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Chapter 6 - Audit Responsibilities and Objectives

Multiple Choice Questions From CPA Examinations

6-18

a.

(2)

b.

(2)

6-19

a.

(1)

b.

(2)

6-20

a.

(3)

b.

(4)

c.

(1)

c.

(4)

6-24
b.

c.

CLASS OF
TRANSACTIONS

a.
FINANCIAL
STATEMENT
BALANCE

TITLE OF
JOURNAL

TRANSACTION
CYCLE

PURCHASE
RETURNS

Purchase returns
& allowances

Acquisitions
Journal

Acquisition &
Payment

RENTAL
REVENUE

Rent revenue

Revenue Journal

Sales &
Collection

CHARGE-OFF OF
UNCOLLECTIBLE
ACCOUNTS

Bad debts

Adjustments
Journal

Sales &
Collection

ACQUISITION OF
GOODS AND
SERVICES

Repair and
maintenance

Acquisitions
Journal

Acquisition
& Payment

RENTAL
ALLOWANCES

Rental allowances

Adjustments
Journal

Sales &
Collection

ADJUSTING
ENTRIES (FOR
PAYROLL)

Accrued payroll

Adjustments
Journal

Payroll &
Personnel

PAYROLL
SERVICE &
PAYMENTS

Sales salaries

Payroll Journal

Payroll &
Personnel

CASH
DISBURSEMENTS

Accounts
payable

Cash Disbursements Journal

Acquisition
& Payment

CASH RECEIPTS

Accounts
receivable

Cash Receipts
Journal

Sales &
Collection

d. Rental revenue is likely to be recorded in the cash receipts journal at the time the
cash is received from renters. It is therefore likely to be recorded as a debit to cash
receipts and a credit to rental revenue. The journal will be summarized monthly and
posted to the general ledger. There will be required adjusting entries for unearned
rent and for rent receivable. A record will be kept of each renter and a determination
made whether rent is unpaid or unearned at the end of each accounting period. The
entries that are likely to be made in the adjustments journal are posted to the general
ledger. Then the financial statements are prepared from the adjusted general ledger.
Reversing entries may be used to eliminate the adjusting entries.

6-25

a.
INCOME STATEMENT
ACCOUNTS

CYCLE

BALANCE SHEET ACCOUNTS

SALES AND
COLLECTION

Accounts receivable
Cash
Notes receivable--trade
Allowance for doubtful accounts
Interest receivable

Sales
Bad debt expense
Interest income

ACQUISITION
AND PAYMENT

Income tax payable


Accounts payable
Unexpired insurance
Furniture and equipment
Cash
Accumulated depreciation of
furniture and equipment
Inventory
Property tax payable

Income tax expense


Advertising expense
Travel expense
Purchases
Property tax expense
Depreciation expense
furniture and equipment
Telephone and fax
expense
Insurance expense
Rent expense

PAYROLL AND
PERSONNEL

Cash
Accrued sales salaries

Sales salaries expense


Salaries, office and
general

INVENTORY
AND
WAREHOUSING

Inventory

Purchases

CAPITAL
ACQUISITION
AND
REPAYMENT

Bonds payable
Common stock
Cash
Notes payable
Retained earnings
Prepaid interest expense

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.

6-26
SPECIFIC BALANCERELATED AUDIT
OBJECTIVE

MANAGEMENT
ASSERTION

a.

There are no
unrecorded
receivables.

2.

Completeness

Unrecorded transactions or
amounts deal with the
completeness objective.

b.

Receivables have
not been sold or
discounted.

4.

Rights and
obligations

Receivables not being sold or


discounted concerns the rights
and obligations objective and
assertion.

c.

Uncollectible
accounts have been
provided for.

3.

Valuation or
allocation

Providing for uncollectible


accounts concerns whether the
allowance for uncollectible
accounts is adequate. It is part
of the realizable value objective
and the valuation or allocation
assertion.

d.

Receivables that
have become
uncollectible have
been written off.

3.

Valuation or
allocation

This is part of the realizable


value objective and the
valuation or allocation
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


list are expected to
be collected within
one year.

3.

Valuation or
allocation

Accounts that are not expected


to be collected within a year
should be classified as longterm 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
condition that
restricts the nature
of trade receivables
is known and
disclosed.

5.

Presentation and
disclosure

The nature of trade receivables


is a part of the presentation and
disclosure objective and
therefore the presentation and
disclosure assertion.

COMMENTS

6-26

(continued)

SPECIFIC BALANCERELATED AUDIT


OBJECTIVE

MANAGEMENT
ASSERTION

g.

All accounts on the


list arose from the
normal course of
business and are not
due from related
parties.

3.

Valuation or
allocation

Concerns the classification of


accounts receivable and is
therefore a part of the
classification objective and the
valuation or allocation
assertion. Some people believe
that like item e., it is a part of
presentation and disclosure.

h.

Sales cutoff at yearend is proper.

3.

Valuation or
allocation

Cutoff is a part of the cutoff


objective and therefore part of
the valuation or allocation
assertion.

6-27

a.

COMMENTS

Management assertions are implied or expressed representations by management


about the classes of transactions and related accounts in the financial statements.
SAS 31 (AU 326) classifies five broad categories of assertions which are stated in
the problem. These assertions are the same for every transaction cycle and
account. General transaction-related audit objectives are essentially the same as
management assertions, but they are expanded somewhat to help the auditor
decide which audit evidence is necessary to satisfy the management assertions.
Accuracy, classification, timing, and posting and summarization are a subset of the
valuation or allocation assertion. Specific transaction-related audit objectives are
determined by the auditor for each general transaction-related audit objective.
These are done for each transaction cycle to help the auditor determine the specific
amount of evidence needed for that cycle to satisfy the general transaction-related
audit objectives.

b.
and
c. The easiest way to do this problem is to first identify the general transaction-related
audit objectives for each specific transaction-related audit objective. It is then easy to
determine the management assertion using Table 6-2 (p. 147 in text) as a guide.

6-27

(continued)
b.

c.
GENERAL
TRANSACTIONRELATED AUDIT
OBJECTIVE

SPECIFIC TRANSACTIONRELATED AUDIT OBJECTIVE

MANAGEMENT
ASSERTION

a.

Recorded cash disbursement


transactions are for the amount
of goods or services received
and are correctly recorded.

3.

Valuation
allocation

or

8.

b.

Cash disbursement transactions


are properly included in the
accounts payable master file and
are correctly summarized.

3.

Valuation
allocation

or

11. Posting and


summarization

c.

Recorded cash disbursements


are for goods and services
actually received.

1.

Existence or
occurrence

6.

Existence

d.

Cash disbursement transactions


are properly classified.

3.

Valuation
allocation

or

9.

Classification

e.

Existing
cash
disbursement
transactions are recorded.

2.

Completeness

7.

Completeness

f.

Cash disbursement transactions


are recorded on the correct
dates.

3.

Valuation
allocation

10. Timing

6-29

or

Accuracy

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 balancerelated 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.

6-29

b.

GENERAL BALANCERELATED AUDIT


OBJECTIVE

SPECIFIC BALANCE-RELATED

1.

EXISTENCE

d.

2.

COMPLETENESS

a.

3.

ACCURACY

e.

Property, plant, and equipment are recorded at the


correct amount.

j.

Depreciation is determined in accordance with an


acceptable method and is materially correct as
computed.

AUDIT OBJECTIVE
Fixed assets physically exist and are being used for the
purpose intended.
There are no unrecorded fixed assets in use.

4.

CLASSIFICATION

i.

Expense accounts do not contain amounts that should


have been capitalized.

5.

CUTOFF

h.

Cash disbursements and/or accrual cutoff for property,


plant, and equipment items are proper.

6.

DETAIL TIE-IN

c.

Details of property, plant, and equipment agree with the


general ledger.

7.

REALIZABLE VALUE

k.

Fixed asset accounts have been properly adjusted for


declines in historical cost.

8.

RIGHTS AND
OBLIGATIONS

b.

The company has valid title to the assets owned.

f.

The company has a contractual right for use of assets


leased.

g.

Liens or other encumbrances on property, plant, and


equipment items are known and disclosed.

9.

PRESENTATION
AND DISCLOSURE