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Review Questions
6-1
6-5 True, the auditor must rely on management for certain information in the
conduct of his or her audit. However, the auditor must not accept management's
representations blindly. The auditor must, whenever possible, obtain competent
evidential matter to support the representations of management. As an example,
if management represents that certain inventory is not obsolete, the auditor
should be able to examine purchase orders from customers that prove part of the
inventory is being sold at a price that is higher than the company's cost plus
selling expenses. If management represents an account receivable as being fully
collectible, the auditor should be able to examine subsequent payments by the
customer or correspondence from the customer that indicates a willingness and
ability to pay.
6-6
6-7 The cycle approach is a method of dividing the audit such that closely
related types of transactions and account balances are included in the same
cycle. For example, sales, sales returns, and cash receipts transactions and the
accounts receivable balance are all a part of the sales and collection cycle. The
advantages of dividing the audit into different cycles are to divide the audit into
more manageable parts, to assign tasks to different members of the audit team,
and to keep closely related parts of the audit together.
6-2
6-8
1. Existence or occurrence
2. Completeness
3. Valuation or allocation
4. Rights and obligations
5. Presentation and disclosure
6-11 General audit objectives follow from and are closely related to
management assertions. General audit objectives, however, are intended to
provide a framework to help the auditor accumulate sufficient competent
evidence required by the third standard of field work. Audit objectives are more
useful to auditors than assertions because they are more detailed and more
closely related to helping the auditor accumulate sufficient competent evidence.
6-12
TRANSACTION-RELATED AUDIT
RECORDING MISSTATEMENT OBJECTIVE VIOLATED
Fixed asset repair is recorded on the wrong Timing
date.
6-3
6-13 The existence objective deals with whether amounts included in the
financial statements should actually be included. Completeness is the opposite of
existence. The completeness objective deals with whether all amounts that
should be included have actually been included.
In the audit of accounts receivable, a nonexistent account receivable will
lead to overstatement of the accounts receivable balance. Failure to include a
customer's account receivable balance, which is a violation of completeness, will
lead to understatement of the accounts receivable balance.
6-14 Specific audit objectives are the application of the general audit objectives
to a given class of transactions or account balance. There must be at least one
specific audit objective for each general audit objective and in many cases there
should be more. Specific audit objectives for a class of transactions or an
account balance should be designed such that, once they have been satisfied,
the related general audit objective should also have been satisfied for that class
of transactions or account.
6-15 For the specific balance-related audit objective, all recorded fixed assets
exist at the balance sheet date, the management assertion and the general
balance-related audit objective are both "existence."
The auditor uses these four phases to meet the overall objective of the
audit, which is to express an opinion on the fairness with which the financial
statements present fairly, in all material respects, the financial position, results of
operations and cash flows in conformity with GAAP. By accumulating sufficient
competent evidence for each audit objective, the overall objective is met. The
accumulation of evidence is accomplished by performing the four phases of the
audit.
6-22 a.
6-6
6-22 (continued)
6-23 SAS No. 99 (AU 316) requires the auditor to assess the risk of material
misstatements of the financial statements due to fraud and to consider that
assessment in designing the audit procedures to be performed. In making this
assessment, the auditor should consider fraud risk factors that relate to both (a)
misstatements arising from fraudulent financial reporting and (b) misstatements
arising from misappropriation of assets. SAS No. 99 (AU 316) goes on to note
that because of (a) the concealment aspects of fraudulent activity, including the
fact that fraud often involves collusion or falsified documentation, and (b) the
6-7
6.23 (continued)
6-24
a. b. c.
FINANCIAL
CLASS OF STATEMENT TITLE OF TRANSACTION
TRANSACTIONS BALANCE JOURNAL CYCLE
PURCHASE Purchase returns Acquisitions Acquisition &
RETURNS & allowances Journal Payment
6-8
6-24 (continued)
a. b. c.
FINANCIAL
CLASS OF STATEMENT TITLE OF TRANSACTION
TRANSACTIONS BALANCE JOURNAL CYCLE
6-9
6-25 a.
INCOME STATEMENT
CYCLE BALANCE SHEET ACCOUNTS ACCOUNTS
SALES AND Accounts receivable Sales
COLLECTION Cash Bad debt expense
Notes receivable--trade Interest income
Allowance for doubtful accounts
Interest receivable
ACQUISITION Income tax payable Income tax expense
AND PAYMENT Accounts payable Advertising expense
Unexpired insurance Travel expense
Furniture and equipment Purchases
Cash Property tax expense
Accumulated depreciation of Depreciation expense—
furniture and equipment furniture and equipment
Inventory Telephone and fax
Property tax payable expense
Insurance expense
Rent expense
PAYROLL AND Cash Sales salaries expense
PERSONNEL Accrued sales salaries Salaries, office and
general
INVENTORY Inventory Purchases
AND
WAREHOUSING
CAPITAL Bonds payable Interest expense
ACQUISITION Common stock
AND Cash
REPAYMENT Notes payable
Retained earnings
Prepaid interest expense
b. The general ledger accounts are not likely to differ much between a
retail and a wholesale company unless there are departments for
which there are various categories. There would be large differences
for a hospital or governmental unit. A governmental unit would use the
fund accounting system and would have entirely different titles.
Hospitals are likely to have several different kinds of revenue accounts,
rather than sales. They are also likely to have such things as drug
expense, laboratory supplies, etc. At the same time, even a
governmental unit or a hospital will have certain accounts such as
cash, insurance expense, interest income, rent expense, and so forth.
6-10
6-26
SPECIFIC BALANCE-
RELATED AUDIT MANAGEMENT
OBJECTIVE ASSERTION COMMENTS
a. There are no 2. Completeness Unrecorded transactions or
unrecorded amounts deal with the
receivables. completeness objective.
b. Receivables have 4. Rights and Receivables not being sold or
not been sold or obligations discounted concerns the rights
discounted. and obligations objective and
assertion.
c. Uncollectible 3. Valuation or Providing for uncollectible
accounts have been allocation accounts concerns whether the
provided for. allowance for uncollectible
accounts is adequate. It is part
of the realizable value objective
and the valuation or allocation
assertion.
d. Receivables that 3. Valuation or This is part of the realizable
have become allocation value objective and the
uncollectible have valuation or allocation
been written off. assertion. There may also be
some argument that this is part
of the existence objective and
assertion. Accounts that are
uncollectible are no longer valid
assets.
e. All accounts on the 3. Valuation or Accounts that are not expected
list are expected to allocation to be collected within a year
be collected within should be classified as long-
one year. term receivables. It is therefore
being included as part of the
classification objective and
consequently under the
valuation or allocation
assertion. Some people believe
that it is also a part of the
presentation and disclosure
assertion.
f. Any agreement or 5. Presentation and The nature of trade receivables
condition that disclosure is a part of the presentation and
restricts the nature disclosure objective and
of trade receivables therefore the presentation and
is known and disclosure assertion.
disclosed.
6-11
6-26 (continued)
SPECIFIC BALANCE-
RELATED AUDIT MANAGEMENT
OBJECTIVE ASSERTION COMMENTS
g. All accounts on the 3. Valuation or Concerns the classification of
list arose from the allocation accounts receivable and is
normal course of therefore a part of the
business and are not classification objective and the
due from related valuation or allocation
parties. assertion. Some people believe
that like item e., it is a part of
presentation and disclosure.
h. Sales cutoff at year- 3. Valuation or Cutoff is a part of the cutoff
end is proper. allocation objective and therefore part of
the valuation or allocation
assertion.
6-12
6-27 (continued)
b. c.
GENERAL
TRANSACTION-
SPECIFIC TRANSACTION- MANAGEMENT RELATED AUDIT
RELATED AUDIT OBJECTIVE ASSERTION OBJECTIVE
a. Recorded cash disbursement 3. Valuation or 8. Accuracy
transactions are for the amount allocation
of goods or services received
and are correctly recorded.
b. Cash disbursement transactions 3. Valuation or 11. Posting and
are properly included in the allocation summarization
accounts payable master file and
are correctly summarized.
c. Recorded cash disbursements 1. Existence or 6. Existence
are for goods and services occurrence
actually received.
d. Cash disbursement transactions 3. Valuation or 9. Classification
are properly classified. allocation
e. Existing cash disbursement 2. Completeness 7. Completeness
transactions are recorded.
f. Cash disbursement transactions 3. Valuation or 10. Timing
are recorded on the correct allocation
dates.
6-28 a. The first objective concerns amounts that should not be included on
the list of accounts payable because there are no amounts due to such
vendors. This objective concerns only the overstatement of accounts
payable. The second objective concerns the possibility of accounts
payable that should be included but that have not been included. This
objective concerns only the possibility of understated accounts
payable.
b. The first objective deals with existence and the second deals with
completeness.
c. For accounts payable, the auditor is usually most concerned about
understatements. An understatement of accounts payable is usually
considered more important than overstatements because of potential
legal liability. The completeness objective is therefore normally more
important in the audit of accounts payable. The auditor is also
concerned about overstatements of accounts payable. The existence
objective is also therefore important in accounts payable, but usually
less so than the completeness objective.
6-13
6-29 a. The purposes of the general balance-related audit objectives are to
provide a framework that the auditor can use to accumulate audit
evidence. Once the nine general balance-related audit objectives have
been satisfied, the auditor can conclude that the account balance in
question is fairly stated. Specific balance-related audit objectives are
applied to each account balance and are used to help the auditor
become more specific about the audit evidence to accumulate.
There is at least one specific balance-related audit objective for
each general balance-related audit objective and in many cases there
are several specific objectives. There are specific balance-related audit
objectives for each account balance, and specific balance-related audit
objectives for an account such as fixed assets are likely to differ
significantly from those used in accounts receivable. In some audits,
the auditor may conclude that certain specific balance-related audit
objectives are not important. At the end of the audit, the auditor must
be satisfied that each specific balance-related audit objective has been
satisfied. The general balance-related audit objectives help the auditor
determine the appropriate specific balance-related audit objectives.
b.
GENERAL BALANCE-
RELATED AUDIT SPECIFIC BALANCE-RELATED
OBJECTIVE AUDIT OBJECTIVE
1. EXISTENCE d. Fixed assets physically exist and are being used for the
purpose intended.
6. DETAIL TIE-IN c. Details of property, plant, and equipment agree with the
general ledger.
6-14
6-29 (continued)
GENERAL BALANCE-
RELATED AUDIT SPECIFIC BALANCE-RELATED
OBJECTIVE AUDIT OBJECTIVE
8. RIGHTS AND b. The company has valid title to the assets owned.
OBLIGATIONS
f. The company has a contractual right for use of assets
leased.
Case
6-15
6-30 (continued)
6-16
Internet Problem Solution: Assertions and Evidence Associated with
New Assurance Services
6-1 Demographic data suggest that the U.S. population is aging. According to
the federal government’s Administration on Aging, citizens who are 65 years old
and older will represent approximately 20% of our nation’s population by 2030.
Caring for our nation’s elderly population will doubtless become more important
in the years ahead. A specific concern that many of us will face relates to the
quality of care received by our parents and grandparents. The AICPA has
developed a “business plan” for an assurance service called CPA ElderCare.
Information about this and other assurance services can be accessed at the
AICPA’s Assurance Services Web site [www.aicpa.org/assurance/index.htm].
The client (e.g., the children or family of the elderly person) would
likely determine the performance criteria. The CPA would most
likely report to the family in a letter or any other form that was
agreed to upon the beginning of the engagement.
2. For the two performance criteria that you identified above, what
"management assertions" would be tested, and how would these
assertions be tested? Please be as specific as you can in the
description of any necessary evidence and audit procedures that
you would use.
(Note: Internet problems address current issues using Internet sources. Because
Internet sites are subject to change, Internet problems and solutions may change.
Current information on Internet problems is available at www.prenhall.com/arens.)
6-17