CHAPTER 12

AUDIT PROCEDURES

I. Review Questions

1. “Procedures” relate to acts to be performed. “Standards” deal with measures of

the quality of performance of those acts and the objectives to be attained by the
use of procedures. The standards are less subject to change. The standards
provide the criteria for rejecting, accepting, or modifying a procedure in a given
circumstance. An example of the relative stability of standards and procedures
is found in the change from non-EDP to EDP systems. New procedures were
required to audit EDP systems, but auditing standards remained unchanged and
were the criteria for determining the adequacy of the new procedures.

2. A “substantive audit procedure” is any action (resembling a specific variation of

one of the seven general audit procedures) undertaken for the purpose of
producing evidence about a peso amount of a disclosure that appears in the
financial statements under audit.

The nature of a procedure is its description – usually associated with one of the
seven general audit procedures. For example, the nature of a procedure may be
confirmation, document, vouching, etc.

The timing of a procedure is the period during which it is performed – usually

distinguished as interim (before the balance sheet date), year-end (on or close to
the balance sheet date), and subsequent (after the balance sheet date).

The extent of a procedure is the number of details audited with it, or another
measure of intensity or frequency. Oftentimes, extent is measured by the sample
size.

3. Inspection techniques include physical examination of assets, examination of

documents and records, performance of mechanical accuracy tests, and
analytical procedures.

4. Vouching and tracing are two types of commonly performed documentation.

Vouching involves the examination of documents that served as a basis for
recording the transaction. Vouching usually starts with a recorded transaction
and works back to the documents and addresses existence. Tracing involves
determining whether source documents have been recorded properly in the
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accounting records. By tracing, an auditor can obtain evidence that the
recording of the transaction is complete.

5. An inquiry involves requesting information from client personnel and receiving

their response. The request and response may be either written or oral. A
confirmation is a response a third party makes directly to the auditor on the
request of a client. The response includes information about certain
transactions, relationships, and/or balances that have an impact on a specific
financial statement assertion.

6. Confirmations are usually considered more reliable because they are from
outside parties, while inquiries are made of client personnel.

7. When equivalent procedures are available to satisfy the need for evidence, an
auditor may consider cost in selecting among the alternatives.

8. Vouching is relevant to testing the existence of sales; tracing is not. Tracing is

relevant to testing the completeness of sales, but vouching is not.

II. Multiple Choice Questions

1. c 3. c 5. c 7. a 9. d
2. d 4. a 6. c 8. d

III. Comprehensive Cases

Case 1. The objectives for the audit of Wesson’s securities investments at

December 31 are to obtain evidence about the assertions implicit in the financial
presentation, specifically:
1. Existence. Obtain evidence that the securities are bona fide and held by
Wesson or by a responsible custodian.
2. Occurrence. Obtain evidence that the loan transaction and securities
purchase transactions actually took place during the year under audit.
3. Completeness. Obtain evidence that all the securities purchase transactions
were recorded.
4. Rights. Obtain evidence that the securities are owned by Wesson.
Obligation. Obtain evidence that P500,000 is the amount actually owed on
the loan.
5. Valuation. Obtain evidence of the cost and market value of the securities
held at December 31. Decide whether any writedowns to market are
required by GAAP.
6. Measurement.
7. Presentation and Disclosure. Obtain evidence of the committed nature of
the assets, which should mean they should be in a non-current classification
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like the loan. Obtain evidence that restrictions on the use of the assets is
disclosed fully and agrees with the loan documents.

Case 2. Types of procedures used by auditors in general, with examples:

1. Recalculation by the auditor
* recomputing the client’s calculation of depreciation expense
2. Observation by the auditor
* observation, test-counting of client’s physical inventory-taking
3. Confirmation by letter
* obtaining accounts receivable confirmations
* obtaining client’s lawyer’s letter
4. Inquiry and written representations
* ask client personnel about accounting events
* complete an internal control questionnaire
* obtain written client representation letter
5. Vouching
* find brokers’ invoices and cancelled checks showing agreement with
record amounts for securities investments
6. Tracing
* select a sample of shipping documents and trace them to sales invoices,
sales journal recording and posting to general ledger
7. Scanning
* scan expense accounts for credit entries
* scan payroll check lists for unusually large checks
8. Analytical procedures – any example that fits one of these:
* compare financial information with prior periods
* compare financial information with budgets and forecasts
* study predictable financial information patterns (e.g., ratio analysis)
* compare financial information to industry statistics
* study financial information in relation to nonfinancial information

Case 3. a. An audit confirmation is a written statement to the CPA from someone

outside the enterprise on a fact that a person is qualified to affirm.

b. The two main characteristics a confirmation should possess are:

1. The party supplying the information requested must be knowledgeable
and independent, i.e., he must have knowledge of information of
interest to the auditor and he must be outside the scope of influence of
the organization being audited, and
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2. The auditor must obtain the information directly from the informed
party.

Case 4. 1. Scanning for debit balances in accounts payable

Recalculation of amounts on supporting documents
Vouching of account entries to supporting documents
2. Vouching of policies from expense and prepayment entries
Recalculation of expiration of insurance premium
Analysis of interrelationships – compare insurance coverage to assets
owned and leased
3. Scanning inventory records for “old” last-issue dates
Verbal inquiry – question inventory control personnel about slow-moving
inventory
Vouching – examine journal entries for evidence of actual book write-down
of the specific inventory items
4. Tracing – trace remittance amounts to appropriate customer’s account
Recalculation – recalculate amount of discounts and allowances
Vouching – examine authoritative documents supporting unusual discounts
and/or allowances
5. Observation and examination by the auditor – of the inventory and the
inventory-taking procedures
Confirmation by letter – of inventory held in outside warehouses
Recalculation – of the accuracy cost-flow calculations

Case 5. a. A material decline in sales may indicate unrecorded sales; a decrease in

cost of goods sold may be due to unrecorded purchases; and an increase in
cost of good sold may be the result of omissions from the ending inventory.
An increase or decrease in gross profit will result from any one or a
combination of the above omissions.

b. A decline in the miscellaneous revenue account balance, or the absence of a

previously existing source of miscellaneous revenue, could be attributable
to a failure to record miscellaneous revenue.

c. Unrecorded accounts payable at year-end would cause an increase in

calculated accounts payable turnover.

d. An apparent increase in accounts receivable turnover may, in fact, be the

result of failure to record credit sales transactions.
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e. A higher than average operating return may be indicative of unrecorded
purchases or operating expenses; a lower than average return could result
from unrecorded sales.

Case 6. a. This is an inappropriate application of cost/benefit to auditing. The

second standard of audit field work states that the auditor is to gather
sufficient competent evidential matter to support the audit opinion. If two
or more sets of audit procedures are available for satisfactorily achieving a
set of specific audit objectives, the cost/benefit concept suggests selection
of the least costly set of procedures. In the present instance, the cost
savings from not observing the branch inventories is achieved only at the
sacrifice of obtaining sufficient evidence to support the audit objective
concerning existence of the inventories.

b. This is an appropriate application of the cost/benefit concept. Confirmation

with the trustee, who is an independent third party, achieves the audit
objectives concerning existence and ownership just as satisfactorily as
examination of the securities – and it is a less costly procedure.

Case 7.
1. f 8. n
2. l 9. k
3. h 10. c
4. e 11. a
5. p 12. g
6. m 13. b
7. d 14. j

Case 8.
1. observation
2. inspection (analytical procedures)
3. inspection (examination of documents)
4. inspection (examination of documents)
5. inquiry
6. inspection (mechanical accuracy tests)
7. inspection (examination of documents)
8. confirmation
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