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PREWEEK AP, MAY 2022

DARRELL JOE O. ASUNCION, CPA, MBA

PREWEEK- AUDITING PROBLEMS

DARRELL JOE O. ASUNCION, CPA, MBA

PROBLEM NO. 1

Vira Company engaged you to examine its books and records for the fiscal year ended June 30, 2022. The

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company’s accountant has furnished you not only the copy of trial balance as of June 30, 2022 but also the copy of
company’s balance sheet and income statement as at said date. The following data appears in the cost of goods sold of
the income statement:

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Inventory, July 1, 2021 ₱ 500,000
Add Purchases 3,600,000

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Total goods available for sale 4,100,000
Less Inventory, June 30, 2022 700,000
Cost of goods sold ₱3,400,000

The beginning and ending inventories of the year were ascertained thru physical count except that no reconciling

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items were considered. Even though the books have been closed, your working paper trial balance show all account with
activity during the year. All purchases are FOB shipping point. The company is on a periodic inventory basis.

In your examination of inventory cut-offs at the beginning and end of the year, you took note of the following:
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July 1, 2021

a. June invoices totaling to ₱130,000 were entered in the voucher register in June. The corresponding goods not received
until July.
b. Invoices totaling to ₱54,000 were entered in the voucher register in July but the goods received during June.
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June 30, 2022

c. Invoices with an aggregate value of ₱186,000 were entered in the voucher register in July, and the goods were received
in July. The invoices, however, were date June.
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d. June invoices totaling ₱74,000 were entered in the voucher register in June but the goods not received until July.
e. Invoices totaling ₱108,000 (the corresponding goods for which were received in June) were entered the voucher
register, July.
f. Sales on account in the total amount of ₱176,000 were made on June 30 and the goods delivered at the time. Book
entries relating to the sales were made in June.
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Based on the above and the result of your cut-offs, answer the following:

1. How much is the adjusted Inventory as of July 1, 2021?

a. ₱500,000 c. ₱576,000
b. ₱630,000 d. ₱370,000

2. How much is the adjusted Purchases for the fiscal year ended June 30, 2022?
a. ₱3,840,000 c. ₱3,894,000

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PREWEEK AP, MAY 2022

b. ₱3,600,000 d. ₱3,914,000

3. How much in the adjusted Inventory as of June 30, 2022?

a. ₱784,000 c. ₱892,000
b. ₱500,000 d. ₱960,000

4. How much is the adjusted Cost of Goods Sold for the fiscal year ended June 30, 2022?
a. ₱3,316,000 c. ₱3,510,000
b. ₱3,970,000 d. ₱3,564,000

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5. The necessary compound adjusting journal entry as of June 30, 2022 would include a net adjustment to Retained
Earnings of
a. ₱130,000 c. ₱76,000
b. ₱184,000 d. ₱54,000

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PROBLEM NO. 2

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In connection with your audit of the Investments account of Bantug Corporation, you noted that the company purchased
30% of the outstanding ordinary shares of Luna Corporation for ₱1,290,000 on January 2, 2022. At the date of acquisition
of the shares, Luna Corp.’s net assets had a carrying value of ₱2,950,000. Assets with an average remaining life of 5 years
have a current market value that is ₱650,000 in excess of their carrying values. The remaining difference between the
purchase price and the value of the underlying sharesholders’ equity cannot be attributed to any identifiable tangible or
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intangible asset. At the end of 2022, Luna Corp. reported net income of ₱900,000. Luna Corp. declared and paid cash
dividends of ₱100,000.
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Based on the above and the result of your audit, determine the following:

1. The entry to amortize the excess of cost attributable to the undervalued assets will include
a. A debit to Investment in Associate of ₱39,000.
b. A debit to Investment Income of ₱39,000
c. A credit to Investment in Associate of ₱130,000.
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d. No entry.

2. The entry to amortize the remaining excess of cost over the carrying value of the net assets acquired will include
a. A debit to Investment Income of ₱10,500.
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b. A debit to Investment Income of ₱42,000

c. A credit to Investment in Associate of ₱35,000
d. No entry.

3. Net investment income for the year 2022 is

a. ₱231,000 c. ₱270,000
b. ₱189,000 d. P 0
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4. Carrying value of Investment in Luna Corp. at December 31, 2022 is

a. ₱1,530,000 c. ₱1,449,000
b. ₱1,491,000 d. ₱1,290,000

5. Which of the following controls would an entity most likely use to assist in satisfying the completeness assertion related
to long-term investments?
a. Senior management verifies that securities in the bank safe deposit box are registered in the entity’s name.
b. The treasurer vouches the acquisition of securities by comparing brokers’ advices with canceled checks.

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PREWEEK AP, MAY 2022

c. The controller compares the current market prices of recorded investments with the brokers’ advices on file.
d. The internal auditor compares the securities in the bank safe deposit box with recorded investments.

PROBLEM NO. 3
In connection with your audit of the financial statements of Seanne Corp. for the year ended December 31,2010, you
conducted a surprise count of the company’s petty cash fund and undeposited collections at 8:20 a.m. on January 3,
2011. Your count disclosed the following:

Bills and Coins

Bills Coins

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₱100.00 5 pieces 5.00 18 pieces
50.00 40 pieces 1.00 206 pieces
20.00 48 pieces 0.25 32 pieces

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Postage stamps (unused) – ₱365

Checks

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Date Payee Maker Amount

Dec. 30 Cash Custodian ₱ 1,200

Dec. 30 Seanne Corp. SLV, Inc. 14,000
Dec. 31 Seanne Corp. Mario Lansang,

Dec. 31
Dec. 31
Dec. 31
Seanne Corp.
Seanne Corp.
Taiwan Corp.
MSU Corp
Ateneo, Inc.
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Sales manager 1,680
17,800
8,300
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(not endorsed) Seanne Corp. 27,000

Unreimbursed Vouchers

Date Payee Description Amount

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Dec. 23 Mario Lansang, Advance for trip to ₱ 20,000

Sales manager Tagaytay City 14,000
Dec. 28 Central Post Office Postage stamps, 1,620
Dec. 29 Messengers Transportation 150
Dec. 39 Byte, Inc. Computer repair 800
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Other items found inside the cash box:

1. Unclaimed pay envelope of Juan MacDonut. Indicated on the pay slip is his net salary of ₱7,500. Your inquiry revealed
that Juan’s salary is mingled with the petty cash fund.
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2. The sales manager’s liquidation report for his Tagaytay City trip.
Cash advance received on December 23 ₱20,000
Less: Hotel accommodation, meals, etc. 16,000
Bus fare for two 1,200
Cash given to Pablo, salesman 1,000 18,200
Balance ₱1,800

Additional information:

1. The custodian is not authorized to cash checks.

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2. The last official receipt included in the deposit on December 30 is No. 4351 and the last official receipt issued for the
current year is No. 4355. The following official receipts are all dated December 31, 2010.

OR No. Amount Form of Payment

4352 ₱ 13,600 Cash
4353 17,800 Check
4354 3,600 Cash
4355 8,300 Check

3. The petty cash balance per general ledger is ₱25,000. The last replenishment of the fund was made on December 22,

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2010.

1. What is the amount of shortage due from the sales manager?

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a. ₱240
b. ₱1,800
c. ₱120

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d. P 0

2. What is the amount of undeposited collections on December 31, 2010?

a. ₱44,300
b. ₱84,300
c. ₱57,300
d. ₱41,000
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3. The adjusting entries on December 31, 2010 should include a net debit to Travel Expenses of
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a.₱17,320
b.₱18,320
c.₱18,200
d.₱18,080
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4. What is the total unreimbursed vouchers on January 3, 2011 (count date)?

a. ₱22,450
b. ₱22.085
c. ₱22,570
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d. ₱22,205

5. What is the total cash shortage?

a. ₱22,166
b. ₱8,166
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c. ₱22,406
d. ₱20,486
6. A cash shortage may be concealed by transporting funds from one location to another or by converting negotiable
assets to cash. Because of this, which of the following is vital?
a. Simultaneous confirmations.
b. Simultaneous bank reconciliations.
c. Simultaneous verification.
d. Simultaneous surprise cash count.

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7. When conducting surprise cash count, the auditor should simultaneously count all cash funds, marketable securities
and other negotiable assets to prevent
a. Time-out c. Substitution
b. Defalcation d. Misappropriation

PROBLEM NO. 4
The Accounts Receivable control account balance of Bryan King Inc. was ₱215,300 as of December 31, 2018. The
subsidiary ledger accounts of the company are summarized below. Credit terms are 60 days net.

Account

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No. Date Debit Credit Balance
1 May 31 ₱ 5,000 ₱ 5,000
July 1 ₱ 3,000 2,000

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7 5,000 7,000
Sept. 1 3,000 4,000
25 8,000 12,000
Nov. 1 3,000 9,000

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Dec. 10 3,000 12,000

2 Aug. 8 8,400 8,400

Oct. 4 8,400 0
Nov. 25 22,000 22,000

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Jan. 1
Mar.1
120,000
121,200
120,000
(1,200)
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(Two month, 6%
note)
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Dec. 1 100,000 98,800
(Two month, 6%
note)

4 Feb. 3 10,000 10,000

Aug. 3 10,000 20,000
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5 Feb. 10 30,000 30,000

Apr. 9 30,000 0
May 4 40,000 40,000
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July 2 40,000 0
Sept. 6 52,780 52,780
Nov. 26 2,220 55,000

6 July 17 5,000 5,000

Aug. 16 4,440 9,440
Sept. 30 7,500 16,940
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Oct. 15 9,440 7,500

Oct. 18 6,000 13,500
Dec. 20 6,000 7,500

The provision for Doubtful Account before audit has a credit balance of ₱5,000. The provision for Doubtful accounts is to
be adjusted to a balance determined as follows:

Accounts not due ½ of 1 percent

Accounts 1-60 days past due 2 percent

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Accounts 61-120 days past due 5 percent

Accounts over 120 days past due 50 percent

The provision is to be based only on the trade accounts. Except where payments are earmarked, the oldest items are paid
first.

Questions:
From the information presented, compute the adjusted balances of the following accounts:
1. Trade accounts receivable at the end of 2018
a. ₱215,300 c. ₱216,500
b. ₱131,200 d. ₱116,500

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2. Allowance for bad debts at the end of 2018.
a. ₱6,402 c. ₱7,052

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b. ₱2,052 d. ₱5,000

3. Bad debts expense in 2018.

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a. ₱6,402 c. ₱7,052
b. ₱2,052 d. ₱5,000

4. Interest income in 2018?

a. ₱500 c. ₱1,200
b. ₱400 d. ₱1,700
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3 -15.For each financial statement assertion on the left, choose the best match from the audit procedures on the right.
Audit procedure may be used only once.
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1. All cash received is recorded. a. Prepare a proof of cash.
(Lapping is not occurring.) b. Observe separation of duties.
2. Cash recorded as received c. Appropriate procedure is not
was actually received. listed.
3. Customers granted cash d. Obtain a cut-off bank
discounts are entitled to statement and ascertain that
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those granted. deposits listed as in transit

4. Cash is not counted twice by were deposited promptly after
using float. year-end.
e. Compare cash receipts entry
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to deposit ticket receipted by

bank.
f. Prepare a bank transfer
schedule.
g. Review the bank
reconciliation.
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3 -16. The following questions relate to tests of controls. Choose the best response.
1) To determine whether an entity’s internal control operated effectively to minimize errors of failures to post invoices
to the Customer’s accounts ledger, the auditor would select a sample of transactions from the population
represented by the
a. Customer order file
b. bill of lading file.

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c. subsidiary Customer’s account ledger.

d. sales invoice file.
2) To gather audit evidence that uncollected items in Customer’s accounts represented valid trade receivables, the
auditor would select a sample of items from the population represented by the
a. Customer order file
b. bill of lading file.
c. subsidiary Customer’s account ledger.
d. sales invoice file.
3) Tracing bills of lading to sales invoices will provide evidence that
a. recorded sales were shipped.

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b. invoiced sales were shipped.
c. shipments to Customers were invoiced.
d. shipments to Customers were recorded as sales.
4) Tracing copies of sales invoices to shipping documents will provide evidence that all

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a. shipments to Customers were recorded as receivables.
b. billed sales were shipped.
c. debit to the subsidiary accounts receivable ledger are for sales shipped.

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d. shipments to Customer were billed.

3–17. The following questions relate to internal controls. Choose the best response.
1) To achieve good internal control, which department should perform the activities of matching shipping documents
with sales orders and preparing daily summaries?
a. Billing
b. Shipping
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c. Credit
d. Sales order
2) Which of the following would the auditor consider to be an incompatible operation for a cashier if the cashier
receives remittances from the mailroom?
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a. Posting the receipts to the account s receivable subsidiary ledger cards.
b. Making the daily deposit at the local bank.
c. Preparing the daily deposit.
d. Endorsing the checks,
3) The most likely result of ineffective internal controls in the sales cycle is that
a. fictitious transactions could be recorded, causing an understatement of revenues and an overstatement of
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receivables.
b. irregularities in recording transactions in the subsidiary accounts could delay the shipment of goods.
c. omission of shipping documents could go undetected, causing an understatements of inventory.
d. final authorization of credit memos by personnel in the sales department could permit an employee defalcation
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scheme.
4) For the most effective internal control, monthly bank statements should be received directly from the banks and
reviewed by the
a. controller c. cash disbursements accountant
b. cash receipts accountant d. internal auditor
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3–18. The following questions relate to the sales and collections cycle. Choose the best response.
1) Which of the following describes the most effective preventive control to ensure proper handling of cash receipt
transactions?
a. Have bank reconciliation prepared by an employee not involved with cash collections and then have them
reviewed by a supervisor.
b. Have one employee issue a pre numbered receipt for all cash collections; have another employee match daily
totals of pre numbered receipts to bank deposits.
c. Use predetermined totals (hash totals) of cash receipts to control posting routines.

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d. Have the employee who receives Customer mail prepare the daily bank deposit; have another employee
actually make the deposit.
2) As payments are received, one mailroom employee is assigned the responsibility of prelisting receipts and
preparing the deposit slip prior to forwarding the receipts, the deposit slip, and the remittance advices to the
accounts receivable for posting. Accounts receivable personnel re-foot the deposit slip, stamp a restrictive
endorsement on the bank of each check, and then forward the receipts and the deposit slip to the treasury
department. Which of the following is a reasonable assessment of internal control in this process?
a. Internal control is adequate.
b. Internal control is inadequate because mailroom employees should not have access to cash.
c. Internal control is inadequate because treasury employees should prepare the deposit slip.

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d. Internal control is inadequate because of lack of segregation of duties.
3) For effective internal control, employees maintaining the accounts receivable subsidiary ledger should not also
approve
a. employee overtime wages

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b. credit granted to Customers.
c. write-offs of Customer’s accounts.
d. cash disbursements.

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4) During an audit of the accounts receivable function, you found that the accounts receivable turnover rate had
fallen from 7.3 to 4.3 over the last three years. What is the most likely cause of the decrease?
a. An increase in the discount offered for early payment.
b. A moral liberal credit policy.
c. A change from net 30 to net 25.
d. Greater cash sales.
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3-19. The following questions relate to auditing the sales and collection cycle. Choose the best response.
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1) Shipping documents should be traced to and compared with sales records or invoices to
a. determine whether payments are properly applied to Customer’s accounts.
b. ensure that shipments are billed to Customers.
c. determine whether unit prices billed are in accordance with sales contracts.
d. ascertain whether all sales are supported by shipping documents.
2) An auditor noted that the accounts receivable department is separate from other accounting activities. Credit is
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approved by a separate credit department. Control accounts and subsidiary ledgers are balanced monthly. The
accounts receivable manager writes off delinquent accounts after one year or sooner. If a bankruptcy or other
unusual circumstance is involved. Credit memoranda are pre numbered and most correlate with receiving reports.
Which of the following areas could be viewed as an internal control weakness of the above organization?
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a. Write offs or delinquent accounts

b. Credit approvals
c. Monthly aging of receivables
d. Handling of credit memos.
3) Checks from Customers are received in the company mailroom each day. Which of the following controls should
be in place to safeguard them?
a. Establish a separate post office box for Customer payments.
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b. Forward all cash to the cashier upon receipt.

c. Require a specific mail clerk to list and restrictively endorse each check.
d. provide bonding protection for mail clerks.

4-6. The following questions relate to auditing the expenditure cycle. Choose the best response.
1) An auditor usually examines receiving reports to support entries in the
a. voucher register and sales returns journal.

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b. sales journal and sales returns journal.

c. voucher register and sales journal.
d. check register and sales journal.
2) An internal control questionnaire indicates that an approved receiving report is required to accompany every
check request for payment of merchandise. Which of the following procedure provides the greatest assurance
that this control is operating effectively?
a. Select and examine canceled checks, and ascertain that the receiving reports are dated no earlier than the
checks.
b. Select and examine canceled checks, and ascertain that the receiving reports are dated no later than the
checks.

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c. Select and examine receiving reports, and ascertain that the related canceled checks are dated no earlier than
the receiving reports.
d. Select and examine receiving reports, and ascertain that the related canceled checks are dated no later than
the receiving reports.

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3) The accounts payable department receives the purchase order to accomplish all the following except
a. comparing the invoice price to the purchase order price.
b. ensuring that the purchase had been properly authorized.

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c. ensuring that the goods had been received by the party requesting them.
d. comparing the quantity ordered to the quantity purchased.

4-7. The following questions relate to internal control for acquisitions and disbursements. Choose the best response.

b. Treasurer
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1) For effective internal control, which of the following individuals should be responsible for mailing singed checks?
a. Receptionist c. Accounts payable clerk
d. Payroll clerk
2) If internal control is properly designed, the same employee should not be permitted to
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a. sign checks and cancel supporting documents.
b. receive merchandise and prepare a receiving report.
c. prepare disbursement vouchers and sign checks.
d. initiate a request to order a merchandise and approve merchandise ordered.
3) In a properly designed accounts payable system, a voucher is prepared after the invoice, purchase order;
requisition and receiving report have been verified. The next step in the system is to
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a. cancel the supporting documents.

b. enter the check amount in the check register.
c. approve the voucher for payment.
d. post the voucher amount to the expense ledger.
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4-8. The following questions relate to the expenditure cycle. Choose the best response.
1) You are auditing the December 31, 2005, accounts payable balance of one of your firm’s divisions. The division
controller’s office has provided you with a schedule listing the creditors and the amount owed to each at
December 31, 2005. Which of the following audit procedures would be your best choice for determining that no
individual account payable has been omitted from the schedule?
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a. Send confirmation requests to randomly selected samples of creditors listed on the schedule.
b. Send confirmation requests to creditors that are listed on the schedule but not listed on the corresponding
December 31, 2004, schedule.
c. Examine support for selected January 2006 payments to creditors, ascertaining that those relating to 2006 are
not on the schedule.
d. Examine support for selected January 2006 payments to creditors, ascertaining that those relating to 2005 are
not on this schedule.

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2) A company uses an automated accounts payable system to process its disbursements. An internal auditor wants
to reconcile the accounts payable balance listed in the firm’s month0end trial balance report to the master
accounts payable file, which is stored on magnetic tape. Which of the following application audit techniques would
be most appropriate to this task?
a. Use general-purpose audit software to recompute the file balance.
b. Review a listing of the accounts payable program source code.
c. Develop and use accounts payable data.
d. Prepare an analytic audit flowchart of the automated accounts payable system.
3) A preliminary survey of the purchasing function indicates the following:

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Department managers initiate purchase requests, which must be approved by the plant superintendent.
• Purchase orders are typed by the purchasing department by using the pre-numbered and controlled
forms.
• Buyers regularly update the official vendor listing as new sources of supply become known.

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• Rush orders can be placed with a vendor by telephone but must be followed by a written purchase order
before delivery can be accepted.
• Vendor invoice payment requests must be accompanied by a purchase order and a receiving report.

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One possible fault of this system is that
a. purchases can be made at prices higher than normal from a vendor controlled by a buyer.
b. unnecessary supplies can be purchased by department managers.
c. payment can be made for supplies not received.

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d. payment can be made for supplies received but not ordered by the purchasing department.

4) Which of the following controls could be used to detect bank deposits that are recorded but never made?
a. Establishing accountability for receipts at the earlier possible time.
b. Linking receipts to other internal accountabilities (i.e., collections to either accounts receivable or sales.)
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c. Consolidating cash receiving points.
d. Having a third party perform bank reconciliations.

5) The treasurer makes disbursements by check and reconciles the monthly bank statements to accounting records.
Which of the following best describes the control impact of this arrangement?
a. Internal control will be enhanced because these are duties a treasurer should perform.
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b. The treasurer will be in a position to make and conceal unauthorized payments.

c. The treasurer will be able to make unauthorized adjustments to the cash accounts.
d. Controls will be enhanced because the treasurer will have two opportunities to discover inappropriate
disbursements.
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6) To minimize the risk that agents in the purchasing department will use their positions for personal gain, the
organization should
a. rotate purchasing agent assignments periodically.
b. request internal auditors to confirm selected purchases and accounts payable.
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c. specify that all items purchased must pass review of value per unit cost.
d. direct the purchasing department to maintain records on purchase prices paid, with review of such being
required each six months.

7) In an audit of a purchasing department, which of the following would ordinarily be considered as risk factor?
a. Purchase specifications are developed by the department requesting the material.
b. Purchases of certain types of items are made against blanket or open purchase orders.
c. Purchases are made from parties related to buyers or other company officials.
d. Purchases are not rotated among suppliers included on an approved vendor list.

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4-9. These questions pertain to basic features of internal control over acquisitions and cash disbursements transactions.
Choose the best response.
1) A client erroneously a large purchase twice. Which of the following internal accounting control measures would
be most likely to detect this error in a timely and efficient manner?
a. Footing the purchases journal.
b. Reconciling vendor’s monthly statements with subsidiary payable ledger accounts.
c. Tracing totals from the purchases journal to the ledger accounts.
d. Sending written quarterly confirmations to all vendors.

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2) For effective internal control purposes, which of the following individuals should be responsible for mailing
signed checks?
a. Receptionist c. Accounts payable clerk
b. Treasurer. d. Payroll clerk

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3) The accounts payable department receives the purchase order form to accomplish all of the following except
a. Compare invoice price to purchase order price.
b. Ensure the purchase had been properly authorized.

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c. Ensure the goods had been received by the party requesting the goods.
d. Compare ordered to quantity purchased.

4-10. These questions involve the study and evaluation of internal control over acquisitions and cash disbursements
transactions. Choose the best response.
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1) In examining cash disbursements, an auditor plans to choose a sample using a systematic selection with random
start. The primary advantage of such a systematic selection is that population items.
a. Which include irregularities will not be overlooked when the auditor exercises compatible reciprocal options.
PA
b. May occur in a systematic pattern, thus making the sample more representative.
c. May occur more than once in a sample.
d. Do not have to be pre-numbered in order for the auditor to use the technique.
2) A client’s material purchasing cycle begins with requisitions from user departments and end with the receipt of
materials and the recognition of a liability. An auditor’s primary objective in reviewing this cycle is to
a. Evaluate the reliability of information generated as a result of the purchasing process.
C

b. Investigate the physical handling and recording of unusual acquisitions of materials.

c. Consider the need to be on hand for the annual physical count if this system is not functioning properly.
d. Ascertain that materials said to be ordered, and paid for are on hand.
EO

4-12. The following questions deal with internal control over acquisitions and cash disbursements. Choose the best
response.
1) To avoid potential errors and irregularities, a well-designed internal control structure in the accounts payable area
should include a separation of which of the following functions?
a. Invoice verification and data entry into the computer.
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b. Invoice verification and merchandise ordering.

c. Physical handling of merchandise received and preparation of receiving reports.
d. Check signing and cancellation of payment documentation.
2) Which of the following is a standard internal control for each disbursement?
a. Checks should be signed by the controller and at least one other employee of the company.
b. Checks should be sequentially numbered and the numerical sequence should be accounted for by the person
preparing bank reconciliations.
c. Checks and supporting documents should be marked “paid” immediately after the check is returned with the
bank statement.

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d. Checks should be resent directly to the payee by the employee who prepares documents that authorize check
preparation.

5-6. The following questions relate to the payroll and personnel cycle. Choose the best response.
1) The auditor can observe the distribution of paychecks to ascertain whether
a. pay rate authorization is properly separated from the operating function.
b. deductions from gross pay are calculated correctly and are properly organized.
c. employees of record actually exist and are employed by the client.
d. paychecks agree with the payroll register and the time cards.

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2) Mary Corp. has changed from a system in which time worked is recorded on cards to a computerized payroll
system in which employees’ record time in and out with magnetic cards. The system automatically updates all
payroll records. Because of this change,
a. the auditor must use a generalized computer audit program.

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b. part of the audit trail is altered.
c. the potential for payroll-related fraud is diminished.
d. transactions must be processed in batches

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5-7. The following questions relate to warehousing activities. Choose the best response.
1) In a manufacturing company, which one of the following audit procedures would give the least assurance of the
valuation of inventory at the audit date?

b. Examining paid vendor’s invoices.

c. Reviewing direct labor rates.
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a. Testing the computation of standard overhead rates.

d. Obtaining information of inventories pledged under loan agreements.

PA
2) When auditing merchandise inventory at year end, the auditor performs a purchase a purchase cutoff test to
obtain evidence concerning whether
a. all goods purchased before year-end are received before the physical inventory count.
b. any goods hold in consignment for Customers are included in the inventory balance.
c. any goods observed during the physical count are pledged or sold.
d. all goods owned at year-end are included in the inventory balance.
C

3) An auditor has accounted for a sequence of inventory tags and is going to trace information on a representative
number of tags to the physical inventory sheets. The purpose of this procedure is to obtain assurance that
a. the final inventory is values at cost.
b. all inventory represented by an inventory tag is listed on the inventory sheets.
EO

c. all inventory represented by an inventory tag is a bona fide.

d. inventory sheets do not include untagged inventory items.
4) The physical count of retailer’s inventory was higher than that 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 and not been taken off the items and
added to the inventory accumulation sheets.
b. Credit memos for several items returned by Customers had not been recorded.
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c. No journal entry had been made on the retailer’s books for several items returned to suppliers.
d. An item purchased FOB shipping point had not arrived at the date of the inventory count and had not been
reflected in the perpetual records.

5-8. The following questions relate to the production activities. Choose the best response.
1) An auditor’s tests of controls over the issuance of raw materials to production would probably include
a. reconciling raw materials and work-in process perpetual inventory.
b. inquiring of the inventory custodian about the procedures followed when defective materials are received from

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vendors.
c. observing that raw material are stored in secure areas and that storeroom security is supervised by a
responsible person.
d. examining material requisitions and re-performing client controls designed to process and record issuances.
2) Which of the following is a question that the auditor would expect to find on the production cycle section of an
internal control questionnaire?
a. Are vendors’ invoices for raw materials approved for payment by an employee who is independent of the cash
disbursements function?
b. Are signed checks for the purchase of raw materials mailed directly after signing without being returned to the
person who authorized the invoice processing?

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c. Are all releases by custodians of raw material from storage based on approved requisition documents?
d. Are details of individual disbursements for raw materials balanced with the total to be posted to the appropriate
general ledger account?

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5-9. The following questions relate to warehousing activities. Choose the best response.
1) An auditor examining inventory out on consignment is faced with the following situation. Goods are located in

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small quantities at a variety of locations throughout the country and cannot be observed. An attempt at obtaining
positive conformations from consignees drew an 80% non response rate; the other 20% confirmed the statement
balance. Given these constraints, what is the best evidence the auditor can use to support the balance sheet
value for inventory out on consignment?
a. Bills of lading adjusted for payments received.
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b. Analytical evidence comparing previous years’ figures with those for the current year.
c. Copies of memorandum invoices sent to consignees.
d. Analytical evidence comparing consignments-out to consignments-in.
2) Which of the following is the most important internal control relating to the raw material inventory of a
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manufacturing company?
a. The physical inventory count should be made by personnel independent of the inventory custodians.
b. Materials from vendors should be received directly by the production department that will be using the
materials.
c. Shortages in shipments from vendor should immediately be reported to the production department that will be
using the materials.
C

d. Issues from inventory should be supported by sales invoices.

5-10. The following questions relate to the payroll and personnel cycle. Choose the best response.
EO

1) An audit of the payroll function showed that on several occasions a payroll clerk had added bogus employees to
the payroll and deposited the checks in accounts of friends and relatives. What controls should have prevented
the occurrence of such irregularities?
a. Using time cards and attendance records in the computation of employee gross earnings
b. Requiring the preparation of a voucher for the payment of payroll
c. Having the treasurer’s office sign and distribute payroll checks
d. Allowing changes to the payroll to be authorized by the personnel department
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2) Which of the following activities performed by a factory supervisor is control strength rather than a control
weakness?
a. Setting the pay rate for production workers
b. Preparing a job time report that summarizes regular and overtime hours
c. Distributing paychecks to the production workers
d. Returning any unclaimed payroll checks to the payroll clerks
3) One payroll audit objective is to determine whether there is proper segregation of duties. Which of the following
activities are incompatible?
a. Hiring employees and authorizing changed to pay rates

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b. Preparing the payroll and filing payroll tax forms

c. Signing and distributing payroll checks
d. Preparing attendance data and preparing the payroll
4) Management is concerned with the potential for unauthorized changes to the payroll. Which of the following is the
proper organizational structure to prevent such unauthorized changes?
a. The payroll department maintains and authorizes all changes to the personnel records.
b. The payroll department is supervised by the management of the human resources division
c. The payroll department’s functions are limited to maintaining the payroll records, distributing paychecks, and
posting the payroll entries to the general ledger
d. The personnel department authorizes the hiring and pay levels of all employees

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5) Which of the following controls would be the most appropriate means to ensure that terminated employees have
been removed from the payroll?
a. Mailing checks to employees’ residences
b. Establishing direct-deposit procedures with employees’ banks

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c. Reconciling payroll and time keeping records
d. Establishing computerized limit checks on payroll rates
6) A means of ensuring the payroll checks are drawn from properly authorized amounts is to

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a. conduct periodic floor verification of employees on the payroll.
b. require that undelivered checks be returned to the cashier.
c. require supervisory approval of time cards.
d. witness the distribution of payroll checks.

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6-12. The following questions relate to the audit of plant, property and equipment. Choose the best response.
1) The audit procedure of analyzing the repairs and maintenance accounts is designed primarily to provide evidence
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in support of the audit proposition that all
a. expenditures for fixed assets have been recorded in the proper period.
b. capital expenditures have been properly expensed.
c. noncapitalizable expenditures have been properly expensed.
d. expenditures for fixed assets have been capitalized.
2) When an entity has few property and equipment transactions during the year, the continuing auditor usually
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carries out
a. a complete review of the related internal controls and performs tests of controls on which the entity relies.
b. a complete review of the related internal controls and performs analytical review tests to verify current-year
additions to property and equipment.
EO

c. a preliminary review of the related internal controls and performs a thorough examination of the balances at the
beginning of the year.
d. a preliminary review of the related internal controls and performs extensive tests of current-year property and
equipment transactions.
3) An auditor may conclude that depreciation charges are insufficient if he or she notes
a. large amounts of fully depreciated assets.
b. continuous trade-ins of relatively new assets.
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c. excessive recurring losses on retired assets.

d. insured values greatly in excess of book values.
4) In violation of company policy, Lilac Company erroneously capitalized the cost of painting its warehouse. The
auditor examining Lilac’s financial statements would be most likely to detect this when
a. discussing capitalization policies with Lilac’s controller.
b. examining maintenance expense accounts.
c. noting, while observing the physical inventory being taken, that the warehouse had been painted.
d. examining the construction work orders supporting items capitalized during the year.

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5) Equipment acquisitions that are misclassified as maintenance expense most likely would be detected by an
internal control that provides for
a. segregation of duties of employees in the accounts payable department.
b. independent verification of invoices for disbursements recorded as equipment acquisitions.
c. investigation of variances within a formal budgeting system.
d. authorization by the board of directors of significant equipment acquisitions.

6-13. The following questions relate to the investing and financing cycle. Choose the best response.
1) A company holds bearer bonds as a short-term investment. Responsibility for the custody of these bonds and for

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the submission of coupons for periodic interest collections probably should be delegated to the
a. chief accountant c. cashier
b. internal auditor d. treasurer
2) A company had temporarily excess funds to invest. The board of directors decided to purchase marketable

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securities, and it assigned the future purchase and sales decisions to a responsible financial executive. The best
person(s) to make periodic reviews of the investment activity would be the
a. investment committee of the board of directors.

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b. treasurer
c. corporate controller.
d. chief operating officer.
3) If an auditor is unable to inspect and count a client’s investment securities until after the balance sheet date, the
bank in which the securities are held in a safe deposit box should be asked to
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a. verify any differences between the contents of the box and the balances in the client’s subsidiary ledger.
b. provide a list of securities added to and removed from the box between the balance sheet date and the security
count date.
c. confirm that there has been no access to the box between the balance sheet date and the security count date.
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d. count the securities in the box so the auditor will have an independent direct verification.
4) Which of the following would provide the best form of evidence pertaining to the annual valuation of a long-term
investment in which the independent auditor’s client owns a 30 percent voting interest?
a. Market quotations of the investee company’s shares.
b. Current fair value of the investee company’s assets.
c. Historical cost of the investee company’s assets.
C

d. Audited financial statements of the investee company.

5) If a corporation employs no independent share transfer agents, and it issues its own shares and maintains its
share records, canceled share certificates should
a. be defaced to prevent reissuance and be reattached to their corresponding stubs.
EO

b. not be defaced but should be segregated from other share certificates and be retained in a canceled
certificates file.
c. be destroyed to prevent fraudulent reissuance.
d. be defaced and be sent to the government that issued the corporate charter.
6) Which if the following controls is most likely to prevent the improper disposition of equipment?
a. Separating duties between those authorized to dispose of equipment and those authorized to approve removal
work orders.
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b. Using serial numbers to identify equipment that could be sold.

c. Periodically comparing removal work orders with authorizing documentation.
Periodically analyzing scrap sales and the repairs and maintenance accounts.

6-14. The following questions relate to investing in property, plant, and equipment. Choose the best response.
1) An auditor could most efficiently test for the misclassification of capital acquisitions expenditures by
a. taking a physical tour of plant facilities before starting an audit.
b. reviewing company capital acquisition policies with purchasing personnel.

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c. tracing capital additions back to source documents.

d. scanning repair and maintenance records and investigating large peso-value entries.
2) The most significant audit step in substantiating additions to office furniture is
a. examining vendor’s invoices and receiving reports for current-year acquisitions.
b. reviewing transactions near balance sheet date for proper period cutoff.
c. calculating ration of depreciation expense to gross office equipment cost.
d. computing current-year acquisitions to prior-year acquisitions.
3) One control objective of the investing and financing cycle is the proper authorization of company transactions
dealing with debt and equity instruments. Which of the following controls would best meet this objective?
a. Separating responsibility for custody of funds from responsibility for recording the transactions

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b. Maintaining written company policies that require the board of directors to review major funding or repayment
proposals
c. Using an underwriter in all cases of issue of debt or equity instruments
d. Requiring two signatures on all organization checks of a material amount

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6-15. The following questions relate to investing in debt and equity securities. Choose the best response.
1) A company makes a practice of investing excess short-term cash in marketable securities. A reliable test of the

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valuation of those securities is
a. comparing cost data with current market quotations.
b. confirming securities held by the broker.
c. recalculating investment carrying value using the equity method.
d. calculating premium or discount amortization.
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2) A company invests material amounts of idle cash in marketable securities. The auditor has reason to believe that
suboptimal use is being made of the idle cash. Which of the following procedure would provide the most reliable
evidence to this concern?
a. Computing rate of return earned on investments and comparing it with alternative investments
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b. Reviewing minutes of the meeting of the company’s investment committee
c. Confirming the security transactions and income received by contacting the company’s independent share
brokers
d. Comparing actual with budgeted investment income earned
3) No employee should be able to visit the corporate safe deposit box containing investment securities without being
accompanied by another corporate employee. What consequence might follow if this rule were not enforced?
C

a. An employee could pledge corporate investments as security for short term personal bank loan.
b. An employee could steal securities and the theft would never be discovered
c. It would be impossible to get a fidelity bond on the employee.
d. There would be no record of when company personnel visited the safe deposit box.
EO

4) In establishing the existence and ownership of a long-term investment in the form of publicly traded shares, an
auditor should inspect the securities or
a. correspond with the investee company to verify the number of shares owned.
b. inspect the audited financial statements of the investee company.
c. confirm the number of shares owned that are held by an independent custodian.
d. determine that the investment is carried at the lower of cost or market.
R

6-16. The following multiple-choice questions concern interest-bearing liabilities. Choose the best response.
1) The auditor’s program for the examination of long-term debt should include steps that require the
a. verification of the existence of the bondholders.
b. examination of any bond trust indenture.
c. inspection of the accounts payable master file.
d. investigation of credits to the bond interest income account.
2) During the year under audit, a company has completed a private placement of a substantial amount of bonds.
Which of the following is the most important step in the auditor’s program for the examination of bonds payable?
a. Confirming the amount issued with the bond trustee.

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b. Tracing the cash received from the issue to the accounting records.
c. Examining the bond records maintained by the transfer agent.
d. Re-computing the annual interest cost and the effective yield.
3) Several years ago, Conway Inc., secured a real estate mortgage loan. Which of the following procedures would
be least likely to be performed by an auditor examining the mortgage balance?
a. Examine the current year’s checks.
b. Review the mortgage amortization schedule.
c. Inspect public records of lien balances.
d. Re-compute mortgage interest expense.

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9-9. Select the best answer for each of the following items:
a. Which of the following is the best audit procedure for the discovery of damaged merchandise in a client’s ending
inventory?

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1. Compare the physical quantities of slow-moving items with corresponding quantities of the prior year.
2. Observe merchandise and raw materials during the client’s physical inventory taking.
3. Review management’s inventory representation letter for accuracy.

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4. Test overall fairness of inventory values by comparing the company’s turnover ratio with the industry average.
b. When verifying debits to the perpetual inventory records of a nonmanufacturing company, an auditor would be
most interested in examining a sample of purchase:
1. Approvals. 3. Invoices.
2. Requisitions. 4. Orders.

c.

1.
auditor should review and test the:
Terms of the open purchase orders.
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To best ascertain that a company has properly included merchandise that it owns in its ending inventory, the
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2. Purchase cutoff procedures.
3. Contractual commitments made by the purchasing department.
4. Purchase invoices received on or year-end.

d. The primary objective of a CPA’s observation of a client’s physical inventory count is to:
1. Discover what a client has counted a particular inventory item or group of items.
C

2. Obtain direct knowledge that the inventory exists and has been properly counted.
3. Provide an appraisal of the quality of the merchandise on hand on the day of the physical count.
4. Allow the auditor to supervise the conduct of the count so as to obtain assurance that inventory quantities are
reasonably accurate.
EO

e. An auditor will usually trace the details of the test counts made during the observation of the physical inventory
taking to a final inventory schedule. This audit procedure is undertaken to provide evidence that items physically
present and observed by the auditor at the time of the physical count are:
1. Owned by the client.
2. Not obsolete.
3. Physically present at the time of the preparation of the final inventory schedule.
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4. Included in the final inventory schedule.

f. A CPA examining inventory may appropriately apply sampling for attributes in order to estimate the
1. Average price of inventory items.
2. Percentage of slow-moving inventory items.
3. Peso value of inventory.
4. Physical quantity of inventory items.

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PROBLEM 17-1
The following questions deal with contingent liabilities. Choose the best response.

1. The audit step most likely to reveal the existence of contingent liabilities is
a. A review of vouchers paid during the month following the year-end.
b. Accounts payable confirmation.
c. An inquiry directed to legal counsel.
d. Mortgage-note confirmation.

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2. When obtaining evidence regarding litigation against a client, the CPA would be least interested in determining.
a. An estimate of when the matter will be resolved.
b. The period in which the underlying cause of the litigation occurred.
c. The probability of an unfavorable outcome.

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d. An estimate of the potential loss.

3. The letter of audit inquiry addressed to the client’s legal counsel will not ordinarily be

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a. Sent to a lawyer who was engaged by the audit client during the year and soon thereafter resigned the
engagement.
b. A source of corroboration of the information originally obtained from management concerning litigation,
claims, ad assessments.
c. Limited to references concerning only pending or threatened litigation with respect to which the lawyer has
been engaged.
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d. Needed during the audit of clients whose securities are not registered with SEC.

4. When a contingency is resolved immediately subsequent to the issuance of a report that was qualified with
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respect to the contingency, the auditor should
a. Insist that the client issue revised financial statements.
b. Inform the audit committee that the report cannot be relied upon.
c. Take no action regarding the event.
d. Inform the appropriate authorities that the report cannot be relied upon.
C

PROBLEM 17-2
The following questions concern letters of representation. Choose the best response.
1. A principal purpose of a letter of representation from management is to
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a. Serve as an introduction to company personnel and an authorization to examine the records.

b. Discharge the auditor from legal liability for his examination.
c. Confirm in writing management’s approval of limitations on the scope of the audit.
d. Remind the management of its primary responsibility for financial statements.

2. A representation letter issued by a client

a. Is essential for the preparation of the audit program.
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b. Is a substitute for testing.

c. Does not reduce the auditor’s responsibility.
d. Reduces the auditor’s responsibility only to the extent that it is relied upon.

3. The date of management representation letter should coincide with the

a. Date of the auditor’s report.
b. Balance sheet date.
c. Date of the latest subsequent event referred to in the notes to the financial statements.
d. Date of the engagement agreement.

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4. Management’s refusal to furnish a written representation on a matter the auditor considers essential constitutes
a. Prima facie evidence that the financial statements are not presented fairly.
b. A violation of the Foreign Corrupt Practices Act.
c. An uncertainty sufficient to preclude an unqualified opinion.
d. A scope limitation sufficient to preclude an unqualified opinion.

PROBLEM 17-3

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The following questions deal with review of subsequent events. Choose the best response.
1. Subsequent events for reporting purposes are defined as events that occur subsequent to the
a. Balance sheet date.
b. Date of the auditor’s report.

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c. Balance sheet date but prior to the date of the auditor’s report.
d. Date of the auditor’s report and concerns contingencies that are not reflected in the financial statements.

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2. A major customer of an audit client suffers a fire just prior to completion of the year-end field work. The audit client
believes that this event could have a significant direct effect on the financial statements. The auditor should
a. Advise management to disclose the event in notes to the financial statements.
b. Disclose the event in the auditor’s report.
c. Withhold submission of the auditor’s report until the extent of the direct effect on the financial statement is
known.
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d. Advise management to adjust the financial statements.
3. An example of an event occurring in the period of the auditor’s fieldwork subsequent to the end of the year being
audited that normally would not require disclosure in the financial statements or auditor’s report would be
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a. Decreased sales volume resulting from a general business recession.
b. Serious damage to the company’s plant from a widespread flood.
c. Issuance of a widely advertised share capital issue with restrictive covenants.
d. Settlement of a large liability for considerably less than the amount recorded.

4. With respect to issuance of an audit report that is dual dated for a subsequent event occurring after the
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completion of field work but before issuance of the auditor’s report, the auditor’s responsibility for events occurring
subsequent to the completion of field work is
a. Extended to include all event occurring until the date of the last subsequent event referred to.
b. Limited to the specific event referred to.
EO

c. Limited to all events occurring through the date of issuance of the report.
d. Extended to include all events occurring through the date of submission of the report to the client.

5. Kai has examined the financial statements of Lou Corporation for the year ended December 31, 2005. Although
Kai’s field work was completed on February 27, 2006. Kai’s auditor’s report was dated February 28, 2006, and
was received by the management of Lou on March 5, 2006. On April 4, 2006, the management of Lou asked that
Kai approve inclusion of this report in their annual report to shareholders, which unaudited financial statements for
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the first quarter ended March 31, 2006. Kai approved the inclusion of this auditor’s report in the annual report to
shareholders. Under the circumstances Kai is responsible for inquiring as to subsequent events through occurring
through
a. February 27, 2006.
b. February 28, 2006.
c. March 31, 2006.
d. April 4, 2006.

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PROBLEM 17-4
The field work for the June 30, 2006, audit of Tracy Brewing Company was finished August 19, 2006, and the completed
financial statements, accompanied by the signed audit reports, were mailed September 6, 2006. In each of the highly
material independent events (1 through 9), state the appropriate action (a through 4) for the situation. The alternative
actions are as follows:
a. Adjust the June 30, 2006, financial statements.
b. Disclose the information in a footnote in the June 30, 2006, financial statements.
c. Request the client to recall the June 30, 2006, statements for revision.
d. No action is required.
The events are as follows:

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1. On December 14, 2006, the auditor discovered that a debtor of Tracy Brewing went bankrupt on October 2, 2006.
The sale has taken place on April 5, 2006, but the amount appeared collectible at June 30, 2006 and August 19,
2006.
2. On August 15, 2006, the auditor discovered that a debtor of Tracy Brewing went bankrupt on August 1, 2006. The

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most recent sale had taken place April 2, 2005, and no cash receipts had been received since the date.
3. On December 14, 2006, the auditor discovered that a debtor Tracy Brewing went bankrupt on July 15, 2006 due
to declining financial health. The sale has taken place January 15, 2006.

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4. On August 6, 2006, the auditor discovered that a debtor of Tracy Brewing went bankrupt on July 30, 2006. The
cause of bankruptcy was an unexpected loss of a major lawsuit on July 15, 2006, resulting from a product
deficiency suit by a different Customer.
5. On August 6, 2006, the auditor discovered that a debtor of Tracy Brewing went bankrupt on July 30, 2006, for a
sale that took place July 3, 2006. The cause of the bankruptcy was a major uninsured fire on July 20, 2006.

February 28, 2006.

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6. On May 31, 2006, the auditor discovered an uninsured lawsuit against Tracy Brewing that had originated on

7. On July 20, 2006, Tracing Brewing settled a lawsuit out of court that had originated in 2003 and is currently listed
as a contingent liability.
PA
8. On September 14, 2006, Tracy Brewing lost a court case that had originated in 2005 for an amount equal to the
lawsuit. The June 30, 2006, footnotes state that in the opinion of legal counsel there will be a favorable
settlement.
9. On July 20, 2006, a lawsuit was filed against Tracy Brewing for a patent infringement action that allegedly took
place in early 2006. In the opinion of legal counsel, there is a danger of a significant loss to client.
C

17-4. Tracy Brewing Company

1. D - The amount appeared collectible at the end of the field work.

2. A - The uncollectible amount was determined before end of field work.
EO

3. C - Amount should have been determined to be uncollectible before end of field work, but it was
discovered after the issuance of the statements. The financial statements should have been known to be in error
on 8-20-06.
4. B - The cause of the bankruptcy took place after the balance sheet date, therefore the balance sheet was
fairly stated. Account may be written off as uncollectible at 6-30-06, but they are not required to do so. Footnote
disclosure is necessary because the subsequent event is material.
5. B - The sale took place after the balance sheet date but, since the loss was material and will affect future
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profits, footnote disclosure is necessary.

6. B - The lawsuit originated in the current year, but the amount of the loss is unknown.
7. A - The settlement should be reflected in the 6-30-06 financial statements as an adjustment of current
period income and not a prior period adjustment.
8. D - The financial statements were believed to be fairly stated for 6-30-06 or 8-19-06.
9. B - The cause of the lawsuit occurred before the balance sheet date and the lawsuit should be included in
the 6-30-06 footnotes.

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DO IT YOURSELF DRILLS
1. Which of the following internal control procedures most likely would be used to maintain accurate inventory
records?
a. Perpetual inventory records are periodically compared with the current cost of individual inventory items.
b. A just-in-time inventory ordering system keeps inventory levels to a desired minimum.
c. Requisitions, receiving reports, and purchase orders are independently matched before payment is
approved.
d. Periodic inventory counts are used to adjust the perpetual inventory records.

(d) Accurate inventory records would reflect actual quantities in existence. If a company periodically counts inventory and

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adjusts the perpetual inventory records accordingly, those inventory records are likely to be accurate. Answer (a) is
incorrect because current cost may not be the basis used to value inventory; a company may be using last-in-first-out,
standard costs, lower of cost or market, etc. Answer (b) addresses management's concern about excessive inventory
levels, not the accuracy of inventory records. Answer (c) is a procedure that relates to the accuracy of amounts paid

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to vendors.

2. An auditor tests an entity's policy of obtaining credit approval before shipping goods to customers in support of

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management's financial statement assertion of
a. Valuation or allocation. b. Completeness.
c. Existence or occurrence. d. Rights and obligations.

(a) The valuation or allocation assertion concerns collectibility of receivables. That is, accounts receivable should be
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valued at estimated net realizable value, after deducting an allowance for uncollectible accounts. If an entity has credit
approval policies, the gross and net amounts presented for receivables on the balance sheet are more likely to be
fairly stated. The completeness assertion in answer (b) is concerned with whether or not all sales that have occurred are
recorded, not whether or not those sales will generate collectible receivables. The existence or occurrence assertion in
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answer (c) is concerned with whether or not recorded sales and receivables are valid and not fictitious, rather than the
amount collectible. The rights and obligations assertion in answer (d) is concerned with whether or not the entity owns
the receivable, not the amount collectible.

3. Proper authorization of write-offs of uncollectible accounts should be approved in which of the following departments?
a. Accounts receivable. b. Credit.
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c. Accounts payable. d. Treasurer.

(d) The treasurer has responsibility for custody of assets; therefore, authorizing the write-off of a receivable (an asset) is
the responsibility of the treasurer. Choice (a) is incorrect because A/R is an accounting function that should be separated
EO

from the custody of the asset. Choice (b) is incorrect because the credit department authorized credit to customers and
they should not be in the position of writing-off what they authorized. Choice (c) is incorrect because the accounts payable
department has nothing to do with receivables.

4. In assessing control risk for purchases, an auditor vouches a sample of entries in the voucher register to the
supporting documents. Which assertion would this test of controls most likely support?
a. Completeness.
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b. Existence or occurrence. c. Valuation or allocation. d. Rights and obligations.

(b) AU 326 states that assertions about existence or occurrence deal with whether assets or liabilities of the entity exist at
a given date and whether recorded transactions have occurred during a given period. For example, management asserts
that finished goods inventories in the balance sheet are available for sale, or management asserts that sales in the
income statement represent the exchange of goods or services with customers for cash or other consideration. Choice
(a) is incorrect because tracing supports completeness. Choices (c) and (d) are incorrect because valuation and rights
would not be tested from the voucher register to the supporting documents.

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5. An internal auditor's work would most likely affect the nature, timing, and extent of an independent CPA’s auditing
procedures when the internal auditor's work relates to assertions about the
a. Existence of contingencies.
b. Valuation of intangible assets.
c. Existence of fixed asset additions.
d. Valuation of related party transactions.

(c) In making judgments about the extent of the effect of an internal auditor's work on the CPA's auditing procedures, the
CPA should consider the materiality of financial statement amounts, the risk of material misstatement, and the

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degree of subjectivity involved in the evaluation of the audit evidence gathered in support of the assertions. Work done
by internal auditors related to assertions about fixed asset additions, because such assertions involve a low degree of
subjectivity and may have a lower risk of material misstatement, will likely affect the CPA's auditing procedures. Answers

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(a), (b) and (d) deal with contingencies, valuation, and related-party transactions, which are examples of assertions that
might have high risk or involve a high degree of subjectivity.

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6. An auditor suspects that a client's cashier is misappropriating cash receipts for personal use by lapping customer
checks received in the mail. In attempting to uncover this embezzlement scheme, the auditor most likely would compare
the
a. Dates checks are deposited per bank statements with the dates remittance credits are recorded.

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b. Daily cash summaries with the sums of the cash receipts journal entries.
c. Individual bank deposit slips with the details of the monthly bank statements.
d. Dates uncollectible accounts are authorized to be written off with the dates the write-offs are actually recorded.

(a) Lapping can occur when cash/check that is received from a customer is misappropriated and a subsequent cash
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receipt is credited to that customer's account. If the auditor suspects lapping of cash receipts, the auditor should compare
the dates checks are listed on bank statements to the dates customer credits are recorded in customer receivable
accounts. This would help find credits given to customers on dates that differ from the date the deposit was made.
Answers (b) and (c) will not detect lapping because they deal with totals, rather than specific customer accounts. If the
total on a cash summary equals the total recorded in the cash receipts journal, or if the total for a given deposit is the
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same on a bank deposit slip as on the bank statement, postings to individual customer accounts may still be incorrect.
Answer (d) has nothing to do with dates cash/checks are received.

7. In testing controls over cash disbursements, an auditor most likely would determine that the person who signs
checks also
EO

a. Reviews the monthly bank reconciliation. b. Returns the checks to accounts payable.
c. Is denied access to the supporting documents. d. Is responsible for mailing the checks.

(d) The individual who signs checks should also mail the checks to reduce the likelihood of others accessing and
misusing checks. Answer (a) is incorrect because the individual with custody of an asset, such as access to blank
checks, should not be responsible for reconciling or comparing assets and records. Answer (b) is incorrect because if
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checks are returned to accounts payable, amounts or payees can be altered or the checks otherwise misappropriated.
Answer (c) is incorrect because the person who signs the checks should review the supporting documents for
agreement with the checks and then cancel those documents to avoid reuse.

8. For effective internal control, the accounts payable department generally should
a. Stamp, perforate, or otherwise cancel supporting documentation after payment is mailed.
b. Ascertain that each requisition is approved as to price, quantity, and quality by an authorized employee.
c. Obliterate the quantity ordered on the receiving department copy of the purchase order.
d. Establish the agreement of the vendor's invoice with the receiving report and purchase order.

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(d) In order to avoid paying incorrect or duplicate amounts to vendors, the accounts payable department should
clerically check the quantities, prices and mathematical calculations on the vendor's invoice and compare the
invoice to the receiving report and purchase order. Answer (a) is a control procedure that should be performed by
the treasurer or cash disbursements clerk. Answer (b) is a control procedure that involves the requisitioning and
purchasing departments. Answer (c) is a control procedure that involves the purchasing and receiving departments.

9. In determining the effectiveness of an entity's policies and procedures relating to the existence or occurrence assertion
for payroll transactions, an auditor most likely would inquire about and
a. Observe the segregation of duties concerning personnel responsibilities and payroll disbursement.
b. Inspect evidence of accounting for prenumbered payroll checks.

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c. Recompute the payroll deductions for employee fringe benefits.
d. Verify the preparation of the monthly payroll account bank reconciliation.

(a) Assertions about existence or occurrence deal with whether assets or liabilities of the entity exist at a given date and

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whether recorded transactions occurred during a given period. Segregating payroll-related duties such as authorizing
new hires and wage rates, as is done by a personnel department, and disbursing payroll checks, as is done by the
treasurer, reduces the likelihood that fictitious payroll transactions that did not occur will get recorded. The auditor,

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therefore, inquires about and observes the segregation of payroll-related duties. Answer (b), which is concerned with
omitted checks, relates to the completeness assertion. Answer (c), which is concerned with appropriate amounts, relates
to the valuation assertion. Answer (d) relates more to completeness and valuation than to existence or occurrence.

10. To reduce the risks associated with accepting e- mail responses to requests for confirmation of accounts receivable,
an auditor most likely would
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a. Request the senders to mail the original forms to the auditor.
b. Examine subsequent cash receipts for the accounts in question.
c. Consider the e-mail responses to the confirmations to be exceptions.
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d. Mail second requests to the e-mail respondents.

(a) The problem with e-mail responses to audit confirmation requests is that the origin of the e-mail is not secure. That
means that someone other than the recipient of the confirmation request may respond. By requesting a "hard copy" of the
confirmation, the auditor may place greater reliance on the communication.
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1. An auditor is testing sales transactions. One step is to trace a sample of debit entries from the accounts receivable
subsidiary ledger back to the supporting sales invoices. What would the auditor intend to establish by this step?
EO

a. All sales have been recorded.

b. Debit entries in the accounts receivable subsidiary ledger are properly supported by sales invoices.
c. All sales invoices have been properly posted to customer accounts.
d. Sales invoices represent bona fide sales.

(b) The client is not inflating sales or accounts receivable by making fictitious entries.
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2. Approximately 95% of returned positive account- receivable confirmations indicated that the customer owed a
smaller balance than the amount confirmed. This might be explained by the fact that
a. The cash-receipts journal was held open after year end.
b. There is a large number of unrecorded liabilities.
c. The sales journal was closed prior to year end.
d. The sales journal was held open after year end.

(d) Shipments made after year end were included in customers' year end accounts receivable balances. Consequently,
customers' accounts payable balances at year end were smaller than confirmed.

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3. The return of a positive account-receivable confirmation without an exception attests to the

a. Collectibility of the receivable balance. b. Accuracy of the receivable balance.
c. Accuracy of the aging of accounts receivable. d. Accuracy of the allowance for bad debts.

(b) Verification from an independent third party as to the validity of an account balance.

4. During his examination of a January 19, 19X3, cut- off bank statement, an auditor noticed that the majority of
checks listed as outstanding at December 31, 19X2, had not cleared the bank. This would indicate

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a. A high probability of lapping. b. A high probability of kiting.
c. That the cash-disbursements journal had been held open past December 31, 19X2.
d. That the cash-disbursements journal had been closed prior to December 31, 19X2.

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(c) Normally, the auditor would expect most checks to clear during the period from year end to the date of his cut-off
bank statement.

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5. To best ascertain that a company has properly included merchandise that it owns in its ending inventory, the
auditor should review and test the
a. Terms of the open purchase orders. b. Purchase cut-off procedures.
c. Contractual commitments made by the purchasing department.
d. Purchase invoices received on or around year end.
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(b) Purchase cutoff procedures are designed to determine that items actually received in inventory have been included in
the proper period.
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6. Which of the following audit procedures would be least likely to lead the auditor to find unrecorded fixed asset
disposals?
a. Examination of insurance policies.
b. Review of repairs and maintenance expense.
c. Review of property tax files.
d. Scanning of invoices for fixed asset additions.
C

(b) The question deals with fixed asset disposals. The auditor examines repairs and maintenance accounts to find
unrecorded fixed asset additions.
EO

7. Which of the following most likely would be detected by an auditor's review of a client's sales cut-off? a.
Unrecorded sales for the year.
b. Lapping of year-end accounts receivable.
c. Excessive sales discounts.
d. Unauthorized goods returned for credit.

(a) An auditor reviews a client's sales cut-off to determine if year-end sales are being recorded in the correct period. Sales
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records are compared with shipping documents. If, assuming title passes at time of shipment, goods were shipped before
year end and no sale was recorded as of year end, the auditor will have detected unrecorded sales. Similarly, if a sale
was recorded as of year end, but goods were not shipped until the following year, sales would be overstated.

8. An auditor's program to examine long-term debt should include steps that require
a. Examining bond trust indentures.
b. Inspecting the accounts payable subsidiary ledger.
c. Investigating credits to the bond interest income account.
d. Verifying the existence of the bondholders.

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(a) When auditing notes payable and long-term debt, the auditor should obtain copies of agreements and determine if
provisions are being adhered to. If the debt is in the form of bonds, the agreement is the bond trust indenture. Answer (b)
does not relate to long-term debt, but short-term payables. Answer (c) refers to interest income, rather than interest
expense. Answer (d) deals with existence of bondholders; the auditor is concerned with existence of the debt.

9. To determine whether accounts payable are complete, an auditor performs a test to verify that all merchandise
received is recorded. The population of documents for this test consists of all
a. Vendor's invoices. b. Purchase orders.
c. Receiving reports. d. Canceled checks.

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(c) The question is concerned with the completeness of the accounts payable balance, i.e., whether everything that
should be recorded as a payable is in fact included in the balance. To test the completeness of an item in the financial
statements, the auditor would draw a sample from the population that represents the source documents. In this case

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the source document is the receiving report which indicates the date the company received the merchandise
and thus, depending on the shipping terms, when the title passes and a liability recognized.

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10. Which of the following internal control procedures most likely addresses the completeness assertion for inventory?
a. Work in process account is periodically reconciled with subsidiary records.
b. Employees responsible for custody of finished goods do not perform the receiving function.
c. Receiving reports are prenumbered and periodically reconciled.
d.
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There is a separation of duties between payroll department and inventory accounting personnel.

(c) The completeness assertion made by management in the form of financial statements means that no
transactions that should be recorded on the books of the entity has been omitted. Answer (a) is incorrect because it
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deals with items already recorded. Answer (b) is incorrect because it does not deal with the accounting records at all.
Answer (d) is incorrect because again it does not deal with accounting records. Answer (c) is correct because by having
the receiving reports prenumbered, the reconciliation process will include determining the status of each receiving report
as being matched with a vendor invoice and recorded, awaiting matching, voided, or unmatched and thus unrecorded.

11. Which of the following audit procedures is best for identifying unrecorded trade accounts payable?
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a. Examining unusual relationships between monthly accounts payable balances and recorded cash payments.
b. Reconciling vendors' statements to the file of receiving reports to identify items received just prior to the
balance sheet date.
c. Reviewing cash disbursements recorded subsequent to the balance sheet date to determine whether the related
EO

payables apply to the prior period.

d. Investigating payables recorded just prior to and just subsequent to the balance sheet date to determine
whether they are supported by receiving reports.

(c) The question concerns unrecorded accounts payable at the balance date. Answer (a) is not valid because other
items in addition to accounts payable affect cash disbursements (payroll, for example). Answer (b) is incorrect because
receiving reports are matched with vendor invoices, not vendor statements. Answer (d) is incorrect because the auditor
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would be testing accounts payable that have been recorded, not unrecorded. Such a test should start with receiving
reports, not accounts payable. Answer (c) is correct because in reviewing subsequent cash disbursements the auditor
would review whether an invoice paid in the current period actually was received in the prior period.

12. An auditor's purpose in reviewing the renewal of a note payable shortly after the balance sheet date most likely is to
obtain evidence concerning management's assertions about
a. Existence or occurrence.
b. Presentation and disclosure. c. Completeness.
d. Valuation or allocation.

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(b) The presentation and disclosure assertion relates to the fact that the financial statements should reflect all pertinent
information necessary to reach an informed decision concerning the company. By reviewing the renewal of a note
payable after year end the auditor will be able to determine whether the year-end financial statements include all
pertinent information such as due date, interest rate and collateral, if any.

13. An auditor's purpose in reviewing credit ratings of customers with delinquent accounts receivable most likely is to
obtain evidence concerning management's assertions about
a. Presentation and disclosure. b. Existence or occurrence.
c. Rights and obligations. d. Valuation or allocation.

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(d) The auditor's review of credit ratings of customers with delinquent accounts is normally accomplished during an
audit in order to test the adequacy of the allowance for doubtful accounts. The auditor is trying to validate the proper dollar

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balance in the account. The valuation assertion is concerned with proper peso valuation.

14. Two assertions for which confirmation of accounts receivable balances provides primary evidence are
a. Completeness and valuation. c. Rights and obligations and existence.

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b. Valuation and rights and obligations. d. Existence and completeness.

(c) The existence assertion refers to the validity of the item. In other words, has a real transaction taken place or is the
accounts receivable real. The rights and obligations assertion refers to the ownership of assets or liabilities. It answers
the question, "Does the entity have a legal right to the asset?" When a customer replies to a confirmation request
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obviously the customer must exist and the client must have legal title to the receivable. If either of these were not
correct the customer would take exception to the confirmation and/or it would be retained as undeliverable by the post
office.
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15. Cutoff tests designed to detect credit sales made before the end of the year that have been recorded in the
subsequent year provide assurance about management's assertion of
a. Presentation.
b. Completeness.
c. Rights.
d. Existence.
C

(b) The completeness assertion means that nothing has been omitted from the financial statements that should be
recorded during a particular period. By performing a cutoff test the auditor is searching for items that have been omitted
from the financial statements of the current period.
EO

16. An auditor concluded that no excessive costs for 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,
including presentation and disclosure and
a. Valuation and allocation. b. Completeness.
c. Existence or occurrence. d. Rights and obligations
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(a) Assertions about valuation or allocation deal with whether asset, liability, revenue, and expense components have
been included in the financial statements at appropriate amounts. If the auditor is concluding that no excessive costs
were charged to inventory, he or she has gathered evidence regarding valuation of amounts in the inventory account.
Proper costing of inventory does not relate to the assertions presented in the other answers. The completeness
assertion in answer (b) deals with whether all accounts and transactions, such as those related to inventory, that should
be presented in the financial statements are so included. The existence or occurrence assertion in answer (c)
deals with whether assets of the entity, such as inventory, exist at a given date and whether recorded transactions, such
as those related to inventory, have occurred during a given period. The rights and obligations assertion in answer (d)
deals with whether assets, such as inventory, are the rights of the entity.

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17. Which of the following combinations of procedures would an auditor most likely perform to obtain evidence about
fixed asset additions?
a. Inspecting documents and physically examining assets.
b. Recomputing calculations and obtaining written management representations.
c. Observing operating activities and comparing balances to prior period balances.
d. Confirming ownership and corroborating transactions through inquiries of client personnel.

(a) The auditor wants to determine that the addition exists, is properly valued and is owned by the client. Physical
examination by the auditor provides competent evidence of existence. Inspection of purchase and title documents by the

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auditor provides evidence regarding amounts and ownership. Answers (b) and (d) involve evidence-gathering
procedures that rely on client claims, which are not very persuasive types of evidence. Answer (c) is an analytical
procedure that would be performed to determine the reasonableness of balances; it is only suggestive of accuracy.

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18. An auditor most likely would inspect loan agreements under which an entity’s inventories are pledged to
support management’s financial statement assertion of
a. Existence or occurrence. b. Completeness.

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c. Presentation and disclosure. d. Valuation or allocation.

(c) Assertions about presentation and disclosure deal with whether particular components of the financial statements
are properly classified, described, and disclosed. An auditor would inspect loan agreements regarding pledged
inventories to determine that management has adequately disclosed the security arrangements.

management’s assertions about

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19. An auditor most likely would analyze inventory turnover rates to obtain evidence concerning
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a. Existence or occurrence. b. Rights and obligations.
c. Presentation and disclosure. d. Valuation or allocation.

(d) Assertions about valuation or allocation deal with whether asset, liability, revenue, and expense components have
been included in the financial statements at appropriate amounts. An auditor would look at inventory turnover rates to
determine if the inventory amount on the balance sheet and the cost of goods sold amount on the income statement are
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reasonable, in relation to each other.

20. Which of the following procedures would an auditor most likely perform to verify management’s assertion of
completeness?
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a. Compare a sample of shipping documents to related sales invoices.

b. Observe the client’s distribution of payroll checks.
c. Confirm a sample of recorded receivables by direct communication with the debtors.
d. Review standard bank confirmations for indications of kiting.

(a) Assertions about completeness deal with whether all transactions and accounts that should be presented in the
financial statements are so included. To test management’s assertion that all sales are included on the income statement,
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the auditor would compare shipping documents, which typically provide evidence that a sale has occurred and
should be recorded, to related sales invoices, which provide the basis for recording the sales transactions. Answers (b),
(c) and (d) are tests that are designed to determine existence of transactions or balances. The concern of the auditor in
(b), (c) and (d) is with fictitious or overstated amounts, not omitted or incomplete amounts.

21. Which of the following most likely would indicate the existence of related parties?
a. Writing down obsolete inventory just before year end.
b. Failing to correct previously identified internal control structure deficiencies.
c. Depending on a single product for the success of the entity.

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d. Borrowing money at an interest rate significantly below the market rate.

(d) Borrowing or lending on an interest-free basis or at a rate of interest significantly above or below market rates
prevailing at the time of the transaction would be an example of a transaction which, because of its very nature,
may be indicative of the existence of related parties. A borrowing between unrelated parties should be at or near the
market rate of interest.

22. Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of
subsequent events?

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a. Recomputing a sample of large-dollar transactions occurring after year end for arithmetic accuracy.
b. Investigating changes in stockholders' equity occurring after year end.
c. Inquiring of the entity's legal counsel concerning litigation, claims, and assessments arising after year end.
d. Confirming bank accounts established after year end.

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(c) The auditor should inquire of the entity’s legal counsel regarding any events occurring after year end as part of the
auditor’s search for subsequent events, which are events or transactions that occur subsequent to the balance sheet date

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but prior to the issuance of the auditor’s report that have a material effect on the financial statements and therefore
require adjustment or disclosure in the statements. Answer (b) is a good choice since the auditor would inquire of officers
as to whether there was any change in capital stock. The reference to “investigating” in answer (b), however, results in
answer (c) being the better choice. An auditor would also review large-dollar transaction after year-end to determine if
they are recorded in the proper period, not for arithmetic accuracy as noted in answer (a). Answer (d) has no direct impact
on the current financial statements.

23. Auditors try to identify predictable relationships when

R using analytical procedures. Relationships
involving transactions from which of the following accounts most likely would yield the highest level of evidence?
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a. Accounts receivable.
b. Interest expense.
c. Accounts payable.
d. Travel and entertainment expense.

(b) When using analytical procedures to identify predictable relationships, higher levels of evidence will be obtained when
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those relationships are most predictable. Relationships involving income statement accounts, such as interest expense,
tend to be more predictable than relationships involving only balance sheet accounts, such as those listed in answers (a)
and (c), because income statement accounts represent transactions over a period of time rather than a point in time.
Also, interest expense, which can be related to debt, is more predictable than the travel and entertainment expense listed
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in answer (d), which is more subject to management discretion.

24. An auditor selected items for test counts while observing a client's physical inventory. The auditor then traced the
test counts to the client's inventory listing. This procedure most likely obtained evidence concerning management's
assertion of
a. Rights and obligations. b. Completeness.
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c. Existence or occurrence. d. Valuation.

(b) Assertions about completeness deal with whether all accounts and transactions that should be presented in the
financial statements are so included. If an auditor test counts selected items while observing a client's physical inventory
and then traces those counts to the client's inventory listing, the auditor is obtaining evidence that all inventory items that
should be included in the listing, which becomes the basis for the financial statement amounts, are so included. The
assertions presented in answers (a), (c) and (d) are not tested by this procedure. If an inventory item is test
counted and on the listing, the client may not have the rights to that item. In order to test existence, the auditor would
compare the listing to the actual items on hand instead of comparing the test counts to the listing. Valuation of inventory
includes tests of lower of cost and market, not just quantities obtained during test counts.

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25. In testing plant and equipment balances, an auditor examines new additions listed on an analysis of plant and
equipment. This procedure most likely obtains evidence concerning management's assertion of
a. Completeness.
b. Existence or occurrence.
c. Presentation and disclosure.
d. Valuation or allocation.

(b) Management's assertion of existence or occurrence deals with whether assets of the entity, such as plant and

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equipment, exist at a given date and whether recorded transactions, such as plant and equipment additions, have
occurred during a given period. If the auditor physically examines new additions listed on an analysis of plant and
equipment, the auditor is obtaining evidence about the existence or occurrence assertion. The assertions presented in

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answers (a), (c) and (d) are not tested by this procedure. The auditor would test in the opposite direction for
completeness. That is, the auditor would select items of plant and equipment or transactions involving plant and
equipment and determine if they have been properly included in the plant and equipment balance rather than
working from the account balance back to the physical item or transaction documentation. The presentation and

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disclosure assertion deals with whether particular components of the financial statements are properly classified,
described and disclosed, not whether additions to an account exist or occurred. Valuation and allocation of plant and
equipment deal with whether plant and equipment has been included in the financial statements at appropriate amounts.
The auditor would test initial valuation at cost and the allocation of that cost to periods benefited, through depreciation.

a. Payroll is extensively audited by the state government.

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26. An auditor most likely would extend substantive tests of payroll when

b. Payroll expense is substantially higher than in the prior year.

c. Overpayments are discovered in performing tests of details.
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d. Employees complain to management about too much overtime.

(c) If overpayments are discovered by the auditor, this suggests that errors and/or irregularities exist.
Accordingly, the auditor would extend substantive tests of payroll. Answer (a) presents a situation that may lead the
auditor to decrease substantive testing. Answer (b) is a trend that the auditor would evaluate as part of analytical
procedures work. If the increase in payroll expense is explained by plausible relationships with other financial and other
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nonfinancial data, substantive testing would not be extended. Answer (d) is incorrect because overtime concerns of
employees do not suggest that the accounting for overtime is incorrect.
EO

27. In establishing the existence and ownership of a long-term investment in the form of publicly-traded stock, an
auditor should inspect the securities or
a. Correspond with the investee company to verify the number of shares owned.
b. Inspect the audited financial statements of the investee company.
c. Confirm the number of shares owned that are held by an independent custodian.
d. Determine that the investment is carried at the lower of cost or market.
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(c) AU 332 states that evidential matter about the existence, ownership, and cost of long-term investments includes
accounting records and documents of the investor relating to acquisition. In the case of investments in the form of
securities (such as stocks, bonds, and notes), this evidential matter should be corroborated by inspection of the
securities, or in appropriate circumstances, by written confirmation from an independent custodian of securities on
deposit, pledged, or in safekeeping. Choice (a) is incorrect because the investee company may not have timely and up-
to-date information regarding ownership of stock. Choices (b) and (d) are incorrect because they support valuation of the
investment and not inspection of the securities.

28. An auditor's purpose in reviewing credit ratings of customers with delinquent accounts receivable most likely is to

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obtain evidence concerning management's assertions about

a. Valuation or allocation.
b. Presentation and disclosure.
c. Existence or occurrence.
d. Rights and obligations.

(a) AU 326 states that assertions about valuation or allocation deal with whether asset, liability, revenue, and expense
components have been included in the financial statements at appropriate amounts. For example, management asserts
that property is recorded at historical cost and that such cost is allocated to the appropriate accounting periods.
Management asserts that AR included in the balance sheet are stated at net realizable value.

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29. Determining that proper amounts of depreciation are expensed provides assurance about management's
assertions of valuation or allocation and

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a. Presentation and disclosure.
b. Completeness.
c. Rights and obligations.
d. Existence or occurrence.

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(a) AU 326 states that assertions about valuation or allocation deal with whether asset, liability, revenue, and expense
components have been included in the financial statements at appropriate amounts. For example, management asserts
that property is recorded at historical cost and that such cost is systematically allocated to appropriate accounting
periods. Similarly, management asserts that trade A/R included in the balance sheet are stated at net realizable
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value. Determining that proper amounts of depreciation are expensed provides assurance about the assertions of
valuation or allocation amounts and presentation such as an expense on the I/S. The other assertions relate to balance
sheet items rights and obligations or to transactions about completeness or existence.
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30. When using confirmations to provide evidence about the completeness assertion for accounts payable, the
appropriate population most likely would be
a. Vendors with whom the entity has previously done business.
b. Amounts recorded in the accounts payable subsidiary ledger.
c. Payees of checks drawn in the month after the year end.
d. Invoices filed in the entity's open invoice file.
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(a) AU 330 states that confirmation requests can be designed to elicit evidence that addresses the completeness
assertion: that is, if properly designed, confirmations may provide evidence to aid in assessing whether all transactions
and accounts that should be included in the financial statements are included. Their effectiveness in addressing the
EO

completeness assertion depends in part on whether the auditor selects from an appropriate population for testing. For
example, when using confirmations to provide evidence about the completeness assertion for accounts payable, the
appropriate population might be a list of vendors rather than the amounts recorded in the accounts payable subsidiary
ledger. Choice (b) is incorrect because confirming amounts recorded would be existence and not completeness.
Choice (c) is incorrect because while these checks are investigated by the auditor, the amount is not confirmed.
Choice (d) is incorrect because some invoices could be excluded from the file, impairing completeness.
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31. In auditing payroll, an auditor most likely would

a. Verify that checks representing unclaimed wages are mailed.
b. Trace individual employee deductions to entity journal entries.
c. Observe entity employees during a payroll distribution.
d. Compare payroll costs with entity standards or budgets.

(d) AU 8012 states that auditors commonly use analytical procedures to provide evidence concerning payroll when
control risk is low. Analytical procedures include comparison of financial information with:

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• comparable information for a prior period or periods,

• anticipated results, such as budgets or forecasts, and
• similar industry information, such as a comparison of the entity's ratio of sales to accounts receivable with
industry averages or with other entities of comparable size in the same industry.
• study relationships among elements of financial information that would be expected to conform to a predictable
pattern based on the entity's experience, such as a study of gross margin percentage.
• study relationships between financial information and relevant non-financial information, such as a study of
payroll costs to number of employees.

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Choice (a) is incorrect because to verify that checks are mailed does not prevent mailing the checks to nonexistent
personnel. Choice (b) is incorrect because tracing does not include observing payroll. Choice (c) is incorrect
because observing payroll distribution would be effective to prevent checks from being distributed to non- employees,

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but the auditor is only satisfying that particular procedure. The question asked is of a general nature.

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32. In auditing long-term bonds payable, an auditor most likely would
a. Perform analytical procedures on the bond premium and discount accounts.
b. Examine documentation of assets purchased with bond proceeds for liens.
c. Compare interest expense with the bond payable amount for reasonableness.
d. Confirm the existence of individual bond-holders at year end.
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(c) AU 8502 states that auditors commonly use inquiries and analytical procedures to provide evidence concerning
loans when control risk is low. These procedures would include:
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• Obtain from management a schedule of loans payable and determine if the total agrees with the trial balance.
• Inquire whether there are any loans where management has not complied with provisions of the loan agreement
and inquire as to management's actions and if appropriate adjustments have been made in the F/S.
• Consider the reasonableness of interest expense in relation to loan balances.
• Inquire whether loans payable are secured.
• Inquire whether loans payable have been classified between noncurrent and current.
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Choice (a) is incorrect because the auditor would recalculate the premium and discount rather than performing an
analytical procedure. Choice (b) is incorrect because the auditor would analyze the instrument rather than the assets
purchased document to check for liens. Choice (d) is incorrect because the auditor would confirm the balance, not the
EO

existence of bondholders.

33. In performing tests concerning the granting of stock options, an auditor should
a. Confirm the transaction with the Secretary of State in the state of incorporation.
b. Verify the existence of option holders in the entity's payroll records or stock ledgers.
c. Determine that sufficient treasury stock is available to cover any new stock issued.
d. Trace the authorization for the transaction to a vote of the board of directors.
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(d) The auditor would normally determine that a stock option was authorized by tracing the authorization to the minutes
of the board of directors. Choice (a) is incorrect because the Secretary of State would have no knowledge of a stock
option granted by a corporation. Choice (b) is incorrect because options might be issued to people or other entities that
do not currently own stock in the corporation and who do not work for the corporation. Choice (c) is incorrect because
stock options may be distributed from authorized common stock instead of using treasury shares to fulfill the options.

34. An auditor analyzes repairs and maintenance accounts primarily to obtain evidence in support of the audit assertion

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that all
a. Noncapitalizable expenditures for repairs and maintenance have been recorded in the proper period.
b. Expenditures for property and equipment have been recorded in the proper period.
c. Noncapitalizable expenditures for repairs and maintenance have been properly charged to expense.
d. Expenditures for property and equipment have not been charged to expense.

(d) AU 326 states that an auditor who is analyzing the repairs and maintenance accounts is testing transactions that have
been recorded in the accounts. Sampling from transactions that have been recorded provides evidence in support of the
presentation and disclosure assertion. Assertions about presentation and disclosure deal with whether particular
components of the financial statements are properly classified, described, and disclosed. For example, management

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asserts that obligations classified as long-term liabilities in the balance sheet will not mature within one year. Or
management asserts that amounts presented as extraordinary items in the income statement are properly classified and
described. The auditor is obtaining evidence that transactions recorded in repairs and maintenance accounts do
represent expenditures properly charged to expense, not assets which should be capitalized. The cost of capitalized

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assets is allocated to the periods benefited in a systematic and rational manner, depreciated, depleted, or amortized, not
expensed in the period incurred. The other choices would not constitute the primary purpose because the auditor should
be selecting from expenditures that did occur, not from the expenditures that were recorded in the repairs and

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maintenance accounts.

35. Which of the following types of audit evidence is the most persuasive?
a. Prenumbered client purchase order forms.
b.
c.
d.
Client work sheets supporting cost allocations.
Bank statements obtained from the client.
Client representation letter.
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(c) Evidence generated by external parties, such as a bank, is more competent, and therefore more persuasive, than
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evidence generated internally by the client. A bank statement, even if obtained from the client rather than directly from
the bank, is more persuasive than internally-generated evidence. Answers (a), (b) and (d) are examples of internally-
generated documents, worksheets and letters, which are less persuasive than a bank statement.

36. An auditor most likely would inspect loan agreements under which an entity's inventories are pledged to support
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management's financial statement assertion of

a. Presentation and disclosure. b. Valuation or allocation.
c. Existence or occurrence. d. Completeness.
EO

(a) Assertions about presentation and disclosure deal with whether particular components of the financial statements are
properly classified, described, and disclosed. An auditor would inspect loan agreements regarding pledged inventories to
determine that management has adequately disclosed the security arrangements.

37. In auditing intangible assets, an auditor most likely would review or recompute amortization and determine whether
the amortization period is reasonable in support of management's financial statement assertion of
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a. Valuation or allocation. b. Existence or occurrence. c. Completeness.

d. Rights and obligations.

(a) Assertions about valuation or allocation deal with whether asset, liability, revenue, and expense
components have been included in the financial statements at appropriate amounts. An auditor would review and
recompute amortization and determine if the amortization period is reasonable to support management's assertion
that amounts shown in the financial statements for intangible assets and amortization expense are appropriate.

38. Cutoff tests designed to detect purchases made before the end of the year that have been recorded in the

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subsequent year most likely would provide assurance about management's assertion of
a. Valuation or allocation. b. Existence or occurrence. c. Completeness.
d. Presentation and disclosure.

(c) Assertions about completeness deal with whether all transactions and amounts that should be presented in the
financial statements are so included. Cutoff tests provide assurance that all purchases made before the end of the year,
which should therefore be included in that year's financial statements, are so included.

39. An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete
or slow-moving inventory to support management's financial statement assertion of

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a. Valuation or allocation.
b. Rights and obligations.
c. Existence or occurrence.

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d. Presentation and disclosure.

(a) Assertions about valuation or allocation deal with whether asset, liability, revenue, and expense components
have been included in the financial statements at appropriate amounts. Inquiries and other tests designed to

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determine if inventory is obsolete or slow-moving will help provide assurance that inventory, which should be adjusted to
lower of cost or market, is properly valued on the financial statements.

40. In confirming with an outside agent, such as a financial institution, that the agent is holding investment securities in

a. Valuation or allocation. b. Rights and obligations. c.

d. Presentation and disclosure.
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the client's name, an auditor most likely gathers evidence in support of management's financial statement assertions of
existence or occurrence and
Completeness.
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(b) Assertions about rights and obligations deal with whether assets are the rights of the entity and liabilities are the
obligations of the entity at a given date. Assertions about existence or occurrence deal with whether assets or liabilities of
the entity exist at a given date and whether recorded transactions have occurred during a given period. Confirming that
an outside agent is holding investment securities in the client's name provides evidence that the securities exist at a given
date and that they are owned by the client on that date.
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41. Which of the following would not be considered an analytical procedure?

a. Estimating payroll expense by multiplying the number of employees by the average hourly wage rate and the
total hours worked.
b. Projecting an error rate by comparing the results of a statistical sample with the actual population characteristics.
EO

c. Computing accounts receivable turnover by dividing credit sales by the average net receivables.
d. Developing the expected current-year sales based on the sales trend of the prior five years.

(b) Analytical procedures consist of evaluations of financial information made by a study of plausible relationships among
both financial and nonfinancial data, and involve comparisons of recorded amounts, or ratios developed from recorded
amounts, to expectations developed by the auditor. Projecting error rates based on sample results relates more to tests
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of controls, rather than to analytical procedures. Answer (a), which involves developing an expectation or estimate
using financial and nonfinancial information, is an analytical procedure. Answer (c), which involves computing ratios,
and answer (d), which involves developing expectations based on prior year trends, are also examples of analytical
procedures.

42. When control risk is assessed as low for assertions related to payroll, substantive tests of payroll balances most
likely would be limited to applying analytical procedures and
a. Observing the distribution of paychecks.
b. Footing and crossfooting the payroll register. c. Inspecting payroll tax returns.

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d. Recalculating payroll accruals.

(d) When the auditor determines that the internal control structure is effective and thus the control risk is assessed as low,
the auditor may alter the nature, timing, and extent of substantive tests performed. In the case of assertions related to
payroll, the auditor may decide to limit substantive tests to performing analytical procedures, which would evaluate the
reasonableness of payroll-related amounts for the year, and recalculating payroll accruals, which would provide some
assurance that the year-end adjustments are proper. Answer (a) is typically a test of controls, rather than a substantive
test. Answers (b) and (c) are incomplete tests in that the payroll register and payroll tax returns would have to be
compared to other payroll records in order to provide any assurance that payroll balances were fairly stated.

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43. The confirmation of customers' accounts receivable rarely provides reliable evidence about the completeness
assertion because
a. Many customers merely sign and return the confirmation without verifying its details.

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b. Recipients usually respond only if they disagree with the information on the request.
c. Customers may not be inclined to report understatement errors in their accounts.
d. Auditors typically select many accounts with low recorded balances to be confirmed.

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(c) Accounts receivable confirmations are likely to be more effective for the existence assertion than for the completeness
assertion. Customers of a client are more likely to report a balance that is nonexistent or overstated, rather than a balance
that is incomplete or understated. Answer (a) is an incorrect statement because if customers do not verify the details of a
confirmation, evidence is not being gathered about any assertion, not just the completeness assertion. Answer (b) is not

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true for positive confirmations and disagreements that would be reported by customers would likely be related to
overstatements, not understatements. Answer (d) in incorrect because when confirming receivables, auditors focus on
larger, material balances.

44. Which of the following sets of information does an auditor usually confirm on one form?
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a. Accounts payable and purchase commitments. b. Cash in bank and collateral for loans.
c. Inventory on consignment and contingent liabilities. d. Accounts receivable and accrued interest receivable.

(b) The standard bank confirmation form is used to obtain bank confirmation of deposit and loan balances. The
confirmation of loan balances includes a request for due dates, interest rates, and collateral descriptions. Answer (a) is
incorrect because an accounts payable confirmation typically asks the vendor to indicate balances due; reference to
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purchase commitments is not standard. Answer (c) is incorrect because the party who would be able to confirm consigned
inventory would not be in a position to confirm contingent liabilities. Answer (d) is incorrect because accounts receivable
confirmations typically ask the customer to indicate if the balance is correct; reference to accrued interest receivable
is not a standard part of that confirmation request.
EO

45. An auditor most likely would limit substantive audit tests of sales transactions when control risk is assessed as low for
the existence or occurrence assertion concerning sales transactions and the auditor has already gathered evidence
supporting
a. Opening and closing inventory balances. b. Cash receipts and accounts receivable.
c. Shipping and receiving activities. d. Cutoffs of sales and purchases.
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(b) If the control risk for the existence or occurrence assertion regarding sales transactions is assessed as low, there is a
reduced likelihood that sales are overstated. Substantive tests of sales would be limited as a result. If, in addition, the
auditor has already gathered evidence regarding cash receipts and accounts receivable, which are the debit sides of the
credits to the sales account, the auditor has already obtained some evidence about sales and would therefore limit any
additional testing of sales transactions. Answer (a) is incorrect because the inventory balances are not directly related
to the sales account. Answers (c) and (d) are incorrect because, although shipping activities and cutoffs of sales relate to
sales transactions, receiving activities and cutoffs of purchases do not.

46. Which of the following procedures would an auditor most likely perform in searching for unrecorded liabilities?

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a. Trace a sample of accounts payable entries recorded just before year end to the unmatched receiving report file.
b. Compare a sample of purchase orders issued just after year end with the year-end accounts payable trial
balance.
c. Vouch a sample of cash disbursements recorded just after year end to receiving reports and vendor invoices.
d. Scan the cash disbursements entries recorded just before year end for indications of
unusual transactions.

(c) An auditor searches for unrecorded liabilities to determine if there are liabilities that were not recorded in the year
being audited that should be recorded in that year. A procedure performed to find these unrecorded liabilities is to
vouch a sample of cash disbursements recorded just after year-end to receiving reports and vendor invoices. If the

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payment was for goods or services received before year-end, the auditor would review the details of accounts payable
and other liabilities to determine that a liability is properly recorded as of year end. Answer (a) is incorrect because the
auditor is concerned about omitted, unrecorded payables. Tracing recorded payables to receiving reports is a test of
recorded liabilities that will not detect unrecorded liabilities. Answer (b) is incorrect because a liability is incurred when

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goods or services are received, not when a purchase order is issued. Answer (d) is incorrect because cash
disbursements made before year end are in payment of recorded liabilities, not unrecorded liabilities.

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47. An auditor traced a sample of purchase orders and the related receiving reports to the purchases journal and the
cash disbursements journal. The purpose of this substantive audit procedure most likely was to
a. Identify unusually large purchases that should be investigated further.
b. Verify that cash disbursements were for goods actually received.
c. Determine that purchases were properly recorded.
d. Test whether payments were for goods actually ordered.
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(c) The purpose of a substantive audit procedure that traces a transaction forward in an accounting system is to
determine if that transaction was properly recorded for the correct amount in the correct accounting period. This
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procedure primarily tests the completeness assertion. Tracing purchase orders to receiving reports to purchase journals
and cash disbursement journals will provide evidence that purchase transactions have been properly recorded,
and not omitted. Answer (a) is incorrect because testing a sample of purchase orders may not detect unusually large
purchases. Answers (b) and (d) are incorrect because the direction of testing would be from the cash disbursements
journal to receiving reports and purchase orders if the purpose was to determine if disbursements were for goods
received and ordered.
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