SU 4 Strategic Planning Issues

The company being audited has an internal auditor that is both competent and objective. The auditor wants to assign tasks for the internal auditor to perform. Under these circumstances, the auditor may: a. Allow the internal auditor to perform tests of internal controls. b. Allow the internal auditor to perform analytical procedures but not be involved with any tests of details. c. Allow the internal auditor to audit a major subsidiary of the company. d. Not assign any task to the internal auditor because of the internal auditor's lack of independence.

a. Allow the internal auditor to perform tests of internal controls. The auditor may request direct assistance from the internal auditor when performing the audit. Thus, the auditor may appropriately request the internal auditor's assistance in obtaining the understanding of internal control, performing tests of controls, or performing substantive procedures. The internal auditor may provide assistance in all phases of the audit if (1) the internal auditor's competence and objectivity have been assessed, and (2) the auditor supervises, reviews, evaluates, and tests the work performed by the internal auditor to the extent appropriate.

In which of the following instances would it be appropriate for the auditor to refer to the work of an appraiser in the auditor's report? a. An adverse opinion is expressed based on a difference of opinion between the client and the auditor's external specialist about the value of certain assets. b. A qualified opinion is expressed because of a matter unrelated to the work of the auditor's external specialist. c. A disclaimer of opinion is expressed owing to a scope limitation imposed on the auditor by the auditor's external specialist. d. An unmodified opinion is expressed and no additional paragraph is added, but the auditor wishes to disclose the use of an auditor's specialist.

a. An adverse opinion is expressed based on a difference of opinion between the client and the auditor's external specialist about the value of certain assets. An auditor's external specialist has expertise in a field other than accounting or auditing. Expertise in a field other than accounting or auditing may include valuation of nonfinancial assets, such as land and buildings, jewelry, or antiques. If, after considering the work of the auditor's external specialist, the auditor concludes that managements' assertions are materially misstated, a qualified or adverse opinion should be expressed. When the opinion is modified, the auditor may report the work of the external specialist when it is relevant to understanding the opinion modification (AU-C 620).

An internal auditor's work would most likely affect the nature, timing, and extent of an independent auditor's auditing procedures when the internal auditor's work relates to assertions about the: a. Existence of fixed asset additions. b. Valuation of intangible assets. c. Existence of contingencies. d. Valuation of related party transactions.

a. Existence of fixed asset additions. Assertions may relate to material financial statement amounts for which the risks of material misstatement or the degree of subjectivity involved in the evaluation of the audit evidence is high. In these cases, reliance on the internal auditor is less effective. However, certain assertions may relate to less material financial statement amounts for which the risks of material misstatement or the degree of subjectivity involved is low. For example, the auditor may be able to rely on the internal auditor's work regarding assertions about the existence of cash, prepaid assets, and fixed asset additions.

In which of the following circumstances is an auditor most likely to rely on work done by internal auditors? a. For financial statement amounts judged by the auditor to require little or no subjectively evaluated audit evidence. b. If financial statement amounts are material and the degree of subjectivity in evaluating the audit evidence is high. c. For financial statement amounts determined largely or entirely on the basis of estimates made by management. d. If the internal auditors have concluded that the risk of material misstatement at the overall financial level is negligible.

a. For financial statement amounts judged by the auditor to require little or no subjectively evaluated audit evidence. The auditor should make all significant judgments. Thus, (s)he should use less of the internal auditors' work and perform more work directly in the following circumstances: (1) the more judgment is involved in planning and performing audit procedures or evaluating evidence, (2) the higher the assessed risk of material misstatement at the assertion level, (3) the less the internal auditors' organizational status and relevant policies and procedures support their objectivity, and (4) the lower their competence. Accordingly, the auditor is most likely to rely on the work of the internal audit function when little or no judgment is required to evaluate audit evidence.

An auditor would be most likely to consider modifying an otherwise unmodified opinion if the client's financial statements include a note on related party transactions: a. Representing without substantiation that certain related party transactions were consummated on terms equivalent to those obtainable in transactions with unrelated parties. b. Presenting the dollar volume of related party transactions and the effects of any change in the method of establishing terms from that used in the prior period. c. Disclosing compensating balance arrangements maintained for the benefit of related parties. d. Explaining the business purpose of the sale of real property to a related party.

a. Representing without substantiation that certain related party transactions were consummated on terms equivalent to those obtainable in transactions with unrelated parties. It is most often not possible to determine whether a particular transaction would have occurred if the parties had not been related or what the terms and manner of settlement would have been. Accordingly, assertions about such matters are difficult to substantiate. The auditor may (1) believe that the assertion is unsubstantiated or (2) not be able to obtain sufficient appropriate evidence. In these cases, the auditor considers the implications for the audit, including whether to modify the opinion (AU-C 550 and AS 2410). (S)he should consider including in the report a comment to that effect and expressing a qualified or adverse opinion.

Auditors should evaluate significant accounting estimates included in the financial statements. The auditor: a. Should understand how management developed the estimate but may adopt a variety of approaches to evaluating its reasonableness. b. Must develop an independent point estimate to corroborate management's. c. Is responsible for events affecting the estimates only through the balance sheet date. d. Should consider the hypothetical assumptions used by management to generate estimates.

a. Should understand how management developed the estimate but may adopt a variety of approaches to evaluating its reasonableness. In evaluating the reasonableness of an accounting estimate, the auditor should obtain an understanding of how it was developed. The auditor then may use one of several approaches, or a combination, to evaluate reasonableness. One approach is to review and test management's process. A second approach is to develop an independent expectation to corroborate the reasonableness of management's estimate. A third approach is to review subsequent events or transactions.

An auditor most likely modifies the opinion if the entity's financial statements include a note on related party transactions: a. Stating without substantiation that a particular related party transaction occurred on terms equivalent to those that would have prevailed in an arm's-length transaction. b. Disclosing loans to related parties at interest rates significantly below prevailing market rates. c. Describing an exchange of real estate for similar property in a nonmonetary related party transaction. d. Presenting the dollar volume of related party transactions and the effects of any change from prior periods in the method of establishing terms.

a. Stating without substantiation that a particular related party transaction occurred on terms equivalent to those that would have prevailed in an arm's-length transaction. The auditor should obtain sufficient appropriate evidence about a management assertion that related party transactions were conducted on terms equivalent to those that prevail in arm's-length transactions. Management is responsible for substantiating the assertion. The auditor evaluates management's support for the assertion.

In using the work of an auditor's external specialist, an agreement should exist between the auditor and the specialist as to the nature of the specialist's work. This agreement most likely should include: a. The applicability of the same confidentiality requirements to the auditor and the specialist. b. A statement that the specialist assumes no responsibility to update the specialist's report for future events or circumstances. c. The conditions under which a division of responsibility may be necessary. d. The auditor's disclaimer as to whether the specialist's findings corroborate the representations in the financial statements.

a. The applicability of the same confidentiality requirements to the auditor and the specialist. The agreement should be documented and should cover (1) the nature, objectives, and scope of the work; (2) the roles of the auditor and specialist; (3) the nature, timing, and extent of communications between the auditor and specialist; and (4) the need for the specialist to observe confidentiality requirements. The agreement between the auditor and the auditor's external specialist generally is documented in an engagement letter. A matter that should be included is the need for the confidentiality provisions of the relevant ethical requirements that apply to the auditor also to apply to the specialist. For example, a member of the AICPA may use a third-party service provider to render professional services to clients. The member should have a contract with the third-party service provider to maintain the confidentiality of the information (Ethics Ruling). Other requirements may be imposed by law or regulation.

Which of the following factors would the independent auditor most likely consider in assessing the objectivity of an internal auditor? a. The audit committee reviews employment decisions related to the director of internal auditing. b. The internal auditor was previously an employee of the auditor's public accounting firm. c. The internal auditor attends a number of comprehensive continuing professional education courses each year. d. The internal auditor has obtained the Certified Internal Auditor designation.

a. The audit committee reviews employment decisions related to the director of internal auditing. Objectivity is impartiality, intellectual honesty, and freedom from conflicts of interest. Factors that the independent auditor most likely considers in assessing the objectivity of an internal auditor include whether those charged with governance (e.g., the audit committee) oversee employment decisions related to internal auditing. Examples are hiring and compensation of the director of the internal audit function.

Which of the following statements is correct concerning an auditor's use of the work of an actuary in assessing a client's pension obligations? a. The auditor is required to understand the objectives and scope of the actuary's work. b. The client is required to consent to the auditor's use of the actuary's work. c. The actuary must be an internal specialist with a continuing relationship with the auditing firm. d. The reasonableness of the actuary's assumptions is strictly the auditor's responsibility.

a. The auditor is required to understand the objectives and scope of the actuary's work. The auditor should obtain an understanding of the expertise of the auditor's specialist sufficient to (1) determine the nature, scope, and objectives of the work and (2) evaluate the adequacy of the work for the auditor's purposes.

In assessing the competence of an internal auditor, an independent CPA most likely would obtain information about the: a. Organization's commitment to integrity and ethical values. b. Quality of the internal auditor's documentation. c. Organizational levels to which the internal auditor reports. d. Influence of management on the scope of the internal auditor's duties.

b. Quality of the internal auditor's documentation. In assessing the competence of an internal auditor, the auditor should consider such factors as (1) educational level and professional experience; (2) professional certification and continuing education; (3) audit policies, programs, and procedures; (4) supervision and review of the internal auditor's activities; (5) practices regarding assignments; (6) quality of documentation, reports, and recommendations; and (7) evaluation of the internal auditor's performance.

Which of the following events most likely would indicate the existence of related party transactions? a. Making a loan with specific scheduled terms for repayment of the funds. b. Selling real estate at a price that differs significantly from its appraised value. c. Insuring the lives of key executives and listing the entity as beneficiary. d. Granting stock options to key executives at favorable prices.

b. Selling real estate at a price that differs significantly from its appraised value. Related party transactions may not be conducted in accordance with customary business practices. For example, in an arm's-length transaction, real estate with an appraised value usually is sold at approximately that value. A material disparity in the consideration exchanged may indicate that the parties are related.

An auditor intends to use the work of an actuary. Under these circumstances, the auditor: a. Is required to disclose the relationship in the auditor's report. b. Should assess the actuary's competence and objectivity. c. Should communicate this matter to the audit committee. d. Is not permitted to rely on the actuary's work.

b. Should assess the actuary's competence and objectivity. When deciding whether to use an auditor's specialist, the auditor should evaluate whether the auditor's specialist has the needed competence, capabilities, and objectivity. For an external specialist, the evaluation should include inquiries about threats to objectivity (AU-C 620). Consideration should be given to the specialist's professional certification, license, or other recognition of competence and the specialist's reputation and standing.

Which of the following factors most likely would assist an auditor in assessing the objectivity of the internal auditor? a. The consistency of the internal audit reports with the results of work performed. b. The organizational status of the director of internal audit. c. The professional certifications of the internal audit staff. d. The appropriateness of internal audit conclusions in the circumstances.

b. The organizational status of the director of internal audit. If the external auditor plans to use the work of the internal auditors to obtain audit evidence or to provide direct assistance, the competence and objectivity should be evaluated. Objectivity is promoted when the internal auditors (1) report to those charged with governance rather than management, (2) are free of any conflicting responsibilities, (3) work without constraints, and (4) are members of professional organizations that obligate them to be objective. The external auditor should assess each of these factors in evaluating objectivity.

What is the primary purpose of reviewing conflict-of-interest statements signed by members of management? a. To assess control risk. b. To identify transactions with related parties. c. To obtain an understanding of business processes. d. To consider limitations of internal control.

b. To identify transactions with related parties. Conflict-of-interest statements obtained by the entity from its management are reviewed to identify material transactions with known related parties or indicate the existence of previously unknown related parties.

Which of the following events least likely would indicate the existence of related party transactions? a. Exchanging property for the benefit of a principal shareholder. b. Writing off obsolete inventory to net realizable value just before year end. c. Borrowing funds at an interest rate significantly below prevailing market rates. d. Making a loan with no scheduled date for the funds to be repaid.

b. Writing off obsolete inventory to net realizable value just before year end. The following suggest possible related party transactions: (1) exchanging property for similar property in a nonmonetary transaction, (2) borrowing or lending at rates significantly above or below market rates, (3) selling realty at a price materially different from its appraised value, and (4) making loans with no scheduled repayment terms (AU-C 550 and AS 2410).

Which approach to planning, performing, supervising, reviewing, and documenting internal audit activities distinguishes it from other monitoring controls that may be performed within the entity? a. An independent approach b. A balanced approach. c. A systematic and disciplined approach. d. A fair and honest approach.

c. A systematic and disciplined approach. The application of a systematic and disciplined approach to planning, performing, supervising, reviewing, and documenting internal audit activities distinguishes it from other monitoring controls that may be performed within the entity.

An auditor may refer to and identify an auditor's external specialist in the auditor's report if the: a. Specialist's work provides the auditor greater assurance of reliability. b. Specialist lacks objectivity with regard to the client. c. Auditor expresses a disclaimer of an opinion as a result of the specialist's findings. d. Auditor wishes to indicate a division of responsibility.

c. Auditor expresses a disclaimer of an opinion as a result of the specialist's findings. The auditor may refer to an auditor's external specialist only if the opinion is modified. A modified opinion is a qualified opinion, adverse opinion, or a disclaimer of opinion. The reference is made because it is relevant to understanding the modification. An auditor's report with such a reference should state that it does not reduce the auditor's responsibility (AU-C 620).

After identifying a significant related party transaction outside the entity's normal course of business, an auditor should: a. Perform analytical procedures to identify similar transactions that were not recorded. b. Add an emphasis-of-matter paragraph to the auditor's report to explain the transaction. c. Evaluate the business purpose of the transaction. d. Substantiate that the transaction was consummated on terms equivalent to those of an arm's-length transaction.

c. Evaluate the business purpose of the transaction. The auditor should inspect any contracts or agreements to evaluate whether (1) the business purpose (or lack of a business purpose) implies that the transaction's intent was fraudulent, (2) the terms are consistent with management's explanations, and (3) the accounting and disclosure are appropriate. The auditor also should obtain evidence of appropriate authorization and approval.

The work of internal auditors may affect the independent auditor's I. Procedures performed in obtaining an understanding of internal control II. Procedures performed in assessing the risks of material misstatement III. Substantive procedures performed in gathering direct evidence a. I and III only. b. II and III only. c. I, II, and III. d. I and II only.

c. I, II, and III. The internal audit function is part of the client's internal control. The auditor should obtain an understanding of this function when obtaining an understanding of internal control. The auditor also may use the internal auditors to provide direct assistance under certain conditions. A primary purpose of internal auditors is to review, assess, and monitor internal control. Thus, their work is relevant to the understanding of internal control and the assessment of risk. Moreover, some procedures performed by internal auditors, such as confirmations, may provide direct evidence about material misstatements.

Which of the following events most likely indicates the existence of related parties? a. Discussing merger terms with a company that is a major competitor. b. Borrowing a large sum of money at a variable rate of interest. c. Making a loan without scheduled terms for repayment of the funds. d. Selling real estate at a price that differs significantly from its carrying amount.

c. Making a loan without scheduled terms for repayment of the funds. The following suggest possible related party transactions: (1) exchanging property for similar property in a nonmonetary transaction, (2) borrowing or lending at rates significantly above or below market rates, (3) selling realty at a price materially different from its appraised value, and (4) making loans with no scheduled repayment terms.

In assessing the competence of internal auditors, an independent CPA most likely would obtain information about the: a. Policies limiting internal auditors from communication with the audit committee. b. Influence of management on the scope of the internal auditors' duties. c. Quality of the internal auditors' working paper documentation. d. Entity's ability to continue as a going concern for a reasonable period of time.

c. Quality of the internal auditors' working paper documentation. In assessing the competence of an internal auditor, the CPA should consider such factors as (1) educational level and professional experience; (2) professional certification and continuing education; (3) audit policies, programs, and procedures; (4) departmental practices regarding assignments; (5) quality of working paper documentation, reports, and recommendations; and (6) evaluation of the internal auditor's performance.

An auditor who uses the work of an auditor's external specialist may refer to the specialist in the auditor's report if the: a. Auditor's use of the specialist's findings is different from that of prior years. b. Specialist's findings provide the auditor greater assurance of reliability about management's representations. c. Reference is needed for an understanding of a modification of the opinion. d. The specialist's findings fully corroborate management's financial statement assertions.

c. Reference is needed for an understanding of a modification of the opinion. The auditor may refer to an auditor's external specialist only if the opinion is modified. A modified opinion is a qualified opinion, adverse opinion, or a disclaimer of opinion. The reference is made because it is relevant to understanding the modification. An auditor's report with such a reference should state that it does not reduce the auditor's responsibility (AU-C 620).

Which of the following statements is true about the use of the work of an auditor's specialist? a. The specialist need not agree to the auditor's use of the specialist's findings. b. The auditor is required to perform substantive procedures to verify the specialist's assumptions and findings. c. The auditor should obtain an understanding of the methods and assumptions used by the specialist. d. The auditor must keep client information confidential, but the specialist is not obligated to do so.

c. The auditor should obtain an understanding of the methods and assumptions used by the specialist. AU-C 620, Using the Work of an Auditor's Specialist, states that the auditor should evaluate the adequacy of the work of the auditor's specialist. This process includes (1) obtaining an understanding of any significant assumptions and methods used by the specialist and (2) evaluating the relevance and reasonableness of those assumptions and methods in the circumstances and in relation to the auditor's other findings and conclusions.

A management's specialist most likely is useful to: a. Add credibility to the financial statements. b. Provide the auditor advice on technical accounting issues. c. Assist the auditor in collecting sufficient appropriate audit evidence. d. Assist the client in preparing the financial statements.

d. Assist the client in preparing the financial statements. A management's specialist is an individual or organization possessing expertise in a field other than accounting or auditing. The work in that field is used by the entity to assist in preparing the financial statements.

If the auditors plan to use the work of the internal auditors to obtain audit evidence or to provide direct assistance, they should assess the internal auditors': a. Efficiency and experience. b. Training and supervisory skills. c. Independence and review skills. d. Competence and objectivity.

d. Competence and objectivity. If the external auditor decides to use the work of the internal auditors, the competence and objectivity of the internal auditors should be assessed. Assessing competence involves obtaining information about (1) education and experience; (2) professional certification and CPE; (3) audit policies, programs, and procedures; (4) practices regarding assignment of internal auditors; (5) supervision and review of their activities; (6) quality of audit documentation, reports, and recommendations; and (7) evaluation of internal auditors' performance. Assessing objectivity includes obtaining information about (1) organizational status (the level to which the internal auditors report, access to those charged with governance, and whether these individuals oversee employment decisions related to the internal auditors) and (2) policies to maintain internal auditors' objectivity concerning the areas audited (AU-C 610).

When assessing an internal auditor's objectivity, an auditor should: a. Inquire about the internal auditor's educational background and professional certification b. Evaluate the adequacy of the internal auditor's audit programs. c. Review the internal auditor's working papers. d. Consider the organizational level to which the internal auditor reports.

d. Consider the organizational level to which the internal auditor reports. If the external auditor plans to use the work of the internal auditors to obtain audit evidence or to provide direct assistance, their competence and objectivity should be evaluated. Objectivity is promoted when the internal auditors (1) report to those charged with governance rather than management, (2) are free of any conflicting responsibilities, (3) work without constraints, and (4) are members of professional organizations that obligate them to be objective. The external auditor should assess each of these factors in evaluating objectivity.

An internal auditor would least likely provide direct assistance to the auditor in: a. Obtaining an understanding of internal control. b. Performing substantive procedures. c. Performing tests of controls. d. Evaluating accounting estimates.

d. Evaluating accounting estimates. The auditor has the ultimate responsibility to express an opinion on the financial statements. Judgments about (1) assessments of the risks of material misstatement, (2) materiality of misstatements, (3) sufficiency of tests performed, (4) evaluation of significant accounting estimates, and (5) other matters affecting the auditor's report always should be those of the auditor.

Which of the following steps should an auditor perform first to determine the existence of related parties? a. Review proxy and other materials filed with the SEC. b. Examine invoices, contracts, and purchasing orders. c. Review the company's business structure. d. Inquire about the existence of related parties from management.

d. Inquire about the existence of related parties from management. When obtaining an understanding of the entity's related party relationships and transactions, the auditor should inquire of management regarding (1) the identity of the entity's related parties, including changes from the prior period; (2) the relationships of the entity with those parties; and (3) the types and purposes of transactions with them.

When assessing the competence of the internal auditors, an auditor should obtain information about the: a. Internal auditors' preliminary assessed risks of material misstatement. b. Policies prohibiting internal auditors from auditing sensitive matters. c. Organizational level to which the internal auditors report. d. Quality of the internal auditors' working paper documentation.

d. Quality of the internal auditors' working paper documentation. Concerning the competence of the internal auditor, it is important to establish the quality of the work. The auditor should obtain information about (1) educational level and professional experience; (2) professional certification and continuing education; (3) audit policies, programs, and procedures (related to competence); (4) practices regarding assignment of internal auditors; (5) supervision and review of the internal auditor's activities; (6) quality of documentation; and (7) performance evaluation.

In evaluating an entity's accounting estimates, one of the auditor's objectives is to determine whether the estimates are: a. Prepared in a satisfactory control environment. b. Based on verifiable objective assumptions. c. Consistent with industry guidelines. d. Reasonable in the circumstances.

d. Reasonable in the circumstances. The auditor is responsible for evaluating the reasonableness of accounting estimates made by management in the context of the applicable reporting framework

In auditing related party transactions, an auditor ordinarily places primary emphasis on: a. The probability that related party transactions will recur. b. Confirming the existence of the related parties. c. Verifying the valuation of the related party transactions. d. The adequacy of the disclosure of the related party transactions.

d. The adequacy of the disclosure of the related party transactions. Accounting principles ordinarily do not require transactions with related parties to be accounted for differently from those with unrelated parties. Primary emphasis should be on the adequacy of disclosure.

Which of the following statements concerning the auditor's use of the work of an auditor's external specialist is true? a. The auditor's specialist need not have an understanding of the extent of the auditor's use of the specialist's work. b. If the auditor believes that the determinations made by the auditor's specialist are unreasonable, only a qualified opinion may be expressed. c. The auditor's specialist may be identified in the auditor's report only when the auditor expresses an unmodified opinion. d. The auditor's specialist should observe the same confidentiality requirements as the auditor.

d. The auditor's specialist should observe the same confidentiality requirements as the auditor. An agreement between the auditor and the auditor's external specialist generally is documented in an engagement letter. A matter that should be included is the need for the confidentiality provisions of the relevant ethical requirements that apply to the auditor to also apply to the specialist. For example, a member of the AICPA may use a third-party service provider to render professional services to clients. The member should have a contract with the third-party service provider to maintain the confidentiality of the information (Ethics Ruling). Other requirements may be imposed by law or regulation.

An auditor might consider the procedures performed by the internal auditors because: a. Their degree of independence may be inferred from the nature of their work. b. They are employees whose work must be reviewed during substantive testing. c. Their work affects the cost-benefit trade-off. d. They are employees whose work may affect the nature, timing, and extent of audit procedures.

d. They are employees whose work may affect the nature, timing, and extent of audit procedures. The internal audit function is part of the monitoring component of internal control. Consequently, the auditor should obtain an understanding of the internal audit function sufficient to identify activities relevant to planning the audit. The external auditor may plan to use the work of the internal auditors to obtain audit evidence or to provide direct assistance. In this case, (s)he should assess their competence and objectivity. If that assessment is favorable, the auditor then considers how the internal auditors' work may affect the audit. If it significantly affects the audit procedures, the auditor should evaluate and test that work.

Which of the following audit procedures is an auditor most likely not to perform related to newly identified related party transactions outside the normal course of business? a. Verify the terms and conditions of the transactions. b. Analyze accounting records for transactions. c. Evaluate the business purpose of the transactions. d. Understand the controls over authorization and approval of such transactions.

d. Understand the controls over authorization and approval of such transactions. Significant transactions outside the normal course of business most likely have a high assessed risk of material misstatement because normal controls do not typically apply. Thus, the focus should be on substantive testing of the transactions.

During an audit, an internal auditor may provide direct assistance to an independent CPA in: Obtaining an Understanding of Internal Control, Performing Test of Controls, Performing Substantive Tests a. No, No, No b. Yes, Yes, No c. Yes, No, No d. Yes, Yes, Yes

d. Yes, Yes, Yes The auditor may request direct assistance from the internal auditor when performing the audit. Thus, the auditor may appropriately request the internal auditor's assistance in obtaining the understanding of internal control, performing tests of controls, or performing substantive procedures (AU-C 610). The internal auditor may provide assistance in all phases of the audit as long as (1) the internal auditor's competence and objectivity have been tested, and (2) the independent auditor supervises, reviews, evaluates, and tests the work performed by the internal auditor to the extent appropriate.