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Chapter 13

Multiple-Choice Questions
1. easy b A listing of all the things which the auditor will do to gather sufficient, competent evidence is the: a. audit strategy. b. audit program. c. audit procedure. d. audit ris model. "hown below #1 through $% are the five types of tests which auditors use to determine whether financial statements are fairly stated. &hich three are substantive tests' 1. procedures to obtain an understanding of internal control !. tests of controls (. tests of transactions ). analytical procedures $. tests of details of balances a. 1, !, and (. b. (, ), and $. c. !, (, and $. d. !, (, and ). Collectively, procedures performed to obtain an understanding of the entity and its environment, including internal controls, represent the auditor*s: a. audit strategy. b. tests of controls. c. ris assessment procedures. d. tests of transactions. +or efficiency, tests of controls are fre,uently done at the same time as: a. analytical procedures. b. compliance tests. c. tests of transactions. d. tests of details of balances. &hich of the following procedures are fre,uently performed in response to the auditor*s assessment of the ris of material misstatement' a. -atio analysis b. .ests of controls c. .ests of details of balances d. -is assessment procedures 0n which stage#s% of an audit are analytical procedures not performed' a. 0n the planning stage. b. 0n the test of controls stage. c. 0n the completion stage. d. 0n con1unction with tests of transactions and tests of details of balances. .ests of controls may include which of the following types of evidence' a. b. Arens/Elder/Beasley -eperformance 4es 5o 3bservation 4es 5o

!. easy b

(. easy c

). easy c

$. easy c

/. easy b

2. easy a

c. d. 6. easy b

4es 5o

5o 4es

.he purpose of tests of controls is to provide reasonable assurance that the: a. accounting treatment of transactions and balances is valid and proper. b. internal control procedures are functioning as intended. c. entity has complied with 7AA8 disclosure re,uirements. d. entity has complied with re,uirements of ,uality control. 0n the conte:t 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 subse,uent events. c. may be either tests of transactions, tests of balances, or analytical tests. d. will increase proportionately with the auditor*s reliance on internal control. &hich of the following is not useful for obtaining an understanding of internal controls' a. Ma e in,uiries of the client*s personnel. b. <:amine documents and records. c. -ead industry trade maga=ines. d. 3bserve client activities and operations. A system wal through is used to: a. test balances. b. test details of transactions. c. gain an understanding of internal controls. d. determine acceptance of the client. 8CA3> "tandard ! ??????? the auditor to perform wal throughs of significant processes. a. encourages b. re,uires c. does not allow d. permits .he most important consideration in developing the audit plan and audit program is the: a. client*s si=e. b. client*s industry. c. audit firm*s available personnel. d. the audit ris model used in its planning form. .ests of controls are directed toward the control*s: a. efficiency. b. effectiveness. c. efficiency and effectiveness. d. cost benefit ratio. &hen the auditor finds that there are missing controls in an area of the accounting system, the audit program in that area would be modified in such a way as to: a. increase the amount of tests of controls. b. increase the reliance on tests of controls. c. cause the issuance of a ,ualified or adverse opinion. d. eliminate the need for a test of controls. A procedure designed to test for monetary misstatements directly affecting the correctness of financial statement balances is a: a. test of controls. b. substantive test.

9. easy c

1;. medium c

11. medium c

1!. #8ublic% medium b

1(. medium d

1). medium b

1$. medium d

1/. medium b

Arens/Elder/Beasley

c. d. 12. medium b

test of attributes. monetary-unit sampling test.

&hich of the following is not appropriate for purposes of testing the effectiveness of controls' a. Ma e in,uiries of client personnel. b. <valuate prior e:perience with the client. c. 3bserve control-related activities. d. -eperform client procedures. &hich of the following is not a direct result of performing analytical procedures' a. 0dentify areas of potential misstatements. b. -educe detailed audit tests. c. @nderstand the client*s business. d. 0dentify specific errors in the accounts. 0f no material differences are found using analytical procedures and the auditor concludes that misstatements are not li ely to have occurred: a. other tests may be reduced. b. it will be necessary to increase the tests of balances. c. it will not be necessary to perform tests of balances. d. it will be necessary to increase the tests of transactions. .he primary emphasis in most tests of details of balances is on the: a. balance sheet accounts. b. revenue accounts. c. cash flow statement accounts. d. e:pense accounts. Analytical procedures are defined in the auditing standards as: a. compliance tests. b. substantive tests. c. tests of controls. d. helpful procedures not possessing the validity of other tests available to the auditor. .ests of transactions are used to determine whether ??????????? have been satisfied. a. compliance test re,uirements. b. balance coverage re,uirements. c. transaction-related audit ob1ectives. d. e:istence assertions &hich of the following statements is not true' a. Analytical procedures emphasi=e the overall reasonableness of transactions and balances. b. .ests of controls are concerned with evaluating whether controls are sufficiently effective to 1ustify reducing control ris and thereby reducing analytical review procedures. c. "ubstantive tests of transactions emphasi=e the verification of transactions recorded in the 1ournals and then posted in the general ledger. d. .ests of details of balances emphasi=e the ending balances in the general ledger. &hich of the following audit tests is usually the least costly to perform' a. Analytical procedures. b. .ests of controls. c. .ests of balances. d. "ubstantive tests of transactions. &hich of the following audit tests is usually the most costly to perform' a. Analytical procedures.

16. medium d

19. medium a

!;. medium a

!1. medium b

!!. medium c

!(. medium b

!). medium a

!$. medium

Arens/Elder/Beasley

b. c. d.

.ests of controls. .ests of balances. "ubstantive tests of transactions.

!/. medium c

Analytical procedures must be performed in: a. the planning and test of control stages. b. con1unction with tests of transactions and tests of details of balances. c. the planning and completion stages. d. the planning, test of control, and completion stages. &hich of the following tests commonly occur together' a. "ubstantive tests of transactions and tests of controls. b. "ubstantive tests of transactions and obtaining an understanding of internal controls. c. Analytical procedures and tests of controls. d. .ests of controls and tests of details of balances. &hich of the following relationships between types of tests and audit evidence is not correct' a. .ests of details and documentation. b. .ests of controls and observation. c. .ests of details and observation. d. "ubstantive tests of transactions and reperformance An increased e:tent of tests of controls is most li ely to occur when: a. it is a first-year audit. b. the auditor is doing a Afraud audit.B c. controls are effective and the preliminary control ris assessment is low. d. controls are ineffective and the preliminary control ris assessment is high. Many auditors perform e:tensive analytical procedures on audits because: a. they are re,uired by 7AA". b. they pinpoint errors in accounts. c. they indicate areas of potential ris and misstatement. d. they are re,uired for tests of controls. &hich of the following types of procedures will be performed in an audit of internal control over financial reporting' a. b. c. d. 8rocedures to obtain an understanding of internal control 4es 5o 4es 5o -atio analysis 4es 5o 5o 4es

!2. medium a

!6. medium c

!9. medium c

(;. medium c

(1. #8ublic% medium c

(!. medium b

.ests of details of balances focus on: a. beginning of the year balances. b. end of the year balances. c. transaction details for the period under audit. d. accounting cycles. Auditors who test manual controls that rely on 0.-generated reports must consider: a. the benefits of relying on 0.-generated reports. b. separation of duties related to the 0.-generated reports. c. the controls related to the accuracy of the information in the report. d. whether the manual controls are approved by the audit committee.. &hen an auditor believes that analytical procedures indicate a reasonable possibility of

((. medium c

().

Arens/Elder/Beasley

medium d

misstatement, the auditor usually would: a. b. c. d. 8erform additional tests of controls 4es 5o 4es 5o Cecide to modify tests of details of balances 4es 5o 5o 4es

($. medium d

0f the results of the tests of controls, substantive tests of transactions, and analytical procedures are not consistent with the predictions, tests of details of balances will be: a. eliminated. b. increased. c. unaffected. d. changed. &hen controls are deemed ineffective and assessed control ris is at the ma:imum for a private company, there will be ?????? emphasis placed on tests of controls. a. no b. relatively little c. moderate d. heavy .ests of controls address each of the following ,uestions e:cept: a. Dow were the procedures performed' b. &hy were the procedures performed' c. &ere the necessary procedures performed' d. &ho performed the procedures' &hich of the following audit tests would be regarded as a test of controls' a. Comparison of the inventory pricing to vendors* invoices. b. .ests of the signatures on canceled chec s to board of directors* authori=ations. c. .ests of the additions to property, plant, and e,uipment by physical inspections. d. -eview of the specific items ma ing up the balance in a given general ledger account. &hich of the following tests form the basis for an auditor*s report on internal control over financial reporting' a. Analytical procedures b. .ests of transactions c. .ests of controls d. .ests of details of balances After finishing the review phase of the study and evaluation of internal control in an audit, the auditor should perform tests of controls on: a. those controls that the auditor wants and plans to rely upon. b. those controls in which material wea nesses 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. At what point in the audit are tests of details most appropriately designed' a. <ngagement evaluation. b. 8lanning. c. .esting. d. Communication of material wea nesses. &hich of the following isEare performed in an audit of internal control over financial reporting'

(/. medium a

(2. medium b

(6. medium b

(9. #8ublic% medium c

);. medium a

)1. medium b

)!. #8ublic% Medium

Arens/Elder/Beasley

b a. b. c. d. )(. medium b

8rocedures to obtain an understanding of internal control 4es 4es 5o 5o

.est of details of balances 4es 5o 4es 5o

Analytical 8rocedures 5o 5o 4es 4es

.he reliance placed on substantive tests in relation to the reliance placed on internal control varies in a relationship that is ordinarily: a. parallel. b. inverse. c. direct. d. e,ual. &hich of the following is ordinarily designed to detect possible material dollar errors on the financial statements' a. .ests of controls. b. Analytical review procedures. c. Computer controls. d. 5one of the above. &hat type of test is used to obtain more types of evidence than any other' a. "ubstantive tests of transactions. b. .ests of controls. c. Analytical procedures. d. .ests of details. 3nly ??????? involve physical e:amination and confirmation. a. tests of controls b. tests of transactions c. tests of balances d. analytical procedures Cocumentation is used in every type of test e:cept ????????. a. tests of controls b. tests of transactions c. analytical procedures d. tests of details &hich of the following types of evidence is not available when using substantive tests of transactions' a. Cocumentation. b. Confirmation. c. 0n,uiries of the client. d. -eperformance. An e:ception in a test of control indicates the ??????? of misstatements. a. the amount b. the li elihood c. the amount, li elihood, and classification d. the amount and the classification &hich of the following is not a valid basis for omitting an audit test' a. the difficulty and e:pense involved in testing a particular item. b. the relative ris involved.

)). medium b

)$. challenging d

)/. challenging c

)2. challenging c

)6. challenging b

)9. challenging b

$;. challenging a

Arens/Elder/Beasley

c. d. $1. challenging b

the degree of reliance on the relevant internal controls. the relationship between the cost of obtaining evidence and its usefulness.

&hich of the following ultimately determines the specific audit procedures necessary to provide an independent auditor with a reasonable basis for the e:pression of an opinion' a. .he audit program. b. .he auditor*s 1udgment. c. 7enerally accepted auditing standards. d. .he auditor*s wor ing papers.

<ssay Questions
$!. easy 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. Answer: 0f the auditor believes that controls have not been operating effectively during the period under audit, or that it would not be cost-effective to test controls, then he or she would choose not to test controls. 0n contrast, if the auditor believes that controls have been operating effectively during the period under audit, and that it would be cost-effective to test controls, the auditor will perform tests of controls. $(. easy .hree factors the auditor considers when assessing control ris are: the auditor*s belief concerning the effectiveness of internal controls, the results of tests of controls, and the costeffectiveness of a reduced assessed control ris . 0dentify the combination of conditions for these three factors that is re,uired before a reduction in substantive testing is permitted. Answer: A reduction in substantive testing is permitted when #1% the auditor identifies specific controls he or she believes have been operating effectively during the period under audit, #!% the auditor believes it will be cost-effective to test those controls, and #(% the results of tests of controls indicate that the controls have indeed been operating effectively. $). medium Fist each of the five types of audit tests and list at least two types of evidence that may be obtained from each type of test. Answer: 8rocedures to obtain an understanding of internal control - documentation, observation, in,uiries of the client, and reperformance. .ests of controls - documentation, observation, in,uiries of the client, and reperformance. "ubstantive tests of transactions - documentation, in,uiries of the client, and reperformance. Analytical procedures - in,uiries of the client and analytical procedures. .ests of details of balances - physical e:amination, confirmation, documentation, in,uires of the client, and reperformance. $$. medium Must auditors always perform tests of controls' Answer: Auditors only need to perform tests of controls in the audit of a private company if they intend to rely on them. Auditors must always perform tests of controls in the audit of a Arens/Elder/Beasley

public company.

$/. medium

Cescribe the five types of audit tests. 0dentify which of the five types are substantive tests, and which are used to reduce assessed control ris . Answer: .he five types of audit tests used to determine whether financial statements are fairly stated are: procedures to obtain an understanding of internal control, tests of controls, substantive tests of transactions, analytical procedures, and tests of details of balances. "ubstantive tests of transactions, analytical procedures, and tests of details of balances are substantive tests, whereas procedures to obtain an understanding of internal control and tests of controls are used to reduce assessed control ris .

$2. medium

Consider the audit ris model and the five types of audit tests. &hich tests provide evidence pertinent to the various elements of the audit ris model' Answer: <vidence can be obtained about control ris via procedures to obtain an understanding of internal controls, tests of controls, and substantive tests of transactions. <vidence can be obtained about planned detection ris via substantive tests of transactions, analytical procedures, and tests of details of balances.

$6. medium

Ciscuss the purposes of #1% substantive tests of transactions, #!% tests of controls, and #(% tests of details of balances. 7ive an e:ample of each. Answer: .he purpose of substantive tests of transactions is to determine whether all si: transactionrelated audit ob1ectives have been satisfied for each class of transactions. +or e:ample, as part of the auditor*s test of the accuracy ob1ective for sales, the auditor would compare the amount recorded in the sales 1ournal for a sample of sales transactions with the total on the corresponding sales invoices. .he purpose of tests of controls is to determine the effectiveness of both the design and operations of specific internal controls. +or e:ample, the auditor might observe for a month whether statements are mailed to all customers. .he purpose of tests of details of balances is to determine the monetary correctness of the accounts to which they relate. .he confirmation of accounts receivable is an e:ample.

$9. medium

.here are three stages of the audit in which analytical procedures are performed. 0dentify each of these three stages and, for each stage, discuss the purpose of performing analytical procedures in that stage. Also indicate in which stage#s% analytical procedures are re,uired by current professional auditing standards. Answer: Analytical procedures are performed in the audit planning stage to help the auditor decide the other evidence needed to satisfy sufficient competent evidence re,uirements. Analytical procedures can also be performed as substantive tests in the testing phase of the audit. Analytical procedures are performed in the audit completion phase as a final test of reasonableness. Auditing standards re,uire that analytical procedures be performed in the planning and completion phases of every audit.

Arens/Elder/Beasley

Arens/Elder/Beasley

/;. medium

Ciscuss the ma1or determinants of the e:tent of tests of details of balances. Answer: Ma1or determinants of the e:tent of tests of details of balances include: the results of tests of controls, substantive tests of transactions, and analytical proceduresG the amount of tolerable misstatementG and the levels of inherent ris and acceptable audit ris .

/1. challenging

&hat are the four steps auditors follow when they plan to reduce assessed control ris ' Answer: .he steps are as follows: 1. Apply transaction-related audit ob1ectives to the class of transaction being tested. !. 0dentify ey controls that should reduce control ris for each transaction-related audit ob1ective. (. Cevelop appropriate tests of controls for all internal controls used to reduce the preliminary assessment of control ris below ma:imum. ). +or potential types of misstatements related to each transaction-related audit ob1ectives, design appropriate substantive tests of transactions, considering deficiencies in internal control and e:pected results of the tests of controls.

/!. challenging

Ciscuss the relationship of each of the following to the e:tent of planned tests of details of balances: #1% tolerable misstatement, #!% inherent ris , #(% control ris , and #)% acceptable audit ris . Answer: 0nherent ris and control ris are directly related to the e:tent of planned tests of details of balancesG that is, as inherent ris andEor control ris increase, the e:tent of planned tests of details of balances also increases. .olerable misstatement and acceptable audit ris are inversely related to the e:tent of planned tests of details of balancesG that is, as tolerable misstatement andEor acceptable audit ris increase, the e:tent of planned tests of details of balances decreases.

/(. challenging

.here are seven types of audit evidence: physical e:amination, confirmation, documentation, observation, in,uiries of the client, reperformance, and analytical procedures. +or 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, #!% substantive tests of transactions, #(% analytical procedures, and #)% tests of details of balances. Answer: 1. Tests of controls. Cocumentation, observation, in,uiries of the client, reperformance. !. (. ). Substantive tests reperformance. of transactions. Cocumentation, in,uiries of the client,

Analytical procedures. 0n,uiries of the client, analytical procedures. Tests of details of balances. 8hysical e:amination, confirmation, documentation, in,uiries of the client, reperformance.

Arens/Elder/Beasley

/). challenging

Ciscuss the ma1or activities and procedures performed by the auditor in each of the four phases of an audit. Answer: .he ma1or activities performed in the planning and design phase #8hase 0% are: preplan the engagementG obtain bac ground information about the clientG obtain information about the client*s legal obligationsG perform preliminary analytical proceduresG set materiality, and assess acceptable audit ris and inherent ris G obtain an understanding of internal control, and assess control ris G and develop an overall audit plan and audit program. 8hase 00 involves tests of controls, substantive tests of transactions, and an assessment of the li elihood of misstatements in the financial statements. 8hase 000 involves analytical procedures and tests of details of balances. 0n 8hase 0H, the auditor performs the review for contingent liabilities, the review for subse,uent events, accumulates final evidence, evaluates results, issues the audit report, and communicates with the client*s audit committee and management.

3ther 3b1ective Answer +ormat Questions


/$. easy a //. easy b /2. easy a /6. easy b /9. easy b 2;. easy a 3ne difference between procedures used to obtain an understanding of internal control and procedures used to test controls is that tests of controls are more e:tensive. a. .rue b. +alse .ests of controls are generally less e:pensive to perform than analytical procedures. a. .rue b. +alse .ests of controls provide evidence about the potential for misstatements in a client*s accounting system. a. .rue b. +alse Auditing standards encourage, but do not re,uire, a written audit program. a. .rue b. +alse "ubstantive tests of transactions are the most e:pensive type of audit test to perform. a. .rue b. +alse An e:ception in a test of control provides only an indication of the li elihood of monetary misstatements in the financial statements because tests of controls do not reveal whether monetary misstatements have actually occurred. a. .rue b. +alse

Arens/Elder/Beasley

21. easy b

An e:ception in a substantive test of transactions provides only an indication of the li elihood of monetary misstatements in the financial statements because substantive tests of transactions do not reveal whether monetary misstatements have actually occurred. a. .rue b. +alse Analytical procedures are the least e:pensive type of audit test. a. .rue b. +alse 0f inherent ris is decreased from medium to low, tests of details of balances can be reduced. a. .rue b. +alse &hen designing an audit program for tests of details of balances, the auditor should ma e assumptions about inherent ris and control ris , and predictions concerning the outcome of tests of controls, substantive tests of transactions, and analytical procedures. a. .rue b. +alse .he e:tent of tests of details of balances can be reduced when transaction-related audit ob1ectives have been satisfied by tests of controls or substantive tests of transactions. a. .rue b. +alse .ests of controls and substantive tests of transactions are rarely, if ever, conducted simultaneously on the same transactions. a. .rue b. +alse @nder normal circumstances, there should be no variation in the audit evidence mi: from cycle to cycle for a given audit engagement. a. .rue b. +alse Auditing standards recogni=e that in instances where a significant amount of audit evidence is in electronic form, it may not be possible to reduce detection ris to an acceptable level by performing only substantive tests. a. .rue b. +alse &hen analytical procedures are performed during substantive testing, they are typically more focused and e:tensive than when performed as part of audit planning. a. .rue b. +alse .ests of controls may be performed prior to substantive tests of transactions. a. .rue b. +alse

2!. easy a 2(. easy a 2). easy a

2$. easy a 2/. easy b 22. easy b 26. medium a

29. medium a 6;. medium a

Arens/Elder/Beasley

61. medium b 6!. medium a 6(. medium b 6). #8ublic% medium b 6$. medium b

.ests of details of balances focus on beginning and ending of the year balances. a. .rue b. +alse 0f tests of controls reveal that controls are sufficiently effective to 1ustify reducing control ris , the auditor is 1ustified in reducing substantive audit tests. a. .rue b. +alse Analytical procedures are the most e:pensive type of audit test to perform because of the e:pertise and training re,uired to properly use them. a. .rue b. +alse 8CA3> "tandard ! re,uires auditors to test controls every three years. a. .rue b. +alse .he auditor must communicate significant deficiencies in internal control only after the entire audit is complete to ensure the auditor has a sufficient understanding of the circumstances surrounding the deficiency. a. .rue b. +alse .he results of tests of controls and tests of details of balances affect the design of substantive tests of transactions. a. .rue b. +alse 0f the auditor*s preliminary assessment of control ris is decreased from high to medium, tests of controls can be reduced. a. .rue b. +alse &hen testing details of balances, most audit procedures satisfy only one balance-related ob1ective, but more than one audit procedure should be used to test each ob1ective. a. .rue b. +alse "ubstantive tests of transactions and substantive tests of details of balances are often conducted simultaneously. a. .rue b. +alse Auditing standards re,uire that tests of controls be performed on every audit engagement. a. .rue b. +alse 0n the audit of a public company, computer controls must be tested if they are considered to be ey controls for reducing the li elihood of material misstatements in the financial statements. a. .rue b. +alse

6/. medium b 62. medium b 66. medium b 69. medium b 9;. medium b 91. #8ublic% challenging a

Arens/Elder/Beasley

9!. challenging a 9(. challenging a 9). challenging b

8rocedures to obtain an understanding of internal control may suffice for tests of controls when the auditor is assessing automated controls. a. .rue b. +alse Analytical procedures are normally designed at the account level, whereas tests of controls and substantive tests of transactions are normally designed at the transaction-related ob1ective level. a. .rue b. +alse 8rocedures to obtain an understanding of internal control may suffice for tests of controls when the auditor is assessing control ris in a well defined transaction cycle that has not contained material misstatements in prior audits. a. .rue b. +alse Analytical procedures provide fewer types of evidence than any other type of audit test. a. .rue b. +alse

9$. challenging a

Arens/Elder/Beasley