Audit and Assurance Practice Exam

In examining a common-sized income statement, when can an auditor's expectation for an expense account be confirmed?

1. When expenses are decreasing

2. When the balance is in line with prior years and industry information

3. After consulting with management only

4. When revenues are increasing

The correct answer is: When the balance is in line with prior years and industry information

The reasoning behind selecting the option that states the balance is in line with prior years and industry information is rooted in the purpose of a common-sized income statement. A common-sized income statement presents all items as a percentage of a common figure, typically total revenue, allowing for easier comparison across time periods or among different companies. When assessing an expense account, an auditor's expectation can be confirmed by analyzing trends and variances in the data. If the expenses are consistent with historical data and match industry benchmarks, this provides a level of assurance regarding their reasonableness. It indicates that the entity is managing its costs in a manner similar to past performance and industry norms, which is a strong indicator of accuracy and absence of irregularities. In contrast, decreasing expenses alone, or increasing revenues, may not necessarily confirm expectations about expense accounts unless these trends are analyzed in a broader context of corresponding data or business circumstances. Consulting with management, while important for gathering qualitative insights, does not provide the empirical confirmation that comes from comparing quantitative data against established historical and industry standards.