Auditing Chapter 1 Questions

LO 5 Define audit quality and identify drivers of audit quality as specified by the Financial Reporting Council's Audit Quality Framework.

A definition published by the GAO (2003) states that a quality audit is one performed"in accordance with generally accepted auditing standards (GAAS) to provide reasonable assurance that the audited financial statements and related disclosures are (1) presented in accordance with GAAP and (2) are not materially misstated whether due to errors or fraud." The FRC's Audit Quality Framework states that there are five primary drivers of audit quality, including (1) audit firm culture, (2) the skills and personal qualities of audit partners and staff, (3) the effectiveness of the audit process, (4) the reliability and usefulness of audit reporting, and (5) factors outside the control of auditors that affect audit quality.

LO 7 Describe the process by which audit firms make client acceptance and continuance decisions.

Clients are newly accepted into the audit firm's portfolio based on the client acceptance decision. These clients are evaluated based upon their relative risk and audit fee profile. The audit firm makes a proposal (and in some cases a formal bid) to the client if the audit firm decides the client is acceptable; if the client accepts, the audit firm adds the client to its portfolio. Existing clients for which the audit firm provided services in the preceding period are evaluated by the audit firm and the individual engagement partner at the completion of the audit to determine whether the audit firm should continue to provide services in the next period. The process by which this decision is made is called the client continuance decision. In short, the engagement partner and the audit firm must decide, based on what they know about the client, whether it is worthwhile to retain the client in the firm's portfolio. Like the client acceptance decision, the client continuance decision is made based on a consideration of the client's relative risk and audit fee profile.

LO 4 Identify organizations that affect the external auditing profession and the nature of their effects.

Congress: Sarbanes-Oxley Act of 2002 PCAOB: private sector, nonprofit organization that oversees auditors of public companies. SEC: was established by Congress in 1934 to regulate the capital market system. The SEC has oversight responsibilities for the PCAOB and for all public companies that are traded on U.S. stock exchanges. AICPA (American Institute of Certified Public Accountants): the AICPA continues to develop standards for audits of nonpublic companies. The ACIPA is responsible for a peer review program in which registered firms are subject to periodic peer review of their nonpublic audits. The AICPA also provides continuing education programs, and through its Board of Examiners, prepares and administers the Uniform CPA Examination. CAQ (Center for Audit Quality): dedicated to enhancing investor confidence and trust in the financial markets. IAASB (International Auditing and Assurance Standards Board): sets International Standards on Auditing (ISAs) and facilitates the convergence of national and international auditing standards. COSO (Committee of Sponsoring Organizations of the Treadway Commission): COSO provides the internal control framework that serves as the benchmark for auditors who assess the effectiveness of their client's internal controls. GAAP & IASB: During the past several years, the U.S. and international standard setters have worked toward global harmonization of U.S. and international accounting standards. State Boards of Accountancy: CPAs are licensed by state boards of accountancy, which are charged with regulating the profession at the state level. The Court System: The court system acts as a quality-control mechanism for the auditing profession.

LO 3 The Big 4 audit firms are the only types of firms that conduct financial statement audits.

False.

LO 3 With regard to working in a team environment, larger audit firms typically have teams with more continuity and overlap across engagements, whereas smaller audit firms typically have multiple teams that typically disband after each engagement.

False.

LO 2 The sole responsibility of management with regard to financial reporting involves preparing and presenting financial statements in accordance with the applicable financial reporting framework.

False. Management has responsibilities for (a) preparing and presenting financial statements in accordance with the applicable financial reporting framework; (b) designing, implementing, and maintaining internal control over financial reporting; and (c) providing the auditors with information relevant to the financial statements and internal controls.

LO 5 One of the key drivers of audit quality is the gross margin achieved by the audit firm and the ability of the engagement partner to maintain those margins over the duration of the audit engagement.

False. The FRC's Audit Quality Framework states that there are five primary drivers of audit quality, including (1) audit firm culture, (2) the skills and personal qualities of audit partners and staff, (3) the effectiveness of the audit process, (4) the reliability and usefulness of audit reporting, and (5) factors outside the control of auditors that affect audit quality.

LO 2 The internal audit function is designed primarily to assist the external auditor in providing assurance to third-party users of the financial statements.

False. The internal audit function provides management and the audit committee with assurance on internal controls and reports.

LO 2 Identify parties involved in preparing and auditing financial statements and briefly describe their roles.

Management has responsibilities for (a) preparing and presenting financial statements in accordance with the applicable financial reporting framework; (b) designing, implementing, and maintaining internal control over financial reporting; and (c) providing the auditors with information relevant to the financial statements and internal controls. The internal audit function provides management and the audit committee with assurance on internal controls and reports. The audit committee, a subcommittee of the organization's board of directors, oversees both management and the internal auditors; they also hire the external auditor. The external auditor's job is to obtain reasonable assurance about whether management's statements are materially accurate and to provide a publicly available report.

LO 3 List the types of audit service providers and the skills and knowledge needed by professionals entering the external auditing profession.

The external auditing profession includes sole-practitioner firms, local and regional firms, and large multinational professional services firms such as the Big 4. The requirements of those entering the auditing profession are demanding. Audits are performed in teams where each auditor is expected to complete tasks requiring considerable technical knowledge and expertise. Auditors also need well-developed skills in leadership, teamwork, communication, decision making, and general professionalism. In terms of technical knowledge and expertise, auditors must understand accounting and auditing authoritative literature, develop industry and client-specific knowledge, develop and apply computer skills, evaluate internal controls, and assess and respond to fraud risk. Furthermore, a strong ethical foundation is critical for each auditor.

LO 1 Define the objective of external auditing and describe its role in meeting society's demands for reliable financial and internal control information.

The objective of external auditing is to provide opinions on the reliability of the financial statements and, as part of an integrated audit, provide opinions on internal control effectiveness. The public needs to have confidence in the objectivity and accuracy of the opinions provided by external auditors.

LO 6 Identify professional requirements that help achieve audit quality and minimize auditor exposure to lawsuits.

These requirements include (1) maintaining auditor independence, (2) participating in review programs, (3) issuing engagement letters, (4) evaluating the audit firm's limitations, and (5) maintaining quality audit documentation.

LO 5 Audit quality is achieved when the audit is performed in accordance with GAAS and when it provides reasonable assurance that the financial statements have been presented in accordance with GAAP and are not materially misstated due to errors or fraud.

True. A definition of audit quality published by the GAO (2003) states that a quality audit is one performed"in accordance with generally accepted auditing standards (GAAS) to provide reasonable assurance that the audited financial statements and related disclosures are (1) presented in accordance with GAAP and (2) are not materially misstated whether due to errors or fraud."

LO 4 Congress passed the Sarbanes-Oxley Act of 2002 in response to a variety of major economic shocks during the early 2000s.

True. During the early 2000s, various shocks affected the future of the auditing profession. In response to these shocks, Congress passed the Sarbanes-Oxley Act of 2002.

LO 7 Existing clients for which the audit firm provided services in the preceding period are evaluated by the audit firm and by the individual engagement partner at the completion of the audit to determine whether the audit firm should continue to provide services again in the next period; the process by which this evaluation occurs is called the client continuance decision.

True. Existing clients for which the audit firm provided services in the preceding period are evaluated by the audit firm and the individual engagement partner at the completion of the audit to determine whether the audit firm should continue to provide services in the next period. The process by which this decision is made is called the client continuance decision. In short, the engagement partner and the audit firm must decide, based on what they know about the client, whether it is worthwhile to retain the client in the firm's portfolio.

LO 1 Independence is referred to as the cornerstone of the auditing profession.

True. Independence requires objectivity and freedom from bias and is often referred to as the cornerstone of the auditing profession.

LO 7 Audit firms may discontinue serving a client because the client does not fit the profile or growth strategy of the audit firm.

True. Like the client acceptance decision, the client continuance decision is made based on a consideration of the client's relative risk and audit fee profile. Discontinued clients are those the audit firm eliminates from its portfolio based on the client continuance decision. In addition to these risk factors, an important consideration in client continuance decisions involves the audit firm's growth strategy. Audit firms may discontinue serving a client because the client does not fit the profile the firm is hoping to achieve.

LO 4 The AICPA sets auditing standards for auditors of nonpublic companies in the United States.

True. That role changed with the establishment of the PCAOB as the body for setting auditing standards for the audits of public companies. However, the AICPA continues to develop standards for audits of nonpublic companies.

LO 6 The three primary types of review programs include: (1) external inspections/peer reviews, (2) engagement quality reviews, and (3) interoffice reviews.

True. Three types of review programs exist: ●External inspections/peer reviews ●Engagement quality reviews ●Interoffice reviews

LO 1 When the auditor has no reservations about management's financial statements or internal controls, the audit opinion is said to be unqualified.

True. When the auditor has no reservations about management's financial statements or internal controls, the report is referred to as an unqualified audit report.

LO 6 The engagement letter states the scope of the work to be done on the audit so that there should be no doubt in the mind of the client, external auditor, or the court system as to the expectations agreed to by the external auditor and the client.

True. The engagement letter states the scope of the work to be done on the audit so that there should be no doubt in the mind of the client, external auditor, or the court system as to the expectations agreed to by the external auditor and the client.

LO 4 Which of the following organizations is the primary organization that performs inspections of registered external audit firms that audit public companies? a. PCAOB b. CAQ c. AICPA d. FASB

a. PCAOB The PCAOB has four primary responsibilities related to auditors of public companies: (1) registering audit firms that audit public companies; (2) periodically inspecting registered audit firms; (3) establishing auditing and related standards for registered audit firms; and (4) investigating and disciplining registered audit firms for violations of relevant laws or professional standards.

LO 5 Audit quality involves which of the following? a. Performing an audit in accordance with GAAS to provide reasonable assurance that the audited financial statements and related disclosures are presented in accordance with GAAP and providing assurance that those financial statements are not materially misstated whether due to errors or fraud. b. Performing an audit in accordance with GAAP to provide reasonable assurance that the audited financial statements and related disclosures are presented in accordance with GAAS and providing assurance that those financial statements are not materially misstated whether due to errors or fraud. c. Performing an audit in accordance with GAAS to provide absolute assurance that the audited financial statements and related disclosures are presented in accordance with GAAP and providing assurance that those financial statements are not materially misstated whether due to errors or fraud. d. Performing an audit in accordance with GAAS to provide reasonable assurance that the audited financial statements and related disclosures are presented in accordance with GAAP and providing assurance that those financial statements contain no misstatements due to errors or fraud.

a. Performing an audit in accordance with GAAS to provide reasonable assurance that the audited financial statements and related disclosures are presented in accordance with GAAP and providing assurance that those financial statements are not materially misstated whether due to errors or fraud. A definition published by the GAO (2003) states that a quality audit is one performed"in accordance with generally accepted auditing standards (GAAS) to provide reasonable assurance that the audited financial statements and related disclosures are (1) presented in accordance with GAAP and (2) are not materially misstated whether due to errors or fraud."

LO 1 Which of the following factors does not create a demand for external audit services? a. Potential bias by management in providing information. b. Requirements of the Center for Audit Quality (CAQ). c. Complexity of the accounting processing systems. d. Remoteness between a user and the organization.

b. Requirements of the Center for Audit Quality (CAQ). The need for independent assurance arises from several factors: ●Potential bias—Management has incentives to bias financial information in order to convey a better impression of the financial data than real circumstances might merit. ●Remoteness—An organization and the users of its financial information are often remote from each other, both in terms of geographic distance and the extent of information available to the both parties. cannot interview management, tour a company's plant, or review its financial records firsthand; instead, they must rely on financial statements to communicate the results of management's performance. These factors can tempt management to keep information from users or bend GAAP so the organization looks better. ●Complexity—Transactions, information, and processing systems are often very complex, so it can be difficult to determine their proper presentation. This factor provides an opportunity for management to deceive users. ●Consequences—When financial information is not reliable, investors and other users lose a significant source of information that they need to make decisions that have important consequences.

LO 5 Which of the following factors is not a driver of audit quality as discussed by the FRC? a. Audit firm culture. b. Skills and personal qualities of client management. c. Reliability and usefulness of audit reporting. d. Factors outside the control of auditors.

b. Skills and personal qualities of client management. The FRC's Audit Quality Framework states that there are five primary drivers of audit quality, including (1) audit firm culture, (2) the skills and personal qualities of audit partners and staff, (3) the effectiveness of the audit process, (4) the reliability and usefulness of audit reporting, and (5) factors outside the control of auditors that affect audit quality.

LO 1 Which of the following expectations can users of the audit report reasonably expect with regard to the audited financial statements? a. The financial statements include all financial disclosures desired by users. b. The financial statements are presented fairly in accordance with GAAP. c. The financial statements are free from all errors. d. All of the above are reasonable expectations. e. None of the above are reasonable expectations.

b. The financial statements are presented fairly in accordance with GAAP.

LO 7 With regard to client acceptance/continuance decisions, which of the following is false? a. Client acceptance/continuance decisions are one part of the audit firm's overall portfolio management activities. b. The primary driver of the client acceptance/continuance decision is the level of audit fees that can be charged to the client. c. One can view an individual audit client as analogous to an individual stock in an investment portfolio. d. Existing clients for which the audit firm provided services in the preceding period are evaluated by the audit firm and individual engagement partner at the completion of the audit to determine whether the audit firm should continue to provide services in the next period.

b. The primary driver of the client acceptance/continuance decision is the level of audit fees that can be charged to the client. These clients are evaluated based upon their relative risk and audit fee profile.

LO 4 The AICPA remains a valuable organization to the external auditing profession because of its continuing involvement in which of the following activities? a. The audit standard setting process for audits of publicly traded companies. b. Regulation and enforcement of the internal auditing profession. c. Education and administration of the CPA exam. d. Promulgation of financial accounting standards.

c. Education and administration of the CPA exam. The AICPA also provides continuing education programs, and through its Board of Examiners, prepares and administers the Uniform CPA Examination.

LO 6 The PCAOB performs external inspections of external audit firms registered to audit publicly traded companies. Which of the following statements is accurate regarding the timing of those inspections? a. Inspections occur once a year for audit firms that conduct over 50 public clients in a given year. b. Inspections occur once every three years for audit firms that conduct over 100 public clients in a given year. c. Inspections occur once a year for audit firms that conduct over 100 public clients in a given year. d. Inspections occur once every five years for audit firms that conduct over 50 public clients in a given year.

c. Inspections occur once a year for audit firms that conduct over 100 public clients in a given year. The PCAOB performs inspections of registered audit firms every year for audit firms that have over 100 public company audits and every three years for the other registered audit firms.

LO 7 Which of the following factors is an example of a risk relevant to the client continuance decision? a. Client entity characteristics. b. Independence risk factors. c. Third party/due diligence risk factors. d. All of the above.

d. All of the above. - Client entity characteristics - Independence risk factors - Third party/due diligence risk factors - Quantitative risk factors - Qualitative risk factors - Entity organizational or governance risks - Financial reporting risks

LO 3 In terms of technical knowledge and expertise, which of the following should external auditors be able to do? a. Understand accounting and auditing authoritative literature. b. Develop industry and client-specific knowledge. c. Develop and apply computer skills. d. All of the above. e. None of the above.

d. All of the above. In terms of technical knowledge and expertise, auditors must understand accounting and auditing authoritative literature, develop industry and client-specific knowledge, develop and apply computer skills, evaluate internal controls, and assess and respond to fraud risk.

LO 3 In which of the following categories do Big 4 audit firms operate? a. Sole-practitioner firms. b. Local firms. c. Regional firms. d. Multinational firms.

d. Multinational firms.

LO 6 Which of the following is not a threat to auditor independence? a. Self-review threat. b. Advocacy threat. c. Adverse interest threat. d. Regulatory interest threat.

d. Regulatory interest threat. Threats to auditor independence include: - Self-review threat - Advocacy threat - Adverse interest threat - Familiarity threat - Undue influence threat - Financial self-interest threat - Management participation threat

LO 2 Which of the following parties are involved in preparing and auditing financial statements? a. Management. b. Audit committee. c. Internal audit function. d. External auditor. e. All of the above.

e. All of the above. Various parties are involved in preparing and auditing financial statements and related disclosures.