AUDIT PLANNING AND TYPES OF AUDIT TESTS
Answers to Review Questions
5-10 The purposes for using analytical procedures at the planning stage of an audit are
(1) to enhance the auditor's understanding of the client's business and the
transactions and events that have occurred since the last audit and (2) to identify
areas that may represent risks relevant to the audit.
5-29 a. The procedures Hall should perform before accepting the engagement include
1. Hall should explain to Adams the need to make an inquiry of Dodd and
should request permission to do so.
2. Hall should ask Adams to authorize Dodd to respond fully to Hall's
3. If Adams refuses to permit Dodd to respond or limits Dodd's response, Hall
should inquire as to the reasons and consider the implications in deciding
whether to accept the engagement.
4. Hall should make specific and reasonable inquiries of Dodd regarding
matters Hall believes will assist in determining whether to accept the
engagement, including specific questions regarding:
Facts that might bear on the integrity of management.
Disagreements with management as to accounting principles, auditing
procedures, or other similarly significant matters.
Dodd's understanding as to the reasons for the change of auditors.
5. If Hall receives a limited response, Hall should consider its implications in
deciding whether to accept the engagement.
b. The additional procedures Hall should consider performing during the planning
phase of this audit that would not be performed during the audit of a continuing
client may include the following:
1. Hall may apply appropriate auditing procedures to the account balances at
the beginning of the audit period and, possibly, to transactions in prior
2. Hall may make specific inquiries of Dodd regarding matters Hall believes
may affect the conduct of the audit, such as
Audit areas that have required an inordinate amount of time.
Audit problems that arose from the condition of the accounting system
3. Hall may request Adams to authorize Dodd to allow a review of Dodd's
4. Hall should document compliance with firm policy regarding acceptance of
a new client.
5. Hall should start obtaining the documentation needed to create a permanent
working paper file.
Audit Procedure Assertion
4 Valuation and allocation
Accounts receivable 2005 2004
Accounts receivable turnover 18.1 times 25 times
(sales divided by accounts receivable)
The accounts receivable turnover is slower for 2005, which implies that the
average collection period has increased. Arthur should first satisfy himself that RCT's
credit terms remained unchanged over those years. If the credit terms have been
liberalized, this increase in collection period may be appropriate. Arthur should also
satisfy himself that these computations do, in fact, represent the year's activity. An
accounts receivable aging schedule can indicate whether the longer collection period is
due to a major delinquent customer or is representative of RCT's annual activity.
Assuming Arthur is satisfied that RCT's credit terms have not changed and that
annual activity is fairly represented, he should include more extensive audit procedures
for sales and accounts receivable. The indicated trend may be due to understated sales or
overstated accounts receivable. Arthur should carefully review the year-end cutoff for
sales to verify that sales are not understated. He should also satisfy himself that there are
no unrecorded sales.
Arthur should verify that the accounts receivable are fairly stated at year-end. He
should check that lapping has not occurred. Furthermore, he may wish to expand his
normal confirmations to cover a larger proportion of the receivables. In addition, Arthur
should satisfy himself that the accounts receivable balance includes only bona fide trade
The changed ratio does not automatically imply that an account is misstated. It
merely highlights an area for further inquiry. It is possible that the changed ratio is
perfectly valid and that the related accounts are fairly stated. If this is so, the auditor
should satisfy himself as to the cause of the changed ratio. For example, RCT may have
increased sales by being less "selective" of its customers. Furthermore, tighter economic
conditions may have caused customers to pay their bills more slowly. By inquiry of sales
managers, Arthur may find out if there has been a change in the sales mix of products
with varying credit terms.
Current Ratio 2005 2004
Current ratio 2.68 to 1 2.49 to 1
(current assets divided by current
The increased current ratio was due to an increase in current assets greater than the
increase in current liabilities. Increases in both current assets and current liabilities are
warranted because activity has increased from 2004 to 2005, but the major increase in
current liabilities has been income taxes. The income taxes each year are directly
proportional to that year's income before federal income taxes; therefore, the amount of
income taxes is logical, assuming that Arthur is satisfied that each year's income before
taxes is fairly stated. The accounts payable, however, have declined. Arthur should
satisfy himself that the accounts payable are fairly stated. He should consider the use of
confirmation requests and check that the cutoff of payables was handled properly. He
should carefully search for unrecorded payables. He should investigate substantial
decreases in long-term liabilities and should ascertain that current maturities of long-term
liabilities are properly reported in the balance sheet.
A ratio that is inconsistent from one year to the next does not necessarily imply
misstatements. The objective of ratio analysis is to point out areas where further
investigation is warranted. The auditor must satisfy himself that the accounts are fairly
stated and that the change is justified.
Answers to Multiple-Choice Questions
5-16 D 5-23 A
5-17 D 5-24 A
5-18 A 5-25 C
5-19 D 5-26 A
5-20 B 5-27 C
5-21 C 5-28 B