Audit Exam 2

The person in charge of authorizing credit to customers does not properly understand what constitutes a credit risk. This is an example of: 1. A deficiency in operation. 2. A material weakness. 3. This is not an internal control deficiency. 4. A design deficiency.

1. A deficiency in operation.

Which of these statements concerning illegal acts by clients is correct? 1. An auditor's responsibility to detect illegal acts that have a direct and material effect on the financial statements is the same as that for errors and fraud. 2. An audit in accordance with generally accepted auditing standards normally includes audit procedures specifically designed to detect illegal acts that have an indirect but material effect on the financial statements. 3. An auditor considers illegal acts from the perspective of the reliability of management's representations rather than their relation to audit objectives derived from financial statement assertions. 4. An auditor has no responsibility to detect illegal acts by clients that have an indirect effect on the financial statements.

1. An auditor's responsibility to detect illegal acts that have a direct and material effect on the financial statements is the same as that for errors and fraud.

In auditing a public company, Natalie, an auditor for N. M. Neal & Associates, identifies four deficiencies in ICFR. Three of the deficiencies are unlikely to result in financial misstatements that are material. One of the deficiencies is reasonably likely to result in misstatements that are not material but significant. What type of audit report should Natalie issue? 1. An unqualified report. 2. An exculpatory opinion. 3. A disclaimer of opinion. 4. An adverse report.

1. An unqualified report.

Entity-level controls can have a pervasive effect on the entity's ability to meet the control criteria. Which one of the following is not an entity-level control? 1. Controls to monitor the inventory taking process. 2. Management's risk assessment process. 3. The period-end financial reporting process. 4. Controls to monitor results of operations.

1. Controls to monitor the inventory taking process.

When is a duty to disclose fraud to parties other than the entity's senior management and its audit committee most likely to exist? 1. In response to inquiries from a successor auditor. 2. When the amount is material. 3. When the fraud results from misappropriation of assets rather than fraudulent financial reporting. 4. When a line manager rather than a lower-level employee commits the fraudulent act.

1. In response to inquiries from a successor auditor.

Client Audit Risk Risk of Material Detection 1 Low Moderate ? 2 Very Low High ? 3 Low Low ? 4 Very Low Moderate ?

1. Moderate 2. Low 3. High 4. Low

Which of the following procedures most likely would provide an auditor with evidence about whether an entity's internal control is suitably designed to prevent or detect material misstatements? 1. Observing the entity's personnel applying the controls. 2. Performing analytical procedures using data aggregated at a high level. 3. Scanning the journals produced by the internal control system. 4. Vouching a sample of transactions directly related to the controls.

1. Observing the entity's personnel applying the controls.

The Sarbanes-Oxley Act of 2002 requires management to include a report on the effectiveness of ICFR in the entity's annual report. It also requires auditors to report on the effectiveness of ICFR. Which of the following statements concerning these requirements is false? 1. The auditor should provide recommendations for improving internal control in the audit report. 2. Management should identify material weaknesses in its report. 3. Management's report should state its responsibility for establishing and maintaining an adequate internal control system. 4. The auditor should evaluate whether internal controls over financial reporting are designed and operating effectively.

1. The auditor should provide recommendations for improving internal control in the audit report.

A deficiency that implies that there is a reasonable possibility of misstatement in the financial statements that is significant but not material is: 1. a significant deficiency. 2. an insignificant deficiency. 3. a probable deficiency. 4. a material weakness.

1. a significant deficiency

The highest-quality and most reliable audit evidence that segregation of duties is properly implemented is obtained by: 1. observation by the auditor of the employees performing control activities. 2. inspection of a flowchart of duties performed and available personnel. 3. inspection of documents prepared by a third party but which contain the initials of those applying entity controls. 4. inquiries of employees who apply control activities

1. observation by the auditor of the employees performing control activities.

1. Preventive Control A: Maintaining backups of Data 2. Detective Control B: Segregation of Duties 3. Corrective Control C: Requirement to prepare bank Rec

1=B 2=C 3=A

In assessing whether to accept a client for an audit engagement, a CPA should consider: 1. The integrity of management. 2. All of these choices are correct. 3. The CPA's overall engagement risk. 4. The current financial health of the prospective client.

2. All of these choices are correct.

If the independent auditors decide that it is efficient to consider how the work performed by the internal auditors may affect the nature, timing, and extent of audit procedures, they should assess the internal auditors': 1. Efficiency and experience. 2. Competence and objectivity. 3. Independence and review skills. 4. Training and supervisory skills.

2. Competence and objectivity.

Which of the following controls would most likely be tested during an interim period? 1. Controls over nonroutine transactions. 2. Controls that operate on a continuous basis. 3. Controls over transactions that involve a high degree of subjectivity. 4. Controls over the period-end financial reporting process.

2. Controls that operate on a continuous basis.

Which of the following statements concerning control deficiencies is true? 1. All significant deficiencies are material weaknesses. 2. The auditor should communicate to management, in writing, all control deficiencies in internal control identified during the audit. 3. An auditor must immediately report material weaknesses and significant deficiencies discovered during an audit to the PCAOB. 4. All control deficiencies are significant deficiencie

2. The auditor should communicate to management, in writing, all control deficiencies in internal control identified during the audit.

Which of the following would an auditor most likely use in determining overall materiality when planning the audit? 1. The anticipated sample size of the planned substantive tests. 2. The entity's income before taxes for the period-to-date (e.g., 6 months). 3. The results of tests of controls. 4. The contents of the engagement letter.

2. The entity's income before taxes for the period-to-date (e.g., 6 months).

Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding the predecessor's: 1. Awareness of the consistency in the application of generally accepted accounting principles between periods. 2. Understanding as to the reasons for the change of auditors. 3. Opinion of any subsequent events occurring since the predecessor's audit report was issued. 4. Evaluation of all matters of continuing accounting significance.

2. Understanding as to the reasons for the change of auditors.

On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed level of risk of material misstatement from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would: 1. decrease amount of substantive testing. 2. decrease detection risk. 3. increase materiality levels. 4. increase detection risk.

2. decrease detection risk.

An auditor learns that a client's employee in control of inventory gets divorced and is responsible for paying a large amount of child support. All of the following for the audit of inventory likely are true except: 1. risk of material misstatement increases. 2. detection risk increases. 3. fraud risk increases. 4. the risk of misappropriation of assets increases.

2. detection risk increases.

When planning an audit, an auditor should.. 1. consider whether the extent of substantive procedures may be reduced based on the results of tests of controls. 2. determine overall materiality for audit purposes. 3. evaluate detected misstatements. 4. conclude whether changes in compliance with prescribed internal controls justify reliance on them.

2. determine overall materiality for audit purposes

The risk of material misstatement differs from detection risk in that it: 1. can be changed at the auditor's discretion. 2. exists independently of the actions of the auditor. 3. may be assessed in either quantitative or qualitative terms. 4. arises from the misapplication of auditing procedures.

2. exists independently of the actions of the auditor.

A substantive strategy differs from a reliance strategy in that a substantive strategy includes: 1. increased emphasis on verbal representations from management. 2. increased implementation of detailed tests of transactions and balances. 3. setting control risk at a minimum level. 4. extra tests of controls.

2. increased implementation of detailed tests of transactions and balances.

A walkthrough is one procedure used by an auditor as part of the internal control audit. A walkthrough requires an auditor to: 1. trace a transaction from each major class of transactions from origination through the entity's information system. 2. trace a transaction from each major class of transactions from origination through the entity's information system until it is reflected in the entity's financial reports. 3. trace a transaction from every class of transactions from origination through the entity's information system. 4. tour the organization's facilities and locations before beginning any audit work.

2. trace a transaction from each major class of transactions from origination through the entity's information system until it is reflected in the entity's financial reports.

Which of the following is a source of detection risk? 1. Unstable business environment. 2. Inherent risk assessed too high. 3. A nonrepresentative sample. 4. Poor client controls

3. A nonrepresentative sample

During the initial planning phase of an audit, a CPA most likely would: 1. Identify specific internal control activities that are likely to prevent fraud. 2. Inquire of the entity's attorney if it is probable that any unrecorded claims will be asserted. 3. Discuss the timing of the audit procedures with the entity's management. 4. Evaluate the reasonableness of the entity's accounting estimates.

3. Discuss the timing of the audit procedures with the entity's management.

Risk of material misstatement refers to a combination of which two components of the audit risk model? 1. Control risk and detection risk. 2. Audit risk and inherent risk. 3.Inherent risk and control risk. 4. Audit risk and control risk.

3. Inherent risk and control risk.

Monitoring is a major component of the COSO Internal Control—Integrated Framework. Which of the following is NOT correct in how the company can implement the monitoring component? 1. Monitoring can be conducted as a separate evaluation. 2. Monitoring can be an ongoing process. 3. The independent auditor can serve as part of the entity's control environment and continuous monitoring. 4. Monitoring and other audit work conducted by internal audit staff can reduce external audit costs.

3. The independent auditor can serve as part of the entity's control environment and continuous monitoring.

A control deviation caused by an employee performing a control procedure that he or she is not authorized to perform is always considered a: 1. deficiency in design. 2. material weakness. 3. deficiency in operation. 4. significant deficiency.

3. deficiency in operation.

For certain controls, such as segregation of duties, documentary evidence may not exist. An auditor would most likely test the procedures by: 1.confirmation and recomputation. 2. inspection and vouching. 3. observation and inquiry. 4. reperformance and corroboration.

3. observation and inquiry.

While substantive procedures may support the accuracy of underlying records, these tests frequently provide no affirmative evidence of segregation of duties because: 1. substantive procedures relate to the entire period under audit, but compliance tests ordinarily are confined to the period during which the auditor is on the entity's premises. 2. many computerized procedures leave no audit trail of who performed them, so substantive procedures may necessarily be limited to inquiries and observation of office personnel. 3. the records may be accurate even though they are maintained by persons having incompatible functions. 4. substantive procedures rarely guarantee the accuracy of the records if only a sample of the transactions has been tested.

3. the records may be accurate even though they are maintained by persons having incompatible functions.

SOC 1, Type 2 reports issued by the service organization's auditor typically: 1. ensure that the entity will not have any misstatements in areas related to the service organization's activities. 2. provide reasonable assurance that their financial statements are free of material misstatements. 3. ensure that the entity is billed correctly. 4. assess whether the service organization's controls are suitably designed and operating effectively.

4. assess whether the service organization's controls are suitably designed and operating effectively.

The existence of audit risk is recognized by the statement in the auditor's standard report that the auditor: 1. is responsible for expressing an opinion on the financial statements, which are the responsibility of management. 2. realizes that some matters, either individually or in the aggregate, are important, while other matters are not important. 3. assesses the accounting principles used and evaluates the overall financial statement presentation. 4. obtains reasonable assurance about whether the financial statements are free of material misstatement.

4. obtains reasonable assurance about whether the financial statements are free of material misstatement.

Engagement risk is: 1. the risk of the entity's financial failure. 2. the overall risk of material misstatement. 3. the risk of issuing an incorrect audit opinion. 4. the auditor's risk of loss from events arising in connection with financial statements audited and reported upon.

4. the auditor's risk of loss from events arising in connection with financial statements audited and reported upon.

Suppose that you are the auditor of a major retail client who has reported the following income before taxes (IBT) for the first two quarters of the year: 1st quarter = $1,200,000 and 2nd quarter = $1,500,000. You are in the process of establishing overall materiality for the client, who is also a public company. Based on prior years, the client has a 10% decline in IBT from the 2nd quarter to the 3rd quarter. You also know that IBT in the 4th quarter increases by 25% over the 3rd quarter. Required: Determine the amount of overall materiality for the audit based on these preliminary amounts. Use the common rule of thumb for public companies noted in the textbook for your %.

Answer: 287,000 3Q (1,500,000 * 0.90)= 1,350,000 4Q (1,350,000 * 1.25)= 1,687,500 Estimated Income before Taxes= $5,737,500 5% benchmark, over materiality based on EIBT: 287,000 (Rounded).

Which of the following is an example of fraudulent financial reporting? 1. Company management falsifies the inventory count, thereby overstating ending inventory and understating cost of sales. 2. An employee borrows small tools from the company and neglects to return them; the cost is reported as a miscellaneous operating expense. 3. An employee diverts customer payments to his personal use, concealing his actions by debiting an expense account, thus overstating expenses. 4. An employee steals inventory, and the shrinkage is recorded as a cost of goods sold.

Company management falsifies the inventory count, thereby overstating ending inventory and understating cost of sales.

Examples of entity-level controls include 1. Management's risk assessment process. 2. Controls to monitor results of operations. 3. The period-end financial reporting process. 4. All of these are examples of entity-level controls.

D. All of these are examples of entity-level controls.

According to PCAOB AS 1305 addressing Internal Controls deficiencies, a deficiency in ______ exists when (a) a control necessary to meet the control objective is missing or (b) an existing control is not properly designed so that, even if the control operates as designed, the control objective would not be met.

Design

A written understanding between the auditor and the entity concerning the auditor's responsibility for fraud is usually set forth in a(n): 1. internal control letter. 2. engagement letter. 3. letter of audit inquiry. 4. management letter.

Engagement letter.

According to AU-C 265 and PCAOB AS 1305 (Formerly AS 5), the three categories of deficiencies in internal control are: Control Deficiency, Significant Weakness, Material Deficiency. True or False?

False

Which of the following is correct concerning required auditor communications about fraud? 1. Fraud that involves senior management should be reported directly by the auditor to the audit committee regardless of the amount involved. 2. Fraud with a material effect on the financial statements should be reported directly by the auditor to the Securities and Exchange Commission. 3. Any requirement to disclose fraud outside the entity is the responsibility of management and not that of the auditor. 4. The professional standards provide no requirements related to the communication of fraud, but the auditor should use professional judgment in determining communication responsibilities.

Fraud that involves senior management should be reported directly by the auditor to the audit committee regardless of the amount involved.

Did not include Chapter 3 Homework #6, #7, #8. Did not include Chapter 4 Homework #8.

Lazy

Tolerable misstatement is: 1. materiality for the balance sheet as a whole. 2. the amount of misstatement that management is willing to tolerate in the financial statements. 3. materiality used to establish a scope for the audit procedures for the individual account balance or disclosures. 4. materiality for the income statement as a whole.

Materiality used to establish a scope for the audit procedures for the individual account balance or disclosures. OR Materiality allocated to a specific account. (other quiz answer)

Auditing standards require auditors to make certain inquiries of management regarding fraud. Which of the following inquiries is required? 1. Whether management has ever intentionally violated the securities laws. 2. Management's attitude about hiring ethical employees. 3. Whether management has any knowledge of fraud that has been perpetrated on or within the entity. 4. Management's attitudes toward regulatory authorities.

Whether management has any knowledge of fraud that has been perpetrated on or within the entity.