Audit Evidence and Audit Program by Konrath

Audit Evidence and Audit Programs
MULTIPLE CHOICE:
1. The permanent file section of the working papers that is kept for each audit
client most likely contains
a. Review notes pertaining to questions and comments regarding the audit work
performed.
b. A schedule of time spent on the engagement by each individual auditor.
c. Correspondence with the client's legal counsel concerning pending
litigation.
d. Narrative descriptions of the client's internal control policies and
procedures
ANSWER: D
2. Of the following procedures, which is not considered part of “obtaining an understanding

of the client’s environment?”
a. Examining trade publications to gain a better understanding of the client's
industry.
b. Confirming customer accounts receivable for existence and valuation.
c. Touring the client's manufacturing and warehousing
facilities to gain a clearer understanding of
operations.
d. Studying the internal controls over cash receipts and disbursements.
ANSWER: B
3. If working papers are to have the characteristics that will ensure that they
achieve their primary purposes, which of the following is the most important?
a. Working papers must be of standard format and standard content.
b. Working papers must be properly indexed and cross- referenced to
the draft audit report.
c. Working papers must provide sufficient, competent, and useful
information to support the audit report. d. Working papers must be arranged in
logical order following the audit program sequence.
ANSWER: C
4. Which of the following is not an example of analytical evidence?

a. Compared inventory turnover by major class with the prior year on a monthly and
quarterly basis.
b. Compared gross profit percentages by major product classes with the prior year.
c. Examined invoices for plant asset additions to determine whether the client had
erroneously recorded ordinary repairs as plant assets.
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Chapter 4 Audit Evidence and Audit Programs
37
d. Examined monthly performance reports and investigated significant variations
from budgeted amounts.
ANSWER: C
5. Choose the best illustration of objective audit evidence from the following
a. The paid invoice file containing invoices matched with receiving reports and
purchase orders.
b. Management's assertion that payment procedures require matching of invoice
with receiving report and purchase order. c.
Clerical staff assurances that management policy regarding payment of
invoices--matching of invoice with receiving report and purchase order--is always
followed.
d. The treasurer's statement of not remembering any exceptions in
which an invoice was submitted for payment that was not accompanied by a
matching receiving report and purchase order.
ANSWER: A
6. An initial (first-time) audit requires more audit time to complete than a recurring audit.
One of the reasons for this is that
a. New auditors are usually assigned to an initial audit.
b. Predecessor auditors need to be consulted.
c. The client's business, industry, and internal control are unfamiliar to the auditor
and need to be carefully studied.
d. A larger proportion of customer accounts receivable need to be confirmed on an
initial audit.
ANSWER: C
7. Which of the following is a basic tool used by the auditor to control the audit work
and review the progress of the audit?
a. Time and expense summary.
b. Engagement letter.
c. Progress flowchart.
d. Audit program.
ANSWER: D
8. An auditor wants to develop an audit test to evaluate the reasonableness of the

quantity of scrap material resulting from a certain production process compared to
industry standards. Which would be the most competent type of
evidence available to satisfy this objective?
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a. Documentary. b. Hearsay.
c. Physical. d. Analytical.
ANSWER: D
9. As part of audit planning, CPAs should design audit programs for each individual
audit and should include audit steps and procedures to
a. Detect and eliminate fraud.
b. Increase the amount of management information available.
c. Provide assurances that the objectives of the audit are met.
d. Ensure that only material items are audited.
ANSWER: C
10. Of the following audit procedures, which best supports the valuation objective?
a. Performing a lower of cost or market test of the client's inventories.
b. Reviewing a contingent liability footnote for proper
wording.
c. Searching for unrecorded liabilities.
d. Observing the client's year-end physical inventory taking.
ANSWER: A
11. An assumption underlying analytical procedures is that

a. These procedures cannot replace tests of balances and transactions.
b. Statistical tests of financial information may lead to the discovery
of material errors in the financial statements.
c. The study of financial ratios is an acceptable alternative to the
investigation of unusual fluctuations.
d. Relationships among data may reasonably be expected to exist and continue in
the absence of known conditions to the contrary.
ANSWER: D
12. An auditor is examining accounts receivable. What is the most competent type
of evidence in this situation?
a. Interviewing the personnel who record accounts receivable.
b. Verifying that postings to the receivable account from journals have
been made.
c. Receipt by the auditor of a positive confirmation. d. No response
received for a request for a negative confirmation.
ANSWER: C
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13. With respect to the auditor's planning of a year-end examination, which of the
following statements is always true?
a. An engagement should not be accepted after the fiscal year-end.
b. An inventory count must be observed at the balance sheet date.
c. The client's audit committee should not be told of the specific audit
procedures that will be performed. d. It is an acceptable practice to carry out
substantial parts of the examination at interim dates.
ANSWER: D
14. A letter to the auditor in response to an inquiry is an example of

a. Physical evidence.
b. Confirmation evidence.
c. Documentary evidence.
d. Analytical evidence.
ANSWER: B
15. Which of the following statements about working papers is correct?

a. Working papers are not permitted to be used as a reference source by the
client.
b. The auditor should document the understanding of the client's internal control
obtained to plan the audit
c. Working papers may be regarded as a substitute for the client's accounting
records.
d. When reporting on comparative financial statements, the independent auditor
may discard working papers after two years.
ANSWER: B
16. Which of the following factors is most important in determining the

competence of audit evidence?
a. The reliability of the evidence in meeting the audit objective.
b. The objectivity of the auditor gathering the evidence. c. The quantity
of the evidence obtained.
d. The independence of the source of evidence.
ANSWER: A
17. The procedures specifically outlined in an audit program are primarily designed to
a. Protect the auditor in the event of litigation. b. Detect errors or fraud.
c. Test internal evidence.
d. Gather evidence.
ANSWER: D
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18. When reviewing audit working papers, the primary responsibility

of an audit supervisor is to determine that:
a. Each worksheet is properly identified with a descriptive heading.
b. Working papers are properly referenced and kept in logical groupings.
c. Standard departmental procedures are adhered to with regard to work paper
preparation and technique. d. Working papers adequately support the audit
findings, conclusions, and report.
ANSWER: D
19. Auditors apply analytical procedures to the client's

operations in order to identify
a. Improper separation of accounting and other financial duties.
b. Weaknesses of a material nature in the client's
internal control.
c. Unusual transactions.
d. Noncompliance with prescribed control procedures.
ANSWER: C
20. Which of the following workpapers would one normally expect to find in the permanent
file?
a. A copy of a long-term bond indenture.
b. The working trial balance.
c. An analysis of additions and disposals relating to marketable securities.
d. A workpaper analyzing customer replies to confirmation requests.
ANSWER: A
21. The in-charge auditor decides that work papers are complete
a. When satisfied that the audit objectives have been met and the
working papers support the conclusions. b. When working papers make
reference to the steps outlined in the audit program.
c. Only after the auditor who prepared the working papers has signed and dated
them.
d. When proper cross-references to other working papers are noted.
ANSWER: A
22. Of the following procedures, which does not produce analytical evidence?
a. Compare revenue, cost of sales, and gross profit with the prior year and
investigate significant variations.
b. Examine monthly performance reports and investigate significant revenue and
expense variances.
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c. Confirm customers' accounts receivable and clear all material exceptions.
d. Compare sales trends and profit margins with industry averages and investigate
significant differences.
ANSWER: C
23. Audit evidence can come in different forms with different degrees of
persuasiveness. Which of the following is the least persuasive type of evidence?
a. Documents mailed by outsiders to the auditor. b.
Correspondence between the auditor and vendors. c. Sales invoices
inspected by the auditor.
d. Computations made by the auditor.
ANSWER: C
24. Analytical procedures are

a. Substantive tests designed to evaluate a system of internal control.
b. Tests of control procedures designed to evaluate the validity of
management's representation letter. c. Substantive tests designed to evaluate the
reasonableness of financial information.
d. Tests of control procedures designed to detect errors in reported financial
information.
ANSWER: C
25. Which of the following statements relating to the

competence of evidential matter is always true?
a. Evidential matter gathered by an auditor from
outside an enterprise is reliable.
b. Accounting data developed under satisfactory conditions of internal control are
more relevant than data developed under unsatisfactory internal control
conditions. c. Oral representations made by
management are not valid evidence. d. Evidence
gathered by auditors must be both valid and relevant to be considered competent.
ANSWER: D
26. An auditor test counted a batch of inventory. This is an example of what kind
of evidence?
a. Analytical. b. Documentary.
c. Physical. d. Hearsay.
ANSWER: C
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27. In evaluating the reasonableness of advertising expense, which of the
following would be the best evidence?
a. Oral evidence obtained through discussions with company marketing executives
and representatives of the advertising agency retained.
b. Documentary evidence obtained by vouching charges to the account
and by retracing charges from source documents to the account.
c. Analytical evidence developed by comparing the ratio of
advertising expenses to sales with historical data for
the company and industry.
d. Arithmetical evidence developed by re-computing charges submitted by
the advertising agency and paid by the company.
ANSWER: C
28. Which of the following is not a consideration in the development of audit programs?
a. Internal control over the recording of plant asset additions and repairs and
maintenance expenditures is found to be weak.
b. The client constructed a major addition to its central manufacturing facility
during the year under audit.
c. The client is a private university located in the Midwest.
d. The client's board or directors is elected by the
stockholders at the annual meeting.
ANSWER: D
29. Audit working papers are used to record the results of the auditor's evidence-
gathering procedures. When preparing working papers, the auditor should remember
that working papers should be
a. Kept on the client's premises so that the client can have access to them for
reference purposes.
b. The primary support for the financial statements being examined.
c. Considered as a part of the client's accounting records that are retained by the
auditor.
d. Designed to meet the circumstances and the auditor's needs on each
engagement.
ANSWER: D
30. The main advantage of properly indexed working papers is to

a. Reduce the size of the file.
b. Better organize the working papers.
c. Allow division of labor within the audit team. d. Facilitate the efficient
use of audit staff.
ANSWER: B
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31. Which of the following is not a typical analytical procedure?

a. Study of relationships of financial information with relevant nonfinancial
information.
b. Comparison of financial information with similar information regarding
the industry in which the entity operates. c.
Comparison of recorded amounts of major disbursements with
appropriate invoices.
d. Comparison of recorded amounts of major disbursements with budgeted
amounts.
ANSWER: C
32. Which of the following is an example of inferential evidence?

a. The auditor observes the taking of the client's physical inventory and performs
test counts.
b. The auditor inspects marketable securities for
existence.
c. An auditor, who notes that customer accounts receivable have increased
significantly in the current year as a percentage of sales, suspects that a larger
proportion of the accounts will prove uncollectible.
d. The auditor counts cash on hand at year-end.
ANSWER: C
33. Which of the following would be least likely to be comparable between

similar corporations in the same industry line of business?
a. Earnings per share.
b. Return on total assets before interest and taxes. c. Accounts receivable
turnover.
d. Operating cycle.
ANSWER: A
34. Which of the following is not an example of confirmation evidence?

a. Requesting the client's outside legal counsel to evaluate the possible outcome of
pending litigation.
b. Questioning the client's employees about existing internal control policies and
procedures.
c. Requesting the client's customers to verify year-end accounts receivable balances.
d. Requesting payees to respond in writing to the terms contained in notes payable
appearing in the client's ledger.
ANSWER: B
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35. A CPA, in performing an independent audit, would most likely use recalculation as a
substantive test for which of the following expense-related accounts?
a. Purchases of supplies.
b. Interest expense.
c. Advertising expense.
d. Repairs and maintenance expense.
ANSWER: B
36. During the course of an audit engagement, an auditor prepares and

accumulates audit working papers. The primary
purpose of the audit working papers is to
a. Aid the auditor in adequately planning his work. b. Provide a
point of reference for future audit engagements.
c. Support the underlying concepts included in the preparation of
the basic financial statements. d. Support the auditor's opinion.
ANSWER: D
37. Which of the following is not an appropriate auditing procedure supporting fairness of
financial presentation?
a. Inspecting plant asset additions for existence.
b. Recalculating accrued interest on notes payable.
c. Examining invoices in support of legal fees recorded during the fiscal year.
d. Reviewing the client's production quality control program.
ANSWER: D
38. Sales commissions as a percentage of sales declined

significantly during the year under audit. Of the following possible causes, the most
likely is
a. Sales increased during the year.
b. The sales force was reduced at the end of the year.
c. Sales commission rates were increased at the beginning of the year.
d. Fictitious sales were recorded at year-end to inflate earnings. Commissions were
not recorded on these
sales.
ANSWER: D
39. Which of the following is responsible for the fairness of the representations
made in financial statements?
a. Client's management.
b. Independent auditor.
c. Audit committee.
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d. AICPA.
ANSWER: A
40. An audit program provides proof that

a. Sufficient competent evidential matter was obtained. b. The work was
adequately planned.
c. There was compliance with generally accepted standards
of reporting.
d. There was a proper study and evaluation of internal control.
ANSWER: B
41. Which of the following ultimately determines the specific

audit procedures necessary to provide an independent
auditor with a reasonable basis for the expression of an opinion?
a. The audit program.
b. The auditor's judgment.
c. Generally accepted auditing standards.
d. The auditor's working papers.
ANSWER: B
42. During the working paper review, an audit supervisor finds that the
auditor's reported findings are not adequately cross-referenced to supporting
documentation. The supervisor will most likely instruct the auditor to
a. Prepare a working paper to indicate that the full scope of the audit was carried
out.
b. Familiarize him/herself with the sequence of working papers so that he(she)
will be able to answer questions about the conclusions stated in the report.
c. Eliminate any cross-references to other working papers
since the system is unclear.
d. Provide a workpaper indexing system that shows the relationship between
findings, conclusions, and the related facts.
ANSWER: D
43. Which of the following would be the most relevant form of evidence to evaluate
the reasonableness of account balances?
a. Analytical. b. Documentary.
c. Physical. d. Hearsay.
ANSWER: A
44. Generally, what source of evidence should most impact audit conclusions?
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a. External b. Inquiry.
c. Oral. d. Informal.
ANSWER: A
45. Most of the independent auditor's work in formulating an opinion on the

financial statements consists of
a. Studying and evaluating internal control.
b. Obtaining and examining evidential matter.
c. Examining cash transactions.
d. Comparing recorded accountability with assets.
ANSWER: B
46. During an audit of the accounts receivable function, you found that the
accounts receivable turnover rate had fallen from 7.3 to 4.3 over the last three years. What is
the most likely cause of the decrease in the turnover rate?
a. An increase in the discount offered for early payment. b. A more liberal credit
policy.
c. A change from net 30 to net 25.
d. Greater cash sales.
ANSWER: B
47. Which of the following is generally included or shown in the auditor's working
papers?
a. The procedures used by the auditor to verify the personal financial status of
members of the client's management team.
b. Analyses that are designed to be a part of, or a substitute for, the client's
accounting records. c. Excerpts from authoritative pronouncements that support
the underlying generally accepted accounting principles used in preparing the
financial statements.
d. The manner in which exceptions and unusual matters disclosed by the
auditor's procedures were resolved or treated.
ANSWER: D
48. To test for unsupported entries in the ledger, the direction of audit testing
should be from the
a. Ledger entries.
b. Journal entries.
c. Externally generated documents.
d. Original source documents.
ANSWER: A
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49. Which of the following does not describe one of the functions of
audit workpapers?
a. Facilitates third-party reviews.
b. Aids in the planning, performance, and review of audits.
c. Provides the principal evidential support for the auditor's report.
d. Aids in the professional development of the operating staff.
ANSWER: D
50. The principal reason for developing a written audit program is to help
assure that the
a. Audit work is properly supervised.
b. Audit work is properly planned and documented. c. Audit report contains
only significant findings. d. Work of different auditors is properly coordinated.
ANSWER: B
51. One of the primary roles of an audit program is to:

a. Serve as a tool for planning, directing, and controlling audit work.
b. Document an auditor's understanding of the internal control.
c. Provide for a standardized approach to the audit engagement.
d. Delineate the audit risk accepted by the auditor.
ANSWER: A
52. The principal purpose for cross-indexing audit working papers is to

a. Give the working papers a professional appearance. b. Explain the
use of tick marks.
c. Provide explanation of the audit steps performed. d. Provide a trail
for the auditor and the reviewer.
ANSWER: D
53. Audit information is generally considered relevant when it

is:
a. Derived through valid statistical sampling.
b. Objective and unbiased.
c. Factual, adequate, and convincing.
d. Consistent with the audit objectives.
ANSWER: D
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54. External auditors often confirm assertions contained in the organization's
financial statements and accounting records with third parties. Which of the following
best explains why confirmation produces evidence of high quality?
a. Written assertions from knowledgeable third parties provide
sufficient evidence to achieve most audit objectives.
b. Confirmation by knowledgeable third parties is usually the most
relevant evidence available.
c. Confirmation by knowledgeable third parties is usually the least costly
evidence available.
d. Confirmation by knowledgeable third parties is highly competent because of
its independent source.
ANSWER: D
55. As a category of evidence, documents may be external or internal. As an

auditor reviewing your client's accounts
receivable, which of the following is an example of internal documentary
evidence?
a. The carrier's bill of lading.
b. Sales invoice copies.
c. A customer's purchase order.
d. A vendor's month-end statement.
ANSWER: B
COMPLETION:
56. Audit programs can be developed only after the auditor has completed the audit
_______________ process.
ANSWER: PLANNING
57. An auditor who gathers increased quantities of evidence for larger account balances is
observing the standard relating to of audit evidence.
ANSWER: SUFFICIENCY
58. An auditor who gathers increased amounts of external evidence under conditions of weak
internal control is observing the standard of of audit evidence.
ANSWER: COMPETENCE (VALIDITY)
59. In performing substantive audit tests, focusing on the existence or occurrence objective
helps locate misstatements due to while the completeness objective directs audit
attention to misstatements due to .
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ANSWER: COMMISSION, OMISSION
60. Evidence consisting of everything that can be counted, examined, observed, or inspected
is referred to as _____________ evidence.
ANSWER: PHYSICAL
61. The audit trail consists of that stream of evidence that enables the auditor to trace a
transaction or event forward from its inception to the appropriate ledger account, or
conversely, vouch a transaction backward from the ledger
account to the inception of the transaction or event. For the audit trail to exist, transactions
must be .
ANSWER: DOCUMENTED
62. Analytical evidence may be the best form of evidence supporting the objective, in
that auditors' suspicions concerning errors of omission are often first aroused by the
application of analytical procedures.
ANSWER: COMPLETENESS
63. An auditor-prepared bank reconciliation is an example of _______________

evidence.
ANSWER: MATHEMATICAL
64. A group of related transactions affecting essentially the same set of general ledger
accounts is referred to as a _________________ .
ANSWER: TRANSACTION CYCLE
65. The focal point of the current file is the ____________ _______________
______________ often referred to as a table of contents.
ANSWER: WORKING TRIAL BALANCE
MATCHING:
66. For each of the listed auditing procedures, indicate, by letter, the type of evidence it
represents.
a. Physical evidence
b. Confirmation evidence
c. Documentary evidence
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d. Analytical evidence
e. Mathematical evidence
f. Hearsay evidence
____ 1. Audited client-prepared bank reconciliation
____ 2. Vouched debits to repairs accounts by examining vendors’ invoices
____ 3. Observed the client’s year-end physical inventory
____ 4. Compared accounts receivable turnover with industry

average
____ 5. Prepared ten-year income summary expressing all

components as a percentage of sales
____ 6. Obtained letter from client’s outside legal counsel

regarding pending litigation
____ 7. Inquired of corporate treasurer as to reason(s) for

acquiring marketable securities
____ 8. Calculated year-end interest accrual and compared

with general ledger balance
____ 9. Obtained replies directly from customers concerning

the correctness of client’s recorded year-end accounts receivable balances
____ 10.Examined securities purportedly owned by the client and held by local
brokers
____ 11.Compared operating cash flows with net income and

identified causes of significant disparities.
SOLUTION:
1. e
2. c
3. a
4. d
5. d
6. b
7. f
8. e
9. b
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10. a
11. d
67. For each of the listed procedures, indicate, by letter, the

assertion(s) being tested.
a. Existence or occurrence
b. Completeness
c. Rights and obligations
d. Valuation or allocation
e. Presentation and disclosure
____ 1. Confirmed customer accounts receivable
____ 2. Vouched property additions to underlying

documentation consisting of vendors’ invoices and
work orders
____ 3. Inquired of corporate treasurer as to reasons for

buying and holding securities
____ 4. Selected a sample of bills of lading representing

shipments to customers and traced to sales invoices
to determine that all shipments have been billed to
customers
____ 5. Examined vendors’ invoices recorded after year-end to

determine whether any of these invoices represent
liabilities of the client as of year-end
____ 6. Obtained confirmation of marketable securities from

client’s brokers
____ 7. Evaluated the reasonableness of the client’s

depreciation policy
____ 8. Obtained letter from client’s outside legal counsel

regarding pending litigation
____ 9. Inspected recorded addition to client materials

handling facilities
____ 10. Investigated decrease in revenue from scrap sales as

revealed by the application of analytical
procedures
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SOLUTION:
1. a,d
2. d
3. e
4. b
5. b,c
6. a,c,d
7. d
8. e
9. a
10. b
PROBLEM/ESSAY
68. For each of the following ledger accounts, give an example of substance underlying the
account balance:
1. Cash in bank
2. Sales revenue
3. Inventories
4. Accounts payable
5. Notes payable
6. Capital stock
7. Marketable securities
8. Operating expenses
9. Wages and salaries expense
10. Property, plant, and equipment
SOLUTION:
1. Bank statement, canceled checks, deposit tickets

2. Sales invoices, shipping documents, cash register tapes 3. Goods in
warehouses, goods out on consignment
4. Vendors’ records of accounts receivable, vendors’
invoices
5. Payees’ confirmation of amounts owed to them, copy of
note in client’s files
6. Records maintained by registrar and transfer agent
7. Securities in vault or in safekeeping, brokers’
advices, brokers’ confirmations
8. Vendors’ invoices, canceled checks, client’s
workpapers supporting such charges as depreciation,
amortization, and product warranty
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9. Payroll summaries, time cards, clock cards, canceled
checks, human resources records
10. Plant assets at various locations, vendors’ invoices
69. Audit evidence must be sufficient and competent. To be competent, the evidence must
be both valid and relevant.
Required:
a. What is meant by “sufficient audit evidence?”

b. Define the concepts of validity and relevance as they
relate to audit evidence.
SOLUTION:
a. Sufficient audit evidence is evidence that is adequate to support the auditor’s
opinion on the financial statements. A matter of audit judgment, sufficiency is usually based on
materiality and the adequacy of existing internal control.
b. Validity of audit evidence is a function of three qualities:
1) The independence and competence of the source of
the evidence (e.g., external evidence possesses
greater validity than internal evidence);
2) The conditions under which the evidence was
obtained (e.g., evidence produced by strong
internal control possesses greater validity
than evidence gathered under weak internal
control); and
3) The manner in which the evidence was obtained
(e.g., evidence obtained directly by the auditor
possesses greater validity than evidence obtained
indirectly).
Relevance means that the evidence pertains to specific audit
objectives. Observing the taking of the inventory, for example, provides evidence concerning
existence of the inventory, but is not relevant to determining ownership.
70. The following operating data has been provided to Erica Chavez by her audit client,
Grimes Hardware. Sales commissions
average 6 percent of sales:
2002 % 2003 % Change (%)
Sales $18,000 100% 22,000 100% 22%

Cost of sales 10,000 11,000
Sales commissions 1,080 1 100
Gross profit 6,920 9,900
Operating expenses 3,200 3,600
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Income before taxes 3,720 6,300
Income taxes 1,200 2,000
Net income $2,520 4,300
===== =====
Required:
a. Complete the vertical and horizontal analysis by calculating the correct percentages.
b. Why are both vertical and horizontal analysis important inputs to analytical
procedures?
c. Assuming sales commissions have been accurately

computed based on 2003 sales, what are the possible explanations for any abnormalities
produced by your percentage calculations?
SOLUTION:
a.
2002 % 2003 % Change (%)
Sales $18,000 100% 22,000 100% 22%

Cost of sales 10,000 56 11,000 50 10
Sales commissions 1,080 6 1,100 5 2
Gross profit 6,920 38 9,900 45 43
Operating expenses 3,200 17 3,600 16 13
Income before taxes 3,720 21 6,300 29 69
Income taxes 1,200 7 2,000 9 67
Net income $2,520 14 4,300 20 71
===== == ===== ==
b. Trend analysis (the “Change” column) examines changes in data over time. Given the
assumption that past trends may be expected to continue into the future, significant changes
warrant further investigation. Vertical analysis (the first two percentage columns), by expressing
all components as percentages of a common base (sales in this case), permits the auditors to
compare percentages with previously developed auditor expectations. If, for example, the
auditor has previously determined that commissions average 6% of sales, he/she may wish to
investigate the lower rate reflected in 2003 results.
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c. If sales commissions are accurate and represent 6 percent of sales, the sales base
must be overstated in order to produce a commission rate of only 5 percent. Sales may have
been fabricated, or 2004 sales may have been recorded in 2003. The material decline in cost of
sales as a percentage of sales suggests that recorded sales transactions were not accompanied by
cost of sales entries.
71. The following financial data have been extracted from the records of Blackwell
Wholesale Tires:
2003 2002
Sales $15,660 14,980

Ending inventory 6,200 4,300
Accounts receivable-trade 2,200 1,300
Total current assets 12,300 10,100
Total current liabilities 7,300 4,980
Customer payment terms:
2/10;n/30
Industry averages:
Gross margin 51%
Current ratio 2:1
Inventory turnover 2.5
Accounts receivable turnover 11.0
Required:
Based on the above data, in which areas do you recommend concentrating audit resources for the
2003 audit? Support your answer by citing the relevant data.
SOLUTION:
2003 2002
Sales $15,660 14,980

Gross margin 7,860 50% 5,580 49%
Inventory and accounts receivable appear to warrant emphasis for Blackwell Wholesale
Tires. Although the gross margin has not changed materially in 2003 relative to 2002 and
approximates the industry average for both years, inventory turnover has declined significantly
and is well below the industry average (1.25 v. 2.5). This suggests the possibility of inflated
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inventory quantities, incorrect inventory prices, obsolete inventory, or some combination of
these. Accounts receivable turnover for 2002 was approximately equal to the industry average;
but for 2003 turnover has declined to approximately 7 times versus 11 times for the industry.
Given payment terms of 2/10;n/30, one would expect a turnover between 11 and 12 times, or
approximately 30 days sales in accounts receivable. A turnover of 7 times equates with
approximately 50 days sales in accounts receivable. Failure to properly investigate customer
credit, or weak collection procedures, or inflated accounts receivable are possible explanations
for the decline in turnover. Although the current ratio appears adequate when compared with the
preceding year and with the industry average, the quick ratio (current assets minus inventory
divided by current liabilities) has declined from 1.16 in 2002 to .84 in 2003. This suggests a
short-term liquidity problem, especially if inventories are overstated and/or customer accounts
receivable are delinquent.
71. Identify the deficiencies in the following audit workpaper:
TRAMWAY ENTERPRISES
Bank Reconciliation
12/31/2003
Balance per bank $5,774 *

Add deposit in transit 1,223 &
6,997
Deduct outstanding checks:
4455 $67 &
4477 180 &

4478 1,023 &
4479 33 &
1,303
Adjusted balance $5,594
=====
57
Balance per ledger $6,300
Adjustment to correct (706)
Adjusted balance as above $5,594
======
SOLUTION:
1. Initials of preparer and reviewer and dates of

preparation and review are missing.
2. Name of bank account being reconciled is omitted.
3. Subtraction error. Adjusted balance should be $5,694
rather than $5,594.
4. Audit adjustment of $706 not explained.
5. Audit legends not explained.

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Audit Evidence and Audit Programs

2. Of the following procedures, which is not considered part of “obtaining an understanding

4. Which of the following is not an example of analytical evidence?

8. An auditor wants to develop an audit test to evaluate the reasonableness of the

11. An assumption underlying analytical procedures is that

14. A letter to the auditor in response to an inquiry is an example of

15. Which of the following statements about working papers is correct?

16. Which of the following factors is most important in determining the

18. When reviewing audit working papers, the primary responsibility

19. Auditors apply analytical procedures to the client's

24. Analytical procedures are

25. Which of the following statements relating to the

30. The main advantage of properly indexed working papers is to

31. Which of the following is not a typical analytical procedure?

32. Which of the following is an example of inferential evidence?

33. Which of the following would be least likely to be comparable between

34. Which of the following is not an example of confirmation evidence?

36. During the course of an audit engagement, an auditor prepares and

38. Sales commissions as a percentage of sales declined

40. An audit program provides proof that

41. Which of the following ultimately determines the specific

45. Most of the independent auditor's work in formulating an opinion on the

51. One of the primary roles of an audit program is to:

52. The principal purpose for cross-indexing audit working papers is to

53. Audit information is generally considered relevant when it

55. As a category of evidence, documents may be external or internal. As an

ANSWER: COMPETENCE (VALIDITY)

ANSWER: COMMISSION, OMISSION

63. An auditor-prepared bank reconciliation is an example of _______________

ANSWER: TRANSACTION CYCLE

ANSWER: WORKING TRIAL BALANCE

____ 1. Audited client-prepared bank reconciliation

____ 2. Vouched debits to repairs accounts by examining vendors’ invoices

____ 3. Observed the client’s year-end physical inventory

____ 4. Compared accounts receivable turnover with industry

____ 5. Prepared ten-year income summary expressing all

____ 6. Obtained letter from client’s outside legal counsel

____ 7. Inquired of corporate treasurer as to reason(s) for

____ 8. Calculated year-end interest accrual and compared

____ 9. Obtained replies directly from customers concerning

____ 11.Compared operating cash flows with net income and

67. For each of the listed procedures, indicate, by letter, the

____ 1. Confirmed customer accounts receivable

____ 2. Vouched property additions to underlying

____ 3. Inquired of corporate treasurer as to reasons for

____ 4. Selected a sample of bills of lading representing

____ 5. Examined vendors’ invoices recorded after year-end to

____ 6. Obtained confirmation of marketable securities from

____ 7. Evaluated the reasonableness of the client’s

____ 8. Obtained letter from client’s outside legal counsel

____ 9. Inspected recorded addition to client materials

____ 10. Investigated decrease in revenue from scrap sales as

1. Bank statement, canceled checks, deposit tickets

a. What is meant by “sufficient audit evidence?”

2002 % 2003 % Change (%)

Sales $18,000 100% 22,000 100% 22%

c. Assuming sales commissions have been accurately

2002 % 2003 % Change (%)

Sales $18,000 100% 22,000 100% 22%