CHAPTER 4

MULTIPLE CHOICE
c 1. Of the following, which is the least persuasive type of audit evidence?
a. Documents mailed by outsiders to the auditor.
b. Correspondence between auditor and vendors.
c. Copies of sales invoices inspected by the auditor.
d. Computations made by the auditor. (AC!A ADA!"#D$
c %. Analytical procedures are
a. &ubstantive tests designed to evaluate a system of internal control.
b. "ests of controls designed to evaluate the validity of management's representation letter.
c. &ubstantive tests designed to evaluate the reasonableness of financial information.
d. "ests of controls designed to evaluate the reasonableness of financial information.
(AC!A ADA!"#D$
c (. )hich of the following best describes the primary purpose of audit procedures?
a. "o detect errors or irregularities.
b. "o comply with generally accepted accounting principles.
c. "o gather corroborative evidence.
d. "o verify the accuracy of account balances. (AC!A ADA!"#D$
d *. "he procedures specifically outlined in an audit program are primarily designed to
a. !rotect the auditor in the event of litigation.
b. Detect errors or irregularities.
c. "est internal control structure.
d. +ather evidence. (AC!A ADA!"#D$
b ,. )hich of the following is ordinarily designed to detect possible material dollar errors on the
financial statements?
a. "ests of controls.
b. Analytical procedures.
c. Computer controls.
d. !ost audit wor-ing paper review. (AC!A ADA!"#D$
d .. )hich of the following statements relating to the competence of evidential matter is always true?
a. #vidential matter gathered by an auditor from outside an enterprise is reliable.
b. Accounting data developed under satisfactory conditions of internal control are more relevant
than data developed under unsatisfactory conditions.
c. Oral representations made by management are not valid.
d. #vidence gathered by auditors must be both valid and relevant to be considered competent.
(AC!A ADA!"#D$
c /. n the conte0t of an audit of financial statements, substantive tests are audit procedures that
a. 1ay be eliminated under certain conditions.
b. Are designed to discover significant subse2uent events.
c. 1ay be either tests of transactions, direct tests of financial balances, or analytical tests.
d. )ill increase proportionately with the auditor's assessment of control ris-.
(AC!A ADA!"#D$
%,
a 3. )hich of the following elements ultimately determines the specific auditing procedures that are
necessary in the circumstances to afford a reasonable basis for an opinion?
a. Auditor 4udgment.
b. 1ateriality.
c. 5elative ris-.
d. 5easonable assurance.
(AC!A ADA!"#D$
d 6. )hich of the following factors will least affect the independent auditor's 4udgment as to the
2uantity, type, and content of the wor-ing papers desirable for a particular engagement?
a. 7ature of the auditor's report.
b. 7ature of the financial statements, schedules, or other information upon which the auditor is
reporting.
c. 7eed for supervision and review.
d. 7umber of personnel assigned to the audit. (AC!A ADA!"#D$
a 18. An auditor's wor-ing papers will generally be least li-ely to include documentation showing how
the
a. Client's schedules were prepared.
b. #ngagement had been planned.
c. Client's internal control structure had been reviewed and evaluated.
d. 9nusual matters were resolved. (AC!A ADA!"#D$
c 11. )hich of the following is not a primary purpose of audit wor-ing papers?
a. "o coordinate the e0amination.
b. "o assist in preparation of the audit report.
c. "o support the financial statements.
d. "o provide evidence of the audit wor- performed. (AC!A ADA!"#D$
b 1%. "he understanding between the client and the auditor as to the degree of responsibility to be
assumed by each is normally set forth in a(n$
a. 5epresentation letter.
b. #ngagement letter.
c. 1anagement letter.
d. Comfort letter. (AC!A ADA!"#D$
b 1(. Audit evidence ta-es different forms and varies in persuasiveness. )hich of the following is the
least persuasive type of evidence?
a. :endor's invoice.
b. ;an- statement obtained from the client.
c. Computations made by the auditor.
d. Canceled chec-s. (AC!A ADA!"#D$
b 1*. "he following statements were made in a discussion of audit evidence by two independent
auditors. )hich statement is untrue?
a. < am seldom convinced beyond all doubt about all aspects of the financial statements being
audited.=
b. < would not underta-e that procedure because, at best, the results would only be persuasive and
'm loo-ing for convincing evidence.=
c. < evaluate the degree of ris- involved in deciding the -ind of evidence will gather.=
d. < evaluate the usefulness of the evidence can obtain against the cost to obtain it.=
%.
(AC!A ADA!"#D$
b 1,. As the acceptable level of detection ris- decreases, an auditor may change the
a. "iming of substantive tests by performing them at an interim date rather than at year>end.
b. 7ature of substantive tests from a less effective to a more effective procedure.
c. "iming of tests of controls by performing them at several dates rather than at one time.
d. Assessed level of inherent ris- to a higher amount. (AC!A ADA!"#D$
d 1.. )hen an independent auditor is approached to perform an audit for the first time, he or she
should ma-e in2uiries of the predecessor auditor. n2uiries are necessary because the predecessor
may be able to provide the successor with information that will assist the successor in
determining whether
a. "he predecessor's wor- should be used.
b. "he company rotates auditors.
c. Control ris- is low, in the predecessor?s opinion.
d. "he engagement should be accepted. (AC!A ADA!"#D$
b 1/. "he purpose of tests of controls is to provide reasonable assurance that
a. "he e0tent of substantive testing is minimi@ed.
b. #vidence will be obtained to determine an assessed level of control ris-.
c. #rrors and irregularities are prevented or detected in a timely manner.
d. "he auditor has an understanding of the control environment. (AC!A ADA!"#D$
c 13. An auditor's wor-ing papers should
a. 7ot be permitted to serve as a reference source for the client.
b. 7ot contain comments critical of management.
c. &how that the accounting records agree or reconcile with the financial statements.
d. ;e considered the primary support for the financial statements being audited.
(AC!A ADA!"#D$
c 16. )hich of the following is not a factor affecting the independent auditor's 4udgment about the
2uantity, type, and content of audit wor-ing papers?
a. "he needs for supervision and review of the wor- performed by assistants.
b. "he nature and condition of the client's records and internal controls.
c. "he e0pertise of client personnel and their participation in preparing schedules.
d. "he type of the financial statements, schedules, or other information on which the auditor is
reporting. (AC!A ADA!"#D$
c %8. During an audit engagement, data are compiled and included in the audit wor-ing papers. "he
wor-ing papers are
a. A client>owned record of conclusions reached by the auditors who performed the engagement.
b. #vidence supporting financial statements.
c. &upport for the auditor's compliance with generally accepted auditing standards.
d. A record to be used as a basis for the following year's engagement. (AC!A ADA!"#D$
c %1. "he current file of the auditor's wor-ing papers generally should include
a. A flowchart of the internal controls.
b. Organi@ation charts.
c. A copy of the financial statements.
d. Copies of bond and note indentures. (AC!A ADA!"#D$
%/
b %%. 9sing laptop computers in auditing may affect the methods used to review the wor- of staff
assistants because
a. &upervisory personnel may not have an understanding of the capabilities and limitations of
computers.
b. )or-ing paper documentation may not contain readily observable details of calculations.
c. "he audit field wor- standards for supervision may differ.
d. Documenting the supervisory review may re2uire assistance of management services personnel.
(AC!A ADA!"#D$
c %(. )hich of the following persons is not a specialist upon whose wor- an auditor may rely?
a. Actuary.
b. Appraiser.
c. nternal auditor.
d. #ngineer. (AC!A ADA!"#D$
b %*. n which of the following instances would an auditor be least li-ely to re2uire the assistance of a
specialist?
a. Assessing the value of inventories of wor-s of art.
b. Determining the 2uantities of materials stored in piles.
c. Determining the value of unlisted securities.
d. Determining the assessed value of fi0ed assets. (AC!A ADA!"#D$
SHORT ANSWER
1. #vidential matter consists of the accounting data that underlies management?s financial
statements and the information that supports the accounting data. !lease compare underlying
accounting data with corroborating information.
Answer:
Underlying accon!ing da!a includes records of original entry (e.g., 4ournals$, general and
subsidiary ledgers, data files, and spreadsheets that capture the details summari@ed in financial
statements. Corro"ora!ing in#or$a!ion includes chec-s, records of electronic fund transfers,
invoices, contracts, minutes of meetings, and other documentsA written representations from
vendors, attorneys, ban-s, and other third partiesA and information obtained by 2uestioning
management or by observing a client?s employees at wor-.

%. Bist the two control activities that audit clients use in practice.
Answer:
a. Controls that create documentation (leave an audit trail$.
b. Controls that do not create documentation.
(. Cow do tests of controls and tests of details differ from one another?
Answer:
"ests of controls provide evidence about whether misstatement is likely (a means to assess control
ris-$, and substantive tests of details provide evidence about whether misstatement actually exists
(a means to control detection ris-$.
%3
*. Bist and define the four categories of ratios used in ratio analysis.
Answer:
1. Activity ratios D measure management?s effectiveness in managing available resources,
among them total assets, inventory and receivables.
%. !rofitability ratios D measure management?s effectiveness in turning a profit on their
investment in assets and on shareholders? investments in the company, and can be more
comprehensive than income statements.
(. Bi2uidity ratios D compare short>term assets to short>term liabilities, and measure
management?s ability to meet current obligations.
*. &olvency ratios D measure management?s long>term financial de0terity in one of two
waysE effectiveness in managing borrowed funds or in generating income on borrowed
funds.
,. Describe the evidence normally included in wor-ing papers.
Answer:
#vidence that wor- was ade2uately planned, supervised, and reviewed.
#vidence that internal control was considered as a basis for planning substantive tests.
#vidence that sufficient competent evidential matter was obtained.
PRO%LEMS
1. Analytical procedures allow the auditor to reach conclusions about the details in an account by
testing aggregated data. )ell>designed analytical procedures offer an alternative to tests of details
especially in low>ris- accounts.
Re&ired:
(a$ Bist two ratios from each category of ratiosE activity ratios, profitability ratios, li2uidity ratios,
and solvency ratios.
(b$ !resent the method of calculating the ratios.
Answer:
&tudent?s answers will vary but will contain ratios and calculation methods from the following
listE
Ra!io Me!'od o# Calcla!ion
Ac!i(i!y Ra!ios
Asset "urnover 7et &alesF"otal Assets
nventory "urnover Cost of &alesFAverage nventory
7umber of Days &upply in nventory (.8 DaysF nventory "urnover
Accounts 5eceivable "urnover 7et &alesFAverage Accounts 5eceivable
7umber of Days &ales in 5eceivables (.8 DaysFAccounts 5eceivable "urnover
Pro#i!a"ili!y Ra!ios
5eturn on Assets Operating ncome ;efore nterest and "a0es
FAverage "otal Assets
5eturn on #2uity Operating ncome ;efore nterest and "a0es
FAverage &hareholders #2uity
Operating 1argin Operating ncome ;efore nterest and "a0es
%6
F7et &ales
Li&idi!y Ra!ios
Current 5atio Current AssetsFCurrent Biabilities
Guic- 5atio Cash, 1ar-etable &ecurities, and 5eceivables
FCurrent Biabilities
Sol(ency Ra!ios
Debt to #2uity 5atio Bong>"erm DebtF&hareholders #2uity
"imes nterest #arned ncome ;efore nterest and "a0esFnterest #0pense
Asset Beverage "otal AssetsF&hareholders #2uity
%. (a$ 7ame and define the five financial statement assertions
(b$ 5elate each of the financial statement assertions to a ;alance &heet specific account.
Answer:
Answers will vary in the ;alance &heet account e0ample. !resented is the answer as it pertains to
the asset account > nventory
Asser!ion )e#ini!ion %alance S'ee! Accon!
E*a$+le ,In(en!ory-
#0istence or Occurrence All recorded assets, liabilities,
and e2uities e0ist, and all
recorded transactions occurred.
nventory physically e0ists.
Completeness All transactions and accounts
that should be presented in the
financial statements are
presented.
nventory includes all products
on hand.
5ights and Obligations Assets are the rights, and
liabilities are the obligations, of
the entity.
"he entity has legal title or
similar rights of ownership.
:aluation or Allocation Assets, liabilities, e2uities,
revenues, and e0penses are
included in the financial
statements at appropriate
amountsA revenues, costs, and
e0penses are allocated to the
proper accounting periods.
nventory is properly stated at
the lower of cost or mar-et.
!resentation and Disclosure Hinancial statement components
are properly classified,
described, and disclosed.
nventory is properly classified
as a current asset.
(8