Some examples of how students should answer qualitative questions.

7.41

Procedure How Used (examples) Assertion(s) Tested

Observation Observe client personnel taking a Completeness, Existence,

physical inventory. Valuation
Physical Physically exam selected inventory Existence, Valuation
Inspection items.
Inquiry Ask whether there is any inventory
1. in on consignment, 1. Rights
2. out on consignment or stored in
public warehouses, 2. Completeness
3. that is obsolete or slow moving. 3. Valuation
Confirmation Confirm inventory out on Existence, Completeness,
consignment or in a public Valuation, Rights
warehouse.
Inspection of Analyze sales/purchase contracts for Valuation, Existence,
Documents any special terms. Completeness
Recalculation Recalculate quantity times unit cost Valuation
and foot the file.
Reprocessing Select receiving documents near year Completeness
end and trace to inventory records
Vouching Trace a sample of inventory costs to Valuation, Rights
vendor invoices.
Analytical Calculate inventory turnover and Valuation
Procedures number of day’s sales in inventory.
7.42

a. Assertion b. Most Persuasive Source of Evidence

Tested
1. Existence and Confirming with the business organization under the assumptions
valuation of that
receivables  The business organization has an information system that
provides a better basis to ensure a knowledgeable response.

 The business is familiar with making such responses and

recognizes that it is part of business.

 The business generally is free from bias in making the

response, which comes from the accounts payable department
not from management.

The above conditions are usually true, but it should be recognized

that they may not hold true across all businesses and thus it is a
mistake to assume that business confirmations are always more
reliable.
(2) Valuation of Inventory turnover and sales analysis by product line are more
inventory reliable because visual inspection of electronic products yields
little information either operationally or functionally, about the
status of the product. The auditor needs sales data to better
determine whether a product can be sold at existing sales prices
for the quantities on hand.

Existence of Visual inspection provides direct evidence of the existence of the

inventory inventory whereas the analytical procedures provide only indirect
evidence.
(3). Existence of Observing the counting of the client's inventory is more persuasive
inventory because (a) the auditor obtains the information directly (including
procedures utilized to gain assurance that inventory owned by the
client is counted) and (b) although the warehouse is independent,
there have been questions about the conscientiousness with
which they respond to such requests. In addition, some
warehouses do not have strong control structures set up whereby
they could easily respond to such requests.

(4). Existence Directly receiving a cut-off bank statement from the bank is the
and valuation most persuasive because it contains information such as canceled
of the cash checks for verifying the client's year-end account balance
account
Most auditors also confirm the year-end balance with the financial
institution because they seek information regarding bank loans to
the client and other contingent liabilities. But if the objective is to
test the existence and valuation of cash, the bank cut-off
a. Assertion b. Most Persuasive Source of Evidence
Tested
statement provides the most persuasive evidence.

(5). Existence of Physically examining the sheet metal is more persuasive because it
inventory is easier to identify, the quality is usually stamped directly on the
metal, and there generally are no major obsolescence problems
with sheet metal. The opposite of each item applies to the
examination of sophisticated electronics equipment.

(6). Existence of Confirmation of the year-end bank balance is more persuasive.

cash versus the First, a factual determination of the actual balance can be made.
completeness Second, the bank is an independent party with strong controls
of a contingent and regulation aimed at not misstating a client balance. On the
liability other hand, although the outside legal counsel is independent, it
is a client advocate and therefore its estimates may be affected by
its optimism in effectively presenting the client's case. Estimates
received from outside attorneys are more likely to reflect
minimum losses than expected losses.

(7). Existence It is not clear which is more persuasive. The first approach can be
and valuation persuasive if it included a step to independently determine that
of the liability the data entered into the client's spreadsheet is accurate and that
account the model had proved to be a good predictor of the actual
warranty liability over a period of time. However, information that
these two assumptions hold is not presented, and barring those
assumptions, the second approach appears to be more persuasive.
The second choice implies that the auditor independently gathered
reliable data and tested the accuracy of the estimate over time and
within the statistical parameters allowed by regression analysis.

(8). Requesting vendor statements is the most persuasive if the auditor

Completeness has sufficient information to ensure that all major vendors are
of the contacted, assuming that most vendors respond to the auditor's
recording of request.
accounts
payable Most auditors use the first approach (examining open items and a
sample of payments after year-end), which provides persuasive
evidence if the client pays its bills on a regular and timely basis
and has sufficient controls to ensure that all bills are identified for
payment and if management is not motivated to understate
accounts payable because of financial difficulty.

(9). The testing of the client's procedures is probably the most

Completeness persuasive because (a) an independent department investigates
of a liability and resolves all customer inquiries, and (b) strong regulatory
(savings controls ensure that the accounting systems to record savings
 a. Assertion b. Most Persuasive Source of Evidence
Tested
deposit is a deposits are strong. On the other hand, research has shown that
liability of the individual customers do not do a good job (as measured by the
financial accuracy of their responses) in confirming their savings or checking
institution balances. This observation holds because the customers (a) must
although it is first complete a bank reconciliation to accurately respond (b) have
an asset for the come in many cases to rely on the accuracy of the bank and do not
client) have their own independent recording system; and (c) have a
natural bias not to report overstatements but to report
understatements.

(10). Existence The auditor is confirming an asset account in this situation versus
and valuation confirming a liability in (9). The confirmation with the borrower is
the more persuasive evidence because it tells the auditor
something about the customer's current acknowledgment of the
debt.

10.57 a

The change in the sales commission is very important because the company has shifted
away from the previous policy. Now, the emphasis (the importance) is focussed on them
(the sales agent) in making sales with little regard for credit, quality or other issues which
may affect the long term profitability of the company in the long term. Specifically, the
changes

 Do not take into account the sales returns as an important compensation factor
 Net realizable value may be affected as the sales commissions do not take into
account whether the ability of the customer to pay
 There is no penalty for selling poor quality products. The sales commissions are
granted even if the product quality is poor.

Hence, there is a need for the auditor to increase and exercise his or her professional
scepticism related to sales. Thus, the auditor needs to carefully review sales returns,
allowances and cash collections after year end. Subsequently, this must then be
compared to with the previous or prior years. In addition, the allowance for doubtful
accounts balance will likely to have higher percent of receivables as compared to prior
years. Hence, the auditor needs to be sure that the allowance appears to be reasonable
in light of the sales may be warranted to the less credit worthy customers.
11.56
Deficiency
Override of Purchase Authorisation System
1. Unauthorised vendors; some may be
fictitious, unauthorised prices,
inferior product
2. Accounts affected are as follows:
Sales returns
Poor quality product – example
increased returns
Inventory – valuation
Inventory pricing greater than
authorised prices
Returned Merchandised not recorded
1. This may cause an improper
valuation in terms of obsolescence
and maintenance of proper and
updated records (see page 617)
2. Accounts affected
Loss on write downs of inventory
Inventory – valuation
Accounts Receivable
Planning Substantive test
1. Increase sampling to examine
subsequent sales returns.
2. To carry out an independent
expectation or estimation model of
inventory write offs – in the case of
inferior products.
3. To carry out stock count or stock take
very near or close to the financial
year end of the company.
4. Substantive Analytical Procedures;
- An analysis of prices paid for all
new vendors, to compare with
market value and previous prices
for the goods
1. Auditor should expand the inventory
stock take near or close to the
financial year end.
2. In addition, there is a need to expand
the confirmation letters send to the
account receivables (larger sampling
size)
3. A review of credit memos issued
subsequent to year end. Why credit
memo??? This is because credit
memo documents the return of the
sales from the customers, thus the
company must credit its accounts
receivables
11.57
Controls – Preventive Measures
Company’s Policies and Procedures
1. Periodic rotation
2. Policy of requiring more than one
supplier for major products
3. Dismissal of employees involved in
kickback scheme.
4. Periodic internal audit of the
purchase function
5. Hiring policies – human resource
6. Long term contracts should be
reviewed by management
Audit Procedures
- Inquire management in terms of
procedures to monitor purchasing
activity to minimize the possibility of
kickback schemes
- If auditor has knowledge of the “lavish
lifestyle” by particular purchasing agents,
the auditor should obtain a schedule of
products which the purchasing
employees are responsible. The products
purchased should be scheduled and
investigated for price increases and the
increased in terms of concentration of
purchases from specific
vendors/suppliers (An example of an AP)
- Thus, the above procedures must be
followed by inquiring the purchasing
employees for the explanation of the
situation above.
- However, if fraud is suspected, there is a
need to increase the level of professional
scepticism by obtaining quoted prices
from selected products from
independent, authorised supplier/
vendor. Determine if differences exist.