Chapter 3

SOLUTIONS FOR REVIEW CHECKPOINTS

3.1 Auditors can use the following sources of information to help decide whether to accept a new audit client:

Financial information prepared by the prospective client such as:

Annual reports to shareholders.
Interim financial statements.
Securities registration statements.
Annual report on SEC Form 10-K.
Reports to regulatory agencies.

Inquiries directed to the prospect’s business associates such as:

Banker.
Legal counsel.
Underwriter.
Other persons (e.g., customers, suppliers).

Communication with Predecessor auditor, if any, regarding:

Integrity of management.
Disagreements with management.

Analyses such as:

Special or unusual risk related to the prospect.
Need for special skills (e.g., computer or industry expertise).

In addition, auditors can conduct an internals search for relationships that would compromise
independence. Also, auditors can search business press articles and stories and legal files on the Lexis-
Nexis system or on the Internet for news about chairman of the board, CEO, CFO, and often other high-
ranking officers. Auditors can engage an outside search firm (private investigators) to conduct additional
searches for information.

Finally, students should always remember that this is a goal-directed search for information. Simply stated,
auditors are looking for information about client risk factors—companies accused of fraud, companies
under SEC or other regulatory investigation, companies that have changed auditors frequently, and
companies showing recent losses.

3.2 Client consent to give information to prospective auditors is required because the Code of Professional
Conduct prohibits the predecessor audit firm from revealing confidential information to the successor audit
firm without consent. As you can see, the confidentiality requirement remains intact even when the
auditor-client relationship ends.

A successor audit firm should inquire specifically about:

 Management’s integrity.
 Disagreements the predecessor may have had with management about accounting principles and audit
procedures.
 Communications the predecessor gave the former client about fraud, illegal acts, and internal control
recommendations.
 The predecessor’s understanding about the reasons for the change of auditors (particularly about the
predecessor’s termination).
3.3 The benefits of an engagement letter include helping to:

 Establish an understanding between client and public accounting firm of the terms of the engagement
and the nature of the work.
 Avoid quarrels and misunderstandings between client and auditor.
 Avoid disputes over the audit fee.
 Avoid legal liability assertions based on failure to do work that the CPA may not have contemplated
or agreed to do.

A termination letter is a letter from a former public accounting firm (fired or resigned) to a former client
specifying terms for future services and the auditors’ understanding of the circumstances related to the
termination.

3.4 An audit plan is a comprehensive list of the specific audit procedures that the audit team needs to perform
to gather sufficient appropriate evidence on which to base their opinion on the financial statements. The
professional standards require that the auditor plan each audit engagement, including the establishment of
an overall strategy for each audit engagement. Specifically, when planning the engagement, the auditor
needs to develop and document a plan that describes the nature, timing, and extent of the procedures to be
performed to assess the risk of material misstatement at the financial statement and the assertion level.
Next, the auditor must carefully plan the nature, timing, and extent of control tests and substantive tests that
are designed to mitigate these risks to an acceptable level. A planning memorandum summarizes all
important overall planning information. The plan is used as a means to document that the audit team is
following generally accepted auditing standards.

3.5 Auditors usually prepare a planning memorandum that summarizes the preliminary analytical procedures,
the materiality assessment, the significant accounts and the relevant assertions about each of the specific
accounts. The planning memo also usually includes information about:

 Investigation or review of the prospective or continuing client relationship.

 Provision of special services or reports and needs for special technical or industry expertise.
 Staff assignment and timing schedules.
 The assessed level of inherent risk.
 The assessed level of control risk.
 Significant industry or company risks.
 The nature, timing and extent of testing of each relevant assertion for each significant account and
disclosure.
 Computer system control environment.
 Utilization of the company’s internal auditors.
 Identification of unusual accounting principles problems.
 Schedules of work periods, meeting dates with client personnel, and completion dates.

3.6 Prior to using internal auditors, external auditors should assess the competence and objectivity of the
persons whose work the auditor plans to use. In general, the higher the degree of competence and
objectivity, the greater the extent to which the auditor can use the work. Stated simply, favorable
conclusions about competence and objectivity enable external auditors to accept and use more of the
internal auditors’ documentation and work. Importantly, the utilization of internal auditors’ work cannot be
a complete substitute for the external auditors’ own procedures and evidence related to accounting
judgments and the material financial statement balances.

3.7 Specialists are persons skilled in fields other than accounting and auditing—actuaries, appraisers, attorneys,
engineers, and geologists—who are not members of the audit team. When a specialist is engaged, auditors
must know about his or her professional qualifications, experience, and reputation. A specialist should be
unrelated to the company under audit. Auditors must obtain an understanding of a specialist’s methods and
assumptions. Provided some additional auditing work is done on the data used by the specialist, auditors
may rely on the specialist’s work in connection with audit decisions.
3.8 It is important to remember that skills often reside in the minds of the persons assigned to the job. As a
result, it is important to make sure that the team is comprised of the persons that possess the skills that are
required to execute the financial statement audit process in an effective and efficient manner. The following
positions are normally assigned to a “full service” audit team:

Audit engagement partner.

Quality assurance (second) audit partner.
Audit manager.
Senior accountant.
Statistical auditing specialist, if needed.
Computer auditing specialist, if needed.
Industry specialist, if needed.
Other specialists, if needed
Staff auditors.
Tax partner.
Tax manager.
Tax accountants.

3.9 Information is material if it is likely to influence financial statement users’ decisions. Thus, material
information is a synonym for important information. The emphasis is on the financial statement users’
point of view, not the auditors’ or managers’ points of view. Although financial statement users are
expected to have a basic knowledge of business and financial statements as well as an understanding of the
limitations of the audit process, auditors remain conservative when setting the materiality level. Thus, if it
is likely to influence the economic decisions of financial statement users, the information should be
considered material.

3.10 On an audit engagement, the audit team uses materiality three ways:

 As a guide to planning substantive procedures (collectively referred to as the audit plan)—directing

attention and audit work to those items or accounts that are important, uncertain, or susceptible to errors or
frauds.

 As a guide to evaluation of the evidence. Auditors use performance materiality (an amount less than
materiality for the financial statements as a whole) to make sure that the aggregate of uncorrected and
undetected immaterial misstatements does not exceed materiality for the financial statements as a whole.
For example, auditors may use an amount less than overall financial statement materiality when auditing
particular classes of transactions, account balances, or disclosures.

 As a guide for making decisions about the audit report. An account such as inventory can be material in an
audit context because of its size or its place in the financial statements. Additionally, inventory’s
importance can result from the potential for misstatement or the effect that a misstatement can have on the
financial statements.

3.11 There are two ways to conduct substantive tests: (1) substantive analytical procedures and (2) tests of
details. When completing a substantive analytical review to gather evidence, the auditor must develop an
independent expectation of what he or she thinks the account balance should be. Once this has been
developed, the expectation is compared to the recorded amount. Any significant differences must be
investigated and then corroborated with evidential matter to be effective. When applying a substantive test
of details, the auditor must seek to understand the account balance and/or economic transactions that
comprise the balance to ensure, based on valid and reliable evidence, that the amount was recorded in
accordance with the applicable financial reporting framework (e.g., GAAP).
 The two types of tests (analytical procedures and tests of details) are considered different in terms of
effectiveness and efficiency. In general, analytical procedures are seen to be more efficient but less
effective, while tests of detail are seen to be more effective but less efficient. Thus, an auditor must take
great care in determining the nature of test procedure to specify in the audit plan. Importantly, the
professional standards are clear that auditors can gain significant assurance from a well-designed
substantive analytical procedure. As a result, some auditing firms encourage the use of analytical
procedures whenever possible as a way to be more efficient.

3.12 The four cycles covered in this book, along with the primary accounts that can be identified within each of
the cycles are shown as follows:

Revenue and collection cycle

Acquisition and expenditure cycle
Production and conversion cycle
Financing and investment cycle

X X X X Cash
X Accounts Receivable
X Allowance for Doubtful Accounts
X Sales
X Sales Returns
X Bad Debt Expense

X X Inventory
X Fixed Assets
X Accumulated Depreciation
X Accounts Payable
X Accrued Expenses
X General Expense

X Cost of Goods Sold

X X Depreciation Expense

X Marketable Securities
X Bank Loans
X Long-Term Notes
X Accrued Interest
X Capital Stock
X Retained Earnings
X Dividends Declared
X Interest Expense
X Income Tax Expense

3.13 Vouching relates to the examination of documents. Generally, items of financial information are selected
from an account recorded in the financial statements, and auditors then go backward through the
accounting process to find the source documentation that supports the item selected. Typically, vouching is
used to test the existence or the occurrence assertion. Tracing occurs in the opposite direction of
vouching. That is, in the process of tracing, auditors select sample items from the source documentation
and proceeds forward through the accounting process all the way to its final recording in the financial
statements. Typically, tracing is used to test the completeness assertion. Finally, Scanning refers to the
auditors scrutinizing documentation for unusual items and events. Scanning is the way auditors exercise
their general alertness to unusual items and events in clients’ documentation. In general, scanning is an
“eyes-open” approach of looking for anything unusual. The scanning procedure usually does not produce
direct evidence itself, but it can raise questions related to other evidence that must be obtained.
3.14 Auditors use eight general audit procedures to gather evidence: (1) inspection of records and documents
(vouching, tracing, scanning), (2) inspection of tangible assets, (3) observation, (4) inquiry,
(5) confirmation, (6) recalculation, (7) reperformance, and (8) analytical procedures. One or more of these
procedures may be used no matter what account balance, control procedure, class of transactions, or other
information is under audit.

3.15 Five types of general analytical procedures and their sources:

Analytical Procedures Sources of Information

1. Comparison of current-year account balances
to balances of one or more comparable
periods
2. Comparison of the current-year account
balances to anticipated results found in the
company’s budgets and forecasts
3. Evaluation of the relationships of current-
year account balances to other current-year
balances for conformity with predictable
patterns based on the company’s experience
4. Comparison of current-year account balances
and financial relationships (e.g., ratios) with
similar information for the industry in which
the company operates
5. Study of the relationships of current-year
account balances with relevant nonfinancial
information (e.g., physical production
statistics)
Financial account information for
comparable period(s)
Example: Current-year Cost of Goods Sold
compared to previous-year balance
Company budgets and forecasts
Example: Current-year Cost of Goods Sold
compared to the company’s budgeted
amount
Financial relationships among accounts in
the current period
Example: Days’ Sales in Inventory
Industry statistics
Example: Days’ Sales in Inventory
compared to industry averages
Nonfinancial information such as physical
production statistics
Example: Days’ Sales in Inventory
compared to unfilled orders

3.16 Professional standards require that analytic procedures be used during planning and during final evaluation
stages of the audit; analytical procedures are optional for use as a substantive audit procedure.

3.17 Additional planning matters that should be considered about a client’s computerized processing
environment include:

 The extent to which the computer is used in each significant accounting cycle.
 The complexity of the computer operations used by the entity, including the use of an outside service
center.
 The organizational structure of the computer-processing activities.
 The availability of data.
 The possibility that computer-assisted audit techniques could be used to increase the efficiency of
audit procedures.
 The need for specialized skills.

3.18 Generally speaking, transactions that are routine and similar in nature are excellent candidates for
computerized processing. Computerized processing subjects similar transactions to the same processing
instructions. Consequently, computerized processing virtually eliminates the occurrence of random errors
normally associated with manual processing; as a result, programming errors (or other similar systematic
errors in either the computer hardware or software) will result in all similar transactions being processed
incorrectly when those transactions are processed under the same conditions.
 In addition, with automatic transaction initiation, certain transactions can be initiated or executed
automatically by a computerized system without human review. Computer-initiated transactions may
include the generation of invoices, checks, shipping orders, and purchase orders. Without a human-readable
document indicating the transaction event, the correctness of automatic transactions is difficult to judge.
The authorization of these transactions cannot be documented in the same way as those in a manual
accounting system, and management’s authorization of these transactions can be implicit in its acceptance
of the design of the system. Therefore, authorization can be more difficult to trace to the proper person.
Control procedures must be designed into the system to ensure the genuineness and reasonableness of
automatic transactions and to prevent or detect erroneous transactions.

3.19 The audit trail (sometimes called management trail because it is used more in daily operations than by
auditors) is composed of the source documents, journal postings, and ledger account postings maintained
by a client in order to keep books. These create a “trail” of the bookkeeping (transaction data processing)
that allows auditors to follow the sequence of processing on (or because of) a transaction with a tracing or
vouching procedures.

In a manual system, this trail is usually visible to the eye with posting references in the journal and ledger
and hard copy documents in files. But in a computer system, the audit trail in advanced systems may not
be in a human readable form and may exist for only a fraction of a second. Furthermore, the posting
references may not exist, and the records must be read using the computer rather than the naked eye. Most
systems still have hard copy papers for basic documentation, but in some advanced systems even these
might be absent.

There are several control implications of an electronic audit trail. The first implication is that concern for an
audit trail needs to be recognized at the time a system is designed. Techniques such as integrated test
facility, audit files, and extended records must be specified to the systems designer. The second control
implication is that if the audit trail exists only momentarily in the form of transaction logs or master records
before destructive update, the audit team must review and evaluate the transaction flow at various times
throughout the processing period. Alternatively, the audit team can rely more extensively on internal
auditors to monitor the audit trail.

3.20 The term computer-assisted audit techniques (CAATs) collectively refers to a set of preprogrammed editing,
operating, and output subroutines so that original programming is not required and the same software can be
used on different clients’ computerized systems. For the most part, the widely used CAATs packages (e.g.,
ACL) are very similar. Most have been developed from standard spreadsheet and database applications, so
if you understand spreadsheet software, you can use most of the audit-specific functions. The applications,
however, have been modified so that auditors can perform common audit tasks at the touch of a button by
accessing predeveloped macros.

3.21 A number of procedures, such as the following six examples, can be performed using CAATs:

 Recalculation.
 Confirmation.
 Document examination (limited).
 Scanning.
 Analytical procedures.
 Advanced fraud investigation.
3.22 a. Advantages of using CAATs to perform recalculations are primarily speed and accuracy. With CAATS,
it is just as easy to recalculate all client computations as it would be to test a sample of calculations. Any
differences from client computations can be printed out for investigation.

b. When using CAATs to select samples and print confirmations, the advantages include the use of
preprogrammed statistical routines to randomly select the sample and the speed with which confirmations
can be prepared on preprinted forms.

3.23 Among other items, in the permanent audit file, you would expect to find:

 Copies or excerpts of the corporate or association charter, bylaws, or partnership agreement.

 Copies or excerpts of continuing contracts such as leases, bond indentures, and royalty agreements.
 A history of the company, its products, markets, and background.
 Copies or excerpts of stockholders, directors, and committee minutes on matters of lasting interest.
 Continuing schedules of accounts whose balances are carried forward for several years, such as owners’
equity, retained earnings, partnership capital, and the like.
 Copies of prior-years financial statements and audit reports.
 Client organization chart.

3.24 Among other items, in the current audit file, you would expect to find:

 Engagement letter.
 Staff assignments.
 Memoranda of conferences with management.
 Memoranda of conferences with the director’s audit committee
 Preliminary analytical review procedures.
 Risk assessment procedures.
 Materiality assessment.
 Engagement-planning memorandum
 Audit engagement time budget.
 Internal control understanding and testing.
 Audit plans.
 Trial balance of general ledger accounts.
 Substantive analytical procedures.
 Substantive test of details procedures.
 Final procedures to complete the audit.
3.25 PCAOB Auditing Standard 3 defines audit documentation as the written record of the basis for the
auditor’s conclusions that provides the support for the auditor’s representations, whether those
representations are contained in the auditor’s report or otherwise. The most important facet of the current
audit evidence documentation files is the requirement that the working papers provide the basis for the
auditors’ conclusions. The documentation must record the management assertions that were audited (book
values or qualitative disclosures), the evidence gathered about them, and final conclusions. Professional
audit standards require the audit documentation to show that (1) the client’s accounting records agree or
reconcile with the financial statements, (2) the work was adequately planned and supervised, (3) a
sufficient understanding of the client’s internal control was obtained, and (4) sufficient appropriate audit
evidence was obtained as a reasonable basis for an audit opinion.

Of course, the audit documentation is sufficient to show that the financial statements conform to the
relevant accounting framework and that the disclosures are adequate. The audit documentation also should
explain how exceptions, unusual accounting questions, and findings contradictory to the audit team’s final
conclusions were resolved or treated. In addition, the resolution of any differences among audit team
members must be documented. Taken altogether, these features should demonstrate that all auditing
standards were observed and executed.

3.26 PCAOB Auditing Standard #3 (AS 3) requires that audit documentation, including work papers and other
documents that form the basis of the engagement, be retained for seven years following the conclusion of
the engagement (usually the audit report release date). AS 3 also stresses that audit documentation including
discussion and subsequent resolution of differences in professional judgment among the audit team
members be retained. Although the AS 3 requirements are only for public companies, most public
accounting firms use the same requirements for their nonpublic clients. For public company audits, the
professional standards also require that all documentation must be finalized within 45 days of the audit
report’s release date. With sufficient (documented) justification, auditors may subsequently add, but may
not remove, documentation after the 45-day period.

SOLUTIONS FOR MULTIPLE-CHOICE QUESTIONS

3.27 a. Incorrect The prospective auditor must take responsibility for obtaining the client’s
consent for the predecessor to give information about prior audits. However,
since response (b) and (c) are also correct, response (d) is the correct answer.
b. Incorrect Cooperation from the predecessor is expected. However, since response (a) and
(c) are also correct, response (d) is the correct answer.
c. Incorrect Cooperation includes obtaining copies of some or all of the predecessor
auditors’ documentation. However, since response (a) and (b) are also correct,
response (d) is the correct answer.
d. Correct All of the above answers are correct. Thus, this is the correct answer.

3.28 a. Incorrect Although strongly encouraged, U.S. GAAS do not explicitly require that
auditors explain their understanding of the client’s business in writing.
b. Incorrect Client consent does not have to be documented in writing.
c. Correct A written audit plan is required to be documented by U.S. GAAS (Clarified
Standards Section 300.14).
d. Incorrect Written time budgets and schedules may be a good idea, but they are not
required to be documented in writing.

3.29 a. Incorrect Audit documentation is necessary to document compliance with GAAS.

b. Incorrect Extracts of contracts should go in the permanent file.
c. Correct While independence is clearly an important consideration, it is not a factor that
dictates the quantity, type and content of audit documentation.
d. Incorrect Materiality judgments will affect the amount of evidence shown in audit
documentation.
3.30 a. Correct Since this is evidence that relates directly on the year under audit, the current
file is appropriate.
b. Incorrect Evidence that relates directly to only the year under audit is usually not in the
permanent file.
c. Incorrect The administrative audit documentation does not contain current-year evidence
about particular balances.
d. Incorrect The planning memo does not contain evidential matter of this type.

3.31 a. Incorrect Internal control analysis for the current year would likely be found in the current
file.
b. Incorrect The latest engagement letter would likely be in the current file.
c. Incorrect Memoranda of conference with management would likely be in the current file.
d. Correct Excerpts of the corporate charter and bylaws would not change often and would
therefore likely be found in the permanent file.

3.32 a. Incorrect Materiality determination does help to concentrate the audit work where it is
most needed.
b. Incorrect Materiality determination helps auditors to do just the right amount of work to
be convinced that no material misstatement exists and not overaudit.
c. Correct The kind of opinion to issue cannot be determined until all the evidence is
obtained and evaluated.
d. Incorrect Materiality determination helps auditors to do just the right about of work to be
convinced that no material misstatement exists and not underaudit.

3.33 a. Incorrect Spreadsheet software would not be appropriate for testing internal controls over
computerized accounting applications.
b. Incorrect Word processing software would be best to prepare an audit plan.
c. Correct Spreadsheet software is ideal for preparing a comparison of current year
expenses with those from the previous year.
d. Incorrect Word processing software would be best for drafting a planning memo.

3.34 a. Incorrect All CAATs are not in the same computer language.
b. Correct CAATs can be transported and used on different types of clients that utilize
different types of computing systems.
c. Incorrect This is not true. Input controls are important and need to be audited separate
from the use of CAATs.
d. Incorrect The use is the means or the method to accomplish testing, but the complete set
of audit procedures can rarely be done all using CAATs.

3.35 a. Incorrect These are characteristics of a client’s computer system and are not the
advantages of using CAATs
b. Correct This is a key advantage of using CAATs. Auditors can use the computer with
ease and it generally allows for a more efficient audit to be completed.
c. Incorrect Machine operations generally do not leave “visible” evidence. In most cases,
this has to be tested by IT audit specialists.
d. Incorrect This is not an advantage of a CAAT. As with documentary evidence, the goal is
to gather the right amount of evidence that convinces an auditor that there are no
material misstatements. There is no advantage to gathering extra evidence,
whether it is machine-readable or paper evidence.
3.36 a. Correct Client cooperation should be specified in the engagement letter. This is a key
purpose of the letter.
b. Incorrect Technical details of the audit process are not contained in the engagement letter.
c. Incorrect Specification of litigation in progress are not covered in the engagement letter.
They are handled with an attorney’s letter of confirmation.
d. Incorrect Client representations about board minutes should be in the client’s written
representation letter, not in the engagement letter.

3.37 a. Incorrect The auditors’ report should not mention the fact that a specialist was used unless
the specialist’s findings affect the auditors’ conclusions.
b. Correct The auditors’ report should only mention the use of the specialist when the
specialist’s findings affect the auditors’ conclusions.
c. Incorrect The auditors’ report need not mention the use of a specialist if the auditors
decide not to take responsibility for the specialist’s findings.
d. Incorrect The auditors’ report should mention the specialist only if Vandalay does not
agree with the specialist’s findings, resulting in an opinion other than
unqualified.

3.38 a. Incorrect Interviewing internal auditors about their reporting responsibilities would assist
the audit team in determining whether the internal auditors were objective but
would provide little evidence of related-party transactions.
b. Incorrect Reviewing accounting records for nonrecurring transactions occurring near year-
end would raise suspicions of fraud but not necessarily related-party
transactions.
c. Incorrect Inspecting communications with the client’s legal counsel regarding recorded
contingent liabilities would be helpful in determining contingent liabilities.
d. Correct Scanning the minutes for significant transactions with members of the board of
directors would be helpful in identifying transactions with parties related to the
client because transactions with board members are likely to be discussed during
the board meeting and board members are related parties.

3.39 a. Incorrect A report to the audit committee on the results of testing of internal control over
cash receipts would typically occur after the entire period could be tested and
therefore would be written after the balance sheet date.
b. Incorrect Confirmation letters to vendors confirming the amounts they owe to the client
are part of substantive procedures performed on balance sheet account amounts.
c. Incorrect An attorney’s letter regarding contingent liabilities would be written as close to
the end of fieldwork as practicable.
d. Correct An engagement letter would be written before accepting an engagement, and
therefore before the balance sheet date.
3.40 a. Incorrect Surprise counts of the client’s petty cash fund may occur during planning but are
more typically performed close to the balance sheet date.
b. Incorrect Reporting internal control deficiencies to the audit committee would typically
occur after internal control testing was complete.
c. Incorrect Performing a search for unrecorded liabilities would be performed as a
substantive procedure after planning.
d. Correct Identifying related parties is an important part of the audit planning process.

3.41 a. Incorrect Prior to accepting a new audit engagement, an audit firm should attempt to
contact the predecessor auditor. But because (b) and (c) are also correct, letter
(d) is the correct response.
b. Incorrect Prior to accepting a new audit engagement, an audit firm should evaluate the
integrity of management. But because (a) and (c) are also correct, letter (d) is the
correct response.
c. Incorrect Prior to accepting a new audit engagement, an audit firm should assess the
firm’s resources to ensure sufficiency. But because (a) and (b) are also correct,
letter (d) is the correct response.
d. Correct Prior to accepting a new audit engagement, an audit firm should (a) attempt to
contact the predecessor auditor, (b) evaluate the integrity of management, and
(c) assess the firm’s resources. So, all of the above is the correct response.

3.42 a. Incorrect An audit plan does not specify audit standards. When applicable, all the GAAS
are relevant throughout the audit process.
b. Correct This is exactly what an audit plan consists of – that is, an audit plan contains
specifications of procedures the auditors believe appropriate for the financial
statements under audit.
c. Incorrect Documentation of the assertions under audit, the evidence obtained, and the
conclusions reached describe audit documentation found in the current file, not
audit plans.
d. Incorrect Reconciliation of the account balances in the financial statements with the
account balances in the client’s general ledger is one element of the content of
audit documentation found in the current file, not audit plans.

3.43 a. Incorrect These accounts are part of the acquisition cycle.

b. Incorrect These accounts are part of the conversion cycles.
c. Correct These accounts are part of the revenue cycle.
d. Incorrect These accounts are part of the financing and investment cycle.
3.44 a. Incorrect It is not possible find an unrecorded item by looking at the amounts that were
recorded in the financial statement balances.
b. Incorrect When testing the completeness assertion, an auditor starts with the potentially
unrecorded items and then traces them forward to the financial statements.
However, this is not a test of the existence assertion.
c. Correct By starting with the amounts recorded in the general ledger, you can find
evidence of existence of recorded amounts by selecting items that have actually
been recorded (in the general ledger) and then examining supporting original
transaction documents for the amounts recorded.
d. Incorrect Selecting from the supporting original transaction documents and going to the
general ledger is an audit for the completeness assertion, not the existence
assertion.

3.45 a. Incorrect Confirmation of accounts receivable are selected from recorded amounts and
thus give the auditor no chance for selecting unrecorded amounts; responses do
not produce evidence of collection so valuation is not correct.
b. Incorrect Confirmation yields some evidence of rights (ownership); however, responses
do not produce evidence of the probability of collection so valuation is not
correct.
c. Correct Confirmation of accounts receivable does produce evidence of existence
because the customer is admitting that it owes the client money and some
evidence of rights to the accounts receivable amount is also supported because
the customer is admitting that it owes the client the money (thus, they own the
receivable).
d. Incorrect Confirmations produce evidence about existence but not completeness because
the items are selected from the list of accounts receivable recorded on the
balance sheet.

3.46 a. Incorrect Materiality may be a qualitative assessment rather than quantitative or both.
b. Incorrect Materiality may be a quantitative assessment rather than qualitative or both.
c. Incorrect AICPA guidelines do not state exactly how judgments should be made.
d. Correct Most definitely, materiality is always a matter of professional judgment.

3.47 a. Incorrect The audit team would be concerned if key factors are not consistent with prior
periods.
b. Incorrect The audit team would be concerned if key assumptions are not similar to
industry guidelines.
c. Incorrect The audit team would be least concerned about measurements that are objective
and not susceptible to bias.
d. Correct Evidence of a systematic bias, whether aggressive or conservative, would be of
most concern to the audit team.

3.48 a. Incorrect The testing of cutoff activities is an example of a substantive test of details.
b. Correct One example of an analytical procedure is when auditors evaluate financial
statement accounts by developing expectations about what an account balance
should be based on an analysis of relevant financial and nonfinancial data.
When examining the inventory balance, the auditor would expect a lower
balance if there was significant sales activity. Thus, this is an example of an
analytical procedure.
c. Incorrect The projection of a deviation rate of a statistical sample to the population is an
example of a step taken following the completion of a test of detail. This topic
is covered in detail in Module E.
d. Incorrect The reconciliation of physical inventory counts to the perpetual records and the
general ledger is an example of a test of details.
3.49 a. Incorrect Making inquiries of the client’s lawyer concerning pending litigation is a step
that is carried out during the audit. Importantly, the step is typically finalized
during the final stages of the audit. Thus, it would not be completed during
planning.
b. Incorrect Performing cutoff tests of cash receipts and disbursements is a step that is
carried out during the testing phase of the audit. Thus, it would not be completed
during planning.
c. Correct Comparing the financial information with nonfinancial operating data is a step
that may be completed during preliminary analytical procedures. This is done
during the planning phase of the audit.
d. Incorrect Recalculating the accruals and deferrals is a step that is carried out during the
testing phase of the audit. Thus, it would not be completed during planning.

3.50 a. Incorrect The completion of preliminary analytical procedures is focused on the financial
statements and is unrelated to control testing. Control tests are designed to test
whether the internal control procedures are being completed as they were
designed by the client.
b. Correct The use of financial and nonfinancial data aggregated at a high level is
commonly used during preliminary analytical procedures.
c. Incorrect Preliminary analytical procedures do not involve the comparison of assertions
developed by management to ratios developed by auditors. During the audit,
management makes assertions about the financial statement balances and
auditors test those assertions. However, the response does not relate to the
completion of preliminary analytical procedures.
d. Incorrect The preliminary analytical procedures completed during planning are not used to
develop a preliminary judgment about materiality.
3.51 a. Correct If the internal auditor is evaluated as both competent and objective; the
professional auditing standards allow the independent auditor to perform
relatively low risk tests, like certain tests of internal control.
b. Incorrect If the internal auditor is evaluated as both competent and objective; the
professional auditing standards allow the independent auditor to perform
relatively low risk tests. However, the audit of a major subsidiary would likely
be too risky and important for the independent auditor to rely on the internal
auditor’s testwork.
c. Incorrect If the internal auditor is evaluated as both competent and objective; the
professional auditing standards allow the independent auditor to perform
relatively low risk tests. As long as they are competent and objective, their lack
of independence would not prevent the independent auditor from assigning tasks
to the internal auditor.
d. Incorrect If the internal auditor is evaluated as both competent and objective; the
professional auditing standards allow the independent auditor to perform
relatively low risk tests. These low risk tests could be either analytical
procedures or test details.
3.52 a. Incorrect This is not a major risk. In fact, it is quite common for audit staff members to
have to be rescheduled to cover a new audit client. As a result, this is not an
issue of concern.
b. Correct This is a major risk factor and is likely to be enough for an auditor to not accept
an audit engagement. Why is there a scope limitation required? Is the potential
client trying to hide a material fact (or a material misstatement) from the
auditor? Given that there is a scope limitation, the auditor would have to think
long and hard about whether to accept the engagement.
c. Incorrect This is not a major risk. In fact, it is quite common for an auditor to have to hire
a specialist for one audit area. As a result, this is not likely to be a major issue
of concern.
d. Incorrect This is not a major risk. In fact, this would be a factor that would make the auditor more
likely to accept the client. As a result, this is a positive factor and would not be an issue of concern