EXAM 1 (CHAPTER 1-4, 6-7, 19)

IC30. Which of the following statements is correct concerning an auditor's assessment of control risk? a. Assessing control risk may be performed concurrently during an audit with obtaining an understanding of the entity's internal control. b. Evidence about the operation of internal control in prior audits may not be considered during the current year's assessment of control risk. c. The basis for an auditor's conclusions about the assessed level of control risk need not be documented unless control risk is assessed at the maximum level. d. The lower the assessed level of control risk, the less assurance the evidence must provide that the control procedures are operating effectively.

Answer: A The requirement is to identify the correct statement concerning an auditor's assessment of control risk. AU-C 315 indicates that assessing control risk may be preformed concurrently during an audit with obtaining an understanding of internal control.

E6. Which of the following types of audit evidence is the LEAST persuasive? a. Prenumbered purchase order forms. b. Bank statements obtained from the client. c. Test counts of inventory performed by the auditor. d. Correspondence from the client's attorney about litigation.

Answer: A The requirement is to identify the least persuasive type of evidence. Evidence secured solely from within an entity, here prenumbered purchase order forms, is considered less persuasive than evidence obtained from independent sources.

PR15. According to the standards of the profession, which of the following activities would most likely NOT impair a CPA's independence? a. Providing advisory services for a client. b. Contacting with a client to supervise the client's office personnel. c. Signing a client's checks in emergency situations. d. Accepting a luxurious gift from a client.

Answer: A Accounting and consulting services do not normally impair independence because the member's role is advisory in nature.

E40. Which of the following factors MOST likely would affect an auditor's judgement about the quantity, type, and content of the auditor's working papers? a. The assessed level of control risk. b. The likelihood of a review by a concurring (second) partner. c. The number of personnel assigned to the audit. d. The content of the management representation letter.

Answer: A The requirement is to identify a factor that would MOST likely affect the auditor's judgement about the quantity, type, and content of the working papers. The Professional Standards state that the assessed level of control risk will affect the quantity, type, and content of the working papers.

E7. In evaluating 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.

Answer: A The requirement is to identify an area of concern to auditors when evaluating the reasonableness of an entity's accounting estimates. AU-C 500 states that in evaluating the reasonableness of estimates auditors normally concentrate on assumptions that are subjective to bias.

EP5. As the acceptable level of detection risk decrease, the assurance directly provided from a. Substantive tests should increase. b. Substantive tests should decrease. c. Tests of controls should increase. d. Tests of control should decrease.

Answer: A The requirement is to identify an effect of a decrease in the acceptable level of detection risk. As the acceptable level of detection risk decreases, the assurance provided from substantive tests should increase. To gain this increased assurance the auditors may (1) change the nature of substantive tests to more effective procedures (e.g. use independent parties outside the entity rather than those within the entity), (2) change the timing of substantive tests (e.g. perform them at year-end rather than at an interim date), and (3) change the extent of substantive tests (e.g. take a larger sample).

E34. Which of the following pairs of accounts would an auditor MOST likely analyze on the same working paper? a. Notes receivable and interest income. b. Accrued interest receivable and accrued interest payable. c. Notes payable and notes receivable. d. Interest income and interest expense.

Answer: A The requirement is to identify the MOST likely pair of accounts to be analyzed on the same working paper. An auditor will often consider interest income with notes receivable because the interest is earned on those notes and therefore closely related.

E5. Which of the following statements relating to the appropriateness of audit evidence is always true? a. Audit evidence gathered by an auditor from outside an enterprise is reliable. b. Accounting data developed under satisfactory conditions of internal control are more relevant than data developed under unsatisfactory internal control conditions. c. Oral representations made by management are NOT valid evidence. d. Evidence gathered by auditors must be both valid and relevant to be considered appropriate.

Answer: D The requirement is to determine the correct statement with respect to the appropriateness of audit evidence. To be appropriate evidence must be both relevant and reliable.

IC26. An auditor assesses control risk because it a. Is relevant tot he auditor's understanding of the control environment. b. Provides assurance that the auditor's materiality levels are appropriate. c. Indicates to the auditor where inherent risk may be the greatest. d. Affects the level of detection risk that the auditor may accept.

Answer: D The requirement is to determine why an auditor assesses control risk. The assessed level of control risk and inherent risk are used to determine the acceptable level of detection risk for financial statement assertions.

IC31. Regardless of the assessed level of control risk, an auditor would perform some, a. Tests of controls to determine the effectiveness of internal control policies. b. Analytical procedures to verify the design of internal control. c. Substantive tests to restrict detection risk for significant transaction clauses. d. Dual-purpose tests to evaluate both the risk of monetary misstatement and preliminary control risk.

The requirement is to determine the correct statement concerning the assessed level of control risk. Ordinarily the assessed level of control risk cannot be sufficiently low to eliminate the need to perform any substantive tests to restrict detection risk for significant transaction classes.

E4. Which of the following presumptions is correct about the reliability of audit evidence? a. Information obtained indirectly from outside sources is the most reliable audit evidence. b. To be reliable, audit evidence should be convincing rather than persuasive. c. Reliability of audit evidence refers to the amount of corroborative evidence obtained. d. Effective internal control provides more assurance about the reliability of audit evidence.

Answer: D The requirement is to identify a correct presumption about the reliability of audit evidence. AU-C 500 indicates that that effective internal control provides more assurance about the reliability of audit evidence than ineffective control.

E13. A client uses a suspense account for unresolved questions whose final accounting has not been determined. If a balance remains in the suspense account at year-end, the auditor would be most concerned about a. Suspense debits that management believes will benefit future operations. b. Suspense debits that the auditor verifies will have realizable value to the client. c. Suspense credits that management believes should be classified as 'Current Liability.' d. Suspense credits that the auditor determines to be customer deposits.

Answer: A The requirement is to determine which balance remaining in a 'suspense' account would be of most concern for an auditor. Suspense debits that management believes will benefit future operations must be audited carefully to determine whether they have value and should be classified as an asset.

EP83. To obtain an understanding of a continuing client's business, and auditor MOST likely would a. Perform tests of details of transactions and balances. b. Review prior year working papers and the permanent file for the client. c. Read current issues of specialized industry journals. d. Reevaluate the client's internal control environment.

Answer: B

EP3. As the acceptable level of detection risk decreases, an auditor may a. Reduce substantive testing by relying on the assessments of inherent risk and control risk. b. Postpone the planned timing of substantive tests from interim dates to the year-end. c. Eliminate the assessed level of inherent risk from consideration as a planning factor. d. Lower the assessed level of control risk from the maximum level to below the maximum.

Answer: B The requirement is to determine a likely auditor reaction to a decreased acceptable level of detection risk. Postponement of interim substantive tests to year-end decreases detection risk by reducing the risk for the period subsequent to the performance of those tests; other approaches to decreasing detection risk include changing to more effective substantive tests and increasing their extent.

EP8. On the basis of the audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk 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 in substantive testing. b. Decrease detection risk. c. Increase in inherent risk. d. Increase in materiality levels.

Answer: B The requirement is to determine the BEST way for an auditor to achieve an overall audit risk level when the audit evidence relating to control risk indicates the need to increase its assessed level. A decrease in detection risk will allow the auditor to achieve an overall audit risk level substantially the same as planned.

EP9. Relationship between control risk and detection risk is ordinarily a. Parallel. b. Inverse. c. Direct. d. Equal

Answer: B The requirement is to determine the relationship between control risk and detection risk. Inverse is correct because as control risk increases (decreases) detection risk must decrease (increase).

E1. Which of the following is NOT an assertion relating to classes of transactions? a. Accuracy. b. Consistency. c. Cutoff. d. Occurrence.

Answer: B The requirement is to identify the reply that is NOT an assertion for classes of transactions. The assertions for classes of transactions are occurrence, completeness, accuracy, cutoff and classification. Consistency is not an assertion for classes of transactions.

EP4. The risk that an auditor will conclude, based on substantive tests, that a material misstatement does NOT exist in an account balance when, in fact, such misstatement does exist is referred to as a. Sampling Risk b. Detection Risk c. Non-sampling Risk d. Inherent Risk

Answer: B The requirement is to identify the risk that an auditor will conclude, based on substantive tests, that a material error does NOT exist in an account balance when, in fact, such error does exist. Detection risk is the risk that the auditor will not detect a material misstatement that exists in an assertion. Detection risk may be viewed in terms of two components (1) the risk that analytical procedures and other relevant substantive tests would fail to detect misstatements equal to tolerable misstatements, and (2) the allowable risk of incorrect acceptance for the substantive tests of details.

PR19. According to the ethical standards of the profession, which of the following acts is generally prohibited? a. Purchasing a product from a third party and reselling it to a client. b. Writing a financial management newsletter promoted and sold by a publishing company. c. Accepting a commission for recommending a product to an audit client. d. Accepting engagements obtained through the efforts of third parties.

Answer: C 'A member in public practice shall not for a commission recommend or refer to a client any product or service, or for a commission recommend or refer any product or service to be supplied by a client.'

IC23. Control risk should be assessed in terms of a. Specific Controls b. Types of potential fraud. c. Financial statement assertions. d. Control environment factors.

Answer: C AU-C 315 requires that control risk be assessed in terms of financial statement assertions.

PR1. Generally accepted auditing standards are a. Required procedures to be used to gather evidence to support financial statements b. Policies and procedures designed to provide reasonable assurance that the CPA firm and its personnel comply with professional standards. c. Pronouncements issued by the Auditing Standards Board. d. Rules acknowledged by the accounting profession because of their universal application.

Answer: C Generally accepted auditing standards are defined as the Statements on Auditing Standards issued by the Auditing Standards Board.

IC27. When an auditor increases the assessed level of control risk because certain control activities were determined to be ineffective, the auditor would MOST likely increase the a. Extent tests of controls. b. Level of detection risk. c. Extent of tests of details. d. Level of inherent risk.

Answer: C Increases in the assessed level of the risk of material misstatement lead to decreases in the acceptable level of detection risk. Accordingly, the auditor will need to increase the extent of substantive tests such as test of details.

PR4. Which of the following is MOST likely to be unique to the audit work of CPAs as compared to work performed by practitioners of other professions? a. Due professional care. b. Competence. c. Independence. d. Complex body knowledge.

Answer: C Independence is absolutely required for the performance of audits; other professions do not in general require such independence.

PR9. According to the standards of the profession, which of the following circumstances will prevent a CPA performing audit engagements form being independent? a. Obtaining collateralized automobile loan from a financial institution client. b. Litigation with a client relating to billing for consulting services for which the amount is immaterial. c. Employment of the CPA's spouse as a client's director of internal audit. d. Acting as a honorary trustee for a not-for-profit organization client.

Answer: C The APICA's Code of Professional Conduct Independence Rule states that, a spouse may be employed by a client if she/he does not exert significant influence over the contents of the client's financial statements.

EP7. Inherent risk and control risk from detection risk in that they a. Arise from the misapplication of auditing procedures. b. May be assessed in either quantitative or non-quantitative terms. c. Exist independently of the financial statements audit. d. Can be changed at the auditor's discretion.

Answer: C The requirement is to determine a manner in which inherent risk and control risk differ from detection risk. Inherent risk and control risk exist independently of the audit of the financial statements as functions of the client and its environment, whereas detection risk relates to the auditor's procedures and can be changed at his or her discretion.

E12. In testing the existence assertion for an asset, an auditor ordinarily works from the a. Financial statements to the potentially unrecorded items. b. Potentially unrecorded items tot he financial statements. c. Accounting records to the supporting evidence. d. Supporting evidence to the accounting records.

Answer: C The requirement is to determine the proper test for the existence assertion of an asset. Testing FROM accounting records TO the supporting evidence discloses whether recorded transactions occurred and whether the asset exists.

EP6. Which of the following audit risk components may be assessed in non-quantitative terms? (Control Risk) (Detection Risk) (Inherent Risk) a. YES YES NO b. YES NO YES c. YES YES YES d. NO YES YES

Answer: C The requirement is to determine whether inherent risk, control risk, and detection risk may be assessed in non-quantitative terms. All these risks may be assessed in either quantitative terms, such as percentages, or non-quantitative terms such as a range from a min to a max.

E3. Which of the following types of audit evidence is the MOST persuasive? a. Prenumbered client purchase order forms. b. Client work sheets supporting cost allocations. c. Bank statements obtained from the client. d. Client representation letter.

Answer: C The requirement is to identify the most persuasive type of evidence. A bank statement represents evidence prepared outside of the entity and is considered audit evidence source which provides the auditor with a high level of assurance.

PR24. Which of the following statements is correct regarding an accountant's working papers? a. The accountant owns the working papers and generally may disclose them as the accountant sees fit. b. The client owns the working papers but the accountant has custody of them until the accountant's bill is paid in full. c. The accountant owns the working papers but generally may not disclose them without the client's consent or a court order. d. The client owns the working papers, but, in the absence of the accountant's consent, may not disclose them without a court order.

Answer: C Information in the CPA's working papers is confidential and may not be disclosed except with the client's consent or by court order.

E36. The permanent file of an auditor's working papers generally would NOT include a. Bond indenture agreements. b. Lease agreements. c. Working trial balance. d. Flowchart of internal control.

Answer: C The requirement is to identify the LEAST likely item to be included in the permanent file of an auditor's working papers. Permanent files include information affecting a number of years' audits, and the working trial balance relates most directly to the current and, to a limited extent, the subsequent year's audit.

E2. Which of the following is a general principle relating to the reliability of audit evidence? a. Audit evidence obtained from indirect sources rather than directly is more reliable than evidence obtained directly by the auditor. b. Auditor evidence provided by copies is more reliable than that provided by facsimiles. c. Audit evidence obtained from knowledgeable independent sources outside the client company is more reliable than audit evidence obtained from nonindependent sources. d. Audit evidence provided by original documents is more reliable than audit evidence generated through a system of effective controls.

Answer: C The requirement is to identify the type of evidence that is generally most reliable. Audit evidence is obtained from knowledgeable independent sources outside the client company is more reliable than audit evidence obtained from nonindependent sources.

PR5. The Public Company Accounting Oversight Board's third general standard states that due care is to be exercised in the performance of an audit. This standard is ordinarily interpreted to require a. Thorough review of the existing safeguards over access to assets and records. b. Limited review of the indications of employee fraud and illegal acts. c. Objective review of the adequacy of the technical training and proficiency of firm personnel. d. Critical review of the judgement exercised at every level of supervision.

Answer: D Due care requires critical review at every level of supervision of the work done and the judgement exercised by those assisting in the audit.

IC28. An auditor uses the knowledge provided by the understanding of internal control and the assessed level of the risk of material misstatement primarily to a. Determine whether procedures and records concerning the safeguarding of assets are reliable. b. Ascertain whether the opportunities to allow any person to both perpetrate and conceal fraud are minimized. c. Modify the initial assessments of inherent risk and preliminary judgments about materiality levels. d. Determine the nature, timing, and extent of substantive tests for financial statement assertions.

Answer: D The requirement is to determine the PRIMARY purpose for which an auditor uses the knowledge provided by the understanding of internal control and the assessed level of the risk of material misstatement. The auditor uses such knowledge in determining the nature, timing, and extent of substantive tests for financial statement assertions.

IC24. After assessing control risk, an auditor desires to seek a further reduction in the assessed level of control risk. At this time, the auditor would consider whether a. It would be efficient to obtain an understanding of the entity's information system. b. The entity's controls have been implemented. c. The entity's controls pertain to any financial statement assertions. d. Additional audit evidence sufficient to support a further reduction is likely to be available.

Answer: D The requirement is to identify a situations in which an auditor may desire to seek a further reduction in the assessed level of control risk. Such a reduction is only possible when additional evidence, evaluated by performing additional tests of controls, is available.

IC29. An auditor may compensate for a weakness in internal control by increasing the a. Level of detection risk. b. Extent of tests of controls. c. Preliminary judgement about audit risk. d. Extent of analytical procedures.

Answer: D The requirement is to identify a way that an auditor may compensate for a weakness in internal control. Increasing analytical procedures decreases detection risk in a manner which may counterbalance the condition in internal control. In effect, the weakness in internal control is compensated for by increased substantive testing.

E11. In evaluating an entity's accounting estimates, one of an auditor's objectives is to determine whether the estimates are a. Not subject to bias. b. Consistent with industry guidelines. c. Based on objective assumptions. d. Reasonable in the circumstances.

Answer: D The requirement is to identify one of an auditor's objectives when evaluating an entity's accounting estimates. When evaluating accounting estimates an auditor's objectives are to obtain sufficient appropriate audit evidence that (1) all material accounting estimates have been developed, (2) those accounting estimates are reasonable, and (3) those accounting estimates are in conformity with GAAP.

E9. Which of the following procedures would an auditor ordinarily perform first in evaluating management's accounting estimates for reasonableness? a. Develop independent expectations of management's estimates. b. Consider the appropriateness of the key factors or assumptions used in preparing the estimates. c. Test the calculations used by management in developing estimates. d. Obtain an understanding of how management developed its estimates.

Answer: D The requirement is to identify the procedure an auditor would perform first in evaluating management's accounting estimates for reasonableness. In evaluating reasonableness, the auditor should first obtain an understanding of how management developed the estimate.

E8. Which of the following is NOT a basic procedure used in an audit? a. Risk assessment procedures. b. Substantive procedures. c. Test of controls. d. Tests of direct evidence.

Answer: D The requirement is to identify the reply that is not a basic procedure used in an audit. The term 'test of evidence' is not used in the professional standards.

PR11. According to the ethical standards of the profession, which of the following acts is generally prohibited? a. Issuing a modified report explaining a failure to follow a governmental regulatory agency's standards when conducting an attest service for a client. b. Revealing confidential client information during a quality review of a professional practice by a team from the state CPA society. c. Accepting a contingent fee for representing a client in an examination of the client's federal tax return by a IRS agent. d. Retaining client records after an engagement is terminated prior to completion and the client has demanded their return.

Answer: D When an engagement is terminated prior to completion, the Acts Discreditable Rule states that a member is required to return only client records.

IC25. Assessing control risk at a low level MOST likely would involve a. Performing more extensive substantive tests with larger sample sizes than originally planned. b. Reducing inherent risk for most of the assertions relevant to significant account balances. c. Changing the timing of substantive tests by omitting interim-date testing and preforming the tests at year-end. d. Identifying specific controls relevant to specific assertions.

Answer: D Assessing control risk at a low level involves (1) identifying specific controls relevant to specific assertions that are likely to prevent or detect material misstatements in those assertions, and (2) performing tests of controls to evaluate the effectiveness of such controls.

E10. In evaluating the reasonableness of an accounting estimate, an auditor MOST likely would concentrate on key factors and assumptions that are a. Consistent with prior periods. b. Similar to industry guidelines. c. Objective and NOT susceptible to bias. d. Deviations from historical patterns.

Answer: D The requirement is to identify a factor that an auditor would concentrate upon when evaluating the reasonableness of an accounting estimate.