ACCT 404 Exam 2

Under which of the following circumstances are auditors permitted to disclose information regarding fraud and noncompliance? if the audit firm resigns or is fired when answering a subpoena

a and b

Analytical procedures are required: at the end of an audit as substantive testing procedures at the beginning of an audit

a and c

Factors related to the susceptibility of accounts to misstatements or fraud include: liquidity organizational structure complexity

a and c

Noncompliance or suspected noncompliance: may require discussions with client's legal council should always be recorded to the audit committee must always be responded to by the auditors

a and c

The professional standards require the auditor to gain an understanding of the client's risk assessment process relates to: fraud company objectives financial reporting risks

a and c

Which of the following is not an input control activity record counts financial totals reasonableness test hash totals

c

Risk of material misstatement

combines inherent and control risk risk a material misstatement exists in the financial statements before the auditors apply their procedures

Management's evaluation process of internal control ____________ with the management report on internal control--the first step of the audit process.

concludes

Specific actions a client's management and employees take to help ensure management's directives are carreid out are called:

control activitiies

The foundation for all other components of internal control is the

control environment

Integrity, ethical values, and competence of the entity's people are all:

control environment factors

Verifying the client's cutoff of cash transactions and analyzing bank transfers occurring at year end verify:

cutoff, existence, occurrence, rights, and completeness

If management's report on internal control contains additional information that the audit team did not have an opportunity to evaluate, the audit team should:

disclaim an opinion on the additional information

A scope limitation may result in a(n) _______________ on the effectiveness of the entity's internal control over financial reporting

disclaimer of opinion

regardless of when analytical procedures are performed, testing is concluded by:

documenting team findings

Omissions of amounts or disclosures is considered a(n) ________.

error

The person who authorizes cash disbursements

should not have custody of checks or be in charge of record keeping for payment or bank reconciliation

An account is ________ if there is a reasonable possibility that it could contain a misstatement that has a material effect on the financial statements.

significant

serious internal control deficiencies can be categorized as either

significant deficiencies or material weaknesses

A deficiency in internal controls that is less severe than a material weakness yet important enough to merit attention from those charged with governance is a(n) _____________

significant deficiency

white collar crimes

the misdeeds of people who steal with a pencil or computer terminal

Obtain analyses of cash balances and reconcile them to general ledger

Existence and accuracy

Auditors should perform five steps when completing analytical procedures:

1. Develop an expectation 2. Define a significant difference 3. Compare expectation with the recorded amount horizontal and vertical analysis 4. Investigate significant differences 5. Document each of the preceding steps

The sources of funding of the company's operations and investment activities

Funded by debt or equity? Restrictions placed by lenders (debt covenants)?

If sales were overstated by recording a false credit sale at the end of the year, where could you find the false "dangling debit"? A. Bad debt expense B. COGS C. Accounts receivable

C

____ controls over computer systems have a pervasive effect

IT

What is meant by the terms nature, timing, and extent of further audit procedures?

Nature - effectiveness Timing - of year Extent - number of

the audit strategy is a result of the:

audit risk model

Auditing standards use the term __________ to refer to the misappropriation of assets

defalcation

____________ i another term for misappropriation of assets

defalcation

Internal Control Deficiencies can be either _______ or ________

design; operating

During an audit of cash, the auditor is most concerned with the management assertion of

existence

Counting cash on hand and confirming cash with balances and financial institutions verify which assertions?

existence, occurrence, accuracy, cutoff, and rights

incentive/pressure, opportunity, rationalization

fraud triangle

if audit tema members believe the SOX section 302 annual certification is misstated by management, the report on internal control over financial reporting should:

include a paragraph describing why modifications are needed

Employee fraud can be classified as:

larceny or embezzlement

Improper segregation of duties provides _______ to commit fraud

opportunity

Auditors should use a ______ approach to assess controls

top-down

Calculating common size statements in which amounts are calculated as percentages of a base such as sales or assets is called

vertical analysis

The significance of accounts should be considered _______ regard to internal control

without

Place the seven stages of a properly planned audit report in order

1. Mangement's report on internal control 2. Plan the engagement 3. Use a top-down approach to identify controls to test 4. test and evaluate design effectiveness 5. Test and evaluate operating effectiveness 6. Form an opinion on the effectiveness of internal control over financial reporting 7. Issue auditor's attestation report

Early information gathering activities include:

1. Reviewing the corporate charter and bylaws or partnership agreement 2. Reviewing contracts, agreements, and legal procedures 3. Reading the minutes of the meetings of directors and committees of the board of directors

Overall audit risk can be broken down into:

1. risk that a material misstatement will even occur (inherent risk) 2. That it would not be prevented or detected by client internal control(control risk) 3. that is not detected by the auditor's own procedures (detection risk)

Two categories of substantive procedures:

1. tests of details of transactions and balances which provide specific evidence directly supporting assertions 2. substantive analytical procedures, which study plausible relationships among financial and non financial data

The risk of material misstatement is composed of which audit risk components? A. inherent risk and control risk B. control and detection risk C. inherent, control, and detection risk

A

Which of the following client internal control activities is not usually performed in the treasurer's department? Approving vendors' invoices for payment Canceling payment vouchers when paid Controlling the mailing of checks to vendors Verifying the accuracy of checks and vouchers

A

Which of the following control activities would best protect against the preparation of the improper or inaccurate cash disbursements? All signed checks must be reviewed and compared with supporting documentation by the treasurer before mailing All checks must be sequentially numbered and accounted for by internal auditors

A

Audit Risk Model

A numerical depiction of the relationship between inherent risk, control risk, detection risk, and audit risk. inherent risk (IR) * control risk (CR) * detection risk (DR)

The sources of company's earnings, including the relative profitability of key products and services, and key supplier and customer relationships

Are there any threats to loss of revenue from losing suppliers or customers? Could key products be overtaken by competitors' products? Could advances in technology make the client's products obsolete? Are any customers or suppliers related parties?

Analytical procedures used when planning an audit should concentrate on: A. Management assertions in financial statements B. Accounts and relationships that can represent specific potential problems and risks in the financial statements

B

In copter systems, the IT general controls (ITGC) would not include: control over physical access to computer hardware processing control activities appropriate documentation of the data processing system separation of various computer system functions

B

Which of these arrangements of duties could most likely lead to an embezzlement or theft? The cashier prepared the bank deposit, endorsed the checks with a company stamp, and delivered the cash and checks to the bank for deposit The inventory warehouse manager has responsibility for making the physical inventory observation and reconciling discrepancies to the perpetual inventory records

B

General business sources include: company charter and bylaws specialized trade magazines and journals business newspapers registration statements and 10-k filings

B C D

The following factors have been suggested as being related to the susceptibility of accounts to misstatement or fraud:

Dollar size of the account Liquidity Volume of transactions Complexity of transactions Subjective estimates

Which of the following is a step in an auditor's decision to assess control risk at below the maximum?

Identify specific internal control policies and activities that are likely to detect or prevent material misstatements

The company's organizational structure and management personnel

Is the client centralized or decentralized? Who makes the decisions? Are senior managers familiar with accounting and reporting requirements? Do they value good controls? Are there any related party transactions?

Assign the following ten duties to three employees without creating A. incompatible duties: B. reconcile bank statement C. open mail and list checks D. prepare checks for signature E. prepare payroll checks F. maintain personnel records G. prepare deposit and take to bank H. maintain itty cash I. maintain accounts receivable records J. maintain general ledger K. reconcile accounts receivable records to general ledger account

Person 1 A E J Person 2 BFGI Person 3 CDH Related Responsibilities cash receipts: B F H J (B and F are grouped together) Disbursements: general: C A payroll: D E Petty Cash: G Receivable records: I

significant risks

Risks that require special audit consideration because of the nature of the risk or the likelihood and potential magnitude of misstatement related to the risk

If you are not given a month's loan balance, what assumption would you make? Example: May $300,000 July $350,000

The missing month is the same as the previous month In this example, June would be $300,000

Control Risk

The probability that the client's internal control activities will fail to prevent or detect material misstatements provided that they enter or would have entered the accounting system

direct-effect noncompliance

The violations of laws or government regulations by the entity or its management or employees that produce direct and material effects on dollar amounts in financial statements.

Defalcation (Embezzlement/Misappropriation of Assets)

Theft of an entity's assets when the effect of the theft causes the financial statements not to be presented in conformity with GAAP.

What is another name of the National Commission on Fraudulent Financial Reporting?

Treadway Commission after its first chair, former SEX commissioner James Treadway

An auditor's analytical procedures indicate a lower than expected return on an equity method investment. This situation most likely could have been caused by A. an error in recording amortization of the excess of the investor's cost over the investment's underlying book value B. The investee's decision to reduce cash dividends declared per share of its common stock

a

Which statements are correct: auditors are not required to provide assurance about indirect-effect noncompliance if an auditor becomes aware of an illegal act procedures must be performed to determine if one occurred auditors are not expected to know all relevant laws and regulations affecting their clients

a and c

An audit team's assessment of control risk is high: implies controls cannot be relied on requires the use of substantive analytical procedures to obtain evidence at an interim date generally precludes the use of substantive tests of details implies controls are ineffective

a and d

Which statements are correct individuals outside of normal cash operations should prepare bank reconciliations vouchers are normally assembled by the accounts payable department someone without access to check writing should perform the recording function

a b c

design deficiency

a problem relating to either a necessary control that is missing or an existing control that is so poorly designed that it fails to satisfy the control's objective

Upon receipt of customers' checks in the mail room, a responsible employee should prepare a remittance list that is forwarded to the cashier. A copy of the list should be sent to the

accounts receivable bookkeeper to update the subsidiary accounts receivable records

If the audit team identifies a material weakness in internal controls, a ___________ on the effectiveness of the entity's internal control is issued

adverse opinion

significant account or disclosure

an account or disclosure that has a reasonable possibility of containing a material misstatement individually or when aggregated with others regardless of the effect of controls

Company's significant investments

are they invested in other companies? how much income does this provide?

Evidence as to the design of internal control and its operating effectiveness should be considered ____________ the date specified in the assessment.

as of

After determining significance, the financial statement _______ come into determination

assertions

The _____ committee is especially important as it exercises oversight responsibility over the financial statements

audit

The probability that an audit team will express an inappropriate audit opinion when the financial statements are materially misstated is the definition of

audit risk

When a material misstatement is not prevented by the clients internal controls or substantive procedures ___________ has manifested

audit risk

detection risk is based on the level of _______ and _______

audit risk material misstatement

the audit plan includes a description of the _________ memorandum

audit strategy

Which of the following matters relating to an entity's operations would an auditor most likely consider as an inherent risk factor in planning an audit? a. the entity's fiscal year ends on June 30 b. The entity enters into significant derivative transactions as hedges c. The entity's financial statements are generated at an outside service centered d. The entity's financial data is available only in computer - readable form

b

On every audit engagement, the risk assessment process includes required __________ sessions in which critical audit areas are discussed

brainstorming

A detailed understanding of an audit client's __________, including its products and services, is an essential part of an auditor's inherent risk assessment process

business model

Allison Everhart, an employee in accounts payable, believes she can run a fictitious invoice through the accounts payable system and collect the money. She knows payments are subject to an audit. Which account would be the best place to hide the fraud?

consulting service expense

Efficient planning of the evaluation of internal control requires ____________ the financial statement audit.

coordination with

In testing control activities, an auditor ordinarily selects from a variety of techniques including: comparison and confirmation inspection and verification inquiry and analytical procedures reperformance and observation

d

A violation of pension laws or government contract regulations is an example of:

direct effect noncompliance

The company's checkbook is the cash

disbursements journal

In an audit financial statements of a non-public company in accordance with generally accepted auditing standards, an auditor is required to:

document the auditor's understanding of the entity's internal control

Company's operating characteristics, including its size and complexity

does the company operate internationally? Do subsidiaries operate in diverse industries?

____-level controls are included in the control environment, or monitoring components, of internal control

entity

Mistakes in data processing can easily result in _______.

errors

Bad debt expense is a ________ transaction

estimate

Accounting ________ involve management's judgment or assumptions

estimates

Comparing a suspect's spending for all purposes to known income is called:

expenditure analysis

A walkthrough can be used to provide evidence of whether the client's control activities were operating effectively during the period under audit

false too limited in scope

You prepare an audit estimate of the amount of interest expense you expect to find as the balance of interest expense account related to these notes payable. How do you determine interest estimates? (Imagine it is prime plus 1.5%. Prime for the first six months is 8 and the last six months is 8.5%) Which type of analytical procedure did you use to determine the estimate?

first six months = Balance *(8%+1.5%) Last six months = Balance *(8.5%+1.5%) recalculation or reperformance because analysis is used

In ___________, the financial statements are intentionally misleading

fraud

Auditors must examine journal entries and other adjustments, especially close to year end, as part of their:

fraud risk assessment

Management fraud is sometimes referred to as

fraudulent financial reporting

Financial statements can be misstated due to errors, _______, or noncompliance with laws or regulations

graud

Related parties

include those individuals or organizations that can influence or be influenced by decisions of the company, possibly through family ties or investment relationships

Under the Private Securities Litigation Reform Act, independent auditors are required to first:

inform the board of directors

An account's significant is based on its ________ risk

inherent

The basis for executing an appropriate response to identified risks is__________________ risk assessment

inherent

when performing assessment procedures, the first step auditors often take is to assess ________ for each relevant assertion

inherent risk

When testing controls, the audit team often uses _______ about the existence of the activity and then corroborate the evidence by observing the control activities are actually being performed

inquiry

The four methods of testing controls are:

inquiry, observation, document examination, and reperformance

common procedures used in tests of controls are:

inspection, reperformance, observation, inquiry

Fidelity Bond

insurance policy that pays the employer money in the case of employees' theft

Issues of particular importance during economic distress:

inventory revenue recognition goodwill impairment fair value measurements

The audit team's decision that it would take more time to test the operating effectiveness of the control activities than it would take to perform the substantive tests necessary fr a relevant assertion:

is equivalent to assessing control risk at 100%

A proof of cash

is used when controls over cash are weak is an effective procedure to verify cash transactions is used to discover unrecorded cash transactions reconciles the bank balance, report pf cash deposited and paid general ledger entries

After understanding the entity's internal controls have been documented, the audit team may choose not to perform tests on the operating effectiveness of the controls because:

it is less time consuming to conduct substantive tests the internal control system is too ineffective to rely on the cost of obtaining a low control risk assessment is high

When detection risk is high, the auditor requires _______ effective testing than when detection risk is low

less

When a fiduciary receives payments, lists the receipts, deposits the money and sends remittance advices, a _____ arrangement exists

lockbox

Relevant assertion

management assertion that has a reasonable possibility of containing a material misstatement without regard to the effect of internal controls

The audit team may issue an adverse opinion on the effectiveness of internal control if:

management's report on internal control is incomplete material weaknesses exist

If the audit team issues an adverse opinion on the effectiveness f the entity's internal control over financial reporting, a paragraph that defines a __________ must immediately follow the inherent limitations paragraph

material weakness

The auditor's goal is to focus on testing controls that are _______ important to the auditor's conclusion on internal control

most

In the fraud context, a reason for a person to take a fraudulent action that is believed to be unshakable with others is a

motive

When doing fraud risk assessment, auditors:

must presume improper revenue recognition is a risk

Financial statement close, depreciation, physical inventory, and LIFO calculation are all _______ transactions

nonroutine

operating deficiency

occurs when a properly designed control is either ignored or inappropriately applied

When properly designed control is either ignored or inappropriately applied, a(n)____________ has occurred

operating deficiency

Audit risk is evaluated both for _________ and _________

overall financial statements each significant account and disclosure through a focus on relevant assertions

Duties of the Audit Committee

overseeing the anonymous fraud hotline oversight of the public accounting firm conducting the audit engaging legal council in the event of management fraud appointing the public accounting firm compensating the public accounting firm approving nonaudit services provided by the external auditor

The ____ of entity-level controls distinguishes them from other controls

pervasiveness

What is an effective audit procedure that an auditor might use to detect kiting between intracompany banks?

prepare a schedule of the bank transfers

Investigate payments to related parties

presentation and disclosure

at the preliminary stage, analytical procedures are _________ tests

reasonableness

Routine transactions are for _____ activities.

recurring

An auditors primary objective in regards to ____________ is to determine if transactions with them have been properly accounted for and disclosed in the FS

related parties

A management assertion that has a reasonable possibility of containing a material misstatement without regard to the effect of internal controls is considered a _____________ assertion

relevant

The key difference between document examination and _______ is that the former provides evidence employees completed an activity and the latter provides evidence it was done correctly

reperformance

The most persuasive type of control test evidence is:

reperformance

The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the:

risk that material misstatement exist in the financial statements

Cash receipts, payroll, cash disbursements, and inventory costing are all ______ transactions

routine

To ensure proper_____, the person who authorizes payments shouldn't be in charge of reconciliations

separation of duties

An account or disclosure that has a reasonable possibility of containing a material misstatement individually or when aggregated with other regardless of the effect of controls is considered a _____________ account or disclosure

significant

Gaining an understanding of internal controls should start by identifying ___________ and _____________

significant accounts and disclosures relevant assertions

More serious internal control deficiencies can be categorized into one of two groups:

significant deficiencies material weaknesses

Tests of operating effectiveness are similar to

tests of control

extended procedures

the audit procedures used in response to heightened fraud awareness as the result of the identification of significant risks

Key components of the auditors' report on the internal control for a public company include:

the definition of internal control, identification of the inherent limitations of internal control, the title of management's report on internal control over financial reporting, a statement regarding auditor responsibilities, brief description o procedures, and the date of the report

Audit Committee

the outside, independent board of director members responsible for financial reporting, regulatory compliance, internal control, and hiring and overseeing internal and external auditors

Audit risk

the probability that an audit team will express an inappropriate audit opinion when the financial statements are materially misstated

Inherent risk

the probability that in the absence of internal controls, material errors or frauds could enter the accounting system used to develop financial statements susceptibility of the account to misstatement for different accounts, various assertions are riskier than others

Detection Risk

the probability that the auditor's own procedures will fail to detect material misstatements provided that any have entered the accounting system in the first place and have not been prevented or detected and corrected by the client's internal controls

indirect-effect noncompliance

the violation of laws and regulations that does not directly affect specific financial statement accounts or disclosures

Business risks

those factors, events, and conditions that could prevent the organization from achieving its business objectives Industry developments new products and services the effects of implementing a strategy Financing requirements

Why did the Treadway commission meet?

to determine what business entities could do to improve financial reporting

The ________ approach starts with controls such as financial statements and entity level controls

top-down

Misstatements can be of two types. The first-an error-is deemed to be unintentional. The second type-fraud- is deemed to be an intentional act.

true

Preliminary Analytical Procedures

when auditors develop an expectation about what an account balance should be and compare the expectation with the recorded analysis