Which of the following accounts is least likely to be confirmed by the auditor

to accompany

Audit and assurance

1

st

edition

by

Leung et al.

© John Wiley & Sons Australia, Ltd 2019

Chapter 11: Designing substantive procedures

Chapter 11: Designing substantive procedures

Multiple-choice questions

1. Which of these would not necessarily be considered to be a risk factor for potential misstatements?

a. Segregation of duties is not practiced. b. An employee in the cash office was passed over for a promotion. c. There is intense price competition in the industry of operation. *d. Profit margin has increased and inventory turnover days has decreased.

The correct option is d. Learning objective 11 ~ describe how various risk factors relate to the type of potential misstatement.

1. If the predominantly substantive approach preliminary audit strategy is used, planned detection risk will be:

*a. low or very low. b. high or very high. c. moderate or high. d. at the higher level.

The correct option is a. Learning objective 11 ~ explain the process for determining the appropriate level of substantive procedures based on the assessment of detection risk, inherent risk and control risk.

1. If the lower assessed level of control risk approach preliminary audit strategy is used, planned detection risk will be:

a. at the lower level. *b. moderate or high. c. at the higher level. d. high or very high.

The correct option is b. Learning objective 11 ~ explain the process for determining the appropriate level of substantive procedures based on the assessment of detection risk, inherent risk and control risk.

© John Wiley & Sons Australia, Ltd 2019

Chapter 11: Designing substantive procedures

1. Extensive tests of details for an income statement account is least likely to be required when:

a. analytical procedures reveal some unexpected fluctuations. *b. detection risk is high. c. control risk is high. d. inherent risk is high.

The correct option is b. Learning objective 11 ~ understand special considerations when designing substantive procedures.

1. If the predominantly substantive approach preliminary audit strategy is used, the planned level of substantive procedures will be:

a. at the lower level. b. moderate or high. *c. at the higher level. d. low or very low.

The correct option is c. Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

1. If the lower assessed level of control risk approach preliminary audit strategy is used, the planned level of substantive procedures will be:

a. high or very high. *b. at the lower level. c. moderate or high. d. at the higher level.

The correct option is b. Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

© John Wiley & Sons Australia, Ltd 2019

Testbank to accompany Audit and assurance 1e

1. For a particular account balance assertion, the auditor is most likely to be able to avoid substantive tests of details with which of these sets of risk assessments?

Inherent Control Results of analytical procedures A. Maximum Maximum Unexpected B. Maximum Maximum Expected C. Low Low Expected D. Low Low Unexpected

a. A. b. B. *c. C. d. D.

The correct option is c. Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

1. Which of these is not considered a substantive procedure?

*a. Tests of controls. b. Tests of details of balances. c. Analytical procedures. d. Tests of details of transactions.

The correct option is a. Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

1. The least costly form of testing is usually:

*a. analytical procedures. b. tests of controls. c. tests of detail of transactions. d. tests of detail of balances.

The correct option is a. Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

© John Wiley & Sons Australia, Ltd 2019

Testbank to accompany Audit and assurance 1e

1. Which of these would not be considered to be a test of details of balances?

a. Accounts receivable confirmations. *b. Tracing an invoice to the sales journal. c. Observing the entity’s stocktake. d. Inspecting plant assets.

The correct option is b. Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

1. Confirmation and direct knowledge by the auditor are most associated with:

a. tests of controls. b. analytical procedures. *c. tests of details of balances. d. tests of details of transactions.

The correct option is c. Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

1. The auditor is performing substantive procedures several months before the end of the year. This most likely means that:

a. inherent risk is set at high. *b. detection risk is set at high. c. control risk is set at maximum. d. none of the above are correct.

The correct option is b. Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

© John Wiley & Sons Australia, Ltd 2019

Chapter 11: Designing substantive procedures

1. The auditor would be least likely to perform early substantive tests of details of balances when:

*a. a number of significant deviations from control policies and procedures were detected during tests of controls. b. variance reports do not distinguish between price and quantity variances. c. the client uses a financial business year instead of the calendar year. d. the taking of the client’s inventory is performed at an early date.

The correct option is a. Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

1. When substantive procedures are performed before the balance sheet date the auditor should, at or after the balance sheet date:

a. obtain a letter from management stating that no significant changes occurred in the account balances between the two dates. *b. perform a comparison of the account balances at the two dates. c. confirm all balances that were not confirmed at interim. d. perform tests of reasonableness on all balances that were not confirmed at interim.

The correct option is b. Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

1. Compared to balance sheet accounts, the audit of income statement accounts generally relies more heavily on:

a. analytical procedures. b. tests of detail of balances. *c. tests of detail of transactions. d. both tests of detail of balances and of transactions.

The correct option is c. Learning objective 11 ~ understand special considerations when designing substantive procedures.

© John Wiley & Sons Australia, Ltd 2019

Chapter 11: Designing substantive procedures

1. In which of these accounts would you not expect the use of estimates?

a. Allowance for bad and doubtful debts. *b. Accounts receivable. c. Warranty expense. d. All of the above involve the use of estimates.

The correct option is b. Learning objective 11 ~ understand special considerations when designing substantive procedures.

1. Why are related party transactions a risk area for auditors? They:

a. have minimal disclosure requirements. *b. have a higher than average risk of irregularities. c. have a direct impact on profit. d. are difficult to assess.

The correct option is b. Learning objective 11 ~ understand special considerations when designing substantive procedures.

1. A procedure the auditor would employ in identifying related party transactions is:

a. reviewing previous period working papers. b. reviewing shareholder records. c. reviewing minutes of shareholders and directors meetings. *d. all of the above.

The correct option is d. Learning objective 11 ~ understand special considerations when designing substantive procedures.

1. Which of the following is not true in relation to external confirmations?

a. They are highly reliable. b. They are expensive to perform. c. They are time-consuming to collect. *d. It is mainly liabilities that require external confirmation.

The correct option is d. Learning objective 11 ~ understand special considerations when designing substantive procedures.

© John Wiley & Sons Australia, Ltd 2019

Testbank to accompany Audit and assurance 1e

Short answer questions

1. The nature of substantive procedures refers to the type and effectiveness of the auditing procedures to be performed.

Identify and discuss the three types of substantive procedures, addressing the relative effectiveness and cost of each.

Correct answer: The three types of substantive procedures are:  Analytical procedures consist of the study and comparison of relationships among data. These procedures have proven quite effective in detecting large misstatements in the financial reports and tend to be the least costly of substantive procedures.  Tests of details of transactions primarily involve tracing and vouching the individual debit and credit entries in the account. When these procedures involve highly appropriate evidence such as externally generated documents, they can be quite effective. They tend to be more costly than analytical procedures, but less costly than tests of details of balances.  Tests of details of balances verify the ending account balances directly, without any explicit reference to the individual debit and credit entries. These procedures tend to be the most effective and costly since they often involve the most competent forms of evidence such as auditor observation and confirmation from outsiders.

Reference: Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

1. Describe the contents and purpose of an audit program.

Correct answer: An audit program is a list of the audit procedures planned for an engagement. The program should include:  Columns for a cross-reference to other working papers detailing the evidence obtained from each procedure  Initials of the auditor who completed each procedure  The date that performance of the procedure was completed.

The purpose of the program includes:  An outline of the work to be done  A basis for coordinating, supervising, and controlling the audit  A record of the work performed and evidence obtained.

Reference: Learning objective 11 ~ describe and apply a general framework for developing audit programs for substantive procedures.

© John Wiley & Sons Australia, Ltd 2019

Testbank to accompany Audit and assurance 1e

Reference: Learning objective 11 ~ describe how various risk factors relate to the type of potential misstatement.

35.

1. List the three assumptions that would cause an auditor to assess control risk as being high and adopt the predominantly substantive approach.
2. Give three reasons as to why the predominantly substantive approach can be more suitable to smaller entities.

Correct answer:

1. The three assumptions are:  there are no significant control procedures that pertain to the assertion  any relevant control procedures are unlikely to be effective  it would not be efficient to obtain evidence to evaluate the effectiveness of relevant control policies or procedures.
2. The three reasons are:  small clients may not have adequate resources to implement all appropriate controls  controls may not be as effective due to the lack of resources  the size of the entity may make it inefficient for the auditor to rely on controls in performing the audit.

Reference: Learning objective 11 ~ explain the process for determining the appropriate level of substantive procedures based on the assessment of detection risk, inherent risk and control risk.

1. List two procedures that could be performed to obtain evidence about accounts receivable for each type of substantive procedure.

Correct answer: Any two of each of the following: Analytical procedures:  comparing this year’s closing balance in the control account with the previous year’s balance, a budgeted amount or other expected value  using the closing balance to determine the percentage of accounts receivable to current assets for comparison with the previous year’s percentage or industry data  using the closing balance to calculate the accounts receivable turnover ratio for comparison with the previous year’s ratio, industry data or other expected value. Tests of details of transactions:  vouching a sample of the individual debits and credits in customer accounts for the transaction classes indicated to the entries in journals and supporting documentation  tracing transactions data from source documents and journals to the corresponding entries in the customer accounts for the transaction classes indicated. Tests of details of balances:  determining that the closing balance in the individual customer accounts add up to the control account balance  confirming the balances for a sample of customer accounts with the customers.

© John Wiley & Sons Australia, Ltd 2019

Chapter 11: Designing substantive procedures

Reference: Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

37.

1. List three substantive procedures that are commonly performed before the reporting date.
2. Explain why there is an increased audit risk from conducting procedures before the reporting date and identify two ways in which this increased risk is controlled.

Correct answer:

1. The confirmation of accounts receivable, the observation of physical inventory, and the physical inspection of investments.
2. There is an increased risk associated with performing substantive procedures before reporting date as there is an increased risk that material misstatements existing in the account at reporting date will not be detected. This risk becomes greater as the time period remaining between the date of the interim report and the reporting date is lengthened.

The potential increased risk audit risk can be controlled if: (Students need only have included two of the following)  The internal control structure during the remaining period is effective  There are no conditions or circumstances that may predispose management to misstate the financial statements in the remaining period.  The year-end balances of the accounts examined at the interim date are reasonably predictable as to the amount, relative significance and composition.  The entity’s accounting system will provide information concerning significant unusual transactions and significant fluctuations that may occur in the remaining period.

Reference: Learning objective 11 ~ explain how the auditor designs substantive procedures for each audit and uses the nature, timing and extent of substantive procedures to achieve an acceptable level of detection risk.

1. Answer each of the following:
   1. Control risk has been assessed as high and detection risk is low. What is the timing of the substantive procedures likely to be?
   2. The auditor has decided that they will use a larger sample for confirmations at year end. What is the level of detection risk?
   3. Control risk has been assessed as low and detection risk is high. What type of substantive procedures are the auditors more likely to use?
   4. Control risk has been assessed as low and detection risk is high. What size sample are the auditors more likely to use?
   5. The auditor has decided that they will do more tests of details of balances and use larger samples. What is the likely level of control risk?
   6. The auditor has been comparing the customer closing balances with the balance in the control account for a large sample of customers at year end. What is the level of control risk and detection risk?

© John Wiley & Sons Australia, Ltd 2019

Chapter 11: Designing substantive procedures

Correct answer:

1. Management may have the incentive to engage in fraudulent financial reporting in order to meet the financial targets. If the control environment is weak then this could have a pervasive effect on many assertions.
2. It is possible that inventory is overstated. The auditor should be alert to problems with the existence and occurrence or valuation and allocation of inventory.
3. Management would be under heightened pressure to meet short-term performance indicators. This would have a pervasive effect on many financial statement assertions.
4. It is possible that the retailer is experiencing problems with inventory shrinkage. This could indicate misappropriation of assets. The relevant assertion would be existence.
5. There is an increased risk of employee fraud with the employee having both the incentive and the opportunity. The auditor should be alert for problems with the existence and occurrence of cash disbursements.

Reference: Learning objective 11 ~ describe how various risk factors relate to the type of potential misstatement.

© John Wiley & Sons Australia, Ltd 2019

Which of the following is least likely to result in a qualification of the auditors?

Which account is least likely to be evaluated by the auditor to obtain evidence relating to retirement of property?

Which of the following is most likely to be detected by an auditor's review?

Which of the following does not indicate verification by the auditor *?