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Review Questions
6-1
6-5 True, the auditor must rely on management for certain information in the
conduct of the audit. However, the auditor must not accept management's
representations blindly. The auditor must, whenever possible, obtain appropriate
evidence to support the representations of management. As an example, if
management represents that certain inventory is not obsolete, the auditor should
be able to examine purchase orders from customers that prove part of the
inventory is being sold at a price that is higher than the company's cost plus
selling expenses. If management represents an account receivable as being fully
collectible, the auditor should be able to examine subsequent payments by the
customer or correspondence from the customer that indicates a willingness and
ability to pay.
6-6
6-7 The cycle approach is a method of dividing the audit such that closely
related types of transactions and account balances are included in the same
cycle. For example, sales, sales returns, and cash receipts transactions and the
accounts receivable balance are all a part of the sales and collection cycle. The
advantages of dividing the audit into different cycles are to divide the audit into
more manageable parts, to assign tasks to different members of the audit team,
and to keep closely related parts of the audit together.
6-2
6-8
6-11 General audit objectives follow from and are closely related to management
assertions. General audit objectives, however, are intended to provide a framework
to help the auditor accumulate sufficient appropriate evidence required by the
third standard of field work. Audit objectives are more useful to auditors than
assertions because they are more detailed and more closely related to helping
the auditor accumulate sufficient appropriate evidence.
6-12
TRANSACTION-RELATED AUDIT
RECORDING MISSTATEMENT OBJECTIVE VIOLATED
6-3
6-13 The existence objective deals with whether amounts included in the
financial statements should actually be included. Completeness is the opposite of
existence. The completeness objective deals with whether all amounts that should
be included have actually been included.
In the audit of accounts receivable, a nonexistent account receivable will
lead to overstatement of the accounts receivable balance. Failure to include a
customer's account receivable balance, which is a violation of completeness, will
lead to understatement of the accounts receivable balance.
6-14 Specific audit objectives are the application of the general audit objectives
to a given class of transactions, account balance, or presentation and disclosure.
There must be at least one specific audit objective for each general audit
objective and in many cases there should be more. Specific audit objectives for a
class of transactions, account balance, or presentation and disclosure should be
designed such that, once they have been satisfied, the related general audit
objective should also have been satisfied for that class of transactions, account,
or presentation and disclosure.
6-15 For the specific balance-related audit objective, all recorded fixed assets
exist at the balance sheet date, the management assertion and the general
balance-related audit objective are both "existence."
6-16 Management assertions and general balance-related audit objectives are
consistent for all asset accounts for every audit. They were developed by the
Auditing Standards Board, practitioners, and academics over a period of time.
One or more specific balance-related audit objectives are developed for each
general balance-related audit objective in an audit area such as accounts
receivable. For any given account, a CPA firm may decide on a consistent set of
specific balance-related audit objectives for accounts receivable, or it may decide
to use different objectives for different audits.
6-17 For the specific presentation and disclosure-related audit objective, read
the fixed asset footnote disclosure to determine that the types of fixed assets,
depreciation methods and useful lives are clearly disclosed, the management
assertion and the general presentation and disclosure-related audit objective are
both "classification and understandability."
6-18 The four phases of the audit are:
1. Plan and design an audit approach.
2. Perform tests of controls and substantive tests of transactions.
3. Perform analytical procedures and tests of details of balances.
4. Complete the audit and issue an audit report.
The auditor uses these four phases to meet the overall objective of the audit,
which is to express an opinion on the fairness with which the financial statements
present fairly, in all material respects, the financial position, results of operations and
cash flows in conformity with applicable accounting standards. By accumulating
sufficient appropriate evidence for each audit objective throughout the four
phases of the audit, the overall objective is met.
6-4
Multiple Choice Questions From CPA Examinations
6-19 a. (2) b. (3) c. (1)
6-20 a. (1) b. (2) c. (1)
6-21 a. (3) b. (2) c. (2)
6-22 a. The purpose of the first part of the report of management is for
management to state its responsibilities for internal control over
financial reporting. The second part of the report states managements
responsibility for the fair presentation of the financial statements.
b. The auditors responsibility is to express an opinion on the fairness of
the presentation of the financial statements and an opinion on the
effectiveness of internal control over financial reporting.
6-23 a. Auditing standards indicate that reasonable assurance is
a high level of assurance. Accordingly, financial statement users
should have a high degree of confidence in the financial
statements. However, reasonable assurance is not an absolute level
of assurance, and there is at least some risk that the audited
financial statements may include material misstatements.
b. The responsibility of the independent auditor is to express an opinion
on the financial statements he or she has audited. Inasmuch as
the financial statements are the representation of management,
responsibility rests with management for the proper recording of
transactions in books of account, for the safeguarding of assets, and
for the substantial accuracy and adequacy of the financial statements.
In developing the basis for his or her opinion, the auditor is
responsible for conducting an audit that conforms to auditing
standards. These standards constitute the measure of the adequacy
of the audit. Those standards require the auditor to obtain sufficient
appropriate evidence about material management assertions in
the financial statements.
The informed judgment of a qualified professional accountant
is required of an independent auditor. The auditor must exercise this
judgment in selecting the procedures he or she uses in the audit and
in arriving at an opinion.
In presenting himself or herself to the public as an independent
auditor, the auditor is responsible for having the abilities expected
of a qualified person in that profession. Such qualifications do not
include those of an appraiser, valuer, expert in materials, expert in
styles, insurer, or lawyer. The auditor is entitled to rely upon the
judgment of experts in these other areas of knowledge and skill.
6-5
6-23 (continued)
6-6
6-23 (continued)
6-24 a.
INCOME STATEMENT
CYCLE BALANCE SHEET ACCOUNTS ACCOUNTS
SALES AND Accounts receivable Bad debt expense
COLLECTION Allowance for doubtful accounts Sales
Cash
Notes receivabletrade
6-7
6-24 (continued)
b. The general ledger accounts are not likely to differ much between a
retail and a wholesale company unless there are departments for
which there are various categories. There would be large differences
for a hospital or governmental unit. A governmental unit would use
the fund accounting system and would have entirely different
titles. Hospitals are likely to have several different kinds of revenue
accounts, rather than sales. They are also likely to have such things
as drug expense, laboratory supplies, etc. At the same time, even
a governmental unit or a hospital will have certain accounts such
as cash, insurance expense, interest income, rent expense, and
so forth.
6-25
a. Management assertions about transactions relate to transactions
and other events that are reflected in the accounting records. In
contrast, assertions about account balances relate to the ending
account balances that are included in the financial statements, and
assertions about presentation and disclosure relate to how those
balances are reflected and disclosed in the financial statements.
6-8
6-25 (continued)
b. c.
CATEGORY OF
MANAGEMENT NAME OF
MANAGEMENT ASSERTION ASSERTION ASSERTION
a. All sales transactions have been Classes of Completeness
recorded. transactions
b. Receivables are appropriately Presentation and Classification and
classified as to trade and other disclosure understandability
receivables in the financial
statements and are clearly
described.
c. Accounts receivable are recorded Account balances Valuation and
at the correct amounts. allocation
d. Sales transactions have been Classes of Cutoff
recorded in the proper period. transactions
e. Sales transactions have been Classes of Classification
recorded in the appropriate transactions
accounts.
f. All required disclosures about Presentation and Completeness
sales and receivables have been disclosure
made.
g. All accounts receivable have Account balances Completeness
been recorded.
h. There are no liens or other Account balances Rights and obligations
restrictions on accounts
receivable.
i. Disclosures related to accounts Presentation and Accuracy and
receivable are at the correct disclosure valuation
amounts.
j. Recorded sales transactions Classes of Occurrence
have occurred. transactions
k. Recorded accounts receivable Account balances Existence
exist.
l. Sales transactions have been Classes of Accuracy
recorded at the correct amounts. transactions
m. Disclosures related to sales and Presentation and Occurrence and rights
receivables relate to the entity. disclosure and obligations
6-9
6-26
SPECIFIC BALANCE-
RELATED AUDIT MANAGEMENT
OBJECTIVE ASSERTION COMMENTS
6-10
6-26 (continued)
SPECIFIC BALANCE-
RELATED AUDIT MANAGEMENT
OBJECTIVE ASSERTION COMMENTS
b.
and
6-11
6-27 (continued)
b. c.
GENERAL
TRANSACTION-
SPECIFIC TRANSACTION- MANAGEMENT RELATED AUDIT
RELATED AUDIT OBJECTIVE ASSERTION OBJECTIVE
6-28
c. Methods and useful lives disclosed for each 3. Accuracy and valuation
category of fixed assets are accurate.
d. Disclosed fixed asset dispositions have occurred. 4. Occurrence and rights and
obligations
6-12
6-29 a. The first objective concerns amounts that should not be included on
the list of accounts payable because there are no amounts due to
such vendors. This objective concerns only the overstatement of
accounts payable. The second objective concerns the possibility of
accounts payable that should be included but that have not been
included. This objective concerns only the possibility of understated
accounts payable.
b. The first objective deals with existence and the second deals with
completeness.
c. For accounts payable, the auditor is usually most concerned about
understatements. An understatement of accounts payable is usually
considered more important than overstatements because of potential
legal liability. The completeness objective is therefore normally more
important in the audit of accounts payable. The auditor is also
concerned about overstatements of accounts payable. The existence
objective is also therefore important in accounts payable, but
usually less so than the completeness objective.
6-13
6-30
PRESENTATION
BALANCE- TRANSACTION AND
RELATED RELATED DISCLOSURE
AUDIT AUDIT AUDIT
AUDIT PROCEDURE OBJECTIVE OBJECTIVE OBJECTIVE
a. Examine a sample of duplicate sales invoices to determine (9) Occurrence
whether each one has a shipping document attached.
b. Add all customer balances in the accounts receivable trial (6) Detail Tie-In
balance and agree the amount to the general ledger.
c. For a sample of sales transactions selected from the sales
journal, verify that the amount of the transaction has been (14) Posting and
recorded in the correct customer account in the accounts summarization
receivable subledger.
d. Inquire of the client whether any accounts receivable
balances have been pledged as collateral on long-term (15) Occurrence
6-14
PRESENTATION
BALANCE- TRANSACTION AND
RELATED RELATED DISCLOSURE
AUDIT AUDIT AUDIT
AUDIT PROCEDURE OBJECTIVE OBJECTIVE OBJECTIVE
h. For a sample of customer accounts receivable balances for (1) Existence
December 31, 2011, examine subsequent cash receipts in (7) Realizable
January 2012 to determine whether the customer paid the value
balance due.
i. Determine whether all risks related to accounts receivable (16) Completeness
are adequately disclosed.
j. Foot the sales journal for the month of July and trace (14) Posting and
postings to the general ledger. summarization
k. Send letters to a sample of accounts receivable customers (1) Existence
6-15
b. Review industry databases to assess the risk of 1. Plan and design an audit
material misstatements in the financial approach (Phase I)
statements.
Case
6-16
amounts of debt.
6-32 (continued)
6-17
6-32 (continued)
6-18
Internet Problem 6-1 (continued)
(Note: Internet problems address current issues using Internet sources. Because
Internet sites are subject to change, Internet problems and solutions may change. Current
information on Internet problems is available at www.pearsonhighered.com/arens).
6-19