Professional Documents
Culture Documents
Review Questions
6-1
6-5 True, the auditor must rely on management for certain information in the
conduct of his or her 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 GAAP. By accumulating sufficient appropriate
evidence for each audit objective, the overall objective is met. The accumulation
of evidence is accomplished by performing the four phases of the audit.
6-4
Multiple Choice Questions From CPA Examinations
6-19 a. (2) b. (2) c. (1)
6-20 a. (1) b. (2) c. (1)
6-5
and skill.
6-22 (continued)
6-6
6-22 (continued)
made with due professional skill and care in accordance with auditing
standards. A subsequent discovery of fraud, existent during the
period covered by the independent audit, does not of itself indicate
negligence on the auditors part.
c. If an independent auditor uncovers circumstances arousing suspicion
as to the existence of fraud, he or she should weigh the effect of
the circumstances on the opinion on the financial statements. When
the auditor believes that the amount of the possible fraud is
material, the matter must be investigated before an opinion can be
given. The auditor should consider the implications for other
aspects of the audit and discuss the matter with an appropriate
level of management that is at least one level above those involved
and with senior management. Additionally, the auditor should
obtain additional evidential matter to determine whether material
fraud has occurred or is likely to have occurred. The auditor may
suggest that the client consult with legal counsel. Whenever the
auditor has determined that there is evidence that fraud may exist,
that matter should be brought to the attention of the audit committee
(or equivalent), unless the matter is clearly inconsequential.
6-7
6-23
a. b. c.
FINANCIAL
CLASS OF STATEMENT TITLE OF TRANSACTION
TRANSACTIONS BALANCE JOURNAL CYCLE
PURCHASE Purchase returns Acquisitions Acquisition
RETURNS & allowances Journal & Payment
RENTAL Rent revenue Revenue Journal Sales &
REVENUE Collection
6-8
6-24 a.
INCOME STATEMENT
CYCLE BALANCE SHEET ACCOUNTS ACCOUNTS
SALES AND Accounts receivable Sales
COLLECTION Cash Bad debt expense
Notes receivabletrade Interest income
Allowance for doubtful accounts
Interest receivable
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.
6-9
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.
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
f. Disclosures related to sales and Presentation and Occurrence and rights
receivables relate to the entity. disclosure and obligations
6-10
6-26
SPECIFIC BALANCE-
RELATED AUDIT MANAGEMENT
OBJECTIVE ASSERTION COMMENTS
6-11
6-26 (continued)
SPECIFIC BALANCE-
RELATED AUDIT MANAGEMENT
OBJECTIVE ASSERTION COMMENTS
b.
and
6-12
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
6-13
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.
6-14
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
6-15
6-16
6-31 (continued)
as to the fair presentation of the financial statements. Given the
potential biases present when management prepares the financial
statements, the stockholders and creditors must consider the
potential for information risk that might be present. The independent
audit conducted by Gonzalez & Fineberg helps stockholders and
creditors reduce their information risk. Management also benefits by
having the external auditors independently assess the financial
statements even though those statements are prepared by
management. Due to the complexities involved in preparing financial
statements in accordance with generally accepted accounting
principles, the potential for misstatement on the part of management
increases the need for an objective examination of those financial
statements by a qualified independent party.
e. The auditor is responsible for obtaining reasonable assurance that
material misstatements are detected, whether those misstatements
are due to errors or fraud. To obtain reasonable assurance, the
auditor is required to gather sufficient, appropriate evidence. Auditors
chief responsibility to stockholders, creditors, and management is
to conduct the audit in accordance with auditing standards in order
to fulfill their responsibilities of the engagement.
6-17
statements
6-18
Internet Problem 6-1 (continued)
as a whole are free from material misstatement, whether due to fraud
or error, thereby enabling the auditor to express an opinion on
whether the financial statements are prepared, in all material respects,
in accordance with an applicable financial reporting framework and
(b) to report on the financial statements, and communicate as
required by the ISAs, in accordance with the auditors findings.
While there are differences in the wording about the objective
of an audit of financial statements, the overall objectives stated in
U.S. GAAS and the ISAs are the same. Both U.S. GAAS and the
ISAs note that the objective of the audit of financial statements is the
expression of an opinion of whether the financial statements comply,
in all material respects, with accounting standards.
2. What is the objective of an audit of internal control over financial
reporting?
Answer:
Paragraph .03 of PCAOB Auditing Standard 5 states that The auditors
objective in an audit of internal control over financial reporting is to
express an opinion on the effectiveness of the companys internal
control over financial reporting. That standard notes that to form a
basis for an opinion, the auditor must plan and perform the audit to
obtain competent evidence that is sufficient to obtain reasonable
assurance about whether material weaknesses exist as of the date
specified in managements assessment.
3. What defines whether financial statements are fairly stated, and
what defines whether internal control is considered effective? Are
they related?
Answer:
Both U.S. GAAS and international auditing standards define financial
statements as being fairly stated when they are free of material
misstatements. PCAOB Auditing Standard 5 defines internal control
as effective when no material weaknesses exist. These definitions are
related. The presence of a material misstatement generally suggests
the presence of a material weakness, since managements internal
controls over financial reporting failed to detect the material
misstatement. While the presence of a material weakness in internal
control does not automatically mean the financial statements contain
a material misstatement, there is a high likelihood that a material
misstatement could occur.
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6-19