approval of the purchase and sale of marketable
securities.
d. Classification of revenue and expense transactions by
product line.
ANSWER: A
35. An auditor usually examines receiving reports to support

entries in the
a. Voucher register and sales returns journal.
b. Sales journal and sales returns journal.
c. Voucher register and sales journal.
d. Check register and sales journal.
ANSWER: A
36. Regardless of whether the auditor decides to test controls

for operating effectiveness, he/she must fully document his
or her understanding of the internal control policies and
procedures obtained through whatever means. Which of the
following does not describe an appropriate means for
documenting such understanding?
a. Internal control flowchart.
b. Internal control implementation.
c. Internal control memorandum.
d. Internal control questionnaire.
ANSWER: B
37. Which of the following best describes the primary reason for
the auditor's use of flowcharts during an audit engagement?
a. To comply with the requirements of generally accepted
auditing standards.
b. To classify the client's documents and transactions by
major operating functions, e.g., cash receipts, cash
disbursements, etc.
c. To record the auditor's understanding of the client's
internal control policies and procedures.
d. To interpret the operational effectiveness of the
client's existing organizational structure.
ANSWER: C
38. An auditor generally tests physical security controls over

inventory by
a. Test counts and cutoff procedures.
b. Examination and reconciliation.
c. Inspection and recomputation.
d. Inquiry and observation.
ANSWER: D
39. Which of the following is not an auditing procedure that is

commonly used in performing control tests?
a. Inquiring.
b. Observing.
c. Confirming.
d. Inspecting.
ANSWER: C
40. If the independent auditor decides that the work performed

by internal auditors may have a bearing on the independent
auditor's own procedures, the independent auditor should
consider the objectivity of the internal auditors. One
method of judging objectivity is to
a. Review the recommendations made in the reports of the
internal auditor.
b. Examine, on a test basis, documentary evidence of the
work performed by internal auditors.
c. Inquire of management about the qualifications of the
internal audit staff.
d. Consider the client's practices for hiring, training,

and supervising the internal audit staff.
ANSWER: A
41. Tracing bills of lading to sales invoices will provide

evidence that
a. Recorded sales were shipped.
b. Invoiced sales were shipped.
c. Shipments to customers were invoiced.
d. Shipments to customers were recorded as sales.
ANSWER: C
42. The development of constructive suggestions to clients for

improvements in internal accounting control is
a. A requirement of the auditor's study and evaluation of
internal accounting control.
b. A desirable byproduct of an audit engagement.
c. Addressed by the auditor only during a special
engagement.
d. As important as establishing a basis for reliance upon
the internal accounting control system.
ANSWER: B
43. Which of the following statements with respect to the

independent auditor's evaluation of internal control is
correct?
a. The auditor should decrease control testing when
weaknesses in cash receipts are mitigated by strong
controls in cash disbursement procedures.
b. The auditor should increase control testing when
weaknesses in billing procedures are mitigated by
strong controls in collection procedures.
c. The auditor generally should not evaluate the overall
effectiveness of internal control, but should
separately evaluate each of the transaction cycles.
d. The auditor should evaluate all internal control
weaknesses before determining the control procedures
that should prevent or detect errors or irregularities.
ANSWER: C
44. Which of the following statements best describes the

auditor's responsibility regarding the detection of material
fraud?
a. Because of the inherent limitations of an audit, the

auditor is not responsible for the failure to detect
material fraud.
b. The auditor is responsible for the failure to detect
material fraud when such failure results from
nonperformance of audit procedures specifically
described in the engagement letter.
c. The auditor should design audit programs that will
provide reasonable assurance that material errors and
fraud will be detected in the ordinary course of the
examination.
d. The auditor is responsible for the failure to detect
material fraud when the auditor's evaluation of
internal control procedures indicates that they are
ineffective.
ANSWER: C
45. Which of the following procedures most likely would be

included as part of an auditor's tests of control
procedures?
a. Inspection.
b. Reconciliation.
c. Confirmation.
d. Analytical procedures.
ANSWER: A
46. If, after obtaining an initial understanding of a client's

internal control, the auditor wishes to further reduce the
assessed level of control risk relating to plant asset
transactions, the auditor should next
a. Make extensive substantive tests of plant asset
balances.
b. Establish the physical existence of current year
additions.
c. Complete the plant asset section of the internal
accounting control questionnaire.
d. Further test those internal control procedures relating
to processing and recording plant asset transactions.
ANSWER: D
47. The auditor is most likely to presume that a high risk of

defalcation exists if
a. The client is a multinational company that does
business in numerous foreign countries.
b. The client does business with several related parties.

c. Inadequate segregation of duties places an employee in
a position to perpetrate and conceal thefts.
d. Inadequate employee training results in lengthy CBIS
exception reports each month.
ANSWER: C
48. After obtaining an understanding of the client’s internal

control, the auditor should consider whether
a. The projected degree of effectiveness of internal
control is justified.
b. The evidential matter obtained from the study of the
internal control system can provide a reasonable basis
for an opinion.
c. Further testing of internal control procedures is
likely to permit further reduction of assessed control
risk.
d. Sufficient knowledge has been obtained about the
entity's entire system of internal control.
ANSWER: C
49. Which of the following is the correct order of performing

the auditing procedures A through C below?
A = Tests of internal control procedures.
B = Preparation of a flowchart depicting the client's
internal control system.
C = Substantive tests.
a. ABC.
b. ACB.
c. BAC.
d. BCA.
ANSWER: C
50. Auditors frequently use flowcharts in connection with which

of the following
a. Preparation of generalized computer audit programs.
b. Review of the client's internal control procedures.
c. Use of statistical sampling in performing an audit.
d. Performance of analytical review procedures of account
balances.
ANSWER: B
51. Which of the following conditions suggest a lowering of the

aggregate materiality threshold?
a. Internal controls in the area of payroll processing are

found to be much stronger than the auditor's initial
assessment.
b. The application of analytical procedures reveals a
favorable sales budget variance that is material and
that remains unexplained.
c. Study of the business and industry reveals a material
decline in both industry and client revenue during the
current year.
d. Tests of internal controls in nearly all transaction
cycle subsets have produced numerous and widespread
errors.
ANSWER: D
52. If, during the course of an annual audit of a publicly held

manufacturing company, an independent auditor becomes aware
of a material weakness in the company's internal control,
the auditor is required to communicate the weakness to
a. The audit committee of the board of directors, or to a
similar body having financial oversight responsibility.
b. The senior management of the company.
c. The board of directors of the company.
d. The treasurer and controller of the client entity.
ANSWER: A
53. Under which of the following conditions would you consider

lowering individual item materiality thresholds.
a. Study of the business and industry, together with the
application of analytical procedures, reveals that the
client has enjoyed a surge in sales and gross profit
during an industry downturn.
b. Application of analytical procedures shows that the
client's gross profit rate is significantly below last
year and also is materially lower than the industry
average.
c. Study of internal controls within the revenue cycle
reveal material weaknesses.
d. Study of internal controls within the payroll cycle
confirm the auditor's belief that few errors have
occurred.
ANSWER: A
54. Which of the following is not a medium that can normally be

used by an auditor to record information concerning a
client's internal control policies and procedures?
a. Narrative memorandum.
b. Procedures manual.
c. Flowchart.
d. Questionnaire.
ANSWER: B
55. With respect to the client's system of internal control, the

auditor is concerned that the existing policies and
procedures provide reasonable assurance that
a. Operational efficiency has been achieved in accordance
with management plans.
b. Errors and fraud have been prevented or detected.
c. Controls have not been circumvented by collusion.
d. Management cannot override the internal controls.
ANSWER: B
56. The auditor observes client employees during the review of

the client's system of internal control in order to
a. Prepare a flowchart.
b. Update information contained in the organization and
procedure manuals.
c. Assist in obtaining an understanding of the client's
internal control policies and procedures.
d. Determine the extent of compliance with quality control
standards.
ANSWER: C
57. An auditor's flowchart of a client's accounting system is a

diagrammatic representation that depicts the auditor's
a. Program for tests of controls.
b. Understanding of the system.
c. Understanding of the types of fraud that are probable,
given the present system.
d. Documentation of the study and evaluation of the
system.
ANSWER: B
58. An independent auditor might consider the procedures

performed by the internal auditors because
a. They are employees whose work must be reviewed during

substantive testing.
b. They are employees whose work might be relied upon.
c. Their work impacts upon the cost/benefit tradeoff in
evaluating inherent limitations.
d. Their degree of independence may be inferred by the
nature of their work.
ANSWER: B
59. A procedure that would most likely be used by an auditor in

performing tests of control procedures that involve
segregation of functions and that leave no transaction trail
is
a. Inspection.
b. Observation.
c. Reprocessing.
d. Reconciliation.
ANSWER: B
60. It is important for the CPA to consider the competence of

the audit client's employees because their competence bears
directly and importantly upon the
a. Cost/benefit relationship of the internal control
system.
b. Achievement of the objectives of the internal control
system.
c. Comparison of recorded accountability with assets.
d. Timing of the tests to be performed.
ANSWER: B
61. In studying internal control and assessing control risk, the

auditor applies the following steps:
a. Determine the internal control policies and procedures
necessary to prevent or detect errors or fraud that
could occur in the absence of controls.
b. Identify control weaknesses.
c. Determine whether the necessary policies and procedures
have been designed and whether they have been placed in
operation.
d. Design substantive audit programs.
e. Consider the types of errors or fraud that could occur
in the absence of necessary controls.
The proper sequence in applying these steps is:
a. CDEAB
b. CBAED
c. EACBD
d. AECBD
ANSWER: C
62. The primary purpose of performing further control tests is

to provide
a. A basis for reducing the assessed level of control risk
below the maximum level.
b. A basis for understanding the flow of transactions
through the accounting system.
c. Assurance that transactions are properly recorded.
d. All accounting control procedures leave visible
evidence.
ANSWER: A
63. To determine whether refunds granted to customers were

properly approved, the auditor should trace accounts
receivable entries to:
a. Sales invoices.
b. Remittance advices.
c. Shipping documents.
d. Credit memos.
ANSWER: D
64. A well-prepared flowchart should make it easier for the

auditor to
a. Prepare audit procedure manuals.
b. Prepare detailed job descriptions.
c. Trace the origin and disposition of documents.
d. Assess the degree of accuracy of financial data.
ANSWER: C
COMPLETION:
65. After assessing inherent risk, the auditor needs to assess

control risk in order to complete the phase of
the audit.
ANSWER: PLANNING
66. Based on the initial understanding of internal control, the

auditor may decide to assess control risk at the maximum
level for some assertions and below maximum for others. To
justify reducing the assessed level of control risk below
maximum, the auditor must obtain an understanding of the
of the controls relating to those
assertions.
ANSWER: OPERATING EFFECTIVENESS
67. As an internal control documentation device, the internal

control , by presenting a pictorial overview of
the processing steps, has the advantage of providing a clear
and easy review of existing internal control policies and
procedures.
ANSWER: FLOWCHART
68. is an effective
means for further testing of selected internal control
policies and procedures where an audit trail in the form of
documentation exists.
ANSWER: DOCUMENT EXAMINATION AND TESTING
69. Whenever control risk is assessed below maximum, the auditor

must document the for such reduction.
ANSWER: BASIS
70. If, based on the study of the business and application of

analytical procedures, the auditor suspects earnings
inflation, individual item materiality thresholds should be
.
ANSWER: LOWERED (DECREASED, REDUCED)
71. For transaction cycle subsets where internal control is weak

and numerous errors are expected, aggregate materiality
thresholds should be set ____ relative to those
applicable to strong internal control subsets.
ANSWER: LOW
72. The nature and timing of substantive audit procedures

requires a approach to designing audit
programs, whereas determining the extent of testing suggests
a approach.
ANSWER: QUALITATIVE, QUANTITATIVE
MATCHING:
73. Indicate by letter how each of the listed controls can be

most effectively tested.
a. Observation
b. Reprocessing
c. Document examination and testing
____1. Computer controls applicable to payroll processing
____2. Correctness of account distribution appearing on vendor

invoices
____3. Whether invoices exist for shipments to customers
____4. Evidence, appearing on the face of receiving reports,

that the goods were transferred from receiving to
stores
____5. Whether computer errors are reprocessed by the “control

group rather than the computer operator
____6. All documents must be attached in order to vouchers to

be approved for payment
SOLUTION:
1. b
2. c
3. c
4. c
5. a
6. c
74. Each of the listed scenarios represents conditions

discovered by the auditor after analyzing inherent risk and
completing tests of financial reporting controls. Indicate by
letter the impact on materiality thresholds set previously by the
auditor during the preliminary planning stages of the audit.

More than one answer may apply to a given scenario.
a. Increase the dollar amount of the individual item

threshold
b. Lower the dollar amount of the individual item
threshold
c. Increase aggregate threshold as a percent of the
individual item threshold
d. Lower aggregate threshold as a percent of the
individual item threshold
e. No need to change initial thresholds
____1. Although controls over sales processing appear to be

effective, analytical procedures indicate possible
management override of the controls in the form of
premature revenue recognition
____2. Originally considered weak, payroll controls now appear

to be effective, based on auditor testing of selected
controls
____3. Although controls over the processing of vendor invoices

were effective in past years and were thought to be
unchanged for the year under audit, tests of controls
revealed a significant deterioration
____4. Testing of sales processing controls caused the auditor

to increase the assessed level of control risk for the
revenue cycle; and the application of analytical
procedures indicates that sales revenue may be materially
overstated and that discounts and returns may have been
understated
____5. After testing controls related to payroll processing,

the auditor was able to reduce the assessed level of
control risk; but application of analytical procedures
suggests that salaries and wages expense may be
materially overstated
____6. The auditor decided not to test controls in the

expenditure cycle because they were considered
ineffective in past years and, in the auditor’s
opinion,
have not improved
____7. In past audits, Sara Lindquest, CPA, lowered the

individual item threshold given the use of “liberal”

accounting practices by Lopez Industries, an audit
client (Proposed audit adjustments typically reduced
unaudited net income by 15% to 20%.) Application of
analytical procedures to the current year’s unaudited
income, however, indicates the use of more
conservative accounting practices
SOLUTION:
1. b
2. c
3. d
4. b,d
5. a,c
6. e
7. e
PROBLEM/ESSAY:
75. In studying her client’s existing internal control over cash

receipts, the auditor determined the following:
1. All sales are made on credit.
2. Customer checks are prelisted and restrictively
endorsed upon receipt.
3. The endorsed checks are then forwarded to data
processing where they are entered into the
computer system.
4. The checks are transferred to the cashier who prepares
the daily deposit and delivers it to the bank.
Required:
a. Identify specific errors or fraud that might occur

given the above system for processing cash
receipts.
b. The above description of cash receipts processing is

unclear as to whether certain controls that may
prevent or detect errors and fraud are present in the
existing system.
1. Identify the controls that are clearly missing;

2. Identify other controls that may or may not be
present, but that are necessary to prevent or
detect the errors and fraud that you listed
in part (a).
c. For the controls that are clearly missing, identify

possible compensating controls?
d. Assuming the auditor determines that the controls

which you listed in (b)(2) are present, how might she
test them? Be specific.
SOLUTION:
a.
1. Checks may be misappropriated by one or more persons
in data processing;
2. Recording errors might occur in processing the
checks
a. Wrong customer credited;
b. Wrong amount entered;
c. Improper discount taken.
3. Checks may be misappropriated by cashier
b.
1. The checks should not be forwarded to data
processing. Rather, the checks should be
transferred directly to the cashier after
being endorsed for deposit only; and a copy of
the prelisting, together with any accompanying
remittance advices, should be sent to data
processing for recording.
2. Controls that should be present:
a. Someone not having access to the checks

should compare the total of the
prelisting of cash receipts with the receipted
deposit ticket obtained from the bank, and
also with the debit to cash produced by
computer processing of the receipts;
b. Computer editing controls should check for
proper customer number and correctness
of cash discounts taken
c. A control total for cash receipts should be

compared by the computer with the total
of cash receipts processed to verify
correctness of cash receipts entered into the
computer.
d. Monthly statements should be mailed to

customers and all exceptions cleared by
persons not having access to
remittances.
c.
Comparing the prelisting of cash receipts with the
deposit ticket and clearing exceptions to monthly
statements should detect any missing checks.
d.
1.Select a sample of daily cash prelistings and
compare with general ledger debit to cash and
to receipted deposit ticket.
2. Select a sample of customer statement copies and
check customer correspondence files for
exceptions and how the exceptions were resolved.
3. Either reprocess or observe reprocessing of
customer remittances to determine
effectiveness of computer editing controls (be
particularly alert to errors in entering customer
account numbers and improper discounts)
76. a. What is the auditor’s documentation responsibility with

regard to the client’s system of internal control?
b. Under what conditions might the auditor elect not to

test controls for operating effectiveness?
SOLUTION:
a.
1. Auditors must document their understanding of
clients’ internal control;
2. If control risk is assessed below maximum, the
auditor must document the basis for such
reduction.
b.
1. The auditor considers the controls to be
ineffective;
2. The cost of testing the controls exceeds the cost
savings associated with reduced substantive
testing.
Audit Evidence and Audit Programs (Reviewer in

Auditing Theory)
Audit Evidence and Audit Programs
MULTIPLE CHOICE:
1. The permanent file section of the working papers that is kept for each audit client
most likely contains
a. Review notes pertaining to questions and comments regarding the audit work
performed.
b. A schedule of time spent on the engagement by each individual auditor.
c. Correspondence with the client's legal counsel concerning pending litigation.
d. Narrative descriptions of the client's internal control policies and procedures
ANSWER: D
2. Of the following procedures, which is not considered part of “obtaining an
understanding of the client’s environment?”
a. Examining trade publications to gain a better understanding of the client's
industry.
b. Confirming customer accounts receivable for existence and valuation.
c. Touring the client's manufacturing and warehousing
facilities to gain a clearer understanding of
operations.
d. Studying the internal controls over cash receipts and disbursements.
ANSWER: B
3. If working papers are to have the characteristics that will ensure that they achieve
their primary purposes, which of the following is the most important?
a. Working papers must be of standard format and standard content. b. Working
papers must be properly indexed and cross- referenced to the draft audit report.
c. Working papers must provide sufficient, competent, and useful information to

support the audit report. d. Working papers must be arranged in logical
order following the audit program sequence.
ANSWER: C
4. Which of the following is not an example of analytical evidence?
a. Compared inventory turnover by major class with the prior year on a monthly
and quarterly basis.
b. Compared gross profit percentages by major product classes with the prior
year.
c. Examined invoices for plant asset additions to determine whether the client
had erroneously recorded ordinary repairs as plant assets.
d. Examined monthly performance reports and investigated significant
variations from budgeted amounts.
ANSWER: C
5. Choose the best illustration of objective audit evidence from the following
a. The paid invoice file containing invoices matched with receiving reports and
purchase orders.
b. Management's assertion that payment procedures require matching of invoice
with receiving report and purchase order. c. Clerical staff assurances that
management policy regarding payment of invoices--matching of invoice
with receiving report and purchase order--is always followed.
d. The treasurer's statement of not remembering any exceptions in which an invoice
was submitted for payment that was not accompanied by a matching receiving report
and purchase order.
ANSWER: A
6. An initial (first-time) audit requires more audit time to complete than a recurring
audit. One of the reasons for this is that
a. New auditors are usually assigned to an initial audit.
b. Predecessor auditors need to be consulted.
c. The client's business, industry, and internal control are unfamiliar to the
auditor and need to be carefully studied.
d. A larger proportion of customer accounts receivable need to be confirmed on
an initial audit.
ANSWER: C
7. Which of the following is a basic tool used by the auditor to control the audit work
and review the progress of the audit?
a. Time and expense summary.
b. Engagement letter.
c. Progress flowchart.
d. Audit program.
ANSWER: D
8. An auditor wants to develop an audit test to evaluate the reasonableness of the
quantity of scrap material resulting from a certain production process compared to
industry standards. Which would be the most competent type of evidence available to
satisfy this objective?
a. Documentary. b. Hearsay. c. Physical. d. Analytical.
ANSWER: D
9. As part of audit planning, CPAs should design audit programs for each individual
audit and should include audit steps and procedures to
a. Detect and eliminate fraud.
b. Increase the amount of management information available.
c. Provide assurances that the objectives of the audit are met. d. Ensure that only
material items are audited.
ANSWER: C
10. Of the following audit procedures, which best supports the valuation objective?
a. Performing a lower of cost or market test of the client's inventories.
b. Reviewing a contingent liability footnote for proper
wording.
c. Searching for unrecorded liabilities.
d. Observing the client's year-end physical inventory taking.
ANSWER: A
11. An assumption underlying analytical procedures is that
a. These procedures cannot replace tests of balances and transactions. b. Statistical

tests of financial information may lead to the discovery of material errors in the
financial statements. c. The study of financial ratios is an acceptable alternative to
the investigation of unusual fluctuations.
d. Relationships among data may reasonably be expected to exist and continue in the
absence of known conditions to the contrary.
ANSWER: D
12. An auditor is examining accounts receivable. What is the most competent type of
evidence in this situation?
a. Interviewing the personnel who record accounts receivable. b. Verifying that
postings to the receivable account from journals have been made.
c. Receipt by the auditor of a positive confirmation. d. No response received for a
request for a negative confirmation.
ANSWER: C
13. With respect to the auditor's planning of a year-end examination, which of the
following statements is always true?
a. An engagement should not be accepted after the fiscal year-end. b. An inventory
count must be observed at the balance sheet date.
c. The client's audit committee should not be told of the specific audit procedures
that will be performed. d. It is an acceptable practice to carry out substantial parts of
the examination at interim dates.
ANSWER: D
14. A letter to the auditor in response to an inquiry is an example of
a. Physical evidence.
b. Confirmation evidence.
c. Documentary evidence.
d. Analytical evidence.
ANSWER: B
15. Which of the following statements about working papers is correct?
a. Working papers are not permitted to be used as a reference source by the
client.
b. The auditor should document the understanding of the client's internal

control obtained to plan the audit
c. Working papers may be regarded as a substitute for the client's accounting
records.
d. When reporting on comparative financial statements, the independent
auditor may discard working papers after two years.
ANSWER: B
16. Which of the following factors is most important in determining the competence
of audit evidence?
a. The reliability of the evidence in meeting the audit objective. b. The objectivity of
the auditor gathering the evidence. c. The quantity of the evidence obtained.
d. The independence of the source of evidence.
ANSWER: A
17. The procedures specifically outlined in an audit program are primarily designed to
a. Protect the auditor in the event of litigation. b. Detect errors or fraud.
c. Test internal evidence.
d. Gather evidence.
ANSWER: D
18. When reviewing audit working papers, the primary responsibility of an audit
supervisor is to determine that:
a. Each worksheet is properly identified with a descriptive heading.
b. Working papers are properly referenced and kept in logical groupings.
c. Standard departmental procedures are adhered to with regard to work paper
preparation and technique. d. Working papers adequately support the audit
findings, conclusions, and report.
ANSWER: D
19. Auditors apply analytical procedures to the client's
operations in order to identify
a. Improper separation of accounting and other financial duties. b. Weaknesses of a
material nature in the client's internal control.
c. Unusual transactions.
d. Noncompliance with prescribed control procedures.

ANSWER: C
20. Which of the following workpapers would one normally expect to find in the
permanent file?
a. A copy of a long-term bond indenture.
b. The working trial balance.
c. An analysis of additions and disposals relating to marketable securities.
d. A workpaper analyzing customer replies to confirmation requests.
ANSWER: A
21. The in-charge auditor decides that work papers are complete
a. When satisfied that the audit objectives have been met and the working papers
support the conclusions. b. When working papers make reference to the steps outlined
in the audit program.
c. Only after the auditor who prepared the working papers has signed and dated
them.
d. When proper cross-references to other working papers are noted.
ANSWER: A
22. Of the following procedures, which does not produce analytical evidence?
a. Compare revenue, cost of sales, and gross profit with the prior year and
investigate significant variations.
b. Examine monthly performance reports and investigate significant revenue
and expense variances.
c. Confirm customers' accounts receivable and clear all material exceptions.
d. Compare sales trends and profit margins with industry averages and
investigate significant differences.
ANSWER: C
23. Audit evidence can come in different forms with different degrees of
persuasiveness. Which of the following is the least persuasive type of evidence?
a. Documents mailed by outsiders to the auditor. b. Correspondence between the
auditor and vendors. c. Sales invoices inspected by the auditor.
d. Computations made by the auditor.
ANSWER: C
24. Analytical procedures are
a. Substantive tests designed to evaluate a system of internal control.
b. Tests of control procedures designed to evaluate the validity of
management's representation letter. c. Substantive tests designed to evaluate
the reasonableness of financial information.
d. Tests of control procedures designed to detect errors in reported financial
information.
ANSWER: C
25. Which of the following statements relating to the
competence of evidential matter is always true?
a. Evidential matter gathered by an auditor from
outside an enterprise is reliable.
b. Accounting data developed under satisfactory conditions of internal control
are more relevant than data developed under unsatisfactory internal
control conditions. c. Oral representations made by management are not
valid evidence. d. Evidence gathered by auditors must be both valid
and relevant to be considered competent.
ANSWER: D
26. An auditor test counted a batch of inventory. This is an example of what kind of
evidence?
a. Analytical. b. Documentary. c. Physical. d. Hearsay.
ANSWER: C
27. In evaluating the reasonableness of advertising expense, which of the following
would be the best evidence?
a. Oral evidence obtained through discussions with company marketing
executives and representatives of the advertising agency retained.
b. Documentary evidence obtained by vouching charges to the account and by
retracing charges from source documents to the account.
c. Analytical evidence developed by comparing the ratio of
advertising expenses to sales with historical data for
the company and industry.
d. Arithmetical evidence developed by re-computing charges submitted by the

advertising agency and paid by the company.
ANSWER: C
28. Which of the following is not a consideration in the development of audit
programs?
a. Internal control over the recording of plant asset additions and repairs and
maintenance expenditures is found to be weak.
b. The client constructed a major addition to its central manufacturing facility
during the year under audit.
c. The client is a private university located in the Midwest.
d. The client's board or directors is elected by the
stockholders at the annual meeting.
ANSWER: D
29. Audit working papers are used to record the results of the auditor's evidence-
gathering procedures. When preparing working papers, the auditor should
remember that working papers should be
a. Kept on the client's premises so that the client can have access to them for
reference purposes.
b. The primary support for the financial statements being examined.
c. Considered as a part of the client's accounting records that are retained by
the auditor.
d. Designed to meet the circumstances and the auditor's needs on each
engagement.
ANSWER: D
30. The main advantage of properly indexed working papers is to
a. Reduce the size of the file.
b. Better organize the working papers.
c. Allow division of labor within the audit team. d. Facilitate the efficient use
of audit staff.
ANSWER: B
31. Which of the following is not a typical analytical procedure?
a. Study of relationships of financial information with relevant nonfinancial

information.
b. Comparison of financial information with similar information regarding the
industry in which the entity operates. c. Comparison of recorded amounts of
major disbursements with appropriate invoices.
d. Comparison of recorded amounts of major disbursements with budgeted
amounts.
ANSWER: C
32. Which of the following is an example of inferential evidence?
a. The auditor observes the taking of the client's physical inventory and
performs test counts.
b. The auditor inspects marketable securities for
existence.
c. An auditor, who notes that customer accounts receivable have increased
significantly in the current year as a percentage of sales, suspects that a
larger proportion of the accounts will prove uncollectible.
d. The auditor counts cash on hand at year-end.
ANSWER: C
33. Which of the following would be least likely to be comparable between similar
corporations in the same industry line of business?
a. Earnings per share.
b. Return on total assets before interest and taxes. c. Accounts receivable
turnover.
d. Operating cycle.
ANSWER: A
34. Which of the following is not an example of confirmation evidence?
a. Requesting the client's outside legal counsel to evaluate the possible
outcome of pending litigation.
b. Questioning the client's employees about existing internal control policies
and procedures.
c. Requesting the client's customers to verify year-end accounts receivable
balances.
d. Requesting payees to respond in writing to the terms contained in notes

payable appearing in the client's ledger.
ANSWER: B
35. A CPA, in performing an independent audit, would most likely use recalculation as
a substantive test for which of the following expense-related accounts?
a. Purchases of supplies.
b. Interest expense.
c. Advertising expense.
d. Repairs and maintenance expense.
ANSWER: B
36. During the course of an audit engagement, an auditor prepares and accumulates
audit working papers. The primary
purpose of the audit working papers is to
a. Aid the auditor in adequately planning his work. b. Provide a point of reference for
future audit engagements. c. Support the underlying concepts included in
the preparation of the basic financial statements. d. Support the auditor's opinion.
ANSWER: D
37. Which of the following is not an appropriate auditing procedure supporting fairness
of financial presentation?
a. Inspecting plant asset additions for existence.
b. Recalculating accrued interest on notes payable.
c. Examining invoices in support of legal fees recorded during the fiscal year.
d. Reviewing the client's production quality control program.
ANSWER: D
38. Sales commissions as a percentage of sales declined
significantly during the year under audit. Of the following possible causes, the most
likely is
a. Sales increased during the year.
b. The sales force was reduced at the end of the year.
c. Sales commission rates were increased at the beginning of the year.
d. Fictitious sales were recorded at year-end to inflate earnings. Commissions

were not recorded on these
sales.
ANSWER: D
39. Which of the following is responsible for the fairness of the representations made
in financial statements?
a. Client's management.
b. Independent auditor.
c. Audit committee.
d. AICPA.
ANSWER: A
40. An audit program provides proof that
a. Sufficient competent evidential matter was obtained. b. The work was adequately
planned.
c. There was compliance with generally accepted standards
of reporting.
d. There was a proper study and evaluation of internal control.
ANSWER: B
41. 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?
a. The audit program.
b. The auditor's judgment.
c. Generally accepted auditing standards.
d. The auditor's working papers.
ANSWER: B
42. During the working paper review, an audit supervisor finds that the auditor's
reported findings are not adequately cross-referenced to supporting
documentation. The supervisor will most likely instruct the auditor to
a. Prepare a working paper to indicate that the full scope of the audit was
carried out.
b. Familiarize him/herself with the sequence of working papers so that he(she)
will be able to answer questions about the conclusions stated in the
report. c. Eliminate any cross-references to other working papers
since the system is unclear.
d. Provide a workpaper indexing system that shows the relationship between
findings, conclusions, and the related facts.
ANSWER: D
43. Which of the following would be the most relevant form of evidence to evaluate
the reasonableness of account balances?
a. Analytical. b. Documentary. c. Physical. d. Hearsay.
ANSWER: A
44. Generally, what source of evidence should most impact audit conclusions?
a. External b. Inquiry. c. Oral. d. Informal.
ANSWER: A
45. Most of the independent auditor's work in formulating an opinion on the financial
statements consists of
a. Studying and evaluating internal control.
b. Obtaining and examining evidential matter.
c. Examining cash transactions.
d. Comparing recorded accountability with assets.
ANSWER: B
46. During an audit of the accounts receivable function, you found that the accounts
receivable turnover rate had fallen from 7.3 to 4.3 over the last three years. What is
the most likely cause of the decrease in the turnover rate?
a. An increase in the discount offered for early payment. b. A more liberal credit
policy.
c. A change from net 30 to net 25.
d. Greater cash sales.
ANSWER: B
47. Which of the following is generally included or shown in the auditor's working

papers?
a. The procedures used by the auditor to verify the personal financial status of
members of the client's management team.
b. Analyses that are designed to be a part of, or a substitute for, the client's
accounting records. c. Excerpts from authoritative pronouncements that
support the underlying generally accepted accounting principles used in
preparing the financial statements.
d. The manner in which exceptions and unusual matters disclosed by the
auditor's procedures were resolved or treated.
ANSWER: D
48. To test for unsupported entries in the ledger, the direction of audit testing should
be from the
a. Ledger entries.
b. Journal entries.
c. Externally generated documents.
d. Original source documents.
ANSWER: A
49. Which of the following does not describe one of the functions of audit workpapers?
a. Facilitates third-party reviews.
b. Aids in the planning, performance, and review of audits.
c. Provides the principal evidential support for the auditor's report.
d. Aids in the professional development of the operating staff.
ANSWER: D
50. The principal reason for developing a written audit program is to help assure that
the
a. Audit work is properly supervised.
b. Audit work is properly planned and documented. c. Audit report contains
only significant findings. d. Work of different auditors is properly coordinated.
ANSWER: B
51. One of the primary roles of an audit program is to:
a. Serve as a tool for planning, directing, and controlling audit work.

b. Document an auditor's understanding of the internal control.
c. Provide for a standardized approach to the audit engagement. d. Delineate the
audit risk accepted by the auditor.
ANSWER: A
52. The principal purpose for cross-indexing audit working papers is to
a. Give the working papers a professional appearance. b. Explain the use of tick
marks.
c. Provide explanation of the audit steps performed. d. Provide a trail for the auditor
and the reviewer.
ANSWER: D
53. Audit information is generally considered relevant when it
is:
a. Derived through valid statistical sampling.
b. Objective and unbiased.
c. Factual, adequate, and convincing.
d. Consistent with the audit objectives.
ANSWER: D
54. External auditors often confirm assertions contained in the organization's financial
statements and accounting records with third parties. Which of the following best
explains why confirmation produces evidence of high quality?
a. Written assertions from knowledgeable third parties provide sufficient evidence to
achieve most audit objectives. b. Confirmation by knowledgeable third parties is
usually the most relevant evidence available.
c. Confirmation by knowledgeable third parties is usually the least costly
evidence available.
d. Confirmation by knowledgeable third parties is highly competent because of
its independent source.
ANSWER: D
55. As a category of evidence, documents may be external or internal. As an auditor
reviewing your client's accounts
receivable, which of the following is an example of internal documentary evidence?

a. The carrier's bill of lading.
b. Sales invoice copies.
c. A customer's purchase order.
d. A vendor's month-end statement.
ANSWER: B
COMPLETION:
56. Audit programs can be developed only after the auditor has completed the audit
_______________ process.
ANSWER: PLANNING
57. An auditor who gathers increased quantities of evidence for larger account
balances is observing the standard relating to of audit evidence.
ANSWER: SUFFICIENCY
58. An auditor who gathers increased amounts of external evidence under conditions
of weak internal control is observing the standard of of audit evidence.
ANSWER: COMPETENCE (VALIDITY)
59. In performing substantive audit tests, focusing on the existence or occurrence
objective helps locate misstatements due to while the completeness objective
directs audit attention to misstatements due to .
ANSWER: COMMISSION, OMISSION
60. Evidence consisting of everything that can be counted, examined, observed, or
inspected is referred to as _____________ evidence.
ANSWER: PHYSICAL
61. The audit trail consists of that stream of evidence that enables the auditor to
trace a transaction or event forward from its inception to the appropriate
ledger account, or conversely, vouch a transaction backward from the ledger
account to the inception of the transaction or event. For the audit trail to exist,
transactions must be .
ANSWER: DOCUMENTED
62. Analytical evidence may be the best form of evidence supporting the objective, in

that auditors' suspicions concerning errors of omission are often first aroused by
the application of analytical procedures.
ANSWER: COMPLETENESS
63. An auditor-prepared bank reconciliation is an example of _______________
evidence.
ANSWER: MATHEMATICAL
64. A group of related transactions affecting essentially the same set of general ledger
accounts is referred to as a _________________ .
ANSWER: TRANSACTION CYCLE
65. The focal point of the current file is the ____________ _______________
______________ often referred to as a table of contents.
ANSWER: WORKING TRIAL BALANCE
MATCHING:
66. For each of the listed auditing procedures, indicate, by letter, the type of
evidence it represents.
a. Physical evidence
b. Confirmation evidence
c. Documentary evidence
d. Analytical evidence
e. Mathematical evidence
f. Hearsay evidence
____ 1. Audited client-prepared bank reconciliation
____ 2. Vouched debits to repairs accounts by examining vendors’ invoices
____ 3. Observed the client’s year-end physical inventory
____ 4. Compared accounts receivable turnover with industry
average
____ 5. Prepared ten-year income summary expressing all
components as a percentage of sales
____ 6. Obtained letter from client’s outside legal counsel
regarding pending litigation

____ 7. Inquired of corporate treasurer as to reason(s) for
acquiring marketable securities
____ 8. Calculated year-end interest accrual and compared
with general ledger balance
____ 9. Obtained replies directly from customers concerning
the correctness of client’s recorded year-end accounts receivable balances
____ 10.Examined securities purportedly owned by the client and held by local
brokers
____ 11.Compared operating cash flows with net income and
identified causes of significant disparities.
SOLUTION:
1. e
2. c
3. a
4. d
5. d
6. b
7. f
8. e
9. b
10. a
11. d
67. For each of the listed procedures, indicate, by letter, the
assertion(s) being tested.
a. Existence or occurrence
b. Completeness
c. Rights and obligations

d. Valuation or allocation
e. Presentation and disclosure
____ 1. Confirmed customer accounts receivable
____ 2. Vouched property additions to underlying
documentation consisting of vendors’ invoices and
work orders
____ 3. Inquired of corporate treasurer as to reasons for
buying and holding securities
____ 4. Selected a sample of bills of lading representing
shipments to customers and traced to sales invoices
to determine that all shipments have been billed to
customers
____ 5. Examined vendors’ invoices recorded after year-end to
determine whether any of these invoices represent
liabilities of the client as of year-end
____ 6. Obtained confirmation of marketable securities from
client’s brokers
____ 7. Evaluated the reasonableness of the client’s
depreciation policy
____ 8. Obtained letter from client’s outside legal counsel
regarding pending litigation
____ 9. Inspected recorded addition to client materials
handling facilities
____ 10. Investigated decrease in revenue from scrap sales as
revealed by the application of analytical
procedures
SOLUTION:
1. a,d
2. d
3. e
4. b
5. b,c
6. a,c,d
7. d
8. e
9. a
10. b
PROBLEM/ESSAY
68. For each of the following ledger accounts, give an example of substance
underlying the account balance:
1. Cash in bank
2. Sales revenue
3. Inventories
4. Accounts payable
5. Notes payable
6. Capital stock
7. Marketable securities
8. Operating expenses
9. Wages and salaries expense
10. Property, plant, and equipment
SOLUTION:
1. Bank statement, canceled checks, deposit tickets
2. Sales invoices, shipping documents, cash register tapes 3. Goods in warehouses,
goods out on consignment
4. Vendors’ records of accounts receivable, vendors’

invoices
5. Payees’ confirmation of amounts owed to them, copy of
note in client’s files
6. Records maintained by registrar and transfer agent
7. Securities in vault or in safekeeping, brokers’
advices, brokers’ confirmations
8. Vendors’ invoices, canceled checks, client’s
workpapers supporting such charges as depreciation,
amortization, and product warranty
9. Payroll summaries, time cards, clock cards, canceled
checks, human resources records
10. Plant assets at various locations, vendors’ invoices
69. Audit evidence must be sufficient and competent. To be competent, the evidence
must be both valid and relevant.
Required:
a. What is meant by “sufficient audit evidence?”
b. Define the concepts of validity and relevance as they
relate to audit evidence.
SOLUTION:
a. Sufficient audit evidence is evidence that is adequate to support the auditor’s
opinion on the financial statements. A matter of audit judgment, sufficiency is usually
based on materiality and the adequacy of existing internal control.
b. Validity of audit evidence is a function of three qualities:
1) The independence and competence of the source of
the evidence (e.g., external evidence possesses
greater validity than internal evidence);
2) The conditions under which the evidence was
obtained (e.g., evidence produced by strong

internal control possesses greater validity
than evidence gathered under weak internal
control); and
3) The manner in which the evidence was obtained
(e.g., evidence obtained directly by the auditor
possesses greater validity than evidence obtained
indirectly).
Relevance means that the evidence pertains to specific audit
objectives. Observing the taking of the inventory, for example, provides evidence
concerning existence of the inventory, but is not relevant to determining ownership.
70. The following operating data has been provided to Erica Chavez by her audit
client, Grimes Hardware. Sales commissions
average 6 percent of sales:
2002 % 2003 % Change (%)
Sales $18,000 100% 22,000 100% 22%
Cost of sales 10,000 11,000
Sales commissions 1,080 1 100
Gross profit 6,920 9,900
Operating expenses 3,200 3,600
Income before taxes 3,720 6,300
Income taxes 1,200 2,000
Net income $2,520 4,300
===== =====
Required:
a. Complete the vertical and horizontal analysis by calculating the correct
percentages.
b. Why are both vertical and horizontal analysis important inputs to analytical
procedures?
c. Assuming sales commissions have been accurately

computed based on 2003 sales, what are the possible explanations for any
abnormalities produced by your percentage calculations?
SOLUTION:
a.
2002 % 2003 % Change (%)
Sales $18,000 100% 22,000 100% 22%
Cost of sales 10,000 56 11,000 50 10
Sales commissions 1,080 6 1,100 5 2
Gross profit 6,920 38 9,900 45 43
Operating expenses 3,200 17 3,600 16 13
Income before taxes 3,720 21 6,300 29 69
Income taxes 1,200 7 2,000 9 67
Net income $2,520 14 4,300 20 71
===== == ===== ==
b. Trend analysis (the “Change” column) examines changes in data over time. Given
the assumption that past trends may be expected to continue into the future,
significant changes warrant further investigation. Vertical analysis (the first two
percentage columns), by expressing all components as percentages of a common base
(sales in this case), permits the auditors to compare percentages with previously
developed auditor expectations. If, for example, the auditor has previously
determined that commissions average 6% of sales, he/she may wish to investigate the
lower rate reflected in 2003 results.
c. If sales commissions are accurate and represent 6 percent of sales, the sales base
must be overstated in order to produce a commission rate of only 5 percent. Sales
may have been fabricated, or 2004 sales may have been recorded in 2003. The
material decline in cost of sales as a percentage of sales suggests that recorded sales
transactions were not accompanied by cost of sales entries.
71. The following financial data have been extracted from the records of Blackwell
Wholesale Tires:
2003 2002
Sales $15,660 14,980
Ending inventory 6,200 4,300
Accounts receivable-trade 2,200 1,300
Total current assets 12,300 10,100
Total current liabilities 7,300 4,980
Customer payment terms:
2/10;n/30
Industry averages:
Gross margin 51%
Current ratio 2:1
Inventory turnover 2.5
Accounts receivable turnover 11.0
Required:
Based on the above data, in which areas do you recommend concentrating audit
resources for the 2003 audit? Support your answer by citing the relevant data.
SOLUTION:
2003 2002
Sales $15,660 14,980
Gross margin 7,860 50% 5,580 49%
Inventory and accounts receivable appear to warrant emphasis for Blackwell
Wholesale Tires. Although the gross margin has not changed materially in 2003 relative
to 2002 and approximates the industry average for both years, inventory turnover has
declined significantly and is well below the industry average (1.25 v. 2.5). This
suggests the possibility of inflated inventory quantities, incorrect inventory prices,
obsolete inventory, or some combination of these. Accounts receivable turnover for
2002 was approximately equal to the industry average; but for 2003 turnover has
declined to approximately 7 times versus 11 times for the industry. Given payment
terms of 2/10;n/30, one would expect a turnover between 11 and 12 times, or
approximately 30 days sales in accounts receivable. A turnover of 7 times equates with
approximately 50 days sales in accounts receivable. Failure to properly investigate
customer credit, or weak collection procedures, or inflated accounts receivable are
possible explanations for the decline in turnover. Although the current ratio appears
adequate when compared with the preceding year and with the industry average, the
quick ratio (current assets minus inventory divided by current liabilities) has declined
from 1.16 in 2002 to .84 in 2003. This suggests a short-term liquidity problem,
especially if inventories are overstated and/or customer accounts receivable are
delinquent.
71. Identify the deficiencies in the following audit workpaper:
TRAMWAY ENTERPRISES
Bank Reconciliation
12/31/2003
Balance per bank $5,774 *
Add deposit in transit 1,223 &
6,997
Deduct outstanding checks:
4455 $67 &
4477 180 &
4478 1,023 &
4479 33 &
1,303
Adjusted balance $5,594
=====
Balance per ledger $6,300
Adjustment to correct (706)
Adjusted balance as above $5,594
======
SOLUTION:
1. Initials of preparer and reviewer and dates of
preparation and review are missing.
2. Name of bank account being reconciled is omitted.
3. Subtraction error. Adjusted balance should be $5,694

rather than $5,594.
4. Audit adjustment of $706 not explained.
5. Audit legends not explained.

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Audit Planning: Assessment of Control Risk

1. Which of the following is ordinarily considered a test of

2. When obtaining an understanding of an entity's control

3. After the study and evaluation of a client's internal

4. A conceptually logical approach to the auditor's evaluation

What should be the order in which these four steps are

5. An auditor evaluates the existing internal control

6. The auditor is studying internal control policies and

d. Internal control over the recording of sales is found

7. A secondary objective of the auditor's study and evaluation

8. In studying the design and implementation of a client's

a. In processing sales orders, the computer is programmed

9. The auditor's review of the client's internal control is

b. Representation as to adherence to requirements of

10. An internal control questionnaire indicates that an approved

11. When considering internal control, an auditor must be aware

12. Statement on Auditing Standards No. 60 requires the auditor

audit committee, to a body having similar oversight

13. In connection with the examination of financial statements

14. An auditor uses the knowledge provided by the understanding

15. Flowcharting as a means of internal control evaluation

16. Which of the following factors most likely affects the

17. If the independent auditors decide that the work performed

18. An auditor's purpose for further testing of internal control

19. Control testing is performed in order to determine whether

20. The independent auditor should acquire an understanding of

21. In the assessment of control risk, the auditor is basically

a. Management cannot override the system.

22. Which of the following may be considered an appropriate

introduce into the system, a voucher containing an

23. Which of the following statements concerning the independent

24. Which of the following would be the best procedure to

25. After studying and evaluating a client's existing internal

c. Set detection risk at a higher level than would be set

26. An auditor is required to obtain a basic understanding of

27. The auditor's understanding of the client's internal control

28. To determine whether the client's system of internal control

29. When evaluating a client's system of internal control to

c. Perform tests of internal control procedures.

30. Of the following internal control policies or procedures,

31. Tracing copies of sales invoices to shipping documents will

32. In assessing control risk, the auditor must, as a minimum

33. An independent auditor has concluded that the client's

based on tests made during the year when internal control

34. An auditor is least likely to further test control

35. An auditor usually examines receiving reports to support

36. Regardless of whether the auditor decides to test controls

d. Internal control questionnaire.

38. An auditor generally tests physical security controls over

39. Which of the following is not an auditing procedure that is

40. If the independent auditor decides that the work performed

d. Consider the client's practices for hiring, training,

41. Tracing bills of lading to sales invoices will provide

42. The development of constructive suggestions to clients for

43. Which of the following statements with respect to the

44. Which of the following statements best describes the

a. Because of the inherent limitations of an audit, the

45. Which of the following procedures most likely would be

46. If, after obtaining an initial understanding of a client's

47. The auditor is most likely to presume that a high risk of

b. The client does business with several related parties.

48. After obtaining an understanding of the client’s internal