Auditing The Art And Science of Assurance Engagements Canadian 12th Edition By Arens – Test Bank

Auditing The Art And Science of Assurance Engagements Canadian 12th Edition By Arens – Test Bank

Auditing, 12e (Arens)

Chapter 10 Audit Strategy and Audit Program 10.1 Explain what an audit strategy is 1) A planned approach to the conduct of audit testing, taking into account assessed risks, is called an A) audit approach. B) audit plan. C) audit program. D) audit strategy. Answer: D Diff: 1 Type: MC Page Ref: 308 Learning Obj.: 10-1 Explain what an audit strategy is 2) Audit risk is assessed at which level of the audit? A) account B) cycle C) transaction-related audit objective D) overall audit Answer: D Diff: 2 Type: MC Page Ref: 309 Learning Obj.: 10-1 Explain what an audit strategy is 3) Materiality is used to help decide the scope of testing, help determine the sample size and to help A) develop the audit report. B) decide which analytical review calculations to use. C) evaluate the results of testing. D) conduct understanding of business tests. Answer: C Diff: 2 Type: MC Page Ref: 311 Learning Obj.: 10-1 Explain what an audit strategy is 4) Risks of fraud are assessed at which level(s) of the audit? A) overall audit, transaction-related audit objectives B) balance-related audit objectives only C) overall audit, cycle and account D) cycle, account and transaction-related audit objectives Answer: C Diff: 3 Type: MC Page Ref: 311-312 Learning Obj.: 10-1 Explain what an audit strategy is 5) Which of the following areas is considered to have a high risk of fraud in the retail industry? A) point-of-sale sales B) customer refunds C) credit sales D) completeness of payroll Answer: B Diff: 3 Type: MC Page Ref: 312 Learning Obj.: 10-1 Explain what an audit strategy is 6) CAS 240 requires which of the following to be considered a significant risk? A) revenue recognition B) inventory valuation C) accounts receivable valuation D) calculation of income taxes Answer: A Diff: 3 Type: MC Page Ref: 312 Learning Obj.: 10-1 Explain what an audit strategy is 7) A substantive procedure is used to A) assess the likelihood of material misstatement in the financial statements. B) obtain an understanding of internal controls. C) analyze the account balance to see if there are potential errors. D) quantify the amount of potential error in an account or transaction stream. Answer: D Diff: 1 Type: MC Page Ref: 312 Learning Obj.: 10-1 Explain what an audit strategy is 8) A procedure designed to test for dollar errors or irregularities directly affecting the correctness of financial statement balances is a A) substantive test. B) analytical test. C) test of controls. D) definition of dollar-unit sampling. Answer: A Diff: 2 Type: MC Page Ref: 312 Learning Obj.: 10-1 Explain what an audit strategy is 9) When the auditor has determined that there is a significant risk of misstatement for a particular assertion (for example, completeness of revenue), what type of audit testing does CAS 330 require? A) tests of risk assessment B) tests of understanding of internal control C) control tests D) substantive tests Answer: D Diff: 2 Type: MC Page Ref: 312 Learning Obj.: 10-1 Explain what an audit strategy is 10) The auditor of ABC Ltd. has concluded that there are significant risks of misstatement of revenue at the company, with potential overstatement of revenue. Which of the following audit tests should the auditor conduct to address this significant risk? A) control tests of authorization, to ensure that credit limits for sales are all approved by the sales manager B) analytical review of sales, comparing sales trends over the last five years by division and to the industry C) examination of sales after the year end to quantify potential cut-off errors (income from the subsequent period included in the current year) D) risk assessment procedures, looking carefully at inherent risks associated with the handling of cash in the sales cycle Answer: C Diff: 3 Type: MC Page Ref: 312 Learning Obj.: 10-1 Explain what an audit strategy is 11) When the auditor assesses the likelihood of material misstatement in the financial statements, the auditor will use A) risk assessment procedures. B) procedures to obtain an understanding. C) tests of control. D) assessment of design effectiveness of controls. Answer: A Diff: 2 Type: MC Page Ref: 312 Learning Obj.: 10-1 Explain what an audit strategy is 12) An example of an audit procedure that relates to the auditor’s understanding of internal control is A) reperform the counting of physical inventory. B) inspect documents and records. C) recalculate the depreciation expenses. D) trace all legal expenses to supporting invoices. Answer: B Diff: 3 Type: MC Page Ref: 313 Learning Obj.: 10-1 Explain what an audit strategy is 13) An example of an audit procedure that relates to the auditor’s understanding of internal control is A) count petty cash at all locations. B) use test data to verify functioning of data entry controls. C) observe entity activities and operations. D) trace all large fixed asset purchases to supporting invoices. Answer: C Diff: 3 Type: MC Page Ref: 313 Learning Obj.: 10-1 Explain what an audit strategy is 14) The purpose of tests of controls is to provide reasonable assurance that the A) accounting treatment of transactions and balances is valid and proper. B) accounting control procedures are operating effectively. C) entity has complied with disclosure requirements of generally accepted accounting framework. D) entity has complied with requirements of quality control. Answer: B Diff: 1 Type: MC Page Ref: 313 Learning Obj.: 10-1 Explain what an audit strategy is 15) Eleonar is inspecting a sample of “Code of Conduct acknowledgement forms” that must be signed by all employees to indicate that they have read and understood the company’s code of conduct. Eleonar is ensuring that they have been signed by the employee. Eleonar is performing A) a test of controls. B) an analytical procedure. C) a substantive procedure. D) a procedure to obtain an understanding of internal controls. Answer: A Diff: 2 Type: MC Page Ref: 313 Learning Obj.: 10-1 Explain what an audit strategy is 16) The auditor selects several transactions in each functional area and traces them through the entire accounting system, paying special attention to evidence about whether or not the control features are in operation. This is an example of a A) sequence test. B) test of controls. C) substantive test. D) functional test. Answer: B Diff: 1 Type: MC Page Ref: 313 Learning Obj.: 10-1 Explain what an audit strategy is 17) The auditor would like to design a test of control to test the following key control: “there is a separation of duties between billing, recording sales, and handling of cash receipts.” Which of the following typical tests of controls would be suitable? A) match the amounts billed to the amounts recorded B) verify that sales have been recorded in the proper period C) trace cash receipts to the duplicate bank deposit slips D) inquire about the duties of the accounting personnel Answer: D Diff: 2 Type: MC Page Ref: 314 Learning Obj.: 10-1 Explain what an audit strategy is 18) The auditor would like to design a test of control to test the following key control: “shipping documents are issued in numerical order by the computer and are accounted for weekly.” Which of the following typical tests of controls would be suitable? A) trace sales documents issued to the sales journal and trace the daily total to the general ledger B) ask the shipping department about the process that they use to issue shipping documents, paying particular attention to continuity of numerical sequence C) use computer assisted audit testing to determine whether there are any numbers in the sequence missing (gap detection) D) match shipments to the associated sales invoice Answer: C Diff: 2 Type: MC Page Ref: 314 Learning Obj.: 10-1 Explain what an audit strategy is 19) The auditor would like to design a test of control to test the following key control: “unit selling prices are obtained from the price list master file of approved prices.” Which of the following typical tests of controls would be suitable? A) compare prices used on sales invoices to the authorized customer purchase order B) review change to price file throughout the year for proper authorizations and trace prices to copy of sales invoice C) use analytical review to compare total sales last year to total sales this year D) discuss the process used to authorize sales prices with the sales manager and the controller Answer: B Diff: 3 Type: MC Page Ref: 314 Learning Obj.: 10-1 Explain what an audit strategy is 20) The auditor would like to design a test of control to test the following key control: “statements are mailed to all customers each month.” Which of the following typical tests of controls would be suitable? A) inquire about who is responsible for mailing the statements B) find out whether customers pay by statement or by invoice C) reconcile subsequent payments to particular invoices D) match remittance advices from customers to customer statements Answer: A Diff: 2 Type: MC Page Ref: 314 Learning Obj.: 10-1 Explain what an audit strategy is 21) If no material fluctuations are found using analytical procedures and the auditor concludes that differences should not have occurred, A) it will be necessary to increase the tests of details of balances. B) other tests may be reduced. C) it will be necessary to increase the tests of controls. D) it will not be necessary to perform tests of details of balances. Answer: B Diff: 2 Type: MC Page Ref: 315 Learning Obj.: 10-1 Explain what an audit strategy is 22) Donna sees a large variation in the gross margin percentage as a result of analytical procedures she performed. This means that A) Donna should perform more tests. B) the financial statements contain an error. C) Donna cannot rely on the company’s internal controls. D) Donna should document this difference. Answer: A Diff: 2 Type: MC Page Ref: 315 Learning Obj.: 10-1 Explain what an audit strategy is 23) Which of the following is an example of a substantive test that could be used for the audit of the accuracy of sales prices? A) inspect sales price master authorization forms for the presence of an approval signature B) observe that the point-of-sale system automatically pulls sales prices from the master file C) inquire about the process that is used to update sales prices in the sales price master file D) calculate the gross margin for each product that is sold by the company Answer: D Diff: 3 Type: MC Page Ref: 318 Learning Obj.: 10-1 Explain what an audit strategy is 24) The auditor has decided that there is a risk of material misstatement with respect to sales revenue. Which of the following audit tests should the auditor use to quantify the potential error? A) discuss the process used to assign credit limits with the sales manager and the controller B) send external confirmations to customers with accounts receivable balances C) determine whether all sales tested have a supporting customer purchase order D) determine whether all sales tested have a matching bill of lading Answer: B Diff: 3 Type: MC Page Ref: 315 Learning Obj.: 10-1 Explain what an audit strategy is 25) The auditor has completed analyzing the results of tests of details of the accounts receivable ending balance. Errors totaling $25,000 were found. These exceptions are A) indications that the credit limit is being incorrectly applied. B) probably cut-off errors that can be explained. C) an indication of potential errors in the ending balance. D) financial statement misstatements. Answer: D Diff: 3 Type: MC Page Ref: 316 Learning Obj.: 10-1 Explain what an audit strategy is 26) In the context of an audit of financial statements, substantive tests are audit procedures that A) may be eliminated under certain conditions. B) are designed to discover significant subsequent events. C) may be either direct tests of financial balances, or analytical tests. D) will increase proportionately with the auditor’s reliance on internal control. Answer: C Diff: 1 Type: MC Page Ref: 316 Learning Obj.: 10-1 Explain what an audit strategy is 27) Performance of tests of controls provide evidence in support of the specific controls that contribute to the auditor’s assessed control risk (where it is reduced below 100%). Also, when dual-purpose tests are used, evidence is also obtained in support of A) the nature of illegal acts that occurred. B) the quantitative effects of fraud risks. C) statistical ratios to assist analytical review. D) monetary correctness of transactions. Answer: D Diff: 3 Type: MC Page Ref: 316 Learning Obj.: 10-1 Explain what an audit strategy is 28) The auditor verifies the summarizing, accuracy, and posting of entries by performing A) analytical procedures. B) tests of controls. C) dual-purpose tests. D) procedures to gain an understanding of internal control. Answer: C Diff: 2 Type: MC Page Ref: 316 Learning Obj.: 10-1 Explain what an audit strategy is 29) A) Describe the five types of audit tests used to determine whether financial statements are fairly stated. Identify which of the five types are substantive tests, and which are used to reduce assessed control risk. B) There are several types of audit procedures that relate to the auditor’s understanding of internal control. One type of procedure is “Update and evaluate the auditor’s previous experience with the entity.” Identify the five additional types of procedures related to understanding internal control, and four types of procedures that are used to test controls. Answer: A) The five types of audit tests used to determine whether financial statements are fairly stated are: (1) risk assessment procedures, (2) procedures to obtain an understanding of internal control, (3) tests of controls, (4) analytical procedures, and (5) tests of details of balances. Analytical procedures and tests of details of balances are substantive tests, whereas procedures to obtain an understanding of internal control and tests of controls are used to reduce assessed control risk. B) Five additional types of procedures related to understanding internal control are: make inquiries of client personnel, read clients’ policy and systems manuals, inspect documents and records, walk through transactions to verify flow of transactions and controls, and observe entity activities and operations. Four types of procedures that are used to test controls are: make inquiries of appropriate client personnel, examine documents, records, and reports, observe control-related activities, and reperform client procedures. Diff: 2 Type: ES Page Ref: 312-313 Learning Obj.: 10-1 Explain what an audit strategy is 30) Discuss the purposes of tests of controls and tests of details of balances. Give an example of each. Answer: The purpose of tests of controls is to determine the effectiveness of both the design and operations of specific internal controls. To determine whether the internal controls prevented material errors to negatively influence the account balance. For example, the auditor might observe for a month whether statements are mailed to all customers. The purpose of tests of details of balances is to detect material misstatements at the assertion level and whether the account balances represent the economic events the organization experienced over the accounting period The confirmation of accounts receivable is an example. Diff: 2 Type: ES Page Ref: 313-315 Learning Obj.: 10-1 Explain what an audit strategy is 31) Greenvale Construction Limited was started by four brothers who lived in the Toronto area. Over time, the brothers have moved to different parts of the country. They decided it was a good idea to keep the company, and organize their work as separate divisions as part of the same company. There are now three divisions, one for each of the brothers who are actively involved in construction. The fourth brother, Ted, is responsible for accounting and record keeping. Ted went back to school and completed an accounting designation, and now has three employees in the accounting area. Each of the brothers has moved on to specialize in a different kind of construction work. In Toronto, it is mainly new home construction. In Edmonton, the work is primarily renovations of large homes and small commercial enterprises, while in Halifax, the work is completely commercial on mid-to-large projects. All of the brothers prefer to subcontract their work rather than hiring full time construction employees, although some of the subcontract relationships have lasted over fifteen years now. Required: Explain what you would do to document your understanding of internal control for Greenvale. Identify potential risk areas where you would need to focus additional attention. Answer: To document my understanding: Update and evaluate the auditor’s previous experience with Greenvale: • Review the prior year audit file. • Identify any risk areas from the prior year’s audit that would likely be risk areas this year. Make inquiries of client personnel: • Discuss with Ted whether there have been any changes in procedures. • Review last year’s management letter to determine if there have been any recommendations that were (or were not) followed up by the client. • Walk through the descriptions of internal control with Ted and his staff to see if there have been any changes in procedures. • Contact each of the brothers in the other locations and inquire with respect to their changes in procedures. Read the client’s policy and systems manuals: • Ask Ted whether there have been any changes to accounting systems in use. • If so, review the supporting documentation for any issues relevant to the audit. • Ask if there are any policy documents that have changed from the prior year and if so, review these. Examine documents and records: • Select a sample of transactions and walk them through the system descriptions updated with the client. Observe entity activities and operations: • Observe accounting staff activities while on premises. Potential risk areas: • Since transactions are sent from other locations to the Toronto head office, there could be cut-off errors, or transactions could be sent late. • Segregation of duties at each of the locations would not exist, since there is essentially only one employee: each of the brothers has the ability to override controls. • Procedures and controls for each of the construction divisions may be different: need to consider them separately. • Need to consider issues like inventory of materials, whether it is material, and whether an accountant in Halifax or Edmonton should be involved in counting these materials. Diff: 3 Type: ES Page Ref: 312-313 Learning Obj.: 10-1 Explain what an audit strategy is 32) Samru has been assigned the sales cycle as part of an audit team. He will be evaluating several key controls in the sales cycle and conducting tests of detail for accounts receivable. Samru has been told to look at 15 customers with respect to the credit limit approval process (a test of control). Then, he has been told to use dual purpose tests for the rest of his testing. Required: Explain the relationship between tests of controls, dual purpose tests and tests of details. Answer: The purpose of tests of controls is to determine whether all transaction-related audit objectives have been satisfied for each class of transactions. The results of the tests will help the auditor assess the effectiveness of internal controls. If internal controls are functioning as designed, and the auditor places reliance on the internal controls, all things being equal, this will result in the need to conduct fewer tests of details and therefore reduce the audit time and cost. Substantive tests (tests of detail and analytical procedures) are designed to test for dollar amounts of errors or fraud and other irregularities directly affecting the correctness of financial statement balances. Dual-purpose tests are tests that provide evidence of whether or not the controls being tested were operating effectively during the period and whether there are misstatements in the data produced by the accounting systems. The use of dual-purpose tests combines an internal control test and a test of detail into one test, saving costs during the audit. Diff: 2 Type: ES Page Ref: 313-316 Learning Obj.: 10-1 Explain what an audit strategy is 33) You are a senior at a PA firm and this is your junior’s first day. He would like you to explain to him what are the different types of audit tests that should be performed over the course of an audit to obtain sufficient and appropriate audit evidence. Further, please indicate to which component of audit risk the type of test is linked. Answer: The types of audit tests are: Risk assessment, procedures to obtain an understanding of internal controls, tests of controls, analytical procedures and tests of detail balances. Risk assessment is linked to the inherent risk. Procedures to obtain an understanding of internal controls and tests of controls are linked to the control risk. Analytical procedures and tests of details of balances are linked the detection risk. Diff: 2 Type: ES Page Ref: 316 Learning Obj.: 10-1 Explain what an audit strategy is 34) Restaurant Products Company (RPC) has been an audit client of your firm for many years. RPC has a March 31 fiscal year end. The company is a successful distributor of restaurant and food industry products, such as trays, weigh scales, dishes, cooking implements. The company sells to businesses only (i.e. not to end consumers), with clients ranging from small restaurants to large food service chains and hotels. The company does have a perpetual inventory system, but the current inventory system relies upon accurate data entry of receipts, shipments and inventory adjustments from paper documents. RPC is looking to improve inventory management and maintain costs in the face of rising competition and growth. Accordingly, it is implementing RFID (radio frequency identification) technology for its inventory in January 2012. RFID chips will be placed on warehouse shelf locations, boxes of products, and on large cost individual products. At the same time the company will implement a wireless mesh system throughout the warehouse, with wireless tracking of product movement. Effective January 31, 2012 a new inventory management system is being implemented to facilitate better decision making and access to online realtime inventory data. The new inventory management system will include a new database that will include internal records of inventory on hand, receipts and shipments of inventory, purchase order details, and payment details. Required: A. For each phase of the financial statement audit process, describe the phase, and explain how the audit process is affected or changed due to the implementation of the new database management system. B. What is the impact of the implementation of RFID on the financial statement audit process? [Note that these points must be different from those raised in Part A above.] Answer: A. Financial statement impact: Audit phase and description How the audit process is affected or changed due to the implementation of the new DBMS system 1. Preplanning, which involves documentation and decisions prior to the actual conduct of the audit, for example: -acceptance/continuance analysis -independence threat analysis -consider whether the firm has sufficient expertise to work with the new systems (e.g. IT audit expert) -assign staff (e.g. IT audit expert) to the engagement that is familiar with the type of DBMS that has been implemented by the client 2. Client risk profile, which involves understanding the client’s business and industry , assessing client business risk and performing preliminary analytical review -need to obtain an understanding of the new DBMS systems and how they relate to the client’s other systems -need to obtain an understanding of the new systems (document the new systems) -need to determine whether the disaster recovery plans (DRP) have been updated to take account of the new systems 3. Plan the audit, which includes assessing risks using the audit risk model, assessing risks of fraud, evaluating design effectiveness of controls, determining risk of material misstatement (RMM) -need to decide upon audit approach -inherent risk increases due to increased complexity and the potential for error or manipulation during the conversion -the auditor will need to document and assess design effectiveness of the conversion process -the auditor will need to document the controls in the new systems and the design effectiveness of those controls -inherent risk and control risk will need to be re-evaluated based upon the new controls in place (overall and at the assertion level for the cycles affected) -the auditor will need to also document and evaluate design effectiveness of new controls at the control environment level (e.g. access controls over the data dictionary) -the auditor will likely choose a combined audit approach since advanced systems tend to have more controls in the programs rather than relying upon manual controls   4. Design further audit procedures -the auditor develops detailed audit programs in response to the assessed risks -audit programs are in alignment with the selected audit strategy (e.g. combined) -develop an audit program for the conversion audit -update audit programs for control environment and affected cycles based upon the information noted above 5. Tests of control -the auditor tests controls on which intended reliance is to be placed or -where control testing is required, for example due to lack of paper audit trail -assess impact of results of tests on control risk or RMM -auditor will need to test new automated controls or new manual controls on which reliance is intended to be placed; computer assisted audit techniques such as test data could be used 6. Substantive tests -the auditor conducts tests of details of balances to quantify potential errors -assess impact of results on RMM -auditor could use computer assisted audit tests such as with ACL to assist with conversion audit or financial statement audit process -auditor may need specialist assistance to access data that is stored in the DBMS 7. Ongoing evaluation, quality control and final evidence gathering -work of the IT auditor will need to be adequately supervised and integrated with the rest of the field work 8. Complete quality control, and issue the auditor’s report -need to consider all of the field work conducted including the quality of the DRP to determine whether an unqualified audit report can be issued B. Impact of implementation -an IT auditor may need to be required to understand the controls embedded into the management of the RFID technology and to consider the impact of these controls upon the financial statement audit process -check to make sure that only authorized employees can change the RFID data -the auditor will need to specifically consider how the technology will be used in the audit cycles affected to determine how the audit process will need to change, for example: • If wireless scanners will be used to count inventory, identify the controls to ensure that all items are tagged with RFID chips so that everything is counted and • Identify the controls to ensure that each tagged item is tagged correctly (i.e. the item number and description are correct) -consider whether the company will be able to ship or receive goods if the wireless system is down. Does this affect going concern risk? -RFID use may reduce control risk since the inventory process is more automated, reducing the likelihood of error Diff: 3 Type: ES Page Ref: 308-317, 322-328 Learning Obj.: 10-1 Explain what an audit strategy is; 10-3 Describe the methodology for designing tests of controls and tests of details in the audit program 10.2 Explain why determining evidence mix is a dynamic process 1) Which of the following audit tests is usually the most costly to perform? A) analytical procedures B) tests of controls C) tests of details of balances D) procedures to obtain an understanding of internal control Answer: C Diff: 2 Type: MC Page Ref: 318 Learning Obj.: 10-2 Explain why determining evidence mix is a dynamic process 2) When considering the relationships between types of audit tests and evidence, which of the following procedures are used for both obtaining an understanding of internal control and for conducting tests of controls? A) inspection, recalculation, observation, inquiry, and reperformance B) inspection, recalculation, external confirmation, and reperformance C) recalculation, observation, inquiry, analytical procedures and reperformance D) analytical procedures, inspection, recalculation and reperformance Answer: A