Deck 10: Audit Strategy and Audit Program

Question 1

Greenvale Construction Limited was started by four brothers who lived in the Toronto area. Over time, the brothers 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 under 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. In Halifax, the work is mid-sized to large commercial 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 1

To document 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 on 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 cutoff 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 at each location: each of the brothers has the ability to override controls.
•Procedures and controls for each of the construction divisions may be different and should be considered separately.
•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.

Question 2

When does the auditor normally conduct tests of controls?

A) prior to the completion of the tests of details
B) after the completion of all analytical review
C) prior to the preparation of the client risk analysis
D) prior to the finalization of the audit risk model

Answer 2

A

Question 3

The auditor would like to design a test of control to test that 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 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 missing in the sequence (gap detection).
D) Match shipments to the associated sales invoices.

Answer 3

C

Question 4

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.

Question 5

After finishing the procedures to obtain an understanding of internal control in an audit engagement, the auditor should perform tests of controls on

A) those controls that the auditor plans to rely upon.
B) those controls in which material weaknesses were identified.
C) those controls that have a material effect upon the financial statement balances.
D) a random sample of the controls that were reviewed.

Question 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

Question 7

Choosing the appropriate analytical procedures requires the auditor to use

A) the standards developed by the auditor's firm.
B) automated working paper software.
C) computer-assisted audit techniques.
D) professional judgment.

Question 8

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 the disclosure requirements of a generally accepted accounting framework.
D) entity has complied with requirements of quality control.

Question 9

The auditor would like to design a test of control to test that 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.

Question 10

"This is really confusing! I've sat in on audit planning meetings for three different clients so far, and each one has gone differently. I've been responsible for the sales section each time. Sure the risks are all different, but in the first one I'm supposed to do flowcharts and detailed narrative for the sales systems, in the second one I'm supposed to use the firm's computerized system to answer detailed questions, and in the last one the partner only wants a brief description of the system in narrative form - no more than one page, he said."
Required:
Explain why it may be necessary to do different types of documentation to support an understanding of internal controls in the context of risks and evidence mix.

Question 11

Eleonora 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. Eleonora is ensuring that they have been signed by the employees. Eleonora 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.

Question 12

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.

Question 13

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

Question 14

An example of an audit procedure that relates to the auditor's understanding of internal control is to

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.

Question 15

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.

Question 16

Jane is a sole practitioner operating out of a local office. She is part of a regional group of firms and occasionally does small audits with the assistance of one staff person. Using automated working paper software, she runs a standard set of analytical review calculations for each audit, then puts them in the working paper file. She does not look at the analytical review process again.
Since most of her audit clients have no internal controls, she then calculates materiality and conducts a substantive audit. She prefers to do more substantive testing rather than having to do all kinds of work with internal controls.
Required:
What is wrong with Jane's audit approach?

Question 17

Analytical procedures are mandatory during which phases of the audit?

A) tests of controls and tests of details
B) planning and final evaluation
C) planning and tests of details
D) tests of details and final evaluation

Question 18

An example of an audit procedure that relates to the auditor's understanding of internal control is to

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.

Question 19

You are a senior at a PA firm and this is your junior's first day. He would like you to explain to him the different types of audit tests that should be performed over the course of an audit to obtain sufficient and appropriate audit evidence. Be sure to indicate which component of audit risk each type of test is linked to.

Question 20

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.

Question 21

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 cutoff errors that can be explained.
C) an indication of potential errors in the ending balance.
D) financial statement misstatements.

Question 22

Audit risk is assessed at which level of the audit?

A) account
B) cycle
C) transaction-related audit objective
D) overall audit

Question 23

A) Describe the five types of audit tests used to determine whether financial statements are fairly stated. Identify which 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 to update and evaluate the auditor's previous experience with the entity. Identify the four additional types of procedures related to understanding internal control.

Question 24

A procedure designed to test for dollar errors or irregularities directly affecting the correctness of financial statement balances is a(n)

A) substantive test.
B) analytical test.
C) test of controls.
D) definition of dollar-unit sampling.

Question 25

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.

Question 26

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 cutoff 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

Question 27

Discuss the purposes of tests of controls and tests of details of balances. Give an example of each.

Question 28

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.

Question 29

When the auditor identifies an area of the accounting system with missing controls (i.e., a weakness or deviation), this would lead to a modification of the audit program in that area that would

A) increase the amount of tests of controls.
B) increase the reliance on tests of controls.
C) cause the issuance of a qualified or adverse opinion.
D) eliminate the need for a test of controls.

Question 30

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.

Question 31

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.

Question 32

The auditor would like to design a test of control to test that 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 changes to the price file throughout the year for proper authorizations and trace prices to copies of sales invoices.
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.

Question 33

The auditor is deciding upon audit procedures to be used in the audit for a particular cycle (i.e., the combination of the four types of tests needed to obtain sufficient appropriate audit evidence). This type of decision is called

A) audit risk.
B) audit strategy.
C) evidence mix.
D) detection risk.

Question 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, and cooking implements. The company sells to businesses only (not to end-consumers), with clients ranging from small restaurants to large food-service chains and hotels. The company has 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. RFID chips will be placed on warehouse shelf locations, boxes of products, and on high-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 of next year, a new inventory management system will be 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 will be affected by the implementation of the new inventory 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.

Question 35

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.

Question 36

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

Question 37

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.

Question 38

If the auditor is not using tests of control, then

A) tests of detail must be used.
B) analytical procedures must be used.
C) tests of design of internal controls must at least be used.
D) the auditor will have to qualify the audit opinion.

Question 39

Materiality is used to help decide the scope of testing, determine the sample size, and

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.

Question 40

The auditor would like to design a test of control to test that 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.

Question 41

After completing tests of key controls, the auditor should review the results and consider whether

A) the planned degree of reliance on internal controls is justified.
B) the audit evidence obtained from the study of internal controls can provide a reasonable basis for an opinion.
C) further study of internal controls is likely to justify any restriction of tests of details of balances.
D) sufficient knowledge has been obtained about the entity's entire internal control structure.

Question 42

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

Question 43

The audit program for most audits is designed in three parts. These parts are

A) risk assessment procedures, tests of controls, and tests of details.
B) risk assessment procedures, analytical procedures, and tests of details.
C) obtaining an understanding of internal controls, analytical procedures, and tests of details.
D) tests of controls, analytical procedures, and tests of details of balances.

Question 44

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

Question 45

Which of the following audit tests is usually the least costly to perform?

A) analytical procedures
B) tests of controls
C) tests of balances
D) confirmations

Question 46

A PA is conducting the audit of Middi Furniture Company, a medium-sized company with few effective controls and significant inherent risks. Management has decided that it is not cost-effective to implement better internal controls. What audit strategy will the PA likely select for this client?

A) combined audit approach for all transaction cycles and accounts
B) substantive audit approach for all transaction cycles and accounts
C) combined audit approach for all cycles except cash and inventory
D) substantive audit approach for all cycles except sales and payroll

Question 47

A PA has designed an audit approach where she places maximum possible reliance on controls. This means that she will be

A) conducting only tests of controls.
B) using analytical review and tests of controls.
C) following a combined audit approach.
D) setting control risk at 100%.

Question 48

Tests of details are designed based upon planned results of analytical review and planned results of tests of controls. Should the planned results differ materially from the actual results of analytical review and tests of controls, then

A) audit risk will be revised.
B) the planned audit program will require revision.
C) inherent risk will be revised.
D) tests of controls will not be considered for overall risk assessment processes.

Question 49

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

Question 50

There will be heavy emphasis on tests of controls when

A) controls are ineffective and assessed control risk is high.
B) controls are effective and assessed control risk is low.
C) the auditor is doing a "fraud audit."
D) it is a first-year audit.

Question 51

Control risk has been assessed at 100% for your client. What audit approach will you follow?

A) a combined approach
B) a substantive approach
C) reliance on analytical review and tests of controls
D) reliance on tests of controls and tests of details

Question 52

Symco Inc. has a policy that all cash disbursements of $2000 or more must be approved by the treasurer. While performing a test of controls on a sample of disbursements, Craig discovered that the assistant controller had authorized a cash disbursement of $3500 while the treasurer was on vacation. This control deviation is significant only if

A) it is determined that the assistant controller is not qualified to approve cash disbursements of this size.
B) it occurred with sufficient frequency to cause the auditor to believe there may be material dollar misstatements in the statements.
C) the amount of the deviation identified is larger than the planning materiality.
D) the amount of the deviation identified is larger than the planning materiality and no compensating control exists.

Question 53

You are conducting the audit of a medium-sized company that has a chief accountant and three employees. Segregation of duties is excellent, with jobs allocated to provide maximum levels of controls. Segregation is supported by accounting software with user identification and passwords that limit functions to the appropriate jobs.
Required:

A) What type of audit approach would you recommend? Why?
B) How would your answer change if the accounting department was organized on a job-sharing basis so that all employees did some of every task to keep the work more interesting? Why?

Question 54

The auditor has conducted tests of controls of the write-off of accounts receivable and found two exceptions. These exceptions are

A) an indication of the likelihood of errors or fraud and other irregularities.
B) confirmation that controls are not functioning as designed throughout the year.
C) information about the quantity of the dollar error in accounts receivable.
D) indications that employee training is required in the accounting area.

Question 55

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

Question 56

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

Question 57

Julianne is performing an analysis of the bad debt expense as a percentage of total sales. When performing the analytical procedure, it is important that Julianne

A) can rely on the internal controls of the accounts receivable process.
B) has an expectation of the result that should be obtained.
C) has concluded that the accounts receivable balance is free from material misstatement.
D) has requested permission from the client.

Question 58

Cimco Forest is a client of your PA firm that has requested that the audit of its financial statements be completed 25 days after its year end. Given the time constraint, the auditor

A) should not accept Cimco as a client.
B) should increase the size of the audit team.
C) can perform audit procedures at an interim date and roll forward the interim balances to year end.
D) should change the audit program to include more tests of controls and fewer tests of details, as they are more time consuming.

Question 59

Last year the materiality for the client was $590 000. This year it is $400 000. All things being equal, how will this change in materiality affect the extent of tests of details?

A) increase
B) decrease
C) no effect as the tests of controls will be increased
D) no effect as the tests of controls will be decreased

Question 60

The highest-cost audit will be incurred when the auditor expects that the internal control system would

A) be effective but the auditor found extensive control test deviations.
B) have few effective controls but client's personnel were well-trained and knowledgeable.
C) be very sophisticated and the tests of controls confirmed this.
D) have few effective controls and tests of balances found many errors.

Question 61

Which of the following ultimately determines the specific audit procedures necessary to provide an auditor with a reasonable basis for the expression of an opinion?

A) the audit program
B) the auditor's professional judgment
C) generally accepted auditing standards
D) the auditor's working papers

Question 62

When considering the relationships between types of audit tests and evidence, which of the following procedures is suitable for use for all types of audit tests (procedures to obtain an understanding of internal control, tests of controls, analytical procedures, and tests of details of balances)?

A) inspection
B) observation
C) inquiries of the client
D) recalculation

Question 63

A) There are seven types of audit evidence: inspection, observation, inquiries of the client, external confirmation, recalculation, reperformance, and analytical procedures. For each of the following types of audit tests, indicate the type(s) of evidence that can be obtained through the test: (1) tests of controls, (2) analytical procedures, and (3) tests of details of balances.
B) Contrast the circumstances in which the auditor would choose not to test controls with those in which he or she would perform tests of controls.
C) Types of audit tests include tests of controls, analytical procedures, and tests of details of balances. Rank these types of tests from least costly to most costly.

Question 64

During a change to an entire IT system, if conversion controls are poor or are not documented, the auditor will need to

A) conduct an implementation audit.
B) conduct a legacy system audit.
C) conduct an audit of the new system.
D) conduct a conversion audit.

Question 65

When considering the relationships between types of audit tests and evidence, which of the following procedures is used only for tests of details of balances?

A) inspection
B) recalculation
C) reperformance
D) external confirmation

Question 66

A standard audit program can dramatically increase

A) audit efficiency.
B) quality of audit evidence.
C) communication among the audit team.
D) the amount of work that can be delegated to more junior staff members.

Question 67

Conversion is the process of

A) testing data.
B) cleaning data in the legacy system.
C) testing data during an implementation.
D) transferring data from a legacy system to a new system.