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CHAPTER 10

MULTIPLE CHOICE
c

1.
a.
b.
c.
d.

A sales cutoff test of billings complements tests of


Sales returns.
Cash.
Accounts receivable.
Sales allowances.

(AICPA ADAPTED)

2. An auditor should perform alternative procedures to substantiate the existence of accounts


receivable when
a. No reply to a positive confirmation request is received.
b. No reply to a negative confirmation request is received.
c. Collectibility of the receivables is in doubt.
d. Pledging of the receivables is probable.
(AICPA ADAPTED)

3. In the confirmation of accounts receivable, the auditor would most likely


a. Confirm a sample of the inactive accounts.
b. Seek to obtain positive confirmations for at least 50 percent of the total dollar amount of the
receivables.
c. Confirm all receivables from agencies of the federal government.
d. Send confirmation requests within one month of the fiscal year-end.
(AICPA ADAPTED)

4. Auditors may use positive and/or negative forms of confirmation requests for accounts
receivable. An auditor most likely will use
a. The positive form to confirm all balances, regardless of size.
b. A combination of the two forms, with the positive form used for large balances and the negative
form for small balances.
c. A combination of the two forms, with the positive form used for trade receivables and the
negative form for other receivables.
d. The positive form when the control structure related to receivables are satisfactory, and the
negative form when controls are unsatisfactory.
(AICPA ADAPTED)

5. An auditor reconciles the total of the accounts receivable subsidiary ledger to the general ledger
control account, as of October 31, 2005. By this procedure, the auditor would be most likely to
learn which of the following?
a. An October invoice was improperly computed.
b. An October check from a customer was posted in error to the account of another customer with a
similar name.
c. An opening balance in a subsidiary ledger account was improperly carried forward from the
previous accounting period.
d. An account balance is past due and should be written off.
(AICPA ADAPTED)

6. Which of the following is the best argument against the use of negative accounts receivable
confirmations?
a. The cost-per-response is excessively high.
b. There is no way of knowing if the intended recipients received them.
c. Recipients are likely to feel that in reality the confirmation is a subtle request for payment.
d. The inference drawn from receiving no reply may not be correct.
(AICPA ADAPTED)

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7. If accounts receivable turned over 7.1 times in 2005, as compared to only 5.6 times in 2004, it is
possible that there were
a. Unrecorded credit sales in 2005.
b. Unrecorded cash receipts in 2005.
c. More thorough credit investigations made by the company in late 2005.
d. Fictitious sales in 2005.
(AICPA ADAPTED)

8. Which of the following would most likely be detected by an auditor's review of a client's sales
cutoff?
a. Unrecorded sales for the year.
b. Lapping of year-end accounts receivable.
c. Excessive sales discounts.
d. Unauthorized goods returned for credit.
(AICPA ADAPTED)

9. The auditor should ordinarily mail confirmation requests to all banks with which the client has
conducted any business during the year, regardless of the year-end balance, since
a. The confirmation form also seeks information about indebtedness to the bank.
b. This procedure will detect kiting activities, which would otherwise not be detected.
c. The mailing of confirmation forms to all such banks is required by generally accepted auditing
standards.
d. This procedure relieves the auditor of any responsibility with respect to non-detection of forged
checks.
(AICPA ADAPTED)

10. Once an auditor has determined that accounts receivable have increased due to slow collections in
a "tight money" environment, the auditor would be likely to
a. Increase the balance in the allowance for bad debts account.
b. Review the going-concern ramifications.
c. Review the credit and collection policy.
d. Expand tests of collectibility.
(AICPA ADAPTED)

11. To gather evidence about the balance per bank in a bank reconciliation, an auditor would examine
all of the following except the
a. Cutoff bank statement.
b. Year-end bank statement.
c. Bank confirmation.
d. General ledger.
(AICPA ADAPTED)

12. Two months before year-end, the bookkeeper erroneously recorded the receipt of a long-term
bank loan by a debit to cash and a credit to sales. Which of the following is the most effective
procedure for detecting this type of error?
a. Analyze the notes payable journal.
b. Analyze bank confirmation information.
c. Prepare year-end bank reconciliation.
d. Prepare a year-end bank transfer schedule.
(AICPA ADAPTED)

13.
a.
b.
c.
d.

An auditor would be least likely to use confirmations in connection with the examination of
Inventories.
Refundable income taxes.
Long-term debt.
Stockholders' equity.
(AICPA ADAPTED)

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14. As one of the year-end audit procedures, the auditor instructed the client's personnel to prepare a
standard bank confirmation request for a bank account that had been closed during the year.
After the client's treasurer had signed the request, it was mailed by the assistant treasurer. What
is the major flaw in this audit procedure?
a. The confirmation request was signed by the treasurer.
b. Sending the request was meaningless because the account was closed before the year-end.
c. The request was mailed by the assistant treasurer.
d. The CPA did not sign the confirmation request before it was mailed.
(AICPA ADAPTED)

15. An unrecorded check issued during the last week of the year would most likely be discovered by
the auditor when the
a. Check register for the last month is reviewed.
b. Cutoff bank statement is reconciled.
c. Bank confirmation is reviewed.
d. Search for unrecorded liabilities is performed.
(AICPA ADAPTED)

16. An auditor compares information on canceled checks with information contained in the cash
disbursement journal. The objective of this test is to determine that
a. Recorded cash disbursement transactions are properly authorized.
b. Proper cash purchase discounts have been recorded.
c. Cash disbursements are for goods and services actually received.
d. No discrepancies exist between the data on the checks and the data in the journal.
(AICPA ADAPTED)

17. Which of the following is one of the better auditing techniques that might be used by an auditor to
detect kiting?
a. Review composition of authenticated deposit slips.
b. Review subsequent bank statements and canceled checks received directly from the banks.
c. Prepare a schedule of bank transfers from the client's books.
d. Prepare year-end bank reconciliations.
(AICPA ADAPTED)

18. An auditor who is engaged to examine the financial statements of a business enterprise will
request a cutoff bank statement primarily in order to
a. Verify the cash balance reported on the bank confirmation.
b. Verify reconciling items on the client's bank reconciliation.
c. Detect lapping.
d. Detect kiting.
(AICPA ADAPTED)

19. Which of the following audit procedures would be most appropriate to address the existence
assertion for sales?
a. Confirm receivables balances.
b. Perform analytical procedures.
c. Review collectibility.
d. Confirm cash deposits in banks.

20. Which of the following financial statement assertions is not addressed by the confirmation of
accounts receivable?
a. Existence.
b. Presentation and disclosure.
c. Rights.
d. Valuation.

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21. Audit working papers often include a client-prepared, aged trial balance of accounts receivable as
of the balance sheet date. An aging is best used by the auditor to
a. Evaluate controls over credit sales.
b. Test the accuracy of recorded charge sales.
c. Estimate credit losses.
d. Verify the validity of the recorded receivables.
(AICPA ADAPTED)

22. An entity's financial statements were misstated over a period of years due to large amounts of
revenue having been recorded in journal entries that involved debits and credits to an illogical
combination of accounts. The auditor could most likely have been alerted to this irregularity by
a. Scanning the general journal for unusual entries.
b. Performing cutoff tests at year-end.
c. Tracing a sample of journal entries to the general ledger.
d. Examining documents supporting sales returns and allowances recorded after year-end.
(AICPA ADAPTED)

23. When auditing the allowance for uncollectible accounts, the least reliance should be placed on
which of the following?
a. The credit manager's opinion.
b. An aging of past due accounts.
c. Collection experience of the client's collection agency.
d. Ratios that show the past relationship of the allowance to net credit sales.
(AICPA ADAPTED)

24. In determining the existence of accounts receivable, which of the following would the auditor
consider most reliable?
a. Documents that supports the accounts receivable balance.
b. Credits to accounts receivable from the cash receipts book after the close of business at year-end.
c. Direct telephone communication between auditor and debtor.
d. Confirmation replies received directly from customers.
(AICPA ADAPTED)

25. An auditor confirms a representative number of open accounts receivable as of December 31 and
investigates respondents' exceptions and comments. By this procedure, the auditor would most
likely to learn of which of the following?
a. One of the cashiers has been covering embezzlement by lapping.
b. One of the sales clerks has not been preparing charge slips for credit sales to family and friends.
c. One of the computer control clerks has been removing from the data file all sales invoices
applicable to his own account.
d. The credit manager has misappropriated remittances from customers whose accounts have been
written off.
(AICPA ADAPTED)

26. Customers with substantial due balances have failed to reply after second requests had been
mailed to them directly. Which of the following audit procedures is most appropriate?
a. Examine shipping documents.
b. Review cash collections during the year being audited.
c. Intensify the study of internal controls for receivables.
d. Increase the balance in the accounts receivable allowance account.
(AICPA ADAPTED)

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27.
a.
b.
c.

The negative form of accounts receivable confirmation is not useful when


Internal control is considered to be effective.
A large number of small balances are involved.
The auditor has reason to believe that persons receiving the requests are likely to consider
them.
d. Individual account balances are relatively large.
(AICPA ADAPTED)

28. Negative confirmation of accounts receivable is less effective than positive confirmation of
accounts receivable because
a. A majority of recipients are usually unwilling to respond objectively.
b. Some recipients may report incorrect balances that require extensive follow-up.
c. The auditor cannot infer that all nonrespondents have verified the account information.
d. Negative confirmations do not produce evidence that is statistically quantifiable.
(AICPA ADAPTED)

29. You are auditing the financial statements of a small rural municipality. The receivable balances
represent residents' delinquent real estate taxes. Control risk is at the maximum. To determine the
existence of the accounts receivable balances at the balance sheet date, you would most likely
a. Send positive confirmation requests.
b. Send negative confirmation requests.
c. Examine evidence of subsequent cash receipts.
d. Inspect internal records such as copies of tax invoices that had been mailed to the residents.
(AICPA ADAPTED)
SHORT ANSWER
1. Name the assertions that management presents within company financial statements.
Answer:

Existence or Occurrence
Completeness
Rights and Obligations
Valuation or Allocation
Presentation and Disclosure

2. In planning substantive audit procedures, the nature, timing, and extent of what three types of risk
are considered? Define these risks.
Answer:
Detection risk the likelihood that error could occur and not be detected by audit
procedures.
Control risk the likelihood that material error could occur and not be detected by
internal control.
Inherent risk the susceptibility of an account balance to material error for which
there is no related internal control.
3. Which three assertions are addressed by the use of confirmation statements in confirming
receivables balances? Why?

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Answer:
Existence to substantiate that recorded receivables exist at the balance sheet date.
Rights to confirm that recorded receivables represent rights the audited entity holds
over debtors
Valuation to confirm that receivables are reported at appropriate amounts.
4. Define, then compare and contrast, positive confirmations and negative confirmations.
Answer:
Positive confirmations request that a customer review the account balance listed on the
confirmation and respond to the auditor directly about whether the balance is correct or incorrect.
Positive conformations are coined blank form confirmations, and request that the respondent
supply the balance. Positive confirmations are appropriate when individual account balances are
relatively large or when substantial numbers of inaccuracies or frauds are expected.
Negative confirmations in contrast request that a debtor respond to the auditor only if the balance
in an attached statement is incorrect. Negative confirmations are generally appropriate when
internal control is adequate, balances are small, and the auditor has no reason to believe that
debtors will not return the confirmation request.
5. What is the general purpose of cutoff bank statements in the course of an audit?
Answer:
Unlike typical month-end bank statements, cutoff bank statements do not represent a full months
transactions. They represent transactions for a short period after year-end and are used by auditors
to verify reconciling items appearing on year-end bank reconciliations prepared by the client.
PROBLEMS
1. Review the following formula. Define the variables used within the equation and then explain the
ending product as it pertains to the confirmation of accounts receivables balances.
n =

RF x B
TE ( AE x EF )

Answer:
B = Population size the total size of the account to be reviewed.
TE = Tolerable error the maximum monetary error that may exist without causing the
financial statements to be misstated materially.
RF = Reliability factor the reliability for overstatement differences.
AE = Anticipated error the error the auditor believes to be present.
EF = Expansion factor
n = The sample size of evidence that will be randomly selected and confirmed to substantiate
the balances of accounts receivables customers.
2. The use of substantive tests in cash balances are planned to substantiate managements five
financial statements assertions. Describe five of the substantive tests used in auditing cash
balances and note the assertion(s) these tests would prove.

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Answer:
Students may list any of the following nine tests noted within the chapter:
Assertion(s)
Existence, Rights, Valuation

Procedure
Confirm year-end cash balances with all
banks and other depositories.
Verify mathematical accuracy of recorded
cash balances by footing cash journals.
Verify mathematical accuracy of recorded
cash balances by tracing totals to the general
ledger and to the year-end bank
reconciliations prepared by the client.
Verify mathematical accuracy of recorded
cash balances by testing cash on hand as
necessary.
Test cutoff by obtaining cutoff bank
statements directly from banks and:
Verifying accuracy of cutoff bank
statements.
Examining information on cutoff
bank statements and trace to
reconciling items in year-end bank
reconciliation and to entries in cash
journals.
Considering necessity of preparing a
proof of cash.
Test cutoff by reconciling recorded cash
balances with returned bank confirmations.
Test cutoff by examining intercompany and
interbank transfers near year-end.
Review financial statements to determine
whether cash balances are properly classified
and disclosed.
Review financial statements to determine
whether disclosures are adequate.

Valuation
Valuation

Valuation
Existence, Completeness, Valuation

Existence, Completeness, Valuation


Existence, Completeness, Valuation
Presentation and disclosure
Presentation and disclosure

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