SU3 Multiple Choice Quiz
Which of the following nonfinancial information would an auditor most likely consider in performing analytical procedures during the planning phase of an audit? a. Square footage of selling space. b. Objectivity of audit committee members. c. Turnover of personnel in the accounting department. d. Management's plans to repurchase stock.
a. CORRECT. Although analytical procedures used in planning the audit often use only financial data, sometimes relevant nonfinancial information is considered as well. For example, number of employees, square footage of selling space, volume of goods produced, and similar information may contribute to accomplishing the purpose of the procedures. b. incorrect. Objectivity of audit committee members is not a measure related to analytical procedures. c. incorrect. Turnover of personnel in the accounting department is not a measure related to analytical procedures. d. incorrect. Management's plans to repurchase stock is not a measure related to analytical procedures.
Which of the following would not be considered an analytical procedure? a. Projecting a deviation rate by comparing the results of a statistical sample with the actual population characteristics. b. Developing the current year's expected net sales based on the sales trend of similar entities within the same industry. c. Converting dollar amounts of income statement account balances to percentages of net sales for comparison with industry averages. d. Estimating the current year's expected expenses based on the prior year's expenses and the current year's budget.
a. CORRECT. Analytical procedures are evaluations of financial information made by a study of plausible relationships among financial and nonfinancial data. However, statistical sampling applies an audit procedure to a portion of the items under audit for the purpose of drawing a conclusion about a characteristic of a balance or transaction class. It is applicable to tests of controls and substantive testing. It is not an analytical procedure. b. incorrect. Developing expected net sales based on information from the client's industry is an analytical procedure. c. incorrect. Comparing client percentages with industry averages is an analytical procedure. d. incorrect. Estimating expected expenses based on information from prior periods and anticipated results is an analytical procedure.
While performing procedures in planning an audit, the auditor's comparison of expectations with recorded amounts yield unusual and unexpected relationships. The auditor should consider the results of the analytical procedures in which of the following? a. Identifying the risks of material misstatement due to fraud. b. Determining which controls to test. c. Determining planning materiality and acceptable error. d. Identifying significant accounts.
a. CORRECT. Plausible relationships among data are reasonably expected to exist and continue in the absence of known conditions to the contrary. Analytical procedures include investigating fluctuations or relationships that (1) are inconsistent with other information or (2) differ significantly from expectations. Analytical procedures may be applied not only as risk assessment procedures (analytical procedures used to plan the audit) but also as substantive procedures. These are procedures (tests of details and analytical procedures) designed to detect material misstatements at the assertion level. b. incorrect. Analytical procedures are generally not performed to determine which controls to test. c. incorrect. Audit risk and materiality are considered in (1) planning and performing the audit, (2) evaluating the results, and (3) forming an opinion on the financial statements. Materiality judgments are made, given the surrounding circumstances, and depend on the size (quantitative considerations) or nature (qualitative considerations, such as whether a misstatement changes income into a loss or a loss into income) of a misstatement (or both). Thus, analytical procedures are generally performed subsequent to the determination of materiality. d. incorrect. Risk assessment underlies the audit, including the determination of (1) significant accounts and disclosures, (2) relevant assertions, (3) controls to test, and (4) the evidence necessary to assess the effectiveness of a given control.
Which of the following ultimately determines the specific audit procedures necessary to provide an independent auditor with a reasonable basis for the expression of an opinion? a. The auditor's judgment. b. The audit plan. c. The audit documentation. d. Auditing standards.
a. CORRECT. The auditor's professional judgment must determine the necessary audit plans and the specific audit procedures that will gather sufficient appropriate evidence to reduce audit risk to an acceptably low level and enable the auditor to draw reasonable conclusions on which to base the opinion. b. incorrect. Audit plans are usually modified during the engagement to adapt to audit evidence as it is gathered. c. incorrect. Audit documentation demonstrates that the auditor has carried out the procedures (s)he has deemed necessary. The documentation does not determine the procedures undertaken. d. incorrect. Auditing standards, whether established by the AICPA's ASB or the PCAOB, are general objectives that are concerned with the quality of the auditor's performance.
Which of the following factors most likely would cause a CPA to decide not to accept a new audit engagement? a. Management's disregard of its responsibility to maintain an adequate internal control environment. b. The CPA's lack of understanding of the prospective client's internal auditor's computer-assisted audit techniques. c. Management's refusal to permit the CPA to perform substantive procedures before year end. d. The CPA's inability to determine whether related-party transactions were consummated on terms equivalent to arm's-length transactions.
a. CORRECT. The control environment is the foundation for all other control components. It provides discipline and structure, sets the tone of the organization, and influences the control consciousness of employees. A precondition of an audit is management's acknowledgment of its responsibilities for internal control relevant to financial reporting. Internal control should enable the preparation and fair presentation of financial statements that are free from material misstatement due to fraud or error. However, management's disregard of this responsibility may raise doubts about the auditability of the financial statements and the integrity of management. b. incorrect. Audit standards require the auditor to obtain an understanding of the entity and its environment, including its internal control, to assess the risks of material misstatement. c. incorrect. Substantive procedures performed at year end are generally more effective than those done before year end. d. incorrect. The conditions surrounding a related party transaction are difficult to substantiate. However, if the CPA can determine that the transaction is sufficiently disclosed in the financial statements, the auditor can accept the engagement.
An auditor who discovers that client employees have committed illegal activities that have a material effect on the client's financial statements most likely would withdraw from the engagement if a. The client does not take the remedial action that the auditor considers necessary. b. The illegal act is a violation of generally accepted accounting principles. c. The illegal act was committed during a prior year that was not audited. d. The auditor has already assessed control risk at a high level.
a. CORRECT. When the auditor concludes that an illegal act has or is likely to have occurred, (s)he should discuss the matter with the appropriate level of management and request that any necessary remedial actions be taken. If the alleged illegal act has a material effect on the financial statements, or the client does not take the remedial action that the auditor considers necessary, the auditor should express a qualified or adverse opinion, depending on the level of materiality, or withdraw from the engagement. b. incorrect. A violation of GAAP is not sufficient reason to withdraw from an engagement. c. incorrect. Withdrawal as a result of an illegal act is not dependent on when the act occurred or whether the statements at that time were audited or unaudited. d. incorrect. The assessment of control risk is irrelevant in these circumstances.
Based on past experience with a client, an auditor determined performance materiality for current assets should be calculated at 1/4 of total materiality (7% of total current assets) and noncurrent assets should be calculated at 1/3 of total materiality (4% of total noncurrent assets). Calculate performance materiality for current assets based on the following: Cash and cash equivalents $900,000 Land 200,000 Accounts receivable 150,000 Prepaids 150,000 Building 400,000 Fixtures and equipment 500,000 Inventory 100,000 Leasehold improvements 100,000 a. $16,000 b. $21,000 c. $22,750 d. $13,000
a. incorrect. $16,000 = [$200,000 + $400,000 + $500,000 + $100,000] × [4% (total materiality %) × 1/3 (performance materiality)]. b. incorrect. $21,000 = [$200,000 + $400,000 + $500,000 + $100,000] × [7% (total materiality %) × 1/4 (performance materiality)]. c. CORRECT. Materiality is a matter of professional judgment. Misstatements, including omissions, are material if a substantial likelihood exists that, individually or in the aggregate, they would influence the judgment made by a reasonable user based on the financial statements. Performance materiality is the amount(s) set by the auditor at less than the materiality for (1) the statements as a whole or (2) particular classes of transactions, balances, or disclosures. Performance materiality is an adjustment to reduce to an appropriately low level the probability that the sum of (1) uncorrected and (2) undetected misstatements (whether or not individually material) exceeds the applicable materiality. $22,750 = [$900,000 + $150,000 + $150,000 + $100,000] × [7% (total materiality %) × 1/4 (performance materiality)]. d. incorrect. $13,000 = [$900,000 + $150,000 + $150,000 + $100,000] × [4% (total materiality %) × 1/4 (performance materiality)].
Which of the following situations most likely represents the highest risk of a misstatement arising from misappropriations of assets? a. A large number of transactions processed in a short period of time. b. A large number of fixed assets with easily identifiable serial numbers. c. A large number of bearer bonds on hand. d. A large number of inventory items with low sales prices.
a. incorrect. A large number of transactions processed in a short period of time is normal in some industries, particularly the banking industry. b. incorrect. Easily identifiable serial numbers reduce the risk of misappropriations of assets. c. CORRECT. Large purchases of bank checks or bonds payable to bearer are often an indication of illegal or suspicious activity. Bearer instruments are negotiable by delivery alone, that is, without a signature. They are equivalent to cash. Thus, the holder has anonymity. They can be used to evade taxes or conceal business transactions. d. incorrect. A large number of inventory items with low sales prices is typical in industries with high inventory turnovers.
If not already done to form an overall conclusion, the auditor should perform analytical procedures relating to which of the following transaction cycles? a. Purchasing. b. Revenue. c. Payroll. d. Inventory.
a. incorrect. Although analytical procedures may be useful for the purchasing cycle, it is not as important as for revenue. b. CORRECT. Revenue is an account for which expectations can be developed by the auditor. It is a key account that should be predictable. c. incorrect. Although analytical procedures may be useful for the payroll cycle, it is not as important as for revenue. d. incorrect. Although analytical procedures may be useful for inventory, it is not as important as for revenue.
A CFO assigned inflated salvage values and extended the useful lives of the company's equipment in order to decrease depreciation expense. Which of the following has occurred as a result of this action? a. Error. b. Collusion. c. Fraud. d. Embezzlement.
a. incorrect. An error occurs when an unintentional deviation occurs in reported numbers. b. incorrect. Collusion occurs when two or more parties work together to deceive. Only the CFO manipulated the numbers in this scenario. c. CORRECT. Financial manipulation to artificially reduce depreciation expense and increase profits is management fraud. d. incorrect. Embezzlement is a fraud related to misappropriation of assets.
During the consideration of fraud in a financial statement audit, the auditor should identify and assess risks that may result in material misstatements due to fraud. This assessment a. Must state an overall judgment about whether an identified risk is high, medium, or low. b. Follows the auditor's determination that the related controls are operating effectively. c. Requires an observation that the three fraud conditions are present. d. Is based on evaluating whether the entity's related controls have been suitably designed and implemented.
a. incorrect. An overall judgment is too broad to be useful. b. incorrect. The assessment is made after evaluating whether related controls have been suitably designed and implemented. c. incorrect. An auditor must not assume that failing to observe all three conditions signifies that no fraud risk is present. d. CORRECT. Identified and assessed fraud risks are treated as significant risks. Thus, the auditor obtains an understanding of the related controls relevant to the risks. This process includes evaluating whether the controls have been suitably designed and implemented to mitigate the fraud risks.
A basic premise underlying analytical procedures is that a. Statistical tests of financial information may lead to the discovery of material misstatements in the financial statements. b. Plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary. c. These procedures cannot replace tests of balances and transactions. d. The study of financial ratios is an acceptable alternative to the investigation of unusual fluctuations.
a. incorrect. Analytical procedures, such as simple comparisons, do not necessarily require statistical testing. b. CORRECT. A basic premise underlying the application of analytical procedures is that plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary. Variability in these relationships can be explained by, for example, unusual events or transactions, business or accounting changes, misstatements, or random fluctuations. c. incorrect. For some assertions, analytical procedures alone may provide the auditor with the level of assurance (s)he desires. d. incorrect. The objective of analytical procedures, such as ratio analysis, is to identify significant differences for evaluation and possible investigation.
In an audit of financial statements for which an auditor's assessment of risk is judgmental and may not be sufficiently precise to identify all risks of material misstatement, the auditor should take which of the following actions? a. Consider whether risk assessment procedures are appropriate given preliminary levels of materiality and tolerable misstatement. b. Determine the effectiveness of general controls over classes of transactions characterized by high transaction volume. c. Discuss strategies to eliminate such risks with top management or those with equivalent authority and responsibility. d. Perform substantive procedures for all relevant assertions related to each material class of transactions.
a. incorrect. Considering whether risk assessment procedures are appropriate will not address all risks of material misstatement. b. incorrect. The effectiveness of general controls over high volume transactions may not identify all risks of material misstatement. c. incorrect. Discussing strategies to eliminate risks will not address all risks of material misstatement. d. CORRECT. Substantive audit procedures are designed to detect material misstatements at the assertion level.
An auditor is required to obtain an understanding of the entity's business, including business cycles and reasons for business fluctuations. What is the audit purpose most directly served by obtaining this understanding? a. To enable the auditor to accurately identify significant deficiencies and material weaknesses. b. To allow the auditor to more accurately perform tests of controls. c. To decide whether it will be necessary to perform analytical procedures. d. To assist the auditor to accurately interpret information obtained during an audit.
a. incorrect. Deficiencies in internal control often are identified by the auditor when testing controls. Tests of controls determine whether they are operating effectively. The understanding of controls involves evaluating their design and determining whether they have been implemented, not whether they are operating effectively. b. incorrect. Tests of controls are further audit procedures, not risk assessment procedures. They are performed to assess operating effectiveness, an objective not achieved when obtaining the understanding. c. incorrect. Analytical procedures should be performed in every audit. d. CORRECT. The auditor performs risk assessment procedures to obtain an understanding of the entity and its environment, including its internal control, to assess the risks of material misstatement. The understanding addresses, for example, (1) the nature of the entity; (2) transactions, balances, and disclosures; (3) objectives, strategies, and business risks; (4) accounting practices; and (5) financial performance. This understanding is necessary for the auditor to interpret the audit evidence obtained and to determine its sufficiency and appropriateness.
Which of the following factors does a CPA ordinarily consider in the planning stage of an audit engagement? 1. Financial statement accounts likely to contain a misstatement. 2. Conditions that require extension of audit tests. a. 1 only b. 2 only c. Both d. Neither
a. incorrect. Financial statement accounts likely to contain a misstatement or conditions that require extensions of audit tests are factors a CPA ordinarily considers in the planning stage of an audit engagement. b. incorrect. Financial statement accounts likely to contain a misstatement or conditions that require extensions of audit tests are factors a CPA ordinarily considers in the planning stage of an audit engagement. c. CORRECT. When planning an audit, the auditor should consider, among other things, the financial statement accounts likely to require adjustment and the conditions that require extension or modification of audit procedures (e.g., risk of material misstatement). d. incorrect. Financial statement accounts likely to contain a misstatement or conditions that require extensions of audit tests are factors a CPA ordinarily considers in the planning stage of an audit engagement.
During the annual audit of BCD Corp., an issuer, Smith, CPA, a continuing auditor, determined that illegal political contributions had been made during each of the past 7 years, including the year under audit. Smith notified the directors of BCD Corp. of the illegal contributions, but they refused to take any action because the amounts involved were immaterial to the financial statements. Because management took no action, Smith should a. Express a qualified opinion or an adverse opinion. b. Consider withdrawing from the engagement. c. Report the illegal contributions to the Securities and Exchange Commission. d. Disregard the political contributions because the board of directors was notified and the amounts involved were immaterial.
a. incorrect. If the effects of the illegal act are not material, a modification of the opinion may not be necessary. b. CORRECT. Under AU-C 250, if the client does not take the remedial action considered necessary by the auditor, the auditor should consider withdrawal from the engagement even when the illegal act is not material. (S)he should weigh the effects on his or her ability to rely on management's representations and the possible results of continued association with the client. The auditor may also wish to seek legal advice. c. incorrect. Notifying others is ordinarily management's responsibility. However, when the auditor withdraws because of the client's failure to take remedial action, the entity may be required to report the auditor change on SEC Form 8-K. The failure may be a reportable disagreement concerning which the auditor will have a duty to notify parties outside the client. d. incorrect. The auditor must consider withdrawal given that the directors took no action.
Which of the following statements about materiality is most likely to be true? a. The materiality level set by the auditor should be approved by the client. b. Materiality at the assertion level is larger than for the financial statements as a whole. c. Performance materiality is less than materiality for the financial statements as a whole. d. Materiality is measured according to specific AICPA standards.
a. incorrect. Materiality is determined by auditor judgment and need not be approved by the client. b. incorrect. Materiality at the financial statement level is not smaller than at the assertion level. c. CORRECT. Performance materiality is one or more amounts set by the auditor at less than the materiality for the statements as a whole. Performance materiality also refers to amounts set at less than materiality for particular classes of transactions, balances, or disclosures. Performance materiality is set to reduce to an appropriately low level the probability that the sum of uncorrected and undetected misstatements exceeds the applicable materiality. Accordingly, performance materiality is an adjustment for (1) individually immaterial misstatements and (2) possible undetected misstatements. d. incorrect. The measurement of materiality is a matter of professional judgment.
The risk of material misstatement (RMM) includes the combined assessment of which kinds of risks? a. Performance risk and detection risk. b. Audit risk and control risk. c. Inherent risk and control risk. d. Detection risk and inherent risk.
a. incorrect. Performance risk is not a type of identified audit risk and thus is not included in the RMM. b. incorrect. Audit risk is the risk that an auditor expresses an inappropriate opinion on materially misstated financial statements. It is not included in the RMM. c. CORRECT. A RMM means a reasonable possibility exists that a material misstatement will occur, and it includes the combined assessment of inherent risk and control risk. Inherent risk is the susceptibility of an assertion about a class of transaction, account balance, or disclosure to a misstatement that could be material, individually or combined with other misstatements, before consideration of related controls. Control risk is the risk that internal control will not timely prevent, or detect and correct, a material misstatement that could occur in an assertion. d. incorrect. Detection risk is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a material misstatement. It is a function of the effectiveness of an audit procedure and its application by the auditor. Detection risk is not included in the RMM.
Audit plans should be designed so that a. The risks of material misstatement are assessed at a sufficiently low level. b. Most of the required procedures can be performed as interim work. c. The auditor can make constructive suggestions to management. d. The audit evidence gathered supports the auditor's conclusions.
a. incorrect. The RMMs are assessed based upon the characteristics of the client. Thus, performing more effective procedures may lead to higher assessed RMMs. b. incorrect. Depending on the assertion, work may be performed at interim dates or in the subsequent events period. c. incorrect. Suggestions to management are not required in an audit. d. CORRECT. The auditor is responsible for collecting sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the opinion. Audit plans describe the steps involved in that process. Thus, the evidence should support the auditor's conclusions.
Which of the following procedures would an auditor most likely perform before auditing the balance sheet? a. Confirm with client's lawyer that all litigation probable of assertion has been disclosed to the auditor. b. Consider the client's plans and ability to meet imminent purchase commitments and cash flow obligations. c. Obtain an understanding of the client's internal control activities. d. Determine whether there are any liens or encumbrances on assets that have been pledged as collateral.
a. incorrect. The audit of the balance sheet includes procedures addressing contingencies and contingent liabilities related to litigation, claims, and assessments. b. incorrect. The audit of the balance sheet includes procedures addressing (1) possible losses (liabilities) on firm, noncancelable purchase commitments and (2) cash balances. c. CORRECT. Planning an audit initially requires developing an overall strategy and an audit plan. Planning includes obtaining an understanding of the entity and its environment, including its internal control, to identify and assess the risks of material misstatement (RMMs) of the financial statements, whether due to fraud or error. The understanding provides a basis for designing and implementing responses to the assessed RMMs. Risk assessment procedures are performed to obtain the understanding. They include (1) inquiries of management, appropriate individuals in the internal audit function, and others within the entity; (2) analytical procedures; and (3) observation and inspection. The plan also includes further procedures at the relevant assertion levels for material transaction classes, account balances, and disclosures. Thus, initial planning activities occur before procedures are applied to amounts reported in the balance sheet. d. incorrect. The audit of the balance sheet includes procedures addressing security arrangements involving reported assets.
