Comprehensive Material Series Audit Reports (Auditing)

Comprehensive Material Series Audit Reports (Auditing) 1) Explain why auditors’ reports are important to users of financial statements and why it is desirable to have standard wording. : 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 auditor’s 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 auditor’s report or opinion. 2) List the seven parts of a standard unqualified audit report and explain the meaning of each part. How do the parts compare with those found in qualified report? : The unqualified audit report consists of: 1. Report title Auditing standards require that the report be titled and that the title includes the word independent. 2. Audit report address The report is usually addressed to the company, its stockholders, or the board of directors. 3. Introductory paragraph The first paragraph of the report does three things: first, it makes the simple statement that the CPA firm has done an audit. Second, it lists the financial statements that were audited, including the balance sheet dates and the accounting periods for the income statement and statement of cash flows. Third, it states that the statements are the responsibility of management and that the auditor's responsibility is to express an opinion on the statements based on an audit. 4. Scope paragraph. The scope paragraph is a factual statement about what the auditor did in the audit. The remainder briefly describes important aspects of an audit. 5. Opinion paragraph. The final paragraph in the standard report states the auditor's conclusions based on the results of the audit. 6. Name of CPA firm. The name identifies the CPA firm or practitioner who performed the audit. 7. Audit report date. The appropriate date for the report is the one on which the auditor has completed the most important auditingprocedures in the field. The same seven parts are found in a qualified report as in an unqualified report. There are also often one or more additional paragraphs explaining reasonsfor the qualifications. 3) What are the purposes of the scope paragraph in the auditor’s report? Identify the most important information included in the scope paragraph. : The purposes of the scope paragraph in the auditor's report are to inform the financial statement users that the audit was conducted in accordance with generally accepted auditing standards, in general terms what those standards mean, and whether the audit provides a reasonable basis for an opinion. The information in the scope paragraph includes: Comprehensive Material Series 1. The auditor followed generally accepted auditing standards. 2. The audit is designed to obtain reasonable assurance about whether the statements are free of material misstatement. 3. Discussion of the audit evidence accumulated. 4. Statement that the auditor believes the evidence accumulated was appropriate for the circumstances to express the opinion presented. 4) What are the purposes of the opinion paragraph in the auditor’s report? Identify the most important information included in the opinion paragraph. : The purpose of the opinion paragraph is to state the auditor's conclusions based upon the results of the audit evidence. The most important information in theopinion paragraph includes: 1. The words "in our opinion" which indicate that the conclusions are based on professional judgment. 2. A restatement of the financial statements that have been audited and thedates thereof or a reference to the introductory paragraph. 3. A statement about whether the financial statements were presented fairlyand in accordance with generally accepted accounting principles. 5) On February 17, 2006, a CPA completed the field work on the financial statements for the Buckheizer Technology Corporation for the year ended December 31, 2005. The audit in satisfactory in all respects except for the existence of a change in accounting principle from FIFO to LIFO inventory valuation., which results in an explanatory paragraph to consistency. On February 26, the auditor completed the tax return and the draft of the financial statements. The final audit report was completed, attached to the financial statements, and delivered to the client on March 7. What is the appropriate date on the auditor’s report? : The auditor's report should be dated February 17, 2006, the date on which the auditor completed the most important auditing procedures in the field. 6) What five circumstances are required for a standard unqualified report to be issued? : An unqualified report may be issued under the following five circumstances: 1. All statements—balance sheet, income statement, statement of retained earnings, and statement of cash flows—are included in the financial statements. 2. The three general standards have been followed in all respects on the engagement. 3. Sufficient evidence has been accumulated and the auditor has conducted the engagement in a manner that enables him or her to conclude that the three standards of field work have been met. 4. The financial statements are presented in accordance with generally accepted accounting principles. This also means that adequatedisclosures have been included in the footnotes and other parts of the financial statements. 5. There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report. 7) Describe the additional information included in the introductory, scope, and opinion paragraphs in a combined audit report on financial statements and the effectiveness of internal control over Comprehensive Material Series financial reporting. What is the nature of the additional paragraphs in the audit report? : The introductory, scope and opinion paragraphs are modified to include reference to management’s report on internal control over financial reporting, and the scopeof the auditor’s work and opinion on internal control over financial reporting. The introductory and opinion paragraphs also refer to the framework used to evaluate internal control. Two additional paragraphs are added between the scope and opinion paragraphs that define internal control and describe the inherent limitations of internal control. 8) What type of opinion should an auditor issue when the financial statements are not in accordance with GAAP because such adherence would result in misleading statements? : When adherence to generally accepted accounting principles would result in misleading financial statements there should be a complete explanation in a separate paragraph. The separate paragraph should fully explain the departure and the reason why generally accepted accounting principles would have resulted in misleading statements. The opinion should be unqualified, but it should refer to the separate paragraph during the portion of the opinion in which generally accepted accounting principles are mentioned. 9) Distinguish between an unqualified report with explanatory paragraph or modified wording and a qualified report. Give examples when an explanatory paragraph or modified wording should be used in an unqualified opinion. : An unqualified report with an explanatory paragraph or modified wording is the same as a standard unqualified report except that the auditor believes it is necessary to provide additional information about the audit or the financial statements. For a qualified report, either there is a scope limitation (condition 1) or a failure to follow generally accepted accounting principles (condition 2). Under either condition, the auditor concludes that the overall financial statements arefairly presented. Two examples of an unqualified report with an explanatory paragraph or modified wording are: 1. The entity changed from one generally accepted accounting principle to another generally accepted accounting principle. 2. A shared report involving the use of other auditors. 10) Describe what is meant by a reports involving the use of other auditors. What are the three options available to the principal auditor and when should each be used? : When another CPA has performed part of the audit, the primary auditor issues one of the following types of reports based on the circumstances. 1. No reference is made to the other auditor. This will occur if the other auditor audited an immaterial portion of the statement, the otherauditor is known or closely supervised, or if the principal auditor has thoroughly reviewed the other auditor's work. 2. Issue a shared opinion in which reference is made to the other auditor. This type of report is issued when it is impractical to review the work of the other auditor or when a portion of the financial statements audited by the other CPA is material in relation to the total. Comprehensive Material Series 3. The report may be qualified if the principal auditor is not willing to assume any responsibility for the work of the other auditor. A disclaimer may be issued if the segment audited by the other CPA is highly material. 11) The client has restated the prior-year statements because of a change from LIFO to FIFO. How should be this reflected in the auditor’s report? : Even though the prior year statements have been restated to enhance comparability, a separate explanatory paragraph is required to explain the change in generally accepted accounting principles in the first year in which the changetook place. 12) Distinguish between changes that affect consistency and those that may affect comparability but not consistency. Give an example of each. : Changes that affect the consistency of the financial statements may involve anyof the following: a. Change in accounting principle b. Change in reporting entity c. Corrections of errors involving accounting principles. An example of a change that affects consistency would be a change in the method of computing depreciation from straight line to an accelerated method. A separate explanatory paragraph is required if the amounts are material. Comparability refers to items such as changes in estimates, presentation, and events rather than changes in accounting principles. For example, a change in the estimated life of a depreciable asset will affect the comparability of the statements. In that case, no explanatory paragraph for lack of consistency is needed, but the information may require disclosure in the statements. 13) List the three conditions that require a departure from unqualified opinion and give one specific example of each those conditions. : The three conditions requiring a departure from an unqualified opinion are: 1. The scope of the audit has been restricted. One example is when the client will not permit the auditor to confirm material receivables. Another example is when the engagement is not agreed upon until after the client's year-end when it may be impossible to physically observe inventories. 2. The financial statements have not been prepared in accordance with generally accepted accounting principles. An example is when the client insists upon using replacement costs for fixed assets. 3. The auditor is not independent. An example is when the auditor owns stock in the client's business. 14) Distinguish between a qualified opinion, adverse opinion, and a disclaimer of opinion, and explain the circumstances under which each is appropriate. 15. Define materiality as it is used in audit reporting. What conditions will affect the auditor’s determination of materiality? Explain how materiality differs for failure to follow GAAP and for lack of independence. How does the auditor’s opinion differ between scope limitations caused by client restrictions and limitations resulting from conditions beyond the client’s control? Under which of these two Distinguish between a report qualified as to opinion only and one with both a scope and opinion qualification. Identify the three alternative opinion that may be appropriate when the client’s financial statements are not accordance with GAAP. Under what circumstances is each appropriate. Discuss why the AICPA has such strict requirements on audit opinions when the auditor is not independent. When an auditor discovers more than one condition that requires departure from or modification of standard unqualified report, what should the auditor’s report include? What responsibility does the auditor have for information on the company’s web site that may be inked to electronic versions of the company’s annual financial statements and auditor’s report? How does this differ from the auditor’s responsibility for other information in the company’s annual report that includes the financial statements and auditor’s report? State the objective of the audit of financial statements. In general terms, how do auditors meet that objective? Distinguish between management’s and auditor’s responsibility for the financial statements being audited. Distinguish between the terms errors and fraud. What is the auditor’s responsibility for finding each? Distinguish between fraudulent financial reporting and misappropriation of assets. Discuss the likely difference between those two types of fraud on the fair presentation of financial statements. “It is well accepted in auditing that throughout the conduct of the ordinary audit, it is essential to obtain large amounts of information from management and to rely heavily on management’s judgments. After all, the financial statements are management’s representations, and simple, it is extremely difficult, if not impossible, for the auditor to evaluate the obsolescence inventory as well as management can in a highly complex business. Similarly, the collectability of accounts receivable and the continued usefulness of machinery and equipment are heavily dependent on management’s willingness to provide truthful responses to questions.” Reconcile the auditor’s responsibility for discovering material misrepresentations by management with these comments. List two major characteristics that are useful in predicting the likelihood of fraudulent financial reporting in an audit. For each of the characteristics, state two things that the auditor can do to evaluate its significance in the engagement. Describe what is meant by the cycle approach to auditing. What are the advantages of dividing the audit into different cycles? Identify the cycle to which each of the following ledger accounts would ordinarily be assigned: sales, account payable, retained earnings, account receivable, inventory and repairs and maintenance. Why are sales, sales R&A, bad debts, cash discounts, AR, and allowance for uncollectible accounts all included in the same cycle? Define what is meant by a management assertion about financial statements. Identify the five board categories of management assertions. Distinguish between the general audit objectives and management assertions. Why are the general audit objectives more useful to auditors? An acquisition of fixed-asset repair by a construction company is recorded on the wrong date. Which transaction-related audit objective has been violated? Which transaction-related audit objective has been violated if the acquisition had been capitalized as a fixed asset rather than expensed? Distinguish between the existence and completeness balance- related audit objectives. State the effect on financial statements (overstatement or understatement) of a violation of each in the audit of accounts receivable. What are specific audit objectives? Explain their relationship to the general audit objectives. Identify the management assertion and general balance-related audit for the specific balance-related audit objective: All recorded fixed assets exist at the balance sheet date. Explain how management assertions, general balance-related audit objectives, and specific balance-related audit objectives are developed for an account balance such as accounts receivable. Identify the four phases of the audit. What is the relationship of the four phases to the objective of the audit of financial statements? Discuss the similarities and differences between evidence in a legal case and evidence in an audit of financial statements. List the four major evidence decisions that must be made on every audit. Describe what is meant by an audit procedure. Why is it important for audit procedures to be carefully worded? Describe what is meant by an audit program for accounts receivable. What four things should be included in an audit program? State the third standard of field work. Explain the meaning of each of the major phrases of the standard. Explain why the auditor can be persuaded only with a reasonable level of assurance, rather than convinced, that the financial statements are correct. Identify the two factors, that determine the persuasiveness of evidence. How are these two factors related to audit procedures, sample size, items to select, and timing? Identify the seven characteristics that determine the competence of evidence. For each characteristics, provide one example of a type of evidence that is likely to be competent. List the seven types of audit evidence included in this chapter and give two examples of each. Distinguish between a confirmation and external documentation. Distinguish between internal documentation and documentation as audit evidence and give three examples of each. Explain the importance of analytical procedures as evidence in Identify the most important reasons for performing analytical procedures. Your client, Harper Company, has a contractual commitment as a part of a bond indenture to maintain a current ratio of 2.0. if the ratio falls below that level on the balance sheet date, the entire bond becomes payable immediately. In the current year, the client’s financial statements show that the ratio has dropped from 2.6 to Distinguish between attention-directing analytical procedures and those intended to eliminate or reduce detailed substantive procedures. Explain why the statement “Analytical procedures are essential in every part of an audit, but these tests are rarely sufficient by themselves for any audit area” is correct or incorrect. List the purposes of audit documentation and explain why each purpose is important. What are the two criteria that auditors of public companies consider when determining whether memos, correspondence, and other documents must be maintained in the audit files? For how long does the Sarbanes-Oxley Act require auditors of public companies to retain audit documentation? Explain why it is important for audit documentation to include each of the following: identification of the name of the client, period covered, description of the contents, initial of the preparer, date of the preparation, and an index code. Define what is meant by a permanent file, and list several types of information typically included. Why does the auditor not include the contents of the permanent file with the current year’s audit file? Distinguish between the following types of current period supporting schedules and state the purpose of each: analysis, trial balance, and tests of reasonableness. Why is it essential that the auditor not leave questions or exceptions in the audit documentation without an adequate explanation? Who owns the audit files? Under what circumstances can they be used by other people? A CPA sells his auditing practice to another CPA firm and includes all audit files as part of the purchase price. Under what circumstances is this a violation of the code of professional conduct? How does the auditor read and evaluate information that is available only in machine-readable form? Explain the purposes and benefits of audit documentation software. what benefits does the auditor derive from planning audits? Identify the eight major steps in planning audits. What are the responsibilities of the successor and predecessor auditors when a company is changing auditors? What factors should an auditor consider prior to accepting an engagement? Explain. Who is considered “the client” when auditing public companies? Which services must be preapproved by the audit committee a public company? Explain why auditors need an understanding of the client’s industry. What sources are commonly used by auditors to learn about the client’s industry? When a CPA has accepted an engagement from a new client who is manufacturer, it is customary for the CPA to tour the client’s plant facilities. Discuss the ways in which the CPA’s observations made during the course of the plant tour will be of help in planning and conducting the audit. Define what is meant by a related party. What are the auditor’s responsibilities for related parties and related party transactions? Which types of loans to executives are permitted by the Sarbanes- Oxley Act? Your firm has performed the audit of Rogers Company for several years and you have been assigned the audit responsibility for the current audit. How would you review of the corporate charter and bylaws for this audit differ from that of the audit of a client who was audited by a different CPA firm in the preceding year? information in a mortgage that is likely to be relevant to the auditor. Identify two types of information in the client’s minutes of the board of directors meetings that are likely to be relevant to the auditor. Explain why it is important to read the minutes early in the engagement. Identify the three categories of client objectives. Indicate how each objective may affect the auditor’s assessment of inherent risk and evidence accumulation. Gale Gordon, CPA, has found ratio and trend analysis relatively useless as a tool in conducting audits. For several engagement, he computed the industry ratios included in publications by Robert Morris Associates and compared them with industry standards. For most engagements, the client’s business was significantly different from the industry data in the publication and the client would automatically explain away any discrepancies by attributing them to the unique nature of its operations. In cases in which the client had more than one branch in different industries, Gordon found the ratio analysis no help at all. How could Gordon improve the quality of his analytical procedures? At the completion of every audit, Roger Morris, CPA, calculates a large number of ratios and trends for comparison with industry averages and prior-year calculations. He believes the calculations are worth the relatively small cost of doing them because they provide him with an excellent overview of the client’s operations. If the ratios are out of line, Morris discusses the reasons with the client and often make suggestions on how to bring the ratio back in line in the future. In some cases, these discussions with management have been the basis for management consulting engagements. Discuss the major strengths and shortcomings in Morris’s use of ratio and trend analysis. Name the four categories of financial ratios and give an example of a ratio in each category. What is the primary information provided by each financial ratio category? Chapter 8 introduced the eight parts of the planning phase of an audit. Which part is the evaluation of materiality and risk? Define the meaning of the term materiality as it is used in accounting and auditing. What is the relationship between materiality and the phrase obtain reasonable assurance used in the auditor’s report? Explain why materiality is important but difficult to apply in practice. What is meant by setting a preliminary judgment about materiality? Identify the most important factors affecting the preliminary judgment. What is meant by using bases for setting a preliminary judgment about materiality? How would those bases differ for the audit of a manufacturing company and a government unit such as school district? Assume that Rosanne Madden, CPA, is using 5% of net income before tax, current assets, or current liabilities as her major guidelines for Distinguish between the terms tolerable misstatement and preliminary judgment about materiality. How are they related to each other? Assume a company with the following balance sheet accounts: How would the conduct of an audit of a medium-sized company be affected by the company’s being a small part of a large conglomerate as compared with it being a separate entity? Define the audit risk model and explain each term in the model. What is meant by planned detection risk? What is the effect on the amount of evidence the auditor must accumulate when planned detection risk is increased from medium to high? Explain the causes of an increased or decreased planned detection risk. Define what is meant by inherent risk. Identify four factors that make for high inherent risk in audits. Explain why inherent risk is set for segments rather than for overall audit. What is the effect on the amount of evidence the auditor must accumulate when inherent risk is increased from medium to high for a segment? Compare your answer with the one for question 12. Explain the effect of extensive misstatements found in the prior year’s audit on inherent risk, planned detection risk, and planned audit evidence. Explain what is meant by term acceptable audit risk. What is its relevance to evidence accumulation? Explain the relationship between acceptable audit risk and the legal liability of auditors. State the three categories of factors that affect acceptable audit risk and list the factors that auditor can use to indicate the degree to which each category exists. Auditors have not been successful in measuring the components of the audit risk model. How is it possible to use the model in a meaningful way without a precise way of measuring risk? Explain the circumstances when the auditor should revise the components of the audit risk model and the effect of the revisions on planned detection risk and planned evidence. Describe the three broad objectives management has designing effective internal control. Describe which of three categories of broad objectives for internal controls would be considered by theauditor in an audit of both financial statements and internal control over financial reporting. Section 404 of Sarbanes-Oxley Act requires management to issue a report on internal control over financial reporting. Identify specific section 404 reporting requirements for management. What two components of internal control must management assess when reporting on internal control to comply with section 404 of theSarbanes-Oxley Act? What is auditor’s responsibility for obtaining an understanding of internal control? How does theresponsibility differ for audits of public and nonpublic companies? When auditing a public company, what are auditor’s responsibilities related to internal control as required by PCAOB standard 2? State thesix transaction-related audit objectives. Management must identify framework used to evaluate effectiveness of internal control over financial reporting. What framework is used by most U.S. public companies? What are five components of internal control in COSO internal control framework? What is meant by control environment? What are factors auditor must evaluate to understand it? What is relationship among five components of internal control? List types of specific control activities and provide one specific illustration of a control in sales area for each control activity. The separation of operational responsibility from record keeping is meant to prevent different types of misstatements than separation of thecustody of assets from accounting. Explain thedifference in purposes of these two types of separation of duties. For each of thefollowing, give an example of a physical control theclient can use to protect asset or record: Cash received by retail clerks Raw material inventory Manufacturing equipment Explain what is meant by independent checks on performance and give five specific examples. What are management’s responsibilities for documenting internal control over financial reporting in a public company? How would thelack of documentation affect an auditor’s report on internal control over financial reporting by PCAOB standard 2? Describe what is meant by a key control and a control deficiency. Distinguish a significant deficiency in internal control form a material weakness in internal control. How would thepresence of one significant deficiency affect auditor’s report on internal control required by PCAOB standard 2? How would thepresence of one material weakness affect an auditor’s report on internal control required by PCAOB standard 2? Frank James, a highly competent employee of Brinkwater Sales Corporation, had been responsible for accounting-related matters for two decades. His devotion to thefirm and his duties always been exceptional, and over years, he had been given increased responsibility. Both president of Brinkwater and thepartner of an independent CPA firm in charge of audit were shocked and dismayed to discover that James had embezzled more than $500,000 over a 10-year period by not recording billings in thesales journal and subsequently diverting thecash receipts. What major factors permitted defalcation to take place? Jeanne Maier, CPA, believes that it is appropriate to obtain an understanding of intaernal control about halfway through theaudit, after she is familiar with theclient’s operations and theway thesystem actually works. Sha has found through experience taht filling out internal control questionnaires and flowcharts early in engagement is not beneficial because system rarely functions way it is supposed to. Later in engagement, theauditor can prepare flowcharts and questionnaires with relative ease because of knowledge already obtained on audit. Evaluate her approach. Distinguish theauditor’s responsibility for testing control in an audit of a public company from theresponsibility to test controls in an audit of a nonpublic company. How does thesufficiency of evidence differ between procedures to obtain an understanding of internal control and tests of controls? During prior-year audits of McKimmon Inc., a public company, auditor did tests of controls for all relevant financial statement assertions. Some of therelated controls are manual while others are automated. Describe theextent auditor can rely on tests of controls performed in prior years. Define fraudulent financial reporting and give two examples that illustrate fraudulent financial reporting. Define misappropriation of assets and give two examples misappropriation of assets. Distinguish fraudulent financial reporting from misappropriation of assets. What are three conditions of fraud often referred to as “the fraud triangle?” Give examples of risk factors for fraudulent financial reporting for each of three fraud conditions: incentives/pressures, opportunities, and attitudes/rationalization. Give examples of risk factors for misappropriation of assets for each of thethree fraud conditions: incentives/pressures, opportunities, and attitudes/rationalization. What sources are used by auditor to gather information to assess fraud risks? What should theaudit team consider in its planning discussion about Auditors are required to make inquiries of individuals in thecompany when gathering information to asses fraud risk. Identify those with whom auditor must make inquiries. Describe thepurpose of corporate codes of conduct and identify three examples of items addressed in a typical code of conduct. Discuss theimportance of thecontrol environment, or “setting thetone at thetop,” in establishing a culture of honesty and integrity in a company. Distinguish management’s responsibility from theaudit committee’s responsibility for designing and implementing antifraud programs and controls within a company. What are three categories of auditor responses to fraud risks? What three auditor actions are required to address thepotential for management override of controls? Describe three main techniques used to manipulate revenue. You go through thedrive-through window of a fast food restaurant and notice a sign that reads “your meal is free if we fail to give you a receipt.” Why would therestaurant post this sign? Name thethree categories of inquiry and describe thepurpose of each when used by an auditor to obtain additional information about a suspected fraud. Identify three verbal and three nonverbal cues that may be observed when making inquiries of an individual who is being deceitful. You have identified a suspected fraud involving company’s controller. What must you do in response to this discovery? How might this discovery affect your report on internal control when auditing a public company? Explain how client internal controls can be improved through proper installation of IT. Identify risks for accounting systems that rely heavily on functions. Define what is meant by an audit trail and explain how it can be affected by client’s integration of IT. Identify traditionally segregated duties in noncomplex IT systems and explain how increases in complexity of IT function affect that separation. Distinguish between general controls and application controls and give two examples of each. Identify thetypical duties within an IT function and describe how those duties should be segregated among IT personnel. Explain how effectiveness of general controls affects theauditor’s tests of automated application controls, including auditor’s ability to rely on tests done in prior audits. Explain relationship between application controls and transaction-related audit objectives. Explain what is meant by auditing around thecomputer and describe what must be present for this approach to be effective when auditing clients who use IT to process accounting information. Explain what is meant by thetest data approach. What are themajor difficulties with using this approach? Define parallel simulation with audit software and provide an example of how it can be used to test a client’s payroll system. Describe risks that are associated with purchasing software to be installed on microcomputer hard drives. What precautions can clients take to reduce those risks? Compare risks associated with network systems to those associated with centralized IT functions. An audit client is in process of creating an online web-based sales ordering system for customers to purchase products using personal credit cards for payment. Identify three risks related to an online sales system that management should consider. For each risk, identify an internal control that could be implemented to reduce that risk. Explain why it is unacceptable for an auditor to assume that an independent computer service center is providing reliable accounting information to an audit client. What can auditor do to test service center’s internal controls? What are thefive types of tests auditors use to determine whether financial statements are fairly stated? Identify which tests are performed to reduce control risk and which tests are performed to reduce planned detection risk. Also, identify which tests will be used by a public company auditor when internal control over financial reporting. What is purpose of tests of controls? Identify specific accounts on thefinancial statements that are affected by performing tests of controls for acquisition and payment cycle. Distinguish between a test of control and a substantive test of transactions. Give two examples of each. State a test of control audit procedure to test effectiveness of following control: approved wage rates are used in calculating employees’ earnings. State a substantive test of transactions audit procedure to determine whether approved wage rates are actually used in calculating employees’ earnings. A considerable portion of tests of controls and substantive tests of transactions are performed simultaneously as a matter of audit convenience. But substantive tests of transactions procedures and sample size, in part, depend on theresults of thetests of controls. How can theauditor resolve this apparent inconsistency? Evaluate thefollowing statement: “tests of sales and cash receipts transactions are such an essential part of every audit that i like to perform them as near end of audits as possible. By that time i have a fairly good understanding of theclient’s business and its internal controls because confirmations, cutoff tests, and other procedures have already been completed.” Explain how thecalculation and comparison to previous years of thegross margin percentage and ratio of accounts receivable to sales are related to theconfirmation of accounts receivable and other tests of accuracy of accounts receivable. Distinguish between substantive tests of transactions and tests of details of balances. Give one example of each for theacquisition and payment cycle. The auditor Ferguson’s Inc. identified two internal controls in thesales and collection receipts cycle for testing. In thefirst control, thecomputer verifies that a planned sale on account will not exceed thecustomer’s credit limit entered in theaccounts receivable master file. In thesecond control, theaccounts receivable clerk matches bills of ladding, sales invoices, and customer orders before recording in thesales journal. Describe how thepresence of general controls over software programs and master file changes affects extent of audit testing of each of these two internal controls. Assume that theclient’s internal controls over therecording and classifying of fixed asset additions are considered deficient because individual responsible for recording new aquisitions has inadequate technical training and limited experience in accounting. How will this situation affect theevidence you should accumulate in auditing fixed assets as compared with another audit in which thecontrols are excellent? Be as specific as possible. For each of theeight types of evidence discussed in chapter 7, identify whether it is applicable for risk assessment procedures, Rank thefollowing types of tests from moct costly to least costly: analytical procedures, tests of details of balances, risk assessment procedures, tests of controls, and substantive tests of transactions. In figure 13-3, explain thedifference among C3, C2, and C1. Explain circumstances under which it will be a good decision to obtain audit assurance from substantive tests at point C1. Do thesame for points C2, and C3. Table 13-3 illustrates variations in theemphasis on different types of audit tests. What are thebenefits to theauditor of identifying thebest mix of tests? Expalin relationship between methodology for designing tests of controls and substantive tests of transactions in figure 13-4 to methodology for designing tests of details of balances in figure 13-6. Explain relationship of tolerable misstatement, inherent risk, and control risk to planned tests of details of balances. List thenine balance-related audit objectives in theverification of ending balance in inventory and provide one useful audit procedure for each of objectives. Why do auditors often consider it desirable to perform audit tests throughout theyear rather than wait until year-end? List several examples of evidence that can be accumulated before year-end.