principles of auditing and other assurance services Chap006_1

8/20/2019 principles of auditing and other assurance services Chap006_1

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Chapter 06 - Audit Planning, Understanding the Client, Assessing Risks, and Responding

Chapter 06

Audit Planning, Understanding the Client, Assessing Risks, and Responding

True / False Questions

1. Audit committees should be made up of the most ualified directors regardless of !hetherthe" are part of management of the compan".#rue $alse

%. Anal"tical procedures are seldom used for planning an audit engagement because the" aresubstanti&e procedures.#rue $alse

'. Preliminar" arrangements !ith clients should be set forth in the management letter.#rue $alse

(. An audit plan includes a detailed listing of the audit procedures to be performed in the&erification of items in the financial statements.#rue $alse

). #he auditors* tests of controls are designed to substantiate the fairness of specific financialstatement accounts.#rue $alse

6. At least a portion of the auditors* consideration of internal control usuall" is performed atan interim date rather than at the balance sheet date.#rue $alse

+. #he substanti&e approach to an audit is appropriate for man" small businesses.#rue $alse

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. Confirming a bank account establishes eistence but not rights to the cash balance.#rue $alse

. #he completeness of recording of assets is generall" &erified b" tracing from the sourcedocuments to the recorded entr".#rue $alse

10. /ouching the acuisition of assets is an audit procedure that is often performed toestablish the &aluation of the assets.#rue $alse

Multiple Choice Questions

11. hich of the follo!ing factors most likel" !ould cause a CPA to not accept a ne! auditengagementA. #he prospecti&e client has fired its prior auditor.2. #he CPA lacks a thorough understanding of the prospecti&e client*s operations andindustr".C. #he CPA is unable to re&ie! the predecessor auditor*s !orking papers.

3. #he prospecti&e client is un!illing to make financial records a&ailable to the CPA.

1%. hich of the follo!ing factors most likel" !ould heighten an auditor*s concern about therisk of fraudulent financial reportingA. 4arge amounts of liuid assets that are easil" con&ertible into cash.2. 4o! gro!th and profitabilit" as compared to other entit"*s in the same industr".C. $inancial management*s participation in the initial selection of accounting principles.3. An o&erl" comple organi5ational structure in&ol&ing unusual lines of authorit".

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1'. hich of the follo!ing factors !ould most likel" cause a CPA to decide not to accept ane! audit engagementA. 4ack of understanding of the potential client*s internal auditors* computer-assisted audittechniues.

2. anagement*s disregard for internal control.C. #he eistence of related part" transactions.3. anagement*s attempt to meet earnings per share gro!th rate goals.

1(. hich of the follo!ing matters is generall" included in an auditor*s engagement letterA. 4imitations of the engagement.2. $actors to be considered in establishing preliminar" 7udgments about materialit".C. anagement*s liabilit" for illegal acts committed b" its emplo"ees.3. #he auditor*s responsibilit" to obtain negati&e assurance relating to the occurrence of

illegal acts.

1). hich of the follo!ing !ould heighten an auditor*s concern about the risk of fraudulentfinancial reportingA. 8nabilit" to generate positi&e cash flo!s from operations, !hile reporting large increases inearnings.2. anagement*s lack of interest in increasing the di&idend paid on common stock.C. 4arge amounts of liuid assets that are easil" con&ertible into cash.3. 8nabilit" to borro! necessar" capital !ithout obtaining !ai&ers on debt co&enants.

16. #o best test eistence, an auditor !ould sample from the9A. :eneral 4edger to source documents.2. :eneral 4edger to the financial statements.C. ;ource documents to the general ledger.3. ;ource documents to 7ournals.

1+. #he auditors* understanding established !ith a client should be established through aral communication !ith the client.2. ritten communication !ith the client.C. ritten or oral communication !ith the client.3. Completel" detailed audit plan.

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1. hich of the follo!ing !ould be least likel" to be considered an audit planning procedureA. Use an engagement letter.2. 3e&elop the o&erall audit strateg"

C. Perform the risk assessment.3. 3e&elop the audit plan.

1. hile assessing the risks of material misstatement auditors identif" risks, relate risk to!hat could go !rong, consider the magnitude of risks andA. Assess the risk of misstatements due to illegal acts.2. Consider the compleit" of the transactions in&ol&ed.C. Consider the likelihood that the risks could result in material misstatements.3. 3etermine materialit" le&els.

%0. hich of the follo!ing is correct concerning reuirements about auditor communicationsabout fraudA. $raud that in&ol&es senior management should be reported directl" to the audit committeeregardless of the amount in&ol&ed.2. All fraud !ith a material effect on the financial statements should be reported directl" b"the auditor to the ;ecurities and ?change Commission.C. $raud !ith a material effect on the financial statements should ordinaril" be disclosed b"the auditor through use of an @emphasis of a matter@ paragraph added to the audit report.

3. #he auditor has no responsibilit" to disclose fraud outside the entit" under an"circumstances.

%1. A predecessor auditor is reuired to attempt to initiate communication !ith the successorauditor9

A. >ption A2. >ption 2C. >ption C3. >ption 3

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%%. hich measure of materialit" ption A2. >ption 2C. >ption C3. >ption 3

%'. hich of the follo!ing factors most likel" !ould lead a CPA to conclude that a potentialaudit engagement should not be accepted

A. #here are significant related part" transactions that management claims occurred in theordinar" course of business.2. 8nternal control acti&ities reuiring the segregation of duties are sub7ect to managemento&erride.C. anagement continues to emplo" an inefficient s"stem of information technolog" torecord financial transactions.3. 8t is unlikel" that sufficient e&idence is a&ailable to support an opinion on the financialstatements.

%(. 8n using the information on the statement of cash flo!s !hile obtaining an understandingof a profitable, gro!ing compan", !hich of the follo!ing !ould ordinaril" be least surprisingto an auditorA. 3ecreases in accounts pa"able.2. 3ecreases in accounts recei&able.C. egati&e cash flo!s from in&esting.3. egati&e operating cash flo!s.

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%). Audits of financial statements are designed to obtain reasonable assurance of detectingmaterial misstatements due to9


%6. hich of the follo!ing is not one of the assertions made b" management about anaccount balanceA. Rele&ance.2. ?istence.C. /aluation.3. Rights and obligations.

%+. hen a compan" has changed auditors, according to the Professional ;tandards9A. #he successor auditor has the responsibilit" to initiate contact !ith the predecessor auditorto ask about the client before the engagement is acceptedB the predecessor has noresponsibilit" to initiate this contact, e&en !hen a!are of matters bearing on the integrit" ofmanagement.2. #he predecessor must respond full" to all inuiries made b" the successor auditor.C. #he successor must discuss !ith the predecessor matters bearing on the engagement priorto accepting the engagement.3. #he successor ma" choose not to attempt an" communication !ith the predecessor auditor.

%. hich of the follo!ing procedures is not performed as a part of planning an auditengagementA. Re&ie!ing the !orking papers of the prior "ear.2. Performing anal"tical procedures.C. Confirmation of all ma7or accounts.3. 3esigning an audit program.

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%. #he risk of a material misstatement occurring in an account, assuming an absence ofinternal control, is referred to as9A. Account risk.2. Control risk.

C. 3etection risk.3. 8nherent risk.

'0. hich of the follo!ing is least likel" to be considered a financial statement audit riskfactorA. anagement operating and financing decisions are dominated b" top management.2. A ne! client !ith no prior audit histor".C. Rate of change in the entit"*s industr" is rapid.3. Profitabilit" of the entit" relati&e to its industr" is inconsistent.

'1. hich of the follo!ing is an eample of fraudulent financial reportingA. Compan" management falsifies in&entor" count tags thereb" o&erstating ending in&entor"and understating cost of goods sold.2. An emplo"ee di&erts customer pa"ments to his personal use, concealing his actions b"debiting an epense account, thus o&erstating epenses.C. An emplo"ee steals in&entor and the @shrinkage@ is recorded in cost of goods sold.3. An emplo"ee @borro!s@ tools from the compan" and neglects to return themB the cost isreported as a miscellaneous operating epense.

'%. hich of the follo!ing is most likel" to be considered a risk factor relating to fraudulentfinancial reportingA. 4o! turno&er of senior management.2. ?treme degree of competition !ithin the industr".C. Capital structure including &arious operating subsidiaries.3. ;ales goals in ecess of an" of the preceding three "ears.

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''. hich of the follo!ing conditions identified during the audit increases the risk ofemplo"ee fraudA. 4arge amounts of cash in the bank.2. ?istence of a mandator" &acation polic" for emplo"ees performing ke" functions.

C. 8n&entor" items of small si5e, but high &alue.3. Presence of reconciling items on a client prepared "ear-end proof of cash.

'(. hich of the follo!ing statements is accurate about @fraud risk factors@ considered !henconducting an auditA. $actors !hose presence indicates that fraud eists.2. $actors !hose presence often ha&e been obser&ed in circumstances !here frauds ha&eoccurred.C. $actors !hose presence !ill reuire modification to planned audit procedures.

3. $actors obtained during the audit !hich lead to reuired communications !ith the auditcommittee.

'). hich of the follo!ing is not an eample of a likel" ad7ustment in the auditors* o&erallaudit approach !hen significant risk is found to eistA. Appl" increased professional skepticism about material transactions.2. 8ncrease the assessed le&el of detection risk.C. Assign personnel !ith particular skill to areas of high risk.3. >btain increased e&idence about the appropriateness of management*s selection of

accounting principles.

'6. hich of the follo!ing is least likel" to be reuired on an auditA. ?&aluate the business rationale for significant, unusual transactions.2. ake a legal determination of !hether fraud has occurred.C. Re&ie! accounting estimates for biases.3. #est appropriateness of 7ournal entries and ad7ustments.

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'+. hich of the follo!ing is


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(1. #he risk that the auditors* procedures !ill lead them to conclude that a materialmisstatement does not eist in an account balance !hen in fact such a misstatement does eistis referred to as9A. Account risk.

2. Control risk.C. 3etection risk.3. 8nherent risk.

(%. hich of the follo!ing statements is correct regarding the auditor*s determination ofmaterialit"A. #he planning le&el of materialit" should normall" be the larger of the amount consideredfor the balance sheet &ersus the income statement.2. #he auditors* planning le&el of materialit" ma" be disaggregated into smaller @tolerable

misstatements@ for the &arious accounts.C. Auditors ma" use &arious rules of thumb to arri&e at an e&aluation le&el of materialit", butnot for determining the planning le&el of materialit".3. #he amount used for the planning should eual that used for e&aluation.

('. #he auditors must consider materialit" in planning an audit engagement. aterialit" for planning purposes is9A. #he auditors* preliminar" estimate of the largest amount of misstatement that !ould bematerial to an" one of the client*s financial statements.

2. #he auditors* preliminar" estimate of the smallest amount of misstatement that !ould bematerial to an" one of the client*s financial statements.C. #he auditors* preliminar" estimate of the amount of misstatement that !ould be material tothe client*s balance sheet.3. An amount that cannot be uantitati&el" stated since it depends on the nature of the item.

((. hich of the follo!ing topics is not normall" included in an engagement letterA. #he auditors* preliminar" assessment of internal control.2. #he auditors* estimate of the fee for the engagement.

C. 4imitations on the scope of the engagement.3. A description of responsibilit" for the detection of fraud.

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(). hich of the follo!ing is most likel" to be an o&erall response to fraud risks identified inan auditA. >nl" use certified public accountants on the engagement.2. Place increased emphasis on the audit of ob7ecti&e transactions rather than sub7ecti&e

transactions.C. ;uper&ise members of the audit team less closel" and rel" more upon 7udgment.3. Use less predictable audit procedures.

(6. hich of the follo!ing is not an assertion that is made in the financial statements b"management concerning each ma7or account balanceA. Completeness.2. Rights and obligations.C. 4egalit".

3. /aluation.

(+. #ests for unrecorded assets t"picall" in&ol&e tracing from9A. ;ource documents to recorded 7ournal entries.2. ;ource documents to obser&ations.C. Recorded 7ournal entries to documents.3. Recorded 7ournal entries to obser&ations.

(. #racing from source documents for!ard to ledgers is most likel" to address !hichassertion related to posted entries9A. Completeness.2. ?istence.C. Rights.3. /aluation.

(. 3etermining that recei&ables are presented at net-reali5able &alue is most directl" related

to !hich management assertionA. ?istence.2. Rights.C. /aluation.3. Presentation and disclosure.

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)0. hich of the follo!ing is not a general ob7ecti&e for the audit of asset accountsA. ?stablishing eistence of assets.2. ?stablishing proper &aluation of assets.C. ?stablishing proper liabilities relating to assets.

3. ?stablishing the completeness of assets.

)1. hich of the follo!ing is not used b" auditors to establish the completeness of recordedassetsA. Assessing control risk.2. #racing from source documents to entries in the accounting records.C. Performing anal"tical procedures.3. /ouching transactions.

)%. #o test for unsupported entries in the 7ournals, the direction of audit testing should be tothe9A. 4edger entries.2. ournal entries.C. >riginal source documents.3. $inancial statements.

)'. A form filed !ith the ;?C !hen a compan" changes auditors is a9A. $orm -D.2. $orm 10-D.C. $orm ;-1.3. $orm 2-1.

)(. hich of the follo!ing is least likel" to render material a uantitati&el" smallmisstatement materialA. Affects the registrant*s compliance !ith regulator" reuirements.

2. asks a change in earnings or other trends.C. Arises from an item not capable of precise measurement.3. #he #ransaction in&ol&es a related part".

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)). A successor auditor has accepted an engagement that !as pre&iousl" performed b" a predecessor auditor and, prior to accepting the engagement, has communicated !ith the predecessor. hen the successor belie&es that the predecessor has performed satisfactor" pre&ious audits, !hich of the follo!ing is correct

A. A second communication is reuired and must include details of pre&ious audits.2. >rdinaril" the successor auditors ma" be able to accept the opening balances of the current"ear !ith a minimum of &erification !ork.C. Absent ongoing litigation, a predecessor must pro&ide all !orking papers reuested b" the predecessor.3. #he client should be informed of the need to perform a detailed audit of all opening balances.

)6. #he first standard of field !ork recogni5es that earl" appointment of the independent

auditors has man" ad&antages to the auditors and the client. hich of the follo!ingad&antages is least likel" to occur as a result of earl" appointment of the auditorsA. #he auditors !ill be able to plan the audit !ork so that it ma" be done epeditiousl".2. #he auditors !ill be able to complete substanti&e procedures prior to "ear-end.C. #he auditors !ill be able to better plan for the obser&ation of the ph"sical in&entories.3. #he auditors !ill be able to perform the eamination more efficientl" and !ill be finishedat an earl" date after the "ear-end.

)+. Preliminar" arrangements agreed to b" the auditors and the client should be reduced to

!riting b" the auditors. #he best place to set forth these arrangements is in9A. A memorandum to be placed in the permanent section of the auditing !orking papers.2. An engagement letter.C. A client representation letter.3. A confirmation letter attached to the constructi&e ser&ices letter.

). #he auditors are planning an audit engagement for a ne! client in a business that isunfamiliar to the auditors. hich of the follo!ing !ould be the most useful source ofinformation for the auditors during the preliminar" planning stage !hen the" are tr"ing to

obtain a general understanding of audit problems that might be encounteredA. Client manuals of accounts and charts of accounts.2. A8CPA 8ndustr" Audit :uides.C. Prior-"ear !orking papers of the predecessor auditors.3. 4atest annual and interim financial statements issued b" the client.

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). #he auditors !ill not ordinaril" initiate discussion !ith the audit committee concerningthe9A. ?tent to !hich the !ork of internal auditors !ill influence the scope of the eamination.2. ?tent to !hich change in the compan"*s organi5ation !ill influence the scope of the

eamination.C. 3etails of potential problems !hich the auditors belie&e might cause a ualified opinion.3. 3etails of the procedures !hich the auditors intend to appl".

60. hich statement is correct relating to a potential successor auditor*s responsibilit" forcommunicating !ith the predecessor auditors in connection !ith a prospecti&e ne! auditclientA. #he successor auditors ha&e no responsibilit" to contact the predecessor auditors.2. #he successor auditors should obtain permission from the prospecti&e client to contact the

predecessor auditors.C. #he successor auditors should contact the predecessors regardless of !hether the prospecti&e client authori5es contact.3. #he successor auditors need not contact the predecessors if the successors are a!are of alla&ailable rele&ant facts.

61. hich of the follo!ing situations !ould most likel" reuire special audit planning b" theauditorsA. ;ome items of factor" and office euipment do not bear identification numbers.

2. 3epreciation methods used on the client*s ta return differ from those used on the books.C. Assets costing less than E)00 are epensed e&en though the epected life eceeds one "ear.3. 8n&entor" is comprised of precious stones.

6%. hen planning an audit, an auditor should9A. Consider !hether the etent of substanti&e procedures ma" be reduced based on the resultsof the internal control uestionnaire.2. ake preliminar" 7udgments about materialit" le&els for audit purposes.C. Conclude !hether changes in compliance !ith prescribed control procedures 7ustifies

reliance on them.3. Prepare a preliminar" draft of the management representation letter.

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6'. An auditor !ho accepts an audit engagement and does not possess the industr" epertiseof the business entit", should9A. ?ngage financial eperts familiar !ith the nature of the business entit".2. >btain a kno!ledge of matters that relate to the nature of the entit"*s business.

C. Refer a substantial portion of the audit to another CPA !ho !ill act as the principal auditor.3. $irst inform management that an unualified opinion cannot be issued.

6(. ith respect to the auditor*s planning of a "ear-end audit, !hich of the follo!ingstatements is al!a"s trueA. An engagement should not be accepted after the fiscal "ear-end.2. An in&entor" count must be obser&ed at the balance sheet date.C. #he client*s audit committee should not be told of an" specific audit procedures !hich !ill be performed.

3. 8t is an acceptable practice to carr" out parts of the eamination at interim dates.

6). Fa!kins reuested permission to communicate !ith the predecessor auditor and re&ie!certain portions of the predecessor auditor*s !orking papers. #he prospecti&e client*s refusalto permit this !ill bear directl" on Fa!kins* decision concerning the9A. Adeuac" of the preplanned audit program.2. Abilit" to establish consistenc" in application of accounting principles bet!een "ears.C. Apparent scope limitation.3. 8ntegrit" of management.

66. #he auditor faces a risk that the audit !ill not detect material misstatements in thefinancial statements. 8n regard to minimi5ing this risk, the auditor primaril" relies on9A. ;ubstanti&e procedures.2. #ests of controls.C. 8nternal control.3. ;tatistical anal"sis.

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6+. An abnormal fluctuation in gross profit that might suggest the need for etended audit procedures for sales and in&entories !ould most likel" be identified in the planning phase ofthe audit b" the use of9A. #ests of transactions and balances.

2. An assessment of internal control.C. ;peciali5ed audit programs.3. Anal"tical procedures.

6. 2efore accepting an audit engagement, a successor auditor should make specific inuiriesof the predecessor auditor regarding the predecessor*s9A. A!areness of the consistenc" in the application of generall" accepted accounting principles bet!een accounting periods.2. ?&aluation of all matters of continuing accounting significance.

C. >pinion of an" subseuent e&ents occurring since the predecessor*s audit report !asissued.3. Understanding as to the reasons for the change of auditors.

6. hich of the follo!ing is least likel" to be included in an auditor*s inuir" ofmanagement !hile obtaining information to identif" the risks of material misstatement due tofraudA. Are all financial reporting operations at one location2. 3oes it ha&e kno!ledge of fraud or suspect fraud

C. 3oes it ha&e programs to mitigate fraud risks3. Fas it reported to the audit committee the nature of the compan"*s internal control

+0. An auditor selects a sample from the file of shipping documents to determine !hetherin&oices !ere prepared. #his test is performed to satisf" the audit ob7ecti&e of9A. Accurac".2. Completeness.C. Control.3. ?istence.

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+1. 8ndi&iduals !ho commit fraud are ordinaril" able to rationali5e the act and also ha&e an9


+%. hich of the follo!ing is not a reuired source of information for the auditors* assessmentof fraud risk

A. 3iscussion among audit team members.2. $raud risk factors.C. Results of tests of controls.3. 8nuir" of management and others.

+'. Auditors must assess fraud risk on e&er" audit and respond to the risks that are identified.hich of the follo!ing is not a procedure reuired to further address the fraud risk ofmanagement o&erride of internal controlA. Re&ie!ing accounting estimates for biases.

2. ?amining ph"sical controls o&er assets.C. ?&aluating the business rationale for significant unusual transactions.3. ?amining 7ournal entries and other ad7ustments for e&idence of fraud.

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Essa Questions

+(. ?ngagement letters are used b" most auditors in performing professional ser&ices.a. 3escribe the purpose of an engagement letter.

b. 4ist four items that are normall" included in an engagement letter.

+). As a part of the planning process, the auditors often prepare an audit plan, an audit

program, and a time budget.a. 3escribe an audit plan and eplain its purpose. b. 3escribe an audit program and eplain its purpose.c. 3escribe a time budget and eplain its purpose.

+6. Auditors perform &arious tasks in planning an audit engagement. Pro&ide an o&eralldescription of ho! each task is performed and its purpose.a. >btain an understanding of the client*s business. b. Assess audit risk and materialit" for the engagement.c. Assess fraud risk.d. Assess the risk of material misstatement of assertions about financial statement accountsand classes of transactions.

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++. an" auditors take an approach to assessing the risk of material misstatement b" beginning !ith an assessment of business risks.a. 3efine business risks. b. h" ha&e auditors found it effecti&e to take the approach of assessing business risks

c. 8dentif" a business risk and eplain ho! it might affect the auditor*s audit procedures.

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Chapter 06 Audit Planning, Understanding the Client, Assessing Risks, andResponding Ans!er De"

True / False Questions

1. Audit committees should be made up of the most ualified directors regardless of !hetherthe" are part of management of the compan".FA!"E

Difficulty: Hard

%. Anal"tical procedures are seldom used for planning an audit engagement because the" aresubstanti&e procedures.FA!"E

Difficulty: Easy

'. Preliminar" arrangements !ith clients should be set forth in the management letter.

FA!"E

Difficulty: Easy

(. An audit plan includes a detailed listing of the audit procedures to be performed in the&erification of items in the financial statements.FA!"E

Difficulty: Medium

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). #he auditors* tests of controls are designed to substantiate the fairness of specific financialstatement accounts.FA!"E

Difficulty: Medium

6. At least a portion of the auditors* consideration of internal control usuall" is performed atan interim date rather than at the balance sheet date.TRUE

Difficulty: Medium

+. #he substanti&e approach to an audit is appropriate for man" small businesses.TRUE

Difficulty: Medium

. Confirming a bank account establishes eistence but not rights to the cash balance.FA!"E

Difficulty: Hard

. #he completeness of recording of assets is generall" &erified b" tracing from the sourcedocuments to the recorded entr".TRUE

Difficulty: Hard

10. /ouching the acuisition of assets is an audit procedure that is often performed toestablish the &aluation of the assets.TRUE

Difficulty: Hard

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Multiple Choice Questions

11. hich of the follo!ing factors most likel" !ould cause a CPA to not accept a ne! audit

engagementA. #he prospecti&e client has fired its prior auditor.2. #he CPA lacks a thorough understanding of the prospecti&e client*s operations andindustr".C. #he CPA is unable to re&ie! the predecessor auditor*s !orking papers.#$ #he prospecti&e client is un!illing to make financial records a&ailable to the CPA.

Difficulty: Medium

Source: AICPA

1%. hich of the follo!ing factors most likel" !ould heighten an auditor*s concern about therisk of fraudulent financial reportingA. 4arge amounts of liuid assets that are easil" con&ertible into cash.2. 4o! gro!th and profitabilit" as compared to other entit"*s in the same industr".C. $inancial management*s participation in the initial selection of accounting principles.#$ An o&erl" comple organi5ational structure in&ol&ing unusual lines of authorit".

Difficulty: Hard

Source: AICPA

1'. hich of the follo!ing factors !ould most likel" cause a CPA to decide not to accept ane! audit engagementA. 4ack of understanding of the potential client*s internal auditors* computer-assisted audittechniues.%$ anagement*s disregard for internal control.C. #he eistence of related part" transactions.3. anagement*s attempt to meet earnings per share gro!th rate goals.

Difficulty: Hard

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1(. hich of the follo!ing matters is generall" included in an auditor*s engagement letterA$ 4imitations of the engagement.2. $actors to be considered in establishing preliminar" 7udgments about materialit".C. anagement*s liabilit" for illegal acts committed b" its emplo"ees.

3. #he auditor*s responsibilit" to obtain negati&e assurance relating to the occurrence ofillegal acts.

Difficulty: Hard

1). hich of the follo!ing !ould heighten an auditor*s concern about the risk of fraudulentfinancial reportingA$ 8nabilit" to generate positi&e cash flo!s from operations, !hile reporting large increases inearnings.

2. anagement*s lack of interest in increasing the di&idend paid on common stock.C. 4arge amounts of liuid assets that are easil" con&ertible into cash.3. 8nabilit" to borro! necessar" capital !ithout obtaining !ai&ers on debt co&enants.

Difficulty: Hard

Source: AICPA

16. #o best test eistence, an auditor !ould sample from the9A$ :eneral 4edger to source documents.

2. :eneral 4edger to the financial statements.C. ;ource documents to the general ledger.3. ;ource documents to 7ournals.

Difficulty: Medium

1+. #he auditors* understanding established !ith a client should be established through aral communication !ith the client.%$ ritten communication !ith the client.

C. ritten or oral communication !ith the client.3. Completel" detailed audit plan.

Difficulty: Easy

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1. hich of the follo!ing !ould be least likel" to be considered an audit planning procedureA. Use an engagement letter.2. 3e&elop the o&erall audit strateg"

C$ Perform the risk assessment.3. 3e&elop the audit plan.

Difficulty: Medium

1. hile assessing the risks of material misstatement auditors identif" risks, relate risk to!hat could go !rong, consider the magnitude of risks andA. Assess the risk of misstatements due to illegal acts.2. Consider the compleit" of the transactions in&ol&ed.

C$ Consider the likelihood that the risks could result in material misstatements.3. 3etermine materialit" le&els.

Difficulty: Medium

%0. hich of the follo!ing is correct concerning reuirements about auditor communicationsabout fraudA$ $raud that in&ol&es senior management should be reported directl" to the audit committeeregardless of the amount in&ol&ed.

2. All fraud !ith a material effect on the financial statements should be reported directl" b"the auditor to the ;ecurities and ?change Commission.C. $raud !ith a material effect on the financial statements should ordinaril" be disclosed b"the auditor through use of an @emphasis of a matter@ paragraph added to the audit report.3. #he auditor has no responsibilit" to disclose fraud outside the entit" under an"circumstances.

Difficulty: Hard

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%1. A predecessor auditor is reuired to attempt to initiate communication !ith the successorauditor9

A. >ption A2. >ption 2C. >ption C#$ >ption 3

Difficulty: Hard

%%. hich measure of materialit" ption A2. >ption 2

C. >ption C3. >ption 3

Difficulty: Medium

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%'. hich of the follo!ing factors most likel" !ould lead a CPA to conclude that a potentialaudit engagement should not be acceptedA. #here are significant related part" transactions that management claims occurred in theordinar" course of business.

2. 8nternal control acti&ities reuiring the segregation of duties are sub7ect to managemento&erride.C. anagement continues to emplo" an inefficient s"stem of information technolog" torecord financial transactions.#$ 8t is unlikel" that sufficient e&idence is a&ailable to support an opinion on the financialstatements.

Difficulty: Medium

Source: AICPA

%(. 8n using the information on the statement of cash flo!s !hile obtaining an understandingof a profitable, gro!ing compan", !hich of the follo!ing !ould ordinaril" be least surprisingto an auditorA. 3ecreases in accounts pa"able.2. 3ecreases in accounts recei&able.C$ egati&e cash flo!s from in&esting.3. egati&e operating cash flo!s.

Difficulty: Hard

%). Audits of financial statements are designed to obtain reasonable assurance of detectingmaterial misstatements due to9

A$ >ption A2. >ption 2

C. >ption C3. >ption 3

Difficulty: Medium

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%6. hich of the follo!ing is not one of the assertions made b" management about anaccount balanceA$ Rele&ance.2. ?istence.

C. /aluation.3. Rights and obligations.

Difficulty: Easy

%+. hen a compan" has changed auditors, according to the Professional ;tandards9A$ #he successor auditor has the responsibilit" to initiate contact !ith the predecessor auditorto ask about the client before the engagement is acceptedB the predecessor has noresponsibilit" to initiate this contact, e&en !hen a!are of matters bearing on the integrit" of

management.2. #he predecessor must respond full" to all inuiries made b" the successor auditor.C. #he successor must discuss !ith the predecessor matters bearing on the engagement priorto accepting the engagement.3. #he successor ma" choose not to attempt an" communication !ith the predecessor auditor.

Difficulty: Hard

%. hich of the follo!ing procedures is not performed as a part of planning an audit

engagementA. Re&ie!ing the !orking papers of the prior "ear.2. Performing anal"tical procedures.C$ Confirmation of all ma7or accounts.3. 3esigning an audit program.

Difficulty: Hard

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%. #he risk of a material misstatement occurring in an account, assuming an absence ofinternal control, is referred to as9A. Account risk.2. Control risk.

C. 3etection risk.#$ 8nherent risk.

Difficulty: Medium

'0. hich of the follo!ing is least likel" to be considered a financial statement audit riskfactorA$ anagement operating and financing decisions are dominated b" top management.2. A ne! client !ith no prior audit histor".

C. Rate of change in the entit"*s industr" is rapid.3. Profitabilit" of the entit" relati&e to its industr" is inconsistent.

Difficulty: Hard

'1. hich of the follo!ing is an eample of fraudulent financial reportingA$ Compan" management falsifies in&entor" count tags thereb" o&erstating ending in&entor"and understating cost of goods sold.2. An emplo"ee di&erts customer pa"ments to his personal use, concealing his actions b"

debiting an epense account, thus o&erstating epenses.C. An emplo"ee steals in&entor and the @shrinkage@ is recorded in cost of goods sold.3. An emplo"ee @borro!s@ tools from the compan" and neglects to return themB the cost isreported as a miscellaneous operating epense.

Difficulty: Medium

'%. hich of the follo!ing is most likel" to be considered a risk factor relating to fraudulentfinancial reporting

A. 4o! turno&er of senior management.%$ ?treme degree of competition !ithin the industr".C. Capital structure including &arious operating subsidiaries.3. ;ales goals in ecess of an" of the preceding three "ears.

Difficulty: Hard

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''. hich of the follo!ing conditions identified during the audit increases the risk ofemplo"ee fraudA. 4arge amounts of cash in the bank.2. ?istence of a mandator" &acation polic" for emplo"ees performing ke" functions.

C$ 8n&entor" items of small si5e, but high &alue.3. Presence of reconciling items on a client prepared "ear-end proof of cash.

Difficulty: Medium

'(. hich of the follo!ing statements is accurate about @fraud risk factors@ considered !henconducting an auditA. $actors !hose presence indicates that fraud eists.%$ $actors !hose presence often ha&e been obser&ed in circumstances !here frauds ha&e

occurred.C. $actors !hose presence !ill reuire modification to planned audit procedures.3. $actors obtained during the audit !hich lead to reuired communications !ith the auditcommittee.

Difficulty: Hard

'). hich of the follo!ing is not an eample of a likel" ad7ustment in the auditors* o&erallaudit approach !hen significant risk is found to eist

A. Appl" increased professional skepticism about material transactions.%$ 8ncrease the assessed le&el of detection risk.C. Assign personnel !ith particular skill to areas of high risk.3. >btain increased e&idence about the appropriateness of management*s selection ofaccounting principles.

Difficulty: Medium

'6. hich of the follo!ing is least likel" to be reuired on an audit

A. ?&aluate the business rationale for significant, unusual transactions.%$ ake a legal determination of !hether fraud has occurred.C. Re&ie! accounting estimates for biases.3. #est appropriateness of 7ournal entries and ad7ustments.

Difficulty: Medium

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'+. hich of the follo!ing is


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(0. 8f the business en&ironment is eperiencing a recession, the auditor most likel" !ouldfocus increased attention on !hich of the follo!ing accountsA. Purchase returns and allo!ances.%$ Allo!ance for doubtful accounts.

C. Common stock.3. oncontrolling interest of a subsidiar" purchased during the "ear.

Difficulty: Hard

Source: AICPA

(1. #he risk that the auditors* procedures !ill lead them to conclude that a materialmisstatement does not eist in an account balance !hen in fact such a misstatement does eistis referred to as9

A. Account risk.2. Control risk.C$ 3etection risk.3. 8nherent risk.

Difficulty: Medium

(%. hich of the follo!ing statements is correct regarding the auditor*s determination ofmaterialit"

A. #he planning le&el of materialit" should normall" be the larger of the amount consideredfor the balance sheet &ersus the income statement.%$ #he auditors* planning le&el of materialit" ma" be disaggregated into smaller @tolerablemisstatements@ for the &arious accounts.C. Auditors ma" use &arious rules of thumb to arri&e at an e&aluation le&el of materialit", butnot for determining the planning le&el of materialit".3. #he amount used for the planning should eual that used for e&aluation.

Difficulty: Hard

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('. #he auditors must consider materialit" in planning an audit engagement. aterialit" for planning purposes is9A. #he auditors* preliminar" estimate of the largest amount of misstatement that !ould bematerial to an" one of the client*s financial statements.

%$ #he auditors* preliminar" estimate of the smallest amount of misstatement that !ould bematerial to an" one of the client*s financial statements.C. #he auditors* preliminar" estimate of the amount of misstatement that !ould be material tothe client*s balance sheet.3. An amount that cannot be uantitati&el" stated since it depends on the nature of the item.

Difficulty: Medium

((. hich of the follo!ing topics is not normall" included in an engagement letter

A$ #he auditors* preliminar" assessment of internal control.2. #he auditors* estimate of the fee for the engagement.C. 4imitations on the scope of the engagement.3. A description of responsibilit" for the detection of fraud.

Difficulty: Hard

(). hich of the follo!ing is most likel" to be an o&erall response to fraud risks identified inan audit

A. >nl" use certified public accountants on the engagement.2. Place increased emphasis on the audit of ob7ecti&e transactions rather than sub7ecti&etransactions.C. ;uper&ise members of the audit team less closel" and rel" more upon 7udgment.#$ Use less predictable audit procedures.

Difficulty: Hard

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(6. hich of the follo!ing is not an assertion that is made in the financial statements b"management concerning each ma7or account balanceA. Completeness.2. Rights and obligations.

C$ 4egalit".3. /aluation.

Difficulty: Easy

(+. #ests for unrecorded assets t"picall" in&ol&e tracing from9A$ ;ource documents to recorded 7ournal entries.2. ;ource documents to obser&ations.C. Recorded 7ournal entries to documents.

3. Recorded 7ournal entries to obser&ations.

Difficulty: Hard

(. #racing from source documents for!ard to ledgers is most likel" to address !hichassertion related to posted entries9A$ Completeness.2. ?istence.C. Rights.

3. /aluation.

Difficulty: Hard

(. 3etermining that recei&ables are presented at net-reali5able &alue is most directl" relatedto !hich management assertionA. ?istence.2. Rights.C$ /aluation.

3. Presentation and disclosure.

Difficulty: Medium

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)0. hich of the follo!ing is not a general ob7ecti&e for the audit of asset accountsA. ?stablishing eistence of assets.2. ?stablishing proper &aluation of assets.C$ ?stablishing proper liabilities relating to assets.

3. ?stablishing the completeness of assets.

Difficulty: Medium

)1. hich of the follo!ing is not used b" auditors to establish the completeness of recordedassetsA. Assessing control risk.2. #racing from source documents to entries in the accounting records.C. Performing anal"tical procedures.

#$ /ouching transactions.

Difficulty: Hard

)%. #o test for unsupported entries in the 7ournals, the direction of audit testing should be tothe9A. 4edger entries.2. ournal entries.C$ >riginal source documents.

3. $inancial statements.

Difficulty: Hard

)'. A form filed !ith the ;?C !hen a compan" changes auditors is a9A$ $orm -D.2. $orm 10-D.C. $orm ;-1.3. $orm 2-1.

Difficulty: Medium

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)(. hich of the follo!ing is least likel" to render material a uantitati&el" smallmisstatement materialA. Affects the registrant*s compliance !ith regulator" reuirements.2. asks a change in earnings or other trends.

C. Arises from an item not capable of precise measurement.#$ #he #ransaction in&ol&es a related part".

Difficulty: Hard

)). A successor auditor has accepted an engagement that !as pre&iousl" performed b" a predecessor auditor and, prior to accepting the engagement, has communicated !ith the predecessor. hen the successor belie&es that the predecessor has performed satisfactor"

pre&ious audits, !hich of the follo!ing is correctA. A second communication is reuired and must include details of pre&ious audits.%$ >rdinaril" the successor auditors ma" be able to accept the opening balances of the current"ear !ith a minimum of &erification !ork.C. Absent ongoing litigation, a predecessor must pro&ide all !orking papers reuested b" the predecessor.3. #he client should be informed of the need to perform a detailed audit of all opening balances.

Difficulty: Hard

)6. #he first standard of field !ork recogni5es that earl" appointment of the independentauditors has man" ad&antages to the auditors and the client. hich of the follo!ingad&antages is least likel" to occur as a result of earl" appointment of the auditorsA. #he auditors !ill be able to plan the audit !ork so that it ma" be done epeditiousl".%$ #he auditors !ill be able to complete substanti&e procedures prior to "ear-end.C. #he auditors !ill be able to better plan for the obser&ation of the ph"sical in&entories.3. #he auditors !ill be able to perform the eamination more efficientl" and !ill be finishedat an earl" date after the "ear-end.

Difficulty: Medium

Source: AICPA

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)+. Preliminar" arrangements agreed to b" the auditors and the client should be reduced to!riting b" the auditors. #he best place to set forth these arrangements is in9A. A memorandum to be placed in the permanent section of the auditing !orking papers.%$ An engagement letter.

C. A client representation letter.3. A confirmation letter attached to the constructi&e ser&ices letter.

Difficulty: Easy

Source: AICPA

). #he auditors are planning an audit engagement for a ne! client in a business that isunfamiliar to the auditors. hich of the follo!ing !ould be the most useful source ofinformation for the auditors during the preliminar" planning stage !hen the" are tr"ing to

obtain a general understanding of audit problems that might be encounteredA. Client manuals of accounts and charts of accounts.2. A8CPA 8ndustr" Audit :uides.C$ Prior-"ear !orking papers of the predecessor auditors.3. 4atest annual and interim financial statements issued b" the client.

Difficulty: Hard

Source: AICPA

). #he auditors !ill not ordinaril" initiate discussion !ith the audit committee concerning

the9A. ?tent to !hich the !ork of internal auditors !ill influence the scope of the eamination.2. ?tent to !hich change in the compan"*s organi5ation !ill influence the scope of theeamination.C. 3etails of potential problems !hich the auditors belie&e might cause a ualified opinion.#$ 3etails of the procedures !hich the auditors intend to appl".

Difficulty: Hard

Source: AICPA

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60. hich statement is correct relating to a potential successor auditor*s responsibilit" forcommunicating !ith the predecessor auditors in connection !ith a prospecti&e ne! auditclientA. #he successor auditors ha&e no responsibilit" to contact the predecessor auditors.

%$ #he successor auditors should obtain permission from the prospecti&e client to contact the predecessor auditors.C. #he successor auditors should contact the predecessors regardless of !hether the prospecti&e client authori5es contact.3. #he successor auditors need not contact the predecessors if the successors are a!are of alla&ailable rele&ant facts.

Difficulty: Medium

Source: AICPA

61. hich of the follo!ing situations !ould most likel" reuire special audit planning b" theauditorsA. ;ome items of factor" and office euipment do not bear identification numbers.2. 3epreciation methods used on the client*s ta return differ from those used on the books.C. Assets costing less than E)00 are epensed e&en though the epected life eceeds one "ear.#$ 8n&entor" is comprised of precious stones.

Difficulty: MediumSource: AICPA

6%. hen planning an audit, an auditor should9A. Consider !hether the etent of substanti&e procedures ma" be reduced based on the resultsof the internal control uestionnaire.%$ ake preliminar" 7udgments about materialit" le&els for audit purposes.C. Conclude !hether changes in compliance !ith prescribed control procedures 7ustifiesreliance on them.3. Prepare a preliminar" draft of the management representation letter.


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6'. An auditor !ho accepts an audit engagement and does not possess the industr" epertiseof the business entit", should9A. ?ngage financial eperts familiar !ith the nature of the business entit".%$ >btain a kno!ledge of matters that relate to the nature of the entit"*s business.

C. Refer a substantial portion of the audit to another CPA !ho !ill act as the principal auditor.3. $irst inform management that an unualified opinion cannot be issued.

Difficulty: Medium

Source: AICPA

6(. ith respect to the auditor*s planning of a "ear-end audit, !hich of the follo!ingstatements is al!a"s trueA. An engagement should not be accepted after the fiscal "ear-end.

2. An in&entor" count must be obser&ed at the balance sheet date.C. #he client*s audit committee should not be told of an" specific audit procedures !hich !ill be performed.#$ 8t is an acceptable practice to carr" out parts of the eamination at interim dates.


6). Fa!kins reuested permission to communicate !ith the predecessor auditor and re&ie!certain portions of the predecessor auditor*s !orking papers. #he prospecti&e client*s refusal

to permit this !ill bear directl" on Fa!kins* decision concerning the9A. Adeuac" of the preplanned audit program.2. Abilit" to establish consistenc" in application of accounting principles bet!een "ears.C. Apparent scope limitation.#$ 8ntegrit" of management.

Difficulty: Medium

Source: AICPA

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66. #he auditor faces a risk that the audit !ill not detect material misstatements in thefinancial statements. 8n regard to minimi5ing this risk, the auditor primaril" relies on9A$ ;ubstanti&e procedures.2. #ests of controls.

C. 8nternal control.3. ;tatistical anal"sis.

Difficulty: Easy

Source: AICPA

6+. An abnormal fluctuation in gross profit that might suggest the need for etended audit procedures for sales and in&entories !ould most likel" be identified in the planning phase ofthe audit b" the use of9

A. #ests of transactions and balances.2. An assessment of internal control.C. ;peciali5ed audit programs.#$ Anal"tical procedures.

Difficulty: EasySource: AICPA

6. 2efore accepting an audit engagement, a successor auditor should make specific inuiriesof the predecessor auditor regarding the predecessor*s9

A. A!areness of the consistenc" in the application of generall" accepted accounting principles bet!een accounting periods.2. ?&aluation of all matters of continuing accounting significance.C. >pinion of an" subseuent e&ents occurring since the predecessor*s audit report !asissued.#$ Understanding as to the reasons for the change of auditors.

Difficulty: Medium

Source: AICPA

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6. hich of the follo!ing is least likel" to be included in an auditor*s inuir" ofmanagement !hile obtaining information to identif" the risks of material misstatement due tofraudA$ Are all financial reporting operations at one location

2. 3oes it ha&e kno!ledge of fraud or suspect fraudC. 3oes it ha&e programs to mitigate fraud risks3. Fas it reported to the audit committee the nature of the compan"*s internal control

Difficulty: Hard

+0. An auditor selects a sample from the file of shipping documents to determine !hetherin&oices !ere prepared. #his test is performed to satisf" the audit ob7ecti&e of9A. Accurac".

%$ Completeness.C. Control.3. ?istence.

Difficulty: Hard

Source: AICPA

+1. 8ndi&iduals !ho commit fraud are ordinaril" able to rationali5e the act and also ha&e an9

A$ >ption A2. >ption 2C. >ption C3. >ption 3

Difficulty: Easy

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+%. hich of the follo!ing is not a reuired source of information for the auditors* assessmentof fraud riskA. 3iscussion among audit team members.2. $raud risk factors.

C$ Results of tests of controls.3. 8nuir" of management and others.

Difficulty: Medium

+'. Auditors must assess fraud risk on e&er" audit and respond to the risks that are identified.hich of the follo!ing is not a procedure reuired to further address the fraud risk ofmanagement o&erride of internal controlA. Re&ie!ing accounting estimates for biases.

%$ ?amining ph"sical controls o&er assets.C. ?&aluating the business rationale for significant unusual transactions.3. ?amining 7ournal entries and other ad7ustments for e&idence of fraud.

Difficulty: Medium

Essa Questions

+(. ?ngagement letters are used b" most auditors in performing professional ser&ices.a. 3escribe the purpose of an engagement letter. b. 4ist four items that are normall" included in an engagement letter.

a. #he purpose of an engagement letter is to establish a !ritten contract bet!een the auditorsand the client. #hus, the letter tends to pre&ent misunderstandings bet!een those t!o parties. b. 8tems that are normall" included in an engagement letter include


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+). As a part of the planning process, the auditors often prepare an audit plan, an audit program, and a time budget.a. 3escribe an audit plan and eplain its purpose. b. 3escribe an audit program and eplain its purpose.

c. 3escribe a time budget and eplain its purpose.

a. #he audit plan is an o&er&ie! of the engagement, outlining the nature and characteristics ofthe client and its en&ironment and the o&erall audit strateg". #he audit plan documents thema7or considerations in planning the engagement. b. #he audit program is a detailed listing of audit procedures to be performed in theengagement. 8t is a tool for scheduling and controlling the !ork.c. #he time budget includes an estimate of the time reuired for each audit task. 8t ser&es as a basis for the fee estimate, controls the audit !ork, and ma" be used to e&aluate performance b" the audit staff.

Difficulty: Medium

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+6. Auditors perform &arious tasks in planning an audit engagement. Pro&ide an o&eralldescription of ho! each task is performed and its purpose.a. >btain an understanding of the client*s business. b. Assess audit risk and materialit" for the engagement.

c. Assess fraud risk.d. Assess the risk of material misstatement of assertions about financial statement accountsand classes of transactions.

a. #he auditors obtain an understanding of the client*s business through procedures such asinuir" of client personnel, obser&ing client operations, stud"ing A8CPA Audit andAccounting :uides and 8ndustr" Risk Alerts and other industr" publications, and re&ie!ing prior annual reports, ;?C filings, ta returns, and interim financial statements. Anunderstanding of the client*s business is necessar" to the e&aluation of the appropriateness ofthe client*s transactions, accounting principles used, and the estimates and assumptionsembodied in the financial statements. 8n addition, it pro&ides part of the information to assess

the risks of material misstatement. b. aterialit" for planning purposes is the auditors* preliminar" estimate of the smallestamount of misstatement that !ould affect the decisions of reasonable users of the financialstatements. #he auditors use 7udgment to determine the amount of planning materialit",usuall" based on some rule of thumb. Audit risk is the possibilit" that the auditors !ill fail tomodif" the opinion on financial statements that are materiall" misstated. #he auditors assessthis risk b" considering characteristics of management, operations, and the engagement.Audit risk and materialit" determine the o&erall scope of the engagement. #he lo!er theamount of planning materialit", the more etensi&e the scope of the audit. #he higher the riskof misstatement of the financial statements, the more etensi&e the scope of the audit.c. #he auditors are reuired to assess fraud risk on e&er" audit. #his assessment is based on

information deri&ed from


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++. an" auditors take an approach to assessing the risk of material misstatement b" beginning !ith an assessment of business risks.a. 3efine business risks. b. h" ha&e auditors found it effecti&e to take the approach of assessing business risks

c. 8dentif" a business risk and eplain ho! it might affect the auditor*s audit procedures.

a. 2usiness risks are those that threaten management*s abilit" to achie&e the organi5ation*sob7ecti&es. b. Auditors ha&e found this approach effecti&e because significant business risks often createrelated risks of material misstatement

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