RE Revisjon 1 Candidate 7608 KANDIDAT PRØVE. RE Revisjon :00. Sensurfrist 1/8

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1 KANDIDAT 7608 PRØVE RE Revisjon 1 Emnekode RE-400 Vurderingsform Skriftlig eksamen Starttid :00 Sluttid :00 Sensurfrist -- PDF opprettet :17 Opprettet av Digital Eksamen 1/8

2 1 RE-400, general information Course code: RE-400 Course name: Auditing 1 Date: October 13th 2017 Duration: 4 hours Resources allowed: English-Norwegian dictionary (Calculator is not necessary) Notes: Directions: Please answer the following questions in complete sentences and in paragraph form. You should have a separate answer for each part of a question and this should be clearly identified. Each question is worth 20 points, so divide your time evenly between the six questions. Good luck. Impress me with your answers The professors sometimes ask for exam answers to be used for teaching purposes, but in order for this to take place, the university needs your consent. Do you grant the University of Agder permision such permission? Select an alternative: No Yes Riktig. 0 av 0 poeng. 2 RE-400, question 1 Question 1 (20 points) Consider the revenue business process and the expenditure business process for a Norwegian company. Answer the following questions regarding the audit work needed for these business processes. 1. Assess the likelihood that you will test internal controls for both of these business processes. Explain your answer. 2. Identify relevant assertions for significant accounts that are likely to be important for each of these business processes. Explain why. 3. Identify two substantive tests of transactions that you are likely to perform for each business process. What evidence will these tests provide? 4. Describe a substantive test of balances that you are likely to perform for each business process. What evidence will these tests provide for each business process? 2/8

3 1. The auditor will most likely test internal controls for both the revenue bussiness process and the expenditure business process. The reason the auditor is likely to do so is because of the quantity of transactions in the two business processes during the year. With such a great amount of transactions we need to identify if the internal controls will prevent or detect materially misstatements. 2. In the revenue business process relevant assertions for significant accounts that are likely to be important is existence, accuracy and cutoff for revenue, and existence, valuation and rights of accounts receivable. The reason these are the relevant assertions for the significant accounts is because we worry most about an overstatement in the revenue business process. In the expenditure business process relevant assertions for significant accounts that are likely to be important is completeness, classification and cutoff for expences, and completeness, valuation and obligations of accounts payable. The reason these are the relevant assertions for the siginicant accounts is because we worry most abount an understatement in the expenditure business process. Management often wants to increase net income, and to do that, management will overstate revenue and understate expenditures. The reason management wants to increase net income is because outsiders expect the company to deliver good results, and growth. The main reason for mangament wanting to meet the outsiders expectations is to keep the company's stockprice up. 3. When performing substantive tests of transactions all transactions during the year are the population. This is because the auditor needs to test all transactions during the year for the income statements. A substantive test of transactions likely to perform for the revenue business process, is for the auditor to select a sample of transactions from during the whole year from the sales records and go to the shipping document to see if the same transactions exists there, if they're really shipped and sold. This gives the auditor evidence for existence of the revenue-account and could also give evidence for existence of the accounts receivable. If the auditor compares the dollar amounts at the same time, he or she also will gather evidence to the accuracy of revenue and valuation of accounts receivable. A cutoff test for the revenue business process is to inspect sales documents from 5-10 days before and after year-end. This will give the auditor evidence about cutoff and both existence and completeness for the revenue-account. Substantive test of transactions likely to perform for the expenditure business process: Here, the relevant assertion is completeness, so we need to test the other way. The auditor could select a sample of vendor invoices and check if all the transactions found in the vendor's invoices are in the expenditure accounts. This gives the auditor evidence for completeness of the expenditure accounts and could also give evidence for completeness of the accounts payable. If the auditor compares the dollar amounts at the same time, he or she will also gather evidence to the accuracy of expenditures and valuation of accounts payable. A cutoff test for the expanditure business process is to inspect purchase-documents from 5-10 days before and after year-end. This will give the auditor evidence about cuttoff and both existence and completeness for the expenditures. 4. When the auditor performs substantive tests of balances, the population is the account balances at year-end. This is because the auditor only is supposed to confirm the account balances at year-end, not the transactions during the year in the balance-sheet accounts. A substantive test of balances the auditor is likely to perform for the revenue process is sending confirmations of accounts receivable to the company's customers. This will provide evidence whether the accounts receivables are valued right, and whether the company have the rights to collect the money (if the customers gives accurate feedbacks). It might also gives evidence regarding existence of the revenue-account. A substantive test of balances the auditor is likely to perform for the expenditure business process is going through the company's documents regarding purchases done during the year, could be vendor's invoice, and compare them up to the financial statements. In this way, the auditor checks the accounts payable account for completeness and valuation and the companys obligations to pay their bills. It might also gives evidence regarding completeness of the expenditure-accounts. 3 RE-400, question 2 3/8

4 3 RE-400, question 2 Question 2 (20 points) Answer the following questions related to the audit sampling process. 1. Why does an auditor sample? 2. What type of evidence can the auditor gather in the sampling process? 3. What decision can an auditor make based on an audit sample? 4. What is the difference between how sampling is done related to tests of controls and how sampling is done for substantive tests? 5. Identify the factor in sampling that is absolutely key to the auditor s ability to rely on the sampling results? Explain why this factor is so important. 6. How does the auditor combine the evidence from internal control tests and the evidence from substantive tests to make a decision about the company? What role does the evidence play in this decision? 7. What decision does sampling allows the auditor to make and how is the decision disclosed to outsiders? 1. An auditor samples when there's populations where the auditor cannot test the whole population (<100%). When sampling, the auditor gathers evidence regarding the whole popluation without testing the whole population. 2. In the sampling process the auditor can gather different evidences if there's sampling for test of internal controls or if it is sampling for substantive tests. When sampling for test of internal controls, the auditor can gather evidence related to if the internal control is working. Internal controls that can be sampled are documented transaction trails, independent reconziliations and authorization procedures. When sampling for substantive tests, the auditor can gather evidence whether the account balance or transaction is without material misstatements. 3. Based on an audit sample, the auditor can make a decision for the whole population. When sampling for test of internal controls, he can make decisions whether to rely on the internal controls or not. When sampling for substantive tests, he can make decisions whether the accounts are without material misstatements. 4. When performing sampling related to tests of controls the sampling unit is the documents controled during the year, and when performing sampling related to substantive tests the sampling unit are either each dollar amount in the balance sheet account or each transaction in the income statement. 5. The factor in sampling that is absolutely key to the auditor's ability to rely on the sampling resluts is the laws of statistics. This factor is so important because if we couldn't belive in the laws of statistics, we couldn't perform samplig. These are laws, not something assumed. 6. The evidence from internal control tests are evidence regarding the company's control risk. The evidence from substantive tests are related to the auditor's detection risk. If the control risk is high, the detection risk is low and the auditor needs to perform more substantive testing. The evidence from substantive testing says if the audit risk is at an acceptably low level, if it is, the auditor can give a clean audit opinion. 7. Sampling allows the auditor to make a decision about the whole population based on a representative sampling unit. if the results of the sampling is that the internal controls are working (if tested), and the balance sheet accounts and income statement transactions are without material misstatements, audit risk is at an acceptably low level, and the decision is disclosed to outsiders as an clean audit opinion. 4 RE-400, question 3 Question 3 (20 points) 4/8

5 Describe the audit risk model. How does the auditor use this model in the three stages of the audit: (1) planning the audit, (2) the testing phase of the audit, and (3) the decision phase of the audit? The audit risk model includes inherent risk, control risk, detection risk that together defines the audit risk. Audit risk is the risk that the auditor will make an unqualified opinon for a financial statement that is materially misstated. Audit risk is a combination of materially misstatement risk and detection risk. Materially misstatement risk is the risk that the financial statements have materially misstatements before the auditor reviews the financial statements. Material misstatements are misstatements who would make outsiders to change their decitions regarding the company, typical selling/buying stocks, investing. This risk inclues inherent risk and control risk. Inherent risk is the risk that the clients financial statements would include materially misstatements given no internal controls. Control risk is the risk that company's internal controls don't prevents or detects the material misstatements. Then there's detection risk, that is the risk that the auditor doesn't find (=detect) the material misstatements during the audit. Detection risk is the only risk the auditor can control, and he or she controls is with the amount of substantive testing performed. Audit risk = Inherent risk x Control risk x Detection risk Audit risk is different for each customer before the audit, but when the audit is complete, the auditor's goal is to get the audit risk to an acceptably low level (thought to be about 5%) for every company audited. The auditor sets the inherent risk based on the individual company's riskprofile. Control risk is either set to maxiumum (1.0) if the auditor don't think that he or she can rely on the company's internal control procedures. Or if the auditor thinks that the company's internal control procedures are realiable he or she will perform test of internal controls to set the control risk. The auditor can set the risk to low (30%), medium, (50%) or high (70%), and then test if the controls are realiable to the level expected. If they are, the auditor sets the risk to this level, and if not, the auditor needs to either adjust the risk up to the level that matched the deviations found during the internal control test (.3->.5,.5->.7), or set the risk to maximum. Detection risk decides the amount of substantive testing the auditor should perform. How the auditor sets detection risk depends on the risk of material misstatements. To find detection risk, we rearange the audit risk model: Detection risk = audit risk / (inherent risk x control risk) If control risk is low, detection risk is high and the auditor could perfom less substantive testing If control risk is high, detection risk is low and the auditor needs to perform more substantive testing. To set control risk to low, the auditor needs to perform more test on controls, but this means that he can perform less substantive testing. (1) planning the audit; the auditor uses the audit risk model to set the company's inherent risk. (2) the testing phase of the audit; the auditor uses the audit risk model to evaluate how much substantive testing to perform. This includes to set the control risk, and choose whether to test internal controls, and set the detection risk based on this, and then perform substantive testing. (3) the decision phase of the audit; the auditor uses the audit risk model to see if an aceptably low level of audit risk is reached, and then if the audior can give an unqualified audit opinion. 5 RE-400, question 4 Question 4 (20 points) Near the end of the audit, the auditor completes several audit procedures required by the auditing standards. Explain how the auditor gathers evidence related to each procedure and how this evidence is reported in the financial statements. 5/8

6 1. Contingent liabilities 2. Related party transactions 3. Audit documentation 4. Proposed audit adjustment schedule 5. Review of other information in the financial statements. 1. Related to contingent liabilities the auditor gathers evidence by inquiring management, inspect documents, observe meetings regarding the liabilities, the auditor could send confirmation to whom the liabilities affects. 2. Related to related party transactions the auditor gathers evidence by inquiring management and inspect documents. 3. Related to the audit documentation, the auditor gathers evidence by getting the confirmation document from management, this is a confirmation from management to the auditor. 4. Related to the proposed audit adjustment schedule, the auditor gathers evidence by propose the adjustment and keep the schedule in the working papers. 5. Related to the review of other information in the financial statements, the auditor gathers evidence by inquiry of the management, inspection, observation, confirmations and recalculations. How this evidence are reported in the financial statements, are in the footnotes. 6 RE-400, question 5 Question 5 (20 points) Please answer the following questions related to the inventory business process. 1. What assertions are likely to be the most relevant for the inventory business process? Explain your answer. 2. Describe the auditor s job related to gathering evidence in the inventory business process. What type of testing does it involve? When is the evidence typically gathered? 3. What accounting issues are important for inventory? Are these issues easy for the auditor to resolve or difficult? Explain your answer. 6/8

7 1. The assertions that are likely to be the most relevant for the inventory business process are existence and valuation. The reason is because we need to know if the inventory reported in the financial statements really exists in the company and when we know if is existes, we need to be sure that it is valuated right. If the inventory doesn't exist, we have an overstating of inventory. We worry most about clients overstating inventory because that means an understating of cost of goods sold, that leads to an increase in net income. 2. The auditor's job related to gathering evidence in the inventory business process is to gather evidence that the inventory business process doesn't involve materially mistatements. In the inventory business process, the auditor normally don't test internal controls unless there's a production company. The main test is for the auditor to participate the physical inventory counting. There the auditor tests inventory from the store up agains the lists to get evidence regarding completeness, and selects items from the list to find the physical inventory to get evidence regarding existence. The auditor also compares the prices from the shelves to the lists to get evidence regarding the valuation of the inventory. If possible, the auditor looks for obsolete inventory that needs to be written off. The evidence is typically gathered at year-end, or if the client have good systems it could be gathered one to two months before year-end. Then the results needs to be adjusted to the year-end values. 3. Accounting issues importat for inventory is to value the inventory to either FIFO or average cost, and then lowest of net realizeable value or cost at year-end. An issue is that the amount of inventory is not correct at year-end before performing the physical inventory count because of theft and obsolete inventory etc. These issues are resolved with making the results from the inventory count the new/correct amount of inventory. And then, when the amount is correct, the inventory needs to be valued right. The company needs to write off obsolete items and value at lowest of net realizeable value or cost. (When written off, net realizeable value needs to be lower than cost). The auditor only controls the corrections, and there's sometimes diffucult for the auditor to find if there's items that should be written off, and isn't. It depends on the type of inventory. 7 RE-400, question 6 Question 6 (20 points) The auditor has documented the following internal control procedures used by the client. For each procedure, explain the test you would perform to determine if the control was working and the assertion that you would be testing. 1. The shipping clerks compare goods received from the warehouse with approved sales orders and initial the sales order indicating their agreement. 2. The accounting department compares the sales invoice price with the master price file and initials the sales invoice indicating agreement. 3. Sales invoices are compared with shipping documents and approved customer orders before invoices are mailed. The accounts receivable clerk initials the shipping document indicating the agreement. 4. Goods returned for credit are approved by the supervisor of the sales department. The credit memo is initialed by the supervisor indicating approval. 5. The total cash payments posted to the accounts receivable ledger from remittance advices is compared to the bank deposit slip by the accounting department. The clerk in the department indicates that the two agree by initialing the reconciliation report. 7/8

8 These are all internal control procedures performed by the client, and to test them the auditor needs to use either inquiry, inspcetion, observation or reperformance since they are the procedures an auditor can use to test internal controls. The controls used by the client are related to segregation of duties, documented transaction trails, independent reconziliations, authorization procedures or physical controls that limit access to assets. All of these internal controls includes authorization procedures, and that could easily be controlled for by inspection of whether the initials exists on the relevant documents. 1. The test I would perform to determine if the control was working, is ispection of the sales order for the shipping clerks initials. The assertion that would be tested is accuracy. 2. The test I would perform to determine if the control was working, is inspcetion of the sales invoice for the accounting depertment's initials. The assertion that would be tested is accuracy. 3. The test I would perform to determine if the control was working, is inspcetion of the shipping document for the accounts receivable clerk's initials. The assertion that would be tested is existence. 4. The test I would perform to determine if the control was working, is inspection of the credit memo for the supervisor's initials. The assertion that would be tested is completeness. 5. The test I would perform to determine if the control was working, is inspection of the reconciliation report for the clerk in the department's initials. The assertion that would be tested is valuation. The auditor could also perform dual-purpose tests by reperforming some of the controls and gather evidence to both if the internal control is working, and if the account balance or transaction is correct. 8/8