AA: Audit evidence

Answer: D. Existence is the assertion that assets, liabilities and equity interests that are recorded actually exist at the period end — option D. Completeness (option A) is the converse — all transactions and balances that should be recorded have been. Accuracy, valuation and allocation (option C) concerns whether amounts are recorded at appropriate amounts. Rights and obligations (option B) concerns whether the entity holds the rights to assets and has the obligations for recorded liabilities.

Answer: C. Cut-off is the assertion that transactions have been recorded in the correct accounting period — option C. It is particularly important for revenue, expenses and inventory at year end. Occurrence (option A) concerns whether recorded transactions actually happened. Classification (option B) concerns whether transactions have been recorded in the appropriate accounts. Completeness (option D) concerns whether all transactions that should have been recorded have been — the opposite risk to occurrence.

Answer: D. Rights and obligations is the relevant assertion — option D. This assertion concerns whether the entity holds the rights to assets and has the obligations for recorded liabilities. For a lease, the auditor is checking: does the entity have the contractual right to use the asset? Has the entity properly evaluated whether the lease gives rise to additional obligations (e.g. under IFRS 16)? Option A (existence) is about whether the physical premises exist, not the legal rights. Option C (completeness) concerns whether all lease payments have been recorded. Option B (valuation) relates to whether the lease payments are measured correctly.

Answer: D. Observation involves the auditor watching a process being performed by others — option D. Attending and watching the inventory count (without doing the counting themselves) is the classic example of observation. Inspection (option A) involves examining records, documents or physical assets — if the auditor were to physically examine the inventory items themselves, that would be inspection. External confirmation (option C) involves obtaining a direct response from a third party. Recalculation (option B) involves checking mathematical accuracy.

Answer: D. Positive confirmations require a response, making non-response distinguishable from agreement — option D. With a positive confirmation, silence is not evidence of agreement — the auditor follows up on non-responses. With a negative confirmation, silence is treated as agreement, but the respondent may have discarded the letter or not responded carefully. ISA 505 permits both types but notes negative confirmations provide less persuasive evidence. Option A is incorrect — both types are permitted. Options C and B are incorrect generalisations.

Answer: D. The source and nature of evidence directly affects its reliability — option D. ISA 500 identifies several principles: evidence from independent external sources is more reliable than from the entity itself; evidence obtained directly by the auditor is more reliable than obtained indirectly; documentary evidence is more reliable than oral; originals are more reliable than photocopies. Options A, C and B are irrelevant to evidence reliability.

Answer: D. To test completeness, the auditor must start from the population that could be omitted — option D. By tracing from despatch notes (which represent goods that have left the entity) to sales invoices, the auditor tests whether all goods despatched have been billed. If a despatch note has no corresponding invoice, that sale has been missed. Option A (vouching invoices to despatch notes) tests occurrence — it confirms invoiced sales actually happened — but does NOT test completeness because it starts from the invoice population which already excludes unrecorded items. Option C may indicate problems but does not directly test completeness. Option B provides weak evidence.

Answer: D. Substantive procedures are designed to detect material misstatements at the assertion level — option D. They consist of: (1) tests of detail (e.g. agreeing balances to source documents, confirming balances with third parties); and (2) substantive analytical procedures (comparing recorded amounts to expected amounts). They are distinct from tests of controls (option A), which evaluate whether controls are operating as designed. Option C is incorrect — substantive procedures are performed throughout the audit. Option B is incorrect — the decision on modifying the report flows from the results of all audit procedures.

Answer: C. When substantive analytical procedures identify unexpected fluctuations, the auditor must investigate — option C. A 35% unexplained increase in depreciation, after adjusting for additions and disposals, suggests either: a change in depreciation policy or useful life estimates (which may require disclosure); an error in calculation; or a change in asset classification. The auditor must obtain a satisfactory explanation and corroborating evidence. Option A fails the professional scepticism requirement. Option B (immediate modification) is premature. Option D fails the evidential requirement.

Answer: D. Accounting estimates require the auditor to evaluate the reasonableness of the methodology, assumptions and underlying data — option D. The key considerations for a warranty provision are: Is the historical claim rate methodology appropriate? Is the underlying data accurate and complete? Are there current factors (e.g. a product recall) that mean the historical rate is no longer reliable? ISA 540 requires auditors to evaluate management's process and key assumptions. Option A is insufficient for a significant estimate. Option C is incorrect — warranty provisions are required under IAS 37 when criteria are met. Option B (board approval) is a control test, not a substantive procedure for valuation.

Answer: D. Inspecting documents for evidence of authorisation is a test of controls — option D. The auditor is testing whether the control (authorisation of invoices before payment) is operating as designed. Tests of controls evaluate whether controls work; they do not directly detect monetary misstatements. A substantive procedure (option A) would be directed at the monetary amount of payables. An analytical procedure (option C) would compare overall payables levels to expected amounts. Recalculation (option B) would re-perform arithmetic on the invoice.

Answer: D. ISA 530 defines audit sampling as applying procedures to less than 100% of a population where all sampling units have a chance of selection, enabling the auditor to draw conclusions about the whole population — option D. Key elements: less than 100% is tested; all items have a chance of being selected; the results are used to draw inferences about the population. Option A describes 100% testing, which is not sampling. Option C describes high-value testing, which may be used alongside but is not the same as sampling. Option B (personal preference) is not a valid sampling approach.

Answer: D. The key distinction is the use of probability theory — option D. Statistical sampling selects items using random methods, allowing the auditor to mathematically quantify sampling risk. Non-statistical (judgemental) sampling relies on the auditor's expertise and judgement — it can be equally effective but does not allow quantification of sampling risk. ISA 530 permits both approaches. Option A is incorrect — both methods can be used for tests of controls or substantive procedures. Option C is incorrect — non-statistical sampling can be just as effective when applied by an experienced auditor. Option B is incorrect — ISA 530 explicitly permits non-statistical sampling.

Answer: C. A lower tolerable deviation rate requires a larger sample — option C. If the auditor sets a low threshold for acceptable control failures, more items must be tested to reliably estimate the actual deviation rate. Conversely: a higher tolerable rate (option A) leads to a smaller sample; lower planned reliance on controls (option B) means controls testing is less important, so a smaller sample; a lower expected deviation rate (option D) means fewer failures are expected, so a smaller sample is sufficient. Understanding these inverse relationships is a common exam challenge.

Answer: D. When the sample deviation rate exceeds the tolerable rate, the auditor cannot place reliance on the control — option D. If the authorisation control is not reliably operating, the auditor must: (1) consider whether the risk of material misstatement for revenue has increased; (2) increase the extent of substantive testing on revenue to compensate. Option A is incorrect — the monetary value of individual deviations is irrelevant to a test of controls; the question is whether the control operates as designed. Option C (reducing sample size) would increase sampling risk, not address the problem. Option B is not the appropriate response.

Answer: D. Direct confirmation obtains evidence directly from the customer — option D. By sending confirmation requests to a sample of customers asking them to confirm the balance owed at the year end, the auditor obtains independent external evidence about: (1) whether the balance exists (existence); and (2) whether the recorded amount is accurate. It is highly reliable evidence because it comes from an independent external party. Option A is incorrect — circularisation only covers balances already recorded; it cannot identify unrecorded receivables. Option C (irrecoverable debt allowance) is a separate valuation judgement. Option B describes post-year-end cash receipts testing.

Answer: D. Testing completeness and occurrence requires procedures in opposite directions — option D. To test completeness (all sales recorded), the auditor traces from till receipts (which capture all transactions) to the sales ledger — if an entry is in POS but missing from the ledger, it has been omitted. To test occurrence (recorded sales actually happened), the auditor vouches from the sales ledger to POS data — if an entry in the ledger has no POS support, it may be fictitious. Option A is a receivables procedure, not a revenue test. Option C provides weak evidence. Option B (board minutes) is useful for policy but not transaction-level testing.

Answer: D. To test completeness of revenue, the auditor must start from the source of uninvoiced transactions — delivery records — option D. By tracing from delivery records to invoices, the auditor can identify deliveries for which no invoice was raised (omitted revenue). Testing only the last week of the year also directly addresses the cut-off risk. Option A (vouching invoices to deliveries) tests occurrence — that invoiced sales happened — not completeness. Option C (aged receivables) relates to collectability of existing balances. Option B (written representations) is insufficient where more reliable evidence — delivery records — is available.

Answer: D. At the inventory count, the auditor should observe, perform test counts, and record cut-off information — option D. Test counts in both directions test existence (from count sheets to floor — confirming items on the sheets actually exist) and completeness (from floor to count sheets — confirming physical items are recorded). Recording the last GRN and despatch note numbers at the count date enables subsequent cut-off testing. Option A is incorrect — counting is management's responsibility. Option C (only high-value) provides incomplete evidence. Option B (photographs only) provides evidence of condition but not quantities.

Answer: D. Cut-off information is used to test whether transactions are recorded in the correct period — option D. GRN cut-off: goods received before year end should be in closing inventory and payables; goods received after should not. Despatch cut-off: goods despatched before year end should be excluded from inventory and revenue should be recognised; goods despatched after should remain in inventory. By noting the last document numbers at the count, the auditor can subsequently trace a sample of documents before and after the cut-off. Option A, C and B are unrelated to cut-off testing.

Answer: D. Valuation at the lower of cost and NRV requires testing whether NRV exceeds cost — option D. Comparing post-year-end selling prices to carrying values provides direct evidence of whether items can be sold above cost. Reviewing aged inventory and order books identifies slow-moving or obsolete items where NRV may have fallen below cost. Option A (warehouse condition) relates to physical safeguarding, not valuation. Option C (recasting) tests mathematical accuracy, not NRV. Option B (confirming quantities) tests existence and completeness, not valuation.

Answer: D. Supplier statements provide independent evidence and help identify completeness and accuracy issues — option D. Unlike receivables circularisation (where the auditor sends the confirmation), supplier statements are independently prepared by the supplier and available for the auditor to inspect. They help identify: invoices the supplier has raised but the client has not recorded (completeness); disputed amounts; and timing differences. They are particularly valuable for testing the completeness of payables, which is the primary risk (understatement). Option A overstates the case — suppliers can make errors too. Option C is incorrect — they supplement, not replace, controls testing. Option B is incorrect — ISA 330 does not specifically mandate them.

Answer: D. A bank confirmation letter obtained directly from the bank is the most reliable evidence — option D. It comes from an independent third party, is obtained directly by the auditor, and confirms the actual balance held. It also typically confirms other information such as security interests and overdraft facilities. Option A (management's reconciliation) is prepared by the client and requires verification. Option C (management representations) is weak evidence — representations alone are insufficient where more reliable evidence is available. Option B (calculated estimate) provides limited assurance about the actual balance.

Answer: D. Testing timing items and their subsequent clearance is the appropriate procedure — option D. Timing differences are normal in a bank reconciliation, but they can also be used to manipulate the apparent cash balance. By agreeing cheques to the cash book and verifying subsequent clearance, the auditor confirms they are genuine. Cheques remaining uncashed for an unusually long time are a red flag for fictitious entries. Option A provides no assurance. Option C would interfere with the client's operations. Option B is incorrect — uncashed cheques represent valid obligations and should remain in the reconciliation.

Answer: D. Physical inspection directly tests existence — option D. By physically locating and inspecting the asset, the auditor obtains direct evidence that it exists, is in the company's possession, and is in usable condition. Option A (agreeing to prior year register) tests completeness of the register update, not existence of new assets. Option C (board minutes) tests authorisation — a control test, not a substantive procedure for existence. Option B (recalculating depreciation) tests accuracy of the charge, not existence of the underlying asset.

Answer: D. Recalculating depreciation directly tests the accuracy assertion — option D. The auditor selects a sample of assets, applies the entity's depreciation policy to each asset's cost or revalued amount, and compares the calculated charge to the amount in the accounts. Differences indicate either a calculation error or an undisclosed policy change. Option A (physical inspection) tests existence. Option C (reviewing the register) tests completeness. Option B (independent valuation) would be relevant for fair value or impairment testing, not routine depreciation.

Answer: A. Under IAS 37, a provision must be recognised when a present obligation exists, it is probable that an outflow will be required, and the amount can be reliably estimated — option A. All three criteria are met: the claim represents a present obligation; probable success means an outflow is likely; lawyers have estimated £350,000. Management's failure to recognise the provision means the completeness assertion for liabilities is at risk. The auditor should request management to recognise the provision; if refused and the amount is material, consider a qualified or adverse opinion. Option B (existence) is not at risk — the claim is known to exist. Option C is incorrect — when recognition criteria are met, it is a provision not just a contingent liability. Option D is incorrect — valuation is secondary to the primary issue of non-recognition.

Answer: D. Confirmation from external lawyers is the most reliable evidence — option D. Lawyers are independent third parties with professional expertise in assessing the likely outcome of legal proceedings. Their letter provides direct, independent evidence about: the existence of the claim; the nature and amount involved; the likely outcome; and any probable obligation. Option A (internal estimate) is prepared by management who have an interest in the outcome. Option C (disclosure note) is management's own presentation and requires corroboration. Option B (management representation) is the weakest form of evidence and is explicitly noted by examiners as insufficient when independent evidence is available.

Answer: D. Directors' remuneration carries inherent risk because directors have an interest in it and because the disclosure requirements are detailed — option D. Directors may be involved in setting their own pay (governance risk), which increases the risk of misstatement. Additionally, company law and accounting standards require specific disclosures about directors' remuneration (note: the S26-J27 syllabus uses 'directors' remuneration', updated from 'directors' emoluments'). The auditor must verify that all elements of remuneration are completely and accurately disclosed. Option A is incorrect — it can be material and is always subject to specific disclosure requirements. Option C has no basis. Option B is incorrect — company law requires it.

Answer: D. This is audit software (a CAAT — computer-assisted audit technique): the auditor uses software to interrogate the client's actual data files and flag exceptions — here, sales invoices with no matching despatch note. Because it starts from recorded sales and looks for missing despatch evidence, it primarily tests occurrence: are the recorded sales genuine (did the goods actually go out)? That makes option D correct on both counts — tool and assertion. Option A identifies the right assertion but the wrong tool: test data involves entering dummy transactions to see how the system processes them, not analysing live data. Option B names audit software but the wrong assertion — authorisation would mean checking approval fields. Option C is wrong on both the tool and the assertion (this is not about inventory valuation).

Answer: D. The ability to analyse complete populations is the primary advantage of data analytics — option D. Rather than testing a sample of 50 invoices from 10,000, data analytics allows the auditor to examine all 10,000 transactions, identifying every exception, anomaly and unusual pattern. This dramatically increases coverage and can identify fraud or error that sampling might miss. Option A is incorrect — professional judgement remains essential in evaluating the results. Option C overstates the case — reliability depends on data quality and controls over the systems from which data is extracted. Option B is incorrect — data analytics is available for audits of all sizes.

Answer: D. Data quality is the primary challenge with data analytics — option D. If the auditor extracts data directly from the client's systems, the quality of the analysis depends on the integrity of those systems. Sophisticated fraudsters may manipulate the data before extraction or maintain shadow records. The auditor must consider: Is the data complete? Has it been extracted correctly? Could it have been manipulated? Option A is incorrect — data analytics is specifically designed for journal entry testing (a key procedure under ISA 240). Option C is incorrect — data analytics reduces but cannot eliminate risk. Option B is incorrect — professional judgement remains essential.

Answer: D. External auditors may use internal audit work to avoid duplicating effort where the work is relevant and reliable — option D. ISA 610 allows the external auditor to use the work of the internal audit function if it is determined to be adequate for external audit purposes. The external auditor must first evaluate the internal audit function's objectivity, competence and systematic approach. Option A is a generalisation. Option C is incorrect — ISAs do not require reliance on internal audit; it is at the external auditor's discretion. Option B is partially true as a practical consideration but is not the professional rationale.

Answer: D. The auditor must evaluate the expert's work before relying on it — option D. Under ISA 620, when using an auditor's expert, the auditor must: (1) evaluate the expert's competence, capabilities and objectivity; (2) obtain an understanding of the expert's field; and (3) evaluate the adequacy of the expert's work as audit evidence. The auditor cannot simply delegate responsibility for an audit area to an expert and accept their conclusion without question. Option A is insufficient — blind reliance is not appropriate. Option C (reperforming all work) is impractical. Option B is incorrect — expert opinion reduces but does not eliminate audit risk.

Answer: B. Password and access controls are general IT controls — option B. General IT controls (ITGCs) are controls over the IT environment as a whole: access controls, change management, IT operations and physical security. They provide the foundation that application controls rely upon. Application controls (options A, C and D) are controls built into specific applications that control input, processing and output. Option A (missing customer number) is an input validation application control. Option C (automatic VAT) is a processing application control. Option D (duplicate rejection) is an input validation application control.

Answer: B. Compliance with charitable objectives and restricted fund conditions is unique to not-for-profit entities — option B. Unlike commercial entities where the primary financial risk is misstatement of profit, in charities the auditor must consider whether: income has been applied for the purposes for which it was received; expenditure is within the charity's stated objects; any restricted fund grants have been used only for permitted purposes; and related disclosures are adequate. Options A, C and D (existence of NCA, statement of financial position, payables completeness) are standard audit matters applicable to all entities.

Answer: B. Owner-managed entities typically have limited segregation of duties — option B. The owner-manager often performs the roles of purchasing, approving, recording and signing cheques — roles that would be separated in larger organisations. While the owner's close involvement can be a mitigating factor, it also means the owner can override any control. The auditor typically responds by increasing substantive procedures. Option A is incorrect — small entities typically have weaker formal controls. Option C is incorrect — many small entities do require audit. Option D is incorrect — the absence of independent checking processes can reduce evidence reliability.

Answer: B. An unexpectedly large margin improvement requires investigation — option B. A 13 percentage point improvement with stable revenue is unusual and warrants professional scepticism. Legitimate explanations might include favourable raw material cost movements or a change in product mix. Misstatement explanations include: revenue overstated; closing inventory overstated (reducing cost of sales); or purchases understated. The auditor must obtain a satisfactory explanation with corroborating evidence. Option A ignores the scepticism requirement. Option C contradicts the appropriate response — an unusual finding increases, not decreases, testing. Option D fails the corroboration requirement.

Answer: B. In monetary unit sampling, each £1 is a sampling unit — option B. Because every £1 has an equal chance of selection, larger balances contain more sampling units and are therefore more likely to be selected. This naturally directs audit effort towards larger, potentially more material items while still giving smaller items a chance of selection. Option A (fixed number) describes simple random sampling, not MUS. Option C (excluding small items) describes stratification, a separate concept. Option D (judgemental) is non-statistical sampling.

Answer: B. When the UEL exceeds materiality, the auditor cannot draw a clean conclusion — option B. The Upper Error Limit represents the maximum likely error in the population at the chosen confidence level. If the UEL exceeds materiality, there is an unacceptably high risk that the population contains a material misstatement. The auditor must: extend the sample; request management to investigate and correct errors; or consider the implications for the audit opinion. Option A is incorrect — the UEL being above materiality prevents this conclusion. Option C is incorrect — reducing the sample size would make the UEL larger, not smaller. Option D is incorrect — the most likely error alone is not sufficient.

Answer: B. Reviewing supplier statements for items not in the client's ledger directly tests completeness — option B. A supplier statement shows all invoices the supplier believes are outstanding. If an invoice appears on the supplier's statement but not in the client's purchase ledger, it suggests an unrecorded liability. This is the primary completeness risk for payables — unlike receivables where the main risk is overstatement, payables carry a risk of understatement. Option A (agreeing balances to invoices) tests existence/accuracy. Option C (confirming with finance director) provides weak internal evidence. Option D (payables days ratio) may indicate a problem but does not specifically identify unrecorded items.

Answer: B. Multiple material risks arise — option B. The interest cover of 1.2x is already below the 1.5x covenant requirement, meaning the covenant is already in breach. Loan covenant breaches typically trigger the right of the lender to demand immediate repayment, making the long-term liability potentially current and creating a going concern risk. The auditor must: (1) confirm whether the covenant has been breached; (2) assess management's plans; (3) evaluate going concern; (4) ensure the liability is correctly classified; (5) test whether adequate disclosure has been made. Option A ignores all risks. Options C and D each identify only one element.

Answer: B. Inherent and control risk operate independently and both affect the assessment — option B. Inherent risk is elevated because: (1) commodity prices are volatile, making NRV uncertain; (2) management must exercise significant judgement in determining whether NRV has fallen below cost. However, strong controls can reduce control risk. If the auditor tests those controls and finds them effective, they can reduce the extent of substantive testing, though the inherent complexity still requires some substantive work. Option A incorrectly reduces inherent risk. Option C incorrectly claims controls eliminate risk. Option D incorrectly reduces inherent risk based on management experience.

Answer: B. Inputting dummy transactions to test system responses is test data — option B. Test data involves the auditor creating controlled transactions (both valid and invalid) and processing them through the client's system to verify that controls operate as expected. In this case, inputting orders that exceed the credit limit tests whether the system's credit limit control correctly rejects them. Option A (audit software analysing live data) examines the actual population, not dummy transactions. Option C (data analytics) similarly analyses live data. Option D (generalised audit software) is a category of tool, not the specific technique described.