Analytical procedures

CPA Auditing & Attestation Analytical Procedures Question Which of the following is a good reason why an auditor performs analytical procedures on the client's operations? A To uncover material weaknesses in internal control B To spot points where there is a lack of separation of accounting and other financial duties C To uncover any non-compliance with prescribed control procedures D To identify unusual transactions that may warrant further investigation The correct answer was D Analytical procedures consist of evaluations of financial information made by a study of various relationships among both financial and nonfinancial data One of the primary objectives of analytical procedures in an audit is to identify unusual transactions and balances that may indicate a high level of risk for a material misstatement Thus, analytical procedures help determine where further investigation is warranted Question Analytical procedures are most likely to detect: A Internal control weaknesses B Unusual transactions C Non-compliance with prescribed control procedures D Material misstatements in the financial statements The correct answer was B Analytical procedures consists of evaluations of financial information made by a study of various relationships among both financial and nonfinancial data This answer is correct because one objective of analytical procedures is the identification of unusual transactions and events, amounts, ratios and trends that might signal misstatements Analytical Procedures Auditing & Attestation CPA Question Many auditors perform extensive analytical procedures on audits because of which of the following? A They pinpoint errors in the accounts B They indicate areas of potential risk and misstatement C They provide evidence that account balances are complete D They help the auditor to establish the strength of the company's internal control The correct answer was B Analytics are concerned with plausible relationships The objective of the procedures is to identify such things as the existence of unusual transactions and events, and amounts, ratios, and trends that might indicate matters that have financial statement and audit planning ramifications Question Which of the following nonfinancial information would an auditor most likely consider in performing analytical procedures during the planning phase of an audit? A Square footage of the selling space B Turnover of the personnel in the accounting department C Commitment of the audit committee members D Management's plans to restructure debt The correct answer was A Analytical procedures are concerned with plausible relationships The square footage of selling space might be used to compare retail revenues and expenses to industry figures and prior year performance Analytical Procedures Auditing & Attestation CPA Question As a result of analytical review procedures, the independent auditor determines that the gross profit percentage has declined from 25% in the preceding year to 15% in the current year The auditor should A Consider the possibility of an error in the financial statements B Require footnote disclosure C Evaluate management's performance in causing this decline D Express an opinion which is qualified due to inability of the client company to continue as a going concern The correct answer was A Analytics are concerned with plausible relationships The objective of the procedures is to identify such things as the existence of unusual transactions and events, and amounts, ratios, and trends that might indicate matters that have financial statement and audit planning ramifications Question An entity's income statements were misstated due to the recording of journal entries that involved debits and credits to an unusual combination of expense and revenue accounts The auditor most likely could have detected this irregularity by A Tracing a sample of journal entries to the general ledger B Evaluating the effectiveness of the internal control structure policies and procedures C Performing analytical procedures designed to disclose differences from expectations D Investigating the reconciliations between controlling accounts and subsidiary records AU 329 states that analytical procedures used in planning the audit generally use data aggregated at a high level An unusual combination of expense and revenue accounts in a journal entry might result in unusual aggregate information Analytical Procedures Auditing & Attestation CPA Question Analytical procedures performed during an audit indicate that accounts receivable doubled since the end of the prior year However, the allowance for doubtful accounts as a percentage of accounts receivable remained about the same Which of the following client explanations would satisfy the auditor? A The client tightened its credit policy during the current year and sold considerably less merchandise to customers with poor credit ratings B The client opened a second retail outlet during the current year and its credit sales approximately equaled the older outlet C A greater percentage of accounts receivable are listed in the 'more than 120 days overdue' category than in the prior year D Internal control activities over the recording of cash receipts has been improved since the end of the prior year The correct answer was B Increase sales to similar customers would double accounts receivable without a change in the allowance for doubtful accounts as a percentage of accounts receivable Question An auditor would most likely apply analytical procedures in the overall review stage of an audit to A Enhance the auditor's understanding of subsequent events B Identify auditing procedures omitted by the staff accountants C Determine whether additional audit evidence is needed D Evaluate the effectiveness of internal control activities The correct answer was C Analytics are used in the overall review stage to assist the auditor in assessing conclusions reached and in evaluating the overall financial statement presentation The results of the review may indicate that additional evidence may be needed Analytical Procedures Auditing & Attestation CPA Question Analytical review procedures are A Compliance tests designed to evaluate the reasonableness of financial information B Substantive tests designed to evaluate the reasonableness of financial information C Compliance tests designed to evaluate the validity of management's representation letter D Substantive tests designed to evaluate a system of internal control The correct answer was B Analytical review procedures are substantive tests Question 10 An auditor's analytical procedures are most likely to be facilitated if the entity A Segregated obsolete inventory before the physical inventory count B Uses a standard cost system that produces variance reports C Develops its data from sources solely within the entity D Corrects material weaknesses in internal control before the beginning of the audit The correct answer was B The use of a standard cost system that produces variance reports allows the auditor the opportunity to compare the output from the standard cost system with the financial information presented by management Note, the objective of utilizing analytical procedures is to identify such things as the existence of unusual transactions and events, amounts, ratios and trend in the financial data Analytical Procedures Auditing & Attestation CPA Question 11 Independent auditors have carried out analytical procedures on an audit client and determined that the reported liabilities at the end of Year One are significantly lower than expected Which of the following is most likely to have created this situation? A Purchases received during the last few days of Year One were recorded in Year Two B Sales made during the first few days of Year Two were recorded in Year One C Cash payments made during the last few days of Year One were recorded in Year Two D Cash collections made during the first few days of Year Two were recorded in Year One The correct answer was A Sales and cash collections are unlikely to have an impact on the amount of reported liabilities However, purchases and cash payments affect the liability balance By not recording the purchases in Year One, the liability was incorrectly omitted and would be too low at the end of the year By not recording the cash payments in Year One, the liability (although paid) incorrectly remains on the books and is too high Question 12 Jones and Winehouse CPAs are doing an audit and are currently carrying out analytical procedures The age of accounts receivable is computed and compared to the prior year The age has increased by a large amount Which of the following is the independent auditor least likely to find as a result of uncovering this information A The client may have loosened up its credit terms so that a larger bad debt expense is needed than in the past B The client may have started selling its accounts receivable to a bank so that a loss should be recognized C Economic times might have gotten worse so we need to look more closely to make sure all bad accounts have been written off D Someone inside of the company might have begun lapping as a way of stealing money Analytical Procedures Auditing & Attestation CPA The correct answer was B When receivables are sold before they are collected (they certainly would not be sold after they were collected), the age should get shorter The company is getting its money faster as a result of the sale Thus, sale of A/R to a bank is a possible answer if the average age had gotten shorter However, if the age gets higher, it could be that the credit terms have been loosened so that customers with less money are able to buy on credit They typically take longer to pay with more risk of becoming uncollectible When economic times are bad, people also tend to pay more slowly and the number of bad accounts goes up And, in lapping, money from a customer is stolen Several days later, to keep the customer from finding out that the money was never recorded by the company, money from a second customer is diverted into the account of the first customer The period in between makes the age of the accounts longer Question 13 An auditor looks at an audit client’s interest expense balance and it seems significantly higher than had been expected What type of problem is the auditor most likely to be concerned might exist? A The company has issued a bond at a discount and is only recording the cash interest payments as interest expense B No year-end adjusting entry was recorded to recognize interest owed by the company on that date C Long-term debt is outstanding but has not been recorded by the company D Interest expense was accidentally recorded as a reduction in interest revenue The correct answer was C A, B, and D are all potential problems but they would each cause the Interest Expense account to be low In A, yearly amortization of the discount was not included in interest expense In B, the interest owed at the end of the year was not included in interest expense In D, interest expense was recorded but not in the Interest Expense account However, with C, because the debt was not recorded, it looks like the company should have a low amount of interest expense If the company then pays interest on this unrecorded debt, the interest expense will be higher than expected That is what the auditor is seeing Analytical Procedures Auditing & Attestation CPA Question 14 A CPA firm is auditing a client that sells merchandise on credit to a wide variety of customers Last year, the accounts receivable turnover ratio was 5.9 but this year it has fallen to 4.1 The auditor is concerned by the significance of that change and hopes to find a logical explanation Which of the following is most likely to explain the cause of that change? A The company has dropped its sales prices but shortened the length of time a customer is given to pay before a late charge is assessed B The company accountant has fraudulently tried to boost reported net income by debiting inventory and crediting sales when no transaction took place C The company is making a higher percentage of its sales for cash D The company started making sales on consignment this year and recording those transactions as credit sales at the time of shipment to the consignee although no cash has yet been collected The correct answer was D The accounts receivable turnover ratio is found by taking sales and dividing it by accounts receivable For example, sales of $590,000 and accounts receivable of $100,000 lead to a 5.9 ratio In D, both the sales and accounts receivable figures are incorrectly inflated because a consignment sale does not occur at the time of shipment but only when the goods are actually sold by the consignee For example, if those sales were recorded at $60,000 and no sale to a third party has yet occurred, sales would be $650,000 ($60,000 too high) and accounts receivable would be $160,000 The accounts receivable turnover ratio would drop to 650,000/160,000 or 4.1 In A, the customers will pay quicker and the turnover ratio will increase rather than decrease In B, the sales figure is increased but not accounts receivable and that will also cause the turnover ratio to rise In C, sales stays the same but accounts receivable goes down which, once again, makes the turnover ratio larger rather than smaller Question 15 The Malfoy Company makes a huge purchase of inventory near the end of Year Two that is shipped to the company on December 30, Year Two It is sent FOB shipping point However, no record is made of this inventory until it is received on January 9, Year Three In looking at the company’s Year Two financial statements, which of the following is most likely to alert the auditor that a recording error has occurred? A The Year Two current ratio is much higher than the Year One current ratio Analytical Procedures Auditing & Attestation CPA B The Year Two gross profit is much lower than the Year One gross profit C The Year Two inventory turnover is much higher than the Year One inventory turnover D The Year Two working capital is much lower than the Year One working capital The correct answer was C Nothing has been recorded in Year Two even though the goods (and the related debt) belong to Malfoy because of the FOB point The goods were not received in Year Two and, therefore, could not have been sold The cost of goods sold was not affected by the purchase and, thus, the gross profit is correctly stated There are only two mistakes Inventory is too low and accounts payable is also too low by the same amount Those mistakes offset so that both working capital and the current ratio are also correctly reported However, inventory turnover is cost of goods sold divided by the average inventory for the period If inventory was too low at the end of Year Two, then the average inventory will also be too low Therefore, since cost of goods sold is correctly stated, the inventory turnover will be too high Question 16 The auditor is examining the financial statements for Zeller Corporation and discovers that the inventory turnover for the current year was much higher than that of the previous year Which of the following is a potential reason for this change that would not concern the auditor as to whether a material misstatement might have occurred? A The company placed a large order for inventory near the end of the year but the delivery got delayed until the following year because of a strike by truck drivers B Inventory sales were made near the end of the year and recorded as FOB shipping point when they were really FOB destination C Near the end of the year, the company started capitalizing inventory costs that had previously been expensed D Goods were shipped out on consignment but recorded as sales The correct answer was A Inventory turnover is the cost of goods sold for the year divided by the average (or ending) inventory An increase in inventory turnover is caused by cost of goods sold increasing or inventory decreasing If an expected order was not received by the end of the year, inventory levels would be below the normal level And, since there is a legitimate reason for this drop, it meets the criteria here An incorrect FOB point is a mistake that would need Analytical Procedures Auditing & Attestation CPA to be investigated Capitalizing a cost causes the inventory balance to increase rather than decrease Recording consignment shipments as sales would cause the noted problem here (high cost of goods sold and low inventory) but that is mistake that would be investigated by the auditor Question 17 Maricela just got hired by a Big Four accounting firm and is currently in "audit boot camp." Her first lesson is on analytical procedures Maricela studied financial ratios in her university classes, so she felt confident going into her boot camp training However, she was surprised to find that only one of following statements about analytical procedures is true Which is the true statement? A Results of analytical procedures not constitute substantive evidence during an audit B Analytical procedures are required to be performed during the final audit review to verify the appropriateness of the auditor's conclusions C Analytical procedures and financial ratios are equivalent, as analytical procedures only involve financial data D While a useful tool, analytical procedures are not required during audit planning The correct answer was B According to AU 329, analytical procedures are required during final audit review The other statements are false Analytical procedures are also required during audit planning Moreover, results of analytical procedures can constitute substantive evidence during an audit and involve studying relationships among both financial and nonfinancial data 10 Analytical Procedures ... statements about analytical procedures is true Which is the true statement? A Results of analytical procedures not constitute substantive evidence during an audit B Analytical procedures are required... auditor''s conclusions C Analytical procedures and financial ratios are equivalent, as analytical procedures only involve financial data D While a useful tool, analytical procedures are not required... 329, analytical procedures are required during final audit review The other statements are false Analytical procedures are also required during audit planning Moreover, results of analytical procedures