Roque Quick Auditing Theory Chapter 7 PDF

447
CHAPTER 7
Audit Objectives,
Procedures,
Evidence, and
Documentation
1. All the information used by the auditor in arriving at the

conclusions on which the audit opinion is based is called
A. Audit information
B. Audit evidence
C. Accounting records
D. Corroborating information
According to PSA 500 (Audit Evidence), audit evidence re-

fers to information used by the auditor in arriving at the
conclusions on which the auditor's opinion is based. It in-
r
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,_
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448 CPA EXAMINATION REVIEWER: AUDITING THEORY
eludes both information contained in the accounting records

underlying the financial statements and other information.
2. An entity's accounting records generally include the ·records

of initial entries and supporting records including
A. Confirmations from third parties.
B. Information obtained by the auditor from such audit pro-
cedures as inquiry, observation, and inspection.
C. Worksheets and spreadsheets supporting cost alloca-
tions.
D. Other information developed by, or available to, the -au-
ditor to permit him/her to reach conclusions through val-
id reasoning.
According to PSA 500, accounting records include the rec-

ords of initial accounting entries an d supporting records,
such as the following:
. • checks and records of e lectron ic fund transfers
(EFT)
• invoices
• con tra cts .
.. I entries,
• the genera l and s ubsidiary ledge rs , Journa 1
its
··
a nd other adjustments to t h e ftnanc1 ·a 1 staterne
.
that are not reflected in formal journ a l e ntries . p-
dsheets su
• records such as works heets a n d sprea ilia·
· re co ne
porting cost allocations, computations,
tions, an d disclosures
audit evi·
Other information that the aud.itor may use as
dence includes the following:
• minutes of meetings
• confirmations received from third parties
• analysts ' reports h - r1<ing)
Cb nc n1'·1
• comparable data about competitors e
",
7 AUdll Objectives. Procedures, Evidence, and Docurr.entation 449

cHAprER
controls manuals
•
• information obtained by the auditor from such audit
procedures as inquiry, observation, and inspection
• other information developed by, or available to, the
auditor to reach conclusions through valid reasoning
Audit evidence _comprises

3
· r. Information that supports and corroborates manage-
ment's assertions.
IL Any information that contradicts management's asser-
tions.
A. I only
B. II only ·
c. Neither I nor IT
D. Both I and II
PSA 500 states that in some cases, the absence of infor-

mation such as management's refusal to provide a request-
ed representation al so constitutes audit evidence that is
used by the auditor.
4. As defined in PSA 500, is an individual or or-

ganization possessing the expertise in a field other than ac-
counting or auditing, whose work in that field is used by the
entity to assist the entity in preparing the financial state-
ments. -
A. Auditor's expert
B. Management's expert
C. Auditor's internal expert
D. Auditor's external expert
5. If a management's expert's work is used to prepare the in-

formation to be used as audit evidence, the auditor shall
' -
I. Evaluate the competence, capabilities and objectivity of

the management's expert.
II. Obtain an understanding of the work of the manage-
ment's expert.
III. Evaluate the appropriateness of the management's ex-
pert's work as audit evidence for the relevant assertion.
A. I and II only
B. I and III only
C. II and III only
D. I, II, and III
6. Which of the following statements concerning the manage-

ment's expert's competence, capabilities, and objectivity is
correct?
A. Objectivity relates to the ability of the management's ex-
pert to exercise the competence in the circumstances ..
B. Competence relates to the possible effects that bias,
conflict of interest or the influence of others may have
on the professional or business judgment of the man-
agement's expert. . f
0
C. Capability relates to the nature and level of expertise
the management's expert. .
Taes
D. The management's expert's competence, capa b11 ~
and objectivity are important factors in relation to the re_
liability. of any information prepared by the manage
ment's expert.
·1·r s and
The standard states that the competence, capab1 1 ie ' 'th·
objectivity of a management's expert, and any controls WI in
in th~ entity over the expert's work, are important racto~y a
relation to the reliability of any information produced
management's. expert.
7 Audit Objectives, Procedures, Evidence, and Documentation 45 1
cl'lAprER
mpetence relates to the nature and level of expertise of

co ,
the managements exper .
t
capability relates to the abi~ity of the management's expert

to exercise that competence m the circumstances.
Objectivity relates to the possible effects that bias, conflict

of interest
. or the influence of others may have on the pro-
fessional or business judgment of the management's expert.
Audit evidence is information used to draw reasonable con-

7· clusions on which to base the auditor's opinion. Audit evi-
dence is obtained by performing
1. Risk assessment procedures
n. Further audit procedures
A. I only
B. II only
C. Either I or II
D. Both I and II
Risk assessment procedures include:

1. Inquiries of management, and of others within the
entity who in the auditor's judgment may have in-
formation that is likely to assist in identifying risks of.
material misstatement due to fraud or error.
2. Analytical procedures.
3. Observation and inspection.
Further audit procedures comprise:

1. Tests of controls when required by the PSAs or when
the auditor has chosen to do so; and
2. Substantive procedures which include tests of details
and substantive analytical procedures.
452 CPA EXAM/NAT/ON REVIEWER: AUDITING THEORY
8. Which of the following statements concerning audit evidence

is correct?
A. Appropriateness is the measure of the quantity of audit
evidence.
B. Sufficiency is the measure of the quality of audit evi-
dence, that is, its relevance and reliability.
C. The quantity of audit evidence needed is affected by its
quality and the risk of misstatement.
D. The sufficiency and appropriateness of audit evidence
are not interrelated.
PSA 500 states, "The quantity of audit evi dence needed is af-
fected by the risk of misstatement (the higher the assessed
risks, the more audit evidence is likely to be required) and
also by the quality of such audit evid ence (the higher the
quality, the less may be required)."
Answer A is incorrect because appropriateness is the meas-

ure of th e quality of audit ev id ence.
Answer B is incorrect beca use suffkiency is th e measure of

lhe quantity of audit evidence.
Answer Dis incorrect because the sufficiency and appropri-

ateness of audit evidence are interrelated.
9 · Y'lhich of the following statements concerning audit evidence

1s correct?
. . en·
A. An. audit usually involves t he authentication of docurn
tat1on.
B A \1 . . ·dence
· ~ :en set of procedures may provide audit evi
that 15 relevant to certain assertions but not others. al
C. Audit e~idence obtained from an lndependent exterf1
source is always reliable.
. ObJ·ectives Procedures, Evidence. and Documentation 453
1 ALJdil '
.. ApfER
crv ·
ntity's accounting records can be sufficient audit ev-
o. :~ce to support the financial statements.
. • set of audit procedures may provide audit evidence
A gl\1e11 . .
tis relevant to certain assertions, but not others. For ex-
rha le, in spection of records and doct~ ments related to ~he
3 ~f tion of re ceivables after the perrod end may provide
co d~tc evidence regarding both existence and valuation, alt-
~~ugh not necessa rily the approp ri ateness of period -end
cutoffs.
Answer A is incorrect because an audit rarely involves the
authentication of documentation, nor is th e auditor tra ined
or expected to be an expert in such authentication.
Answer C is inco rrect because au dit evidence obtained from

an independ ent so urce may not be reliable if the source is
not knowledgeabl e.
Answer D is incorrect because accounting records a lone do

not provide sufficient a udit evidence on which to base an
audit opinion .
.
10. Which of the following generalizations does not relate to the
reliability of audit evidence?
A. Audit evidence is more reliable when it is obtained from
independent sources outside the entity.
B. Audit evidence obtained directly by the auditor is more
reliable than 'audit evidence obtained indirectly or by in-
ference .
C. Audit evidence that is generated internally is more relia-
ble when the related controls imposed by the entity are
effective.
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D. An auditor's opinion, to be economically useful, is formed

within a reasonable time and based on audit evidence
obtained at a reasonable cost.
Cost-benefit considerations relate to the sufficiency, not the

reliability, of audit evidence.
PSA 500 gives the following generalizations about the reli·

ability of audit evidence:
1. Audit evidence is more reliable when it is obtained
from independent sources outside the entity.
2. Audit evidence that is generated internally is more
reliable when the related controls impos~d by the
entity are effective.
3. Audit evidence obtained directly by the auditor (for
example, observation of the application of a con_tr~~)
is more reliable than audit evidence obtained mhi·
rect1y or by inference (for example, inquiry about t e
application of a control).
4. Audit evidence is more reliable when it exi~ts ~~
documentary form, whether paper, electronic~slY
other medium (for example, a contem~orane~an a
written record of a meeting is more rehable t dis·
subsequent oral representation of the matters
cussed). .
nts JS
5. Audit evidence provided by original ~oc~~~ phO"
more reliable than audit evidence provide
tocopies or facsimiles.
. . dit evidence
11. Which of the following statements concerning au
is false?
-rr=R 7 Audit Objectives, Procedures, Evidence and 0 .
cHAP'" · .ocumenrauon 4 55
A The auditor uses professional J·udgm t .

· profess1ona
· I skeptic1sm
·· en
in evaluating th and exercises
.
quality of audit evidence and thus its e ffiqu~nt1ty and
· t t ' su 1ciency and
appropn~ eness~ o .support the audit opinion.
8 The auditor ordinarily finds it necessary to 1 d.
· · h · . re y on au 1t
ev1denc_e t at 1s pe:sua~1~e rather than conclusive.
c. . In forming _the aud1~ opinion, the auditor does not exam-
ine all the information available because conclusions or-
dinarily can be reached by using sampling approaches
and o~her means of selecting items for testing.
o. Tue difficulty and expense of obtaining audit evidence
concerning an account balance is a valid basis for omit-
ting the test.
The standard states that the auditor considers the relation-

ship between the cost of obtaining audit evidence and the
usefulness of the information obtained. However, the mat-
ter of difficulty or expense involved is not in itself a valid ba-
sis for omitting an audit procedure for which there is no al-
ternative.
12. In representing that the financial statements are presented

fairly, in all material respects, in accordance with the appli-
cable financial reporting framework, management implicitly
or explicitly makes regarding the recognition,
measurement, presentation, and disclosure of the various
elements of financial statements and related disclosures.
A. Assertions
B. Allegations
C. Conclusions
D. Assurances
As defined in the standard, assertions are representations

by management, explfcit or otherwise, that are embodied in
the financial statements.
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CPA EXAMINATION REVIEWER: AUDITING THEORY

c.t!IPTER 7 ·QhiDr.fives,Pf{.l\;l:IU · '
Alt11t UJ"v
456
. about .accou r
14. The following are assertron 5
13. The auditor is required to use assertions for classes of trans- period end, except
actions, account balances, and presentation and disclosures A. Existence
in sufficient detail to form a basis for the assessment of risks B. Rights and obligations
of material misstatement and the design and performance of
further audit procedures. Assertions about classes of trans-
c. Valuation and allocation
actions include occurrence, completeness, accuracy, cutoff,
D. Cutoff
and
A. Valuation and allocation
B. Rights and obligations
C. Existence
D. Classification
Assertions about classes of transactions and events for the

period under audit include:
1. Occurrence - transactions and events that have
been recorded have occurred and pertain to the enti·
ty.
2. Completeness - all transactions and events that
should have been recorded have been recorded.
3. Accuracy - amounts and other data relating to rec·
orded transactions and events have been recorded
appropriately.
4 · Cutoff - transactions and events have been recorded
in the correct accounting period.
5· Classification - transaction s and events have been
recorded in the proper accounts.
Answe rs A B I · . . · and Cl. I·
' • anc l a1 e in correct because valuation . 11s
location 1·· h . ertJ0 ·
. • ig ts and obligations, and ex istence are ass
about account balauces al the period end .
AUdit Objectives, Procedures, Evidence, and Documentation 457
o-1.Ap1ER
1
he following are assertions about account balances at the
14. T ·ad end, except
pen
Existence . .
A. Rights and obl1gat1on_s
B. Valuation and allocation
c.
0 . cutoff
. cutoff assertio n deals with whether tra ns a ctions a nd
I
Tieents have bee n recor d e d 111
. t he co rrect accounting . peno . d.
ev
Thus, .
it is an as~er tJon a b out .c Ia ss es o 1· tran sa clt.o ns a n d.
events for the pe ri od und er a udit.
Assertions about account balances at the period end in -

clude th e following:
1. Existence - asse t , li Jb ilili es, a nd e quity inte r es ts
exist.
z. Rights and obligations - t he e ntity hold s or con -
trol s the r igh ts to e1sse ts, and li a bilitie., are t he ob li -
ga tions of the e ntity.
3. Complete ness - a ll assets, li ab iliti es, a nd equ ity in -
teres ts th a t s ho uld have be en reco rd ed ha ve been
recorded.
4. Valuation a nd allocation - assets, lia bilities, a nd
equity interests a re included in the financial state-
ments at appropriate amounts and any resulting val-
ua tion or allocation adjustments are prope r ly rec-
.orded.
15. The following are assertions about present ation and disclo-
sure, except
A. Occurrence and rights and obligations
B. Accuracy and valuation
C. Classification and understandability
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D. Existence
Existence is an assertion about account balances at the pe-

riod end. It deals with whether assets, liabilities, and equity
interests exist.
Assertions about presentation and disclosure include:

1. Occurrence and rights and obligations - disclosed
events, transactions, and other- matters have oc-
curred and pertain to the entity.
2. c;ompleteness - all disclosures that should have
been included in the financial statements have been
included.
3. Classification and understandability - financial in-
for!11ation is appropriately presented and described,
and disclosures are clearly expressed.
4. Accuracy and valuation - financial and other in-
formation are disclosed fairly and at appropriate
amounts.
16. Which of the following statements concerning the auditor's

use of assertions is correct?
A. The auditor may combine the assertions about transac·
tions and events with the assertions about account bal·
ances.
8
· In every audit engagement the auditor should use the
assertions as des~ribed in PSA 500, i.e., the assertion~
should always fall into three categories: assertions aboU
classes of trar:1sactions and events, account balances,
and presentation and disclosure
C. There should always be a sep~rate assertion related to
cutoff of transactions and events.
. 1 AUdit Objectives, Procedures, Evidence, and Documentation 459
cHAprER
rhe completeness assertion deals only with whether all
o. transactions and events that should have been recorded
have been recorded.
he auditor may use the .assertions as d.escribed in PSA 500

T ·maY express them differently provided all aspects de-
or 'bed in the standard have been covered.
sen
Answer B is incon~ect because the auditor may choose. to
combine the assert10ns about transactions and events with
the assertions about account balances.
Answer C is incorrect because there may not be a separate

assertion related to cutoff of transactions and events when
the occurrence and completeness assertions include appro-
priate consideration of recording transactions in the correct
accounting period. ·
Answer D is incorrect because the completeness assertion

may relate to classes of transactions and events for the peri-
od under audit, account balances at the period end, and
presentation and disclosure.
17. Which of the following statements concerning audit objec-

tives is incorrect?
A. The auditor should resolve any substantial doubt about
any of management's material financial statement asser-
tions.
B. Selection of tests to meet audit objectives should depend
upon the understanding of internal control.
C. There should be a one-to-one relationship between audit
objectives and procedures.
--
D. Audit objectives should be developed in light of man-

agement assertions about the financial statement ele-
ments.
Audit objectives and procedures need not have a one-to-one

relationship. Some audit procedures may satisfy more than
one specific audit objective. In some cases, a combination of
audit procedur.e s may be needed to achieve a single audit
objective.
Answer A is incorrect because the auditor should resolve all

substantial doubts about any of management's material fi·
nancial statement assertions before an opinion is rendered.
Answer B is incorrect because the auditor's understanding

of internal control and the assessed level of control risk in·
fluence the nature, timing, and extent of the substantive test
procedures.
Answer D is incorrect because, in developing specific audit

objectives, the auditor considers the assertions made by
management.
18. The primary difference between an audit of the balanc~

sheet and an audit of the income statement is that the audit
of the income statement addresses the verification of
A. Cutoffs
B. Authorizations
C. Transactions
D. Costs
B large
ecause most income statement elements represent 1+
volumes of transactions, the auditor's focus is on the proP
dit Objectives, Procedl)res, Evidence, and Documentation 461
ct-iAPf
1 AU
ER '
the accounting for transactions and events during the

etY 0 f
period.
er A is incorrect because cutoff procedures apply to
Ans W
both statements.
Answer B is incorrect because all transactions must be au-

thorized.
Answer Dis incorrect because the auditor i-s concerned with

the costs reflected in both statements.
Which of the following would least likely affect the appropri-

19' ateness of evidence available to an auditor?
A. The sampling meth~d employed by the auditor to obtain
a sample of such evidence.
B. The relevance of such evidence to the financial state-
ment assertion being verified·.
c. The relationship of the· preparer of such evidence to the
entity being audited.
D. The timeliness of such evidence.
Appropriateness is the measure of the quality of audit evi-

dence, that is, its relevance and reliability. Generally, audit
evidence obtained from independent sources outside the
entity, generated under effective controls, or obtained di-
rectly by the auditor is presumed to be the most reliable.
The relevance and reliability of audit evidence will not be af-
fected by the sample selection method as long as the sample
is representative of the population. ·
Answer B is incorrect because appropriate audit evidence

must be relevant and reliable .
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.
Answer C is incorrect because audit evidence obtained·from

independent sources outside the entity is generally more re·
liable than that ob.tained from the client.
Answer D is incorrect because the timeliness of evidence in·

fluences its relevance and, therefore, its appropriateness.
20. Which of the following forms of documentary evidence

would be considered the most reliable by an auditor?
A. Internally generated
B. Prenumbered
C. Easily duplicated
D. Authorized by a responsible official
It is generally presumed that externally generated docu·

ments ~re more reliable than those prepared by the client.
However, the reliability of internally generated documen~
is enhanced if they are prepared under a satisfactory condi·
tion of internal control. Thus, a document that is authorized
by a responsible official can be considered credible because
• such authorization increases the likelihood that the underly-
ing transaction is authorized and valid.
erated
Answers A and Care incorrect because internally gen
·1 ble to
and easily duplicated documents are readily avai a
employees who commit fraud.
111·
Answer B is incorrect because although the use of prenunts
bered documents is an effective control, such docume
may be accessible to employees who commit fraud.
d as
21. The objective of tests of details of transactions perfornie
substantive tests is to
/
/
7 Audit Objectives, Procedures, Evidence, and Documentation 463
ctlApiER
Attain assurance about the reliability of the accounting .

A· system.
Evaluate whether management's policies and procedures
a. operated effectjvely.
Detect material misstatements in the financial state-
C.
ments. .
comply with Philippine Standards on Auditing (PSAs).
o.
substantive tests are performed primarily to detect material
misstatements at the assertion level. These include t~sts of
details of classes of transactions, account balances, and dis-
closures and substantive analytical procedures.
Answers A and Bare incorrect because tests of controls are

performed to test the reliability of the accounting system
and to determine whether management's policies and pro-
cedures operated effectively.
Answer D is incorrect because the auditor may apply a vari-

ety of audit procedures and is not required to perform tests
of details of transactions to comply with PSAs.
22. In testing the existence assertion for an asset, an auditor

ordinarily works from the
A. Potentially unrecorded items to the financial statements.
B. Financial statements to the potentially unrecorded items.
C. Sup.porting evidence to the accounting records. ·
D. Accounting records to the supporting evidence.
The existence assertion deals with whether assets, liabili-

ties, and equity interests of the entity exist at a given time.
In testing the existence as~ertion, the direction is ordinarily
from the ar.counting records to the supporting evidence.
-----.. . .------~-----------!
Answers A, B, and Care incorrect because these procedures

relate to the completeness assertion. The completeness as-
sertion concerns whether all assets, liabilities, ~nd equity in-
terests of the entity that should have been recorded have
been recorded.
23. In determining whether transactions have been recorded,

the direction of the audit testing should be from the
A. General journal entries
8. Original source documents
t. General ledger balances
0. Adjusted trial balance
The completeness assertion deals with whether all transac-

tions and events that should have been recorded have been
recorded. Thus, determining whether transactions have
been recorded is testing the completeness assertion. In ap-
plying this test, the auditor ordinarily begins with the origi-
nal source documents and traces them to the appropriate
accounting records to determine whether the underlying
transactions were properly recorded.
Answers A, C, and D are incorrect because beginning with

the accounting records is unlikely to provide evidence about
unrecorded transactions.
24. Which of the following audit procedures consists of looking

at a process or procedure being performed by others?
A. Observation
B. Inspection of records and documents
C. Inspection of tangible assets
D. Inquiry
IER 7 Audit Objectives, Procedures, Evidence, and Documentation 465
ctiAP
As state<;l in PSA 500, o?servation consists of looking at a

process or pro~edur_e bemg pe:formed by others. An exam-
ple is observat10n of the counting of inventories by the enti-
ty's personnel.
Answer B is incorrect because inspection consists of exam:

ining records or documents, whether internal or external in
paper form, electronic form, or other media. '
Answer C is incorrect because inspection of tangible assets

consists of physical exa111ination of the assets.
Answer Dis incorrect beca use inguiry consists of seeking in-

formation of knowledgeable persons, both financial and
non-financial, throughout the entity or outside the entity.
2s. Which of the following elements ultimately determines thf

specific auditing procedures that are necessary in the cir-
cumstances to afford a reasonable basis for an opinion?
A. Materiality
B. Audit risk
C. Auditor judgment
D. Reasonable assurance
The auditor is required to obtain sufficient appropriate au-

dit evidence to afford a reasonable basis f~r an opinion re-
garding the financial statements. The auditor uses his/her
professional judgment in determining the na~ure, timing,
and extent of specific audit procedures to be applied to ob-
tain sufficient appropriate audit evidence.
Answers A and B are incorrect because materiality and audit

risk are considered in exercising professional judgment.
466 <;PA EXAMINATION REVIEWER: AUDITING THEORY
Answer D is incorrect because the auditor exercises profes-

sional judgment in determining ·whether reasonable assur-
ance that the financial statements are free of material mis-
statement has been obtained. ·
ANALYTICAL PROCEDURES
26. The auditor should apply analytical procedures

I. As risk assessment procedures.
II. As substantive procedures.
III. In the overall review at the end of the audit.
A. I and II only
B. II and III only
C. I and III only
D. I, II, and III
The auditor should apply analytical procedures as risk a~

sessment procedures to obtain an understanding of the ent~
ty and its environment and in the overall review at the en
1. d as
of the audit. Analytical procedures may also be app ie
substantive test procedures.
27. Anal~ical procedures include the consideration of cornpari·

sons of the entity's financial information with
I. Comparable information for prior periods.
II. Anticipated results of the entity.
III. Similar industry information.
A. I and II only
B. II and III only
C. I and III only
D. I, II, and III
TER 7 Audi! Objectives, Procedures, Evidence ·
cHAP , and Documentarion
467
Analytical procedures include th .
f h t . , t·
sons o t e en 1ty s mancial infore cons1derat'
. mn of compari-
. mat1on With, for example:
• Comparable information of .
Prior periods.
• Anticipated results of the t'
forecasts, or expectations e~ t~y, sue~ as budgets or
0
estimat_ion of depreciation. e auditor, such as an
• Similar industry informatio h
. n, sue as a compar·s 1 on
of the entity's ratio of sales t 0
·h · d accounts receivable
wit rn ustry averages or wi"th th ..
b · . o er ent1t1es of
compara le size m the same industry.
Moreo~er, a~alytical procedures may include consideration .

of relat10nsh1ps:
• Among elements of financial information that would

be expected to conform to a predictable pattern
based on the entity's experience, such as gross profit
ratios.
• Between financial information and relevant non-
financial information, such as payroll costs to num-
ber of employees.
28. Which of the following should be considered by the auditor

when designing and performing analytical procedures as
substantive procedures?
I. The suitability of using substantive analytical procedures
given the assertions.
n. The reliability of the dat.a, whether internal or external,
from which the -expectation ~f recorded amounts or ra-
tios is developed.
• .. 4 - ····-- · · - .\4 .. ~u
III. Whether the expectation is sufficiently precise to identi-

fy a material misstatement at the desired level of assur-
ance.
IV. The amount of any difference of recorded amounts from
expected values that is acceptable.
A. I, II and III only
B. I, III, and IV only
C. II, III, and IV only
D. I, II, III, and IV
29. The following statements relate to the use of analytical pro-

cedures as substantive procedures. Which is false?
A. Substantive analytical procedures are applicable when
there is only a small volume of transactions.
B. The ~pplication of substantive analytical procedures is
based on the expectation that relationships among data
exist and continue in the absence of known conditions to
the contrary.
C. The presence of relationships among data provides evi-
dence as to the completeness, accuracy, and occurrence
of transactions captured in the information produced bY
the entity's information system.
D. Reliance on the results of substantive analytical proce-
dures will depend on the auditor's assessment of the risk
that the analytical procedures may identify relationship~
~s expected when, in fact, a material misstatement ex
1sts.
Accor~ing to PSA 520 (Analytical Procedures), sub~tantive

analytical procedures are generally more applicable to targe
v.olumes of transactions that tend to be pred ictable over
time. ·
cHAprER
7 AUdil Objectives, Procedures,
•
Evidence, and Documentation 469
Which of _t~e followin~ s~?uld be consid_ered by the auditor

30. . determining the su1~ab1ltty of substantive analytical proce-
~ures given the assertions?
I. The assess~ent ?f t~e risk of material misstatement.
IL Any tests of details directed toward the same assertion.
A. I only
B. II only
c. Both I and II
D. Neither I nor II
The standard states that the auditor considers the under-

standing of the entity and its internal control, the materiali-
ty and likelihood of mis~tat~ment of the items involved, and
the nature of the assert10n in determining the suitability of
substantive analytical procedures. It st;:ites further tha t
substantive a nalytical procedures may also be considered
appropriate when tests of details are performed on the
same assertion.
31. The reliability of data is influenced by its source and by its

nature and is dependent on the circumstances under whiC:h
it is obtained. Which of the following should the auditor
consider in determining whether data is reliable for purposes
of designing substantive analytical procedures?
I. Source of the information available.
II. Comparability of the information available.
III. Nature and relevance of the information available.
IV. Controls over the preparation of the information.
A. I, III, and IV only
B. II, III, and IV only
C. I, II, and III only
(
32. A:cc~rding to PSA .s20, when ~nal~ical procedures identify

significant fluctuations or relat1onsh1ps that are inconsistent
with other relevant information or that deviate from predict-
. ed amounts, the auditor should investigate and. obtain ade-
quate explanations and appropriate corroborative audit evi-
dence. The auditor's investigation of unusual fluctuations
and relationships ordinarily begins with inquiries of man-
agement, followed by
I. Corroboration of management's responses.
II. Consideration of the need to apply other audit proce-
dures based on the results of such inquiries, if man·
agement is unable to provide an explanation or if the
explanation is not considered adequate.
A. I only
B. II only
C. Both I and II
D. Neither I nor II
REVENUE/RECEIPT CYCLE
. . 1·n the au·
33. The following are the auditor's principal obJect1ves
dit of revenues, except h entitY at
A. To determine whether all cash owned by t e e sheet.
the balance sheet date is included on the bal~n~n record·
B. To determine whether earned revenue has e
ed and recorded revenue has been earned. d in the in·
c. To determine whether revenues are repo~e ed
come statement at the appropriate amoun · 1y c1assifi '
. re proper ts in·
o. To determine whether revenues a . tatenien 1 ·al
described, and disclosed in the financial ~ ble fina11C1
eluding notes, in conformity with a~ appltca
reporting framework.
7
cH-AprE~
rnining whether all cash owned by the entity at the end
. oet~~ reporting period is included on the statement of fi-
of t ·al position is not part of the audit of sales and other
nan~ues. A separate audit program is ordinarily prepared
rev~he audit of cash, including bank balances .
. for
uditors are often concerned with t.he possibility of over-
34. At tement of sales and receivables. However, management
5
:y also have reasons for understating these balances.
~hich of the following would explain understatement of
sales and receivables?
r. To avoid paying taxes.
n. To windowdress the financial statements.
m. To meet budgets and forecasts.
A. I only
s. II only
c. I and Ill only
D. I, II, and III
One way of avoiding tax liability is by not recording and re-

porting all sales and receivables.
Answers B, C, and D are incorrect because management may

attempt to overstate sales and receivables to windowdress
the financial statements or to meet budgets and forecasts.
35. In the audit of which of the following general ledger ac-

counts will tests of controls be particularly appropriate?
A. Bank charges
B. Equipment
C. Bonds payable
o.·Sales
- .,.. _ .,. ~ .. •. "'.. -,,.
. ··--..-
;.
- . :: :
Because of the large volume of sales transactions, tests of

controls are particularly appropriate to restrict substantive
testing, provided that the evidence obtained supports an as-
sessment of control risk at less than the maximum .
Answer A is incorrect because bank charges can be easily

verified by examining the monthly bank statement.
Answer B is incorrect because the small volume of equip-

ment transactions and the ease of verifying its physical ex-
istence and computing depreciation may mC1ke evaluation of
the effectiveness of controls inefficient.
Answer C is incorrect because the infrequency of transac-

tions and the availability of bond contracts may make it inef-
fi cient to perform tests of controls.
36. Which of the following might be detected by an auditor's re·

view of the entity's sales cutoff7
A. Inflated sales for the year.
B. Lapping of year-end accounts receivable .
C. Unrecorded sales discounts.
D. Excessive goods returned for credit.
An auditor's review of the client's sales cutoff involves ex·

a mining recorded sales for several days (for example, one
week) before and after the balance sheet date and compar·
ing thet~ With sales invoices and shipping documents. B~
performing this substantive procedure the auditor rnaY d~
t h J· t 1n
ect t e recording of a sale in a period oth e r than t 1 ~
I
which title passed. The completeness and cutoff assertions

are directly related to the auditor's cutoff tests.
AUdil Objectives, Procedures, Evidence, and Documentation 473
ct-LAprE.R
1
r 8 is incorrect. Lapping is the concealment of a cash
Answege resulting from delays in recording cash receipts.
sh~r~ay be detected by confirming receivable balances and
'f}1JS mparing bank validated deposit s!ip·s to the entries in
bY coccounts receivable subsidiary ledger.
the a
wer c is incorrect because unrecorded sales discounts
rnaY be reveale d b y exammmg
Ans · · cas h co·11 ect1ons.
·
Answer Dis incorrect beca use an auditor's review of the cli -

ent's sales cutoff does not include exa mination of sa les re-
turns.
An auditor most likely would review a client's periodic ac-

37· counting for the numerical sequence of shipping documents
and sales invoices to support management's financial state-
ment assertion of
A. Existence
c. Completeness
D. Valuation and allocation
An auditor's test of the numerical sequence of shipping doc-

uments and sales invoices may reveal omitted items. This
procedure addresses management's completeness assertion
that deals with whether all transactions, assets, liabilities,
and equity interests that should have been recorded have
been recorded.
Answer A is incorrect because existence is an assertion that

all assets, liabilities, and equity interests exist.
Answer B is incorrect because the rights and obligations as-

sertion addresses whether the entity holds or controls the
•
rights to assets, and liabilities are the obligations of the enti-

ty.
Answer D is incorrect because the valuation and allocation

assertion concerns whether assets, liabilities, and equity in-
terests are included in the financial statements at appropri-
ate amounts and any resulting valuation or allocation ad-
justments are appropriately recorded.
38. If the objective of a test of details of transactions is to de-

tect overstatements of sales, the auditor's direction of test-
ing should be from the
A. Cash receipts journal to the sales journal.
B. Accounting records to the source .documents.
C. Source documents to the accounting records.
D. Sales journal to the cash receipts journal.
The existence of source documents such as sales invoices

and · shipping documents indicate that the sales are valid.
Thus, the proper direction of testiag should be from the rec·
orded sales transactions to the source documents. This pro·
cedure may reveal overstatements of sales that are likely to
result from entries in the sales account with no supporting
documentation.
Answers A and D are incorrect because the cash receipts

journal and the sales journal are not source documents.
A C. . l f source
nswer is incorrect because tracing a samp e 0 d·
d acumen t s to t h e accounting records may revea1 unrecor
ed sales, not overstatements of sales.
R 7 Audit Objeclives, Procedures, Evidence and Doc
cHAPTE ' umenlalion
475
cutoff tests designed to detect credit
39· end of the year that have been recor~ade~
1
made before the
year provide assurance about managem~ ;~ the s~bsequent
A. Accuracy n s assertion of
a. Classification
c. Rights and obligations
o. Cutoff
The cutoff assertion addresses whether t .
. ransact1ons and
events have been recorded in the correct account· . d
. . mg peno .
This assert10n 1s tested by examining recorded sales for sev-
eral days before and after the balance sheet date.
Answer A is incorrect because accuracy is an assertion that

amounts and other data relating to recorded transactions
and events have been recorded appropriately.
Answer B is incorrect because the classification assertion

addresses whether transactions and events have been rec-
orded in the proper accounts.
Answer C is incorrect b~cause the rights and obligations

assertion concerns whether the entity controls or holds the
rights to assets, and liabilities are the obligations of the enti-
ty.
40. An auditor most likely would limit substantive aL:Jdit tests of

sales transactions when control risk is assessed as low for
the occurrence assertion concerning sales transactions and
the auditor t;ias already gathered evidence supporting
A. Beginning and ending inventory balances.
B. Cash receipts and accounts receivable.
C. Cutoffs of sales and purchases.
D. Shipping and receiving activities.
a
The occurrence assertion concerns whether transactions

and events that have been recorded have occurred and per-
tain to the entity.
Because cash receipts and accounts receivable are directly

related to sales (a cash sale is debited to cash and credited
to sales; a sale on account is debited to accounts receivable
and credited to sales), evidence related to these accounts
provides assurance about the occurrence of sales transac·
tions.
Answer A is incorrect because the beginning and ending in·

ventory balances do not have a direct relationship with
sales transactions.
Answers C and D are incorrect because cutoffs of purchases

and receiving activities are not related to sales.
41. Tracing bills of lading to sales invoices provides_evidence

that
A. Invoiced sales were shipped.
B. Recorded sales were shipped.
C. Shipments to customers were recorded as sales.
D. Shipments to customers were invoiced.
Tracmg . d ocuments (such as bills of la ct·mg) to sales

. s h"ippmg re
invoices provides direct proof that the goods shipped we
billed to customers.
rnining
Answers A and B are 'incorrect because in deter the
whether invoiced and recorded sales were shipped, the
. ·
proper d irect10n of testing is from the sales records to
shipping documents.
7 AUdit Objectives, Procedures, Evidence, and Documentation 477
cHApfER
Answer C is incorrect because to determine whether ship-

rnen t s were. recorded
. as sales, the auditor would have to
trace the shipping documents to the sales records.
"'T"he auditor finds a sit. uation in whic;h one person has the
11
42. ability
' to collect rece1v~ bl es, make deposits, issue credit
rnemos, and record receipt of payments. Ttie auditor sus-
pects the individu~I may be stealing cash receipts. Which of
the following audit procedures would be most effective in
discovering fraud in this scenario? .
A. Perform a detailed review of debits to sales discounts,
sales returns and allowances, or other debit accounts,
excluding cash posted to the cash receipts journal.
s. Take a sample of bank deposits and trace the detail in
each bank deposit back to the entry in the cash receipts
journal.
c. Send negative confirmations to all outstanding accounts
receivable customers.
D. Send positive confirmations to a random selection of cus-
tomers.
A theft of cash collections can be concealed by debiting a

non-cash account (for example, sales discounts, sales re-
turns and allowances, or allowance for bad debts). Thus, the
most effective procedure is to revjew debits posted to these
accounts.
Answer Bis incorrect because bank deposits wil1 agree with

the entries in the cash receipts journal. The theft of cash is
concealed by debiting a non-cash account when recording
cash collections.
Answers C and D are incorrect because a stolen cash collec-

tion is recorded by debiting a non-cash account and credit-
..........
ing accounts receivable. Thus, customers would be unaware

of the fraudulent act of the employee because the balance
per their records will agree with the amount provided in the
confirmation request.
43. Which of the following most likely would give the most as-
surance concerning the valuation and allocation assertion of
accounts receivable?
A. Vouching amounts in the subsidiary ledger to details on
shipping documents.
B. Inquiring about receivables pledged under loan agree·
ments.
C. Assessing the allowance for bad debts for reasonable-
ness.
D. Comparing receivable turnover ratios with industry statis-
tics for reasonableness.
Valuation and allocation is an assertion that assets, Iiabili·

ties, and equity interests are included in the financial state·
ments at appropriate amounts and any 1~esulting valuation
or allocation adjustments are appropriately recorded.
t d at
Management asserts that accounts receivable are sta el w·
0
net realizable value (gross accounts receivable minus al ce
ance for bad debt,, allowance· for sales returns, anowa~le·
for sales discounts, etc.). Hence, assessing the reason~ the
ness of the allowance accounts provides evidence aboU
valuation of the accounts receivable.
. the sub·
Answer A is incorrect because vouching amounts in 'des e'I·
sidiary ledger to details on shipping documents provt
idence about the occurrence of sales transactions.
ct!Apff;R
j\nswer B is incorrect because inquiring about receivables

tedged under l~an agreements relates to presentation and
~isclosure assertion.
Answer D is ~nc~rrect becaus~ ~omparing receivable turno-

ver ratios with industry stat1st1cs for l'easonableness pro-
vides evidence about the completeness assertion.
Which of the following is not a principal objective in auditing

44
· accounts receivable?
A. To determine whether receivables are carried at their net
realizable value.
B. To determine whether receivables are properly classified,
described, and disclosed in the financial statements, in-
cluding notes, in accordance with the applicable financial
reporting framework.
C. To determine whether the entity has real claims in all re-
ceivables on the balance sheet.
D. To determine whether the accounts are collected by the
balance·sheet date.
Accounts receivable are claims against customers ansmg

from the sale of goods or services. In auditing this account,
the auditor should not anticipate collections at the balance
sheet date.
45. A large university has relatively ineffective internal control.

To obtain assurance that all tuition revenue has been rec-
orded, the auditor should
A. Confirm a sample of tuition payments with the students.
B. Prepare a year-end bank reconciliation.
C. . Compare business office revenue records with registrar's
office records of students enrolled.
D. Observe tuition payment procedures on a surprise basis.
480 CPA EXAMINATION REVIEWER: AUQITING THEORY
An auditor who seeks assurance that all tuition revenue has

been recorded should perform substantive procedures such
as tests of details and substantive analytical procedures.
For example, the auditor may obtain analytical evidence by
comparing business office revenue records with registrar's
office records of students enrolled.
Answers A and B are incorrect because confirming tuition

payments with the students and preparing year-end bank
reconciliation will not detect unrecorded stolen cash re·
ceipts.
Answer D is incorrect because observing tuition payment

procedures is a test of controls and does not provide evi·
dence about the completeness of the revenue account.
46. The process of obtaining and evaluating audit evidence

through a direct communication from a third party in. re·
sponse to a request for information about a particular it~~
affecting assertions made by management in the financia
statements is cailed
A. Reperformance
B. External confirmation
C. Inquiry
D. Recalculation
. e of in-
According to PSA 500, confirmation is a spec1fi.c typ f infor·
quiry which involves obtaining a representat10n °. d par·
mation or of an existing condition directly from a thtr
ty.
. ·ng e~
PSA 505 (External Confirmations) gives the f? 110 "'~aY be
amples of situations where external confinnauons
used:
cHAprER
Bank balances and other information from bankers .

•• Accounts receivable balances.
• Inventories held by third parties at bonded ware-
houses for processing or on consignment.
• Property title deeds held by lawyers or financiers for
safe custody or as security.
• Investments purchased from stockbrokers but not
delivered at the balance sheet date.
• Loans from lenders.
• Accounts payable balances.
Answer A is incorrect because reperformance is the audi-

tor's independent execution of procedures or controls that
were originally performed as part of the entity's internal
control, either manually or through the use of CAATs. An
example is reperforming the aging of accounts receivable.
Answer C is incorrect because inquiry consists of seeking

information of knowledgeable persons, both financial or
non-financial, throughout the entity or outside·the entity.
Answer D is incorrect because recalculation consists of

checking the mathematical accuracy of documents or rec-
ords. For example, the auditor-may obtain an electronic file
from the entity and check the accuracy of the summariza-
tion of the file by using.CAATs.
47. The confirmation of customers' accounts receivable rarely

provides reliable evidence about the valuation assertion be-
cause
A. Customers may not be inclined to report understatement
errors in their accounts.
B. Auditors typically select many accounts with low record-
ed balances to be confirmed.
; . - . • • t- -~. ~-- ·~ · :· ¥:"" --~-- - ~.
·r·; · ···'· .,,.. ·· -~.::=:.::::::.;.;:·:·:'"J'!t!~~I:
c. It is not practicable to asl< the customer to confirm de-

tailed information relating to its ability to pay the ac-
count.
D. Recipients usually respond only if they disagree with the
information on the request.
PSA 505 states that external confirmation does not normally

provide all the necessary audit evidence relating to the val-
uation assertion since it is not practicable to ask the debtor
to confirm detailed information relating to its ability to pay
the account.
Answer A is incorrect because non-reporting by customers

of understatement errors in their accounts does not provide
reliable evidence about the completeness assertion.
Answer B is incorrect because auditors typically select ac·

counts with material balances since confirmation provides
strong evidence regarding the existence of accounts receiv·
able as at a certain date.
Answer D is incorrect because a positive external confirm~

tion request asks the respondent to reply to the auditor.in
all cases, that is, whether or not the respondent agrees with
the information provided in the request. ·
48. Aud~tors may use positive and/or negative forms of confir·

mat1on requests. An auditor most likely will use·
A. The neg~~ive form for small balances. of
B. The pos1t1ve form, when the combined assessed level
inherent and control risk for related assertions is accept·
ably low, and the negative form when it is unacceptablY
high.
,,a_pTER 1 AUdit Objectives, Procedu~es , Evidence,
.
and Documentation 483
err -
The positive form to confirm all balances regardless of

c.
size. · .
A combination of the two forms, with the positive form
o. used for trade balances and the negative form for other
balances.
According to PSA 505, a negative external confirmation re-

est asks the respondent to reply only in the event of disa-
~~ee~ent with the information provided in the request.
Negative confirmation requests may be used when:
• The combined assessed level of inherent and control
risk is low.
• A large number of small balances is involved.
• A substantial number of errors is not expected.
• The auditor has no reason to believe that re_spond-
ents will disregard these requests.
Answer B is incorrect because the positive form is used

when the combined assessed level of inherent and control
risks is high.
Answer C is incorrect because the negative form is used

when a large number of small balances is involved.
Answer D is incorrect because the type of confirmation re-

quest does not depend on the nature of the balances.
49. The following statements relate to the use of negative con-

firmation requests. Which is true?
A. Negative confirmation requests are effective when detec-
tion risk is low.
B. Unreturned negative confirmation requests indicate that
alternative procedures are necessary.
re:::' I :
__,-is,.,-..--j1~ 11
-·--'.··---··._. ~_·~.·_
.__~.•~...c::l~.l ,_._-~-.~ ~-~--~_.:_;_;;_·'.-[••'<.F-j:.·4-i:::::- · ,jt
.'-.-·---- ..:..:
C. Unreturned negative confirmation requests rarely provide

sign~ficant explicit evidence.
D. Negative confirmation iequests are effective when un-
derstatements of account balances are suspected.
PSA 505 states that, "A negative external confirmation re-

quest asks the respondent to reply only in the event of disa-
greement with the information provided in the request.
However, the auditor remains aware that there will be no
explicit audit evidence that intended third parties have re-
ceived the confirmation requests and verified that the in-
formation contained therein is correct."
Answers A and D are incorrect because positive confirma-

tion requests are more effective when detection risk is low
and when understatements of account balances are sus-
pected.
Answer B is incorrect because unreturned negative confir-

mation requests indicate that the recipients agree with the
information provided in the request, thus alternative proce·
dures may be unnecessary.
50. In confirming accounts receivable, an auditor decided to

confirm customers' account balances rather than individ4al
invoices. Which of the following most likely would be in·
eluded with the client's confirmation letter?
A. An auditor-prepared letter explaining that a nonresponse
may cause an inference that the account balance is cor·
rect.
B. An auditor-prepared letter requesting the customer to
supply missing and incorrect information directly to the
auditor.
.p~R
1
C~"
client-prepared letter reminding the customer that a
c. ~onresponse will cause a second request to be sent.
A client-prepared statement of account showing the de-
o. tails of the customer's account balance.
Jient-prepared statement of account that shows the de-

A.~ of the receivable balance would make it easier for the
tai stomer to reconcile the account balance and thus, may in-
cus
crease response rates.
Answers A and Bare incorrect because a confirmation of the

account balance must be requested by the client, not the au-
ditor.
Answer C is incorrect because a confirmation requ~st

should not contain any form of threat to customers.
SL Which of the following statements would an auditor most

likely add to the negative form of confirmations of accounts
receivable to encourage timely consideration by the recipi-
ent?
A. "This is not a request for payment; remittances should
not be sent to our auditors in the enclosed envelope."
B. "If you do not report any differences within 15 days, it
will be assumed that this statement is correct."
C. "The follqwing invoices have been selected for confirma-
tion and represent amounts that are overdue."
D. "Report any differences on the enclosed statement di-
rectly to our auditors; no reply is necessary if this
amount agrees with your records."
Indicating a time limit on the negative form of confirmation

request may encourage timely consideration by the recipi-
ent.
Answers A and D are incorrect because the statements do

not encourage a timely response.
Answer C is incorrect because stating that the amount is

overdue could discourage a customer from responding
promptly.
52. An auditor confirms a representative number of open ac-

counts as of December 31 and investigates respondents' ex-
ceptions and comments. By this procedure, the auditor is
most likely to learn of which of the following?
A. One of the cashiers has been covering a personal em-
bezzlement by lapping.
B. The credit manager has misappropriated remittances
from customers whose accounts have been written off.
C. One of the sales clerks has not been preparing charge
·slips for credit sales to family and friends.
D. One of the computer processing. control clerks has been
removing all sales invoices applicable to his account from
the data file.
Lapping is the concealment of a cash shortage resulting

from the delay in recording cash receipts. For example, the
theft of cash receipt from one customer is concealed by
crediting that customer's account when another customedr
· d tecte
pays his/her account. Lapped accoµnts can be e the
through confirmation of receivable balances bec~use re·
customer will not agree with the balance provided in the
quest.
are no
Answer B is incorrect because written off accounts
longer open accounts.
C~TfR
er c is incorrect because there will be no account bal-
AnsWto be confirmed if a charge slip has not been prepared
ance
bY the sales clerk.
wer D is incorrect because there will be no account bal-

AnS 1 . . d
ance if the sa es mvo1ces are not processe .
ouring the proce~s of confirmi.ng receivables as of December

53. , zooA, a positive confirmation was returned indicating the
31
"balance owed as of December 31 was paid on January 6,
2ooB." The auditor will most likely
A. Reconfirm the zero balance as of January 7, 200B.
B. verify that the amount was received.
c. Determine whether a cash discount was taken by the
customer.
D. Determine whether there were any changes in the ac-
count between January 1 and January 6, 2008.
When a response indicates that the balance was already

paid, the a'u ditor should trace the customer's remittance to
verify that the payment was actually received by the client.
Answer A is incorrect because there is no requirement to

reconfirm the balance.
Answer C is incorrect because the auditor's primary focus is

the customer's confirmation of the year-end balance, not
whether a cash discount was taken.
Answer D is incorrect because the auditor's objective is to

confirm the year-end receivable balance, not the transac-
tions subsequent to year-end.
54. A company has computerized sales and cash receipts jour-

nals. The computer programs for these journals have been
properly debugged. The auditor's examination of the ac-
counting records revealed that the total of the accounts re-
ceivable subsidiary accounts differs materially from the ac-
counts receivable control account. This discrepancy could
indicate
A. Credit memoranda being improperly recorded.
B. Statements being intercepted prior to mailing.
C. Lapping of receivables.
D. Receivables not being properly aged.
Based on approved credit memoranda, sales returns and al·

lowances are recorded by crediting accounts receivable.
The discrepancy between the subsidiary ledger and the con·
trol account could be due to the recording of unauthorized
credit memoranda, assuming sales and cash receipts have
been properly recorded.
Answer B is incorrect because, although the interception of

customer statements might be indicative of fraud, such ac·
tion would not cause the ledger discrepancy.
·n
Answer C is incorrect because lapping results from delays ~I
recording cash receipts from customers. It would conceto
the the.ft of cash but would not cause ledg.er discrepancy
arise.
. t ieS are
Answer D is incorrect because no accounting en r
made when aging receivables.
. . sponse.5
SS. To reduce the risks associated with accepting fax ~e an au·
to requests for confirmations of accounts rece1vab e,
ditor most likely would
R 7 AUdit Objectives, Procedures, Evidence, and Documentation 489
ct1APTE
Inspect the faxes for forgeries or alterations and consid-

A.
er them to be acceptable if none are noted.
B. consider the faxes to be nonresponses and evaluate
them as unadjusted differences.
c. verify the sources and con.tents of the faxes in telephone
calls to the senders.
D. Examine the shipping documents that provide evidence
for the existence assertion.
PSA SOS (External Confirmations) states t·h at the auditor

should consider validating the source of replies received in
electronic format (for example, fax or electronic mail). The
auditor may verify the source and contents of a response in
a telephone call to the purported sender. Moreover, the au-
ditor should consider requesting the purported sender to
mail the original confirmation directly to the auditor.
Answer A is incorrect because faxes may not be signed. In

addition, PSA 500 (Audit Evidence) states that an audit rare-
ly involves the authentication of documentation, nor is the
auditor trained as or expected to be an expert in such au-
thentication.
Answer B is incorrect because replies received in electronic

format are. considered valid if the source and contents can
be verified.
Answer D is incorrect because the auditor's purpose is to

verify the existence of receivables by direct communication
with the customers.
56. PSA 505 defines confirmation as "thP process of obtaining

and evaluating audit evidence through a representation of
information or an existing condition directly from a third par-
.
···~
. ~
;z._ .. .,,, .
; ... ....- ......... .
~ ~.
~
t,;: - .~
tc:: : 1
:::: :
ty in response to a request for information about a particular

item affecting assertions in the financial statements or relat-
ed disclosures." Two assertions for which confirmation. of
accounts receivable balances provides primary evidence are
A. Completeness and valuation and allocation.
B. Valuation and allocation and rights and obligations.
C. Rights and obligations and existence.
D. Existence and completeness.
Confirmation of receivable balances directly with customers

is most likely to be effective for the rights and obligations
and existence assertions. It provides reliable evidence that
the receivables exist and that the client has the right to col-
lect such receivables from customers.
Answers A, B, and D are incorrect because confirmation

does not provide sufficient evidence about the completeness
and valuation and allocation assertions.
57. For accounts receivable, negative confirmation is less effec-

tive than positive confirmation because
A. Some recipients may report incorrect balances that re-
quire extensive follow-up.
B. A majority of recipients usually lack the willingness to re·
spond objectively.
C. Th~ audito~ cannot infer· that all nonrespondents have
venfie_d their accou~t information. is
D. Neg~t1_ve confirmations do not produce evidence that
stat1st1cally quantifiable.
When negative confirmations are used unreturned requests

ind i~ate that the intended recipients ~gree with the inf~~
matio~ provided in the requests. However, no explicit e ·
dence 1s provid e d th at t h e intended
. · d the 1r
recipients receive
requests and verified the information.
' ct'li4prt:R
wer A is incorrect because inaccurate reporting of bal-

Anses by the intended parties is always a possibility under
anc
both forms o f con f'Irma t'10n.
A swer B is incorrect because the assumed lack of willing-

0;55 to respond objectively would affect both forms of con-
firmation .
Answer D is incorrect because both forms of confirmation

provide quantjfiable audit evidence.
Which of the following procedures would an auditor most

58. likely perform ~1or yecir-en d accounts receivable confirmations
when the auditor did not receive replies to second requests?
A. Inspect the shipping records documenting the merchan-
dise sold to the debtors.
B. Review the cash receipts journal for the month prior to
year-end.
c. Intensify the study of internal control concerning the
revenue cycle.
D. Increase the assessed level of detection risk for the ex-
. istence assertion.
When no response is received to a second positive confirma-

tion request, the auditor should perform alternative proce-
dures such as examination of subsequent cash receipts, ex-
amination of shipping· documents or other client documen-
tation to provide audit evidence for the existence assertion,
and examination of sales for several days before and after
the balance sheet date to provide audit evidence for the·cut-
off assertion.
Answer B is incorrect because the auditor should examine

subsequent c~sh receipts.
Answer C is incorrect because nonresponses do not neces-

sarily indicate that the client's internal control is weak.
Answer D is incorrect because the auditor assesses inherent

and control risks, not detection risk. The level of detection
risk acceptable to the auditor depends on the combined as·
sessed level of inherent and control risks.
59. Which of the following is the most effective procedure for

determining the collectibility of an account receivable?
A. Confirmation of the account.
B. Review of the subsequent cash collections.
C. Review of authorization of credit sales to the customer
and the previous history of collections.
D. Examination of the related sales invoice(s). ·
The most effective procedure for determining co\lectibility

is to obtain audit evidence that it was subsequently collect·
ed. Collectibility relates to the valuation and allocation as·
sertion and is primarily considered in determining the ade·
quacy of the allowance for bad debts.
Answer A is incorrect beca use confirmation provides aud::

ev idence that the receivable exists and that the custo~ot
acknowledges the liability. However, confirmation d~~~e
provide complete assurance that the amount is collectl ·
I" t's historY of
Answer C is incorrect because while the c 1e.n. . ·r is 0ot
1
collections may be a good indicator of collect1b1hty,
as good as subsequent cash collections.
h related
Answer D is incorrect because examination of~ ereceiva·
sales invoice(s) provides audit evidence about t e
ble's validity, not collectibility.
..-.=R
cHAP'"
7 Audit Objectives, Procedures, Evidence•and 0ocumentat1on
.
493
An auditor reconciles the total of the .

60· . · I d t h accounts receivable
subs1d1ary e ger o t e genera/ ledger cont I
31 B h. ro account as of
oecem ber ·. Y t ts procedure, the auditor is most likely
to /earn of which of the following?
A. Affn account balance is past due and should be written
0 .
a. A December invoice was improperly computed.
C. A December check from a customer was posted in error
to the a~count of an~ther customer ·with a similar name.
o. ~n opening ba~ance tn a subsidiary ledger account was
improperly earned fonrvard from the previous accounting
period.
An auditor's reconciliation of the subsidiary ledger totaJ to

the general ledger will identify erroneous balances in the
subsidiary ledger at the end of the previous period carried
forward to the current period.
Answer A is incorrect because aging receivables wiJI most

probably detect uncollectible ~ccounts.
Answer Bis incorrect because reconciliation of the subsidi-

ary ledger and general ledger control account will not detect
an improper amount posted to both records if such amount
is based on the same erroneous document. The auditor
should consider recalculation of invoice amounts to detect
the error.
Answer C is incorrect because confirmation will most likely

detect posting of customer payment to a wrong account.
This error will not affect the subsidiary ledger and general
ledger control balances.
~
- -"-ll. . . . . . . . . . a...111111. . . .•s........................ ~;iJll!lll..~,.,.....
• 1
. ,• . ;- .. -:.., -
61. Once a CPA has determined that accounts receivable have

increased because of slow collections in a tight money envi-
ronment, the CPA is likely to
A. Review the entity's credit and collection policy.
B. Expand tests of collectibility.
C. Review the going concern ramifications.
D. Increase the balance in the allowance for bad debts ac-
count.
The auditor should determine the effect of slow collections

of accounts receivable on the allowance for bad debts ac-
count. The auditor should expand his/her tests of collecti-
bility such as a review of collections subsequent to the bal-
ance sheet date.
Answer A is incorrect because the auditor's review of the

credit and collection policy is just a part of the expansion of
tests of collectibility.
Ans~er C is incorrect because slow collections of accourts

receivable does not n . . .
'ty f h . ecessan 1Y raise doubts about the abd-
1 o t e client to continue as a going concern.
Answer D is incorrect b
not be increased b ecause the allowance balance need
are expected to be ~~~use_ of slo"." collections if the accounts
ectible as m prior periods.
62. All of the following are
to verify the valuation ~xamples of substantive procedures
the f net accounts receivable, except
A_. Comparison of th
records. e allowance for bad debts with past
B. Recomputation of th
e allowance for bad debts.
I .
ct·t.APTER
c. Inspection of the aging schedule and credit records of

past due accounts.
0 . Inspection of accounts for current versus noncurrent sta-
tus in the statement of financial position.
The inspection of accounts for current versus noncurrent

status tests management's assertion about presentation and
disclosure, not valuation.
Answers A, 8, and Care incorrect because comparison of the

allowance for bad debts with past records, recomputation of
the allowance for bad debts, and inspection of the aging
schedule and credit records of past due accounts are tests of
management's valuation assertion about the account bal-
ance.
63. The most likely reason for the auditor to be concerned about
the valuation of cash is that
A. The proof of cash cannot be reconciled.
B. The client uses a checking account.
c. Both currency and negotiable securities are on nand.
D. The client has foreign currency accounts.
The audit objective of valuation is normaHy ot minimum

concern during the audit of cash. However, the client's for-
eign currency accounts must be converted tCJ Philippine pe-
sos using the current exchange rate. Changes in the ex-
change rate and restrictions on the client's foreign accounts
may affect the valuation of these accounts.
Answers A and C are incorrect because a proof of cash that

cannot be reconciled and currency and negotiable securities
that are both on hand affect the auditor's concern about the
existence of cash, not its valuatjon.
~ -~ 1[ ,:: I : '. : : :
.
' .' • • • . o : ;
.-· ·.· ...,. · ~''r'~.:--~~~ ,,~=~~;~- .::::~. _;~~.~~~·~-~:-~-~·~

: l -~. ~
~-:' ?'"~;=~iflililiii-iL
. .~ ··· ~ .~-. ~ r' ....
·-
·- --- - -...,....__
,_.--#
Answer Bis incorrect because most entities maintain check-

ing accounts for cash disbursements.
64. When counting cash on hand, the auditor must exercise con-
trol over all cash and other negotiable assets to prevent
A. Theft
B. Deposits in transit
C. Substitution
D. Irregular endorsement
There should be simultaneous verification of cash and other

negotiable assets to prevent the likelihood of converting ne-
gotiable assets to cash to conceal a cash shortage.
Answers A and D are incorrect because simultaneous verifi-

cation does not directly prevent theft or irregular endorse-
ments except during the time the auditor performs the veri-
fication procedures.
Answer B is incorrect because deposits in transit (callee·

tions recorded on the client's books but are not yet credited
by the bank) normally arise from cash transactions.
·15 doc·
65. The best evidence regarding yeqr-end bank balances
umented in the
A. Bank reconciliations
B. Interbank transfer schedule
C. Cash in bank lead schedule
D. Cu?off bank statement
.. . explains
A bank reconc1hat1on statement is a schedule that d the
any differences between the bank statement balance adn c"sh
. ste "
cash balance per the company's records . The a dJU . ncial
balance is the amount of cash reported in the fina
7 Audi! Objectives, Procedures, Evidence; and Documentation 497
cHAp~R
tatements. Thus, a bank reconciliation statement pro.vides

~irect evidence of the year-end bank baJance.
Answer Bis incorrect because an interbank transfer sched-

ule shows only the transfers of funds between banks.
Answer C is incorrect because a cash in bank Jead scheduJe

shOWS the components of the amount of cash included in th·e
working trial balance.
Answer D is incorrect because a cutoff bank statement re-

ports cash transactions for a short period after the baJance
sheet date and is used by the auditor to verify year-end rec-
onciling items such as deposits in transit and outstanding
checks.
66. Which of the following sets of information does an auditor

usually confirm on one form?
A. Accounts receivable and accrued interest receivable.
B. Cash in bank and collateral for loans.
c. Accounts payable and purchase commitments.
D. Inventory on consignment and contingent liabilities.
The standard bank confirmation form is used by auditors to

confirm the cash in bank balance and reriuest loan infor-
mation such as balance, maturity date, interest rate, and de-
scription of collateral.
Answers A, C, and D are incorrect because accounts receiva-

ble and accrued interest receivable; accounts payable and
purchase commitments; and inventory on consignment and
contingent liabilities are pairs of information that are not
usually confirmed on one form.
· 67. An auditor ordinarily sends a standard confirmation request

to all banks with which the client has done business during
the yea~ under audit, regardless of the year-end balance. A
purpose of this procedure is to
A. Detect kiting activities that may otherwise not be discov·
ered. .
B. Provide the data necessary to prepare a proof of cash.
C. Request that a cutoff bank statement and related checks
be sent to the auditor.
D. Seek information about other deposit and loan amounts
that come to the attention of the institution in the pro·
cess of completing the confirmation.
The bank confirmation form requests information about

cash in bank and direct liabilities of the entity to the bank.
Answer A is incorrect because kiting can be detected by

preparing an interbank transfer schedule for a few days be-
fore and after the balance sheet date to determine whether
fund transfers between banks have been recorded in the
proper periods.
Answer B is incorrect because the cash records and~~~

month-end bank statement provide data for the prepara
of a proof of cash.
ld be
Answer C is incorrect because a separate letter shoU te·
k sta
prepared by the client to request for a cutoff .ban
ment.
.
68. Which of the following items is not requested on a 5
~n~~
bank account balance confirmation form?
A. The principal amount paid on a direct liability·
B. Maturity date of a direct liability.
C. Description of collateral for a direct liability·
prER 7 Audit Objectives. Procedures Ev'd
cHA ' ' ence, and Documentation
499
o. The interest rate of a direct liab·l·ty
" .
The bank confirmation form re .
count num b er and description quests
b Inform a r10n a bout ac-
1
terest rate, date through whi"ch '. ta ance, maturity date, in-
. merest· 'd
tion of collateral. The auditor . is pa1 , and descrip-
amount paid . on a direct liability. is not concerned w1'th t h e
69 . Which of the following is not considered b. .

audit of cash? an ~ect1ve of the °
A. Cash is sta~ed at its realizable value.
B. Compensating cash balances are reported as 0 th -
rent assets. er cur
C. Cash is p:operly classified, described, and disclosed in
t~e financial .statements, including notes, in accordance
with t~e applicable financial reporting framework.
D. The client has ownership rights in the reported cash.
Compensating balances are classified according to the ap-

propriate classification of the related borrowing, either cur-
rent or noncurrent.
70. The purpose of a proof of cash is to

A. Validate that the client's bank did not make an error dur-
ing the period being .examined.
B. Confirm that the client has properly separated the custo-
dy function from the recording function with respect to
cash. ·
C. Prove that the client's year-end balance of cash is fairly
stated.
D. Determine whether any unauthorized disbursements or
unrecorded deposits were made for the given time peri-
od.
A proof of cash is a four-column schedule that reconciles

bank balances for two successive months (first and last col-
umns) and cash receipts and disbursements for the period
(middle columns). It can be used to detect unauthorized
disbursements or unrecorded deposits for the period.
Answer A is incorrect because detection of bank errors is

not the primary reason why a proof of cash is prepared.
Answer B is incorrect because the auditor should obtain

knowledge about internal control relevant to cash transac-
tions to determine whether the custody and the recording
functions are properly segregated.
Answer C is incorrect because a proof of cash reconciles

cash balances and transactions for two su ccess ive months of
only one bank account. Other substantive procedures must
be performed to examine other cash a ccounts (for ex~mple,
cash on hand) to obtain audit evidence about the fairness of
the cash balance.
71. An internal auditor would be concerned about the possibility

of fraud if
A. Only one person has access to the petty cash fund.
B. Cash receipts, net of the amounts used to pay pettY
cash-type expenditures, are deposited in the bank daily.d
C. The monthly bank statement reconciliation is perforrn.e
by the same employee who maintains the perpetual in·
ventory records.
D. The accounts receivable subsidiary ledger and accounts
payable subsidiary ledger are maintained by the same
person.
1 AUdit Objectives, Procedures, Evidence, and DoeoJrnentation 50 1
ct!A"li;R
from the standpoint 0 ~ a g~od internal control, all cash re-

ceipts should be deposite~ mtac~ daily. Using cash receipts
petY petty cash expenditures increases the possibility of
~aking unau~horized removal of cash before deposit. An
imprest petty cash fund should be maintained for small dis-
bursements.
Answer A is incorrect because accountability for petty cash

fund is established if only one person, designated as the pet-
ty cash custodian, has access to the petty cash fund.
Answers C and D are incorrect because the functions de-

scribed are not incompatible and thus, can be performed by
the same person. Incompatible functions are those that will
allow a person to both commit and conceal errors or fraud.
EXPENDITURE/DISBURSEMENT CYCLE
72. Purchase cutoff procedures test the completeness assertion.

An entity should include goods in its inventory if it
A. Has paid for the goods.
B. Holds legal title to the goods.
c. Has physical possession of the goods.
D. Has sold the goods.
A purchase cutoff test is a substantive procedure to obtain

audit evidence about whether purchases are recorded in the
appropriate period. An entity should include goods in in-
ventory and recognize a liability in the period in which it
acquired title to the goods.
Answer A is incorrect because goods purchased on account

need not be paid for by the cutoff date.
' ' . -~ .
502 CPA' EXAMINATION REVIEWER: AUDITING THEORY
Answer C is incorrect because title to the goods can pass be-

fore actual delivery to the buyer, for example, in transit
goods purchased under FOB shipping point term.
Answer D is incorrect because goods already sold should be

. excluded from inventory.
73. In auditing accounts payable, an auditor's procedures most

likely will focus primarily on management's assertion of
A. Existence
B. Valuation and allocation
C. Completeness
D. Presentation and disclosure
The primary audit risk for liabilities, including accounts

payable, is the possible understatement of the account
~hus, in auditing accounts payable, the auditor will most
hkely focus on the completeness assertion.
~nswer A is incorrect because the risk that reported liabili·

ties do not exist is generally lower than the risk that the bal·
ance is understated.
Answer 8 is incorrect because the risk that accounts paya~le

are not reported at appropriate amounts is less than the risk
that the balance is understated.
Answer D · · aya·
bl e are not isproperl
incorrect because the risk that accounts P · I
h financ1a
stateme . Y presented and disclosed in t e ·allY
underst nttsd1s not as high as the risk that they are mater!
ae .
74. Which of the fi0 II . terf11irif

if ac::counts owing is the primary ;;tudit test to de
payable are valued properly?
. ER
cw.PT
7 Audit Objectives, Procedures, Evidence•and Documenlalion
.
503
A. vouching accounts payable to supportin d .

B. An analytical procedure. 9 ocumentat1on.
c. verification
. b"l'ty
that accounts payable are report d
. th e balance sheet. e as a cur
_
rent Ira r t tn
o. Examination of cash disbursements subsequent to year-
end.
To deter~ine if accounts payable are properly valued, the

auditor will _v ouch a sample of recorded accounts payable to
the supporting ~o:umentation of purchase-namely, pur-
chase order, rece1vmg report, and vendor invoice.
Answer B is incorrect because analytical procedures are

performed to provide an overall review of the accounts, not
to test the valuation of specific accounts.
Answer C is incorrect because determining whether ac-

counts payable are classified as a current liability addresses
the presentation and disclosure assertion rather than valua-
tion.
Answer D is incorrect because examining subsequent cash

disbursements may reveal unrecorded liabilities but does
not address the valuation of those liabilities that .are record-
ed on the company books.
75. Which of the following procedures is least likely to be per-

formed before the balance sheet date?
A. Search for unrecorded liabilities.
B. Confirmation of accounts receivable.
C. Attendance at the physical inventory count.
D. Testing internal control over cash.
-
504
CPA EXAMINATION REVIEWER: AUDITING THEORY
The auditor searches for unrecorded liabilities by reviewing

cash disbursements made after year-end to determine if
they pertain to unrecorded liabilities as of the client's bal-
ance sheet ct.ate.
Answer B is incorrect because, depending on the combined

assessed level of inherent and control risks for receivables,
confirmation may be made before, on, or after the balance
sheet date.
Answer C is incorrect because if the internal control over in-

ventory is effective, attendance at the physical inventory
count usually can be made during or at the end of the period
under audit.
Answer D is incorrect because the understanding of internal

control is usually obtained prior to the balance sheet date as
part of the auditor's risk assessment procedures.
76. An auditor performs a test to determine wheth~r all m:~

chandise for which the client was billed was received.
population for this test consists of all
A. Receiving reports
B. Vendors' invoices
C. Canceled checks
D. Merchandise received
. . . . describes
A supplier bills the buyer through an mvo1ce thatd terrnine
the item(s), amount due, and payment te~ms. To b~lled was
whether all merchandise for which the client was. to the
received, the auditor should trace vendors' invoice5
related receiving reports.
R 7 Audit Objectives, Procedures, Evidence, and Doc~mentation 505
cH.ApTE
,Answer A is incorrect because tracing receiving reports to

vendors' invoices provides audit evidence about whether all
goods received were billed by suppliers.
Answer C is incorrect because tracing canceled checks to re-

ceiving reports assures that go.ads paid for-not goods
billed-were received.
Answer D is incorrect because if the direction of testing is

from goods received, merchandise received but not billed
will not be detected.
77. Which of the following js a substantive procedure that an

auditor would most likely perform to verify the existence and
valuation of recorded accounts payable?
A. Confirming accounts payable balances with known sup-
pliers who have zero balances.
B. Investigating the open purchase order file to ascertain
that prenumbered purchase orders are used and ac-
counted for.
C. Receiving the client's mail, unopened, for a reasonable
period of time after year-end to search for unrecorded
vendor's invoices.
D. Vouching selected entries in the accounts payable sub-
sidiary ledger to purchase orders and receiving reports.
Vouching a sample of entries in the accounts payable sub-

sidiary ledger to purchase orders and receiving reports pro-
vides audit evidence about whether recorded liabilities exist
at a given date and are reported at appropriate amounts.
Answer A is incorrect because confirming payables with

known suppliers who have zero balances will probably de-
tect unrecorded liabilities. Hence, this procedure relates

more to management's completeness assertion.
Answer B is incorrect because investigating the open pur-

chase order file to ascertain that prenumbered purchase or-
ders are used and accounted for is most directly related to
management's completeness assertion.
Answer C is incorrect because the auditor's search for unre-

corded vendor's invoices is most directly related to man-
agement's completeness assertion.
78. When using confirmations to provide evidence about the

completeness assertion for accounts payable, the appropri-
ate population most likely is
A. Amounts recorded in the accounts payable subsidiary
ledger.
B. Vendors with whom the entity has previously done busi-
ness.
C. Invoices filed in the entity's open invoice file.
D. Payees of checks drawn in the month subsequent to the
balance sheet date.
The completeness assertion for accounts payable addresses

whether all amounts due to vendors that should have been
recorded have been recorded. If confirmation is to be used
to verify this assertion the population must be all vendo~s
wi'th w h om the entity
· 'has previously done business.
. ThtS
to
means that confirmation requests will be sent not 001 Y. h
vendors with large year-end balances, but also to those w~tr·
small or zero balances as long as the entity has made p
chases of their goods during the year under audit.
cHAPT"'<=R 1 AUdit Objectives, Procedures, Evidence· and 0ocumentat1on
.
507
Answers A and Care· hincorrect

. becaus e, m
. testing
. the com-
leteness assert10n, t e auditor is co ncerne d with
. accounts
.
p
ayable that
·1 dhave not been recognized or mvo1ces
· . that have
P
f
not been 1 e .
Answer. D is incorrect because the populat·ion 1or

c t h e con-
firmation process should consist of vendors' accoun t s re-
gardless of the balance-large, small, or zero-at the con-
firmation date.
. unrecorded l!abilities are most likely to be found during the

79
I
review of which of the following documents?
" A. Bills of lading
B. Unpaid bills
c. Unmatched sales invoices
D. Shipping records
The auditor's review of unpaid bills may reveal payables

that should have been recorded or accrued but have not
been recognized as liabilities as of the balance sheet date.
Answers A, C, and D are incorrect because these records and

documents relate to the entity's sa,les, not liabilities.
.l
ll5 :1 80. Which of the following audit procedures is least likely to de-
)(ti ) tect an unrecorded· liability?
~ - A. Reading the minutes of meetings of the board of direc-
~ ·'l tors.
r~ :l B. Analysis and recomputation of interest expense.
~[ C. Analysis and recomputation of depreciation expense.
ti: D. Mailing of bank confirmation forms.
Analysis and recomputation of depreciation expense will

provide audit evidence about management's valuation and
~ .
,•. ~~,;...~~~-~-~·:"'';~".' " .. ·-; - · ·-:-~ ·,r
----
allocation assertion concerning the entity's property, plant,

and equipment. Thus, these procedures do not relate to the
auditor's objective of detecting unrecorded liabilities.
Answer A is incorrect because the entity's board of directors

usually authorizes transactions that will result to incurrence
of large amounts of liabilities.
Answer B is incorrect because the auditor's computation of

the current year's interest expens_e based on the client's
recorded liabilities may reveal that it is unreasonably lower
than the actuc;il interest expense paid and accrued. The au·
ditor's investigation of the significant difference may lead to
the detection of unrecorded liabilities.
Answer D is incorrect because the bank confirmation form

requests information about the client's direct liabilities to
the bank which may have not been recognized oo the com·
pany's books.
d't
81. When title to merchandise in transit has passed to the ~~~
client, t~e auditor engaged in the performan_ce of_a_ purcssur·
cutoff will encounter the greatest difficulty in gaining a
dnce with respect to the
A. Quality
B. Quantity
C. Price
D. Terms
. . d through
The _qua~1ty of _merchandise can be deter1!une Thus. th~
physical mspect1on of the goods a lready rece1v_ed. . ing as
auditor will encounter the greatest difficulty in gadind ill in'
· clu e
surance about quality with respect to goods in
ventory but have not yet arrived .
cl'lAprER 1 AUdit Objectives, Procedures, Evidence, and Documentation 509
Answers B, C, and . D ar~ incorrect because supporting pur-

chase documentation will provide information to the audi-
tor about the quantity, price, and terms of the purchase.
Which of the following audit procedures is best for identify-

82· ing unrecorded trade accounts payable?
A. Reconciling. ven~or~' statements to the file of receiving
reports to 1dent1fy items received just prior to the bal-
ance sheet date.
a.Examining unusual relationships between monthly ac-
counts payable balances and recorded cash payments.
c. Investigating payables recorded just prior to and just
subsequent to the balance sheet date to determine
whether they are supported by receiving reports .
D. Reviewing cash disbursements recorded subsequent to
~
the balance sheet date to determine whether the related
payables apply to prior period .
.\
The auditor's search for unrecorded liabilities includes the
following audit procedures:
Examining cash disbursements made subsequent to
• the balance sheet date and comparing them with
recorded accounts payable as at year-end.
Sending confirmations to vendors, including those
,.
• having zero balances.
Reconciling payable balances with vendor_s' docu-
•
mentation.
Answer A is incor;~. because reconciling vendors' state-
ments to the file of receiving reports to identify items :e-
ceived just prior to the balance sheet date does not provide
audit evidence about whethe-r the items have been recorded.
~
E:ii:====- p==·=-~:w.:~p~~,:fi::_:,:::_:;. .:.- .:.:;~:.:.:").:-~:_.:t
. :.~:.,_.:<., :.:·-=.;:._~tLtt~:,1~:-;:_,:-~-~.:~-.._ _
-
510
CPA EXAMINAnON REV/EWE~: AUDITING THEORY
A~swer B is inc~rrect because examining unusual relation-

ships between monthly accountc; payable balances and rec-
orded cash payments tests only the recorded payables.
Answer C is incorrect because investigating recorded paya-

bles to determine if they are supported by receiving reports
tests only the recorded payables and does not assure the
auditor that all goods received have been recorded.
83. In a payables application, checks are authorized and paid

based on matching purchase orders, receiving reports, and
vendor invoices. Partial payments are common. An appro·
priate audit procedure for verifying that a purchase order
llas not been paid twice is to sort the
A. Check register file by purchase order, compute total
amounts paid by purchase order, compare total amounts
paid with purchase order amounts, and investigate any
discrepancies between the total amounts paid and pur·
chase order amounts. . d in·
8. Receiving report file by vendor invoice amounts an ts
vestigate any discrepancies between the total amoun
received and vendor invoice amounts. · t total
C. Vendor invoice . file by purchase order, compu: total
amounts invoiced by purchase order, comparand in·
amounts invoiced with purchase order amoun~, mounts
vestigate any discrepancies between the tota a
invoiced and purchase order amounts. ute total
D Receiving report file by purchase order, comP re total
. amounts received by purchase order' compa d ·n-
ts an 1
amounts received with purchase order amou; ~mounts
1
vestigate any discrepancies between the to a
received and purchase order amounts. ."
t1t1!10
er cornP rt1l
. the check register
Sortmg . r·11 e bY pu rchase or dmparin
, . g to
total amounts paid by purchase order, co
7 AUdit Objectives, Procedures, Evidence, and Documentation 5 11
c~pri:R
amounts paid ~ith purchase order amounts, and investigat-

. g discrepancres between the total amounts paid and pur-
~ase order amounts will provide reasonable assurance to
the auditor that a purchase order has not been paid twice.
Answers B, C, and D are incorrect because the a.udit proce-

dures described do not include examination of the check ·
register file. Thus, they do not provide assurance that no
overpayments have been made by the entity.
Which of the following procedures relating to the examina-

84' tion of accounts payable could the auditor delegate entirely
to the client's employees?
A. Mail confirmations for selected account balances.
s. Prepare a schedule of accounts payable.
c. Test footings in the accounts payable ledger.
D. Reconcile unpaid invoices to vendors' statements.
The preparation of a schedule of accounts payable merely

involves listing of vendors' accounts and amounts taken
from the accounts payable subsidiary ledger. This proce-
dure could be delegated entirely to the client's employees.
However, the auditor should test and review this client-
prepared schedule.
Answers A, C, and D are incorrect because the procedures

described should be performed by the auditor.
85. In an audit of a purchasing department, which of the follow-

ing usually is considered a risk factor?
A. Pur.chase specifications are developed by the department
requesting the material.
B. Purchases are not rotated among suppliers included on
an approved vendor list.
C. Purchases are made from parties related to buyers or

other company officials.
D. Purchases are made against blanket or open purchase
orders for certain types of items.
Purchasing from parties related to buyers or other company

officials is a risk factor because this may heighten the possi-
bility of fraud.
Answer A is incorrect because the department in need of the

material normally develops specifications.
Answer Bis incorrect because rotation is not usually appro-

priate. Moreover, maintaining an approved vendor list is a
control to ensure that purchases are made only from ap-
proved vendors.
Answer D is incorrect because blanket or open purchase or-

ders are normally prepared for materials that are frequently
purchased.
86. The following statements compare confirmation of acco~n~

payable with vendors and confirmation of accounts receiv
ble with customers. Which is false? va·
- A. As compared with the confirmation of accoun~ re~~ to
ble, the confirmation of accounts payable will te lance
emphasize accounts with zero balances at the ba
sheet date. . te in
B. Statistical sampling techniques are more ap~rop~ia con·
the confirmation of accounts receivable than in t e
firr:nation ~f accounts payable. nt to the
C. It 1s less likely that the confirmation request se eQ 11est
vendor will show the amount owed than that the r
sent to the customer will show the amount due.
cHApifR
confirmation of accounts receivable· with customers is a

0
· more widely accepted auditing procedure than is confir-
mation of accounts payable with vendors.
Statistical samp!ing ~e~hniques are appropriate for large

opulations havmg s1m1lar characteristics. This is true for
~oth confirmation of accounts receivable with customers
and confirmation of accounts payable with vendors.
Answer A is a correct statement. As compared with the con-

firmation of accounts receivable, the confirmation of ac-
counts payable will tend to focus on accounts with zero bal-
ances at the balance sheet date to detect possible under-
statements of payables.
Answer C is a correct statement. So that all purchases may

be confirmed-including those current shipments whose
bills are still being processed by the vendor, the confirma-
tion request for accounts payable generally does not show
the amount owed by the client. For accounts receivable, of-
ten only payments of customers in transit will need to be
reconciled.
Answer D is a correct statement. Confirmation of accounts

receivable is a more widely accepted auditing procedure
than is confirmation of accounts payable. This is because
externally generated vendor documentation is often availa-
ble for accounts payable, which may lessen the need to send
confirmation requests to vendors.
87. Which of the following procedures would an auditor least

likely perform before the balance sheet date?
A. Confirmation of accounts payable
B. Identification of related parties
aq
C. Assessment of control risk

D. Attendance at the physical inventory count
In auditing accounts payable, the most important assertion

to verify is completeness. Thus, accounts payable balances
are best confirmed at year-end.
Answers B, C, and D are incorrect because identification of

related parties, assessment of control risk, and attendance
at the physical inventory count may be performed before
the balance sheet date.
PRODUCTION CYCLE
88. Which of the following statements concerning the auditor's

attendance at the physical inventory count is incorrect?
A. A financial statement audit should always include attend·
ance at the physical inventory count.
B. If the auditor is unable to attend the physical inv~nt~~
count on the date planned due to unforeseen e1rc~ al
stances, he/she should take or observe some phY ~r
51
counts on an alternative date and, when necessary, P

form audit procedures on intervening transactions. ·uch
C. Where attendance is impracticable, due to factors ~itor
as the nature and location of the inventory, the auovide
should consider whether alternative procedures pr and
sufficient appropriate audit evidence of existe~c~ation
condition to conclude that reference to a scope lirni
need not be made. trol of
D. ln~entori~s. that are under the cus~ody and c~; publi:
third parties (for example, inventone~ ~ocat~dect confir
warehouses) may be verified by obtaining dir dil19 on
mation from the custodians, provided that, depen
cH-AprER
the materiality of the amount involved, additional proce-

dures should be applied as deemed necessary.
pSA 501 (Audit Evidence - Specific Considerations for Se-

Jected Items) states, "When_inventory is material to the fi -
ncial statements, the auditor should obta in sufficient ap-
na .d
ropriate audit ev1 ence rega rding its existence and condi-
~on by attendance at physical inventory counting unless
impractitable."
t
f
'
: I gg, PSA 501 states that in planning attendance at the physical
inventory count, the auditor considers the risks of material
misstatement related to inventory as well as the nature of
the internal control related to inventory. Which of the fol-
lowing would the auditor also consider?
I. Whether adequate procedures are expected to be es-
tablished and proper instructions issued for the physical
inventQry count.
II. The timing of the count.
III. The locations at which inventories are held.
IV. Whether an expert's assistance is to be sought.
A. I and IV only
8. II and III only
D. I, II, 1II, and IV
90. According to PSA 501, when inventories are under the cus-
tody and control of a third party, the auditor would ordinarily
obtain direct confirmation from the third party as to the
quantities and conditiqn of inventories held on behalf of the
entity. Which of the following would the auditor also con-
sider?
I. The integrity and independence of the third party.

II. Observing, or arranging for another auditor to observe .

the physical inventory count. '
III. Obtaining another auditor's report on the adequacy of
the third party's internal control for ensuring that inven-
tories are correctly counted and adequately safeguard-
ed.
IV. Inspecting documentation regarding inventories held by
third parties (for example, warehouse receipts) or ob-
taining confirmation from other parties when such in-
ventories have been pledged as collateral.
A. I, II, and IV only
B. I, III, and IV only
91. In an audit of inventories, an auditor is least likely to verify

that
A. The client has used proper inventory pricing. rl
B. Damaged goods and obsolete items have been prope Y
accounted for. . is
C. The financial statement presentation of inventories
appropriate. tirne
D. All inventory owned by the client is on hand at the
of the count.
d at the
Inventory owned by the client need not be on han ed un·
time of the count. For example, some items purch~S on the
der FOB shipping point term may still be in transl hiPPed
5
da te of the count. Also, some goods may have been
to customers on consignment basis.
ould
d'tor
1 sh
Answers A and B are incorrect because the au tion·
. n asser
ven'fy management's valuation and allocatio
cHAPT""r::R 7 AUdit Objectives, Procedures, Evidence· and. Documentatron
. 5 17
Answer C js , incorrect
. t because
. the auditor sho uId ven'fy
rnanagemen t s presen at1on and disclosure assertion.
An auditor selected items for test counts whi'le ob ·

92· h · · t serving a
client's P ysrca 1.mv;n. ory · The auditor then traced the test
counts to ~he clle~t s inventory listing. This procedure most
likely obtained evidence concerning management's assertion
of
A. Existence
c. completeness
o. Valuation and allocation
completeness is an assertion of management that all as-
sets, liabilities, and equity interests that should have been·
recorded have been recorded. Tracing the test counts to the
client's inventory listing assures the auditor that items in-
cluded in the observed physical inventory are reflected in
the inventory records.
Answer A is incorrect because the direction of testing must

be from the client's inventory listing to the inventory tags to
obtain evidence that items included in the listing have been
counted, that is, they exist.
Answer Bis incorrect because tracing the test counts to the

inventory listing does not provide evidence that the inven-
tory is owned by the client.
Answer D is incorrect because the valuation and allocation

assertion is verified by determining whether inventory
items are valued at the lower of cost or net realizable value.
..
.,-.~~ .. ·i~:W1~.-- J .:~~.... ': •. , ... , · . .. . \.' •.
93. An auditor is most likely to inspect loan agreements under

wt:iich an entity's inventories are pledged to support man-
agement's financial statement assertion of
A. Presentation and disclosure
B. Existence
C. Completeness
Management's assertion about presentation and disclosure

addresses whether particular financial statement elements
are properly classified, described, and disclosed. Inspecting
loan agreements to determine whether the pledge of inven·
tories is appropriately disclosed provides evidence about
this assertion.
Answer B is incorrect because inspection of loan agr~e·

ments does not provide evidence about whether inventories
physically exist.
Answer C is incorre~t because inspection of loan agreemen~

does not assure the auditor that inventory records reflect al
inventory items owned by the company.
Answer D is incorrect because inspection of loan agreed

ments does not determine whether inventories are reporte
at the lower of cost or net realizable value.
94. !f the perpetual inventory records show lower. quanftieSe dif·of

1
inventory ~han the physical count, an explanation of th

ference might be unrecorded
A. Purchases
B. Sales
C. Sales discounts
D. Purchase discounts
7 AUdit Objectives, Procedures, Evidence, ano Documentation 51 9
ctiApfER
Under the p~r~etu~l invento~ system, purchases are rec-

orded by deb1tmg directly the inventory qCcount rather than
urchases account. Also, the cost of goods sold is credit-
the P h .
ed directly to t e inventory account. Hence, inventory will
be understated for unrecorded purchases.
Answer B is incorrect because an unrecorded sale will over-

state inventory.
Answers C and D are incorrect because unrecorded sales

and purchase discounts do not affect inventory quantity.
A client maintains perpetual inventory records in both quan-

95' tities and pesos. I f t he assessed level· of control risk is high,
an auditor will probably
A. Increase the extent of tests of controls relevant to the
inventory cycle.
s. Request the client to schedule the physical inventory
count at the end of the year.
c. Apply gross profit tests. to ascertain the reasonableness
of the physical counts.
D. Insist that the client perform physical counts of inventory
items several times during the year.
lf control risk is high, the acceptable level of detection risk

should be low. A low level of detection risk ordinarily re-
quires performance of substantive procedures at year-end
rather than at an interim date. Thus, attendance at the
physical inventory count at year-end provides the best evi-
dence about the existence of inventories.
\
Answer A is incorrect because the auditor would not per-

form tests of controls if controls are unlikely to be effective.
bz
. . '• -. .·-: .... -·--- - . . . . . _
~ :- .
.... .; .... _;:-_.. ; _ .

_
' I ,,._'-?._.._,:, ·~· .,o ~-

I, r
f 1,
Answer C is incorrect because applying gross profit tests

will provide evidence about sales and cost of goods sold but
not inventory.
Answer D is incorrect because the risk relates to the possi·

ble misstatement of year-end inventory.
96. While obtaining an understanding of the client's internal con·

trol system in the production cycle, management stated that
the sale of scrap was well controlled. Which of the following
is the best audit procedure to verify this assertion?
A. Interviewing persons responsible for collecting <Jnd stor·
ing the scrap.
B. Comparing current revenue from scrap sales with that of
prior periods.
C. Comparing the quantities of scrap expected from the
production process with the quantities sold.
D. Comparing the results of a .physical inventory of scrap on.
hand with perpetual inventory records.
A well-controlled sale of scrap means it is sold soon after it

is produced. Hence, a large amount of scrap will not be ex·
pected to be on hand. The auditor can assume that the sa~
of scrap is well controlled if the quantities of scrap expecte t
from the production process are not materially differen
from the quantities sold.
A nswer A is. . h t can be

incorrect because the information t a ·g
bt
0 aine· d b ·
Y interviewing persons responsible for c
ollectin
be·
and storing the scrap pertains only to controls in place
fore the sale.
A . . nt reve·
nswer Bis incorrect because by comparing curr~ . pre·
15
nue from scrap sales with that of prior periods, it
" 7 Audit Objectives, Procedures, Evidence• and Documen1a1.ion
cHApTEI' 521
50 01edthat prior period revenue was correct and that the

quantity of scrap produced did not change.
Answer D is incorrect because comparing .the results of a

physical in~e~tory of scrap on hand with perpetual invento-
ry records ts intended to verify only the accuracy of the rec-
ords.
7 To obtain- evidence as to the reasonableness and complete-

9. b I
ness of inventory. a ances, auditors often perform analytical
procedures. Which of the following quantitative relation-
ships is.not applicable to inventory balances?
A. Number of days' sales in inventory
B. D~bt-to-equity ratio
c. The gross profit percentage
D. Inventory turnover ratios
The debt-to-equity ratio is calculated by dividing total debt

by total equity. It is a measure of leverage and relates to
corporate financing, not inventory.
Answers A, C, and D are incorrect because the gross profit

percentage (gross profit+ net sales), the inventory turnover
ratio (cost of goods sold+ average inventory), and the num-
ber of days' sales in inventory (360 + inventory turnover)
are quantitative relationships applicable to invei;itory bal-
ances. ·
98. An auditor concluded that no excessive costs for an idle

plant were charged to inventory. This conclusion most likely
related to the auditor's objective to obtain evidence about
the financial statement assertions regarding inventory, in-
cluding presentation and disclosure and
A. Valuation and allocation
·~ ~ • ::±"- ·P··-~ --·
- ........
rt:
-- . . - ....... . . .p_
f ..
\,- • .·-' ..:.:..-. _ _,.
--..··- · '~-.
'-" C o~: c~..._ ..... .'~·;_"": ~'
f; '~~~~~
_...... . . . . . . . . . . . . .
, . , . . . . . . . . . . . . . . . . . . . . .1111111. . . . . . . . . . . . . . . . .__
~
B. Completeness
C. Rights and obligations
D. Existence
The cost of inventory includes the cost of raw materials

used and the conversion costs-namely, direct labor and
factory overhead. To achieve proper valuation of inventory,
factory- overhead should not include the costs of an idle
plant.
Answers B, C, and Dare incorrect because the auditor's con·

clusion that no excessive costs for an idle plant were
charged to inventory does not affect the completeness,
rights and obligations, and existence assertions.
99. An auditor's attendance at· the physical inventory at the cli·

ent's main plant at year-end provides direct evidence to
support which of the following objectives?
A.. Accuracy of the priced-out inventory.
B. Determination of goods in the hands of consignees.
C. Evaluation of lower of cost or net realizable value t~st. to
D. Identification of obsolete or damaged merchandise
evaluate allowance (reserve) for obsolescence.
The auditor's observation of the physical inventory cou;~

provides evidence about the physical existence and coner·
tion of the client's inventory. Damaged or ob.sol:te :Ser·
chandise that may be discovered during the auditors°. n of
vation of the physical count will affect his/her evaluatJO
the allowance (reserve) for obsolescence.
. 's attend·
Answers A and Care incorrect because the auditor torY's
ance at the physical inventory count verifies the inven
523
1 AUdrt. Obi·ectives ' Procedures, Evidence, and Documentation
cWip'fBR
. existence and condition, not the accuracy of price
phys1ca 1
or cost.
r B is incorrect because the auditor's observation of
Ans~~ nt's physical inventory at the main plant does not
the ~diee evidence of the existence of inventories in the
Pro vi . of consignees.
.
haO ds
audit of year-end physical inventories should include
100· ~~s to verify that the client's purchases and sales cutoffs
5
ere adequate. The audit steps should be designed to de-
~~ whether merchandise included in the physical count at
year-end was not ;-ecorde~ as a
A. sale in the current penod.
a. Purchase in the current period.
c. Sale in the subsequent period.
o. Purchase return in the subsequent period.
The physical count of goods should not include those that

have been sold during the current period.
Answers 8, C, and D are incorrect because goods purchased

in the current period, unsold goods at year-end, and unre-
turned goods are owned by the client and should be includ-
ed in the physical count.
101. PSA 501 states that when inventory is material to the finan-
cial statements, the auditor should obtain sufficient appro-
priate audit evidence regarding its existence and condition
by attendance at physical inventory counting unless imprac-
ticable. Which of the following statements concerning this
audit procedure is incorrect?
A. Regardless of the inventory system operated by the cli-
ent, an annual physical count must be made of each
item in the inventory, and test counts must be made by

the auditor.
B. Inventories located in public warehouses may be verified
by direct confirmation in writing from the custodians,
provided that, depending on the materiality of these in-
ventories, additional procedures are applied as deemed
necessary.
C. When the well-kept perpetual inventory records are
checked by the client periodically by comparisons with
physical counts, the auditor's observation procedures
usually can be performed either during or after the end
of the period under audit.
D. The independent auditor, when asked to audit financial
statements covering the current period and one or more
periods for which he/she had not observed or made
some physical counts, may be able to become satisfied
as to such prior inventories through appropriate alterna·
tive procedures. ·
An annual physical count of inventory may be unnecessary

if the client maintains perpetual inventory records that are
periodically compared with physical counts during the year.
'de5
102. Which of the following audit procedures probably prov~on
the most reliable evidence concerning the entity's asse
of rights and obligations related to inventories? . t corn·
A. Inspect the open purchase order file for sign1fican
mitments that should be considered for disclosu~e· 1 count
B. Trace test counts noted during the entity's physica
to the entity's summarization of quantities. . ventorY
C. Inspect agreements to determine whether anY in
is pledged as collateral or subject to any liens. fore we
D. Selec:t the last few shipping advices used b:hiP111e~ts
physical count and determine whether the
were recorded as sales.
1 AUdit Objectives, Proce?ures, Evidence, and Documentation 525
ctil\pf~R
erifying the assertion of rights and obligations for inven-

Jn ~ 5 the auditor determines if the client has legal title or
tone , .
. Har rights of ownership to the inventories. Audit evi-
sirn ce concerning this assertion can be obtained by examin-
den d , . . . d
ing paid ven ors invoices, consignment agreements, an
Joan contracts.
Answer A is incorrect because determining whether signifi-

ant commitments should be disclosed relates to the
~resentation and disclosure assertion.
Answers Band Dare incorrect because the audit procedures
described deal with the completeness assertion.
103 . After accounting for a sequence of inventory tags, an auditor

traces a sample of tags to the physical inventory listing to
obtain evidence that all items
A. Represented by inventory tags are included in the listing.
s. Represented by inventory tags are bona fide.
c. Included in the listing have been counted.
o. Included in the listing are represented by inventory tags.
The auditor's purpose in tracing a sample of inventory tags
to the physical inventory listing is to verify the complete-
ness assertion-that all items represented by inventory tags
are included in the listing.
Answer B is incorrect because the validity of the inventory

tags can b.e verified by examining the inventory itself.
Answers C and D are incorrect because to obtain evidence

that all items included in the listing have been counted and
are represented by inventory tags, the direction of testing
should be from the inventory listing to the inventory tags.
'
1 i
. 9'
__.#
104. When outside firms of nonaccountants specializing in the

taking of physical inventories are used to count, list, price,
and subsequently compute the total peso amount of inven-
tory on hand at the date of the physical count, the auditor
will ordinarily
A. Consider the reduced audit effort with respect to the
physical count of inventory as a scope limitation.
a. Make or observe some physical counts of the inventory,
recompute certain inventory calculations, and test cer-
tain inventory transactions.
C. Consider the report of the outside inventory-taking firm
to be an acceptable alternative procedure to the obser-
vation of physical inventories.
D. ~ot reduce the extent of work on the physical count of
inventory.
The use of experts to count the client's inventory may re·

~uce the extent of other audit procedures on inventory, but
is 0 ?t a substitute for the auditor's observation of the physi·
cal inventory count. The auditor should still perform sorne
test counts recomp t · · d
t . '. u e certam inventory calculations, an
est certain inventory transactions.
Answer A· ·
respect to ~~~ncorr~ct because the reduced audit effort with
the die t . ~hysical count is not a scope limitation unless
n 1 estncts the aud 1·t • · va·
tion and review of h . ors involvement in the obser
t e inventory count.
Answer c is· incorrect
· b y
reduce the ext ecause using the expert's work rna
considef\ed an ent of the auditor's work but it cannot b~
physical inventoac~eptable alternative to ~he observation o
nes. ·
fER 7 AUdit Objectives, Procedures', Eviden~e, and Documentation 527
cf'lAP
Answer D is incorre~t because the auditor may decide to re-
duce the extent of h~s/her work on the invP.ntory after mak-
ing a proper evaluation of the expert's work.
periodic or cycle counts of selected inventory items are

105. rnade at va.n.ous t"1mes dunng
. the year rather than a single
inventory count ~t year-end. Which of the following is nec-
essary if the auditor plans to observe inventories at interim
dates?
A. Inventory balances are rarely at low levels.
a. complete recounts by independent teams are performed.
c. perpetual inventory records are maintained.
D. Unit cost records are integrated with production account-
ing records.
When an entity maintains a perpetual inventory system and

its well-kept perpetual inventory records are periodically
compared with physical counts during the year, the audi-
tor's observation procedures usually can be performed ei-
ther during or after the end of the current period.
Answer A is incorrect because it is easier to conduct a physi-

cal inventory count when inventory balances are at low lev-
els.
Answer B is incorrect because complete recounts of inven-
tory by independent teams may be necessary only in rare
circumstances.
Answer D is incorrect because integrating unit cost records
with production accounting records is not a necessary con-
dition for observing physical count of inventories at interim
dates.
: .... ...
.....
106. Purchase cutoff procedures should be designed to test

whether all inventory
A. Purchased and received before year-end was paid for.
B. Purchased and received before year-end was recorded.
C. Owned by the company is in the possession of the com·
pany at year-end.
D. Ordered before year-end was received.
A purchase cutoff tests the completeness assertion about in·

ventories. This substantive procedure is performed primar-
ily to obtain evidence that all goods owned by the client at
the balance sheet date are included in inventory and that
the related liability is properly recognized. For goods in
transit, ownership is determined by reference to the ship-
ping terms-FOB shipping point or FOB destination.
Answer A is incorrect because goods owned by the client are

included in inventory even if not yet paid for.
Answer C is incorrect because goods owned by the company

may not be in its possession such as goods shipped out on
consignment.
Answer D is. incorrect

. because the client does no t have title
yet to goods on order.
· the
107. Which of the following is the best audit test to evaluate ·na
1
accuracy of the inventory records for materials inventorY
production operation? f 5e-
A. Reconc.ile quan.tities on hand per physical countsd ~erifY
lected items with perpetual inventory records an
pricing. nto~
I 1·nve
B. Trace selected inventory receipts to perpetua
records.
1 AUdil Objectives, Procedures, Evidence, and Documentation 529
cHApfER
vouch selected postings in the perpetual inventory rec-

c. ords to source documents.
o. perform turnover tests for materials inventory.
To verify the accuracy of the matP.rials inventory records,
the auditor should observe the physical count, reconcile
uantities on hand per count with inventory records, and
q . .
verify pncmg.
Answers B and C are incorrect because observation of the

physical inventory count provides more reliable evidence
than the procedures described.
Answer Dis incorrect because performing turnover tests for

materials inventory does not provide direct evidence about
the accuracy of inventory records.
l08. An auditor is most likely to learn of slow-moving inv.entory

through
A. Inquiry of sales personnel.
B. Inquiry of warehouse personnel.
c. Review of perpetual inventory records.
D. Physical observation of inventory.
The perpetual inventory records are designed to provide in-

formation about: the date, quantity, and price of inventory
receipts and issuances. The auditor can easily identify slow-
moving items-and possibly obsolete inventories-by com-
paring the date of inventory receipt and issuance.
Answers A and B are incorrect because inquiries provide

less reliable evidence than a review of perpetual inventory
records.
Answer D is incorrect because physical observation of in-

ventory will reveal slow-moving items if the condition of the
inventory suggests the length of time it is being stored in the
warehouse.
109. The physical count of inventory of a retailer was higher than

shown by the perpetual records. Which of the following
could explain the difference?
A. Inventory items had been counted but the tags placed
on the items had not been taken off the items and added
to the inventory accumulation sheets.
B. An item purchased "FOB shipping point" had not arrived
yet at the date of the inventory count and had not been
reflected in the perpetual records.
C. Credit memos for several items returned by customers
had not been recorded.
D. No journal entry had been made on the retailer's boOkS
for severril items returned to its suppliers.
Items returned by customers for which credit memo~ h~~:

not been prepared and recorded will be reflected m ry
physical inventory count but not in the perpetual invento
records.
·n be un·
Answer A is incorrect because the physical count ~ 1 torY
derstated if items counted are not added to the inven
accumulation sheets.
t and
Answer B is incorrect because both the physical _cot~ iteJll
perpetual inventory records will be understated ifth count
purchased "FOB shipping point" has not arrived at erd>
date and no entry has been made in the perpetua1reco
ctiAPTER 1 Aud l Objectives, Procedures, E idence. and Documentalion 5 .3 1
Answer D is incorrect because the perpetual inventory rec-

ords will be overstated if no entry has been made for items
returned to suppliers.
110. Which of the following audit procedures most likely would

provide assurance about a manufacturing entity's inventory
valuation?
A. Tracing test counts to the entity's inventory listing.
s. Reviewing shipping and receiving cutoff procedures for
inventories.
c. Obtaining confirmation of inventories pledged under loan
agreements.
D. Testing the entity's computation of standard overhead
rates.
Valuation and allocation is a management assertion that the

entity's assets, liabilities, and equity interests are reported
in the financial statements at appropriate amounts and any
resulting valuation or allocation adjustments are appropri-
ately recorded.
By testing the entity's computation of standard overhead

rates, the auditor will be able to obtain evidence that the in-
ventory has been included in the financial statements at the
appropriate amount
Answers A and 8 are incorrect because the procedures de-

scribed relate more directly to the completeness and exist-
ence assertions.
Answer C is incorrect because obtaining confirmation of in-

ventories pledged under loan agreements relates more di-
rectly to the presentation and disclosure assertion.
---------------:i
532
CPA EXAMINATION REVIEWER: AUDLTING THEORY
INVESTING CYCLE
111. W~ich. of t_he foll_ow_ing is not one of the auditor's primary

ob]ect1ves m an audit of trading securities?
A. To determine whether securities are authentic.
B. To determine whether securities actually exist.
C. To determine whether securities are the property of the
client.
D. To determine whether securities are properly classified
on the balance sheet. '
An audit rarely involves the authentication of documenta-

tion, nor is the auditor trained as, or expected to be, an ex-
pert in such authentication. Hence, the auditor should con-
sider engaging an expert if forgery i~ suspected.
The primary objectives in auditing investments (induding

trading securities) and the related investment income are to
determine that:
• Investments exist (held by the entity or by custodi-
ans for the entity) and are owned by the entity.
accrued
• All recorded income from investments has me
t All inco
to the entity at the balance sheet d a e. t date
from investments earned as of the balance shee
has been recorded. e
_. the balanc
• All investments owned by the entity at
sheet date are included on the balance sheet. .
heet at aP
• Investments are included on the balance s t incoroe
l d · vestmen ri·
propriate amounts: The re ate m t the approP
is reported on the mcome statement a
ate amount.
rER 7 Audit Objectives, Procedures, Evidence, and Documentation
ctiAP 533
• All investments are free of liens pledg h

. . , es, or ot er se-
curity interests. If not such liens pl d h
. . ' , e ges, or ot er
security interests are properly identified and dis-
closed.
• Investments a.nd related income accounts are

properly classified, described, and disclosed in the
financial statements in conformity with PFRS.
Answers B, C, and D are incorrect because they describe the

auditor's primary objectives in auditing trading securities.
112. A company ~akes a ~~actice of investing excess short-term

cash in trading securities that are traded regularly on the
Philippine Stock Exchange (PSE). A reliable test of the valu-
ation pf those securities is
A. Calculation of premium or discount amortization.
B. Confirmation of securities held by the broker.
c. Consideration of current market quotations.
D. Recalculation of investment value using a valuation mod-
el.
Trading securities are reported on the balance sheet at fair

value. The auditor tests the valuation of trading securities
that are traded regularly on the PSE by reference to market
quotations.
Answer A is incorrect because no amortization of premium

or discount is recorded for trading securities.
Answer B is incorrect because confirmation with brokers

addresses the existence and rights and obligations asser-
tions, not the valuation of securities.
Answer D is incorrect because the use of valuation models

may be appropriate for certain securities only when no
quoted market prices exist.
113. Which of the following is the most effective audit procedure

for verification of dividends earned on investments ir. equity
securities?
A. Reconciling amounts received with published dividend
records.
B. Recomputing selected extensions and footings of divi-
dend schedules and comparing totals to the general
ledger.
C. Comparing dividends received in the current year with
that of the preceding year.
D. Tracing deposited dividend checks to the cash receipts
book. ·
The best audit procedure to verify dividends earned is by

performing an independent recomputation of the reported
income based on published dividend records.
Answer B is incorrect because recomputing selected exten·

sions and footings of dividend schedules and comparing to·
tals to the general ledger will provide evidence about the
arithmetic accuracy of the records, not the validity of the
dividends recorded.
Answer C is incorrect because it may not be useful to corn·

pare the amounts of dividends received since dividends rnaY
vary from period to period.
Answer D is incorrect because tracing deposited di~id~~

checks to the cash receipts book does r.ot provide evide
about whether all dividend checks were deposited.
Ai.Jdit Objectives. Procedures Eviu n ~. nd DJCumen tation 535
ct#'rt:R
1
ich of the follow~ng audit proce~~res would give the least
114· Wh ance of the existence of secunt1es held by the entity?
ass~onfirmation from the custodian.
A. Simultaneous count of liq~id assets.
6· vouching all changes during the year to supporting doc-
c. umentat'ion.
Examination of paid checks issued in payment of securi-
0
. ties purchased.
amination of paid checks in payment for securi ties pur-

Ex ..
hased does not provide ass ura nce tha t at the balance sheet
~ate, the securities exis t zrn d are still ow ned by the e ntity.
Answers A, B, and C a re incorrect because the procedures
described provide assurance about the existence of the
company's securities.
115. In confirming with an outside agent, such as a financial insti-

tution, that the agent is holding investment securities in the
client's name, an auditor most likely gathers evidence in
support of management's financial statement assertions of
existence and
A. Rights and obligations
B. Completeness
C. Presentation and disclosure
Because the issue is whether the custodia n is holding in-

vestment securities in the cli ent's na me, confirmation with
the custodian will most likely provide evidence about the
existence assertion (i.e., wheth er th e securities exist at a
given date) and the rights assertion (i.e., whether the entity
has an ownership interest in the securities) .
Answers B, C, and D are incorrect because confirming that

the agent is holding securities in the client's name does not
adequately address the completeness; presentation and dis-
closure; and valuation and allocation assertions.
116. In establishing the existence and ownership of an invest-

ment held by a corporation in the form of publicly traded
stock, an auditor should inspect the securities or
A. Determine that the investment is carried at the lower of
cost or market.
B. Confirm the number of shares owned that are held by an
independent custodian.
C. Inspect the audited financial statements of the investee
company.
D. Obtain written representations from management con-
firming that the securities are properly classified as trad-
ing securities.
For those securities that are held by an independent cust~

dian, testing the existence assertion and the rights and obh·
gations assertion should include confirmation with the cus·
todian of the number of shares owned by the client.
Answ_er A is incorrect because determining the appropriate

carrymg value of the investment is more directly related to
the valuation and allocation assertion. Moreover, invest·
men ts in trading securities should be carried at fair value.
~nswer C is incorrect because inspecting the audited fin~n~

cial statem~nts of the inv~stee company tests the vaJuatiod
and a~locat1on assertion for investments that are accounte
for using the equity method.
\

cHAprER
Answer Dis incorrect because obtaining written representa-

tions from ma nagement that the investments are properly
classified addresses the presentation and disclosure asser-
tion.
The auditor is making an assessment as to whether the cli-

7
11 · ent has adopted the appropriate accounting policy for its in-
vestment in the voting stock of the investee. The auditor
should obtain evidence primarily by
A. Inquiries to the client as to whether the client has the
ability to exercise significant influence over the financial
and operating policy decisions of the investee.
B. Direct confirmation with the investee about the control
or influence that can be exercised by the client.
c. An independent, third party's opinion concerning the po-
tential influence or control that can be exercised by the
client over the investee.
D. Comparison of the number of shares held by the investor
with the investee's number of shares outstanding ac-
cording to the written confirmation.
The auditor should inquire of the client's management con-

cerning the client's ability to exercise significant influence
over the investee's financial and operating policy decisions.
lf the client can demonstrate that it has the ability to exer-

cise significant influence over the investee, the appropriate
accounting policy is the equity accounting method.
According to PAS 28 (Investments in Associates), if the in-

vestor holds, directly or indirectly through subsidiaries,
20% or more of the voting power of the investee, it is pre-
sumed that the investor has significant influence, unless it
can be clearly demonstrated that this is not the. case. Con-
CPA EXAMlfVATION REVIEWER: AUDITING THEORY
538
versely, if the investor holds, directly or indirectly through

subsidiaries, less than 20% of the voting power of the inves-
tee, it is presumed that the investor does not have signifi-
cant influence, unless such influence can be clearly demon-
strated.
The existence of significant influence by an investor is usual-

ly evidenced in one or more of the following ways:
Representation in the board of directors or equiva-
• lent governing body of the investee.
Participation in policy-making processes, including
• participation in decisions about dividends or other
distributions.
Material transactions between the investor and the
•
investee.
• Interchange of managerial personnel.
Provision of essential technical information .
•
· · hould be
Answers B and C are incorrect because inquiry s d t
made of the client, not of the investee or an indepen ell
third party.
de·
Answer D is incorrect because significant influenc~ ma~ilitY
pend more on the entity's ability to demonstrate its a
to exercise significant influence over the investee.
f evidence
0
118. Which of the following provides the best form . which
pertaining to the annual valuation of an investment in
the client owns a 30% voting interest?
A. Historical cost of the investee company's assets. anY·
B. Audited financial statements of the .investee's con1Pts
asse ·
C. Current fair value of the investee company 5 stOck .
I
D. Market quotations of the investee cornpanY

''
7 Audit Objectives, Procedures. E,vidence, and Documentation 539

cf'l.ApfER
n be presumed that the entity has significant influence

It ca the investee because of its 30% voting interest This
overuires the use o f t h e equity
.
accounting method for its in-
re;tn1ent. Under this method, the investor recognizes its
v~ re in the investee's profit as a debit to investment and a
5
adi't to income. Dividends decrease the investment bal-
cre
anee.
In verifying if the investment is carried at the appropriate
amount (valuation), the audited financial statements of the
investee company are usually considered to provide suffi-
cient evidence about the investor's equity.
Answer A is incorrect because an investment accounted for

using the equity method is not carried at historical cost.
Answer C is incorrect because the relevant valuation is of

the equity in net assets and fina1:1cial performance of the in-
vestee.
Answer D is incorrect because, under the equity method, the

investment is not carried at the fair value of the securities at
each financial year-end.
1.li9. An auditor is most likely to verify the interest earned on

bond investments by
A. Verifying the receipt and deposit of interest checks.
B. Testing controls relevant to cash receipts.
C. Recomputing the interest earned on the basis of face
amount, interest ~ate, and period held.
D. Confirming the bond interest rate with the issuer of the
bonds.
The auditor should recompute the interest earned on bond

investments on the basis of the information appearing on
the bond certificate such as face amount, issue date, interest
rate, and payment dates.
Answer A is incorrect because verifying the receipt and de·

posit of interest checks does not consider accrued interest
(interest earned but is not yet collected) as of the balance
sheet date.
Answer B is incorrect because the auditor should perform

substantive procedures, not tests of controls. to verify inter·
est earned.
Answer D is incorrect because confirming the bond interest

rate is not, in itself, an adequate audit procedure to substan·
tiate the amount of interest earned.
120. The auditor can best verify a client's bond sinking fund
transactions and year-end balance by
A. Confirmation with the bond trustee.
5
B. Confirmation with individual holders of retired bon? · the
C. Examination and count of the bonds retired during
year. bl and
D. Recomputation of interest expense, interest paya e,
amortization of bond discount or premium.
f an inde·
If the bond sinking fund is under the custody 0 . and
005
pendent bond trustee .. the sinking fund tran~act:hiS trus·
year-end balance can be confirmed directly with
tee.
Audit Objectives, Procedures, Evidence, and Documentation 54 1
cHAprER
1
C and D are incorrect because the procedures
we rs B' ' .
Ans ··bed do not directly relate to the verification of bond
d.esCI I . d
k' g fund transactions an year-end balance.
sin in
the audit of property, plant, and equipment, the auditor.
121· 1 ~ to do all of the following except to
triesAssess the adequacy of rep 1acement funds.
A. Obtain an understanding of internal control.
~: Determine the extent of property abandoned during the
year.
Judge the reasonableness of the depreciation.
D.
The auditor is not required to assess the adequacy of the cli-
ent's replacement funds. A financial statement audit does
not include evaluation of the soundness of the client's busi-
ness practices or financial prospects.
Answer Bis incorrect because the standards require the au-

ditor to obtain an und~rstanding of the entity and its envi-
ronment, including its internal control, sufficient to identify
and assess the risks of material misstatement of the finan-
cial statements.
Answer C is incorrect because the auditor should determine

if abandoned properties were properly recorded to detect
possible misstatement of assets.
Answer D is incorrect because depreciation affects both the

valu.ation and allocation assertion concerning property,
plant, and equipment and the determination of profit or loss
for the period.
-
122. Which of the following combinations of procedures is an au-

ditor most likely to perform to obtain evidence about fixed
asset additions?
A. Confirming ownership and corroborating transactions
through inquiries of client personnel.
B. Inspectihg do.cuments and physically examining assets.
C. Recomputing calculations and obtaining written man-
agement representations.
D. Observing operating activities and comparing balances to _
prior period balances.
The auditor's physical examination of fixed assets may re-

veal that additions have been made. These are traced to the
accounting records to determine if they have been properly
recorded. Moreover, inspection of documents such as in·
voices, canceled checks, deeds, and lease agreements may
also reveal fixed asset additions.
Answer A is incorrect because confirmation of owners~i~

and corroboration of transactions are considered only~ ~s
the auditor has become aware that fixed asset additIO
have been made by the client.
· · s base d on
Answer C is incorrect because recomputat10n d asset
recorded amounts will not disclose unrecorded fixe
additions.
- to prI·or
Answer D is incorrect because comparing balancesd out bY
period balances may not reveal additions cancele
disposals.
. the folio
W'
123. If an auditor tours a production facility, wh1c_h of t liKelY to
ing misstatements or questionable practices is rnos
be detected by the audit procedure specified?
fER 7 AUdit Objectives, Procedures, Evidence, and Documentation 543
C~p
A. oepreciation_ expense on fully depreciated machinery has

been recognized.
B. Insurance cf.o~e_ rage on the facility has lapsed.
1
C. Necessary ac11ty maintenance has not been performed.
D. overhead has been overapplied.
An auditor's tour of the client's facility and physical exami-

nation of the asset condition may reveal that necessary facil -
ity maintenance has not been performed.
Answer A is incorrect because the auditor should examine

depreciation records to determine if depreciation has been
recorded on fully dep r eciated machinery.
Answer B is incorrect because the auditor should inspect

the insurance contra ct to determine if the insurance cover-
age on the facility has lapsed.
Answer D is incorrect because the auditor should compare

actual overhead incurred with overhead applied to deter-
mine whether overhead was overapplied.
124. An auditor analyzes repairs and maintenance accounts pri-

marily to obtain evidence in support of the audit assertion
that all
A. Expenditures for property and equipment have been rec-
ordec;f in the proper period.
B. Expenditures for property and equipment have not been
charged to expense.
C. Noncapitalizable expenditures for repairs and mainte-
nance have been recorded in the proper period.
D. Noncapitalizable expenditures for ~epairs and mainte-
nance have been properly charged to expense.
Vouching signlficant debits to repairs and maintenance may

reveal expenditures that should have been capitalized.
Answer A is incorrect because the analysis of repairs and

maintenance accounts does hot provide evidence about the
cutoff of expenditures.for property and equipment.
Answer C is incorrect because the auditor does not consider

an improper cutoff of repairs and maintenance expenses to
be a major risk.
Answer D is incorrect because the auditor should vouch ad·

ditions to property, plant, and equipment to determine if
noncapitalizable expenditures have been erroneously capi-
talized.
125. Determining that proper amounts of depreciation are ex·

pensed provides assurance about management's assertions
of valuation and allocation and
A. Presentation and disclosure
B. Existence
C. Completeness
D· Rights and obligations
The presentation and disclosure assertion address~

whether particular financial statement items are dassifiel'
~escribed, and disclosed in accordance with the applicab e
financial reporting framework.
If ex nt bY
~enses are to be reported in the income staterne . te
function th d' ropna
' e au 1tor should determine if apP JeS,
a~l~unts of depreciation have been inducted in cost of sa
se mg expenses, and administrative expenses.
...cR 1 AUdit Objectives, Procedures, Evidence · and 0ocumentation
cHAP'.. 5 45
.Answers 8, C, and D are incorrect because de . .

proper amounts of depreciation have b termmmg that
to the valuation
. and allocation and pr esen
eentexpens.ed relates
at1on and disclo-
sure asser t 10ns.
. The auditor is le~st likely to learn of retirements of e ui _

126 ent through which of the following? q P
111
A. Review of depreciation.·
B. Analysis of the debits to accumulated depreciation ac-
count.
c. Review of insurance policy riders.
o. Review of the purchase returns and allowances account.
The purchase returns and allowances account is used to

record returns of goods purchased by the company. Thus, a
review of this account does not provide any form of evi-
dence about equipment retirements.
Answers A, B, and C are incorrect because the procedures

described may reveal retirements of equipment.
127. One audit procedure for an audit of facilities and equipment

is to test the accuracy of recorded depreciation. Which of
the following is the best source of evidence that the equip-
ment in question is in service?
A. A review of inventory documentation for the equipment.
B. A comparison of depreciation schedules with the mainte-
nance and repair logs for the same equipment.
C. A comparison of depreciation schedules with a listing of
insurance appraisals for the same equipment.
D. A review of depreciation policies and procedures.
The best evidence is. the auditor's direct observation of the

facilities and equipment but it is not one of. the possib~e ~n
swers. The audito,r may consider companng deprec1at10n
~.
---·
546 CPA EXAM/NATION REVIEWER: AUDITING THEORY
schedules. with the maintenance and repair logs for the

same eqmpment. Equipment that exists and in use would
more likely require periodic maintenance than retired
equipment.
Answer A is incorrect because the inventory documentation

for the equipment may still include retired equipment.
Answer C is incorrect because retired equipment could still

be insured.
Answer D is incorrect the entity's depreciation policies and

procedures offer no information about the existence of its
assets.
128. An entity has leased an asset and appropriately recorded a

finance lease because of the existence of a bargain purchase
option. The auditor should determine nt
A. Whether the interest rate used in computing .the presete
value of the minimum lease payments is the interest ra
implicit in the lease. 0
f the
B. That the cost recorded by the entity is the cost
property to the lessor. . . . over the
C. That the leased property 1s being depreciated
lease term. ts equals
D. Whether the sum of the minimum lease paymen
the fair value of the property.
of
t the su 111 .
The lessee should capitalize the leased asset a r the fair
the present value of the minimum lease paymentsh~chever i5
value of the asset at the inceptjon of the lease, w
lower.
~pf€R
1
lculating the present value of the minimum lease pay-
In c~s the lessee should use the interest ·rate implicit in the
men
1ease,
lfthis is practicable to determine. Otherwise the les-
. ,
see's incremental borrowing rate should be used.
Answer B is incorrect because the lessee should capitalize

the leased asset at the sum of ~he present value of the mini-
urn lease payments or the fair value of the asset at the in-
~:ption of the lease, whichever is lower.
Answer C is incorrect because the leased asset should be
depreciated over the useful life of the asset since there is a
bargain purchase option.
· Answer D is incorrect because the sum of the minimum

lease payments (undiscounted) includes both the cost of the
asset and interest expense.
129. In violation of a company policy, Victoria Company errone-

ously capitalized the cost of painting its warehouse. The
auditor examining Victoria's financial statements will most
likely detect this misstatement when
A. Observing, during the physical inventory observation,
. that the warehouse had been painted.
B. Examining the construction work orders supporting items
capitalized during the year.
C. Examining maintenance expense accounts.
D. Discussing capitalization policies with Victoria's controller.
The audit of property, plant, and equipment (PPE) includes

vouching of PPE additions to source documents such as con-
struction work orders, vendors' invoices, deeds, etc. Thus,
examining construction work orders supporting items capi-
·-
talized during the year may reveal that an expense had been
erroneously capitalized.
Answer A is incorrect because the auditor will not detect the

erroneous capitalization of the painting cost by just observ-
ing the painted warehouse.
·Answer C is incorrect because expenses incorrectly capital-

ized will not be reflected in. the maintenance expense ac·
counts.
Answer Dis incorrect because the auditor will not detect the
misstatement by merely discussing the company's capitali-
zation policies with the company's controller.
FINANCING CYCLE
130. During an audit of a publicly held company, the audito~

should obtain written confirmation regarding debentur
transactions from the
A. Trustee
B. Client's attorney
C. Debenture holders
D. Internal auditors
I securitY·
Debentures are bonds issued without collatera fan
Normally, the issuing company engages the servicesd ~rus·
independent financial institution as trustee. The boO J11ent5
tee is typically responsible for making interest paY ditor
· . The au
an d protectmg the interests of the bondholders. h con·
obtains evidence about debenture transactions throug
firmation with the bond trustee.
ctW'rfR
wer B is incorrect because the client's attorney does not
Ans . .b t h ,
have informatwn a ou t e company s debenture transac-
tions.
Answer C is incorrect because confirmation with debenture

holders is unnecessary when the company employs the ser-
vices of an independent trustee.
Answer D is incorrect because internal auditors are not in-

dependent of the issuing company and do not have
knowledge about debenture transaction details.
131. A bond trust indenture is the contractual agreement be-

tween the bondholders and the issuing company. In an au-
dit of bonds payable, an auditor expects the trust indenture
to include the
A. Subscription list.
B. Description of the collateral.
c. Effective yield of the bonds issued.
o. Issuing company's debt-to-equity ratio at the time of is-
suance.
A bond trust indenture usually contains the following in-

formation:
• Date of issue
• Maturity date
• Face value of the bonds
• Interest rates and payment dates
• Descriptions of collateral
• Provisions for conversion or retirement
• Duties of the bond trustee
• Bond sinking fund requirements
• Restrictions on the issuing company (borrower)
--
Answers A, C, and Dare incorrect·because the subscription

list, effective yield, and current financial ratios such as debt-
to-equity ratio are not included in the trust indenture.
132. An auditor's program to audit long-term debt should include

steps that require
A. Verifying the existence of the bondholders.
B. Inspecting the accounts payable subsidiary ledger.
C. Investigating credits to the bond interest income ac-
count.
D. Examining bond trust indentures.
A bond trust indenture is the contractual agreement be·

tween the bondholders and the issuing company. The audi·
tor should examine any bond trust indenture to obtain evi·
dence about the issuing company's compliance with its pro·
visions.
Answer A is incorrect because the company's reporting of

the bonds payable implies the existence of bondholders.
Answer B is incorrect because accounts payable are clas~~

f~ed as current liabilities, not long-term (noncurrent) .liabih·
ties.
Answ er c ·is-·mcorrect because .interest income

. re lat es to in·
vestments.
1 ing long-term bonds payable an auditor most likelY

:t33. In au d't·
Will I
A· y~
Confirm the existence of individual bondholders at
end. ~
B p rf · /Tl a"
· ~ orm analytical procedures on the bond premiu
. discount accounts.
fER 7 Audit Objectives, Procedures, Evidence, and Documentation 551
ctiAP
c. compare interest expense with the bond payable amount

for reasonableness.
o. Examine doc~mentation of assets purchased with bond
proceeds for liens.
In auditing bonds payable, an auditor usually reconciles the

recorded interest expense with the outstanding bonds pay-
able. This procedure may reveal unrecorded liabilities if the
recorded interest expense appears excessive in relation to
the recorded bonds payable.
Answer A is incorrect because the auditor's primary focus in

the audit of liabilities such as long-term bonds payable is on
determining the completeness of the account balance. Con-
·firmation .of the existence of individual bondholders at year-
end do.e s not necessarily provide evidence that the bonds
payable balance is complete.
Answer B is incorrect because performing anaiytical proce-

dures on the bond premium and discount accounts may not
be effective in detecting possible unrecorded payables.
Answer D is incorrect because examining documentation of

assets purchased is performed in the audit of assets, not
bonds payable.
134. An auditor's purpose in reviewing the renewal of a note pay-

able shortly after the balance sheet date most likely is to ob-
tain evidence· concerning management's assertion about
A. Existence
B. Presentation and disclosure
C. Completeness
552 CfA EXAMINATION REVIEWER: AUDITING THEORY
Events after the balance sheet date (also called subsequent

events) are those events occurring after the end of the re-
porting period but before the financial statements are au-
thorized for issue. These events provide information about
conditions that existed as at, or subsequent to, the balance
sheet date.
The renewal of a note payable shortly after the balance

sheet date, a ,subsequent event of the second type, does not
require adjustment of the financial statements but may re·
quire disclosure.
Answers A, C, and D are incorrect because the renewal of a

note payable subsequent to the balance sheet date does not
have a significant effect on the existence, completeness, and
valuation and allocation assertions.
135. In the audit of a medium-sized manufacturing concern,

which one of the following areas can be expected to require
the least amount of audit time?
A. Revenue
B. Assets
C. Liabilities
D. Shareholders' equity
Shareholders' equity transactions typically involve stock.i~

suances, ac.quisitions and sales of treasury stock, a~d di:~
1
1
d.en~~· These transactions are usually few but may 1 ~vo ui·
significant amounts. Hence the audit of shareholders eq
ty · ' hose
requires a small amount of a udit time compared t~ t
accounts that are affected by high volumes of transacuons.
Audit Objectives, Procedures, Evidence, and Documentation 553
~~f\
1
rs A, 8, and Care incorrect because the audit of reve-
p.nswessets, an d 1·ia b·1· · ·11 d. ·
l it1es w1 or manly require more audit
nue, a
tiJtle·
n audit of shareholders' equity, an auditor is most con-
136· ~r~ed that . .
Share capital transactions are properly authorized.
~: All changes in t~e shareholders' equity accounts are
monitored by an independent transfer agent and regis-
trar.
C. Share splits are charged to retained earnings at par or
stated value.
o. Dividends declared during the year were approved by
the shareholders.
Because share capital transactions are usually significant in

amount, the auditor's primary concern is that all share capi-
tal transactions are properly authorized. Accordingly, the
auditor vouches all entries in the share capital account to
the minutes of the board of directors' meetings. Moreover,
the auditor also reviews the company's articles of incorpo-
ration, by-laws, and minutes of shareholders' meetings.
Answer B is incorrect because the stock registrar and trans-

fer agent is not responsible for monitoring all changes in the
equity accounts.
Answer C is incorrect because share splits do not affect any

equity element and are not formally recorded on company
books.
Answer D is incorrect because dividends are usually ap-

proved by the company's board of directors.
-
137. Which of the following transactions would not require a deb-

it to retained earnings?
A. An appropriation of retained earnings for treasury
shares.
B. A 5% st'.ock dividend.
C. A two-for-one share split.
D. A 25% stock dividend.
A share split increases the number of shares with a propor-

tionate decrease in the par or stated value per share. No
journal entry is prepared for a share split because it does
not affect the company's assets, liabilities, and equity ele·
ments. However, a memorandum entry is made to indicate
the change in the number of shares and the par or stated
value per share.
Answers A, B, and D are incorrect because the entry to rec•

or.d ~stock dividend or an appropriation for treasury sha~e.s
will mclude a debit to retained earnings. A small stock dwi·
dend (i.e., less than 20%) is capitalized at fair value (or par
value if higher than fair value) while a large stock dividend
(ZO% or more) is capitalized at par value.
138
· Th~ audit?r is concerned with establishing that dividends a~
paid to client corporation shareholders owning shares as 0
the '
A. Payment date
B. Record date
C. Declaration date
D. Issue date
Dividends are n 'd , of the

""at to shareholders owning shares as
record date.
c~reR 1 Audit Objectives, Procedures, Evidence· and Documentalion
.
555
nswer A is incorrect because, on the a . .
Ad nds will be paid to shareholders ownf Yrn:nt date, d1v1-
e d date ng s ares as of the
recor ·
Answer C is incorrect because, on the declar t' d

~ • b d f d· a ion ate the
company s odar o.f. irectors announces that dividend~ are
to be paid an spec1 ies the record date.
Answer D is ~ncorrect because the issue date is the date the

shares were issued.
139. When a clien~ company does not maintain its own share rec-
ords, the auditor should obtain written confirmation from the
transfer agent and registrar concerning
A. The number of shares issued and outstanding.
s. Restrictions on the payment of dividends.
c. The number of shares subject to agreements to repur-
chase.
o. Guarantees of preference share liquidation value.
An entity engages an independent stock registrar to pre-
vent improper issuances of shares, particularly over-
issuances.
The stock registrar is responsible for ensuring that each

share issue is properly authorized by the company's articles
of incorporation and properly issued by the transfer agent.
Prior to issuance, new share certificates are examined and
registered by the stock registrar.
The transfer agent facilitates transfer of shares and main-

tains detailed shareholder records.
In most cases, these functions are performed by a single fi-

nancial institution.
Thus, the auditor is most likely to obtain evidence ab.out the

number of shares issued and outstanding at year-end by ob-
taining written confirmation directly from the stock transfer
agent and registrar.
140. If the client corporation has a material amount of treasury

shares on hand at year-end, the auditor should
A. Count the certificates only if the company reports treas-
ury shares as an asset.
B. Not count the certificates if treasury shares are reported
as a deduction from total shareholders' equity.
C. Count the certificates only if the company had material
treasury share transactions during the year.
D. Count the certificates at the same time other securities
are counted.
Counting the certificates at the same time the other securi·

ties are counted provides direct evidence that the treasury
shares exist and in the possession of the client.
Answers A, B, and C are incorrect because the auditor must

verify all share capital transactions. Thus, the auditor
should count and inspect treasury share certificates at year·
end. Moreover, treasury shares are never reported as an as·
set.
141. During an d't ·n, ac·

au ' of a company's shareholders' equ 1 ~ 1 .
counts the d't ·ct1ons
' au 1 or determines whether there are restn r
ol n retai~ed earnings resulting from loans agreements, ·ofY
aw. This d't r ven
au 1 procedure most likely is intended to
manaqement's assertion of
A. Existence.
Audit Objectives, Procedures, Evidence, and Documentation 557
~pf~~
1
presentation and disclosure
a. cornpleteness
~'. Valuation and allocation
e auditor should determine that restrictions on retained

Th ·ngs have been properly disclosed in the financial
earn1
statements.
wers A, C, and D are incorrect because restrictions on re-

AnS . 'f'1cantly affect management's as-
tained earnings d o no t s1gm
sertions of existence, completeness, and valuation and allo-
cation.
An audit program for the retained earnings account should

142· include a step that requires verification of the
A. Gain or loss resulting from disposition of treasury shares.
s. Approval of the adjustment to the beginning balance as
a result of a write-down of an account receivable.
c. Authorization for both cash and stock dividends.
o. Fair value used to charge retained earnings to account
for a two-for-one share split.
Because cash or stock dividends declared are recognized on

books by a charge to retained earnings, the audit of retained
earnings should include verification of dividends.
The auditor should examine the minutes of meetings of the

board of directors to obtain evidence that proper authoriza-
tion has been made for both cash and stock dividends.
Answer A is incorrect because gains and some losses from

disposition of treasury shares are taken to share premium-
treasury shares, not to retained earnings.
ft>:· t I tu I I ..
Answer B is incorrect because a write-down of accounts re-

ceivable (i.e., a bad debt provision) is reported in profit or
loss for the period, not directly to retained earnings.
Answer D is incorrect because share splits do not affect re-

tained earnings and are not formally recorded on books.
HUMAN RESOURCES
143. In auditing payroll, an auditor most likely would

A. Observe entity employees during a payroll distribution.
B. Compare payroll costs with entity standards and budg-
ets.
C. Trace individual employee deductions to entity journal
entries.
D. Verify that checks representing unclaimed wages are
mailed.
The audit of the payroll fu~ction typically includes analyti~al

procedures such as comparison of payroll costs with ent:ty
standards or budgets.
Answer A is incorrect because observing payroll distribU·

tion may be unnecessary when control risk is assessed as
low.
An swer C is
· incorrect
· because payroll journal entn·es are.
prepared for cumulative amounts, not for individual ern
ployees.
An D· · k are not
~wer ls incorrect because unclaimed paychec s tbe
malled but maintained by the treasurer until claimed bY
employees involved.
cHAf'TER
An auditor is most likely to perform substantive tests of de-

144· tails on payroll transactions and balances when
A. Analytical procedur~s indjcate unusuat fluctuatioRs in re-
curring payroll entries.
8. cutoff tests indicate a substantial amount of accrued
payroll expense.
c. The assessed level of control risk relative to payroll
transactions is low.
o. Accrued payroll expense consists primarily of unpaid
commissions.
Substantive tests of payroll usually focus primarily on ana-

lytical procedures. If these procedures indicate unusual
fluctuations in recurring payroll entries, the auditor should
evaluate the unexpected differences by reconsidering the
methods used to develop expectations and by making in-
quiries of management.
Additional procedures such as substantive tests of details on

payroll transactions and balances must be performed when
no suitable explanation for the unexpected differences is re-
ceived.
Answer B is incorrect because a substantial amount of ar.-

crued payroll expense is not an unusual condition.
Answer C is incorrect because a low assessed level of con-

trol risk will allow the auditor to restrict substantive testing.
Answer D is incorrect because the existence of unpaid com-

missions is not an abnormal condition and does not indicate
that the accrued payroll expense account is misstated.
I!
j\
145. Which of the following audit procedures would provide the

least relevant evidence in determining that payroll payments
were made to bona fide employees?
A. Reconcile time cards in use to employees on the job.
B. Test the payroll account bank reconciliation by tracing
outstanding checks to the payroll register.
C. Examine canceled checks for proper endorsement and
compare with personnel records.
D. Test for segregation of the authorization for payment
from the hire/fire authorization.
Tracing outstanding checks to the payroll register provide~

evidence about the completeness of recorded transactions,
not their validity.
Answer A is incorrect because reconciling time cards in use

to employees on the job may reveal nonexistent employees.
Answer C is incorrect because improper payments may be

detected by examining paid checks for proper endorsement
and comparing them with personnel records.
Answer D is incorrect because payments to fictitious e~:

ployees can be prevented if payroll authorization is segr
gated from employment decisions.
146 · One payroll audit objective is to determine whether the e~~

~loyees received pay in amounts recorded in the paY
Journal. To achieve this obJ·ective the auditor should ·sts
A· Det ermine
· whether a proper segregation
' d
of u ties eY:'
ayroll
between recording payroll and reconciling the p
bank account. all
B. Requesting that a company official distribute
paychecks.
C. Reconcile the payroll bank account.
cHAP
TER 1 Audit Objectives, Procedures, Evidence ' and 0ocumentation
.
56 1
o. compare canceled payroll checks w'th

1
th .
nal. e payroll 1our-
The auditor verifies the accuracy of the a .

. mounts recorded m
the payroll !ournal by vouching a sample of the entries to
the
. supporting
. documents such as canceled chec ks, recor d s
of authonzed salary rates, and timekeeping data (for exam-
ple, time cards) .
Answers A and C a~e incorrect because, although determin -

ing whether there IS proper segregation of duties and rec-
onciling the payroll bank account are appropri.a te audit pro-
cedures for payroll, neither procedure provides evidence
that the amounts paid to employees agree with the amounts
recorded in the payroll journal.
Answer B is incorrect because designating a company offi-

cial to handle the distribution of all paychecks does not pro-
vide assurance that the amounts received by employees
agree with the payroll journal entries.
147. Substantive procedures for payroll transactions and balances

primarily focus on analytical procedures to identify unex-
pected fluctuations in recurring payroll entries. Which of the
following is an appropriate analytical procedure for payroll?
A. Reconcile the payroll bank account.
B. Compare the relationship of hours worked and payroll
with that of the preceding year.
C. Inspect authorization on time cards.
D. Compare authorized wage rates with payroll records.
Substantive analyticai procedures involve comparisons of

recorded amounts with expectations developed based on
various sources of information like anticipated results (e.g.,
... d
l ...
budgets and forecasts); financial information for compara-

ble prior periods; published industry information; and rela·
tionships of financial information with relevant nonfinancial
information.
An appropriate analytical review procedure for payroll is

comparing and evaluating the relationship of hours worked
and payroll for the current and preceding years. This in·
volves comparing financial information with relevant nonfi·
nancial information.
Answers A and D are incorrect because reconciling the pay·

roll bank account and comparing authorized wage rates
with payroll records are substantive tests of details that
provide direct evidence of the validity of payroll.
Answer C is incorrect because inspecting authorizations.on

time cards is a test of controls, not a substantive analytical
review proct:dure.
148. To check the accuracy of hours worked, an auditor would

ordinarily compare clock cards with
A. Sbop job time tickets
B. Personnel records
C. Time recorded in the payroll register
D. Labor variance reports
. . . . t the to·
The shop Job time tickets provide informat10n aboU hours
tal hours worked on each job. The accuracy of with
worked can be determined by comparing clock cards
time tickets.
el de·
Answer B is incorrect because a company's personn
partment should not perform timekeeping function·
ct!ApTER
Answer C is ~ncorrect because the time recorded in the pay-

roll register is based on clock cards.
Answer D is incorrect because labor variance reports only

indicate the difference between the time budgeted and the
actual time charged to specific jobs.
49. An auditor found that employee time cards in one depart-

1 ment are not properly approved by the supervisor. Which of
the following could occur?
A. Payroll checks might not be distributed to the appropri-
ate payees.
s. The wrong hourly rate could be used to calculate gross
pay.
c. Employees might be paid for hours they did not work.
o. Duplicate paychecks might be issued.
Unapproved time cards could result in employees being
paid for hours they did not work.
Answer A is incorrect because the company's paymaster

should assure that paychecks are distributed only to bona
fide employees.
Answer B is incorrect because the personnel department

provides the record of authorized wage rates.
Answer D is incorrect because if each employee uses only

one time card, each employee will receive only one
paycheck.
- 9 7
DOCUMENTATION
150. As used in PSA 230 (Audit Documentation), it refers to the

record of audit procedures performed, relevant audit evi-
dence obtained, and conclusions the auditor reached.
A. Audit documentation
B. Audit file
C. Audit planning memorandum
D. Management letter.
151. According to PSA 230, working papers may be in the form of

data stored on paper or on electronic or other media. Work-
ing papers
I. Assist in the planning and performance of the audit.
II. /\ssist in the supervision and review of the audit work.
III. Record the audit evidence resulting from the audit work
performed to support the auditor's opinion.
A. I and II only
B. II and III only
C. I and III only
D. I, II, and III
tent of
152. The following statements relate to the form and con
working papers. Which is false? ·ch are
A. The auditor should prepare working pap~rs whroverall
sufficiently complete and detailed to provide an
understanding of the audit. . rs ;ntor·
B. The auditor should include in the working pape tirnin91
mation on planning the audit work; the natu~e'and the
and extent of the audit procedures perform~ ns drawn
results of such procedures; and the conclusro
from the audit evidence obtained. . n of everf
C. Working papers should include docurnenta.tro
matter the auditor considers during the audit. I
I
cHApiER
working papers should include the auditor's reasoning

0· on all significant matters which require the exercise of
judgment, together with his/her conclusion thereon.
pSA 230 states that determining the extent of workin g pa-

ers is a matter of professional judgment because it is nei-
fher necessary nor practicable to document every matter
the auditor considers during the audit.
. The primary p~rpose of audit wor~ing papers is t~ _

153 A. provide evidence of the planning and execution of audit
procedures performed.
s. comply with the Philippine Standards on Auditing (PSAs).
c. Document weaknesses in internal control with recom-
mendations to management for improvement.
D. Serve as a means for the preparation of the financial
statements.
PSA 230 requires the aud itor to reco rd in th e working pa-

pers information on planning the audit work; th e nature,
timing, and extent of the audit procedures and the res ults of
such procedures; and the conclusions drawn from the audit
evidence obtained.
Answer B is incorrect because, although the auditor is re-

quired by the standards to prepare adequate working pa-
pers, compl iance with the standards is not the prim a ry rea-
son for their existence.
Answer C is incorrect because documentation of control

weaknesses is not the primary purpose for working pape r
but an example of matters to be included in the audi t wo rk-
ing papers.
Answer D is incorrect because working papers do not serve

as basis for the preparation of the financial statements.
154. Working papers that record the procedures used by the au- ,
ditor to gather audit evidence should be
A. Destroyed when the audited entity ceases to be a client.
B. Considered the primary support for the financial state-
ments being audited .
C. Viewed as the connecting link between the books of ac-
counts and the financial statements.
D. Designed to meet the circumstances of the particular en-
gagement.
According ·to PSA 230; working papers should be designed

to meet the circumstances and the auditor's needs for each
individual audit.
Answer A is incorrect because working papers should be re·

tained by the auditor for a period sufficient to meet th~
needs of his/her practice and in accordance with legal an
professional requirements of record retention.
· rec·
Answer B is incorrect because the client's accounting ncial
ords are considered the primary support for the fina
statements.
0 "Alt· I
Answer C is incorrect because, as stated in. PSA r~ f113Y

23
hough portions of or extracts from the :vork~ng P~~~e 3udi·
be made available to the entity at the d1scretwn ° ting rec·
tor, they are not a substitute for the entity's accoun
ords."
roPnate
155. Which of the following conditions constitutes inapP
working paper preparation?
ct!AprER
A. Tick marks are explained in working papers.

B. All forms and directives used by the client are included in
the working papers.
c. Flowcharts are included in the working papers.
o. Findings are cross-referenced -to supporting documenta-
tion.
pSA 230 provides that the extent of working paper docu-

mentation is a matter of professional judgment because it is
neither necessary nor practicable to document every matter
the auditor considers during the audit. Accordingly, forms
and directives used by the client should be included only to
the extent they support the conclusions drawn by the audi-
tor.
Answers A, C, and D are proper parts of working paper doc-

umentation.
156. Which of the following factors would least likely affect the
form, content, and extent of an auditor's working papers?
A. The content of the representation letter.
B. The identified risks of material misstatement.
C. The audit methodology and tools used.
D. The significance of the audit evidence obtained.
The management representation letter reflects manage-

ment's acknowledgment of its responsibility for the fair
presentation of the financial statements in accordance with
the applicable financial reporting framework.
Answers B, C, and D are incorrect because PSA 230 states
that the form, content, and extent of working papers are af-
fected by matters such as the following:
• The nature of the audit procedures to be performed.
• The identified risks of material misstatement.
• The extent of judgment required in performing the

work and evaluating the results.
• The significance of the audit evidence obtained.
• The nature and extent of exceptions identified.
• The need to document a conclusion or the basis for a
conclusion not readily determinable from the docu-
mentation of the woi:-k performed or audit evidence
obtained.
• The audit methodology and tools used.
157. An auditor's working papers will ordinarily be least likely to

include documentation showing how the
A. Client's schedules were prepared.
B. Unusual matters were resolved.
C. Understanding of the client's internal control was ob-
tained and control risk was assessed.
D. Engagement was planned.
There is no need to document how the client's schedules

were prepared because the schedules themselves reflect
how they were prepared.
According to the standard, working papers ordinarily include:

• Information concerning the legal and organization
structure of the entity.
• Extracts or copies of important legal documents,
agreements, and minutes. .
. .1 env1-
• Informat10n concerning the industry, eco~ 0 1:1 c hich
ronment, and legislative environmenl within w
the entity operates.
. audit
• Evidence of the planning process including
programs and any changes thereto.
cH-AprER
• Evidence of the auditor's understanding of the ac-

counting and internal control systems.
• Evidence of inherent and control risk assessments
and any revisions thereof.
• Evidence of the auditor's consideration of the work

of internal auditing and conclusions reached.
• Analyses of transactions and balances .
• Analyses of significant ratios and trends .
• A record of the nature, timing, and extent of a udit
procedures perfo r med and the results of such pro-
cedures.
• Evidence tha t the work performed by assistants was
supervised and reviewed.
• An indication as to who performed the audit proce-
dures and when they were performed.
• Details of procedures applied regarding components
whose financial statements are audited by another
auditor.
• Copies of communications with other auditors, ex-
perts, and other third parties.
• Letters of representation received from the entity.
• Conclusions reached by the auditor concerning sig-
nificant aspects of the audit, including how excep-
tions and unusual matters, if any, disclosed by the
auditor's procedures were resolved or treated.
• Copies of the financial statements and auditor's re-
port.
158. Which of the following is usually included or shown in the

auditor's working papers?
-
A. The procedures used by the auditor to verify the person-

al financial status of members of the client's manage-
ment team.
B. The manner in which exceptions and unusual matters
disclosed by the auditor's procedures were resolved or
treated.
C. Analyses that are designed to be a part of, or a substi-
tute for, the client's accounting records.
D. Excerpts from authoritative pronouncements that sup-
port the financial reporting framework used in preparing
the financial statements.
PSA 230 states that working papers ordinarily include con·

clusions reached by the auditor concerning significant as·
pects of the audit, including how exceptions and unusual
matters, if any, disclosed by the auditor's procedures were
resolved or treated.
Answer A is incorrect because a financial state·ment audit

does not generally include verification of the personal finan·
cial status of the client's management.
Answer C is incorrect because, as stated in PSA 230, workin;

papers are not a substitute for the entity's accounting re ·
ords.
uditor,
Answer D is incorrect because management, not the~ cial
has the responsibility to document and support the fi~a; the
reporting framework used in preparing and presentin
company's financial statements.
eference
159. Audit working papers are indexed by me~ns of r rpose of
numbers. Which of the following is the pnmarv pu
indexing?
'fER 7 Audit Objectives, Procedures, Evidence, and Documentation 57 1
c~
A. oetermine t~at working papers adequately support find-

ings, cone1us1ons, and reports.
6. support the audit opinion. ·
c. permit cross-referencing and simplify supervisory review.
o. Eliminate the need for follow-up reviews.
Indexing creates an audit trail of related items through the

working papers. Thus, indexing permits cross-referencing
and simplifies supervisory review.
Answer A is incorrect because a supervisory review should

be conducted to determine if working papers adequately
support findings, conclusions, and reports.
Answer B is incorrect because the working papers as a

whole support the audit opinion.
Answer D is incorrect because indexing does not eliminate

the need for follow-up reviews.
160. Although the quantity and content of audit working papers

vary with each particular engagement, an auditor's perma-
nent files most likely include
A. Analyses of share capital and other shareholders' equity
elements.
B. Schedules that support the current year's adjusting en-
m~. .
C. Prior years' accounts receivable confirmations that were
classified as exceptions.
D. Documentation indicating that the audit work was ade-
quately plann~d. and supervised.
The standard provides that in the case of recurring audits,

some working paper files may be classified as permanent
audit files which are updated with new information of con-
.. '
tinuing importance, as distinct from current audit files

which contain information relating primarily to the audit of
a single period. The auditor's permanent file usually in-
cludes analyses from previous audits of noncurrent liabili-
ties; property, plant, and equipment; and shareholders' eq-
uity.
Answers B, C, and Dare incorrect because the schedules that

support the current year's adjusting entries; prior year's ac-
counts receivable confirmations; and documentation indi·
eating that the audit work was adequately planned and su-
pervised are included in the auditor's current files.
161. The audit working paper theit reflects the major components
of an amount reported in the financial statements is the
A. Supporting schedule
B. Interbank transfer schedule
C. Lead schedule
D. Carryforward schedule
. d
A lead schedule (also called top schedule) classifies an
summarizes similar or related items contained on the sup-
porting schedules. It reflects the components of an amoun~
reported as a line item on the face of the financial state
·tern
ments. For example, the lead schedule for the line 1 . 1
"cash and cash equivalents" on the statement of financia_
position might consist of petty cash fund cash in bank (sav
ings account), cash in bank (current acc~unt), and a three·
month time deposit.
. . d Jes re· I
Answer A is incorrect because supporting sche u for
fleet details of amounts aggregated in the lead schedule,
example, a bank reconciliation schedule for cash in bank·
C~pfER
wer B is incorrect because an interbank transfer

Ans k.
chedule is a wor mg paper prepared for several days be-
~ re and after the balance sheet date to determine if inter-
bo nk transfers have been correctly recorded (both receipts
a~d disbursements) in the proper accounting period.
Answer Dis incorr~ct because a carryforward schedule is
a continuing analysis of an account (e.g., a noncurrent liabil-
ity like bonds payable; property, plant, and equipment; or a
stockholders' equity account) whose balance is carried for-
ward in the permanent file.
. Which of the following analyses appearing in a predecessor's

162
working papers is the successor auditor least likely to be in-
terested in reviewing?
A. Analysis of income statement accounts.
B. Analysis of noncurrent assets and liabilities.
c. Analysis of current assets and liabilities.
D. Analysis of shareholders' equity accounts.
In an initial audit, the auditor is required to obtain sufficient

appropriate audit evidence concerning the opening balances
of certain accounts. The opening (or beginning) balance of
an account is based upon its closing balance at the end of
the prior period.
According to PSA 510 (Initial Engagements-Opening Bal-

ances), when the prior period's financial statements were
audited by another auditor, the current (successor) auditor
may be able to obtain sufficient appropriate audit evidence
regarding opening balances by reviewing the predecessor
auditor's 'Norking papers.
--
Because income statement accounts (also called nominal ac-

counts) are closed at the end of each reporting period, there
will be no opening balances for these accounts at the begin-
ning of the succeeding period.
Answers B, C, and D are incorrect because the auditor is

concerned with the opening balances of balance sheet ac-
counts.
163. An auditor ordinarily uses a working trial balance resembling

the financial statements without footnotes, but containing
columns for
A. Cash flow increases and decreases.
B. Reclassifications and adjustments.
C. Audit objectives and assertions.
D. Reconciliations and tickmarks.
A working trial balance reflects line items that are to be

shown on the financial statements. It contains columns for
year-end general ledger balances (per books); reclassifica-
tions and adjustments; and adjusted year-end balances (per
audit).
Answer A is incorrect because cash flows are reflected on

the statement of cash flows.
Answer C is incorrect because management's assertions

about a _particular account to be audited are translated bY
t~: audi~?r i~ terms of specific audit objectives. These spe~
c1f1c audit ob1ectives are listed on the audit program for th
account to be audited.
Answer D is incorrect because the working trial balance

does not have column for reconciliations and tickmarkS·
C~prER
ditors often use standardized working papers primarily

164· A~cause they allow working papers to be prepared more
~ Efficiently ·
a: Accurately
c. Neatly
o. professionally
The standard provides that the use of standardized working

papers (for example, checklists, specimen letters, standard
organization of working papers) may improve the efficiency
with which such working papers are prepared and re-
viewed.
Answers 8, C, and D are incorr.e ct because standardized

working papers may enhance efficiency (i.e., the time to
prepare the working papers will significantly be dimin-
ished) but will not necessarily result in greater accuracy,
neatness, or pro(essionalism.
165. Using personal computers in auditing may affect the meth-

ods used to review the work of staff assistants because
A. Working paper documentation may not contain readily
. observable details of calculations.
B. The quality control standards may differ.
C. Documenting the supervisory review may require assis-
tance of consulting services personnel.
D. Supervisory personnel may not have an understanding of
the capabilities and limitations of personal computers.
The use of personal computers in the preparation of work-

ing papers usually results in fewer manual calculations. For
example, a spreadsheet software will automatically produce
answers . to mathematical calculations (e.g., depreciation
computation) based on formulas defined by the auditor.
Answer Bis incorrect because the quality control standards

are the same whether or not a personal computer is used.
Answers C and D are incorrect because auditors generally

have skills for using personal computers in the audit pro-
cess.
166. Audit documentation is ·the record of audit procedures per-

formed, relevant audit evidence, and the auditor's conclu-
sions. Which of the following statements concerning audit
documentation is incorrect?
A. Audit documentation should include superseded drafts of
working papers and financial statements.
B. Audit documentation prepared after the performance of
the audit work is likely to be less accurate than docu-
mentation prepared at the time such work is perforr:ied~
C. Audit documentation may include abstracts or copies
the entity's records such as significant and specific con·
tracts and agreements. ny's
1
D. Audit documentation is not a substitute for the en
accounting records.
. ntatwn:
The following need not be included in audit docume
d financial
• Superseded drafts of working papers an
statements. . . r think·
• Notes that reflect incomplete or prehmina Y
ing. t)'Po·
• Previous copies of documents corrected for
graphical or other errors.
• Duplicates of documents.
·on in. a/an
167. The auditor shall assemble the audit documenta t 1
A. Working paper
7 AUdit Objectives. Procedures, Evidence, .and Documentation 577
ctlApfER
a. workpaper
C. Audit file
(). Audit memorandum
pSA 230 defines audit file as "one or more folders or other

storage media, in physical or electronic form, containing the
records that comprise the audit documentation for a specific
engagement."
. The auditor is ~equired to com~lete the administrative pro-

168
cess of ·assembling the final audit file on a timely basis after
the date of the auditor's report. The time limit within which
:· to complete the assembly of the audit file is ordinarily
A. Not more than 30 days after the date of the auditor's re-
port.
B. Not more than 60 days after the date of the auditor's re-
port.
c. Not more than 90 days after the end of the entity's re-
porting period.
D. Not more than 60 days after the date the entity's finah-
cial statements are authorized for issue.
PSQC 1 requires firms to adopt policies and procedures for

the timely completion of the assembly of audit files. An ap- ·
propriate time limit within which to complete the assembly
of the final audit file is ordinarily not more than 60 days af-
ter the date of the auditor's report.
169. Audit documentation may be recorded on paper or on elec-

tronic or other media. The following are . examples of audit
documentation, except
A. Audit programs
B. Letters of confirmation and representation
C. Correspondence (including e-mail) concerning significant
matters ·
D. The entity's accounting records
170. The completion of the assembly of the final audit file after
the date of the auditor's report does not ordinarily involve
A. The performance of new audit procedures or the drawing
of new conclusions.
B. Sorting, collating and cross-referencing working papers.
C. Deleting or discarding superseded documentation.
D. Signing off on completion checklists relating to the file
assembly process.
The process of completing the assembly of the final audit file

after the date of the auditor's report is administrative in na-
ture and does not ordinarily involve the performance of new
audit procedures or the drawing of new conclusions.
TRUE OR FALSE
1. To be relevant, evidence must be derived from a system in-

cluding effective internal controls.
2. Footing is an example of analytical procedures.

' ~
J. Analytical procedures are required at the planning stage
all audits and as a part of the final overall review .
evidence
4. The twp characteristics of the appropriateness of
are relevance and reliability.
ecorded,
5. I~ determining whether transactions have been rthe gen·
the direction of the audit testing should start frorn
eral ledger balances.
cHAp'fER
@uring fi~ancial statement audits, auditors seek to restrict

6. inherent risk.
The decision o~ how many items to test should not be influ-

7· enced by the rncreased costs of performing the additional
tests.
Analytical procedures are used for planning, but they should

s. not be used to obtain evidence as to the reasonableness of
specific account balances.
The more effective the internal control system, the more as-
9· surance it provides the auditor about the reliability of finan-
cial reporting by the client.
10. A schedule listing account balances for the current and pre-
vious years, and columns for adjusting and reclassifying en-
tries p·roposed by the auditors to arrive at the final amount
that will appear in the financial statement, is referred to as a
lead schedule.
11. To test for unsupported entries in the ledger, the direction of

audit testing should start from the ledger entries.
12. Evidence obtained from independent sources outside the

entity is generally more reliable than evidence secured solely
within the ehtity.
13. Failure to detect material misstatements in the financial

statements is a risk which the auditors primarily mitigate by
assessing control risk.
14. Lead schequles show the detailed general ledger accounts

that make up a financial statement line item on the auditor's
working trial balance.
I
I
I
L
15. The independent auditor's direct personal knowledge, ob-

tained through inquiry, observation and inspection, is gener-
ally more persuasive than information obtained indirectly.
16. An example of an analytical procedure is the comparison of

recorded amounts of major disbursements with appropriate
invoices.
17. Evidence is generally considered appropriate when there is

enough of it to afford a reasonable basis for an opinion on
fin<;mcial statements.
18. The auditor performs tests to collect convincing evidence

that the financial statements are not misstated.
19. The auditor considers the amount of risk present·in deciding

the nature and extent of evidence to be collected.
20. Given the economic and time constraints in which auditors

can collect evidence about management assertions abo~t
the financial statements, the auditor normally gathers evi·
dence that is conclusive.
21. A~counting data alone may be considered sufficient appro·

pnat~ audit evidence to issue an unmodified opinion on fi·
nanc1al statements.
· External evidence, such as communications from bank~,~~

22
gene~ally .r~garded as more reliable than answers obtain
from inquiries of the client.
23. ~ccounting data developed under satisfactory conditions~~

~ternal c?ntrol are more relevant than data developed u
er unsatisfactory internal control conditions. .
cHAPTCR 7
Audit Objectives. Procedures, Evidence and Docume .
· n1a1ion 581
4
Informa~ion obtained i~directly from independent outside
2 · 50urces is more. persuasive than the auditor's direct personal
knowledge obtained through observation and inspection.
A practical ~nd e.ffective audit procedure for the detection of

25
· lapping is preparing a proof of cash.
26 To test the existence assertion for recorded receivables, an

' auditor would select a sample from the shipping documents
file.
27. In verifying debits to perpetual inventory records of a non-

manufacturing firm, the auditor would be interested in ex-
amining the vendors' invoices.
28. In testing for unrecorded retirements of equipment, an audi-

tor might trace equipment items observed during the plant
tour to the equipment subsidiary ledger.
29.. Auditors may choose not to confirm accounts payable be-

cause other reliable external evidence to support the balanc-
es is likely to be available.
30. An example of an external document that provides reliable

information for the auditor is purchase order for company
purchases.
31. A primary purpose of audit working papers is to support the

financial statements.
32. In some instances, other txpes of evidence may be reduced

when analytical procedures indicate that an account balance
appears reasonable.
----
33. Although the quantity, type, and content of working papers

will vary with the circumstances, the working papers gener-
ally would include the auditing procedures followed and the
testing performed in obtaining audit evidence.
34. Audit documents may be regarded as a substitute for the

client's accounting records.
35. In evaluating an entity's accounting estimates, one of the

auditor's objectives is to determine . whether the estimates
are reasonable in the circumstances.
36. Audit documents should be kept on the client's premises so

that the client can have access to them for reference pur-
poses.
37. A client's accounting data cannot be considered sufficient

audit evidence to support the financial statements.
· tna
38. The permanent audit file usually includes working · I bal·
ance.
39. Significant unexpected fluctuations identified by ana~~:~

1
procedures will usually necessitate an audit report mo
tion.
ployed
40. Where no independent stock transfer agents are ern·ntains
and the corporation issues its own stocks and rn~~faced
stock records, cancelled stock certificates sh.ould be ondin9
to prevent reissuance and attached to their corre5P •
stubs.
cW'pfER
30. c 59. B 88. A 117. A 146. D

1. s 31. ·o 60. D 89. D 118. B 147. B
2. c 32. c 61. B 90. D 119. c 148. A
3, D 62. D 91. D 120. A 149. c
33. A
4. s 34. A 63. D 92. c 121. A 150. A
5. D 64. c 93. A 122. B 151. D
35. D
6. D c
36. A 6S. A 94. A 123. c 152.
7, D 153. A
s. c 37. c 66. B 95. B 124. B
38. B 67. D 96. c 125. A 154. D
9. s
39. D 68. A 97. B 126. D lSS. B
10. D
40. B 69. B 98. A 127. B 1S6. A
. 11. D
41. D 70. D 99. D 128. A 157. A
12. A
42. A 71. B 100. A 129. B 158. B
13.0
14. 0 43. c 72. B 101. A 130. A 159. c
15. D 44. D 73. c 102. c 131. B 160. A
16. A 45. c 74. A 103. A 132. D 161. c
17. c 46. B 7S. A 104. B 133. c 162. A
18. c 47. c 76. B 105. c 134. B 163. B
19. A 48. A 77. D 106. B 135. D 164. A
20. D 49. c 78. B 107. A 136. A 165. A
21. c 50. D 79. B 108. c 137. c 166. A
22. D 51. B 80. c 109. c 138. B 167, c
23. B 52. A 81. A 110. D 139. A 168. B
24. A S3. B 82. ·o 111. A 140. D 169. D
25. c 54. A 83. A 112. c 141. B 170. A
26. c SS. C 84. B 113. A 142. c
27. D 56. c 85. c 114. D 143. B
2s. o· S7. c 86. B 115. A 144. A
29. A S8. A 87. A 116. B 145. B
_..--·
-
TRUE OR FALSE
1. False 9. True 17. False 25. False 33. rrue
2. False 10. False 18. False 26. False 34. False
3. True 11. True 19. True 27. True 35. True
4. True 12. True 20. False 28. False 36. False
5. False 13. False 21. False 29. True 37. True
6. False 14. True 22. True 30. False 38. False
7. False 15. True 23. False 31. False 39. False
8. False 16. False 24. False 32. True 40. True

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447

1. All the information used by the auditor in arriving at the

According to PSA 500 (Audit Evidence), audit evidence re-

448 CPA EXAMINATION REVIEWER: AUDITING THEORY

eludes both information contained in the accounting records

2. An entity's accounting records generally include the ·records

According to PSA 500, accounting records include the rec-

7 AUdll Objectives. Procedures, Evidence, and Docurr.entation 449

Audit evidence _comprises

PSA 500 states that in some cases, the absence of infor-

4. As defined in PSA 500, is an individual or or-

5. If a management's expert's work is used to prepare the in-

450 CPA EXAMINATION REVIEWER: AUDITING THEORY

I. Evaluate the competence, capabilities and objectivity of

6. Which of the following statements concerning the manage-

mpetence relates to the nature and level of expertise of

capability relates to the abi~ity of the management's expert

Objectivity relates to the possible effects that bias, conflict

Audit evidence is information used to draw reasonable con-

Risk assessment procedures include:

Further audit procedures comprise:

8. Which of the following statements concerning audit evidence

Answer A is incorrect because appropriateness is the meas-

Answer B is incorrect beca use suffkiency is th e measure of

Answer Dis incorrect because the sufficiency and appropri-

9 · Y'lhich of the following statements concerning audit evidence

Answer C is inco rrect because au dit evidence obtained from

Answer D is incorrect because accounting records a lone do

454 CPA EXAMINATION REVIEWER: AUDITING THEORY

D. An auditor's opinion, to be economically useful, is formed

Cost-benefit considerations relate to the sufficiency, not the

PSA 500 gives the following generalizations about the reli·

A The auditor uses professional J·udgm t .

The standard states that the auditor considers the relation-

12. In representing that the financial statements are presented

As defined in the standard, assertions are representations

CPA EXAMINATION REVIEWER: AUDITING THEORY

Assertions about classes of transactions and events for the

Assertions about account balances at the period end in -

458 CPA EXAMINATION REVIEWER: AUDITING THEORY

Existence is an assertion about account balances at the pe-

Assertions about presentation and disclosure include:

16. Which of the following statements concerning the auditor's

he auditor may use the .assertions as d.escribed in PSA 500

Answer C is incorrect because there may not be a separate

Answer D is incorrect because the completeness assertion

17. Which of the following statements concerning audit objec-

D. Audit objectives should be developed in light of man-

Audit objectives and procedures need not have a one-to-one

Answer A is incorrect because the auditor should resolve all

Answer B is incorrect because the auditor's understanding

Answer D is incorrect because, in developing specific audit

18. The primary difference between an audit of the balanc~

the accounting for transactions and events during the

Answer B is incorrect because all transactions must be au-

Answer Dis incorrect because the auditor i-s concerned with

Which of the following would least likely affect the appropri-

Appropriateness is the measure of the quality of audit evi-

Answer B is incorrect because appropriate audit evidence

462 CPA EXAMINATION REVIEWER: AUDITING THEORY

Answer C is incorrect because audit evidence obtained·from

Answer D is incorrect because the timeliness of evidence in·

20. Which of the following forms of documentary evidence

The auditor should apply analytical procedures as risk a~