Professional Documents
Culture Documents
SUBSTANTIVE TESTS OF
TRANSACTIONS AND BALANCES
I. Review Questions
1. The cutoff bank statement is a bank statement sent by the bank directly to the
auditor, and it is usually for a fifteen or twenty day period following the
reconciliation date. The basic use of the statement by the auditor is to determine
whether outstanding checks were actually mailed before the reconciliation date.
2. All cash funds (and negotiable investment stock and bond certificates) should be
counted at the same time (simultaneously) so that money (or securities) cannot
be shifted from one location to another to conceal a shortage. If simultaneous
count cannot be made, as each fund (or each negotiable asset) is counted, it
should be locked and sealed until all are counted.
9. Auditors get in the most trouble by missing overstated assets and understated
liabilities. Therefore, they need to audit for the existence of assets and the
completeness of liabilities.
10. Notes payable audit evidence obtained from a standard bank confirmation used
in the audit cash. Sales tax liability derived partially from the audit of sales
revenue (also commissions payable and excise taxes payable). Income tax
liability is derived from the net income number (audit of all revenue and
expense accounts).
11. The types of fraud and material misstatement with respect to cash disbursements
include:
1. The sending of checks to a fictitious person or company to accomplices
outside (coupled with internal record alterations).
2. The increasing (altering) of amounts payable to outside accomplices.
3. The intercepting of payments to a bank (coupled with internal record
alterations).
4. The drawing of checks payable to cash or bearer for one’s own use.
12. The characteristics that the auditor is looking for in his review of the client’s
inventory-taking instructions include:
1. Names of client personnel responsible for the count.
2. Dates and times of inventory-taking.
3. Names of client personnel who will participate in the inventory-taking.
4. Detail instructions for recording accurate descriptions of inventory items,
for count and double-count, and for measuring or translating physical
quantities.
5. Detail instructions for making notes of obsolete or worn items.
6. Detail instructions for the use of tags, punched cards, count sheets, or other
media devices, and for their collection and control.
7. Plans for shutting down plant operations or for taking inventory after store
closing hours, and plans for having goods in proper places.
8. Plans for counting or controlling movement of goods in receiving and
shipping areas if those operations are not shut down during the count.
9. Detail instructions for compiling the count media (e.g., tags and punched
cards) into final inventory listings or summaries.
10. Detail instructions for pricing the inventory items.
11. Detail instructions for review and approval of the inventory count, notations
of obsolescence, or other matters by supervisory personnel.
13. As is true in other areas of a financial audit, verbal inquiry is a valuable tool for
obtaining preliminary evidence in the audit of inventory and cost of sales. For
example, the auditor can gain information such as the locations of inventory,
dates for the physical count, inventory held by consignees and public
warehouses, the cost-flow assumption used to price cost of goods sold and
inventories, and the pledging of inventory as collateral on loans.
16. To obtain relevant audit data about investment securities, auditors’ procedures
include:
1. Inspecting the securities in the presence of a responsible client officer.
2. Personally examining the securities while other negotiable fund sources are
sealed off or are being examined simultaneously.
3. Obtaining a written statement from the client’s representative that the
securities were returned intact.
4. Obtaining the information by confirmation from an independent party (e.g.,
trustee) who holds the securities.
17. Investment cost can be vouched to brokers’ advices, monthly statements and
canceled checks. The auditors can similarly vouch the price of securities sold
and investment income to this documentary evidence and then trace amounts to
income, gain and loss, and cash accounts.
18. If investments are sold at substantial losses early in the period following year-
end, there is evidence that the securities were overvalued at the balance sheet
date. Accordingly, the auditor will consider whether such securities should be
written down in the financial statements of the period under audit.
19. The long-term liabilities (and fixed assets and owners’ equity) are characterized
by a few large transactions, unlike the current assets and liabilities which have
numerous small transactions. Except for the initial year of an audit, the entire
balance is not verified each year. Only the changes in the account that occurred
in the current period need to be audited. The results of the audit of prior year’s
changes are recorded in “carry-forward” working papers for these accounts.
22. The following matters are usually covered during the conference with the client
at audit completion:
a. Proposed audit adjustments;
b. Material internal financial control weaknesses;
c. Recommended footnote disclosures;
d. Type of audit report to be rendered.
1. b 5. c 9. b 13. c 17. d
2. b 6. c 10. c&d 14. d 18. a
3. d 7. c 11. b 15. d 19. a
4. d 8. b 12. b 16. c 20. c
Case 1. a. The CPA’s test of the sales cutoff at June 30 should include the
following steps:
1. Determine what JETO’s cutoff policy is, review the policy for
reasonableness, and compare it to the prior year for consistency.
2. Select a sample of sales invoices (including the last serial invoice
number) from those recorded in the last few days of June and the first
few days of July.
3. Trace these sales invoices to shipping documents and determine that
sales have been recorded in the proper period in accordance with
company cutoff policy.
4. Determine that the cost of goods sold has been recorded in the period
of sale.
24-6 Solutions Manual - Principles of Auditing and Other Assurance Services
5. Select a sample of shipping documents for the same period and trace
these to the sales invoice. Determine that the sale and the cost of goods
sold have been recorded in the proper period.
6. Review the cutoff for sales returns and allowances, determine that it
has been based upon a consistent policy and that there have not been
abnormal sales returns and allowances in July; this might indicate
either an overstatement of sales during the audit period or the need for a
valuation account at June 30 to provide for future returns and
allowances.
b. (1) The CPA will use the July 10 cutoff bank statement in his review of the
June 30 bank reconciliation to determine whether:
(a) The opening balance on the cutoff bank statement agrees with the
“balance per bank” on the June 30 reconciliation.
(b) The June 30 bank reconciliation includes those canceled checks
that were returned with the cutoff bank statement and are dated or
bear bank endorsements prior to July 1.
(c) Deposits in transit cleared within a reasonable time.
(d) Interbank transfers have been considered properly in determining
the June 30 adjusted bank balance.
(e) Other reconciling items which had not cleared the bank at June 30
(such as bank errors) clear during the cutoff period.
3. a. Valid liabilities are recorded and none omitted (sound error checking
practices).
b. Observe client personnel making comparisons. Review correcting
journal entries that result from the comparison.
c. Purchases or other liabilities may fail to be recorded and the error not
detected by any other means.
Case 4. a. The fact that the client made a journal entry to record vendors’ invoices
which were received late should simplify the CPA’s audit for unrecorded
liabilities and reduce the possibility of a need for a further adjustment, but
the CPA’s audit is nevertheless required. If the client has not journalized
late invoices, the CPA is compelled in his testing to substantiate what will
ultimately be recorded as an adjusting entry. In this examination the CPA
should audit entries in the 2004 voucher register to ascertain that all items
which according to dates of receiving reports or vendors’ invoices were
applicable to 2004 have been included in the journal entry recorded by the
client.
24-8 Solutions Manual - Principles of Auditing and Other Assurance Services
b. No. The CPA should obtain a letter in which responsible executives of the
client’s organization represent that to the best of their knowledge all
liabilities have been organized. However, this is done as a normal audit
procedure to afford additional assurance to the CPA and it does not relieve
him of the responsibility for doing his own audit work.
d. In addition to the 2005 voucher register, the CPA should consider the
following sources for possible unrecorded liabilities:
1. Unentered vendors’ invoice file.
2. Status of tax returns for prior years still open.
3. Discussions with employees.
4. Representations from management.
5. Comparison of account balances with preceding year.
6. Examination of individual accounts during the year.
7. Existing contracts and agreements.
8. Minutes.
9. Attorney’s bills and letter of representation.
10. Status of renegotiable business.
11. Correspondence with principal suppliers.
12. Audit testing of cutoff date for reciprocal accounts, e.g., inventory and
fixed assets.
Case 5. a. Lourdes should find in the audit working papers a planning memo
describing the client’s inventory-taking plan and notes about the auditor’s
first-hand observation of the instructions being given to counters, along
with a memo about the auditors’ observation of the counting. This memo
should tell about supervision of the audit staff, and the working papers (test
counts) should show the review signatures of the supervising auditors.