THE UNIVERSITY OF THE SOUTH PACIFIC
SCHOOL OF ACCOUNTING AND FINANCE
AF 304 - AUDITING
(Semester 2 - 2007)
( (Time allowed: 3hours + 10 min extra reading time)
INSTRUCTIONS FOR CANDIDATES:
? ATTEMPT ALL QUESTIONS.
? SHOW ALL CALCULATIONS.
? YOU MAY USE SILENT, NON-PROGRAMMABLE
QUESTION DESCRIPTION MARK SUGGESTED
ALLOCATION TIME 1 Section A - Multiple choice (General) 25 45 MINUTES 2 Section B – Audit tests/Flowcharts 25 45 MINUTES 3 Section C - Audit Sampling 25 45 MINUTES 4 Section D - Audit Review & Reporting 25 45 MINUTES
TOTAL 100 3 HOURS
Section A Multiple Choice - General [25 marks]
Circle the BEST answer for each of the following multiple-choice items. Each
multiple-choice question is each worth one (1) mark.
Which of the following best describes the reason why an independent auditor reports on financial statements?
A: A management fraud may exist and it is more likely to be detected by
independent auditors. B: Different interests may exist between the company preparing the statements and
the parties using the statements. C: A misstatement of account balances may exist and is generally corrected as the
result of the independent auditor's work. D: A poorly designed internal control system may be in place.
Which of the following is not a requirement of a profession?
A: Community sanction.
B: Regulative code.
C: Large membership.
D: Professional expertise.
Which of the following is an example of teleological ethics?
C: The principle of beneficence.
Which of the following tasks is a function of an audit committee?
A: Overseeing the application of appropriate accounting policies and procedures to
ensure appropriate disclosure. B: Appointing the external auditor.
C: Preparing the financial report for audit.
D: Making decisions regarding the purchase of company assets.
An auditor will most likely be considered negligent when they fail to:
A: Detect all of a client's fraudulent activities.
B: Include a negligence disclaimer in the client engagement letter. C: Warn a client of known internal control weaknesses.
D: Warn a client's customers of embezzlement by the client's employees.
An auditor, John Jupp, failed to follow generally accepted auditing standards in auditing Ace Ltd‟s financial report. Ace‟s management had told Jupp that the audited report would be submitted to several banks to obtain financing. Relying on the report, New Bank gave Ace a loan. Ace defaulted on the loan. If New Bank sues Jupp, Jupp will most likely:
A: win because there is insufficient proximity between Jupp and New Bank
B: lose because Jupp knew that the banks would be relying on the financial report C: win because New Bank was contributorily negligent in granting the loan D: lose because Jupp was negligent in performing the audit
An auditor should not accept a management consulting engagement if: A: The engagement is with a continuing audit client.
B: The engagement is with a continuing audit client, which is a public company. C: The engagement involves making management decisions for an audit client. D: The engagement would require the review of the work of another auditor.
Your audit client is a store that sells some of its own merchandise and some merchandise held on consignment. Which account balance assertion for inventory would you be most concerned about verifying?
A: Existence or occurrence
C: Rights and obligations
D: Valuation and allocation
When an auditor increases the assessed level of control risk because certain control procedures are determined to be ineffective, the auditor will most likely increase the:
A: extent of tests of controls
B: level of detection risk
C: extent of substantive tests
D: level of inherent risk
In assessing whether to accept a client for an audit engagement, an auditor should consider the:
Entity's Business Risk Auditor‟s Engagement Risk
A: Yes Yes
B: Yes No
C: No Yes
D: No No
In considering materiality for planning purposes, an auditor believes that misstatements aggregating $10 000 would have a material effect on an entity‟s profit and loss statement but that misstatements would have to aggregate $20 000 to materially affect the balance sheet. Ordinarily, it would be appropriate to design auditing procedures that would be expected to detect misstatements that aggregate:
A: $10 000
B: $15 000
C: $20 000
D: $30 000
Which of the following is not a medium that can normally be used by an auditor to record information concerning a client's internal control?
A: Narrative memorandum
B: Procedures manual
D: Decision table
A procedure that would most likely be used by an auditor in performing tests of controls that involve segregation of functions and that leave no transaction trail is:
Which of the following procedures would an auditor most likely perform in searching for unrecorded payables?
A: Reconcile receiving reports with related cash payments made just prior to year-
B: Compare the ratio of accounts payable to purchases with the prior year‟s ratio.
C: Vouch a sample of creditor balances to supporting invoices, receiving reports,
and purchase orders. D: Compare cash payments occurring after the balance sheet date with the list of
creditors at year-end.
Based on the results of test of control, an auditor decides to increase the assessed level of control risk from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would: A: Increase inherent risk.
B: Increase materiality levels.
C: Decrease substantive testing.
D: Decrease detection risk.
Johnson is engaged in the audit of a power company which supplies power to a residential community. All accounts receivable balances are small and the internal control structure is effective. Customers are billed twice monthly. In order to obtain evidence with regards the valuation and allocation assertion of the accounts receivable balances as at balance date, Johnson would most likely:
A: Send positive confirmation requests.
B: Examine evidence of subsequent cash receipts.
C: Use statistical sampling instead of sending confirmation requests. D: Send negative confirmation requests.
The risk, in which an auditor will conclude, based on substantive tests, that a material error does not exist in an account balance when, in fact, such an error does exist is
referred to as:
A: sampling risk
B: detection risk
C: nonsampling risk
D: inherent risk
If an auditor is evaluating a sample for a test of controls of 50 items and specifies a risk
of assessing control risk too low of 10 per cent and finds 2 deviations, the approximate
maximum deviation rate is: (Use the following table to determine your answer)
Number of Factors for Sampling Risks of
Deviations 10% 5%
0 2.4 3.0
1 3.9 4.8
2 5.4 6.3
3 6.7 7.8
A: 10 per cent.
B: 6 per cent.
C: 11 per cent.
D: 4 per cent.
In examining cash disbursements, an auditor plans to choose a sample using systematic
selection with a random start. The primary advantage of such a systematic selection is
that population items:
A: that include fraud will not be overlooked
B: may occur in a systematic pattern, thus, making the sample more representative.
C: may occur more than once in a sample
D: do not have to be prenumbered in order for the auditor to use the technique
A major customer of an audit client suffers a fire just prior to completion of year-end
fieldwork. The audit client believes that this event could have a significant direct effect on
the financial report. The auditor should:
A: Advise management to disclose the event in notes to the financial report.
B: Disclose the event in the audit report.
C: Withhold submission of the audit report until the extent of the direct effect on the
financial report is known.
D: Advise management to adjust the financial report.
In which of the following situations would an auditor ordinarily choose between
expressing an “except for” or an adverse opinion?
A: The auditor did not observe the entity‟s physical inventory and is unable to
become satisfied as to its balance by other auditing procedures.
B: The financial report fails to disclose information that is required by the accounting
standards. C: The Company has material inherent uncertainties affecting the financial report. D: Events disclosed in the financial report causes the auditor to have substantial
doubt about the entity‟s ability to continue as a going concern.
When a financial report is presented that is not in conformity with accounting standards, an auditor may issue an:
opinion of opinion
A: Yes Yes
B: Yes No
C: No No
D: No Yes
Which of the following statements best describes internal auditing?
A: An activity located within an entity, primarily to detect fraud.
B: An accounting function located within an entity.
C: An activity located within an entity that determines the fiscal integrity of a
financial report. D: An independent and objective assurance activity within an entity.
An auditor believes that there is substantial doubt about the ability of ABC Ltd to continue as a going concern for a reasonable period of time. In evaluating ABC Ltd‟s plans for dealing with the adverse effects of future conditions and events, the auditor would most likely consider, as a mitigating factor, ABC Ltd‟s plans to:
A: Accelerate research and development projects related to future products. B: Enhance the quality of existing product lines by investing in new manufacturing
technology. C: Purchase equipment and production facilities currently being leased. D: Negotiate reductions in interest rates on outstanding debt.
Which of the following circumstances would most likely cause an auditor to consider whether material misstatements exist in an entity‟s financial report?
A: Management places little emphasis on meeting earnings projections.
B: The board of directors makes all major financing decisions.
C: Audit trails of computer-generated transactions exist for only a year. D: Transactions selected for testing are not supported by proper documentation.
__________________________________________________________________ Section B Audit Tests & Flowcharts [25 marks]
Part A: Internal control [5 marks]
International Standards on Auditing (ISA 315.43) states that a company‟s internal control
consists of five elements.
Discuss these 5 interrelated components that make up the UC Berkeley‟s control process.
Part B: Audit Tests [10 marks]
Your client is SkyHigh Limited, whose main business is maintaining commercial aircraft.
Skyhigh has contracts with several major airlines to carry out maintenance exclusively
on their planes when they are in Australia.
Stock items range from screws and wire to more expensive items such as paneling and
electronic components. Due to the value of some of the larger items, Skyhigh keeps
stock levels to a minimum. The majority of the stock is held at the company‟s warehouse near Sydney Airport.
This is the first year your firm has performed the audit of Skyhigh. Your review of the
predecessor auditor‟s working papers revealed that problems with cut-off were experienced regularly. Problems were also noted in relation to some obsolete stock not
being properly identified as part of the stocktake, and to the use of some inexperienced
staff on the stock-take resulting in a number of counting errors.
Your firm‟s standard audit program for inventories is as described in the box (see next page).
a) For each of the audit steps identified in the audit program, identify the audit
assertion(s) it addresses. [6 marks]
b) List procedures that you would add, amend or delete on your firm‟s standard
audit program for this client. [2 marks]
c) Explain whether analytical review tests could replace all of the tests of details
of balances and tests of details of transactions of balances for this part of the
audit. Discuss. [2 marks]
STANDARD AUDIT PROGRAM FOR INVENTORIES Stocktake Procedures
1. Attend the year-end stocktake and perform the following:
1.1 Ensure the stocktake is carried out in accordance with client instructions, and that
the instructions are reasonable.
1.2 Tour the warehouse and check to ensure all locations are included in the count.
1.3 Ensure no movement of stock occurs during the count.
1.4 Select a random sample of stock items from the floor and agree to count sheets.
1.5 Select a random sample of stock items from the count sheets and agree to
1.6 Inquire as to how obsolete or damaged stock is identified, and ensure these
procedures are followed.
1.7 Record details of any apparently obsolete stock for later use in auditing the
provision for obsolescence.
1.8 Check cut-off by obtaining details of the last sale pre-stocktake and the first sale
post-stocktake. Agree to general ledger. Re-perform procedure for goods inwards.
1.9 Copy a sample of stock sheets for later agreement to final inventory listing.
2. Obtain final inventory listing and then do the following:
2.1 Check adds, cross-adds and calculations.
2.2 Agree items from stock-take to listing, ensuring any adjustments are correctly
2.3 Agree balance to general ledger.
3. Select a sample of items from the final inventory listing and ensure they are valued at
the lower of cost and net realizable value.
Provision for Obsolescence
4. Obtain a copy of the client‟s calculation of the provision for obsolescence and then do
4.1 Check the adds, cross adds and calculations.
4.2 Check that calculation appears reasonable in the light of our knowledge of the
4.3 Agree items noted as obsolete during the stock-take to the provision calculation.
4.4 Agree balance to the general ledger.
5. Review classification and description of inventory balances. Review accounting
policies and ensure they are appropriate to the client‟s business.
6. Perform appropriate analytical procedures and compare results to those for prior year
and to industry data where applicable (e.g. inventory turnover by product line/location.
Ensure results are consistent with our knowledge of the client‟s business.
Part C: Flowchart [10 marks]
Until recently, TATA Phone Company employed a batch processing system for recording
the receipt of customer payments. The following narrative describes the procedures
involved in this system.
1. The customer‟s payment and the remittance advice (a punch card) are
received in the treasurer‟s office. An accounts receivable clerk in the
treasurer‟s office key punches the cash receipt into the remittance advice and
forwards the card to the computer information system department (CISD).
The cash receipt is added to a control tape listing and filed for deposit later in
the day. When the deposit slips are received from the computer information
system later in the day (at approximately 2.30pm each day), the cash receipts
are removed from the file and deposited with the original deposit slip. The
second copy of the deposit slip and the control tape are compared for
accuracy before the deposit is made, and then filed together. 2. In the CISD, the remittance advices received from the treasurer‟s office are
held each day until 2.00pm. At that time the customer payments are
processed to update the records on magnetic tape and prepare a deposit slip
in triplicate. During the update process, data are read (non-destructively) from
the master accounts receivable tape, processed and then recorded on a new
master tape. The original and second copies of the deposit slip are forwarded
to the treasurer‟s office. The old master tape (former accounts receivable file),
the remittance advices (in customer number order) and the third copy of the
deposit slip are stored and filed in a secure place. The updated accounts
receivable master tape is maintained in the system for processing the next
3. TATA Phone Company has revised and redesigned its computer system so it
has on-line capabilities. The new cash receipts procedures, described below,
are designed to take advantage of the new system.
4. The customer‟s payment and remittance advice are received in the
treasurer‟s office as before. A terminal is located in the treasurer‟s office to
enter the cash receipts. An operator keys in the customer‟s number and
payment from the remittance advice and cheques. The cash receipt is
entered into the system once the operator has confirmed that the proper
account and amount are displayed on the screen. The payment is then
processed online against the accounts receivable file maintained on magnetic
disk. The cash receipts are filed for deposit later in the day. The remittance
advices are filed in the order they are processed; these cards will be kept
until the next working day and then destroyed. The computer prints out a
deposit slip in duplicate at 2.00pm for all cash receipts since the last deposit.
The deposit slips are forwarded to the treasurer‟s office. The cash receipts
are removed from the file and deposited with the original deposit slip; the
duplicate deposit slip is filed for further reference. At the close of business
(5.00pm) each day, the CISD prepares a record of the current day‟s cash
receipts activity on a magnetic tape. This tape is then stored in a secure
place in the event of a systems malfunction; after ten working days, the tape
is released for further use.
Prepare a systems flowchart for TATA Phone Company‟s new on-line cash receipts
procedures. [10 marks]