6-19

The following questions concern the reasons auditors do audits. Choose the
best response.
a. Which of the following best describes the reason why an independent auditor reports
on financial statements?
(1) A misappropriation of assets may exist, and it is more likely to be detected by
independent auditors.
(2) Different interests may exist between the company preparing the statements
and the persons using the statements.
(3) A misstatement of account balances may exist and is generally corrected as
the result of the independent auditors work.
(4) Poorly designed internal controls may be in existence.
Answer: (2) Different interests may exist between the company preparing
the statements and the persons using the statements.
b. Because of the risk of material misstatement, an audit should be planned and
performed with an attitude of
(1) Objective judgment.
(2) Independent integrity.
(3) Professional skepticism.
(4) Impartial conservatism.
Answer: (3) professional skepticism.
c. The major reason an independent auditor gathers audit evidence is to
(1) Form an opinion on the financial statements.
(2) Detect fraud.
(3) Evaluate management.
(4) Assess control risk.
Answer: (1) form an opinion on the financial statements.
6-20
The following questions deal with errors and fraud. Choose the best
response.
a. An independent auditor has the responsibility to design the audit to provide
reasonable assurance of detecting errors and fraud that might have a material effect on
the financial statements. Which of the following, if material, is a fraud as defined in
auditing standards?
(1) Misappropriation of an asset or groups of assets.
(2) Clerical mistakes in the accounting data underlying the financial statements.
(3) Mistakes in the application of accounting principles.
(4) Misinterpretation of facts that existed when the financial statements were
prepared.
Answer: (1) Misappropriation of an asset or groups of assets.
b. What assurance does the auditor provide that errors, fraud, and direct-effect illegal
acts that are material to the financial statements will be detected?

Errors

Fraud

Direct-Effects Illegal
Acts

(1) Limited

Negative

Limited

(2) Reasonable

Reasonable

Reasonable

(3) Limited

Limited

Reasonable

(4) Reasonable

Limited

Limited

Answer: (2) Errors - Reasonable ; Fraud - Reasonable ; Direct - Effects

Illegal Acts - Reasonable.
c. Which of the following statements describes why a properly designed and executed
audit may not detect a material misstatement in the financial statements resulting from
fraud?
(1) Audit procedures that are effective for detecting unintentional misstatements
may be ineffective for an intentional misstatement that is concealed through
collusion.
(2) An audit is designed to provide reasonable assurance of detecting material
errors, but there is no similar responsibility concerning fraud.
(3) The factors considered in assessing control risk indicated an increased risk of
intentional misstatements, but only a low risk of unintentional misstatements.
(4) The auditor did not consider factors influencing audit risk for account
balances that have effects pervasive to the financial statements taken as a whole.
Answer: (1) Audit procedures that are effective for detecting unintentional
misstatements may be ineffective for an intentional misstatement that is
concealed through collusion.
6-27
The following are specific transaction-related audit objectives applied to the
audit of cash disbursement transactions (a through f), management
assertions about classes of transactions (1 through 5), and general
transaction-related audit objectives (6 through 11).
Specific Transaction-Related Audit Objective
a. Recorded cash disbursement transactions are for the amount of goods or
services received and are correctly recorded.
b. Cash disbursement transactions are properly included in the accounts payable
master file and are correctly summarized.
c. Recorded cash disbursements are for goods and services actually received.
d. Cash disbursement transactions are properly classified.
e. Existing cash disbursement transactions are recorded.
f. Cash disbursement transactions are recorded on the correct dates.

Management Assertion about

Classes of Transactions

General Transaction-Related Audit

Objective

(1) Occurrence

(06) Occurrence

(2) Completeness

(07) Completeness

(3) Accuracy

(08) Accuracy

(4) Classification

(09) Posting and summarization

(5) Cut Off

(10) Classification
(11) Timing

Required
a. Explain the differences among management assertions about classes of
transactions and events, general transaction-related audit objectives, and
specific transaction-related audit objectives and their relationships to each
other.
b. For each specific transaction-related audit objective, identify the
appropriate management assertion.
c. For each specific transaction-related audit objective, identify the
appropriate general transaction-related audit objective.
ANSWERS
a) Management assertions are implied or expressed representations by management
about the classes of transactions and related accounts in the financial statements. SAS
31 (AU 326) classifies five broad categories of assertions - (1) Occurrence ; (2)
Completeness ; (3) Accuracy ; (4) Classification ; (5) Cut Off. These assertions are the
same for every transaction cycle and account. General transaction-related audit
objectives are essentially the same as management assertions, but they are expanded
somewhat to help the auditor decide which audit evidence is necessary to satisfy the
management assertions. Accuracy, classification, timing, and posting and
summarization are a subset of the valuation or allocation assertion. Specific transactionrelated audit objectives are determined by the auditor for each general transactionrelated audit objective. These are done for each transaction cycle to help the auditor
determine the specific amount of evidence needed for that cycle to satisfy the general
transaction-related audit objectives.

b&c
SPECIFIC TRANSACTIONRELATED AUDIT
OBJECTIVE

MANAGEMENT
ASSERTION

GENERAL TRANSACTIONRELATED AUDIT

OBJECTIVE

a. Recorded cash
disbursement transactions
are for the amount of
goods or services received
and are correctly recorded.

3. Accuracy

8.

b. Cash disbursement
transactions are properly
included in the accounts
payable master file and are
correctly summarized.

3. Accuracy

9. Posting and

c. Recorded cash
disbursements are for
goods and services actually
received.

1. Existence or occurrence

6. Occurrence

d. Cash disbursement
transactions are properly
classified.

3. Accuracy

10. Classification

e. Existing cash
disbursement transactions
are recorded.

2. Completeness

7. Completeness

f. Cash disbursement
transactions are recorded
on the correct dates.

5. Cut off

11. Timing

Accuracy

Summarization

7-25
The following questions concern persuasiveness of evidence. Choose the
best response.

a. Which of the following types of documentary evidence should the auditor consider to
be the most reliable?
(1) A sales invoice issued by the client and supported by a delivery receipt from an
outside trucker.
(2) Confirmation of an account payable balance mailed by and returned directly
to the auditor.
(3) A check, issued by the company and bearing the payees endorsement, that is
included with the bank statements mailed directly to the auditor.
(4) An audit schedule prepared by the clients controller and reviewed by the
clients treasurer.
Answer: (2) Confirmation of an account payable balance mailed by and
returned directly to the auditor.
b. Which of the following statements concerning audit evidence is true?
(1) To be appropriate, audit evidence should be either persuasive or relevant, but
need not be reliable.
(2) The measure of the quantity and quality of audit evidence lies in the auditors
judgment.
(3) The difficulty and expense of obtaining audit evidence concerning an account
balance is a valid basis for omitting the test.
(4) A clients accounting records can be sufficient audit evidence to support the
financial statements.
Answer: (2) The measure of the quantity and quality of audit evidence lies
in the auditors judgment.
c. Audit evidence can come in different forms with different degrees of persuasiveness.
Which of the following is the least persuasive type of evidence?
(1) Vendors invoice
(2) Bank statement obtained from the client
(3) Computations made by the auditor
(4) Prenumbered sales invoices
Answer: (4) Prenumbered sales invoices
d. Which of the following presumptions is correct about the reliability of audit
evidence?
(1) Information obtained indirectly from outside sources is the most reliable
audit evidence.
(2) To be reliable, audit evidence should be convincing rather than merely
persuasive.
(3) Reliability of audit evidence refers to the amount of corroborative evidence
obtained.
(4) Effective internal control provides more assurance about the reliability of
audit evidence.
Answer : (4) Effective internal control provides more assurance about the
reliability of audit evidence.

7-26
The following questions concern audit documentation. Choose the best
response.
a. Which of the following is not a primary purpose of audit documentation?
(1) To coordinate the audit.
(2) To assist in preparation of the audit report.
(3) To support the financial statements.
(4) To provide evidence of the audit work performed.
Answer: (3) To support the financial statements.
b. During an audit engagement, pertinent data are compiled and included in the audit
files. The audit files primarily are considered to be
(1) A client-owned record of conclusions reached by the auditors who performed
the engagement.
(2) Evidence supporting financial statements.
(3) Support for the auditors representations as to compliance with auditing
standards.
(4) A record to be used as a basis for the following years engagement.
Answer: (3) Support for the auditors representations as to compliance with
auditing standards.
c. Although the quantity, type, and content of audit documentation will vary with the
circumstances, audit documentation generally will include the
(1) Copies of those client records examined by the auditor during the course of
the engagement.
(2) Evaluation of the efficiency and competence of the audit staff assistants by the
partner responsible for the audit.
(3) Auditors comments concerning the efficiency and competence of client
management personnel.
(4) Auditing procedures followed and the testing performed in obtaining audit
evidence.
Answer: (4) Auditing procedures followed and the testing performed in
obtaining audit evidence.
d. The permanent file of an auditors working papers most likely would include copies of
the
(1) Lead schedule.
(2) Attorneys letters.
(3) Bank statements.
(4) Debt agreements.
Answer: (4) Debt agreements.

7-27
The following are examples of documentation typically obtained by
auditors.
Required
a. Classify each of the preceding items according to type of documentation:
(1) internal or (2) external.
b. Explain why external evidence is more reliable than internal evidence.

01. Vendors invoices - External

02. General ledger files - Internal
03. Bank statements - External
04. Cancelled payroll checks - External
05. Payroll time records - Internal
06. Purchase requisitions - External
07. Receiving reports (documents prepared when merchandise is received) - Internal
08. Minutes of the board of directors - Internal
09.Remittance advices - External
10. Signed W-4s (Employees Withholding Exemption Certificates) - Internal
11. Signed lease agreements - External
12. Duplicate copies of bills of lading - External
13. Subsidiary accounts receivable records - Internal
14. Cancelled notes payable - External
15. Duplicate sales invoices - Internal
16. Articles of incorporation - External
17. Title insurance policies for real estate - External
18. Notes receivable - External
b) External evidence is considered more reliable than internal evidence because external
evidence has been in the hands of both the client and another party, implying
agreement about the information and the conditions stated on the document.
7-28
The following are examples of audit procedures.
Required
Classify each of the preceding items according to the eight types of audit
evidence:
(1) Physical examination, (2) confirmation, (3) documentation, (4)
analytical procedures, (5) inquiries of the client, (6) recalculation, (7) reperformance, and (8) observation.
1. Review the accounts receivable with the credit manager to evaluate their collectibility.

Answer : Inquiries of the client.

2. Compare a duplicate sales invoice with the sales journal for customer name and
amount.
Answer: Documentation
3. Add the sales journal entries to determine whether they were correctly totaled.
Answer: Recalculation
4. Count inventory items and record the amount in the audit files.
Answer: Physical Examination.
5. Obtain a letter from the clients attorney addressed to the CPA firm stating that the
attorney is not aware of any existing lawsuits.
Answer: Confirmation.
6. Extend the cost of inventory times the quantity on an inventory listing to test whether
it is accurate.
Answer: Recalculation.
7. Obtain a letter from an insurance company to the CPA firm stating the amount of the
fire insurance coverage on buildings and equipment.
Answer: Confirmation.
8. Examine an insurance policy stating the amount of the fire insurance coverage on
buildings and equipment.
Answer: Documentation.
9. Calculate the ratio of cost of goods sold to sales as a test of overall reasonableness of
gross margin relative to the preceding year.
Answer: Analytical procedures.
10. Obtain information about internal control by requesting the client to fill out a
questionnaire.
Answer: Inquiry of client.
11. Trace the total in the cash disbursements journal to the general ledger.
Answer: Re-performance.
12. Watch employees count inventory to determine whether company procedures are
being followed.
Answer: Observation.
13. Examine a piece of equipment to make sure that a major acquisition was actually
received and is in operation.
Answer: Physical Examination.

14. Calculate the ratio of sales commission expense to sales as a test of sales
commissions.
Answer: Analytical Procedures.
15. Examine corporate minutes to determine the authorization of the issue of bonds.
Answer: Documentation.
16. Obtain a letter from management stating that there are no unrecorded liabilities.
Answer: Inquiry of client.
17. Review the total of repairs and maintenance for each month to determine whether
any months total was unusually large.
Answer: Analytical procedures.
18. Obtain a written statement from a bank stating that the client has $15,671 on deposit
and liabilities of $500,000 on a demand note.
Answer: Confirmation.
8-25
The following questions concern the planning of the engagement. Select the
best response.
a. Which of the following is an effective audit planning procedure that helps prevent
misunderstandings and inefficient use of audit personnel?
(1) Arrange to make copies, for inclusion in the audit files, of those client
supporting documents examined by the auditor.
(2) Arrange to provide the client with copies of the audit programs to be used
during the audit.
(3) Arrange a preliminary conference with the client to discuss audit objectives,
fees, timing, and other information.
(4) Arrange to have the auditor prepare and post any necessary adjusting or
reclassification entries prior to final closing.
Answer: (3) Arrange a preliminary conference with the client to discuss
audit objectives, fees, timing, and other information.
b. When auditing related party transactions, an auditor places primary emphasis on
(1) Confirming the existence of the related parties.
(2) Verifying the valuation of related party transactions.
(3) Evaluating the disclosure of the related party transactions.
(4) Ascertaining the rights and obligations of the related parties.
Answer: (3) evaluating the disclosure of the related party transactions.
c. Which of the following will most likely indicate the existence of related parties?
(1) Writing down obsolete inventory prior to year end.

(2) Failing to correct deficiencies in the clients internal control.

(3) An unexplained increase in gross margin.
(4) Borrowing money at a rate significantly below the market rate.
Answer: (4) Borrowing money at a rate significantly below the market rate.
d. Which of the following is least likely to be included in the auditors engagement
letter?
(1) Details about the preliminary audit strategy.
(2) Overview of the objectives of the engagement.
(3) Statement that management is responsible for the financial statements.
(4) Description of the level of assurance obtained when conducting the audit.
Answer: (1) Details about the preliminary audit strategy.
8-28
The following are various activities an auditor does during audit planning.
Required
For each procedure, indicate which of the first four parts of audit planning
the procedure primarily relates to: (1) accept client and perform initial
audit planning; (2) understand the clients business and industry; (3) assess
client business risk; (4) perform preliminary analytical procedures.
1. Send an engagement letter to the client.
Answer: (1) Accept client and perform initial audit planning.
2. Tour the clients plant and offices.
Answer: (2) understand the clients business and industry.
3. Compare key ratios for the company to industry competitors.
Answer: (4) Perform preliminary analytical procedures.
4. Review managements risk management controls and procedures.
Answer: (3) Assess client business risk.
5. Review accounting principles unique to the clients industry.
Answer: (2) Understand the clients business and industry.
6. Determine the likely users of the financial statements.
Answer: (1) Accept client and perform initial audit planning.
7. Identify potential related parties that may require disclosure.
Answer: (2) Understand the clients business and industry.
8. Identify whether any specialists are required for the engagement.
Answer: (1) Accept client and perform initial audit planning.