Auditing, 12e (Arens)
Chapter 10 Audit Strategy and Audit Program
10.1 Explain what an audit strategy is
1) A planned approach to the conduct of audit testing, taking into account assessed risks, is
called an
A) audit approach.
B) audit plan.
C) audit program.
D) audit strategy.
2) Audit risk is assessed at which level of the audit?
A) account
B) cycle
C) transaction-related audit objective
D) overall audit
3) Materiality is used to help decide the scope of testing, help determine the sample size and to
help
A) develop the audit report.
B) decide which analytical review calculations to use.
C) evaluate the results of testing.
D) conduct understanding of business tests.
4) Risks of fraud are assessed at which level(s) of the audit?
A) overall audit, transaction-related audit objectives
B) balance-related audit objectives only
C) overall audit, cycle and account
D) cycle, account and transaction-related audit objectives
5) Which of the following areas is considered to have a high risk of fraud in the retail industry?
A) point-of-sale sales
B) customer refunds
C) credit sales
D) completeness of payroll
6) CAS 240 requires which of the following to be considered a significant risk?
A) revenue recognition
B) inventory valuation
C) accounts receivable valuation
D) calculation of income taxes
7) A substantive procedure is used to
A) assess the likelihood of material misstatement in the financial statements.
B) obtain an understanding of internal controls.
C) analyze the account balance to see if there are potential errors.
D) quantify the amount of potential error in an account or transaction stream.
8) A procedure designed to test for dollar errors or irregularities directly affecting the correctness
of financial statement balances is a
A) substantive test.
B) analytical test.
C) test of controls.
D) definition of dollar-unit sampling.
9) When the auditor has determined that there is a significant risk of misstatement for a particular
assertion (for example, completeness of revenue), what type of audit testing does CAS 330
require?
A) tests of risk assessment
B) tests of understanding of internal control
C) control tests
D) substantive tests
10) The auditor of ABC Ltd. has concluded that there are significant risks of misstatement of
revenue at the company, with potential overstatement of revenue. Which of the following audit
tests should the auditor conduct to address this significant risk?
A) control tests of authorization, to ensure that credit limits for sales are all approved by the sales
manager
B) analytical review of sales, comparing sales trends over the last five years by division and to
the industry
C) examination of sales after the year end to quantify potential cut-off errors (income from the
subsequent period included in the current year)
D) risk assessment procedures, looking carefully at inherent risks associated with the handling of
cash in the sales cycle
11) When the auditor assesses the likelihood of material misstatement in the financial statements,
the auditor will use
A) risk assessment procedures.
B) procedures to obtain an understanding.
C) tests of control.
D) assessment of design effectiveness of controls.
12) An example of an audit procedure that relates to the auditor’s understanding of internal
control is
A) reperform the counting of physical inventory.
B) inspect documents and records.
C) recalculate the depreciation expenses.
D) trace all legal expenses to supporting invoices.
13) An example of an audit procedure that relates to the auditor’s understanding of internal
control is
A) count petty cash at all locations.
B) use test data to verify functioning of data entry controls.
C) observe entity activities and operations.
D) trace all large fixed asset purchases to supporting invoices.
14) The purpose of tests of controls is to provide reasonable assurance that the
A) accounting treatment of transactions and balances is valid and proper.
B) accounting control procedures are operating effectively.
C) entity has complied with disclosure requirements of generally accepted accounting
framework.
D) entity has complied with requirements of quality control.
15) Eleonar is inspecting a sample of “Code of Conduct acknowledgement forms” that must be
signed by all employees to indicate that they have read and understood the company’s code of
conduct. Eleonar is ensuring that they have been signed by the employee. Eleonar is performing
A) a test of controls.
B) an analytical procedure.
C) a substantive procedure.
D) a procedure to obtain an understanding of internal controls.
16) The auditor selects several transactions in each functional area and traces them through the
entire accounting system, paying special attention to evidence about whether or not the control
features are in operation. This is an example of a
A) sequence test.
B) test of controls.
C) substantive test.
D) functional test.
17) The auditor would like to design a test of control to test the following key control: “there is a
separation of duties between billing, recording sales, and handling of cash receipts.” Which of
the following typical tests of controls would be suitable?
A) match the amounts billed to the amounts recorded
B) verify that sales have been recorded in the proper period
C) trace cash receipts to the duplicate bank deposit slips
D) inquire about the duties of the accounting personnel
18) The auditor would like to design a test of control to test the following key control: “shipping
documents are issued in numerical order by the computer and are accounted for weekly.” Which
of the following typical tests of controls would be suitable?
A) trace sales documents issued to the sales journal and trace the daily total to the general ledger
B) ask the shipping department about the process that they use to issue shipping documents,
paying particular attention to continuity of numerical sequence
C) use computer assisted audit testing to determine whether there are any numbers in the
sequence missing (gap detection)
D) match shipments to the associated sales invoice
19) The auditor would like to design a test of control to test the following key control: “unit
selling prices are obtained from the price list master file of approved prices.” Which of the
following typical tests of controls would be suitable?
A) compare prices used on sales invoices to the authorized customer purchase order
B) review change to price file throughout the year for proper authorizations and trace prices to
copy of sales invoice
C) use analytical review to compare total sales last year to total sales this year
D) discuss the process used to authorize sales prices with the sales manager and the controller
20) The auditor would like to design a test of control to test the following key control:
“statements are mailed to all customers each month.” Which of the following typical tests of
controls would be suitable?
A) inquire about who is responsible for mailing the statements
B) find out whether customers pay by statement or by invoice
C) reconcile subsequent payments to particular invoices
D) match remittance advices from customers to customer statements
21) If no material fluctuations are found using analytical procedures and the auditor concludes
that differences should not have occurred,
A) it will be necessary to increase the tests of details of balances.
B) other tests may be reduced.
C) it will be necessary to increase the tests of controls.
D) it will not be necessary to perform tests of details of balances.
22) Donna sees a large variation in the gross margin percentage as a result of analytical
procedures she performed. This means that
A) Donna should perform more tests.
B) the financial statements contain an error.
C) Donna cannot rely on the company’s internal controls.
D) Donna should document this difference.
23) Which of the following is an example of a substantive test that could be used for the audit of
the accuracy of sales prices?
A) inspect sales price master authorization forms for the presence of an approval signature
B) observe that the point-of-sale system automatically pulls sales prices from the master file
C) inquire about the process that is used to update sales prices in the sales price master file
D) calculate the gross margin for each product that is sold by the company
24) The auditor has decided that there is a risk of material misstatement with respect to sales
revenue. Which of the following audit tests should the auditor use to quantify the potential error?
A) discuss the process used to assign credit limits with the sales manager and the controller
B) send external confirmations to customers with accounts receivable balances
C) determine whether all sales tested have a supporting customer purchase order
D) determine whether all sales tested have a matching bill of lading
25) The auditor has completed analyzing the results of tests of details of the accounts receivable
ending balance. Errors totaling $25,000 were found. These exceptions are
A) indications that the credit limit is being incorrectly applied.
B) probably cut-off errors that can be explained.
C) an indication of potential errors in the ending balance.
D) financial statement misstatements.
26) In the context of an audit of financial statements, substantive tests are audit procedures that
A) may be eliminated under certain conditions.
B) are designed to discover significant subsequent events.
C) may be either direct tests of financial balances, or analytical tests.
D) will increase proportionately with the auditor’s reliance on internal control.
27) Performance of tests of controls provide evidence in support of the specific controls that
contribute to the auditor’s assessed control risk (where it is reduced below 100%). Also, when
dual-purpose tests are used, evidence is also obtained in support of
A) the nature of illegal acts that occurred.
B) the quantitative effects of fraud risks.
C) statistical ratios to assist analytical review.
D) monetary correctness of transactions.
28) The auditor verifies the summarizing, accuracy, and posting of entries by performing
A) analytical procedures.
B) tests of controls.
C) dual-purpose tests.
D) procedures to gain an understanding of internal control.
29) A) Describe the five types of audit tests used to determine whether financial statements are
fairly stated. Identify which of the five types are substantive tests, and which are used to reduce
assessed control risk.
B) There are several types of audit procedures that relate to the auditor’s understanding of
internal control. One type of procedure is “Update and evaluate the auditor’s previous experience
with the entity.” Identify the five additional types of procedures related to understanding internal
control, and four types of procedures that are used to test controls.
30) Discuss the purposes of tests of controls and tests of details of balances. Give an example of
each.
31) Greenvale Construction Limited was started by four brothers who lived in the Toronto area.
Over time, the brothers have moved to different parts of the country. They decided it was a good
idea to keep the company, and organize their work as separate divisions as part of the same
company. There are now three divisions, one for each of the brothers who are actively involved
in construction. The fourth brother, Ted, is responsible for accounting and record keeping. Ted
went back to school and completed an accounting designation, and now has three employees in
the accounting area.
Each of the brothers has moved on to specialize in a different kind of construction work. In
Toronto, it is mainly new home construction. In Edmonton, the work is primarily renovations of
large homes and small commercial enterprises, while in Halifax, the work is completely
commercial on mid-to-large projects. All of the brothers prefer to subcontract their work rather
than hiring full time construction employees, although some of the subcontract relationships
have lasted over fifteen years now.
Required:
Explain what you would do to document your understanding of internal control for Greenvale.
Identify potential risk areas where you would need to focus additional attention.
32) Samru has been assigned the sales cycle as part of an audit team. He will be evaluating
several key controls in the sales cycle and conducting tests of detail for accounts receivable.
Samru has been told to look at 15 customers with respect to the credit limit approval process (a
test of control). Then, he has been told to use dual purpose tests for the rest of his testing.
Required:
Explain the relationship between tests of controls, dual purpose tests and tests of details.
33) You are a senior at a PA firm and this is your junior’s first day. He would like you to explain
to him what are the different types of audit tests that should be performed over the course of an
audit to obtain sufficient and appropriate audit evidence. Further, please indicate to which
component of audit risk the type of test is linked.
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34) Restaurant Products Company (RPC) has been an audit client of your firm for many years.
RPC has a March 31 fiscal year end. The company is a successful distributor of restaurant and
food industry products, such as trays, weigh scales, dishes, cooking implements. The company
sells to businesses only (i.e. not to end consumers), with clients ranging from small restaurants to
large food service chains and hotels. The company does have a perpetual inventory system, but
the current inventory system relies upon accurate data entry of receipts, shipments and inventory
adjustments from paper documents.
RPC is looking to improve inventory management and maintain costs in the face of rising
competition and growth. Accordingly, it is implementing RFID (radio frequency identification)
technology for its inventory in January 2012. RFID chips will be placed on warehouse shelf
locations, boxes of products, and on large cost individual products. At the same time the
company will implement a wireless mesh system throughout the warehouse, with wireless
tracking of product movement. Effective January 31, 2012 a new inventory management system
is being implemented to facilitate better decision making and access to online realtime inventory
data. The new inventory management system will include a new database that will include
internal records of inventory on hand, receipts and shipments of inventory, purchase order
details, and payment details.
Required:
A. For each phase of the financial statement audit process, describe the phase, and explain how
the audit process is affected or changed due to the implementation of the new database
management system.
B. What is the impact of the implementation of RFID on the financial statement audit process?
[Note that these points must be different from those raised in Part A above.]