Review Questions and Problems Chapter 7

REVIEW QUESTIONS AND PROBLEMS
Questions
1. Describe the processing of transactions in the expenditure cycle.
Transactions in the expenditure cycle are recorded in the purchases and cash
payments journal or in the voucher register and the check register. Relevant accounts
are cash; vouchers payable; inventory, property, plant and equipment; purchases;
purchase returns and allowances; purchase discounts; prepaid rent and other prepaid
accounts; and expense accounts.
2. Identify major risks of misstatements in the expenditure cycle.
Errors that occur in the expenditure cycle include recording purchases in the
wrong period (cutoff errors), recording goods held on consignment as a purchase,
misclassifying purchases, failing to record payments, recording payments twice, and
failing to recognize prepaid expenses. Irregularities often relate to purchases and
include paying for fictitious purchases, purchasing goods for personal use, and
obtaining kickbacks.
3. Identify the financial statement assertions for acquisitions transactions.
Audit objectives for acquisitions transactions are to verify the following assertions:
 Existence or occurrence: Recorded acquisitions are for items that were

acquired.
 Completeness: Acquisitions that occurred are recorded.
 Rights and obligations: Recorded acquisitions are the entity’s purchases and
liabilities.
 Valuation or allocation: Acquisitions are recorded for the proper amounts.
 Presentation and disclosure: Acquisitions are recorded to result in presentation
and disclosure in accordance with GAAP.
4. When an entity's controls are ineffective for payments, what potential
misstatements could arise in the financial statements?
The following misstatements could arise if controls for payments are ineffective:
Existence or occurrence
 Unauthorized or inappropriate payments may be made.
Completeness
 Checks may be issued and not recorded.
Rights and obligations
 Unauthorized payments may be made.
Valuation or allocation
 Improper amounts may be paid because of math errors or incorrect

discount.
 Account may not reconcile or discrepancy may not be disclosed.
Presentation and disclosure
 Payments may be credited to wrong accounts.
5. Compare a vendor's statement to a vendor's invoice and describe how an

auditor might use each.
A vendor’s invoice is a bill for a single purchase, whereas the vendor’s monthly
statements report the beginning balance, additional sales, any payments, and the
ending balance. Auditors reconcile the monthly statements to the details included in the
vouchers payable listing to ascertain that all vouchers payable are recorded. Vendors’
statements are generally considered to be a strong form of evidence about amounts
owed to particular vendors.
6. Give two reasons audit work on cash is likely to be more extensive than might
appear to be justified by the relative amount of the balance sheet figure for cash.
Liabilities, revenue, expenses and most other assets flow through the Cash
account; thus the examination of cash transactions assists the auditors in the
substantiation of many other items in the financial statements.
Cash is the most liquid of assets and offers the greatest temptation for theft,
embezzlement, and misappropriation.
7. Among the departments of J-R Company are a purchasing department,

receiving department, accounting department, and finance department. If you
were preparing a flowchart of a voucher system to be installed by the company,
in which department would you show
The assembling of the purchase order, receiving report, and vendor's

invoice to determine that these documents are in agreement?
Assembling of the purchase order, receiving report & vendor's invoice to

determine that these documents are in agreement should be done in the
accounting department.
The preparation of a check?
Preparation of a check should be done in the Accounting Department
The signing of a check?
The signing of a check should be done in the Finance Department
The mailing of a check to the payee?
The mailing of a check to the payee should be done by the Finance Department.
The cancellation of the voucher and supporting documents?
The perforation of the voucher and supporting documents should be done by the
Accounting Department.
8. During your audit of a small manufacturing firm, you find numerous checks for
large amounts drawn payable to the treasurer and charged to the Miscellaneous
Expense account. Does this require any action by the auditor? Explain.
There is a possibility that the funds went to the treasurer personally and were not
expended for business purposes.
The auditors should investigate:
Is there adequate documentary evidence supporting the charge to Miscellaneous

Expense, such as purchase orders, invoices, receipts
Was the disbursement specifically approved by the president or other officer besides
the treasurer before issuance of the checks.
If fraud has been detected, the auditor should assure himself/herself that the audit
committee of the board of directors is adequately informed.
Prepare an example of lapping of cash receipts, showing actual transactions and the
cash receipts journal entries. Lapping involves withholding cash receipts and covering
such withholding by a subsequent entry. This covering entry creates a shortage as to
some other customer or source of receipts and it will in turn be covered as was the first
shortage. The result is a constant shifting of the shortage from each account to a more
current account.
9. During your reconciliation bank of accounts in an audit, you find that a number
of checks for small amounts have been outstanding for more than a year. Does
this situation call for any action by the auditor? Explain.
The old outstanding checks should be eliminated as they cause unnecessary clerical
work in each bank reconciliation and also represent a threat to good internal control. A
dishonest employee may conceal a cash shortage merely by omitting old outstanding
checks from the bank reconciliation. The auditor should prepare a list of the old checks
and ask the client to contact the payees and request them to present the checks for
payment. If this is not feasible, the checks should be eliminated by restoring the
appropriate amount to the cash balance and setting up a special liability account.
10. Explain the objectives of each of the following audit procedures for cash.
a. Obtain a cutoff bank statement returned subsequent with the bank to the
statement balance to sheet
The bank cutoff permits the examination of many checks listed as outstanding and
established collectibility of customers checks. Including the undeposited recipts on
the balance sheet. Any unrecorded outstanding checks at year end will also be
disclosed by the cutoff bank statement.
b. Compare paid checks returned with the bank statement to the list of
outstanding checks in the previous reconciliation.
Obtain assurance that the cash cutoff at the beginning of the bank reconciliation
period is accurate, and that cash shortages are not being obscured by
manipulation of the outstanding checks list.
c. Trace all bank checks transfers in the during previous the last week of the
audit year and the first week of the following year.
This is to disclose kiting, where a check is drawn on one bank is not recorded as a
disbursement as of the balance sheet date, although the deposit of the check in
another bank is properly recorded.
d. Investigate any checks representing large or unusual payments to related

parties.
1. Were properly authorized and recorded
2. Are adequatley disclosed in the financial statements

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REVIEW QUESTIONS AND PROBLEMS

1. Describe the processing of transactions in the expenditure cycle.

2. Identify major risks of misstatements in the expenditure cycle.

3. Identify the financial statement assertions for acquisitions transactions.

 Existence or occurrence: Recorded acquisitions are for items that were

 Unauthorized or inappropriate payments may be made.

 Checks may be issued and not recorded.

Rights and obligations

 Unauthorized payments may be made.

 Improper amounts may be paid because of math errors or incorrect

Presentation and disclosure

 Payments may be credited to wrong accounts.

5. Compare a vendor's statement to a vendor's invoice and describe how an

7. Among the departments of J-R Company are a purchasing department,

The assembling of the purchase order, receiving report, and vendor's

Assembling of the purchase order, receiving report & vendor's invoice to

The preparation of a check?

Preparation of a check should be done in the Accounting Department

The signing of a check?

The signing of a check should be done in the Finance Department

The mailing of a check to the payee?

The cancellation of the voucher and supporting documents?

The auditors should investigate:

Is there adequate documentary evidence supporting the charge to Miscellaneous

d. Investigate any checks representing large or unusual payments to related

1. Were properly authorized and recorded

2. Are adequatley disclosed in the financial statements

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