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17 Cards in this Set

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16-1 Distinguish among tests of details of balances, tests of controls, and substantive tests of transactions for the sale and collection cycle. Explain how the tests of controls and substantive tests of transactions affect the tests of details of balances.
Tests of details of balances are designed to determine the reasonableness of the balances in sales, accounts receivable, and other account balances that are affected by the sales and collection cycle. Such tests include confirmation of accounts receivable, and examining documents supporting the balance in these accounts.
Tests of controls and substantive tests of transactions for the sales and collection cycle are intended to determine the effectiveness of internal controls and to test the substance of the transactions that are produced by this cycle. Such tests consist of activities such as examining sales invoices in support of entries in the sales journal, reconciling cash receipts, or reviewing the approval of credit.
The results of the tests of controls and substantive tests of transactions affect the procedures, sample size, timing and items selected for the tests of details of balances (i.e., effective internal controls will result in reduced testing when compared to the tests of details required in the case of inadequate internal controls). The results of tests of controls also affect the public company auditor’s report on internal controls over financial reporting.
16-12 state the most important factors affecting the sample size in confirmations of accounts recievable.
The most important factors affecting the sample size in confirmations of accounts receivable are:
• Tolerable misstatement
• Inherent risk (relative size of total accounts receivable, number of accounts, prior year results, and expected misstatements)
• Control risk
• Achieved detection risk from other substantive tests (extent and results of substantive tests of transactions, analytical procedures, and other tests of details)
• Type of confirmation (negatives normally require a larger sample size)
16-16 Explain why the analysis of differences is important in the confirmation of accounts receivable, even if the misstatements in the sample are not material.
Confirmation of accounts receivable is normally performed on only a sample of the total population. The purpose of the confirmation is to obtain outside verification of the balance of the account and to obtain an indication of the rate of occurrence of misstatements in the accounts. Most misstatements which are indicated by the differences on the confirmation replies will not be material; however, each difference must be analyzed to determine its effect and all others considered together on the total accounts receivable balance. Though the individual differences may not be material, they may indicate a material problem when extended to the entire population, and with regard to the internal controls over the accounts receivable.
17-2 Define stratified sampling and explain its importance in auditing. How can an auditor obtain a stratified sample of 30 items from each of three strata in the confirmation of accounts receivable?
Stratified sampling is a method of sampling in which all the elements in the total population are divided into two or more subpopulations. Each subpopulation is then independently sampled, tested and the results projected to the population. After the results of the individual parts have been computed, they are combined into one overall population measurement. Stratified sampling is important in auditing in situations where the misstatements are likely to be either large or small.
In order for an auditor to obtain a stratified sample of 30 items from each of three strata in the confirmation of accounts receivable, he or she must first divide the population into three mutually exclusive strata. A random sample of 30 items is then selected independently for each stratum.
17-3 Distinguish between the point estimate of the total misstatements and the true value of the misstatements in the population. How can each be determined?
The point estimate is an estimate of the total amount of misstatement in the population as projected from the known misstatements found in the sample. The projection is based on either the average misstatement in the sample times the population size, or the net percent of misstatement in the sample times the population book value.
The true value of misstatements in the population is the net sum of all misstatements in the population and can only be determined by a 100% audit.
17-5 Define monetary unit sampling and explain its importance in auditing. How does it combine the features of attributes and variable sampling?
Monetary unit sampling is a method whereby the population is defined as the individual dollars (or other currency) making up the account balance. A random sample is drawn of these individual monetary units and the physical audit units containing them are identified and audited. The results of auditing the physical audit units are applied, pro rata, to the random monetary units, and a statistical conclusion about all population monetary units is derived.
Monetary unit sampling is now the most commonly used method of statistical sampling for tests of details of balances. This is because it uses the simplicity of attributes sampling yet still provides a statistical result expressed in dollars. It does this by using attribute tables to estimate the total proportion of population dollars misstated, based on the number of sample dollars misstated, and then modifies this amount by the amounts of misstatements found. This latter aspect gives monetary unit sampling its "variables" dimension, although normal distribution theory is not used; rather an arbitrary rule of thumb is applied to make the adjustment.
17-9 Explain how the auditor determines tolerable misstatement for MUS.
A unique aspect of monetary unit sampling is the use of the preliminary judgment about materiality, as discussed in Chapter 9, to directly determine the tolerable misstatement amount for the audit of each account. Most sampling techniques require the auditor to determine tolerable misstatement for each account by allocating the preliminary judgment about materiality. This is not required when monetary unit sampling is used. The preliminary judgment about materiality is used.
17-12 what is the relationship between ARIA and ARACR?
ARIA for tests of details of balances is the equivalent of ARACR for tests of controls and substantive tests of transactions. If internal controls are considered to be effective, control risk can be reduced. A lower control risk requires a lower ARACR, which requires a larger sample size for testing. If controls are determined to be effective after testing, control risk can remain low, which permits the auditor to increase ARIA. An increased ARIA allows the auditor to reduce sample sizes for tests of details of balances.
18-5 what is the importance of cash discounts to the client and how can the auditor verify whether they are being taken in accordance with company policy?
The importance of cash discounts to the client is that the client can produce a substantial savings if it makes use of the cash discounts available. The auditor should examine vouchers and invoices to determine whether discounts are being taken in accordance with the terms available.
18-12 the cpa examines all unrecorded invoices on hand as of February 28,2012, the last day of the audit. Which of the following misstatements is most likely to be uncovered by this procedure? Explain.
a. Accounts payable are overstated at december 31,2011
b. Accounts payable are understated at December 31, 2011
c. Operating expenses are overstated for the 12 months ended December 31,2011
d. Operating expenses are overstated fo the two months ended February 28, 2012
The procedure will most likely uncover the misstatement in item b. The search for unrecorded invoices is designed to detect an understatement of accounts payable.
8-13 explain why it is common for auditors to send confirmation requests to vendors with zero balances on the clients accounts payable listing but uncommon to follow the same approach in verifying accounts receivable.
Unless evidence is discovered which indicates that a different approach should be followed, auditors traditionally follow a conservative approach in selecting vendors for accounts payable confirmations and customers for accounts receivable confirmations. The auditor assumes that the client is more likely to understate accounts payable, and therefore concentrates on the vendors with whom the client deals actively, especially if that vendor's balance appears to be lower than normal on the client's accounts payable listing at the confirmation date. In verifying accounts receivable, the auditor assumes that the client is more likely to overstate account balances; and for that reason concentrates more on the larger dollar balances and is not as concerned with "zero balances."
19-2 explain why the emphasis in auditing property, plant, and equipment is on the current period acquisitions and disposals rather than on the balances in the account carried forward from the preceding year. Under what circumstances will the emphasis be on the balances carried forward?
The reason for the emphasis on current period acquisitions in auditing property, plant, and equipment is that there is an expectation that permanent assets will be kept and maintained on the records for several years. The assets carried over from the preceding years can be assumed to have been verified in the prior years' audits.
If it cannot be shown through tests of controls and substantive tests of transactions that all disposals have been recorded, additional testing of the prior balance could be required. A first year audit also necessitates tests of the beginning balance.
19-3 what is the relationship between the audit of property, plant, and equipment accounts and the audit of repair and maintenance accounts? Explain how the auditor organizes the audit to take this relationship into consideration.
Many clients may accidentally or intentionally record purchases of assets in the repair and maintenance account. The misstatement is caused by a lack of understanding of generally accepted accounting principles and some clients' desire to avoid income taxes. Repair and maintenance accounts are verified primarily to uncover unrecorded property purchases. In other cases, however, management has fraudulently capitalized repair and maintenance expenses to boost profitability and assets.
The auditor typically vouches the larger amounts debited to those expense accounts at the same time that property accounts are being audited.
19-5 In auditing depreciation expense, what major considerations should the auditor keep in mind? Explain how each can be verified.
The two considerations to be kept in mind in auditing depreciation expense are:

• Whether the client is following a consistent depreciation policy from period to period.
• The accuracy of the client's calculations.

An overall reasonableness test can be made by calculating the depreciation rate for the year times the undepreciated fixed assets. In addition, it is desirable to check the accuracy of the depreciation calculation. The extent of the accuracy tests will vary depending on the engagement circumstances.
21-3 state what is meant by cost accounting records and explain their importance in the conduct of an audit.
Cost accounting records are those which are concerned with the processing and storage of raw materials, work in process, and finished goods, insofar as these activities constitute internal transfers within the inventory and warehousing cycle. These records include computerized files, ledgers, worksheets and reports which accumulate material, labor, and overhead costs by job or process as the costs are incurred.
Cost accounting records are important in conducting an audit because they indicate the relative profitability of the various products for management planning and control, and determine the valuation of inventories for financial statement purposes.
21-10 explain why a proper cutoff of purchases and sales is heavily dependent on the physical inventory observation. What information should be obtained during the physical count to make sure that the cutoff is accurate?
A proper cutoff of purchases and sales is heavily dependent on the physical inventory observation because a proper cutoff of sales requires that finished goods inventory included in the physical count be excluded from sales and all inventory received be included in purchases.
To make sure the cutoff for sales is accurate, the following information should be obtained during the taking of the physical inventory:

1. The last shipping document number should be recorded in the working papers for subsequent follow-up to sales records.
2. A review should be made of shipping to test for the possibility of shipments set aside for shipping and not counted or other potential cutoff problems.
3. When prenumbered shipping documents are not used, a careful review of the client's method of getting a proper sales cutoff is the first step in testing the cutoff.
4. A list of the most recent shipments should be included in the working papers for subsequent follow-up to sales records.

For the purchase cutoff, the following information should be noted:

1. The last receiving report number should be noted in the working papers for subsequent follow-up to purchase records.
2. A review should be made of the receiving department to make sure all inventory has been properly included in the physical inventory.
21-12 list the major analytical procedures for testing the overall reasonableness of inventory. For each test, explain the type of misstatements that could be identified.
ANALYTICAL PROCEDURE TYPE OF
POTENTIAL MISSTATEMENT
1. Compare gross margin percentage with previous years. <Overstatement or understatement of inventory amounts (prices and/or quantities).>
2. Compare inventory turnover with previous years. <Obsolete inventory.>
3. Compare unit costs with previous years. <Overstatement or understatement of unit costs.>
4. Compare extended inventory value with previous years. <Errors in compilation, unit costs, or extensions.>
5. Compare current year manufacturing costs with previous years. <Misstatement of unit costs of inventory, especially direct labor and manufacturing overhead.>

nothing = analytical procedures
<potential misstatement>