(1)

In the brief description presented of Lakeside's inventory procurement system,

several specific control activities can be seen:
the company maintains a perpetual inventory which provides significantly greater
control than does a periodic system;
the case implies that the company uses preprinted forms so that adequate
information is captured whenever a document is prepared;
all purchase requisitions are reviewed and authorized before merchandise is
ordered;
incoming inventory is inspected for damage upon receipt;
all invoices are matched with the appropriate
receiving report before payment is approved;

purchase

requisition

and

prices of every invoice are verified; and

the mathematical accuracy of each invoice is checked prior to payment.
(2)
Canceled checks are the last document in this system, while receiving reports are
one of the first. Whenever auditors select a final document such as a canceled
check and search for its documentation, they are seeking to substantiate the
validity of the balance being reported. All forms and documents must be present to
prove that the amount and the company's reporting were both correct. Such testing
also seeks to discover whether false transactions have been entered into the
system. For example, if a canceled check is found without a corresponding receiving
report or purchase requisition, the possibility exists that money has been stolen
from the company; a payment was made for merchandise that was not ordered
nor received.
Taking a beginning document such as a receiving report and tracing the impact of
the transaction through an entire system is intended to provide evidence of
completeness and that the system and its controls are working as designed.
Obviously, such testing will also provide evidence as to the validity of the account
balance, but this particular procedure is more often associated with the
completeness assertion and internal control evaluation.
(3)
How might Lakeside pay for goods that were received? The company could, as an
example, receive an invoice and not properly match it with the corresponding
receiving report. The receiving report might state that 10 items were actually

acquired while the invoice was for 20 or 100. The individual doing the review may
not notice the discrepancy and erroneously approve the invoice. As another
possibility, this individual might authorize an incorrect invoice in order to receive a
kickback from the vendor.
How might Lakeside fail to pay for goods that were not received? If either the
receiving report or the invoice is lost, the documents will not match and payment
cannot be made. Thus, the company may wait indefinitely for the other (lost) form
before approving the cash disbursement.
(4)
Audit documentation, also called a working paper, is designed to demonstrate that
the auditor has obtained sufficient, competent evidence on which to base an
opinion as to the fair presentation of the client's financial statements. Given that
overall objective, the working paper indicates the testing that was performed and
the evidence that was accumulated. The working paper should also specify any
problems that were encountered and their resolution. The working paper must
demonstrate that this portion of the examination was properly planned and that all
assistants were adequately supervised. In addition, the audit documents as a whole
must indicate that internal control was studied and evaluated. All audit documents
are the property of the auditor and are maintained by the auditor in order to support
the opinion rendered by the auditor.
(5)
A CPA firm must establish policies and procedures for the supervision of work at all
organizational levels to provide reasonable assurance that the examination
conforms to generally accepted auditing standards. Procedures for supervision are
necessary to ensure that appropriate judgments and conclusions have been drawn
from the work performed. Not every member of an audit team will have the
expertise necessary to evaluate the handling of each accounting and auditing
problem that arises. Furthermore, some of the audit staff may lack an in-depth
knowledge of the client or the client's industry, thus increasing the possibility of
incorrect judgments. Supervision by auditors having the necessary experience and
expertise provides reasonable assurance that sufficient evidence and proper
conclusions were obtained.
Auditing literature places emphasis on the existence of appropriate supervisory
policies and anticipates that practices will be used by a firm in each audit
engagement to verify proper supervision. One such procedure is to have staff
members leave their initials to indicate the completion of a test or later review.
Thus, the working paper shown in Exhibit 6-1 was originally produced by Art
Heyman (AH) and subsequently reviewed by Carole Mitchell (CM), and Wallace
Andrews (WA). From the location of the initials, this auditing firm must require

acknowledgment at every point of audit judgment to indicate that the supervisors

concur with the actions taken. This policy enables the firm to monitor the degree of
supervision in each area of the audit as well as to ensure that no critical problem
will escape the attention of supervising auditors.
(6)
Because of the great volume of audit documentation accumulated during an
engagement, most firms use an indexing system to organize all materials.
Indexing allows the auditor easier access to the various documents and
expedites the review process. The "N-2" designation on this document is
apparently part of an indexing system, although no indication is given in the case as
to the actual derivation of the symbols. Abernethy and Chapman may be using a
code in which the letter N refers to the inventory account, and this particular
document presents the results of the second testing procedure performed on
that account.
(7)
One of the purposes of audit documentation is to serve as an historical record of all
audit testing performed by the CPA firm. This documentation provides a guideline
for future audits but, more importantly, serves as evidence should the auditor's
work ever come under question. To assure that the audit documents clearly reflect
the procedures that were carried out and the evidence gathered, many auditing
firms require that the objective, the scope, and the conclusions reached be included
in the documentation of each test. Furthermore, by having to furnish this
information, the staff auditor is more likely to understand the purpose of the
procedures being applied.
(8)
Audit procedures are the steps that are required to test a particular control,
transaction, or account. Some firms write procedures specifically designed for a
particular audit client. Also, some firms have standardized audit procedures for use
on all audits. For quality control standards, standardized procedures are preferable
to ensure that all audits are performed in a like fashion.
However, these
standardized procedures should be supplemented with procedures designed to
meet the particular circumstances of each client.