Chapter 5 : Audit Evidence

1. Distinguish between internal documentation and external documentation as audit evidence and give
three examples of each.
@: Internal documentation is prepared and used within the clients organization without ever going to
an outside party, such as a customer or vendor.
Examples:
<

check request form

<

receiving report

<

payroll time card

<

adjusting journal entry

External documentation either originated with an outside party or was an internal document that went
to an outside party and is now either in the hands of the client or is readily accessible.
Examples:
<

vendors invoice

<

cancelled check

<

cancelled note

<

validated deposit slip

2. Identify the two factors that determine the persuasiveness of evidence.

@: The two determinants of the persuasiveness of evidence are competency and sufficiency.
Competency refers to the degree to which evidence can be considered believable or worthy of trust.
Competency relates to the audit procedures selected, including the timing of when those procedures
are performed. Sufficiency refers to the quantity of evidence and it is related to sample size and items
to select.

3. Discuss five types of audit evidence

TYPES OF AUDIT
EVIDENCE
1. Physical examination

EXAMPLES
< Count petty cash on hand
< Examine fixed asset additions
< Confirm accounts receivable balances of a sample of client

1. Confirmation

customers
< Confirm clients cash balance with bank
< Examine cancelled checks returned with cutoff bank statement

1. Documentation
< Examine vendors invoices supporting a sample of cash
disbursement transactions throughout the year
< Evaluate reasonableness of receivables by calculating and
comparing ratios
1. Analytical procedures

< Compare expenses as a percentage of net sales with prior years

percentages

TYPES OF AUDIT
EVIDENCE

EXAMPLES
< Inquire of management whether there is obsolete inventory

1. Inquiries of the client

< Inquire of management regarding the collectibility of large accounts
receivable balances
< Re-compute invoice total by multiplying item price times quantity
1. Re-performance

sold
< Food the sales journal for a one-month period and compare all totals
to the general ledger

1. Observation

< Observe client employees in the process of counting inventory

< Observe whether employees are restricted from access to the check
signing machine

4. Discuss the reason for performing analytical procedures

i)

Understand the clients industry and business

ii)

Assess the entitys ability to continue as a going concern

iii)

Indicate the presence of possible misstatements in the financial statement

iv)

Reduce detailed audit tests.

5.

List four major evidence decisions that must be made on every audit.

i)

Which audit procedure to use

ii)

What sample size to select for a given procedure

iii)

Which items to select from population

iv)

When to perform the procedures(timing)

6. Define what is meant by permanent file and list several types of information typically included.
Ans : The permanent file contains data of an historical and continuing nature pertinent to the current
audit. Examples of items included in the file are:
1.

Articles of incorporation

2.

Bylaws, bond indentures, and contracts

3.

Analysis of accounts that have continuing importance to the auditor

4.

Information related to the understanding of internal control:

5.

flowcharts

6.

internal control questionnaires

7.

Results of previous years analytical procedures, such as various ratios and percentages

compiled by the auditors

7. Who owns the audit file under circumstances can they be used by other people?
Ans: Audit files are owned by the auditor. They can be used by the client if the auditor wants to
release them after a careful consideration of whether there might be confidential information in them.
The audit files can be subpoenaed by a court and thereby become the property of the court. They can
be released to another CPA firm without the clients permission if they are being reviewed as a part of
a voluntary peer review program under AICPA, state CPA society, or state Board of Accountancy
authorization. The audit files can be sold or released to other users if the auditor obtains permission
from the client.

8. List the purpose of audit documentation

Ans: The purposes of audit documentation are as follows:
1. To provide a basis for planning the audit. The auditor may use reference information from the
previous year in order to plan this years audit, such as the evaluation of internal control, the time
budget, etc.
2. To provide a record of the evidence accumulated and the results of the tests. This is the primary
means of documenting that an adequate audit was performed.
3. To provide data for deciding the proper type of audit report. Data are used in determining the scope of
the audit and the fairness with which the financial statements are stated.
4. To provide a basis for review by supervisors and partners. These individuals use the audit
documentation to evaluate whether sufficient competent evidence was accumulated to justify the audit
report.
Audit documentation are used for several purposes, both during the audit and after the audit is
completed. One of the uses is the review by more experienced personnel. A second is for planning the
subsequent year audit. A third is to demonstrate that the auditor has accumulated sufficient competent
evidence if theres a need to defend the audit at a later date. For these uses, it is important that the
audit documentation provide sufficient information so that the person reviewing an audit schedule
knows the name of the client, contents of the audit schedule, period covered, who prepared the audit
schedule, when it was prepared, and how it ties into the rest of the audit files with an index code.

Chapter 8

1. Explain the importance of proper credit approval for sales.

Answer: very important that there is supervision in each loan transaction and loan approval is usually
done by a financial manager in a company. effect adequate control is to oversee every loan transaction
can be responsible for anyone who approve the credit transaction.

2. List the transaction related audit objective for the verification of sales transaction
Answer: 1. Recorded sales are for shipments actually made to notifictitious customers = credit is
approved automically by computer by comparison to authorized credit limits.
2. Existing sales transactions are recorded (completeness) = shipping documents are
preenumbered and accounted for weekly.
3. Recorded sales are for the amount of goods shipped and are correctly billed and recorded
(accuracy) = batch total of quantities shipped are compared with quantities billed.
4. sales transaction are correctly included in the accounts receivable master file and are
correctly summarized (posting and summarization) = computer automically post transactions to the
accounts receivable master file and general ledger.
5. sales transactions are correctly classfiled (classification) = accounts classification are
internally verified.
6. sales are recorded on the correct dates (timing) = shipping documents are prenumbered
and accounted for weekly by the accountant.

3. Explain the most important duty that should be segregated in the sales and collection cycle
Answer: proper separation of duties helps prevent various types of misstatements due to both errors
and fraud.

4. Explain how pre-numbered shipping document and sales invoice can be useful control for preventing
misstatement in sales.
Answer: Prenumbering is meant to prevent both the failure to bill or record sales and the accurrence
of duplicates billings of recordings. To use this control effectively, a billing clerk will file a copy of
all shipping documents in sequential order after each shipment is billed, while someone else will
periodically account for all numbers and investigate the reason for any missing documents.

Chapter 10 : Audit in Cash

1. Discuss in monthly reconciliation of bank account by independent person and why the bank
reconciliation is important?

The monthly reconciliation of bank accounts by an independent person is an important internal

control over cash balances because it provides an opportunity for an internal verification of the cash
receipts and cash deposit transactions, investigation of reconciling items on the bank reconciliation,
and the verification of the ending cash balance. [One mark] Anyone responsible for the following
duties would not be considered independent for the purposes of preparing monthly bank
reconciliations:
Issuance of cheques
Receipt and deposit of cash
Other handling of cash
Record keeping

2. Explain what is cut-off bank statement?

A cut-off bank statement is a partial-period bank statement and the related cancelled checks, duplicate
deposit slips, and other documents included in bank statements, mailed by the bank directly to the
CPA firms office.

3. Discuss the proof of cash.

(slide:297) (pg 50)

4. List the examples of possible misstatement which may discovered & may not be discovered as a part
of the audit of the bank reconciliation
(slide: 283,284,285,286) (pg:48)

Chapter 11: Audit of Inventory

1. Give the reason why inventory is often the most difficult and time consuming part of many audit
engagement.
Inventory is often the most difficult and time consuming part of many audit engagements because:

Inventory is generally a major item on the balance sheet and often the largest item making up the
accounts included in working capital.

The need for organizations to have the inventory in diverse locationsmakes the physical control and
counting of the inventory difficult.

Inventory takes many different forms that are difficult for the auditor to fully understand.

The consistent application of different valuation methods can be fairly complicated.

The valuation of inventory is difficult due to such factors as the large number of different items
involved, the need to allocate the manufacturing costs to inventory, and obsolescence.

2. Explain the relationship between the acquisition and payment cycle and the inventory warehousing
cycle in the audit manufacturing company.
The acquisition and payment cycle includes the system for purchasing all goods and services,
including raw materials and purchased parts for producing finished goods. Purchase requisitions are
used to notify the purchasing department to place orders for inventory items. When inventory reaches
a predetermined level or automatic reorder point, requisitions may be initiated by stockroom
personnel or by computer. In other systems, orders may be placed for the materials required to
produce a customer order, or orders may be initiated upon periodic evaluation of the situation in light
of the prior experience of inventory activity. )

After receiving the materials ordered, as part of the acquisition and payment cycle, the materials are
inspected with a copy of the receiving document used to book perpetual inventory. In a standard cost
inventory system, the acquisition and payment cycle computes any inventory purchase variances,
which then enter the inventory system. The following audit procedures in the acquisition and payment
cycle illustrate the relationship between that cycle and the inventory and ware housing cycle.

Compare the inventory cost entered into the inventory system to the supporting invoice to determine
that it was properly recorded and the purchase variance (standard cost system), if any, was properly
reflected.

Test the purchase cut-off at the physical inventory date and year-end to determine whether or not the
physical inventory and year-end inventory cut-offs are proper from a purchase standpoint

3. Give reasons why company provide online access to description of inventory product and on-hand
quantity levels to key inventory suppliers.

Companies provide online access to descriptions of inventory products and on-hand quantity levels to
key inventory suppliers because this information helps the suppliers work with management to
monitor the flow of inventory items. There are risks associated with providing this information,
however. First, there is a risk that sensitive proprietary information may be made available to
unauthorized users. The use of the Internet and other e-commerce applications may also lead to
financial reporting risks if access to inventory databases and systems is not adequately controlled. The
risks of providing online access to inventory information can be reduced by the use of security access
password restrictions, firewalls, and other IT management controls.

4. Discuss the risk when provide online access.

There are risks associated with providing this information, however there is a risk that sensitive
proprietary information may be made available to unauthorised users. The use of the Internet and
other e-commerce applications may also lead to financial reporting risks if access to inventory
databases and systems is not adequately controlled.

5. Discuss the three decisions of timing,sample size, selectiom of item (related with physical observation)
(slide: 333,334,335,336)

6. Explain the analytical for the inventory and ware housing cycle.
(slide: 326-328) (pg:55)
Chapter 15: Auditors Report

1. Discuss the purpose of audit report.

Auditor's reports are important to users of financial statements because they inform users of the
auditor's opinion as to whether or not the statements are fairly stated or whether no conclusion can be
made with regard to the fairness of their presentation. Users especially look for any deviation from the
wording of the standard unqualified report and the reasons and implications of such deviations.
Having standard wording improves communications for the benefit of users of the auditors report.
When there are departures from the standard wording, users are more likely to recognize and consider
situations requiring a modification or qualification to the auditors report or opinion.

2. Discuss the qualified, adverse & disclaimer audit report opinion.

A qualified opinion states that there has been either a limitation on the scope of the audit or a
departure from GAAP in the financial statements, but that the auditor believes that the overall
financial statements are fairly presented. This type of opinion may not be used if the auditor believes
the exceptions being reported upon are extremely material, in which case a disclaimer or adverse
opinion would be used.
An adverse opinion states that the auditor believes the overall financial statements are so
materially misstated or misleading that they do not present fairly in accordance with GAAP the
financial position, results of operations, or cash flows.
A disclaimer of opinion states that the auditor has been unable to satisfy him or herself as to
whether or not the overall financial statements are fairly presented because of a significant limitation
of the scope of the audit, or a nonindependent relationship under the Code of Professional
Conduct between the auditor and the client.

Examples of situations that are appropriate for each type of opinion are as follows:

OPINION TYPE
Disclaimer

EXAMPLE SITUATION
Material physical inventories not observed
and the inventory cannot be verified through
other procedures.
Lack of independence by the auditor.

Adverse

A highly material departure from GAAP.

Qualified

Inability to confirm the existence of an asset

which is material but not extremely material
in value.

3. Discuss the five conditions of the standard unqualified audit reports

1. All statements are included in the financial statements, including income statement, retained earnings
statement, balance sheet and cash flow statement;

2. The three general standards (adequate training, independence and due professional care) have been
followed during the audit engagement;
3. there is sufficient evidence to conclude that the three standards of field work (planning and
supervision, understanding of internal control and competent evidentiary matter) have been met;
4. The financial statements have been presented in accordance with U.S. GAAP;
5. There are no circumstances warranting an explanatory paragraph or rewording of the report.

4. Explain the elements should be included within unqualified objective.