Chapter05 - Answer

CHAPTER

5

AUDIT OF THE EXPENDITURE CYCLE: TESTS OF CONTROLS AND SUBSTANTIVE TESTS OF TRANSACTIONS - II

5-1.

The following duties must be separated in the preparation of payroll: hiring, reporting and approval of time, paycheck preparation, check signing, and paycheck distribution.

5-2.

Payroll checks should be prenumbered and accounted for in a bank reconciliation.

5-3.

Auditors’ substantive tests of payroll balances are primarily analytical procedures.

5-4.

Procedure

Possible Error

Scan the payroll register, general ledger, and payroll earnings records for entries that appear unusual, such as very large paychecks or employees not assigned to departments.

Fictitious employees may be paid, or significant overpayments may be made to genuine employees.

Compare average pay per employee for the current year to average pay for prior year (taking into consideration pay raises).

Payroll expense may be overstated or understated.

Compare direct labor as a percentage of cost of sales with the previous year’s percentage.

Payroll expense may be overstated or understated.

Compare the ratio of commission expense to sales with previous year’s percentage.

Commission expense overstated or understated.

Compare payroll tax expense as a percentage of cost of goods sold with percentage of previous years.

Payroll tax expense may be overstated or understated.

a. b. c. d.

may

be

A production order provides a record of authorization to production personnel to produce products. A bill of materials is a list that indicates components to be used in producing a product. A materials requisition is a recorded authorization to issue materials to production. A cost accumulation report is a record prepared by operating personnel of costs incurred as goods are transferred through production.

5-2

Solutions Manual to Accompany Applied Auditing, 2006 Edition e. f. g. h.

5-5.

A materials requisition summary is a record of materials used for a period, such as a day. A labor ticket is a record of the time a production employee works on a job. A labor ticket summary provides a record of labor used in production for a period, such as a day. A completed production report provides a basis for inventory valuation.

Auditors perform three procedures that provide evidence that all production transactions that occur are recorded. First, auditors observe that prenumbered production orders are accounted for to determine that all materials issued are recorded. An auditor might also account for a sequence of production orders. A second procedure is to observe that the client accounts for prenumbered materials requisitions to reduce inventory and to assign costs to production. An auditor might also account for a sequence of materials requisitions. Finally, an auditor might observe that a clerk reconciles completed and charged time tickets with the total hours for which production workers are paid.

5-6.

1) c

2) b

5-7.

1) d

2) d

5-8.

1) d

2) c

5-9.

1) a

2) a

5-10.

1) d 2) b

3) d 4) d

5-11.

1.

a. b. c. d.

Existence or occurrence Payroll may include fictitious or former employees. Examine approval signatures. For selected entries, examine signed authorizations for hiring and compare signature on paid check to signature on job application.

2.

a. b. c. d.

Rights and obligations Employees may be paid for more hours than they work. Examine signature on cards. Reconcile time charged to jobs to total hours worked.

3.

a. b. c. d.

Rights and obligations Employees may be paid for more hours than they work. Examine signature on cards. Reconcile time charged on cards to total charged to jobs.

3) b

4) b

5) c 6) c

Audit of the Expenditure Cycle: Tests of Controls and Substantive Tests of Transactions – II

5-3

4.

a. b. c. d.

Existence or occurrence Payroll may include fictitious or former employees. Observe separation of duties. For selected entries, examine signed authorizations for hiring, pay rates, and deductions, and compare signature on paid check to signature on application, or distribute paychecks in a surprise payoff.

5.

a. b. c.

Completeness Paychecks may be issued but not recorded. Observe whether paychecks are prenumbered and determine whether a bank reconciliation is prepared by a person independent of the payroll function. Test or prepare a bank reconciliation.

d. 6.

a. b. c. d.

Completeness Paychecks may be issued but not recorded. Observe whether a bank reconciliation is prepared by a person independent of the payroll function. Test or prepare a bank reconciliation.

5-12.

Match objectives and procedures: 1. d 2. c 3. a

5-13.

1.

a. b. c.

2.

a. b. c.

3.

a. b. c.

4.

a.

Production planning should sign a production order authorizing personnel to undertake work. Examine signature on production orders. Rights and obligations. Materials requisitions should be prenumbered and accounted for by a clerk in accounting. Observe procedure and account for a sequence of materials requisitions. Completeness Chart of accounts should adequately describe accounts to be used, and account coding should be assigned by one person and checked by another. Examine chart of accounts and signature of employee performing check on the account coding. Presentation and disclosure Chart of accounts should adequately describe accounts to be used, and account coding should be assigned by one person and checked by another.

5-4

Solutions Manual to Accompany Applied Auditing, 2006 Edition b. c. 5.

a. b. c.

6.

a. b. c.

5-14.

1.

a. b. c.

2.

a. b. c.

3.

a. b. c.

4.

a. b. c.

5.

a. b. c.

Examine chart of accounts and signature of employee performing check on the account coding. Presentation and disclosure. Production orders should be prenumbered and accounted for to determine that all production is recorded. Observe procedure and account for a numerical sequence of production orders. Completeness Time charged on job tickets should be reconciled to time-clock cards from which employees are paid. Observe procedure. Completeness An inventory storage clerk should sign a copy of the prenumbered receiving report after counting goods transferred to the storage area. Observe procedure and examine signature on receiving reports. Rights and obligations Receiving reports and requisitions should be prenumbered and accounted for by a clerk in accounting. Observe procedure and account for a numerical sequence of receiving reports to determine that they all have been recorded. Completeness Provision for inventory obsolescence should be reviewed by officials and adjusted as necessary. Inquire about review for obsolescence. Valuation Access to inventory storage should be limited to personnel responsible for its custody. Observe procedures. Completeness of inventory or completeness of issuances A production employee should sign a copy of the purchase requisition after counting goods transferred to production. Observe procedure and examine signature on requisition. Rights and obligations