6-45
a. – shipment were recorded before the actual shipment took place: Shows less inventory than actual inventory, so net income will be higher than actual.
Shipping documents is missing: This is very serious. There may be chances of fraud.
Goods were received and sat on the dock for up to seven day before the receipt was recorded: This will show understatement in the inventory. And it shows overstatement of net income
b. Substantive test is the test of account balances to verify the correctness of the amounts they are design to identify errors and irregularities. In this case misstatement of inventory identified would be considered significantly enough to require substantive testing of inventory. In this case inventory is not entering proper time and missing the records. So auditor has to do substantive test of inventory.
c. Substantive testing procedures that evaluate the accuracy, completeness and existence of amounts stated in general ledger accounts and financial statements. In this case substantive testing should performed by physical inspection of inventory, verification of vendors invoice, verification of delivery documentation, tracing of related disbursement records, and ascertaining that the inventory is recorded in appropriated general ledger account, and timing of the transaction record.
d. If there is no deficiencies were found in the auditor’s tests of control, auditor doesn’t have to do all substantive tests. They can reduce their work load. They can take continuous inventory. A daily record is maintained for the physical quantity of the inventory, and this should reconciled to actual physical counts at short intervals.
7-39
a. Confirmation is a verification of a condition or fact. Auditors written or oral request to a third party to verify the existence or amount of a financial item related to the client and evidence from independent outside sources is more reliable than evidence from within the client’s organization.
b. More reliable evidences: Evidence received from well controlled information system, original documents, and evidences from independent outside sources.
Less reliable evidences: Evidence derived from poorly controlled system, evidence from within the client’s organization, and photocopies or facsimiles, or digitized data.
c. Observation or inspection is useful and it gives strong evidence in verifying the existence of tangible assets and in identifying potential obsolescence or sign of wear and tear. However, inspection alone does not provide evidence on completeness, ownership, or valuation. In addition, inspection does not provide evidence about the cost of inventory. Auditor should have enough knowledge about inventory or should have somebody with knowledge of inventory to make observation of inventory both relevant and reliable.
d. Internal documentation ranges from legal agreements to business document, accounting documents, planning and control documents. The reliability of internal documentation varies according to the following: Effectiveness of internal controls, Risk and management motivation to misstate individual accounts, Formality of documentation, such as acknowledgement of its validity by parties outside the organization or independent of the accounting function. Independence of those preparing the documentation from those recording the transactions.
e. Analytical testing involves comparisons, either judgmentally or statistically, of data over time, across operating units, or between related components of the financial statements to develop insight concerning expected relationships. Direct tests involves testing