Test 2

Which of the following best describes what is meant by the term "fraud risk factor"?

Factors often observed in circumstances where frauds have occurred.

Which of the following should the auditors obtain from the predecessor auditors before accepting an audit engagement?

Facts that might bear on the integrity of management.

Analytical procedures are extremely useful throughout the audit. Explain how analytical procedures are useful in (1) The risk assessment stage of the audit. (2) The substantive procedures stage of the audit. (3) Near the end of the audit.

In-Class Notes

A primary objective of procedures performed to obtain an understanding of internal control is to provide the auditors with:

Knowledge necessary to determine the nature, timing, and extent of further audit procedures.

Which portion of an audit is least likely to be completed before the balance sheet date?

Substantive procedures

An auditor may compensate for a weakness in internal control by increasing the extent of:

Substantive tests of details.

Three conditions generally are present when fraud occurs. Select the one below that is not one of those conditions.

Supervisory position

A primary purpose of the audit working papers is to:

Support the auditors' opinion.

When the auditors are performing a first-time internal control audit in accordance with the Sarbanes-Oxley Act and PCAOB standards, they should:

Test controls for all significant accounts.

You are performing an audit of Systex Corporation and evaluating various controls. Classify the following controls as being primarily preventive (P), detective (D), or corrective (C). Explain your answers. Adjustment of perpetual inventory records to physical counts.

Corrective

To have an adequate basis to issue a management report on internal control under Section 404(a) of the Sarbanes-Oxley Act, management must do all of the following, except:

Establish internal control with no material weakness.

Marion Watson & Co., CPAs, is planning its audit procedures for its tests of the valuation of inventories of East Coast Manufacturing Co. The auditors on the engagement have assessed inherent risk and control risk for valuation of inventories at 100 percent and 50 percent, respectively. Calculate the appropriate level of detection risk for the audit of this assertion, given that the auditors wish to restrict audit risk for the assertion to 3 percent.

6%

Which of the following should not normally be included in the engagement letter for an audit?

A listing of the client's branch offices selected for testing.

Marion Watson & Co., CPAs, is planning its audit procedures for its tests of the valuation of inventories of East Coast Manufacturing Co. The auditors on the engagement have assessed inherent risk and control risk for valuation of inventories at 100 percent and 50 percent, respectively. Calculate the appropriate level of detection risk for the audit of this assertion, given that the auditors wish to restrict audit risk for the assertion to 5 percent.

10%

Which of the following business characteristics is not indicative of high inherent risk?

A large amount of assets

A CPA has been asked to audit the financial statements of a nonpublic company for the first time. All preliminary discussions have been completed between the CPA, the company, the predecessor auditors, and all other necessary parties. The CPA is now preparing an engagement letter. List the items that should be included in the engagement letter.

Addressed to board (not management) Purpose of engagement - Objectivity and Scope of audit Responsibility of auditor What We expect of Managment Fee Arrangements, Billing Reporting

In planning and performing an audit, auditors are concerned about risk factors for two distinct types of fraud: fraudulent financial reporting and misappropriation of assets. Which of the following is a risk factor for misappropriation of assets?

An unreliable accounting system

Which of the following is not a function of audit working papers?

Assist management in illustrating that the financial statements are in accordance with generally accepted accounting principles.

Comment on the reliability of each of the following examples of audit evidence. Arrange your answer in the form of a separate paragraph for each item. Explain fully the reasoning employed in judging the reliability of each item. Auditors' independent computation of earnings per share

Auditors are competent, so highly reliable

In using the work of a specialist, the auditors referred to the specialist's findings in their report. This would be an appropriate reporting practice if the:

Auditors, as a result of the specialist's findings, give a qualified opinion on the financial statements. Wouldn't give clean opinion

Precision Industries, Inc., is a manufacturer of electronic components. When a purchase order is received from a customer, a sales clerk prepares a serially numbered sales order and sends copies to the shipping and accounting departments. When the merchandise is shipped to the customer, the shipping department prepares a serially numbered shipping advice and sends a copy to the accounting department. Upon receipt of the appropriate documents, the accounting department records the sale in the accounting records. All shipments are FOB shipping point. How can the auditors determine whether Precision Industries, Inc., has made a proper year-end cutoff of sales transactions? Assume that all shipments for the first five days of the following year were recorded as occurring in the current year. If not corrected, what effect will this cutoff error have upon the financial statements for the current year?

Best scenario - Be there and see last shipment out Revenues overstated, CoGS understand

Comment on the reliability of each of the following examples of audit evidence. Arrange your answer in the form of a separate paragraph for each item. Explain fully the reasoning employed in judging the reliability of each item. Copies of client's sales invoices

Client could make more if needed so less reliable

Which of the following is not a primary approach to auditing an accounting estimate?

Confirm the amounts. Nobody can confirm

Which of the following is not ordinarily a procedure for documenting an auditor's understanding of internal control for planning purposes?

Confirmation Occurs Later

When a CPA decides that the work performed by internal auditors may have an effect on the nature, timing, and extent of the CPA's procedures, the CPA should consider the competence and objectivity of the internal auditors. Relative to objectivity, the CPA should:

Consider the organizational level to which the internal auditors report the results of their work.

Of the following, which is the least reliable type of audit evidence?

Copies of sales invoices inspected by the auditors.

Michael Green, CPA, is considering audit risk at the financial statement level in planning the audit of National Federal Bank (NFB) Company's financial statements for the year ended December 31, 20X1. Audit risk at the financial statement level is influenced by the risks of material misstatements (including fraud risks), which may be indicated by a combination of factors related to management, the environment, and the entity. For each of the following factors, indicate whether it increases or decreases the risk of material misstatement and (2) whether it creates a risk of fraud. Government regulation and overview of the banking industry is extensive and effective.

Decrease

Michael Green, CPA, is considering audit risk at the financial statement level in planning the audit of National Federal Bank (NFB) Company's financial statements for the year ended December 31, 20X1. Audit risk at the financial statement level is influenced by the risks of material misstatements (including fraud risks), which may be indicated by a combination of factors related to management, the environment, and the entity. For each of the following factors, indicate whether it increases or decreases the risk of material misstatement and (2) whether it creates a risk of fraud. Management has been receptive to Green's suggestions relating to accounting adjustments.

Decrease

Michael Green, CPA, is considering audit risk at the financial statement level in planning the audit of National Federal Bank (NFB) Company's financial statements for the year ended December 31, 20X1. Audit risk at the financial statement level is influenced by the risks of material misstatements (including fraud risks), which may be indicated by a combination of factors related to management, the environment, and the entity. For each of the following factors, indicate whether it increases or decreases the risk of material misstatement and (2) whether it creates a risk of fraud. NFB operates in a growing, prosperous area and has remained profitable over the years.

Decrease

Effective internal control in a small company that has an insufficient number of employees to permit proper separation of responsibilities can be improved by:

Direct participation by the owner in key record-keeping and control activities of the business.

Michael Green, CPA, is considering audit risk at the financial statement level in planning the audit of National Federal Bank (NFB) Company's financial statements for the year ended December 31, 20X1. Audit risk at the financial statement level is influenced by the risks of material misstatements (including fraud risks), which may be indicated by a combination of factors related to management, the environment, and the entity. For each of the following factors, indicate whether it increases or decreases the risk of material misstatement and (2) whether it creates a risk of fraud. The accounting department has experienced little turnover in personnel during the five years Green has audited NFB.

Decrease

Michael Green, CPA, is considering audit risk at the financial statement level in planning the audit of National Federal Bank (NFB) Company's financial statements for the year ended December 31, 20X1. Audit risk at the financial statement level is influenced by the risks of material misstatements (including fraud risks), which may be indicated by a combination of factors related to management, the environment, and the entity. For each of the following factors, indicate whether it increases or decreases the risk of material misstatement and (2) whether it creates a risk of fraud. The internal auditor reports directly to Harris, a minority shareholder, who also acts as chairman of the board's audit committee.

Decrease

Michael Green, CPA, is considering audit risk at the financial statement level in planning the audit of National Federal Bank (NFB) Company's financial statements for the year ended December 31, 20X1. Audit risk at the financial statement level is influenced by the risks of material misstatements (including fraud risks), which may be indicated by a combination of factors related to management, the environment, and the entity. For each of the following factors, indicate whether it increases or decreases the risk of material misstatement and (2) whether it creates a risk of fraud. NFB is a continuing audit client.

Decrease, No

The primary objective of tests of details of transactions performed as substantive procedures is to:

Detect material misstatements in the financial statements.

Which of the following would be least likely to be considered an objective of internal control?

Detecting management fraud.

The risk that the auditors will conclude, based on substantive procedures, that a material misstatement does not exist in an account balance when, in fact, such misstatement does exist is referred to as

Detection risk

You are performing an audit of Systex Corporation and evaluating various controls. Classify the following controls as being primarily preventive (P), detective (D), or corrective (C). Explain your answers. Annual physical inventory.

Detective

You are performing an audit of Systex Corporation and evaluating various controls. Classify the following controls as being primarily preventive (P), detective (D), or corrective (C). Explain your answers. Internal audits of payroll.

Detective

You are performing an audit of Systex Corporation and evaluating various controls. Classify the following controls as being primarily preventive (P), detective (D), or corrective (C). Explain your answers. Management review of budget/actual information.

Detective

You are performing an audit of Systex Corporation and evaluating various controls. Classify the following controls as being primarily preventive (P), detective (D), or corrective (C). Explain your answers. Monthly reconciliation of bank accounts.

Detective

Listed below are several of the auditors' general objectives in performing substantive procedures on an asset account: Establish the existence of assets. Establish that the company has rights to the assets. Establish the completeness of recorded assets. Verify the cutoff of transactions.Page 239 Determine the appropriate valuation of the assets. Establish the clerical accuracy of the underlying records. Determine the appropriate financial statement presentation and disclosure of the assets. Identify related parties

Determine the appropriate financial statement presentation and disclosure of the assets Presentation and Disclosure

Listed below are several of the auditors' general objectives in performing substantive procedures on an asset account: Establish the existence of assets. Establish that the company has rights to the assets. Establish the completeness of recorded assets. Verify the cutoff of transactions.Page 239 Determine the appropriate valuation of the assets. Establish the clerical accuracy of the underlying records. Determine the appropriate financial statement presentation and disclosure of the assets. Obtain a listing of inventory and reconcile the total to the general ledger.

Determine the appropriate valuation of the assets Valuation

A difference of opinion concerning accounting and auditing matters relative to a particular phase of the audit arises between an assistant auditor and the auditor responsible for the engagement. After appropriate consultation, the assistant auditor asks to be disassociated from the resolution of the matter. The working papers would probably:

Document the assistant auditor's position and how the difference of opinion was resolved.

Which of the following is not a financial statement assertion made by management?

Effectiveness of internal control.

Which of the following is not an advantage of establishing an enterprise risk management system within an organization?

Eliminates all risks.

Listed below are several of the auditors' general objectives in performing substantive procedures on an asset account: Establish the existence of assets. Establish that the company has rights to the assets. Establish the completeness of recorded assets. Verify the cutoff of transactions. Determine the appropriate valuation of the assets. Establish the clerical accuracy of the underlying records. Determine the appropriate financial statement presentation and disclosure of the assets. Trace a sample of shipping documents to recorded sales transactions.

Establish the completeness of recorded assets Completeness

Listed below are several of the auditors' general objectives in performing substantive procedures on an asset account: Establish the existence of assets. Establish that the company has rights to the assets. Establish the completeness of recorded assets. Verify the cutoff of transactions.Page 239 Determine the appropriate valuation of the assets. Establish the clerical accuracy of the underlying records. Determine the appropriate financial statement presentation and disclosure of the assets. Locate on the client's premises a sample of the equipment items listed in the subsidiary plant and equipment ledger.

Establish the existence of assets

Listed below are several of the auditors' general objectives in performing substantive procedures on an asset account: Establish the existence of assets. Establish that the company has rights to the assets. Establish the completeness of recorded assets. Verify the cutoff of transactions.Page 239 Determine the appropriate valuation of the assets. Establish the clerical accuracy of the underlying records. Determine the appropriate financial statement presentation and disclosure of the assets. Observe the client's physical inventory.

Establish the existence of assets Existence

Listed below are several of the auditors' general objectives in performing substantive procedures on an asset account: Establish the existence of assets. Establish that the company has rights to the assets. Establish the completeness of recorded assets. Verify the cutoff of transactions.Page 239 Determine the appropriate valuation of the assets. Establish the clerical accuracy of the underlying records. Determine the appropriate financial statement presentation and disclosure of the assets. Vouch selected purchases of securities to brokers' advices

Establish the existence of assets, Establish the completeness of recorded assets, Determine the appropriate valuation of the assets

Michael Green, CPA, is considering audit risk at the financial statement level in planning the audit of National Federal Bank (NFB) Company's financial statements for the year ended December 31, 20X1. Audit risk at the financial statement level is influenced by the risks of material misstatements (including fraud risks), which may be indicated by a combination of factors related to management, the environment, and the entity. For each of the following factors, indicate whether it increases or decreases the risk of material misstatement and (2) whether it creates a risk of fraud. During 20X1, NFB increased the efficiency of its accounting operations by installing a new, sophisticated computer system.

Increase

Michael Green, CPA, is considering audit risk at the financial statement level in planning the audit of National Federal Bank (NFB) Company's financial statements for the year ended December 31, 20X1. Audit risk at the financial statement level is influenced by the risks of material misstatements (including fraud risks), which may be indicated by a combination of factors related to management, the environment, and the entity. For each of the following factors, indicate whether it increases or decreases the risk of material misstatement and (2) whether it creates a risk of fraud. Interest rates have been very volatile recently.

Increase

Michael Green, CPA, is considering audit risk at the financial statement level in planning the audit of National Federal Bank (NFB) Company's financial statements for the year ended December 31, 20X1. Audit risk at the financial statement level is influenced by the risks of material misstatements (including fraud risks), which may be indicated by a combination of factors related to management, the environment, and the entity. For each of the following factors, indicate whether it increases or decreases the risk of material misstatement and (2) whether it creates a risk of fraud. Management at the bank's branch offices has authority for directing and controlling NFB's operations and is compensated based on branch profitability.

Increase

Michael Green, CPA, is considering audit risk at the financial statement level in planning the audit of National Federal Bank (NFB) Company's financial statements for the year ended December 31, 20X1. Audit risk at the financial statement level is influenced by the risks of material misstatements (including fraud risks), which may be indicated by a combination of factors related to management, the environment, and the entity. For each of the following factors, indicate whether it increases or decreases the risk of material misstatement and (2) whether it creates a risk of fraud. NFB's board of directors is controlled by Smith, the majority stockholder, who also acts as the chief executive officer.

Increase

Michael Green, CPA, is considering audit risk at the financial statement level in planning the audit of National Federal Bank (NFB) Company's financial statements for the year ended December 31, 20X1. Audit risk at the financial statement level is influenced by the risks of material misstatements (including fraud risks), which may be indicated by a combination of factors related to management, the environment, and the entity. For each of the following factors, indicate whether it increases or decreases the risk of material misstatement and (2) whether it creates a risk of fraud. NFB's formula has consistently underestimated the allowance for loan losses in current year

Increase

Michael Green, CPA, is considering audit risk at the financial statement level in planning the audit of National Federal Bank (NFB) Company's financial statements for the year ended December 31, 20X1. Audit risk at the financial statement level is influenced by the risks of material misstatements (including fraud risks), which may be indicated by a combination of factors related to management, the environment, and the entity. For each of the following factors, indicate whether it increases or decreases the risk of material misstatement and (2) whether it creates a risk of fraud. The banking industry has been significantly impacted by the downturn in the economy in recent years.

Increase, Yes

Financial statements contain a number of assertions about account balances, classes of transactions, and disclosures. Identify who makes these assertions. List and describe each of the assertions regarding each financial statement component.

Management Refer to in-class notes

An entity's ongoing monitoring activities often include:

Management review of weekly performance reports.

Which of the following elements underlies the application of generally accepted auditing standards, particularly the standards of fieldwork and reporting?

Materiality and audit risk

The audit committee of a company must be made up of:

Members of the board of directors who are not officers or employees.

Auditors should plan and perform their audits to provide reasonable assurance of detecting material misstatements in financial statements, including those resulting from fraud. Distinguish between fraudulent financial reporting and misappropriation of assets. Describe the three fundamental conditions necessary for the commission of fraud. Provide an illustration of these three conditions for a case of fraudulent financial reporting. Describe the three ways in which the auditors may respond to fraud risks in an audit.

Nature, timing, extent change

At 12 o'clock, when the plant whistle sounded, George Jones, an assistant auditor, had been working on his laptop computer. Jones stopped work immediately, but not wanting to waste a lot of time, he simply closed his laptop. He then departed for lunch. The auditor-in-charge, who had been observing what was going on, was critical of the assistant's actions. What do you think was the basis for criticism by the auditor-in-charge?

Need to lock, secure, and remove content that client could access

In what section of the audit working papers would a long-term lease agreement be filed?

Permanent working paper file Will need to go back for reference

"The best means of verification of cash, inventory, office equipment, and nearly all other assets is a physical count of the units; only a physical count gives the auditors complete assurance as to the accuracy of the amounts listed on the balance sheet." Evaluate this statement.

Physical Exam - Proves existence but not completeness by counting

Controls over financial reporting are often classified as preventative, detective, or corrective. Which of the following is an example of a detective control?

Preparing bank reconciliations.

You are performing an audit of Systex Corporation and evaluating various controls. Classify the following controls as being primarily preventive (P), detective (D), or corrective (C). Explain your answers. Dual signatures for checks.

Preventive

You are performing an audit of Systex Corporation and evaluating various controls. Classify the following controls as being primarily preventive (P), detective (D), or corrective (C). Explain your answers. Segregation of duties over purchasing.

Preventive

You are performing an audit of Systex Corporation and evaluating various controls. Classify the following controls as being primarily preventive (P), detective (D), or corrective (C). Explain your answers. Supervisory approval of time cards.

Preventive

Comment on the reliability of each of the following examples of audit evidence. Arrange your answer in the form of a separate paragraph for each item. Explain fully the reasoning employed in judging the reliability of each item. Representation letter signed by controller of client company stating that all liabilities of which she has knowledge are reflected in the company's accounts.

Putting words in client's mouth, so less reliable (but does give legal liability)

List the five sources of information that are available to the auditors in developing expectations for analytical procedures.

Ratios - Industry, Previous Years, Budget Journals Nonfinancial

Comment on the reliability of each of the following examples of audit evidence. Arrange your answer in the form of a separate paragraph for each item. Explain fully the reasoning employed in judging the reliability of each item. Paid checks returned with a bank statement

Really reliable because created by bank

What would you accept as satisfactory documentary evidence in support of entries in the following? Sales returns journal

Receipt, Return Document, Correspondence, Receiving Document

As one step in testing sales transactions, a CPA traces a random sample of sales journal entries to debits in the accounts receivable subsidiary ledger. This test provides evidence as to whether:

Recorded sales have been properly posted to customer accounts.

When in the course of an audit might the auditors find it useful to apply analytical procedures?

Risk assessment (beg) and at end

What would you accept as satisfactory documentary evidence in support of entries in the following? Sales journal.

Sales invoice, Purchase Order, Contract, Shipping Documents

As part of the verification of accounts receivable as of the balance sheet date, the auditors might inspect copies of sales invoices. Similarly, as part of the verification of accounts payable, the auditors might inspect purchase invoices. Which of these two types of invoices do you think represents the stronger type of evidence? Why?

Sales invoices are made by company, so purchase invoices are more reliable (come from third party)

Which of the following statements best describes why auditors investigate related party transactions?

The substance of related party transactions may differ from their form. May not really exist

Comment on the reliability of each of the following examples of audit evidence. Arrange your answer in the form of a separate paragraph for each item. Explain fully the reasoning employed in judging the reliability of each item. Response from customer of client addressed to auditors' office confirming amount owed to client at balance sheet date.

Third party so highly reliable

As part of their audit, auditors obtain a representation letter from their client. Which of the following is not a valid purpose of such a letter?

To increase the efficiency of the audit by eliminating the need for other audit procedures. Doesn't change the work done

List and describe four techniques that may be used by the auditors in developing expectations for analytical procedures.

Trend, Ratio, Regression, Reasonableness

Analytical procedures are most likely to detect:

Unusual transaction

Which of the following is most likely to be an overall response to fraud risks identified in an audit?

Use less predictable audit procedures.

Morgan, CPA, is approached by a prospective audit client who wants to engage Morgan to perform an audit for the current year. In prior years, this prospective client was audited by another CPA. Identify the specific procedures that Morgan should follow in deciding whether to accept this client.

What wrong with last firm? (8K) How does the company look? Why do they need audit? Talk to previous auditor What is our experience with industry? What is the integrity of management? Talk to 3rd parties, meet with audit committee