ADDIS ABABA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

Department of Accounting and Finance
Auditing Principles and Practices-II
Answers to Assignment

1. Sampling risk occurs when the sample is not representative of the population; that is, the
characteristics of interest in the sample are not the same as those in the population.

2. The tolerable exception rate and acceptable risk of assessing control risk too low are
inversely related to sample size; that is, as TER or ARACR increase, sample size will
decrease. The estimated population exception rate and the population size are directly
related to sample size; that is, as EPER increases, sample size will also increase, and as
population size increases, sample size may slightly increase.

3. The key control procedures relating to the client’s physical count of inventory include
proper instructions for the physical count, supervision by responsible personnel,
independent internal verification of the counts, independent reconciliations of the physical
counts with perpetual inventory master files, and adequate control over count sheets or tags

4. A cutoff bank statement is a partial-period bank statement and the related canceled checks,
duplicate deposit slips, and other documents included in bank statements, mailed by the
bank directly to the CPA firm’s office. The purpose of the cutoff bank statements is to
verify the reconciling items on the client’s year-end bank reconciliation with evidence that
is inaccessible to the client.

5. Auditors would prepare a proof of cash when the client has material weaknesses in internal
controls over cash
6. The accuracy of the information on the interbank transfer schedule should be verified.
The interbank transfers must be recorded in both the receiving and disbursing banks.
The date of the recording of the disbursements and receipts for each transfer must be in the
same fiscal year.
Disbursement on the interbank transfer schedule should be correctly included in or
excluded from year-end bank reconciliations as outstanding checks.
Receipts on the interbank transfer schedule should be correctly included in or excluded
from year-end bank reconciliations as deposits in transit.

7. Kiting is the transfer of money from one bank to another and improperly recording the
transaction to cover a defalcation of cash or to “window-dress” the financial statements.
Near the balance sheet date, a check is drawn on one bank account and immediately
deposited in a second account for credit before the end of the accounting period. In making
this transfer, the embezzler is careful to make sure that the check is deposited at a late
enough date so that it does not clear the first bank until after the end of the period. If the
bank transfer is not recorded until after the balance sheet date, the amount of the transfer
is recorded as an asset in both banks, overstating the kiter’s total cash balance.

8. The purpose of testing the client's reconciliation is to verify whether the client's recorded
bank balance is the same amount as the actual cash in the bank. Procedures include:
• Verify that the client’s bank reconciliation is mathematically accurate.
• Trace the balance on the cutoff statement to the balance per bank on the bank
reconciliation.
• Trace checks included with the cutoff bank statement to the list of outstanding checks on
the bank reconciliation and to the cash disbursements records.
• Investigate all significant checks included on the outstanding checks list that have not
cleared the bank as of the cutoff statement.
• Trace deposits in transit to the subsequent bank statement.
• Account for other reconciling items on the bank statement and bank reconciliation.
9. The following points are answers
o Billing a customer at a lower price than called for by company policy.
o A defalcation of cash by interception of cash receipts from customers before they are
recorded; the account is charged off as a bad debt.
o Duplicate payment of a vendor’s invoice.
o Improper payments of officers’ personal expenditures.
o Payment for raw materials that were not received.
o Payment to an employee for more hours than he or she worked.
o Payment of interest to a related party for an amount in excess of the going rate.
o If these misstatements are to be uncovered in the audit, their discovery must come about
through tests of controls and substantive tests of transactions.

10. 1g 2j 3c 4e 5h 6a

11. 1, Customer order – request for merchandise by a customer. Appears in the Sales class of
transactions.
2, Shipping document – document prepared to initiate shipment of goods, indicating the
description of the merchandise, the quantity shipped, and other relevant data. Appears in
the Sales class of transactions.
3, Remittance advice – document that accompanies the sales invoice mailed to the customer
and can be returned to the seller with payment. Appears in the Cash receipts class of
transactions.
4, Sales returns and allowance journal – journal used to record all sales returns and
allowances, analogous to the sales journal. Appears in the Sales returns and allowance
class of transactions.
5Uncollectible account authorization form – document used internally to indicate authority
to write off an account receivable. Appears in the charge off of Uncollectible accounts class
of transactions.
12. The potential audit tests include the following:

• Recorded sale for which there was no shipment. Vouch selected entries in the sales
journal to related copies of shipping and other supporting documents.
• Sale recorded more than once. Review a numerically sorted list of recorded sales
transactions for duplicate numbers. The auditor may also test for proper cancellation of
shipping documents.
• Shipment made to nonexistent customers. Trace customer information on sales invoices
to the customer master file.

13. A positive confirmation requests the recipient to respond regardless of whether the balance
as stated on the confirmation is correct or incorrect. In contrast, a negative confirmation
requests the recipient to respond only if the balance as stated on the confirmation is
incorrect. Positive confirmations are more reliable because the auditor can perform follow-
up procedures if a response is not received from the customer.

14. For any positive confirmation not returned, the auditor can examine the following to verify
the existence of individual sales transactions making up the ending balance in accounts
receivable:

➢ Subsequent cash receipts—evidence of the receipt of cash after the confirmation

date includes examining remittance advices and entries in the cash receipts records.
➢ Duplicate sales invoices.
➢ Shipping documents.
➢ Correspondence between the customer and the client.

15. The auditor must carefully consider the following:

➢ The effectiveness of the client’s internal controls

➢ Results of substantive tests of transactions
➢ The appropriateness of analytical procedures as evidence on the fairness of accounts
receivable.
 ➢ Whether a large majority of recipients will give careful consideration to the
confirmation.

16. Proper authorization, both general and specific, for acquisition transactions is an essential
internal control of the processing purchase orders function. A purchasing department that
is independent of the authorization or receiving functions is often established by companies
to ensure an adequate quantity of goods and services at a minimum price. Purchase orders
should be prenumbered and should include sufficient columns and spaces to minimize the
likelihood of unintentional omissions on the form when goods are ordered

17. For good internal control over the receiving goods and services function, most companies
require that the receiving department prepares a receiving report when goods are received,
one copy of which is sent to the storeroom and another to the accounts payable department.
To prevent theft, it is important that the goods be physically controlled from the time of
their receipt until their disposal. The personnel in the receiving department should be
independent of the storeroom personnel and the accounting department. In addition, the
accounting records should transfer responsibility for the goods as they are transferred from
receiving to storage and from storage to manufacturing.

18. Property, plant, and equipment

• There are usually fewer current period acquisitions of property, plant, and equipment
than current assets.
• The amount of any given acquisition is often material.
• The equipment is likely to be kept and maintained in the accounting records for several
years.
Because of these three differences, the emphasis in auditing property, plant, and equipment is
on the verification of current period acquisitions rather than on the balance in the account
carried forward from the preceding year. In addition, the expected life of assets over one year
requires depreciation and accumulated depreciation accounts, which are verified as a part of
the audit of the assets.