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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 containsa. 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: D2. Of the following procedures, which is not considered part of obtaining an understanding of the clients 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: B3. If working papers are to have the characteristics that will ensure that they achieve their primary purposes, which of thefollowing is the most important?a. Working papers must be of standard format and standard content.b. Working papers must be properly indexed and crossreferenced 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: C4. 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 ordinaryrepairs as plant assets. d. Examined monthly performance reports and investigated significant variations from budgeted amounts.ANSWER: C5. 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 andpurchase 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 i nvoice was submittedfor payment that was not accompanied by a matching receiving report and purchase order.ANSWER: A6. An initial (firsttime) audit requires more audit time to complete than a recurring audit. One of the reasons for thi s isthata. 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 nee d to be carefully studied. d. A larger proportion of customer accounts receivable need to be confirmed on an initial audit.A NSWER: C7. Which of the following is a basic tool used by the auditor to control the audit work and review the progress of theaudit?a. Time and expense summary.b. Engagement letter.c. Progress flowchart. d. Audit program. ANSWER: D8. An auditor wants to develop an audit test to evaluate the reasonableness of the quantity of scrap materialresulting from a certain production process compared to industry standards. Which woul d bethe most competent type of evidence available to satisfy this objective? a. Documentary. b. Hearsay. c. Physical. d. Analytical. ANSWER: D9. As part of audit planning, CPAs should design audit programs for each individual audit and should include auditsteps and procedures toa. 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 materialitems are audited.ANSWER: C10. 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 properwording.c. Searching for unrecorded liabili ties.d. Observing the client's year-end physical inventory taking.ANSWER: A11. An assumption underlying analytical procedures is thata. These procedures cannot replace t ests of balances and transactions. b. Statistical tests of financial information may lead to the disc overy of material errors in the financial statements. c.The study of financial ratios is an acceptabl e alternative to the investigation of unusualfluctuations. d. Relationships among data may reasonably be expected to exist and continue in the absen ce of knownconditions to the contrary. ANSWER: D12. An auditor is examining accounts receivable. What is the most competent type of evidence in thissituation?a. Interviewing the personnel who record accounts receivable. b. Verifying that p ostingsto 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 anegative confirmation.ANSWER: C13. With respect to the auditor's planning of a yearend examination, which of the following statements is always true?a. An engagement should not be accepted after the fiscal yearend. b. An inventory countmust be observed at the balance sheet date.c. The client's audit commi ttee should not be told of the specific audit procedures that will beperformed. d. It is an acceptable practice to carry out substantial parts of the examination at interimda tes. ANSWER: D14. 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: B15. 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 auditc. 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: B16. Which of the following factors is most important in determining the competence of auditevidence?a. The reliability of the evidence in meeting the audit objective. b. The objectiv ity of theauditor gathering the evidence. c. The quantity of the evidence obtained d. The independence of the source of evidence.ANSWER: A17. The procedures specifically outlined in an audit program are primarily designed toa. Protect the auditor in the event of litigation. b. Detect errors or fraud.c. Test internal evidence.d. Gather evidence.ANSWER: D18. When reviewing audit working papers, the primary responsibility of an audit supervisor ist o 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 preparat ion and technique. d.Working papers adequately support the audit findings, conclusions, and report.ANSWER: D19. Auditors apply analytical procedures to the client'soperations in order to identifya. Improper separation of accounting and other financial duties. b. Weaknesses of a mater ialnature in the client's internal control.c. Unusual transactions.d. Noncompliance with prescribed control procedures.ANSWER: C20. Which of the following workpapers would one normally expect to find in the permanent fil e?a. A copy of a longterm bond indenture.b. The working trial balance.c. An analysis of additions and disposals relatin g to marketable securities.d. A workpaper analyzing customer replies to confirmation requests.A NSWER: A21. The incharge auditor decides that work papers are completea. When satisfied that the audit objectives h ave been met and the working papers support theconclusions. b. When working papers make reference to the steps outlined in the auditprogram.c. Only after th e auditor who prepared the working papers has signed and dated them.d. When proper crossreferences to other working papers are noted.ANSWER: A22. Of the following procedures, which does not produce analytical evidence?a. Compare reve nue, cost of sales, and gross profit with the prior year and investigate significant variations.b. Ex amine 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: C23. Audit evidence can come in different forms with different degrees of persuasiveness. Whic h of the following isthe least persuasive type of evidence?a. Documents mailed by outsiders to th e auditor. b. Correspondence between the auditor and vendors.c. Sales invoices inspected by the auditor.d. Computations made by the auditor.ANSWER: C24. Analytical procedures area. Substantive tests designed to evaluate a system of internal

control.b. Tests of control procedures designed to evaluate the validity of management's represen tation 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.ANSW ER: C25. Which of the following statements relating to thecompetence of evidential matter is always true? a. Evidential matter gathered by an auditor fromoutside an enterprise is reliable.b. Accounting data developed under satisfactory conditions of internal control are more r elevant than datadeveloped under unsatisfactory internal control conditions. c. Oral representatio ns made by managementare not valid evidence. d. Evidence gathered by auditors must be both va lid and relevant to be considered competent.ANSWER: D26. 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: C27. In evaluating the reasonableness of advertising expense, which of the following would be th e bestevidence?a. Oral evidence obtained through discussions with company marketing executives and representatives of the advertisingagency retained.b. Documentary evidence obtained by vouching charges to the account and by retracing charges fromsource documents to the account.c. Analytical evidence developed by comparing the ratio of advertising expenses to sales with historical data forthe company and industry.d. Arithmetical evidence developed by recomputing charges submitted by the advertising agency and paid by thecompany.ANSWER: C28. Which of the following is not a consideration in the development of audit programs?a. Inter nal control over the recording of plant asset additions and repairs and maintenance expenditures i s found to beweak.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 clie nt's board or directors is elected by thestockholders at the annual meeting.ANSWER: D29. Audit working papers are used to record the results of the auditor's evidencegathering procedures. When preparingworking papers, the auditor should remember that working papers should bea. 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.ANS WER: D30. The main advantage of properly indexed working papers is toa. 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: B31. 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 indust ry in which the entityoperates. c. Comparison of recorded amounts of major disbursements with appropriate invoices.d. Comparison of recorded amounts of major disbursements with budgeted amounts.ANSWER: C32. Which of the following is an example of inferential evidence?a. The auditor observes the ta

king of the client's physical inventory and performs test counts.b. The auditor inspects marketabl e securities forexistence.c. An auditor, who notes that customer accounts receivable have increas ed significantly in the current year as apercentage of sales, suspects that a larger proportion of the accounts will prove uncollectible.d. The auditor counts cash on hand at year-end. NSWER: C33. Which of the following would be least likely to be comparable between similar corporation s inthe same industry line of business?a. Earnings per share.b. Return on total assets before interest and taxes. c. Accounts receivable turnover.d. Opera ting cycle.ANSWER: A34. 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 yearend accounts receivable balances.d. Requesting payees to respond in writing to the terms contain ed in notes payable appearing in the client's ledger.ANSWER: B35. A CPA, in performing an independent audit, would most likely use recalculation as a substa ntive test for which of thefollowing expense-related accounts?a. Purchases of supplies.b. Interest expense.c. Advertising expense.d. Repairs and maintenance expense.ANSWER: B36. During the course of an audit engagement, an auditor prepares and accumulates audit worki ngpapers. The primarypurpose of the audit working papers is toa. Aid the auditor in adequately planning his work. b. Provide a point of reference for future au ditengagements. c. Support the underlying concepts included in the preparation of thebasic finan cial statements. d. Support the auditor's opinion.ANSWER: D37. Which of the following is not an appropriate auditing procedure supporting fairness of fina ncial presentation?a. Inspecting plant asset additions for existence.b. Recalculating accrued inter est on notes payable.c. Examining invoices in support of legal fees recorded during the fiscal yea r.d. Reviewing the client's production quality control program.ANSWER: D38. Sales commissions as a percentage of sales declinedsignificantly during the year under audit. Of the following possible causes, the most likely isa. 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 thesesales.ANSWER: D39. Which of the following is responsible for the fairness of the representations made in financi al statements?a. Client's management.b. Independent auditor.c. Audit committee.d. AICPA.ANSWER: A40. An audit program provides proof thata. Sufficient competent evidential matter was obtained . b. The work was adequately planned.c. There was compliance with generally accepted standardsof reporting.d. There was a proper study and evaluation of internal control.ANSWER: B41. Which of the following ultimately determines the specificaudit 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: B42. During the working paper review, an audit supervisor finds that the auditor's reported findin gs are notadequately crossreferenced to supporting documentation. The supervisor will most likelyinstruct the auditor toa. 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 aboutthe conclusions stated in the report. c. Eliminate any cross-references to other working paperssince the system is unclear.d. Provide a workpaper indexing system that shows the relationship between findings, co nclusions, and therelated facts.ANSWER: D43. Which of the following would be the most relevant form of evidence to evaluate the reason ableness of accountbalances?a. Analytical. b. Documentary. c. Physical. d. Hearsay.ANSWER: A44. Generally, what source of evidence should most impact audit conclusions?a. External b. Inquiry. c. Oral. d. Informal.ANSWER: A45. Most of the independent auditor's work in formulating an opinion on the financial statement s 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: B46. During an audit of the accounts receivable function, you found that the accounts receivable turnoverrate had fallen from 7.3 to 4.3 over the last three years. What is the most likely cause of the decrease in the turnoverrate?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: B47. 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 recor ds. c. Excerpts fromauthoritative pronouncements that support the underlying generally accepted accounting pri nciples used in preparing thefinancial statements.d. The manner in which exceptions and unusual matters disclosed by the auditor's procedures were resolved ortreated.ANSWER: D48. To test for unsupported entries in the ledger, the direction of audit testing should be from th ea. Ledger entries.b. Journal entries.c. Externally generated documents.d. Original source docum ents.ANSWER: A49. 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 evid ential support for the auditor's report d. Aids in the professional development of the operating staff.ANSWER: D50. The principal reason for developing a written audit program is to help assure that thea. Audit work is properly supervised.b. Audit work is properly planned and documented. c. Audit report contains only sign ificant findings. d. Workof different auditors is properly coordinated.ANSWER:

B51. 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 auditrisk accepted by the auditor.ANSWER: A52. The principal purpose for crossindexing audit working papers is toa. Give the working papers a professional appearance. b. Expl ain the use of tick marks.c. Provide explanation of the audit steps performed. d. Provide a trail fo r the auditor and thereviewer.ANSWER: D53. Audit information is generally considered relevant when itis:a. Derived through valid statistical sampling.b. Objective and unbiased.c. Factual, adequate, and convincing.d. Consistent with the a udit objectives.ANSWER: D54. External auditors often confirm assertions contained in the organization's financial statements and accountingrecords with third parties. Which of the following best explains why confirmation pro duces evidenceof high quality?a. Written assertions from knowledgeable third parties provide sufficient evidence to ach ieve mostaudit objectives. b. Confirmation by knowledgeable third parties is usually the most rel evantevidence available.c. Confirmation by knowledgeable third parties is usually the least costly evidence avai lable.d. Confirmation by knowledgeable third parties is highly competent because of its independ ent source.ANSWER: D55. As a category of evidence, documents may be external or internal. As an auditor reviewing your client'saccountsreceivable, which of the following is an example of internal documentary ev idence?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: PLANNING57. An auditor who gathers increased quantities of evidence for larger account balan ces is observing the standard relatingto of audit evidence.ANSWER: SUFFICIENCY58. An auditor who gathers increased amounts of external evidence under conditi ons of weak internal control is observingthe standard of of audit evidence.ANSWER: COMPETENCE (VALIDITY)59. In performing substantive audit tests, focusing on the existence or occurrence o bjective helps locate misstatementsdue 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: PHYSICAL61. The audit trail consists of that stream of evidence that enables the auditor to trace a transaction or event forward fromits inception to the appropriate ledger account, or conversely, vouch a transaction backward from the ledgeraccount to the inception of the transaction or event. For the audit trail to exist, transactions must be .ANSWER: DOCUMENTED62. Analytical evidence may be the best form of evidence supporting the object ive, in that auditors' suspicions concerningerrors of omission are often first aroused by the application of analytical procedures.ANSWER: COMPLETENESS63. An auditor-

prepared bank reconciliation is an example of _______________ evidence.ANSWER: MATHEMATICAL64. A group of related transactions affecting essentially the same set of general ledger accounts is referred to as a _________________ .ANSWER: TRANSACTION CYCLE65. 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 represent s.a. Physical evidenceb. Confirmation evidencec. Documentary evidenced. Analytical evidencee. Mathematical evidencef. Hearsay evidence ____ 1. Audited client-prepared bank reconciliation ____ 2. Vouched debits to repairs accounts by examining vendors invoices ____ 3. Observed the clients year -end physical inventory ____ 4. Compared accounts receivable turnover with industryaverage ____ 5. Prepared ten-year income summary expressing allcomponents as a percentage of sales ____ 6. Obtained letter from clients ou tside legal counselregarding pending litigation ____ 7. Inquired of corporate treasurer as to reason(s) foracquiring marketable securities ____ 8. Calculated year-end interest accrual and comparedwith general ledger balance ____ 9. Obtained replies directly from customers concerning the correctness of clients 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 andidentified causes of significant disparities.SOLUTION:1. e2. c3. a4. d5. d6. b7. f 8. e9. b10. a 11. d67. For each of the listed procedures, indicate, by letter, theassertion(s) being tested.a. Existence or occurrenceb. Completenessc. Rights and obligationsd. Valuation or allocatione. Presentation and disclosure __ __ 1. Confirmed customer accounts receivable ____ 2. Vouched property additions to underlying documentation consisting of vendors invoi ces andwork orders ____ 3. Inquired of corporate treasurer as to reasons forbuying and holding securities ____ 4. Selected a sample of bills of lading representingshipments to customers and traced to sales invoicesto determine that all shipments have been billed tocustomers ____ 5. Examined vendors invoices recorded after year -end todetermine whether any of these invoices representliabilities of the client as of yearend ____ 6. Obtained confirmation of marketable securities fromcl ients brokers ____ 7. Evaluated the reasonableness of the clients depreciation policy ____ 8. Obtained letter from clients outside legal counsel regarding pending litigation ____ 9. Inspected recorded addition to client materialshandling facilities ____ 10. Investigated decrease in revenue from scrap sales asrevealed by the application of analyticalproceduresSOLUTION:1. a,d2. d3. e4. b5. b,c6. a,c,d7. d8. e9. a10. b

PROBLEM/ESSAY 68. For each of the following ledger accounts, give an example of substance underlying the acco unt balance:1. Cash in bank2. Sales revenue3. Inventories4. Accounts payable5. Notes payable6. Capital stock7. Marketable securities8. Operat ing expenses9. Wages and salaries expense10. Property, plant, and equipment SOLUTION:1. Bank statement, canceled checks, deposit tickets2. Sales invoices, shipping docu ments, cash register tapes 3. Goods in warehouses, goods out onconsignment4. Vendors records of accounts receivable, vendors invoices5. Payees confirmation of amounts owed to them, copy of note in clients files 6. Records maintained by registrar and transfer agent7. Securities in vault or in safekeeping, brokers ad vices, brokers confirmations 8. Vendors invoices, canceled checks, clients workpapers supporting such charges as depreciation,amortization, and product warranty9. Payroll summaries, time cards, clock cards, canceledchecks, human resources records10. Plant assets at various locations, vendors invoices 69. Audit evidence must be sufficient and competent. To be competent, the evidence must be bo th valid and relevant.Required:a. What is meant by sufficient audit evidence? b. Define the concepts of validity and relevance as theyrelate to audit evidence.SOLUTION:a. Sufficient audit evidence is evidence that is adequate to support the auditors opinion on the financial statements. A matter of audit judgment, sufficiency is usually based on materiality and the adequacy of existing internalcontrol.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 possessesgreater validity than internal evidence);2) The conditions under which the evidence wasobtained (e.g., evidence produced by stronginternal control possesses greater validitythan evidence gathered under weak internalcontrol); and3) The manner in which the evidence was obtained(e.g., evidence obtained directly by the auditorpossesses greater validity than evidence obtainedindirectly).Relevance means that the evidence pertains to specific auditobjectives. Observing the taking of the inventory, for example, provides evidence concerning existence of the inventory, but isnot relevant to determining ownership.70. The following operating data has been provided to Erica Chavez by her audit clien t, Grimes Hardware. Salescommissionsaverage 6 percent of sales:2002 % 2003 % Change (%)Sales $18,000 100% 22,000 100% 22%Cost of sales 10,000 11,000Sales commissions 1,080 1 100Gross profit 6,920 9,900Operating expenses 3,200 3,600Income before taxes 3,720 6,300Income taxes 1,200 2,000Net income $2,520 4,30