Auditing - Chapter 4

Which of the following circumstances most likely would cause an auditor to believe that material misstatements may exist in an entity's financial statements? A. Accounts receivable confirmation requests yield significantly fewer responses than expected. B. Audit trails of computer-generated transactions exist only for a short time. C. The chief financial officer does not sign the management representation letter until the last day of the auditor's fieldwork. D. Management consults with other accountants about significant accounting matters.

A. Accounts receivable confirmation requests yield significantly fewer responses than expected.

A properly planned and performed audit may fail to detect a material misstatement resulting from fraud because A. Audit procedures that are otherwise effective may be ineffective for fraud that is concealed through collusion. B. An audit is planned and performed to provide reasonable assurance of detecting material misstatements caused by errors but not by fraud. C. The factors considered in assessing control risk indicated an increased risk of error but only a low risk of fraud in the financial statements. D. The auditor did not consider factors influencing audit risk for account balances that have effects pervasive to the financial statements taken as a whole.

A. Audit procedures that are otherwise effective may be ineffective for fraud that is concealed through collusion.

An auditor discovers a likely fraud during an audit but concludes that the overall effect of the fraud is not sufficiently material to affect the audit opinion. The auditor should probably A. Disclose the fraud to the appropriate level of the client's management. B. Disclose the fraud to appropriate authorities external to the client. C. Discuss with the client the additional audit procedures that will be needed to identify the exact amount of the fraud. D. Modify the audit program to include tests specifically designed to identify the fraud and its impact on the financial statements.

A. Disclose the fraud to the appropriate level of the client's management.

The acceptable level of detection risk is inversely related to the A. Extent of the substantive procedures. B. Risk of misapplying auditing procedures. C. Overall materiality. D. Risk of failing to discover material misstatements.

A. Extent of the substantive procedures.

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

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

Which of the following factors most likely would heighten an auditor's concern about the risk of fraudulent financial reporting? A. Inability to generate cash flows from operations while reporting substantial earnings growth. B. Management's lack of interest in increasing the entity's earnings trend. C. Large amounts of liquid assets that are easily converted into cash. D. Inability to borrow necessary capital without granting debt covenants.

A. Inability to generate cash flows from operations while reporting substantial earnings growth.

As the acceptable level of detection risk decreases, the assurance directly provided from A. Substantive procedures should increase. B. Substantive procedures should decrease. C. Tests of controls should increase. D. Tests of controls should decrease.

A. Substantive procedures should increase.

When assessing the risk of material misstatement, auditors evaluate the reasonableness of an entity's accounting estimates. An auditor normally would be concerned about assumptions that are A. Susceptible to bias. B. Consistent with prior periods. C. Insensitive to variations. D. Similar to industry guidelines.

A. Susceptible to bias.

Which of the following is not a misstatement of the financial statements? A. The entity uses different inventory accounting methods for internal and external reporting. B. A departure from GAAP. C. The footnote for pensions is omitted. D. A clerk incorrectly based the allowance for doubtful accounts on 31% of sales as opposed to 13% of sales as determined by the controller.

A. The entity uses different inventory accounting methods for internal and external reporting.

Which of the following is a factual misstatement? A. A management estimate that is outside the range of reasonable outcomes determined by the auditor. B. A fixed asset being recorded at the incorrect cost. C. A projected misstatement resulting from errors found during sampling. D. Difference in judgment between the auditor and management.

B. A fixed asset being recorded at the incorrect cost.

When an entity moves into a significant new line of business, all of the following increase except: A. Client risk. B. Acceptable audit risk. C. Risk of material misstatement. D. Entity business risk.

B. Acceptable audit risk.

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 A. Decrease amount of substantive testing. B. Decrease detection risk. C. Increase detection risk. D. Increase materiality levels.

B. Decrease detection risk.

The risk that an auditor will conclude, based on substantive procedures, that a material error does not exist in an account balance when, in fact, such an error does exist is referred to as A. Sampling risk. B. Detection risk. C. Nonsampling risk. D. Inherent risk.

B. Detection risk.

Under Statements on Auditing Standards, which of the following would be classified as an error? A. Misappropriation of assets for the benefit of management. B. Misinterpretation by management of facts that existed when the financial statements were prepared. C. Preparation of records by employees to cover a fraudulent scheme. D. Intentional omission of the recording of a transaction to benefit a third party.

B. Misinterpretation by management of facts that existed when the financial statements were prepared.

As the acceptable level of detection risk decreases, an auditor may change the A. Timing of tests of controls by performing them at an interim date rather than at year-end. B. Nature of substantive procedures from less effective to more effective procedures. C. Timing of tests of controls by performing them at several dates rather than at one time. D. Assessed level of risk of material misstatement to a higher amount.

B. Nature of substantive procedures from less effective to more effective procedures.

All of the following represent an increased opportunity for management to commit fraud except: A. Significant related party transactions. B. The auditor's relationship with management is strained. C. Management is dominated by a single person. D. The financial statements include highly subjective estimates.

B. The auditor's relationship with management is strained.

Engagement risk is: A. The risk of issuing an incorrect audit opinion. B.The auditor's risk of loss from events arising in connection with financial statements audited and reported upon. C. The overall risk of material misstatement. D. The risk of the entity's financial failure.

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

Client risk as defined in the text is A. The auditor's risk of loss from events arising in connection with financial statements audited and reported upon. B. The overall risk of material misstatement. C. The risk that audit procedures will fail to detect material misstatements. D. The risk of the entity's financial failure.

B. The overall risk of material misstatement.

Which of the following is a source of detection risk? A. Unstable business environment. B. Poor client controls. C. A nonrepresentative sample. D. Inherent risk assessed too high.

C. A nonrepresentative sample.

The achieved (actual) level of audit risk A. Can always be accurately assessed by the auditor. B. Should be greater than or equal to acceptable audit risk. C. Can never be known with certainty. D. Is the same for all audit engagements.

C. Can never be known with certainty.

The risk of material misstatement differs from detection risk in that it A. Arises from the misapplication of auditing procedures. B. May be assessed in either quantitative or qualitative terms. C. Exists independently of the actions of the auditor. D. Can be changed at the auditor's discretion.

C. Exists independently of the actions of the auditor.

When an auditor increases the assessed level of risk of material misstatement because certain control procedures were determined to be ineffective, the auditor would most likely increase the A. Extent of tests of controls. B. Level of detection risk. C. Extent of substantive tests. D. Level of inherent risk.

C. Extent of substantive tests.

The auditor is most likely to presume that a high risk of a fraud exists if A. The entity is a multinational company that does business in numerous foreign countries. B. The entity does business with several related parties. C. Inadequate segregation of duties places an employee in a position to perpetrate and conceal theft. D. Inadequate employee training results in lengthy EDP exception reports each month.

C. Inadequate segregation of duties places an employee in a position to perpetrate and conceal theft.

The auditor can respond to an increased risk of fraud by doing all of the following except: A. Evaluating whether the accounting policies selected may be indicative of fraudulent financial reporting through earnings management. B. Assigning more experienced personnel to the audit. C. Increasing detection risk. D. Taking steps to obtain more reliable evidence.

C. Increasing detection risk.

The risk of material misstatement includes which of the following? A. Detection risk. B. Audit risk. C. Inherent risk. D. Nonsampling risk.

C. Inherent risk.

Increased fraud risk could result in all of the following except: A. Lower detection risk. B. Higher inherent risk. C. Lower control risk. D. Higher client risk.

C. Lower control risk.

Which of the following characteristics most likely would heighten an auditor's concern about the risk of intentional manipulation of financial statements? A. Turnover of senior accounting personnel is low. B. Insiders recently purchased additional shares of the entity's stock. C. Management places substantial emphasis on meeting earnings projections. D. The rate of change in the entity's industry is slow.

C. Management places substantial emphasis on meeting earnings projections.

Which of the following procedures would not be used to obtain an understanding of the entity and its environment? A. Observe entity operations. B. Reperform entity processes. C. Verify proper valuation of inventory subject to technological obsolescence. D. Review prior year's audit documentation.

C. Verify proper valuation of inventory subject to technological obsolescence.

An auditor knows that an audit client operating in an industry in which common stock is valued based on the price-earnings ratio will soon make an initial public offering. All of the following are true except: A. Materiality should be reduced. B. Risk of material misstatement should increase. C. Detection risk should decrease. D. Audit risk should increase.

D. Audit risk should increase.

Which of the following is not an important consideration in an auditor's evaluation of an entity's business risk? A. The specific business risks an entity faces that may result in financial statement errors and fraud. B. Business risk factors that impact the ability of the entity to be profitable and survive. C. Audit standards include many entity business risk factors that identify circumstances that increase the likelihood of material misstatements. D. Audit standards require the auditor to evaluate the entity's business risk in order to provide suggestions to improve the entity's profitability.

D. Audit standards require the auditor to evaluate the entity's business risk in order to provide suggestions to improve the entity's profitability.

Which of the following audit risk components may be assessed in qualitative terms? A. Risk of material misstatement. B. Detection risk. C. Neither risk of material misstatement nor detection risk. D. Both risk of material misstatement and detection risk.

D. Both risk of material misstatement and detection risk.

In general, material frauds perpetrated by which of the following are most difficult to detect? A. Internal audit function. B. Keypunch operator. C. Cashier. D. Controller.

D. Controller.

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: A. Fraud risk increases. B. The risk of misappropriation of assets increases. C. Risk of material misstatement increases. D. Detection risk increases.

D. Detection risk increases.

The objectives of the engagement partner's communication with the audit team include A. Maintaining an adversarial atmosphere between the auditor and management. B. Complying with SEC rules. C. Complying with FASB rules. D. Emphasizing the importance of professional skepticism.

D. Emphasizing the importance of professional skepticism.

Engagement risk can be eliminated by A. Establishing policies for client acceptance and continuance. B. Lowering audit risk. C. Lowering materiality. D. Engagement risk cannot be eliminated.

D. Engagement risk cannot be eliminated.

All of the following are inherent risk factors that are pervasive to the financial statements except: A. Highly complex significant transactions. B. Non-routine transactions. C. Classes of transactions are not processed systematically. D. Supplies inventory is difficult to count.

D. Supplies inventory is difficult to count.

The primary responsibility for preventing fraud in an organization lies with A. The audit committee of the board of directors. B. The internal audit function. C. The external auditor. D. The organization's management.

D. The organization's management.