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. (AICPA ADAPTED)

c 2. Analytical procedures are

a. Substantive tests designed to evaluate a system of internal control.
b. Tests of controls designed to evaluate the validity of management's representation letter.
c. Substantive tests designed to evaluate the reasonableness of financial information.
d. Tests of controls designed to evaluate the reasonableness of financial information.
(AICPA ADAPTED)

c 3. Which of the following best describes the primary purpose of audit procedures?
a. To detect errors or irregularities.
b. To comply with generally accepted accounting principles.
c. To gather corroborative evidence.
d. To verify the accuracy of account balances. (AICPA ADAPTED)

d 4. The procedures specifically outlined in an audit program are primarily designed to

a. Protect the auditor in the event of litigation.
b. Detect errors or irregularities.
c. Test internal control structure.
d. Gather evidence. (AICPA ADAPTED)

b 5. Which of the following is ordinarily designed to detect possible material dollar errors on the
financial statements?
a. Tests of controls.
b. Analytical procedures.
c. Computer controls.
d. Post audit working paper review. (AICPA ADAPTED)

d 6. Which of the following statements relating to the competence of evidential matter is always true?
a. Evidential 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. Evidence gathered by auditors must be both valid and relevant to be considered competent.
(AICPA ADAPTED)

c 7. 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 tests of transactions, direct tests of financial balances, or analytical tests.
d. Will increase proportionately with the auditor's assessment of control risk.
(AICPA ADAPTED)

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a 8. Which 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 judgment.
b. Materiality.
c. Relative risk.
d. Reasonable assurance.
(AICPA ADAPTED)

d 9. Which of the following factors will least affect the independent auditor's judgment as to the
quantity, type, and content of the working papers desirable for a particular engagement?
a. Nature of the auditor's report.
b. Nature of the financial statements, schedules, or other information upon which the auditor is
reporting.
c. Need for supervision and review.
d. Number of personnel assigned to the audit. (AICPA ADAPTED)

a 10. An auditor's working papers will generally be least likely to include documentation showing how
the
a. Client's schedules were prepared.
b. Engagement had been planned.
c. Client's internal control structure had been reviewed and evaluated.
d. Unusual matters were resolved. (AICPA ADAPTED)

c 11. Which of the following is not a primary purpose of audit working papers?
a. To coordinate the examination.
b. To assist in preparation of the audit report.
c. To support the financial statements.
d. To provide evidence of the audit work performed. (AICPA ADAPTED)

b 12. The 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. Representation letter.
b. Engagement letter.
c. Management letter.
d. Comfort letter. (AICPA ADAPTED)

b 13. Audit evidence takes different forms and varies in persuasiveness. Which of the following is the
least persuasive type of evidence?
a. Vendor's invoice.
b. Bank statement obtained from the client.
c. Computations made by the auditor.
d. Canceled checks. (AICPA ADAPTED)

b 14. The following statements were made in a discussion of audit evidence by two independent
auditors. Which statement is untrue?
a. “I am seldom convinced beyond all doubt about all aspects of the financial statements being
audited.”
b. “I would not undertake that procedure because, at best, the results would only be persuasive and
I'm looking for convincing evidence.”
c. “I evaluate the degree of risk involved in deciding the kind of evidence I will gather.”
d. “I evaluate the usefulness of the evidence I can obtain against the cost to obtain it.”

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 (AICPA ADAPTED)
b 15. As the acceptable level of detection risk decreases, an auditor may change the
a. Timing of substantive tests by performing them at an interim date rather than at year-end.
b. Nature of substantive tests from a less effective to a more effective procedure.
c. Timing of tests of controls by performing them at several dates rather than at one time.
d. Assessed level of inherent risk to a higher amount. (AICPA ADAPTED)

d 16. When an independent auditor is approached to perform an audit for the first time, he or she
should make inquiries of the predecessor auditor. Inquiries are necessary because the predecessor
may be able to provide the successor with information that will assist the successor in
determining whether
a. The predecessor's work should be used.
b. The company rotates auditors.
c. Control risk is low, in the predecessor’s opinion.
d. The engagement should be accepted. (AICPA ADAPTED)

b 17. The purpose of tests of controls is to provide reasonable assurance that

a. The extent of substantive testing is minimized.
b. Evidence will be obtained to determine an assessed level of control risk.
c. Errors and irregularities are prevented or detected in a timely manner.
d. The auditor has an understanding of the control environment. (AICPA ADAPTED)

c 18. An auditor's working papers should

a. Not be permitted to serve as a reference source for the client.
b. Not contain comments critical of management.
c. Show that the accounting records agree or reconcile with the financial statements.
d. Be considered the primary support for the financial statements being audited.

(AICPA ADAPTED)

c 19. Which of the following is not a factor affecting the independent auditor's judgment about the
quantity, type, and content of audit working papers?
a. The needs for supervision and review of the work performed by assistants.
b. The nature and condition of the client's records and internal controls.
c. The expertise of client personnel and their participation in preparing schedules.
d. The type of the financial statements, schedules, or other information on which the auditor is
reporting. (AICPA ADAPTED)

c 20. During an audit engagement, data are compiled and included in the audit working papers. The
working papers are
a. A client-owned record of conclusions reached by the auditors who performed the engagement.
b. Evidence supporting financial statements.
c. Support 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. (AICPA ADAPTED)

c 21. The current file of the auditor's working papers generally should include
a. A flowchart of the internal controls.
b. Organization charts.
c. A copy of the financial statements.
d. Copies of bond and note indentures. (AICPA ADAPTED)

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b 22. Using laptop computers in auditing may affect the methods used to review the work of staff
assistants because
a. Supervisory personnel may not have an understanding of the capabilities and limitations of
computers.
b. Working paper documentation may not contain readily observable details of calculations.
c. The audit field work standards for supervision may differ.
d. Documenting the supervisory review may require assistance of management services personnel.
(AICPA ADAPTED)

c 23. Which of the following persons is not a specialist upon whose work an auditor may rely?
a. Actuary.
b. Appraiser.
c. Internal auditor.
d. Engineer. (AICPA ADAPTED)

b 24. In which of the following instances would an auditor be least likely to require the assistance of a
specialist?
a. Assessing the value of inventories of works of art.
b. Determining the quantities of materials stored in piles.
c. Determining the value of unlisted securities.
d. Determining the assessed value of fixed assets. (AICPA ADAPTED)

SHORT ANSWER

1. Evidential matter consists of the accounting data that underlies management’s financial
statements and the information that supports the accounting data. Please compare underlying
accounting data with corroborating information.

Answer:
Underlying accounting data includes records of original entry (e.g., journals), general and
subsidiary ledgers, data files, and spreadsheets that capture the details summarized in financial
statements. Corroborating information includes checks, records of electronic fund transfers,
invoices, contracts, minutes of meetings, and other documents; written representations from
vendors, attorneys, banks, and other third parties; and information obtained by questioning
management or by observing a client’s employees at work.

2. List 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.

3. How do tests of controls and tests of details differ from one another?

Answer:
Tests of controls provide evidence about whether misstatement is likely (a means to assess control
risk), and substantive tests of details provide evidence about whether misstatement actually exists
(a means to control detection risk).

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 4. List and define the four categories of ratios used in ratio analysis.

Answer:
1. Activity ratios – measure management’s effectiveness in managing available resources,
among them total assets, inventory and receivables.
2. Profitability ratios – 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.
3. Liquidity ratios – compare short-term assets to short-term liabilities, and measure
management’s ability to meet current obligations.
4. Solvency ratios – measure management’s long-term financial dexterity in one of two
ways: effectiveness in managing borrowed funds or in generating income on borrowed
funds.

5. Describe the evidence normally included in working papers.

Answer:
 Evidence that work was adequately planned, supervised, and reviewed.
 Evidence that internal control was considered as a basis for planning substantive tests.
 Evidence that sufficient competent evidential matter was obtained.

PROBLEMS

1. Analytical procedures allow the auditor to reach conclusions about the details in an account by
testing aggregated data. Well-designed analytical procedures offer an alternative to tests of details
especially in low-risk accounts.

Required:
(a) List two ratios from each category of ratios: activity ratios, profitability ratios, liquidity ratios,
and solvency ratios.
(b) Present the method of calculating the ratios.

Answer:
Student’s answers will vary but will contain ratios and calculation methods from the following
list:

Ratio Method of Calculation

Activity Ratios
Asset Turnover Net Sales/Total Assets
Inventory Turnover Cost of Sales/Average Inventory
Number of Days Supply in Inventory 360 Days/ Inventory Turnover
Accounts Receivable Turnover Net Sales/Average Accounts Receivable
Number of Days Sales in Receivables 360 Days/Accounts Receivable Turnover
Profitability Ratios
Return on Assets Operating Income Before Interest and Taxes
/Average Total Assets
Return on Equity Operating Income Before Interest and Taxes
/Average Shareholders Equity
Operating Margin Operating Income Before Interest and Taxes

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 /Net Sales
Liquidity Ratios
Current Ratio Current Assets/Current Liabilities
Quick Ratio Cash, Marketable Securities, and Receivables
/Current Liabilities
Solvency Ratios
Debt to Equity Ratio Long-Term Debt/Shareholders Equity
Times Interest Earned Income Before Interest and Taxes/Interest Expense
Asset Leverage Total Assets/Shareholders Equity

2. (a) Name and define the five financial statement assertions

(b) Relate each of the financial statement assertions to a Balance Sheet specific account.

Answer:
Answers will vary in the Balance Sheet account example. Presented is the answer as it pertains to
the asset account - Inventory

Assertion Definition Balance Sheet Account

Existence or Occurrence
Completeness
Rights and Obligations
Valuation or Allocation
Presentation and Disclosure
Example (Inventory)
All recorded assets, liabilities, Inventory physically exists.
and equities exist, and all
recorded transactions occurred.
All transactions and accounts Inventory includes all products
that should be presented in the on hand.
financial statements are
presented.
Assets are the rights, and The entity has legal title or
liabilities are the obligations, of similar rights of ownership.
the entity.
Assets, liabilities, equities, Inventory is properly stated at
revenues, and expenses are the lower of cost or market.
included in the financial
statements at appropriate
amounts; revenues, costs, and
expenses are allocated to the
proper accounting periods.
Financial statement components Inventory is properly classified
are properly classified, as a current asset.
described, and disclosed.

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