Question 1

An auditor discovered that a client's accounts receivable turnover is substantially lower for the current year than for the prior year. This may indicate that:

Accepted Answer

Choice "A" is correct. Recording fictitious sales generally has the same impact on revenues and receivables: both would be overstated by the same dollar amount. However, this will cause the accounts receivable turnover ratio to decrease, because the sales figure for the year is generally much larger than the average receivables amount. Since the numerator (sales) is being increased far less proportionately than is the denominator (receivables), overall the ratio will decline. (Try using actual numbers if you want to see how this works: Assume sales of $2,000,000 and average receivables of $300,000. What will happen to the ratio if you increase both of these numbers by $50,000? It will go from 6.7% to 5.9%--a decline.) Choice "B" is incorrect. Inventory stolen by employees just before year-end would not affect the accounts receivable turnover ratio, which is calculated as net credit sales divided by average gross receivables. Choice "C" is incorrect. A substantially lower accounts receivable turnover ratio may indicate collectability issues. This might be the result of the client loosening (not tightening) its credit-granting policies. Choice "D" is incorrect. If an employee has been lapping receivables in both years, the accounts receivable turnover ratio would not be substantially lower in one year compared to the other.

Question 2

Which of the following procedures would yield the most reliable evidence?

Accepted Answer

Choice "D" is correct. The auditor's direct personal knowledge (obtained through observation, examination, inspection, or recalculation) is one of the most reliable forms of evidence. Choice "A" is incorrect. Scanning of trial balances may indicate areas where more attention should be focused (e.g., unusual balances, zero balances, etc.), but would seldom provide reliable evidence in and of itself. Choice "B" is incorrect. Inquiry of client personnel provides evidence that is not particularly reliable, which is why it often needs to be corroborated by the auditor. Choice "C" is incorrect. A comparison of beginning and ending retained earnings may provide information about certain transactions and events (e.g., dividends, income, etc.), but would not in and of itself provide evidence supporting those items.

Question 3

Which of the following factors would most likely influence an auditor's consideration of the reliability of data when performing analytical procedures?

Accepted Answer

Choice "C" is correct. Strong, effective internal controls improve the reliability of data. Choice "A" is incorrect. The type of accounting system used does not affect the reliability of data. Both computerized and manual accounting systems can provide reliable data, as long as there are appropriate controls in place. Choice "B" is incorrect. The accounting basis used does not affect the reliability of data. Reliable data may be provided regardless of whether the cash basis or accrual basis (GAAP) is used, as long as there are appropriate controls in place. Choice "D" is incorrect. The type of processing system used does not affect the reliability of data. Both online systems and batch systems can provide reliable data, as long as there are appropriate controls in place.

Question 4

Tests designed to detect purchases made before the end of the year that have been recorded in the subsequent year most likely would provide assurance about management's assertion regarding:

Accepted Answer

Choice "C" is correct. If purchases made before the end of the year have been recorded in the subsequent year, inventory will not be complete. The auditor uses cutoff tests to detect such situations and to determine that inventory quantities include all products, materials and supplies owned by the company. (Note that the cutoff assertion is closely related to the completeness and occurrence assertions.) Choice "A" is incorrect. Assertions about accuracy deal with whether data related to recorded transactions has been included in the financial statements at appropriate amounts. Cutoff tests do not provide evidence related to the accuracy assertion for purchases. Choice "B" is incorrect. Assertions about obligations deal with account balances, not with transactions and events. Choice "D" is incorrect. Assertions about classification deal with whether particular components of the financial statements are properly presented, described, and disclosed. Cutoff tests would not provide evidence relevant to classification.

Question 5

An auditor reviews the reconciliation of payroll tax forms that a client is responsible for filing in order to:

Accepted Answer

Choice "D" is correct. An auditor reviews the reconciliation of payroll tax forms that a client is responsible for filing in order to identify potential liabilities for unpaid payroll taxes. Choice "A" is incorrect. Payroll deductions are verified by inspecting the payroll register and, for a sample of employees, tracing deductions back to employee authorization forms held in the personnel department. Choice "B" is incorrect. Review of the reconciliation of payroll tax forms is a substantive test that would not indicate whether internal control activities with respect to payroll are operating effectively. Choice "C" is incorrect. Review of the reconciliation of payroll tax forms would not uncover fictitious employees. The auditor would need to observe payroll distribution (or examine direct deposits) to ensure that all personnel being paid are actually employed by the company.

Question 6

An auditor usually tests the reasonableness of dividend income from investments in publicly-held companies by computing the amounts that should have been received by referring to:

Accepted Answer

Choice "A" is correct. Dividend income from investments is tested by referring to the dividend record books produced by investment advisory services, such as "Moody's Dividend Record." These books state the dividend that was declared and paid by the investee. Choice "B" is incorrect. Stock indentures (initial stock agreements) published by corporate transfer agents discuss intent with respect to dividend declaration, but actual dividend declarations may vary. In addition, it is more efficient to use a single source (such as "Moody's") than to obtain and review stock indentures for each individual investment. Choice "C" is incorrect. Stock ledgers maintained by independent registrars indicate how many shares of stock are issued and outstanding, and identify the shareholders of record, but they do not contain information concerning dividends. Choice "D" is incorrect. Annual audited financial statements of the investee companies give the total dividends paid, but there may not be enough information to determine exactly how much went to each type of stock and hence to each stockholder. In addition, it is more efficient to use a single source (such as "Moody's") than to obtain and review the financial statements of each investee.

Question 7

To reduce the risks associated with accepting e-mail responses to requests for confirmation of accounts receivable, an auditor most likely would:

Accepted Answer

Choice "A" is correct. E-mail responses to requests for confirmations of accounts receivable present a problem to the auditor, since the sender might not be as requested and the content might be altered. To reduce these risks, the auditor should request the senders to mail the original forms to the auditor. Choice "B" is incorrect. Examination of subsequent cash receipts might be an acceptable alternative procedure, but it would not reduce the risks associated with accepting e-mail responses to requests for confirmations of accounts receivable. Choice "C" is incorrect. Since the e-mail responses may be valid responses, the auditor should not consider them to be exceptions. Choice "D" is incorrect. Mailing second requests to the e-mail respondents would not be necessary, since the sender did receive and respond to the first request. Requesting that the original confirmation be returned is a more likely response.

Question 8

Which of the following procedures would be most effective in reducing attestation risk?

Accepted Answer

Choice "B" is correct. Evidence obtained directly by the accountant (e.g., through physical examination) provides more persuasive evidence than evidence obtained through inquiry, discussion, or analytical procedures, and therefore reduces attestation risk. Choices "A", "C", and "D" are incorrect, based on the above Explanation.

Question 9

Which of the following circumstances most likely would cause an auditor to suspect an employee payroll fraud scheme?

Accepted Answer

Choice "A" is correct. Significant unexplained variances between standard and actual labor costs may cause the auditor to suspect an employee payroll fraud scheme. Choice "B" is incorrect. Payroll checks generally are disbursed by the same person (or the same department) each payday, and this would not cause the auditor to suspect an employee payroll fraud scheme. Choice "C" is incorrect. Time card approval by departmental supervisors is a standard practice, and would not raise an auditor's suspicions of a payroll fraud scheme. Choice "D" is incorrect. Maintenance of a separate payroll bank account is a standard practice, and would not raise an auditor's suspicions of a payroll fraud scheme.

Question 10

The most reliable procedure for an auditor to use to test the existence of a client's inventory at an outside location would be to:

Accepted Answer

Choice "A" is correct. The auditor's personal observation is generally one of the most reliable forms of evidence. Observing physical inventory counts provides reliable evidence that the inventory actually exists. Choice "B" is incorrect. Tracing totals from the inventory listing to the general ledger inventory account provides evidence of completeness, not existence. Choice "C" is incorrect. A confirmation from the client indicating ownership provides some evidence regarding rights and obligations, but does not provide evidence of existence. Choice "D" is incorrect. Analytical comparisons of current year to prior year inventory balances might provide some evidence regarding completeness, existence, and valuation, but this is not as reliable a procedure for verifying existence as is the auditor's direct personal observation.

Question 11

An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete or slow-moving inventory to support management's financial statement assertion of:

Accepted Answer

Choice "A" is correct. An audit objective for inventory valuation and allocation is to determine that slow-moving, excess, defective and obsolete items included in inventory are properly identified. Inquiries of production and sales personnel concerning possible excess or obsolete inventory items would support management's assertion of valuation and allocation. Choice "B" is incorrect. Assertions about rights and obligations deal with whether assets are the rights of the entity and liabilities are the obligations of the entity at a given date. Choice "C" is incorrect. Assertions about existence deal with whether assets, liabilities, and equity interests exist at a given date. Choice "D" is incorrect. Assertions about understandability and classification deal with whether particular components of the financial statements are properly presented, described, and disclosed.

Question 12

Which of the following Explanation: s most likely would satisfy an auditor who questions management about significant debits to the accumulated depreciation accounts?

Accepted Answer

Choice "B," is correct. A, debit to accumulated depreciation decreases the balance in that account. T,he retirement of plant assets necessitates the removal (decrease) of accumulated depreciation related to the retired asset by debiting accumulated depreciation. C,hoice "A," is incorrect. R,emember that correction of an estimate is given prospective, not retroactive, treatment. T,herefore, there would not be any decrease in the accumulated depreciation taken in previous years, although future credits would be lower than previous credits had been. C,hoice "C," is incorrect. I,f the prior year's depreciation expense were understated (i.e., too low), the entry to correct the error would be a credit to accumulated depreciation. C,hoice "D," is incorrect. R,evision of overhead allocations would not result in a debit to accumulated depreciation.

Question 13

In determining the effectiveness of an entity's internal controls relating to the occurrence assertion for payroll transactions, an auditor most likely would inquire about and:

Accepted Answer

Choice "A" is correct. The occurrence assertion as it relates to payroll transactions would correspond to an audit objective to determine that payroll transactions actually occurred (i.e., that all payroll checks were issued to valid employees for hours actually worked). Segregation of duties between personnel and payroll departments is an important control to ensure that only valid employees receive paychecks. Choice "B" is incorrect. Inspecting evidence related to prenumbering of payroll checks would relate to the completeness assertion. Choice "C" is incorrect. Recomputing payroll deductions is a substantive test related to the accuracy assertion. Choice "D" is incorrect. Verifying the preparation of the monthly payroll account bank reconciliation would provide significant evidence for the accuracy assertion for payroll transactions.

Question 14

A weakness in internal control over recording retirements of equipment may cause an auditor to:

Accepted Answer

Choice "D" is correct. Testing to see whether equipment listed in the accounting records is physically present in the plant and still in service is an effective way to test whether unrecorded disposals occurred. Choice "A" is incorrect. Tracing from equipment found in service to accounting records would be performed to test the completeness assertion that all equipment on hand has been recorded, rather than testing the assertion that all recorded equipment is still in service. Choice "B" is incorrect. Reviewing whether depreciation is still being taken would not provide evidence about unrecorded fixed asset disposals unless the auditor also performs a physical inspection of the assets being depreciated. Also, assets that are fully depreciated but still in service would not appear in depreciation records. Choice "C" is incorrect. Examining additions to the other assets account would not be likely to lead to discovery of unrecorded fixed asset disposals, since newer assets are not likely to have been retired.

Question 15

Which of the following procedures would an auditor most likely perform in auditing the statement of cash flows?

Accepted Answer

Choice "A" is correct. To audit the statement of cash flows, the auditor reconciles the amounts on the statement to amounts on other financial statements. Choice "B" is incorrect. Vouching a sample of cash receipts and disbursements is a procedure used to audit the cash balance, rather than the statement of cash flows. Choice "C" is incorrect. Reconciling the cutoff bank statement to the proof of cash to verify the accuracy of the year-end cash balance is a procedure used to audit the cash balance, rather than the statement of cash flows. Choice "D" is incorrect. Confirming cash amounts with the entity's financial institution is a procedure used to audit the cash balance, rather than the statement of cash flows. Evidential Procedures for Selected Accounts

Question 16

An auditor compared the current-year gross margin with the prior-year gross margin to determine if cost of sales is reasonable. What type of audit procedure was performed?

Accepted Answer

Choice "B" is correct. Analytical procedures are evaluations of financial information made by a study of plausible relationships among data, and they include comparisons between current year and prior year financial information. Choice "A" is incorrect. Tests of transactions involve selecting specific transactions and evaluating whether they were properly recorded. Comparing current year and prior year gross margin would not provide information regarding specific transactions. Choice "C" is incorrect. Tests of controls are performed to evaluate the effectiveness of controls. Comparing current year and prior year gross margin would not provide information regarding controls. Choice "D" is incorrect. Test of details are audit procedures used to gather evidence to support specific account balances. Comparing current year and prior year gross margin does not provide much information regarding specific account balances, although it might identify an account balance worthy of further consideration.

Question 17

In auditing accounts receivable, the negative form of confirmation request most likely would be used when:

Accepted Answer

Choice "D" is correct. Negative confirmations are most likely to be used when the assessed level of audit risk, including inherent and control risk, is low. Choice "A" is incorrect. If the total amount of accounts receivable is immaterial, the auditor is not likely to send any confirmations. Choice "B" is incorrect. If prior year response rates were low, negative confirmations would not be used since the auditor would be concerned that the negative confirmations would not receive adequate attention from the recipients. Choice "C" is incorrect. An auditor would need to feel comfortable that the confirmations would receive adequate attention from the recipients before deciding to send negative confirmations.

Question 18

When there are numerous property and equipment transactions during the year, an auditor who plans to assess control risk at a low level usually performs:

Accepted Answer

Choice "C" is correct. Since control risk is assessed at a low level, tests of controls would be required to evaluate the effectiveness of the internal controls to support that assessed level. Assuming controls are operating effectively, only limited substantive testing would be performed. Choice "A" is incorrect. Extensive tests of property and equipment balances would not typically be required when control risk is assessed at a low level. Choice "B" is incorrect. Since control risk is to be assessed at a low level, tests of controls would be required. Analytical procedures would not be particularly useful, since property and equipment transactions are subject to management discretion. Choice "D" is incorrect. Analytical procedures would not be particularly useful, since property and equipment transactions are subject to management discretion. Year-end balances may therefore be unpredictable.

Question 19

An auditor most likely would inspect loan agreements under which an entity's inventories are pledged to support management's financial statement assertion of completeness with respect to:

Accepted Answer

Choice "A" is correct. Inspecting loan agreements under which an entity's inventories are pledged provides evidence regarding completeness with respect to presentation and disclosure, since such information must be disclosed in the financial statements. Choices "B", "C", and "D" are incorrect. Inspecting loan agreements under which an entity's inventories are pledged does not provide information regarding the completeness of transactions, events, or account balances.

Question 20

Which of the following strategies most likely could improve the response rate of the confirmation of accounts receivable?

Accepted Answer

Choice "A" is correct. Some accounting systems facilitate the confirmation of single transactions rather than entire balances. In such cases, inclusion of statements of account showing details of the balances being confirmed makes it easier for the customers to confirm the balances, and therefore may improve the overall response rate. Choice "B" is incorrect. Restricting the selection of accounts to be confirmed to those customers with large balances would not necessarily improve the response rate, as there is no particular relationship between balance size and the likelihood of response. Choice "C" is incorrect. Requesting customers to respond to the confirmation requests electronically would not necessarily improve the response rate. It also might not be appropriate to request responses in electronic form, since the auditor will still request that the original be mailed back. Choice "D" is incorrect. Notifying the recipients that second requests will be mailed would not necessarily improve the response rate, since the consequence of not responding (receiving a second request) is relatively minor.

Exam 1: CPA Auditing and Attestation Exam