Lew Pherson and Vera Collier are friends who are employed by different CPA firms. One day during lunch they are discussing the importance of internal control in determining the amount of audit evidence required for an engagement. Pherson expresses the view that internal control must be evaluated carefully in all companies, regardless of their size or whether they are publicly held, in a similar manner. His CPA firm requires a standard internal control questionnaire on every audit as well as a flowchart of every transaction area. In addition, he says the firm requires a careful evaluation of the system and a modification in the evidence accumulated based on the controls and deficiencies in the system. Collier responds by saying she believes that internal control cannot be adequate in many of the small companies she audits; therefore, she simply ignores internal control and acts under the assumption of inadequate controls. She goes on to say, "Why should I spend a lot of time obtaining an understanding of internal control and assessing control risk when I know it has all kinds of weaknesses before I start? I would rather spend the time it takes to fill out all those forms in testing whether the statements are correct." Required a. Express in general terms the most important difference between the nature of the potential controls available for large and small companies. b. Criticize the positions taken by Pherson and Collier, and express your own opinion about the similarities and differences that should exist in understanding internal control and assessing control risk for different-sized companies. c. Discuss whether Collier's approach is acceptable under existing auditing standards for either public or nonpublic companies. d. Describe what additional procedures Pherson must perform if auditing the financial statements of a public company.
> The following questions concern audit objectives and management assertions for accounts receivable. Choose the best response. a. When evaluating the adequacy of the allowance for uncollectible accounts, an auditor reviews the entity's aging of receivable
> Items 1 through 9 are selected questions of the type generally found in internal control questionnaires used by auditors to obtain an understanding of internal control in the sales and collection cycle. In using the questionnaire for a client, a "yes" re
> When performing an integrated audit of a public company, what are the auditors responsibilities related to internal control as required by PCAOB standards?
> The following questions deal with audit evidence for the sales and collection cycle. Choose the best response. a. An auditor is performing substantive tests of transactions for sales. One step is to trace a sample of debit entries from the accounts recei
> Management must identify the framework used to evaluate the effectiveness of internal control over financial reporting. What framework is used by most U.S. public companies?
> Describe how the nature of evidence used to evaluate the control environment differs from the nature of evidence used to evaluate control activities.
> The following questions deal with materiality. Choose the best response. a. Which one of the following statements is correct concerning the concept of materiality? (1) Materiality is determined by reference to guidelines established by the AICPA. (2) Ma
> The following are audit procedures from different transaction cycles: 1. Examine duplicate copy of shipping documents for evidence that quantities were verified before shipment. 2. Select a sample of payroll checks and agree hours to employee time record
> In evaluating the audit approach for McClain for the current year's audit, Sessions believed that a substantive approach was really only appropriate for the audits of small nonpublic companies. In his judgment, McClain Plastics, with sales of $200 millio
> For each of the following types of misstatements (parts a through d), select the control that should have prevented the misstatement: a. A manufacturing company received a substantial sales return in the last month of the year, but the credit memorandum
> The following questions deal with internal controls in the sales and collection cycle. Choose the best response. a. The accounting system will not post a sales transaction to the sales journal without a valid bill of lading number. This control is most r
> Diane Smith, CPA, performed tests of controls and substantive tests of transactions for sales for the month of March in an audit of the financial statements for the year ended December 31, 2011. Based on the excellent results of both the tests of control
> State one test of control and one substantive test of transactions that the auditor can use to verify the following sales transaction-related audit objective: Recorded sales are stated at the proper amounts.
> Under what circumstances is it acceptable to perform tests of controls and substantive tests of transactions for sales and cash receipts at an interim date?
> Distinguish between a sampling error and a nonsampling error. How can each be reduced?
> Define what is meant by alternative procedures in the confirmation of accounts receivable and explain their purpose. Which alternative procedures are the most reliable? Why?
> What three types of authorizations are commonly used as internal controls for sales? For each authorization, state a substantive test that the auditor could use to verify whether the control was effective in preventing misstatements.
> Define what is meant by inherent risk. Identify four factors that make for high inherent risk in audits.
> How will the conduct of an audit of a medium-sized company be affected by the company's being a small part of a large conglomerate as compared with it being a separate entity?
> What are the five types of tests auditors use to determine whether financial statements are fairly stated? Identify which tests are performed to reduce control risk and which tests are performed to reduce planned detection risk. Also, identify which test
> The following questions deal with confirmation of accounts receivable. Choose the best response. a. The negative form of accounts receivable confirmation request is useful except when (1) Internal control surrounding accounts receivable is considered to
> State the relationship between the confirmation of accounts receivable and the results of the tests of controls and substantive tests of transactions.
> Evaluate the following statement: "Tests of sales and cash receipts transactions are such an essential part of every audit that I like to perform them as near the end of the audit as possible. By that time I have a fairly good understanding of the client
> The following are 11 audit procedures taken from an audit program: 1. Foot the accounts payable trial balance and compare the total with the general ledger. 2. Confirm accounts payable balances directly with vendors. 3. Account for a sequence of checks i
> Explain the circumstances when the auditor should revise the components of the audit risk model and the effect of the revisions on planned detection risk and planned evidence.
> The following questions deal with tests of controls. Choose the best response. a. Which of the following statements about tests of controls is most accurate? (1) Auditing procedures cannot concurrently provide both evidence of the effectiveness of intern
> Explain the importance of proper credit approval for sales. What effect do adequate controls in the credit function have on the auditor's evidence accumulation?
> Define the meaning of the term materiality as it is used in accounting and auditing. What is the relationship between materiality and the phrase obtain reasonable assurance used in the auditor's report?
> The following questions concern types of audit tests. Choose the best response. a. The auditor looks for an indication on duplicate sales invoices to see whether the accuracy of invoices has been verified. This is an example of (1) A test of details of b
> Explain what is meant by block sample selection and describe how an auditor can obtain five blocks of 20 sales invoices from a sales journal.
> Explain how the calculation and comparison to previous years of the gross margin percentage and the ratio of accounts receivable to sales are related to the confirmation of accounts receivable and other tests of the accuracy of accounts receivable.
> Describe the four phases performed by the auditor when obtaining an understanding of internal control and assessing control risk.
> Why do auditors often consider it desirable to perform audit tests throughout the year rather than wait until year-end? List several examples of evidence that can be accumulated before year-end
> List the eight balance-related audit objectives in the verification of the ending balance in inventory and provide one useful audit procedure for each of the objectives.
> Explain the relationship of tolerable misstatement, inherent risk, and control risk to planned tests of details of balances.
> What audit procedures are most likely to be used to verify accounts receivable written off as uncollectible? State the purpose of each of these procedures.
> You have been assigned to the confirmation of aged accounts receivable for the Blank Paper Company audit. You have tested the aged trial balance and selected the accounts for confirming. Before the confirmation requests are mailed, the controller asks to
> State three types of differences that might be observed in the confirmation of accounts receivable that do not constitute misstatements. For each, state an audit procedure that will verify the difference.
> List the most important duties that should be segregated in the sales and collection cycle. Explain why it is desirable that each duty be segregated.
> The auditor's risk assessment procedures identified several risks that the auditor deems to be significant risks. Several internal controls exist that are designed to mitigate the risks identified. Describe the auditor's responsibilities for considering
> Assume a company with the following balance sheet accounts: You are concerned only about overstatements of owner's equity. Set tolerable misstatement for the three relevant accounts such that the preliminary judgment about materiality does not exceed $5,
> Why is it desirable to design tests of details of balances before performing tests of controls and substantive tests of transactions? State the assumptions that the auditor must make in doing so. What does the auditor do if the assumptions are wrong?
> State the three categories of factors that affect acceptable audit risk and list the factors that the auditor can use to indicate the degree to which each category exists.
> State the four-step approach to designing tests of controls and substantive tests of transactions.
> List several audit procedures that the auditor can use to determine whether all cash received was recorded.
> In Part V of the Pinnacle Manufacturing case, you prepared a performance format audit program. In Part VI, sample sizes will be determined by using nonstatistical or attributes sampling, and the results of the tests will be evaluated. You should use nons
> Explain what is meant by lapping and discuss how the auditor can uncover it. Under what circumstances should the auditor make a special effort to uncover lapping?
> Section 404(a) of the Sarbanes-Oxley Act requires management of a public company to issue a report on internal control over financial reporting (ICOFR) as of the end of the company's fiscal year. Many companies have reported that their ICOFR was operatin
> The Albring Company sells electronics equipment, and has grown rapidly in the last year by adding new customers. The audit partner has asked you to evaluate the allowance for doubtful accounts at December 31, 2011. Comparative information on sales and ac
> The following are misstatements that have occurred in Fresh Foods Grocery Store, a retail and wholesale grocery company: 1. The incorrect price was used on sales invoices for billing shipments to customers because the wrong price was entered into the com
> List the transaction-related audit objectives for the audit of sales transactions. For each objective, state one internal control that the client can use to reduce the likelihood of misstatements.
> Rank the following types of tests from most costly to least costly: analytical procedures, tests of details of balances, risk assessment procedures, tests of controls and substantive tests of transactions.
> In Figure13-3, explain the difference among C3, C2, and C1. Explain the circumstances under which it will be a good decision to obtain audit assurance from substantive tests at point C1. Do the same for points C2 and C3. Figure 13-3 Audit Assurance from
> Each of the following internal controls has been taken from a standard internal control questionnaire used by a CPA firm for assessing control risk in the payroll and personnel cycle. 1. Approval of department head or foreman on time cards is required be
> The following questions deal with assessing control risk in a financial statement audit. Choose the best response. a. The auditor's tests of controls revealed that required approvals of cash disbursements were absent for a large number of sample transact
> The following questions deal with deficiencies in internal control. Choose the best response. a. Which of the following is an example of an operation deficiency in internal control? (1) The company does not have a code of conduct for employees to conside
> What is a walkthrough of internal control? What is its purpose?
> The auditor of Ferguson's Inc. identified two internal controls in the sales and collection cycle for testing. In the first control, the computer verifies that a planned sale on account will not exceed the customer's credit limit entered in the accounts
> List the transaction-related audit objectives for the verification of cash receipts. For each objective, state one internal control that the client can use to reduce the likelihood of misstatements.
> Dodge, CPA, is auditing the financial statements of a manufacturing company with a significant amount of trade accounts receivable. Dodge is satisfied that the accounts are correctly summarized and classified and that allocations, reclassifications, and
> Describe the concept of an integrated audit of the financial statements and internal control required by PCAOB standards.
> Distinguish between the sales journal and the accounts receivable master file. What type of information is recorded in each and how do these accounting records relate?
> Explain the effect of extensive misstatements found in the prior year's audit on inherent risk, planned detection risk, and planned audit evidence.
> What two conditions must be present for the auditor to issue an unqualified opinion on internal control over financial reporting? What type of condition will cause the auditor to issue a qualified or disclaimer of opinion on internal control over financi
> What is the difference between the auditor's approach in verifying sales returns and allowances and that for sales? Explain the reasons for the difference.
> Distinguish between the terms tolerable misstatement and preliminary judgment about materiality. How are they related to each other?
> List the types of specific control activities and provide one specific illustration of a control in the sales area for each control activity.
> The following internal controls for the acquisition and payment cycle were selected from a standard internal control questionnaire. 1. Checks are mailed by the owner or manager or a person under her supervision after signing. 2. All supporting documents
> What is the relationship among the five components of internal control?
> Explain what is meant by making an estimate of the total misstatement in a segment and in the overall financial statements. Why is it important to make these estimates? What is done with them?
> Chapter 8 introduced the eight parts of the planning phase of audits. Which part is understanding internal control and assessing control risk? What parts precede and follow that understanding and assessing control risk?
> Niosoki Auto Parts sells new parts for foreign automobiles to auto dealers. Company policy requires that a prenumbered shipping document be issued for each sale. At the time of pickup or shipment, the shipping clerk writes the date on the shipping docume
> Identify the eight accounts receivable balance-related audit objectives. For each objective, list one audit procedure.
> What two aspects of internal control must management assess when reporting on internal control to comply with Section 404 of the Sarbanes-Oxley Act?
> What is meant by the control environment? What are the factors the auditor must evaluate to understand it?
> Section 404(a) of the Sarbanes-Oxley Act requires management to issue a report on internal control over financial reporting. Identify the specific Section 404(a) reporting requirements for management.
> Describe which of the three categories of broad objectives for internal controls are considered by the auditor in an audit of both the financial statements and internal control over financial reporting.
> The following are various changes in audit circumstances. Audit Circumstance 1. Analytical procedures indicated a significant slowing in accounts receivable turnover. 2. The client entered into sales contracts with new customers that differ from the clie
> State a test of control audit procedure to test the effectiveness of the following control: Approved wage rates are used in calculating employees' earnings. State a substantive test of transactions audit procedure to determine whether approved wage rates
> Gale Brewer, CPA, has been the partner in charge of the audit of Merkle Manufacturing Company, a nonpublic company, for 13 years. Merkle has had excellent growth and profits in the past decade, primarily as a result of the excellent leadership provided b
> Distinguish between the TER and the CUER. How is each determined?
> The following are parts of a typical audit for a company with a fiscal year-end of July 31. 1. Confirm accounts payable. 2. Do tests of controls and substantive tests of transactions for the acquisition and payment and payroll and personnel cycles. 3. Do
> Auditors have not been successful in measuring the components of the audit risk model. How is it possible to use the model in a meaningful way without a precise way of measuring the risk?
> Define the audit risk model and explain each term in the model. Also describe which two factors of the model when combined reflect the risk of material misstatement.
> Kim Bryan, a new staff auditor, is confused by the inconsistency of the three audit partners she has been assigned to on her first three audit engagements. On the first engagement, she spent a considerable amount of time in the audit of cash disbursement
> Describe accounting requirements for proper recording of sales returns and allowances.
> The following are three situations, all involving nonpublic companies, in which the auditor is required to develop an audit strategy: 1. The client has inventory at approximately 50 locations in a three-state region. The inventory is difficult to count a
> Define each of the following terms: a. Acceptable risk of assessing control risk too low (ARACR) b. Computed upper exception rate (CUER) c. Estimated population exception rate (EPER) d. Sample exception rate (SER) e. Tolerable exception rate (TER)
> Following are several decisions that the auditor must make in an audit of a nonpublic company. Letters indicate alternative conclusions that could be made. Required a. Identify the sequence in which the auditor should make decisions 1 to 4. b. For the a
> A considerable portion of the tests of controls and substantive tests of transactions are performed simultaneously as a matter of audit convenience. But the substantive tests of transactions procedures and sample size, in part, depend on the results of t
> Following are evidence decisions for the three audits described in Figure 3-3 Figure 3-3 Audit A Ineffective client internal controls Audit B Very effective client internal controls Audit C Somewhat effective client internal controls Evidence Decisions 1
> Beds and Spreads, Inc. specializes in bed and bath furnishings. Its inventory system is linked through the Internet to key suppliers. The auditor identified the following internal controls in the inventory cycle: 1. The computer initiates an order only w
> Assume that Rosanne Madden, CPA, is using 5% of net income before taxes, current assets, or current liabilities as her major guidelines for evaluating materiality. What qualitative factors should she also consider in deciding whether misstatements may be
> What is meant by planned detection risk? What is the effect on the amount of evidence the auditor must accumulate when planned detection risk is increased from medium to high?
> Distinguish among tests of details of balances, tests of controls, and substantive tests of transactions for the sales and collection cycle. Explain how the tests of controls and substantive tests of transactions affect the tests of details of balances.
> For this problem use the Metaphor-Trans-All file in ACL Demo, which is a file of outstanding sales invoices (each row represents an invoice transaction). The suggested command or other source of information needed to solve the problem requirement is incl
> BestSellers.com sells fiction and nonfiction books to customers through the company's Web site. Customers place orders for books via the Web site by providing their name, address, credit card number, and expiration date. What internal controls could Best
> You are auditing the sales and collection cycle for the Smalltown Regional Hospital, a small not-for-profit hospital. The hospital has a reputation for excellent medical services and deficient record keeping. The medical people have a tradition of doing
> In the confirmation of accounts receivable for the Reliable Service Company, 85 positive and no negative confirmations were mailed to customers. This represents 35% of the dollar balance of the total accounts receivable. Second requests were sent for all
> Frank James, a highly competent employee of Brinkwater Sales Corporation, had been responsible for accounting-related matters for two decades. His devotion to the firm and his duties had always been exceptional, and over the years, he had been given incr
