Exam 3 Practice Questions

Chapter 9
1. The revenue cycle considered by auditors includes the sales process but not collections.
False
2. The revenue cycle involves the procedures in generating a sales order, shipping the products,
recording the transaction, and collecting the receivable.
True
3. The shipping department confirms the shipment of goods by completing the packing slip and
returning it to the purchasing department.
False
4. Substantive tests of details for revenue transactions focus primarily on the completeness assertion.
False
5. As required by auditing standards, auditors should ordinarily presume there is a risk of material
misstatement caused by fraud relating to revenue recognition.
True
6. A company that ships a large quantity of its products from its manufacturing plant to a warehouse that
it leases until the customer is ready for the product should record the delivery to the warehouse as
revenue.
False
7. The intentional loading of sales at the end of a period to customers that do not need the goods at that
time should not be recorded as revenues.
True
8. A tendency for fraud may exist when the granting of stock options is dependent on reaching an
earnings goal.
True
9. A consistent pattern of earnings growth would eliminate the auditor’s concern for fraud in revenue
recognition.
False
10. Ratio analysis performed by the audit team may include the comparison of gross profit percentage to
industry averages.
True
11. Use of reasonableness tests by Bono Mullins, PC, will include relationships between financial but not
non-financial data.
False
12. Current auditing standards do not require the confirmation of receivables if accounts receivable are
not material.
True
13. Accounts receivable confirmation letters should be prepared on the auditing firm's letterhead.
False
14. Lapping of accounts receivable is least likely to occur when there is an inadequate segregation of
duties.
False
15. Positive accounts receivable confirmations should be used on all accounts which represent small
immaterial balances.
False
16. When the client has a large number of relatively small accounts receivable and the assessed level of
control risk for receivables and related revenue transactions is high, the auditor is more likely to use
negative confirmations.
False
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17. The auditor would examine a sample of sales transactions throughout the entire period to determine if
sales were recorded in the proper period when performing a sales cutoff test.
False
18. A method of testing for the completeness of sales is to test the sequence of sales invoices used during
the period under audit.
True
19. The use of data analytics tools makes the audit of the revenue cycle more effective, but not more
efficient.
False
20. Valid evidence obtained in an audit for testing the cutoff of sales includes receiving reports for
returned merchandise.
True
21. Exceptions found in the confirmation of accounts receivable balances need not be projected as errors
to the population as they are typically isolated errors.
False
22. A timing difference type of exception in the confirmation process may arise when goods are in transit
at the confirmation date.
True
23. An auditor's primary concern with identifying related party sales and receivables rests with the
presentation and disclosure assertion.
True
24. Customer complaints noted in returned accounts receivable confirmations may be an indicator of
fraud.
True
25. While electronic confirmations of receivables are more efficient, they are seldom used because they
are not considered as reliable as paper confirmations.
False
26. Which of the following processes are not included in the revenue cycle?
D. Sending payments to suppliers.
27. Which of the following is the fifth step in the five-step revenue recognition process prescribed by
ASC 606?
A. Satisfaction of a performance obligation.
28. Which of the following is a formal document that conveys responsibility for shipped merchandise to
the shipper?
D. Bill of lading.
29. Credit approval policies are implemented by organizations primarily to accomplish which of the
following objectives?
D. To minimize credit losses.
30. Sales transactions should be documented at initiation in order to accomplish which of the following
objectives?
C. To provide evidence of authorization and recording.
31. The purpose of the bill of lading is to provide which of the following?
C. Evidence of title transfer of goods to customers.
32. The risk of material misstatement due to fraud relating to revenue recognition should be
B. ordinarily presumed by the auditor.
33. A method used by companies to fraudulently inflate revenues includes which of the following?
D. All of the above. (a. Use of hidden “side letters” giving the customer an irrevocable
right to return the product, b. recording of fictitious sales, c. shipment of product not ordered by
customers).
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34. Which of the following evidences delivery of product to customers sufficient for company recording
as revenues?
C. A bill of lading and tracking number with the shipper.
35. Which of the following must exist prior to the recognition of revenue by a company from the sale of a
product?
B. the product is transferred to the customer.
36. Fraud related to revenue recognition will most likely be identified by the auditor through which of the
following independent situations?
D. Sales are higher in the month preceding each quarter end.
37. Calculating the turnover of receivables is often used in testing the sales cycle by auditors when
performing which of the following?
B. Ratio analysis.
38. An analysis of monthly sales compared with past years and budgets is a form of what type of testing?
B. Trend analysis.
39. Lithgow and Harris, CPAs, are performing the audit of Wild Flower Grocery Stores. Lithgow and
Harris relates annual revenue to sales per square feet and sales per customer. What type of analysis is
Lithgow and Harris most likely performing?
C. Reasonableness tests.
40. In an audit of financial statements, risks related to a high rate of return of products sold include which
of the following?
A. Sales that are recorded improperly.
41. The major risk associated with receivables is related to which of the following?
A. They will not be realized for the entire amount due.
42. Which of the following is a proper control for the detection of unusual sales transactions recorded in
the general ledger?
A. Review of transaction by upper management or the board.
43. A control that may be implemented to ensure all sales that occur are recorded in the general ledger
includes which of the following?
C. Use of prenumbered shipping, invoice and sales documents.
44. The internal audit department at Monument Company receives electronic exceptions reports for all
sales transactions entered over $10,000 in total. This process is performed for which purpose?
C. Monitoring revenue transactions.
45. Auditors will examine significant sales returns immediately subsequent to the period under audit in
order to do which of the following?
B. Substantiate cutoff and the occurrence of net sales transactions.
46. The auditor of the revenue cycle of ABC Company computes an estimate of ABC's allowance for
doubtful accounts and compares it to the estimate provided by ABC's management. The purpose for
this procedure is to substantiate which assertion?
D. Valuation of receivables.
47. What evidence is utilized by the auditor for analytical purposes in substantiating the completeness of
the allowance for bad debt estimate?
B. Accounts receivable aging schedule.
48. Much of the understanding of revenue transactions for compliance with GAAP can be performed by
accomplishing which of the following tasks?
A. Examining sales contracts and inquiry of management.
49. The auditor traces recorded sales to invoices, sales orders, and shipping documents in order to
substantiate which assertion?
A. Occurrence.
50. In the audit of the revenue of Hiram Manufacturing Company, the auditors obtain a number of
shipping documents shortly before year-end and immediately following the year under audit. The
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auditors compare the documents to the sales journal in order to test which of the following assertions?
A. Cutoff of sales transactions.
51. Completeness of revenues may be tested by the auditor through the selection of a sample of which of
the following?
D. Shipping documents and tracing them to the sales journal.
52. Homer and Moe, PC are auditing the financial statements of Lyoncraft, Inc. and decide to confirm a
sample of accounts receivable. This test is performed by Homer and Moe primarily to substantiate
which of the following assertions?
B. Existence of accounts receivable.
53. The aged accounts receivable report is utilized by the auditor to accomplish which of the following?
B. Assess the adequacy of the allowance for doubtful accounts.
54. According to auditing standards, accounts receivable confirmations are required to be used in which
of the following situations?
B. If the accounts receivable balance is material.
55. The primary difference between positive and negative confirmations used in the audit of accounts
receivable is which of the following?
A. The mode of response.
56. For which of the following accounts receivable customer populations would the use of negative
confirmations be most appropriate?
C. A cable company with control risk over the revenue cycle assessed low.
57. Accounts receivable confirmations usually provide strong evidence about which of the following?
A. The existence of receivables.
58. Confirmations that are sent to select customers asking them to review the current balance due the
client as shown on the client's statement and return the letters directly to the auditor indicating
whether they agree with the indicated balance, are known by which of the following terms?
B. Positive confirmations.
59. Which one of the following procedures would be considered improper by the auditor in the process of
confirming receivables?
A. The auditor allows the client’s staff to mail the confirmation letters after he or she has
proofed the typing of the letters.
60. An auditor's examination of the sales account using a cutoff test would most likely detect which of
the following?
D. Sales recorded in the wrong period.
61. Alternative procedures that would provide evidence of the existence of receivables would include
which of the following?
D. Review of subsequent collections.
62. Auditors are concerned with the addresses provided for customers in the confirmation of accounts
receivable because of which of the following reasons?
B. The address may be routed to the client for retrieval and fraudulent signing.
63. Unreturned positive confirmations for accounts receivable warrant which of the following actions?
C. Sending second requests and possibly performing subsequent procedures.
64. An example of alternative procedures for the confirmation of accounts receivable includes which of
the following actions?
C. Review of subsequent collections on account by the client.
65. A key indicator of fraud in the revenue cycle is the auditor's detection of which of the following?
A. Altered shipping documents and invoices.
66. In the audit of accounting estimates, such as the allowance for doubtful accounts, the auditor strives
to provide reasonable assurance about which of the following?
D. All of the above are true. (a. All material accounting estimates have been developed
properly; b. The estimates are reasonable; c. The estimates are presented in accordance with GAAP).
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67. The allowance for doubtful accounts balance will not be a precise amount because of which of the
following reasons?
D. It is an accounting estimate based upon judgement.
68. To determine whether any accounts receivable are pledged or assigned to others, the auditor would
most likely perform which of the following procedures?
D. Review loan agreements and board of directors’ meeting minutes.
69. Which of the following criteria must be met in order to recognize revenue in the current accounting
period?
D. All of the above. (a. Goods or services have been transferred to the customer; b. The
transaction price has been determined; c. Collectability is reasonably assured).
70. Management has been found involved in many fraudulent schemes; a common one is “channel
stuffing.” What does “channel stuffing” involve?
A. Shipment of goods not ordered.
71. Which of the following is not a form of ratio analysis?
B. Monthly sales analysis compared with past years.
72. Sources of audit planning information may come from which of the following?
D. All of the above. (a. knowledge of client’s business and industry; b. assessment of risk
of material misstatement; c. results of analytical procedures).
73. Which of the following audit procedures does not address existence/occurrence for accounts
receivables and sales?
D. Trace bill of lading to sales invoice and sales journal.
74. Substantive tests of the revenue cycle typically do not provide evidence of which of the following?
C. The balance in the allowance account is correct.
75. A sample of positive confirmations is mailed for material accounts receivable balances. Frequently
there is a lack of response. Which of the following is not an acceptable alternative procedure?
D. Inquiry of management.
76. Which of the following statements is true regarding assertions in the revenue cycle?
C. If a client has an incentive to overstate revenues, the existence assertion would be
more relevant than the completeness assertion.
77. Which of the following statements is true regarding the processing and recording of revenue
transactions?
C. Sales transactions typically begin with the receipt of a purchase order from a customer.
78. Under the FASB's guidance on revenue recognition, which of the following is not criteria that must be
met in order for a contract to exist?
D. The auditor has ensured that the contract’s valuation is reasonable in all material respects.
79. Which of the following statements is false regarding the fraud at ArthroCare?
D. Two of ArthroCare's sales executives overstated ending inventory that improperly
inflated company revenue and earnings.
80. Which of the following factors is not a motivation for clients to fraudulently misstate revenue?
A. Controls over revenue process are ineffective.
81. Which of the following explanations best describes the purpose of lapping?
B. Lapping is a technique used by client personnel to cover up the embezzlement of cash.
82. Which of the following procedures can organizations use to address credit risk most effectively?
C. A periodic review of the credit policy by key executives to determine whether changes
are dictated either by current economic events or by deterioration of the receivables.
83. Which of the following statements about the Medicis fraud is false?
B. The PCAOB found that EY and its partners failed to properly evaluate a material
component of the company’s financial statements—its allowance for doubtful accounts.
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84. Which of the following statements is false regarding planning analytical procedures in the revenue
cycle?
D. All of these statements are false.

85. Assume that an auditor expected that the client's activities related to sales and accounts receivable
would be similar to industry averages. Which of the following relationships detected as part of
planning analytical procedures would not suggest a heightened risk of material misstatement in the
revenue cycle?
A. The number of days’ sales in accounts receivable decreased from sixty-five days in the
prior year to forty-seven days in the current year. The industry average increased from forty-five to
forty-seven days.
86. After identifying the risks of material misstatement, the auditor develops an audit plan in response to
those risks. Which of the following plans for testing revenue would be most likely when the auditor
believes that control risk is high?
A. The only evidence the auditor plans to obtain is from tests of details.
87. Responding to identified risks involves developing an audit approach that addresses those risks.
Which of the following statements about the planned audit approach is true for the revenue cycle?
A. The audit approach will typically require more evidence for higher risk assertions than
lower risk areas.
88. When auditing a nonpublic company, the auditor would generally make a decision not to test the
operating effectiveness of controls in which of the following situations?
D. All of these are situations when the auditor would likely not test the operating
effectiveness of controls.
89. An auditor performs tests of controls in the revenue cycle. First, the auditor makes inquiries of
company personnel about credit-granting policies. The auditor then selects a sample of sales
transactions recorded in the general ledger and examines documentary evidence of credit approval.
Which of the financial statement assertion(s) does this test of controls most likely support?
Completeness Valuation or Allocation
a. Yes Yes
b. No Yes
c. Yes No
d. No No
C. B
90. To test the completeness of sales, the auditor would select a sample of transactions from which of the
following populations?
D. Bill of lading file.
91. The auditor is concerned that the client has recorded fictitious sales. Which of the following
procedures would be the best audit procedure to identify fictitious sales?
C. Selecting a sample of recorded sales invoices and trace to shipping documents (bills of
lading and packing slips) to verify shipment of goods.
92. It is not possible for internal controls to mitigate risks associated with the valuation of accounts
receivable.
False
93. Diageo made improper cash payments to government officials in Mexico, Brazil, and Argentina
during the period 2003 to 2009, which violated provisions of the Foreign Corrupt Practices Act.
False
94. The auditor might conclude that a heightened risk of fraud exists if the planning analytical procedures
indicate increases in revenue and net income, but negative cash flow from operations.
True
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95. Responding to identified risks in the revenue cycle rarely involves developing an audit approach that
contains substantive procedures (e.g., tests of details and, when appropriate, substantive analytical
procedures).
False
96. While audit firms may have a standardized audit program for the revenue cycle, the auditor should
customize the audit program based on the assessment of risk of material misstatement.
True
97. In testing controls over whether sales are properly valued, the auditor could take a sample of recorded
sales invoices and agree the price on the invoice to an authorized price list.
True
98. Surprisingly, AmTrust's restatement was followed by a stock price increase, likely because investors
inferred that by revealing the restatement the company could move forward with confidence.
False
99. Auditors in practice commonly use negative confirmations.
False
100. A substantive audit procedure that would reveal ownership and related disclosure issues includes
scanning the cash receipts journal for relatively large inflows of cash that from unusual sources.
True

Chapter 10
1. A risk of fraud is not associated with petty cash funds because of the small amounts of money
involved.
False
2. In auditing cash accounts, auditors typically focus primarily on the existence/occurrence and
completeness assertions.
True
3. Planning analytical procedures for cash balances typically include trend analysis and ratios for
comparison with the auditor’s expectations.
True
4. The existence of debt covenants with restrictions related to cash or working capital increases the risks
of material misstatement in cash accounts.
True
5. The existence or occurrence assertion as related to cash is concerned with proper classification on the
balance sheet.
False
6. Cash and cash equivalents reported on the balance sheet may include debt securities that mature less
than six months from the balance sheet date.
False
7. Because substantive audit procedures are largely ineffective for cash accounts, auditors typically
focus on tests of controls when the risk of material misstatement is assessed at a high level.
False
8. Electronic funds transfers have controls built into the process and do not require further reconciliation
by the client.
False
9. The auditor’s performance of an independent reconciliation of the client’s bank accounts provides
evidence as to the rights and obligations of the year-end cash balances.
False
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10. Customer checks received at the client company should be restrictively endorsed within one week of
receipt.
False
11. A turnaround document is an effective control because it contains information useful for further
processing of a payment received from a customer.
True
12. Auditors usually perform relatively limited substantive analytical procedures for cash accounts and
instead focus on substantive tests of details.
True
13. Client management’s review of monthly bank reconciliations prepared by employees is an example of
a control over the accuracy of cash balances that the auditor might test.
True
14. Periodic bank reconciliations should be performed by the individual who makes the client’s bank
deposits.
False
15. Kiting is an example of a technique used to intentionally overstate cash.
True
16. The standard bank confirmation should be sent to all banks used by the client during the year except
those banks holding client accounts with a zero balance at year-end.
False
17. The auditor may discover evidence of kiting by preparing an interbank transfer schedule.
True
18. Money laundering is designed to create the appearance that large sums of cash obtained from criminal
activities, such as drug trafficking, originated from legitimate business sources.
True
19. The cutoff statement is mailed to the client for an agreed-upon date and then copied for the audit files.
False
20. Testing debt securities and commercial paper would typically include an analysis of interest income.
True
21. Gains and losses are not considered by auditors in testing marketable securities, as they do not need to
be disclosed.
False
22. All marketable securities are carried at fair market value on the balance sheet.
False
23. Thinly traded securities have a greater inherent risk related to valuation.
True
24. Effective internal control over the cash account requires that the person responsible for making the
bank deposit does not post the increase to cash in the accounting system.
True
25. When auditing financial hedges, the auditor should understand the product, identify relevant risks and
controls, and understand the appropriate accounting.
True
26. Many financial instruments offer a potentially higher return for investors along with a reduced level
of risk.
False
27. Which one of the following risks is not a risk associated with cash?
D. Complex valuation issues.
28. Under which of the following circumstances would the valuation assertion for cash most likely have
an increased level of inherent risk?
A. Client has cash holdings in foreign currency in a politically unstable country.
Exam 3 Practice Questions

29. The cash account is significant to the auditor for which of the following reasons?
D. The cash account balance is the culmination of a large volume of transactions.
30. Which of the following situations would normally be discovered by testing the bank reconciliation?
C. Failure to include a deposit in transit on the bank reconciliation.
31. Which of the following is not a normal edit test as part of computerized control for checks?
A. Cross-references.
32. Which one of the following is not a fundamental internal control the auditor would expect to find in
place for a cash processing system?
C. Electronic payments.
33. During the testing of a year-end bank reconciliation, an auditor noticed that the majority of checks
listed as outstanding at year-end did not clear the bank until the middle of the subsequent month.
Which of the following is a likely explanation?
A. Checks were issued before year-end but not mailed until the subsequent period.
34. As cash processing systems become more automated and integrated, which of the following is true
about the general concept of segregation of duties?
C. The importance of segregation of duties does not change.
35. Which of the following controls would be most successful in mitigating the theft of customer checks
received in the mail?
C. Restrictive endorsements placed on checks as soon as they arrive.
36. Which of the following controls over cash would an auditor expect to observe?
A. Checks permanently marked “for deposit only” with the proper routing information.
37. What form of evidence is used by the auditor to verify bank reconciliation items?
C. Cutoff statement.
38. Electronic authorization privileges for cash transactions may be best assigned to individuals based on
which of the following?
D. Roles and activities falling within appropriate segregation of duties.
39. Which of the following describes documents that accompany customer payments to help the clerk
identify the payments?
B. Turnaround documents such as remittance advices.
40. Which of the following best describes kiting?
B. A fraudulent scheme to overstate cash at year-end by manipulating year-end transfers
between bank accounts.
41. Which of the following represents a typical substantive audit procedure for cash balances?
A. Verify material deposits in transit to subsequent statements.
42. How will the auditor most likely utilize the bank reconciliation as evidence in the audit of cash?
A. The auditor tests deposits in transit and outstanding items to other corroborating
evidence.
43. Which of the following is the primary reason the auditor obtains and reviews a cutoff bank statement?
C. Verify the reconciling items on the year-end bank reconciliation.
44. The auditor will send a standard bank confirmation to which of the following?
A. Financial institutions with which the client has transacted during the year.
45. The ease with which cash can be stolen is most related to which of the following risks?
D. Inherent risk.
46. Which of the following best describes a fraudulent scheme to overstate cash assets at year-end by
recording deposits in transit in both the account from which the cash is withdrawn and the account to
which it is transferred?
C. Kiting of cash.
47. The emphasis in verifying petty cash is normally on which of the following?
A. Controls over petty cash.
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48. When auditing marketable securities, the auditor will do which of the following?
E. All of the above. (Examine broker’s advices evidencing purchases of securities;
recompute income; foot schedule)
49. The reported fair market value of securities held by the client can be verified by the auditor through
which of the following procedures?
D. Comparing the fair values to credible publications and websites.
50. Which of the following items would not normally appear on bank reconciliations?
B. Outstanding deposits list.
51. Investments in securities are classified as which of the following?
D. All of the above. (Held-to-maturity; trading securities; available-for-sale securities).
52. Which of the following is the most relevant assertion with regards to the audit of cash?
B. Existence.
53. Which of the following would not be used as part of analytical procedures for marketable securities?
B. Verify ending balances prior to calculating the percent change.
54. Which of the following would the auditor use to test the existence of investments?
C. Confirming or examining recorded investments.
55. Which assertion related to investments is tested when the auditor examines the documents for any
restrictions?
A. Rights.
56. Which of the following types of securities is valued at amortized cost, subject to an impairment test?
C. Held-to-maturity securities.
57. Which of the following procedures does the auditor typically perform when testing the existence of
cash?
A. Sending a standard bank confirmation.
58. When testing cash balances at the balance sheet date, the auditor foots the bank reconciliation and
traces its reported book balance to the trial balance and its bank balance to the standard confirmation.
Which of the following assertions is being tested with these procedures?
B. All of the above. (existence, valuation, rights).
59. Assume that an auditor notes a large series of checks that does not clear the bank for an unusually
long time after period end. Which of the following would the auditor likely suspect from this
observation?
D. The presence of held checks at period-end.
60. The standard bank confirmation includes a designated place for the financial institution to report
which of the following?
B. Loans and collateral.
61. Which of the following is not a common test of controls for marketable securities?
A. Review broker’s advice for accurate recording of security.
62. Which of the following would be used by the auditor to address the possibility of kiting?
A. Interbank transfer schedules.
63. Interbank transfer schedules are used by the auditor to address which of the following concerns?
B. Kiting.
64. The cutoff bank statement is used by the auditor to address which of the following concerns?
C. Omitting outstanding checks on reconciliations.
65. Which of the following would not be included as part of the documentation related to the substantive
procedures for marketable securities?
D. Policies over purchase or sale of marketable securities.
66. Which of the following is not an internal control the auditor would expect to find in place for all cash
processing systems?
C. Walkthrough.
67. Which of the following is a cash management technique frequently used by management?
A. Cash management agreement with financial institutions.
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68. The auditor prepares a schedule for marketable securities. Which of the following is not one of the
items in the schedule related to the value of the securities?
D. Interest and dividends.
69. Which of the following types of financial instruments is a contract between a buyer and a seller in
which the buyer has the right (but not the obligation) to buy an agreed quantity of a specified
commodity or financial instrument at a certain time for a certain price.
B. Call option.
70. Which of the following is a risk associated with complex financial instruments?
D. All of the above are risks.
71. Which of the following assertions is relevant to whether the company owns the cash accounts as of
the balance sheet date?
C. Rights and Obligations.
72. Which of the following assertions is relevant to whether the cash balances reflect the true underlying
economic value of those assets?
D. Valuation or allocation.
73. Inherent risk for cash is usually assessed as high for which of the following reasons?
E. All of these.
74. Which of the following questions would be relevant for an inherent risk analysis questionnaire related
to cash?
A. Does the company have significant cash flow problems in meeting its current obligations on a
timely basis?
75. Which of the following terms best defines this scenario?
The employee steals a payment from Customer X. To cover the theft, the employee applies a
payment from Customer Y to Customer X's account. Before Customer Y has time to notice that its
account has not been appropriately credited, the employee applies a payment from Customer Z to
Customer Y's account.
D. Lapping.
76. Affirmative answers to which of the following questions would lead the auditor to assess fraud risk at
a higher level for cash?
E. All of these.
77. Skimming most likely results in a violation of which of the following management assertions?
B. Completeness.
78. Which of the following is not a type of common control over cash?
C. Bank reconciliations by employees who handle cash.
79. The first step in performing planning analytical procedures is to develop an expectation of the
account balance. Which of the following does not typically represent a likely expected relationship
for cash accounts?
A. The company reports consistent profits over several years, but operating cash flows
are declining.
80. Which of these is a common example of trend analysis of accounts and ratios that the auditor might
consider for cash accounts?
D. All of these. (Compare monthly cash balances with past years and budgets; identify
unexpected spikes or lows in cash during the year; compute trends in interest returns on investments).
81. Which mix of evidence would be most appropriate for the following scenario?
This is a client where the auditor has assessed the risk of material misstatement related to the
existence and completeness of cash at high. This client has incentives to overstate cash in order to
meet debt covenants. Further, the client has relatively weak controls to prevent theft of cash.
B. 100% tests of details.
82. Which mix of evidence would be most appropriate for the following scenario?
Exam 3 Practice Questions

This is a client where the auditor has assessed the risk of material misstatement related to the
existence and completeness of cash as low, and believes that the client has implemented effective
controls in this area.
A. 50% tests of details, 10% analytics, 40% tests of controls.
83. Refer to Exhibit 10.6. Which of the following represents a reasonable test of controls for cash
receipts?
B. Segregation of duties between those handling cash and those recording cash transactions.
84. Which of the following represents a control related to cash that an auditor might test?
D. All of these.
(reviews of reconciliations of reported cash receipts with remittances prepared by independent
parties; review of cash budgets and comparison of them with actual cash balances; review of
discrepancies in cash balances).
85. Which of the following statements regarding reperformance of bank reconciliations is true?
D. Two of the statements are true.
86. A bank confirmation contains which of the following two parts?
1) A part that seeks information on the client's deposit balances, the existence of loans, due dates
of the loans, interest rates, dates through which interest has been paid, and collateral for loans
outstanding.
2) A part that contains a listing of the last checks issued near year-end.
3) A part that seeks information about any loan guarantees.
4) A part that lists all transfers between the company's bank accounts for a short period of time
before and after year-end.
C. 1 & 3
87. Refer to Exhibit 10.15. Which of the following assertions is relevant to whether the marketable
securities balances include all securities transactions that have taken place during the period?
B. Completeness.
88. Refer to Exhibit 10.15. Which of the following assertions is relevant to the audit procedure for
marketable securities that requires the auditor to examine selected documents to identify any
restrictions on the securities?
C. Rights and obligations.
89. An audit client has invested heavily in new equity and debt securities. Which of the following
would not constitute an appropriate role for the organization's board of directors or others charged
with governance?
D. Approve all new investments prior to reviewing their risks.
90. Which of the following is a risk associated with complex financial instruments?
A. Management’s objective for entering into such transactions may relate to misstating
the financial statements.
91. The volume of activity in cash accounts makes cash accounts less susceptible to error than most other
accounts.
False
92. The electronic transfer of cash and the automated controls over cash are such that if errors are built
into computer programs, they could be repeated on a large volume of transactions.
True
93. Planning analytical procedures for cash balances are highly effective because of the generally stable
relationship with past cash levels and the fact that cash is a managed account.
False
94. If the auditor observes that the company reports consistent profits over several years while cash
inflows are decreasing, the auditor should likely assess a heightened risk of fraud in cash.
True
Exam 3 Practice Questions

95. The relative percentage of substantive analytics that an auditor will use as evidence in the audit of
cash will be somewhat limited regardless of the riskiness of the client.
True
96. When auditing cash, the auditor will perform a relatively larger percentage of tests of details for a
high-risk client compared to a low-risk client.
True
97. An example of a monitoring control in cash would include a review of cash budgets and a comparison
of them with actual cash balances, with appropriate follow-up.
True
98. Because cash balances are usually relatively low at year-end, auditing standards encourage auditors to
send bank confirmations on a sample basis.
False
99. The following is an inherent risk that is particularly applicable to owning stock in a company like
Genie Energy: Risk of sudden market declines, which would adversely affect the valuation of
securities.
True
100. Auditor expertise is critically important in evaluating the validity of the valuation of complex
financial instruments.
True

Chapter 11
1. Supply chain management has helped many companies improve the efficiency of operations.
True
2. Management may intentionally misstate inventory balances by overvaluing items that are obsolete.
True
3. Understatement of either purchases or ending inventory will result in a lower cost of goods sold and
higher net income.
False
4. A networked software system linking a company’s information system to vendors whose offerings
and prices have been preapproved by appropriate management is called an automated purchasing
system.
True
5. Cycle counts involve periodic testing of the accuracy of the perpetual inventory records.
True
6. Auditors should consider the inherent risk that management is more likely to understate, rather than
overstate, accounts payable and expenses.
True
7. The auditor's primary concern with accounts payable is that of existence.
False
8. Reconciliation of vendor statements to recorded payables provides assurance related to the
completeness assertion.
True
9. Approval of items for payment usually involves a three-way match among the vendor invoice, the
purchase order, and the receiving report.
True
10. The purchasing department should make sure that only authorized goods are received, the goods meet
order specifications, an accurate count of the goods received is taken, and that accountability is
established to assure that all receipts are recorded.
False
Exam 3 Practice Questions

11. In an audit where there is a heightened risk of fraud related to inventory, the auditors may want to
observe all inventory locations simultaneously.
True
12. The use of substantive analytical procedures applied to related expense accounts would not be used to
determine if accounts payable were understated.
False
13. Analytical review of related expense accounts when auditing accounts payable would be used when
control risk is assessed as low.
True
14. Proper internal control over the inventory account would require that inventory items should be
reviewed for obsolescence and proper accounting treatment.
True
15. Many frauds are committed by overstating inventory accounts.
True
16. Sources of information regarding a client's inventory obsolescence can be partially noted during the
inventory observation.
True
17. One reason for observing inventory is to determine the accuracy of client counting procedures.
True
18. Test counts are performed by the auditor only when it is not possible for the auditor to observe the
client taking a physical inventory.
False
19. It is likely in the acquisition and payment cycle that audit evidence from substantive analytical
procedures alone will be sufficient for the auditor.
False
20. Legal expenses are reviewed by auditors for possible litigation that would require recording or
disclosure.
True
21. A walkthrough is typically not a useful means of obtaining information about controls in the
acquisition and payment cycle.
False
22. The cash account is not part of the acquisition and payment cycle.
False
23. Auditors observe the client taking physical inventory at year-end primarily to obtain assurance about
the value of inventory.
False
24. The acquisition cycle begins with the receipt of goods and services and ends with their payment as
reflected in cash disbursements.
False
25. Prenumbered receiving documents establish the completeness of the population and are useful in
determining that all goods are recorded in the correct period.
True
26. The tracing of a sample of receiving reports through the recording process tests the completeness
assertion.
True
27. Substantive tests of accounts payable and related expense accounts for valuation usually involve
simply verifying the mathematical accuracy of the accounts and agreeing them to general ledger and
supporting documentation.
True
Exam 3 Practice Questions

28. In observing the client’s inventory at year-end, the auditor makes test counts that are later traced into
the client’s inventory compilation.
True
29. Stable relationships are expected between specific accounts (for example, cost of goods sold and
sales) that can be investigated for unusual discrepancies.
True
30. Which of the following activities is not included in the acquisition and payment cycle?
C. Application of cash receipts.
31. Which of the following accounts is not a major account in the acquisition and payment cycle?
D. All of the above are major accounts.
32. Which of the following is a significant risk related to purchasing?
C. Purchasing agents may enter into kickbacks arrangements with vendors.
33. When a purchasing agent benefits personally by accepting payment from a vendor, the purchasing
agent is guilty of which of the following?
B. Receiving kickbacks.
34. Reducing the risk of understated payables can be accomplished by focusing on which assertion?
D. Completeness.
35. Which of the following is not a management assertion relevant to inventory?
D. Accuracy.
36. Which of the following is not an indicator of fraud in the acquisition and payment cycle?
A. Excess inventory because of a production slowdown.
37. The internal control that requires that “checks are pre-numbered and accounted for” satisfies which
assertion?
B. Completeness.
38. Which of the following would meet the need for additional control procedures when using computer-
generated purchase orders?
D. Establishment of maximum quantity limits that can be ordered within a given time
period.
39. Which of the following signals a potential fraud that may cause the overstatement of inventory
accounts?
C. Inventory amounts are growing faster than sales.
40. Accounting for inventories is a major consideration for many companies because of its significance to
which of the following financial statements?
D. Both A and B. (Balance sheet and Income statement).
41. Which of the following is a major factor in management's ability to overvalue inventory without rapid
detection by auditors?
B. Complexity in the valuation of inventory.
42. Which of the following is an example of the type of analytical procedures that an auditor would use
for inventory?
C. Inventory turnover for the previous five years.
43. Which relationship might suggest a heightened risk of fraud in the acquisition and payment cycle?
A. Unexpected increases in the number of suppliers.
44. During your audit of Brown Company you are trying to determine whether all accounts payable were
recorded. Which assertion are you gathering evidence for?
A. Completeness.
45. Which of the following procedures would the auditor perform in testing the completeness assertion
for accounts payable?
A. Examine a sample of cash disbursements made after year-end to determine whether
the disbursements were for goods acquired in the previous year.
46. Why should the client’s legal expenses be examined?
A. To determine if there is any litigation pending or threatened.
Exam 3 Practice Questions

47. Which assertion has the greatest emphasis when auditing accounts payable?
A. Completeness.
48. An auditor may best test commissions expense for salespeople when control risk is low by
performing which of the following procedures?
A. Analytical procedures.
49. Which of the following is a required disclosure for inventory?
A. Inventory valuation method used (FIFO, LIFO, moving average) and percentage of
inventory valued under each method.
50. A primary feature of automated control in the acquisition cycle includes which of the following?
C. Calculated order quantities based on set criteria.
51. Bar code scanning may best be utilized in the receiving process to accomplish which of the
following?
C. Match incoming goods with purchase orders.
52. When auditing expense accounts, which of the following would the auditor be least likely to subject
to a detailed test of transactions?
C. Utilities expense.
53. Identify the proper sequence of the acquisition and payment cycle:
1. Approval of items for payment.
2. Authorized requisition for goods or services.
3. Cash disbursements.
4. Receipt of goods and services.
5. Authorized purchase of goods or services.
A. 2, 5, 4, 1, 3
54. Which one of the following accounts would an auditor most likely test by performing analytical
procedures?
D. Sales commission expense.
55. Which of the following is NOT a reason why inventory is a complex accounting and auditing area?
B. Low volume of activity.
56. Which of the following might an auditor do in testing for the existence of accounts payable?
B. Perform a cutoff test of purchases and cash disbursements.
57. Which of the following is not an inherent risk associated with inventory?
B. Inventory costing methods frequently change from one year to the next.
58. Which of the following is not an element of internal control for inventory?
C. Rapid introduction of new products without market studies.
59. Which of the following would the auditor most likely do when testing the existence assertion for
inventory?
A. Observe the client’s count of the annual physical inventory and perform test counts.
60. Which of the following would the auditor most likely do when testing the valuation assertion for
inventory?
D. Vouch inventory purchases to vendor invoices.
61. The auditor may discover that the recorded cost of inventory exceeds the designated market price
when testing which assertion?
B. Valuation.
62. Which of the following procedures will usually be performed by the auditor to determine if obsolete
inventory exists?
D. Analysis of inventory turnover and sales reports.
63. A perpetual inventory system is preferable to a periodic system if adequately controlled and
maintained because of which of the following?
A. It provides information to management where book inventory is continuously in agreement
with inventory on hand within specified time periods.
Exam 3 Practice Questions

64. Which of the following is not a procedure that the auditor should perform related to the physical
inventory count?
B. Make counts of all items and record the counts for subsequent tracing into the client’s
inventory compilation.
65. The principle of lower of cost or market and the potential obsolescence of inventory are concerns for
the audit team because of which of the following?
B. They are an inherent component of complexity related to valuation.
66. An auditor reviews purchase contracts to assess the conditions for the return of merchandise as a test
related to which management assertion?
B. Rights and obligations.
67. Which of the following is not an item reviewed by the auditor to test the client’s assertion related to
the presentation and disclosure of inventory?
A. the amount of obsolete inventory on hand.
68. Which of the following is a procedure used in an audit where there is a heightened risk of fraud
related to accounts payable and other related expense accounts?
D. All of these.
69. When testing a standard cost system, the auditor does not normally make which of the following
inquiries?
D. The method for identifying sales cutoff.
70. The acquisition cycle begins with which of the following?
C. A requisition.
71. Which of the following is not a potential fraud indicator in the acquisition and payment cycle?
A. Expense accounts that have significant debit entries.
72. Which of the following is not a standard procedure that the auditor normally should follow in the
observation of inventory at year-end?
B. Review disclosure of inventory valuation.
73. Which of the following is a condition which would not create a conducive situation for a client to take
a physical inventory at an interim date before year-end?
C. The control risk over inventory is high.
74. Which of the following activities is not an activity associated with the acquisition and payment cycle?
D. Receive a customer purchase order.
75. Which of the following tasks will an automated purchasing system perform?
D. All of these.
76. Which of the following is a common inherent risk relating to accounts payable and related expenses?
C. Because of debt covenants requiring that the client maintain a certain level of the
current ratio, management may prefer to understate accounts payable.
77. Which of the following is not an inherent risk relating to inventory?
D. Sales contracts may contain unusual terms, and revenue recognition is often complex.
78. Which of the following is an example of fraud in the acquisition and payment cycle?
D. All of these.
79. Refer to Exhibit 11.2 to identify the possible inventory or cost of goods sold manipulation that might
occur when inventory is sold.
C. Not record cost of goods sold nor reduce inventory.
80. Refer to Exhibit 11.3 to identify which of the following is a typical control associated with the
requisition process for inventory purchases in a just-in-time manufacturing process.
B. An agreement is signed with the supplier whereby the supplier agrees to ship
merchandise according to the production schedule set by the manufacturer.
81. Which of the following controls is related to the payment of inventory purchases?
C. A three-way match.
Exam 3 Practice Questions

82. Which of the following expected relationships is reasonable in terms of performing planning
analytical procedures in the acquisition and payment cycle?
B. Assume that the company has introduced a new product with a low price point and
significant customer demand. Inventory turnover is expected to increase and days’ sales in inventory
is expected to decrease.
83. Which of the following planning analytical relationships is most typically suggestive of a heightened
risk of fraud in the acquisition and payment cycle?
B. Unexpected increases in gross margin.

84. Which mix of evidence would be most appropriate for the following scenario?
Assume a client where the auditor has assessed the risk of material misstatement related to
the existence of inventory as high. This client has incentives to overstate income to achieve profit
targets that affect management bonuses. Oversight of the vice president of finance is relatively weak
because of a lack of supervision by top management. Other controls are effectively designed.
B. 50% tests of details, 30% analytics, 20% tests of controls.
85. Which mix of evidence would be most appropriate for the following scenario?
Assume a client where the auditor has assessed the risk of material misstatement related to
the existence of inventory as low. Top management appears to have a high level of integrity.
Management has spent the resources necessary to ensure effective design, implementation, and
operation of controls.
D. 20% tests of details, 40% substantive analytics, 40% tests of controls.
86. Which of the following statements is false regarding obtaining evidence about internal control
operating effectiveness in the acquisition and payment cycle?
B. Evidence of proper payment is not necessary for each purchase and payment, but it only
necessary for those that are material.
87. Refer to the Why It Matters feature "Inventory Controls at Flow International Corporation." Which of
the following represents an implication of weaknesses in the company's controls over inventory?
C. The Company could not adequately process and account for the valuation of inventory
and the company developed a plan to remediate its material weaknesses related to inventory.
88. Which of the following audit procedures would an auditor use to test the existence assertion for
inventory?
A. Review the client’s proposed physical inventory procedures to determine whether they
are likely to result in a complete and correct physical inventory.
89. Which of the following audit procedures would an auditor use to test the valuation or allocation
assertion for inventory?
D. All of these.
90. The existence and presentation/disclosure assertions are usually the most relevant for inventory.
False
91. The most common concerns for inventory are that purchases are understated or ending inventory is
overstated, both of which will result in lower cost of goods sold and higher net income.
True
92. One of the common ways that managers have committed fraud in the acquisition and payment cycle
involves inappropriately classifying assets (e.g., inventory) as expenses.
False
93. Because a purchase order is an external document, its level of reliability is higher than that of a
requisition, which is an internal document.
False
Exam 3 Practice Questions

94. In terms of planning analytical procedures, assume that the client has introduced a new product with a
low price point and significant customer demand. The auditor would expect inventory turnover to
increase and days' sales in inventory to also increase.
False
95. A planning analytical procedure in the acquisition and payment cycle that might indicate fraud is that
inventory is growing at a rate greater than sales.
True
96. When conducting the audit of the acquisition and payment cycle for a client with a high risk of
material misstatement in its inventory accounts, the following mix of evidence would be appropriate:
significant tests of internal control, significant reliance on substantive analytical procedures, and
limited tests of details.
False
97. When considering the appropriate mix of evidence, the sufficiency and appropriateness of selected
procedures vary across inventory assertions to achieve the desired level of assurance for each relevant
assertion.
True
98. When selecting controls to test and performing tests of controls in the acquisition and payment cycle,
the auditor might reasonably take a sample of receiving reports and trace them through the system to
test controls related to the completeness assertion for inventory and accounts payable.
True
99. When conducting the audit of acquisition and payment cycle accounts, the auditor will likely conduct
less substantive tests for companies with effective internal controls than for companies with
ineffective internal controls.
True
100. A substantive procedure appropriate for testing the existence of inventory would be to perform
year-end cutoff tests by noting the last shipping and receiving document numbers used before the
physical inventory count is taken.
False