ACCT 4123 Chapter 3

In considering overall materiality for planning purposes, an auditor believes that misstatements aggregating $10,000 would have a material effect on an entity's income statement but that misstatements would have to aggregate $20,000 to materially affect the balance sheet. Ordinarily, it would be appropriate to design audit procedures that would be expected to detect misstatements aggregating:

$10,000.

North, CPA, is planning an independent audit of the financial statements of General Company. In determining the nature, timing, and extent of the audit procedures, North is considering General's internal audit function, which is staffed by Tyler. In what ways can the internal auditor's work be relevant to North, the independent auditor?

- Tyler can assist with performing certain substantive testing. - Tyler's internal auditing work may be relevant to North for obtaining a sufficient understanding of General's internal controls.

Reperformance ______.

- can be completed for any client control procedure - is commonly used when completing internal control system walkthroughs - may be done manually or with the assistance of CAATs - similar to recalculation but broader in approach

Recalculation ______.

- can use computer-assisted audit techniques - provides evidence of valuation when used with other procedures - produces compelling evidence

Reported net income under GAAP is not one "true" figure but a possible range of measure influenced by the choice of ______.

- classification of marketable securities - fixed asset lives - depreciation methods

Engagement letters ______.

- define management and auditor responsibilities - set forth audit objectives - reduce the risk of misunderstandings

A planning memorandum ______.

- documents the audit team is following generally accepted accounting standards - includes specific directions related to the audit - summarizes all important planning information - includes the engagement letter

Time budgets ______.

- identify problem areas early in the engagement - may be based on a predecessor auditor's experience - are often based on prior years audits

Inquiry ______.

- is never enough on its own to reach an audit conclusion - generally involves the collection of verbal evidence

The audit engagement partner ______.

- is usually an industry specialist - has final responsibility for the audit

Audit documentation ______.

- may be in either electronic or hard copy form - should contain support for the audit decision - provides the auditors' record of compliance with standards

External auditors ______.

- must review, evaluate and perform independent testing of the internal audit work - may rely on some work completed by the internal audit department - cannot delegate tasks that require professional judgment

Favorable conclusions about the competence and objectivity of internal auditors allow external auditors to rely on the work of internal auditors related to ______.

- substantive testing of balances on the audit - testing the internal control system

The objectivity of internal auditors is questionable when ______.

- they are scheduled for promotion to areas under internal audit review - they report to a line manager - divisional managers set their pay

Confirmation can provide evidence regarding ______.

- valuation - rights and obligations - cutoff - existence

Assume that Smith & Smith, CPAs, audited Apollo Shoes Inc., last year. Now CEO Larry Lancaster wishes to engage Anderson, Olds, and Watershed, CPAs (AOW) to audit its annual financial statements. Lancaster is generally pleased with the services provided by Smith & Smith, but he thinks the audit work was too detailed and interfered excessively with normal office routines. AOW has asked Lancaster to inform Smith & Smith of the decision to change auditors, but he does not wish to do so. Put in order the steps AOW should follow with regard to dealing with a predecessor auditor and a new client before accepting the engagement.

1. Explain to Lancaster the need to inquire of Smith & Smith and request permission to make such inquiries. 2. Ask Lancaster to authorize Smith & Smith to respond fully to all inquiries because Smith & Smith would be prohibited from disclosing confidential information without former client permission. 3. Advise Smith & Smith of Lancaster's decision to change auditors. Advising Smith & Smith would be a good business judgment as well as an act of professional courtesy. 4. Make reasonable inquiries of Smith & Smith regarding matters that will aid in deciding whether to accept the engagement. (AOW should ask about facts that might bear on the integrity of management, disagreements with management about accounting and auditing matters, and Smith & Smith' understanding of the reason[s] for the change of auditors.) 5. If Smith & Smith does not response fully to AOW's questions, consider the implications of the limited response in deciding whether to accept the engagement. 6. Inform Lancaster that a first-time audit is more time consuming than a recurring audit because the new audit team is generally unfamiliar with the client's operations and does not have the benefit of past knowledge of company affairs to use as a guide. 7. Discuss with Lancaster the estimated required audit time and fee arrangement with a clear explanation of the purpose and scope of the audit. Any work that can be done by client personnel should also be discussed so that excess audit time might be eliminated and proposed report deadlines can be reasonably met. 8. Use procedures such as reviewing Apollo's financial statements; inquiring of third parties such as Apollo's banks, legal counsel, investment bankers, and others in the business community as to Apollo's reputation; and evaluating AOW's ability to serve Lancaster and Apollo properly with reference to industry expertise, size of engagement, and available staff. This is done in effort to satisfy AOW's quality control objectives. 9. Accept the engagement and confirm the understandings in an engagement letter.

Which of the following is not a category of audit documentation? A. Temporary files. B. Permanent files. C. Audit administrative files. D. Current documentation files.

A. Temporary files.

Which of the following explanations best describes why an auditor may decide to reduce tests of details for a particular audit objective?

Analytical procedures have revealed no unusual or unexpected results.

Which of the following matters does an auditor usually include in the engagement letter?

Arrangements regarding fees and billing.

Which of the following most likely would give the most assurance concerning the valuation assertion of accounts receivable?

Assessing the allowance for uncollectible accounts for reasonableness.

Which of the following is not one of the four major cycles?

Cash receipts and disbursements.

Which of the following is not considered an accounting estimate?

Credit sales.

Audit planning memorandum

Current year file

Bank confirmations

Current year file

Engagement letter

Current year file

Schedule for current year depreciation calculation

Current year file

The auditor looked at a bank statement received and held by the client. What kind of audit procedure would this be considered?

Examination of documents.

The confirmation of an accounts receivable balance provides primary evidence regarding which management assertion?

Existence.

True or false: One objective of a financial statement audit is to determine if, in all material respects, the entity being audited is reporting the one true net income.

False

True or false: Auditors should resist using analytical procedures during the substantive testing of balances.

False [Reason: A well planned analytical procedure can be very effective.]

C. Hill, CPA, has been retained to audit the financial statements of Monday Co. Monday's predecessor auditor was K. Post, CPA, whom Monday has notified by that its services have been terminated. Under these circumstances, which party should initiate the communications between Hill and Post?

Hill, the auditor.

Which of the following audit procedures probably would provide the most reliable evidence concerning the entity's assertion of rights and obligations related to inventories?

Inspect agreements for evidence of inventory held on consignment.

With respect to the concept of materiality, which of the following statements is correct?

Materiality is a matter of professional judgment.

Audit Procedure: Inquiry

PCAOB Assertion: All assertions ASB Assertion: All assertions

Audit Procedure: Inspection of records or documents (tracing)

PCAOB Assertion: Completeness ASB Assertion: Completeness

Audit Procedure: Inspection of records or documents (scanning)

PCAOB Assertion: Completeness ASB Assertion: Existence, Occurrence, Completeness, Valuation and allocation, Rights and obligations, Accuracy, Classification

Audit Procedure: Inspection of records or documents (vouching)

PCAOB Assertion: Existence or occurence ASB Assertion: Existence, occurence

Audit Procedure: Observation

PCAOB Assertion: Existence or occurrence, Valuation ASB Assertion: Existence, Valuation

Audit Procedure: Inspection of tangible assets

PCAOB Assertion: Existence or occurrence, Valuation ASB Assertion: Existence, Valuation

Audit Procedure: Analytical Procedures

PCAOB Assertion: Existence or occurrence, Valuation, Completeness ASB Assertion: Existence, Occurrence, Valuation, Completeness

Audit Procedure: Confirmation

PCAOB Assertion: Existence or occurrence, Valuation, Rights, Completeness ASB Assertion: Existence or occurrence, Valuation, Rights, Completeness

Audit Procedure: Recalculation

PCAOB Assertion: Existence, Valuation ASB Assertion: Existence, Valuation

Audit Procedure: Reperformance

PCAOB Assertion: Valuation ASB Assertion: Valuation

Client organizational chart

Permanent file

Prior years' financial statements and audit reports

Permanent file

Royalty agreements

Permanent file

Which of the following provides the best method of obtaining an understanding of a continuing client's business for planning an audit?

Reviewing prior year audit documentation and the permanent file for the client.

Which of the following statements is most accurate regarding sufficient and appropriate documentation?

Sufficient and appropriate documentation should include evidence that the audit working papers have been reviewed.

True or false: Public accounting firms devote substantial time to make sure their audit clients are not likely to become the focus of an accounting scandal.

True

A comprehensive list of the specific procedures that need to be performed to gather sufficient appropriate evidence to base an opinion on the financial statements is called a(n) _____ _____.

audit plan

Risk management activities are undertaken ______.

before beginning any audit engagement

The planning process begins with a calculation of a preliminary materiality amount that is based on a relevant _____ and a rule of thumb percentage applied to it.

benchmark

During the substantive testing of balances analytical procedures ______.

can be very effective

Internal auditors ______.

can never be considered independent in the same sense that external auditors are considered independent

Inspecting records or documents (tracing) prepared by the client is a representative audit procedures of the PCAOB assertion of _____.

completeness

An auditor most likely would review an entity's periodic accounting for the numerical sequence of shipping documents and invoices to support management's financial statement assertion of:

completeness.

In auditing accrued liabilities, an auditor's procedures most likely would focus primarily on management's assertion of:

completeness.

A widely used auditing procedure is _____ by direct correspondence with independent parties.

confirmation

The permanent files are also called _____ _____ files.

continuing audit

Observation is commonly used as a test of ______.

control

Professional standards require auditors to reach a mutual understanding with clients concerning requirements and expectations which is usually done by preparing a written _____ _____.

engagement letter

An engagement letter is used primarily to:

ensure a clear contractual understanding of the services to be provided by the CPA.

The physical presence of assets is an example of evidence available to test the ASB assertion of _____.

existence

Physical inspection of tangible assets provides strong evidence regarding the assertion of _____ and may provide some evidence related to the assertion of _____.

existence; valuation

Giving each document a title including the name of the company, balance sheet date, and a descriptive title is called ______.

heading

An auditor's unbiased "state of mind" towards the financial statements and other information audited is referred to as the auditor possessing in _____ in _____.

independence; fact

Perceptions of others in regards to an auditor being unbiased is referred to as _____ in _____.

independent; appearance

Giving each electronic and paper document a number, like a book page number so it can be found, removed, and replaced without loss is called ______.

indexing

The collection of verbal evidence from independent parties and management is the audit procedure known as _____.

inquiry

An audit plan ______.

is a comprehensive list of specific procedures needed to gather sufficient appropriate evidence

Public accounting firms are ______.

not obligated to provide services for any new or existing client

North, CPA, is planning an independent audit of the financial statements of General Company. In determining the nature, timing, and extent of the audit procedures, North is considering General's internal audit function, which is staffed by Tyler. What factors should North consider, and what inquiries should North make in deciding whether to use Tyler's internal audit work? A: Prior to relying on the work of Tyler, North should consider Tyler's _____ and _____.

objectivity; competence

Viewing a client's physical facilities and participating in a surprise payroll distributions are examples of the audit procedure known as _____.

observation

In determining whether transactions have been recorded, the direction of the audit testing should start from the:

original source documents.

Information to familiarize new audit team members with a client, company history, continuing schedules and prior years financial statements and audit reports may all be found in the _____ files.

permanent

The two categories of audit documentation are _____ files and _____ files.

permanent; current

All important overall planning information and documentation that the audit team is following generally accepted auditing standards is often summarized in a(n) _____ _____.

planning memorandum

The independent auditors' audit design prepared prior to the start of fieldwork is appropriately considered documentation of:

planning.

An auditor's purpose in auditing the information contained in the pension footnote most likely is to obtain evidence concerning management's assertion about:

presentation and disclosure.

Materiality is based on ______

professional judgment

In addition to the audit engagement partner, audit teams typically include a(n) _____ _____ partner who reviews the audit team's work in critical audit areas.

quality assurance

When the audit team recomputes computations previously performed by client personnel, the audit procedure is called

recalculation

An audit procedure that is similar to recalculation but much broader in approach is called _____.

reperformance

Inspection of tangible assets does not necessarily provide any evidence of ______.

rights [Reason: Assets may be leased or held on consignments.]

The probability that the firm could issue a clean, unmodified opinion when in fact a modified opinion should have been issued is referred to as _____.

risk

The assignment of staff to an audit engagement depends on the ______.

riskiness of the engagement

Auditors should design the written audit plan so that:

the audit procedures selected will achieve specific audit objectives.

Auditor's shorthand for abbreviating comments about work performed are called audit or _____ _____.

tick marks

To ensure the audit is completed on schedule, a(n) _____ _____ is prepared to assist in identifying problem areas early in the engagement.

time budget

Testing the completeness assertion by following a sample of shipping documents forward to sales invoices, the sales journal and revenue earned is called _____.

tracing

The auditor selects a basic source document and follows its processing path forward to its final recording and to the financial statements when engaged in ______.

tracing

Selecting an item in the financial records and following its path back to the source document is referred to as _____.

vouching

The auditor begins the search for evidence by focusing on transactions that have already been recorded in the financial statements and following them back to the source when engaged in ______.

vouching