Audit Exam 2

10) The "tone at the top" provides a foundation upon which a more detailed code of conduct can be developed to provide specific guidance for the organization and its employees. Components of a code of conduct may include sections on 1) general employee conduct, 2) relationships with clients and suppliers and 3) conflicts of interest. Give a narrative description of what might be included in each of the above components of a code of conduct.

(may vary) General employee conduct—Employees should conduct themselves in a businesslike manner and prohibit unprofessional activities such as drinking, gambling, fighting, and swearing, while on the job. Relationships with client and suppliers—Employees should avoid investing in or acquiring a financial interest in any business organization that has a contractual relationship with the organizations. Conflicts of Interest—Employees are expected to perform their duties conscientiously, honestly, and in accordance with the best interests of the organization and to not use their positions or knowledge gained for private or personal advantage. Terms: Elements of code of conduct Diff: Challenging Objective: LO 10-4 AACSB:

22) Discuss three of the following characteristics of relevant evidence. 1. Independence of provider 2. Effectiveness of client's internal controls 3. Auditor's direct knowledge 4. Qualification of individuals providing the information 5. Degree of objectivity 6. Timeliness

1. Independence of provider — Evidence obtained from a source outside the entity is more reliable and persuasive than that obtained from within. 2. Effectiveness of client's internal controls — When a client's internal controls are effective, evidence obtained is more reliable than when the controls are not effective. 3. Auditor's direct knowledge — Evidence obtained directly by the auditor through physical examination, observation, computation and inspection is more reliable than information obtained indirectly. 4. Qualification of individuals providing the information — Although the source of information is independent, the evidence will not be reliable unless the individual providing it is qualified to do so. Communications from attorneys and bank confirmations are typically more highly regarded than accounts receivable confirmations from persons not familiar with the business world. Also, evidence obtained directly by the auditor may not be reliable if the auditor lacks the qualifications to evaluate the evidence. 5. Degree of objectivity — Objective evidence is more reliable than evidence that requires considerable judgment to determine whether it is correct. 6. Timeliness — The timeliness of audit evidence can refer either to when it is accumulated or to the period covered by the audit. Evidence is usually more reliable for balance sheet accounts when it is obtained as close to the balance sheet date as possible. Terms: Characteristics of reliable evidence Diff: Moderate Objective: LO 7-3 AACSB:

31) Match nine of the terms (a-k) with the definitions provided below (1-9): a. foot b. compute c. scan d. inquire e. count f. trace g. reperform h. read i. examine j. observe k. compare ________ 1. a calculation done by the auditor independent of the client ________ 2. addition of a column of numbers to determine if the total is the same as the client's ________ 3. a comparison of information in two different locations ________ 4. a use of the senses to assess certain activities ________ 5. following details of transactions from original documents to journals ________ 6. a less detailed examination of a document or record to determine if there is something unusual warranting further investigation ________ 7. obtaining information from the client in response to specific questions ________ 8. a determination of assets on hand at a given time ________ 9. an examination of written information to determine facts pertinent to the audit

1. b, 2. a, 3. k, 4. j, 5. f, 6. c, 7. d, 8. e, 9. h Terms: Audit procedures Diff: Moderate Objective: LO 7-4 AACSB:

32) Match five of the terms (a-h) with the definitions provided below (1-5): a. audit documentation b. audit procedures c. audit objectives d. analytical procedures e. budgets f. reliability of evidence g. sufficiency of evidence h. persuasiveness of evidence ________ 1. use of comparisons and relationships to assess the reasonableness of account balances ________ 2. detailed instructions for the collection of a type of audit evidence ________ 3. the degree to which evidence can be considered believable or trustworthy ________ 4. contains all the information that the auditor considers necessary to conduct an adequate audit and to provide support for the audit report ________ 5. this is determined by the amount of evidence obtained

1. d 2. b 3. f 4. a 5. g Terms: Audit procedures and audit evidence Diff: Moderate Objective: LO 7-4 AACSB:

29) Define the following terms commonly used in audit procedures: 1. examine 2. scan 3. compute 4. foot 5. compare 6. count 7. vouch

1. examine — a reasonably detailed study of a specific document or record to determine specific facts about it 2. scan — a less detailed examination of a document or record to determine whether there is something unusual warranting further investigation 3. compute — a calculation done by the auditor independent of the client 4. foot — addition of a column of numbers to determine whether the total is the same as the client's 5. compare — a comparison of information in two different locations 6. count — a determination of assets on hand at a given time. This term is associated only with the type of evidence defined as physical examination. 7. vouch — the use of documents to verify recorded transactions or amounts Terms: Audit procedures Diff: Moderate Objective: LO 7-4 AACSB:

33) Below are 10 documents typically examined during an audit. Classify each document as either internal or external. Type of Document Documents 1. canceled checks for payments of accounts payable 2. payroll time cards 3. duplicate sales invoices 4. vendors' invoices 5. bank statements 6. minutes of the board of directors' meetings 7. signed lease agreements 8. notes receivable 9. subsidiary accounts receivable records 10. remittance advices

1. external 6. internal 2. internal 7. external 3. internal 8. external 4. external 9. internal 5. external 10. external Terms: Internal and external evidence Diff: Moderate Objective: LO 7-4 AACSB:

30) Below are 12 audit procedures. Classify each procedure according to the following types of audit evidence: (1) physical examination, (2) confirmation, (3) documentation, (4) observation, (5) inquiry of the client, (6) reperformance, and (7) analytical procedure. Type of Evidence Audit Procedures 1. Watch client employees count inventory to determine whether company procedures are being followed. 2. Count inventory items and record the amount in the audit files. 3. Trace postings from the sales journal to the general ledger accounts. 4. Calculate the ratio of cost of goods sold to sales as a test of overall reasonableness of gross margin relative to the preceding year. 5. Obtain information about the client's internal controls by asking questions of client personnel. 6. Trace column totals from the cash disbursements journal to the general ledger. 7. Examine a piece of equipment to make sure a recent purchase of equipment was actually received and is in operation. 8. Review the total of repairs and maintenance for each month to determine whether any month's total was unusually large. 9. Compare vendor names and amounts on purchase invoices with entries in the purchases journal. 10. Foot entries in the sales journal to determine whether they were correctly totaled by the client. 11. Make a surprise count of petty cash to verify that the amount of the petty cash fund is intact. 12. Obtain a written statement from the client's bank stating the client's year-end balance on deposit.

1. observation 2. physical examination 3. reperformance 4. analytical procedure 5. inquiry of the client 6. reperformance 7. physical examination 8. analytical procedure 9. documentation 10. reperformance 11. physical examination 12. confirmation Terms: Audit evidence and audit procedures Diff: Moderate Objective: LO 7-4 AACSB:

6) Below are five audit procedures, all of which are tests of transactions associated with the audit of the sales and collection cycle. Also below are the six general transaction-related audit objectives and the five management assertions. For each audit procedure, indicate (1) its audit objective, and (2) the management assertion being tested. Audit Objectives A. occurrence B. completeness C. accuracy D. posting and summarization E. classification F. timing Assertions V. occurrence W. completeness X. accuracy Y. classification Z. cutoff 1. Vouch recorded sales from the sales journal to the file of bills of lading. (1) ________ (2) ________ 2. Compare dates on the bill of lading, sales invoices, and sales journal to test for delays in recording sales transactions. (1) ________ (2) ________ 3. Account for the sequence of prenumbered bills of lading and sales invoices. (1) ________ (2) ________ 4. Trace from a sample of prelistings of cash receipts to the cash receipts journal, testing for names, amounts, and dates. (1) ________ (2) ________ 5. Examine customer order forms for credit approval by the credit manager. (1) ________ (2) ________

: 1. (1) A (2) V 2. (1) F (2) Z 3. (1) B (2) W 4. (1) B, C (2) W, X 5. (1) A (2) V Terms: Management assertions and transaction-related audit objectives Diff: Challenging Objective: LO 6-9 AACSB: Analytic

7) Below are five audit procedures, all of which are tests of transactions associated with the audit of the acquisition and payment cycle. Also below are the six general transaction-related audit objectives and the five management assertions. For each audit procedure, indicate (1) its audit objective, and (2) the management assertion being tested. Audit Objectives A. occurrence B. completeness C. accuracy D. posting and summarization E. classification F. timing Assertions V. occurrence W. completeness X. accuracy Y. classification Z. cutoff 1. Foot the purchases journal and trace the totals to the related general ledger accounts. (1) ________ (2) ________ 2. Recompute the cash discounts taken by the client. (1) ________ (2) ________ 3. Compare dates on cancelled checks with the bank cancellation date. (1) ________ (2) ________ 4. Trace from a sample of cancelled checks to the cash disbursements journal. (1) ________ (2) ________ 5. Examine supporting documentation for a sample of transactions for authorized payee and amount and to determine services or goods were received. (1) ________ (2) ________

: 1. (1) D (2) X 2. (1) C (2) X 3. (1) F (2) Z 4. (1) B (2) W 5. (1) A (2) V Terms: Management assertions and transaction-related audit objectives Diff: Challenging Objective: LO 6-9 AACSB: Analytic

9) Below are five audit procedures, all of which are tests of balances associated with the audit of accounts receivable. Also below are the eight general balance-related audit objectives and the four management assertions. For each audit procedure, indicate (1) its audit objective, and (2) the management assertion being tested. Audit Objectives A. existence B. completeness C. accuracy D. classification E. cutoff F. detail tie-in G. realizable value H. rights and obligations Assertions V. existence W. completeness X. valuation and allocation Y. rights and obligations 1. Obtain an aged listing of accounts receivable. For a sample of individual customers on the listing, agree the customer's name, amount, and other information with the corresponding information in the accounts receivable master file. (1) ________ (2) ________ 2. Examine details of sales for five days before and five days after year-end to determine whether sales have been recorded in the proper period. (1) ________ (2) ________ 3. Assess the reasonableness of the balance in the allowance for doubtful accounts. (1) ________ (2) ________ 4. Inquire as to whether any accounts receivable have been factored or sold during the period. (1) ________ (2) ________ 5. Inquire as to whether there are any receivables from related parties. (1) ________ (2) ________

: 1. (1) F (2) X 2. (1) E (2) X 3. (1) G (2) X 4. (1) H (2) Y 5. (1) D (2) X Terms: Management assertions and balance-related audit objectives Diff: Challenging Objective: LO 6-10 AACSB: Analytic

10) Match seven of the terms (a-k) with the definitions provided below (1-7): a. tests of details of balances b. tests of controls c. substantive tests of transactions d. analytical procedures e. transaction-related audit objectives f. management assertions g. balance-related audit objectives h. fraud i. illegal act j. error k. management fraud ________ 1. an intentional misstatement of the financial statements ________ 2. a set of six audit objectives the auditor must meet, including timing, posting and summarization, and accuracy ________ 3. implied or expressed representations made by the client about classes of transactions, account balances and disclosures in the financial statements ________ 4. audit procedures testing for monetary misstatements to determine whether the balance-related audit objectives have been satisfied for each significant account balance ________ 5. a set of nine audit objectives the auditor must meet, including completeness, detail tie-in, and rights and obligations ________ 6. audit procedures designed to test the effectiveness of control policies and procedures ________ 7. use of comparisons and relationships to assess whether account balances or other data appears reasonable

: 1. h 2. e 3. f 4. a 5. g 6. b 7. d Terms: Tests of balances; Tests of controls; Substantive tests of transactions; Analytical procedures; Management assertions; Balance-related audit objectives; Fraud Diff: Moderate Objective: LO 6-11 AACSB: Reflective

8) List the four phases of a financial statement audit.

: 1. plan and design an audit approach based on risk assessment procedures 2. perform tests of controls and substantive tests of transactions 3. perform substantive analytical procedures and tests of details of balances 4. complete the audit and issue an audit report Terms: Phases of financial statement audit Diff: Moderate Objective: LO 6-11 AACSB: Reflective

11) Briefly explain each management assertion related to account balances at period end.

: • Existence. Assets, liabilities, and equity interests exist. • Completeness. All assets, liabilities, and equity interests that should have been recorded have been recorded. • Valuation and allocation. Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation adjustments are appropriately recorded. • Rights and obligations. The entity holds or controls the rights to assets, and liabilities are the obligation of the entity. Terms: Management assertions related to account balances at period end Diff: Moderate Objective: LO 6-8 AACSB: Reflective

32) Discuss three reasons why auditors are responsible for "reasonable" but not "absolute" assurance.

: • Most audit evidence results from testing a sample of a population. Sampling involves some risk of not uncovering material misstatements. • Accounting presentations contain complex estimates, which inherently involve uncertainty and can be affected by future events. As a result, the auditor has to rely on evidence that is persuasive but not convincing. • Fraudulently prepared financial statements are often very difficult for the auditor to detect, especially when there is collusion among management. Terms: Reasons auditors are responsible for reasonable but not absolute assurance Diff: Moderate Objective: LO 6-3 AACSB: Reflective

12) Briefly explain each management assertion related to presentation and disclosure.

: • Occurrence and rights and obligations. Disclosed events and transactions have occurred and pertain to the entity. • Completeness. All disclosures that should have been included in the financial statements have been included. • Accuracy and valuation. Financial and other information are disclosed appropriately and at appropriate amounts. • Classification and understandability. Financial and other information is appropriately presented and described and disclosures are clearly expressed. Terms: Management assertions related to presentation and disclosure Diff: Moderate Objective: LO 6-8 AACSB: Reflective

10) Briefly explain each management assertion related to classes of transactions and events for the period under audit.

: • Occurrence. Transactions and events that have been recorded have occurred and pertain to the entity. • Completeness. All transactions and events that should have been recorded have been recorded. • Accuracy. Amounts and other data relating to recorded transactions and events have been recorded appropriately. • Classification. Transactions and events have been recorded in the proper accounts. • Cutoff. Transactions and events have been recorded in the correct accounting period. Terms: Management assertions related to classes of transactions Diff: Moderate Objective: LO 6-8 AACSB: Reflective

9) Listed below are several accounts listed from a company's trial balance. Next to each account put the letter corresponding to the transaction cycle used to audit the account. S = Sales and collection cycle I = Inventory and warehousing cycle A = Acquisition and payment cycle C = Capital acquisition and repayment cycle P = Payroll and personnel cycle 1. ________ Sales returns and allowances 5. ________ Salaries and commissions 2. ________ Capital stock 6. ________ Cost of goods sold 3. ________ Buildings 7. ________ Trade accounts receivable 4. ________ Notes payable 8. ________ Rent

: 1. S, 2. C, 3. A, 4. C, 5. P, 6. I, 7. S, 8. A Terms: Financial statement cycle approach when performing a financial statement audit Diff: Moderate Objective: LO 6-6 AACSB: Reflective

3) The most important general ledger account included in and affecting several cycles is the A) cash account. B) inventory account. C) income tax expense and liability accounts. D) retained earnings account.

: A Terms: Account included in and affected several cycles Diff: Moderate Objective: LO 6-6 AACSB: Reflective

7) ________ are used as evidence to provide assurance about an account balance. A) Substantive analytical procedures B) Tests of transactions C) Audit risks D) Tests of details of balances

: A Terms: Analytical procedures; Substantive tests Diff: Moderate Objective: LO 6-11 AACSB: Reflective

4) When an auditor believes that an illegal act may have occurred, the auditor should first A) obtain an understanding of the nature and circumstances of the act. B) consult with legal counsel or others knowledgeable about the illegal act. C) discuss the matter with the audit committee. D) withdraw from the engagement.

: A Terms: Auditor believes an illegal act may have occurred Diff: Easy Objective: LO 6-3 AACSB: Reflective

2) If management insists on financial statement disclosures that the auditor finds unacceptable, the auditor can withdraw from the engagement or A) Issue an adverse opinion Issue a qualified opinion Yes Yes B) Issue an adverse opinion Issue a qualified opinion No No C) Issue an adverse opinion Issue a qualified opinion Yes No D) Issue an adverse opinion Issue a qualified opinion No Yes

: A Terms: Auditor insists on financial statement disclosures that management finds unacceptable Diff: Easy Objective: LO 6-2 AACSB: Reflective

11) An auditor has a duty to A) provide reasonable assurance that material misstatements will be detected. B) be a guarantor of the fairness in the statements. C) be equally responsible with management for the preparation of the financial statements. D) be an insurer of the fairness in the statements.

: A Terms: Auditor responsibility for notifying users as to whether statements are properly stated Diff: Moderate Objective: LO 6-3 AACSB: Reflective

24) Which of the following statements best describes the auditor's responsibility with respect to illegal acts that do not have a material effect on the client's financial statements? A) Generally, the auditor is under no obligation to notify parties other than personnel within the client's organization. B) Generally, the auditor is under an obligation to inform the PCAOB. C) Generally, the auditor is obligated to disclose the relevant facts in the auditor's report. D) Generally, the auditor is expected to compel the client to adhere to requirements of the Foreign Corrupt Practices Act.

: A Terms: Auditor responsibility with respect to illegal acts Diff: Moderate Objective: LO 6-3 AACSB: Reflective

1) The auditor's best defense when material misstatements are not uncovered is to have conducted the audit A) in accordance with generally accepted auditing standards. B) as effectively as reasonably possible. C) in a timely manner. D) only after an adequate investigation of the management team.

: A Terms: Auditors' best defense when material misstatements are not uncovered Diff: Easy Objective: LO 6-3 AACSB: Reflective

4) The classification balance-related audit objective A) involves determining if items included on a client's listing are included in the correct general leger accounts. B) is the counterpart to the management assertion of completeness. C) involves determining if items included on a client's listing are disclosed properly in the financial statements. D) involves tying in the account balances to the general ledger.

: A Terms: Balance-related audit objectives Diff: Moderate Objective: LO 6-10 AACSB: Reflective

3) ________ is the tendency to make assessments by starting from an initial value and then adjusting insufficiently away from that initial value. A) Anchoring B) Availability C) Overconfidence D) Confirmation

: A Terms: Common judgment tendencies Diff: Moderate Objective: LO 6-5 AACSB: Reflective

8) The concept of reasonable assurance indicates that the auditor is A) not a guarantor of the correctness of the financial statements. B) not responsible for the fairness of the financial statements. C) responsible only for issuing an opinion on the financial statements. D) responsible for finding all misstatements.

: A Terms: Concept of reasonable assurance Diff: Easy Objective: LO 6-3 AACSB: Reflective

3) Two overriding considerations affect the many ways an auditor can accumulate evidence: 1. Sufficient appropriate evidence must be accumulated to meet the auditor's professional responsibility. 2. Cost of accumulating evidence should be minimized. In evaluating these considerations A) the first is more important than the second. B) the second is more important than the first. C) they are equally important. D) it is impossible to prioritize them.

: A Terms: Considerations for accumulating evidence Diff: Moderate Objective: LO 6-11 AACSB: Reflective

6) The cycle approach to auditing A) ties to the way transactions are recorded in journals and then summarized in the general ledger and financial statements. B) cannot combine transactions recorded in different journals with the general ledger balances that result from those transactions. C) is the only way of segmenting an audit. D) assumes that each account has two or more cycles associated with it.

: A Terms: Cycle approach to segmenting an audit Diff: Moderate Objective: LO 6-6 AACSB: Reflective

19) If there is collusion among management, the chance a normal audit would uncover such acts is A) very low. B) very high. C) zero. D) none of the above.

: A Terms: Employees collude to falsify documents Diff: Moderate Objective: LO 6-3 AACSB: Reflective

3) Which of the following statements is the most correct regarding errors and fraud? A) An error is unintentional, whereas fraud is intentional. B) Frauds occur more often than errors in financial statements. C) Errors are always fraud and frauds are always errors. D) Auditors have more responsibility for finding fraud than errors.

: A Terms: Errors and fraud Diff: Easy Objective: LO 6-3 AACSB: Reflective

4) ________ deals with potential overstatement and ________ deals with understatements (unrecorded transactions). A) Occurrence; completeness B) Completeness; occurrence C) Accuracy; classification D) Classification; accuracy

: A Terms: General and specific audit objectives Diff: Challenging Objective: LO 6-9 AACSB: Reflective

13) When dealing with laws and regulations that do not have a direct effect on the financial statements, the auditor A) should inquire of management about whether the entity is in compliance with such laws and regulations. B) has no responsibility to determine if any violations of these laws has occurred. C) must report all violations, including inconsequential violations, to the audit committee. D) should perform the same procedures as for violations having a direct effect on the financial statements.

: A Terms: Indirect-effect illegal acts Diff: Moderate Objective: LO 6-3 AACSB: Reflective

4) Management assertions are A) directly related to the financial reporting framework used by the company, usually U.S. GAAP or IFRS. B) stated in the footnotes to the financial statements. C) explicitly expressed representations about the financial statements. D) provided to the auditor in the assertions letter, but are not disclosed on the financial statements.

: A Terms: Management assertions Diff: Moderate Objective: LO 6-8 AACSB: Reflective

1) The objective of an audit of the financial statements is an expression of an opinion on A) the fairness of the financial statements in all material respects. B) the accuracy of the financial statements. C) the accuracy of the annual report. D) the accuracy of the balance sheet and income statement.

: A Terms: Objective of ordinary audit of financial statements Diff: Easy Objective: LO 6-1 AACSB: Reflective

2) Which of the following is an accurate statement about professional skepticism? A) Professional skepticism involves a critical assessment of the evidence. B) Professional skepticism is easy to implement in practice. C) It is easy for auditors to understand that their clients may try to deceive them throughout the audit process. D) Professional skepticism is only necessary for the audits of public companies.

: A Terms: Professional skepticism Diff: Easy Objective: LO 6-4 AACSB: Reflective

6) ________ is the self-confidence to resist persuasion and to challenge assumptions or conclusions. A) Self-esteem B) Interpersonal understanding C) Suspension of judgment D) Autonomy

: A Terms: Professional skepticism Diff: Moderate Objective: LO 6-4 AACSB: Reflective

7) An auditor should recognize that the application of auditing procedures may produce evidence indicating the possibility of errors of fraud and therefore should A) plan and perform the engagement with an attitude of professional skepticism. B) not rely on internal controls that are designed to prevent or detect errors or fraud. C) design audit tests to detect unrecorded transactions. D) extend the work to audit the majority of the recorded transactions and records of an entity.

: A Terms: Professional skepticism when auditing a client Diff: Moderate Objective: LO 6-4 AACSB: Reflective

1) Why does the auditor divide the financial statements into smaller segments? A) Using the cycle approach makes the audit more manageable. B) Most accounts have few relationships with others and so it is more efficient to break the financial statements into smaller pieces. C) The cycle approach is used because auditing standards require it. D) All of the above are correct.

: A Terms: Reason auditor divides financial statements into smaller segments Diff: Moderate Objective: LO 6-6 AACSB: Reflective

4) Which of the following is not one of the steps used to develop audit objectives? A) know the proper type of audit opinion to issue B) divide the financial statements into cycles C) know the management assertions about the financial statements D) know the specific audit objectives for classes of transactions

: A Terms: Steps the AICPA and accounting profession taking to reduce practitioner's exposure to lawsuits Diff: Easy Objective: LO 6-1 AACSB: Reflective

9) Describe what analytical procedures and tests of details of balances are and give an example of each.

: Analytical procedures consist of evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data. Analytical procedures use comparisons and relationships to assess whether account balances and other data appear reasonable. An example of an analytical procedure is to examine sales transactions in the sales journal for unusually large amounts and/or compare monthly sales with prior years. Tests of details of balances are specific procedures intended to test for monetary misstatements in balances in the financial statements. An example is direct written communication with the client's customers to identify any incorrect amounts. Terms: Analytical procedures and tests of balances Diff: Challenging Objective: LO 6-11 AACSB: Reflective

33) Discuss the differences in the auditor's responsibilities for discovering (1) material errors, (2) material fraud (3) illegal acts having a direct effect on the financial statements, and (4) illegal acts that do not have a direct effect on the financial statements.

: Auditing standards make no distinction between the auditor's responsibilities for searching for errors and fraud. In either case, the auditor must obtain reasonable assurance about whether the statements are free of material misstatements. The standards also recognize that fraud is often more difficult to detect because management or the employees perpetrating the fraud attempt to conceal the fraud. Still, the difficulty of detection does not change the auditor's responsibility to properly plan and perform the audit to detect material misstatements, whether caused by error or fraud. The auditor's responsibility for uncovering illegal acts that have a direct effect on the financial statements is the same as for errors and fraud. However, the auditor is not required to search for illegal acts that do not have a direct effect on the financial statements unless there is reason to believe they exist. Terms: Auditor responsibilities for discovering material errors, material fraud, direct-effect illegal acts, and indirect-effect illegal acts Diff: Challenging Objective: LO 6-3 AACSB: Reflective

7) Which of the following assertions is described as "this assertion addresses whether all transactions that should be included in the financial statements are in fact included"? A) occurrence B) completeness C) rights and obligations D) existence

: B Terms: Assertion which addresses whether all transactions that should be included are included Diff: Moderate Objective: LO 6-8 AACSB: Reflective

1) An audit must be performed with an attitude of professional skepticism. Professional skepticism consists of two primary components: a questioning mind and A) the assumption that upper-level management is dishonest. B) a critical assessment of the audit evidence. C) the assumption that all employees are motivated by greed. D) verification of all critical information by independent third parties.

: B Terms: Attitude of professional skepticism Diff: Easy Objective: LO 6-4 AACSB: Reflective

22) When an auditor knows that an illegal act has occurred, she must A) report it to the proper governmental authorities. B) consider the effects on the financial statements, including the adequacy of disclosure. C) withdraw from the engagement. D) issue an adverse opinion.

: B Terms: Auditor knows illegal act occurred Diff: Moderate Objective: LO 6-3 AACSB: Reflective

4) If the auditor has obtained a reasonable level of assurance about the fair presentation of the financial statements through understanding internal control, assessing control risk, testing controls, and analytical procedures, then the auditor A) can issue an unqualified opinion. B) can significantly reduce other substantive tests. C) can write the engagement letter. D) needs to perform additional tests of controls so that the assurance level can be increased.

: B Terms: Auditor obtained reasonable level of assurance about fair presentation Diff: Moderate Objective: LO 6-11 AACSB: Reflective

25) Which of the following statements best describes the auditor's responsibility regarding the detection of fraud? A) The auditor is responsible for the failure to detect fraud only when such failure clearly results from nonperformance of audit procedures specifically described in the engagement letter. B) The auditor is required to provide reasonable assurance that the financial statements are free of both material errors and fraud. C) The auditor is responsible for detecting material financial statement fraud, but not a material misappropriation of assets. D) The auditor is responsible for the failure to detect fraud only when an unqualified opinion is issued.

: B Terms: Auditor responsibility regarding detection of fraud Diff: Moderate Objective: LO 6-3 AACSB: Reflective

1) Which of the following is not one of the AICPA categories of assertions? A) assertions about classes of transactions and events for the period under audit B) assertions about financial statements and correspondence to GAAP C) assertions about account balances at period end D) assertions about presentation and disclosure

: B Terms: Categories of assertions Diff: Easy Objective: LO 6-8 AACSB: Reflective

3) One of the characteristics of professional skepticism is ________, which is the conviction to decide for oneself, rather than accepting the claims of others. A) interpersonal understanding B) autonomy C) suspension of judgment D) self-esteem

: B Terms: Characteristics of professional skepticism Diff: Moderate Objective: LO 6-4 AACSB: Reflective

3) The detail tie-in is part of the ________ assertion for account balances. A) classification B) valuation and allocation C) rights and obligations D) completeness

: B Terms: Detail tie-in is and assertion for account balances Diff: Moderate Objective: LO 6-10 AACSB: Reflective

2) The detail tie-in objective is not concerned that the details in the account balance A) agree with related subsidiary ledger amounts. B) are properly disclosed in accordance with GAAP. C) foot to the total in the account balance. D) agree with the total in the general ledger.

: B Terms: Detail tie-in objective Diff: Moderate Objective: LO 6-10 AACSB: Reflective

1) Which of the following statements is true regarding the distinction between general audit objectives and specific audit objectives for each class of transactions? A) The specific audit objectives are applicable to every class of transactions. B) The general audit objectives are applicable to every class of transactions. C) Once the specific transaction-related audit objectives are established, they can be used to develop the general transaction-related objectives. D) For any given class of transactions, usually only one audit objective must be met to conclude the transactions are properly recorded.

: B Terms: Difference between general and specific audit objectives Diff: Moderate Objective: LO 6-9 AACSB: Reflective

10) An auditor discovers that the company's bookkeeper unintentionally made an mistake in calculating the amount of the quarterly sales. This is an example of A) employee fraud. B) an error. C) misappropriation of assets. D) a defalcation.

: B Terms: Errors and fraud Diff: Moderate Objective: LO 6-3 AACSB: Reflective

28) The provisions of many laws and regulations affect the financial statements A) directly. B) only indirectly. C) both directly and indirectly. D) materially if direct; immaterially if indirect.

: B Terms: Illegal acts, effect on financial statements Diff: Challenging Objective: LO 6-3 AACSB: Reflective

23) Which of the following is an accurate statement concerning the auditor's responsibility to consider laws and regulations? A) Auditors can follow an easy, step-by-step procedure to determine how laws and regulations impact the financial statements. B) The auditor's responsibility will depend on whether the laws or regulations are expected to have a direct impact on the financial statements. C) It is the responsibility of the auditor to determine if an act constitutes noncompliance. D) The auditor must inform an outside party if management has knowingly not complied with a law or regulation.

: B Terms: Illegal acts, effect on financial statements Diff: Moderate Objective: LO 6-3 AACSB: Reflective

29) If a client has violated federal tax laws, A) the auditor must notify the IRS. B) and the amount is significant, the auditor should communicate with those charged with governance. C) the noncompliance generally will not impact the financial statements. D) the auditor does not need to evaluate the effects of the noncompliance on other aspects of the audit.

: B Terms: Illegal acts, effect on financial statements Diff: Moderate Objective: LO 6-3 AACSB: Reflective

16) In comparing management fraud with employee fraud, the auditor's risk of failing to discover the fraud is A) greater for management fraud because managers are inherently more deceptive than employees. B) greater for management fraud because of management's ability to override existing internal controls. C) greater for employee fraud because of the higher crime rate among blue collar workers. D) greater for employee fraud because of the larger number of employees in the organization.

: B Terms: Management fraud vs. employee fraud and auditor failure to detect both Diff: Challenging Objective: LO 6-3 AACSB: Reflective

1) In testing for cutoff, the objective is to determine A) whether all of the current period's transactions are recorded. B) whether transactions are recorded in the correct accounting period. C) the proper cutoff between capitalizing and expensing expenditures. D) the proper cutoff between disclosing items in footnotes or in account balances.

: B Terms: Objective in testing cutoff Diff: Moderate Objective: LO 6-10 AACSB: Reflective

5) When performing the review and completing the documentation and rationale for the conclusion step of the professional judgment process, auditors will A) consider the accounting and auditing standards relevant to the issues. B) articulate in written form the rationale of their judgment. C) identify the issue. D) gather the facts.

: B Terms: Professional judgment process Diff: Easy Objective: LO 6-5 AACSB: Reflective

4) When the auditor considers whether he understands the form and substance of the transaction or event, and whether the relevant authoritative literature has been applied consistently by the client, he is performing which step in the professional judgment process? A) identifying and defining the issue B) performing the analysis and identifying potential alternatives C) making the decision D) gathering the facts

: B Terms: Professional judgment process Diff: Moderate Objective: LO 6-5 AACSB: Reflective

2) Why does the auditor divide the financial statements into segments around the financial statement cycles? A) Most auditors are trained to audit cycles as opposed to entire financial statements. B) The approach aids in the assignment of tasks to different members of the audit team. C) The cycle approach is required by auditing standards. D) The cycle approach allows the auditor to detect illegal acts.

: B Terms: Reason auditor divides financial statements into smaller segments Diff: Moderate Objective: LO 6-6 AACSB: Reflective

26) When reporting identified or suspected noncompliance, A) the auditor must report inconsequential noncompliance to the audit committee. B) the auditor should communicate all material noncompliance matters to those charged with governance. C) any intentional noncompliance must be reported to local law enforcement. D) all noncompliance, whether material or not, must result in a disclaimer of opinion.

: B Terms: Reporting of identified or suspected noncompliance Diff: Moderate Objective: LO 6-3 AACSB: Reflective

1) The responsibility for adopting sound accounting policies and maintaining adequate internal control rests with the A) board of directors. B) company management. C) financial statement auditor. D) company's internal audit department.

: B Terms: Responsibility for adopting sound accounting policies and maintaining adequate internal controls Diff: Easy Objective: LO 6-2 AACSB: Reflective

5) The responsibility for the preparation of the financial statements and the accompanying footnotes belongs to A) the auditor. B) management. C) both management and the auditor equally. D) management for the statements and the auditor for the notes.

: B Terms: Responsibility for preparation of the financial statements and the accompanying footnotes Diff: Moderate Objective: LO 6-2 AACSB: Reflective

1) Auditors have found that generally the most efficient and effective way to conduct audits is to A) obtain complete assurance about the correctness of each class of transactions affecting the account. B) obtain some combination of assurance for each class of transactions and for the ending balance in the related accounts. C) obtain assurance about the ending balance of the account only. D) verify each entry that was made into an account.

: B Terms: Setting audit objectives Diff: Moderate Objective: LO 6-7 AACSB: Reflective

1) The procedures used to test the effectiveness of the internal controls are known as A) tests of transactions. B) tests of controls. C) substantive analytical procedures. D) control risk.

: B Terms: Tests of controls Diff: Easy Objective: LO 6-11 AACSB: Reflective

6) Management's disclosure of the amount of unfunded pension obligations and the assumptions underlying these amounts is an example of the ________ assertion. A) completeness B) existence C) accuracy and valuation D) rights and obligations

: C Terms: Accuracy and valuation assertion Diff: Moderate Objective: LO 6-8 AACSB: Reflective

2) If the auditor believes that the financial statements are not fairly stated or is unable to reach a conclusion because of insufficient evidence, the auditor A) should withdraw from the engagement. B) should request an increase in audit fees so that more resources can be used to conduct the audit. C) has the responsibility of notifying financial statement users through the auditor's report. D) should notify regulators of the circumstances.

: C Terms: Auditor believes that financial statements are nor fairly presented Diff: Easy Objective: LO 6-1 AACSB: Reflective

5) The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements that are not ________ are detected. A) important to the financial statements B) statistically significant to the financial statements C) material to the financial statements D) identified by the client

: C Terms: Auditor has no responsibility to plan and perform audit to obtain reasonable assurance Diff: Easy Objective: LO 6-3 AACSB: Reflective

15) Auditing standards make ________ distinction(s) between the auditor's responsibilities for searching for errors and fraud. A) little B) a significant C) no D) various

: C Terms: Auditor responsibility for searching for errors and fraud Diff: Moderate Objective: LO 6-3 AACSB: Reflective

5) Balance-related audit objectives A) are never applied to income statement accounts. B) are designed to detect fraud. C) provide a framework to help the auditor accumulate sufficient appropriate evidence related to account balances. D) can have only one specific-related audit objectives.

: C Terms: Balance-related audit objectives Diff: Moderate Objective: LO 6-10 AACSB: Reflective

3) In certifying their annual financial statements, the CEO and CFO of a public company certify that the financial statements comply with the requirements of A) GAAP. B) the Sarbanes-Oxley Act. C) the Securities Exchange Act of 1934. D) GAAS.

: C Terms: Certifying annual financial statements by CEO and CFO Diff: Easy Objective: LO 6-2 AACSB: Reflective

4) When using the cycle approach to segmenting the audit, the reason for treating capital acquisition and repayment separately from the acquisition of goods and services is that A) the transactions are related to financing a company rather than to its operations. B) most capital acquisition and repayment cycle accounts involve few transactions, but each is often highly material and therefore should be audited extensively. C) Both A and B are correct. D) Neither A nor B is correct.

: C Terms: Cycle approach to segmenting an audit Diff: Challenging Objective: LO 6-6 AACSB: Reflective

7) Which balance sheet accounts are included in the payroll and personnel cycle? A) cash in bank, accrued payroll, trade accounts receivable B) accrued payroll, notes payable, and deferred tax C) accrued payroll, cash in bank, and accrued payroll taxes D) salaries and commissions, cash in bank, accrued payroll taxes

: C Terms: Cycle approach to segmenting an audit Diff: Moderate Objective: LO 6-6 AACSB: Reflective

7) Which of the following would most likely be deemed a direct effect illegal act? A) violation of federal employment laws B) violation of federal environmental regulations C) violation of federal income tax laws D) violation of civil rights laws

: C Terms: Direct-effect illegal act Diff: Easy Objective: LO 6-3 AACSB: Reflective

2) The auditor is determining that the correct selling price was used for billing and that the quantity of goods shipped was the same as the quantity billed. She is gathering evidence about which transaction-related audit objective? A) existence B) completeness C) accuracy D) cut-off

: C Terms: Evidence for transaction-related audit objective if recorded sales are for amount shipped and correctly billed and recorded Diff: Moderate Objective: LO 6-9 AACSB: Analytic

18) When comparing the auditor's responsibility for detecting employee fraud and for detecting errors, the profession has placed the responsibility A) more on discovering errors than employee fraud. B) more on discovering employee fraud than errors. C) equally on discovering errors and employee fraud. D) on the senior auditor for detecting errors and on the manager for detecting employee fraud.

: C Terms: Fraud and errors Diff: Moderate Objective: LO 6-3 AACSB: Reflective

6) Fraudulent financial reporting is most likely to be committed by whom? A) line employees of the company B) outside members of the company's board of directors C) company management D) the company's auditors

: C Terms: Fraudulent financial reporting Diff: Easy Objective: LO 6-3 AACSB: Reflective

9) Which of the following is the auditor least likely to do when aware of an illegal act? A) discuss the matter with the client's legal counsel B) obtain evidence about the potential effect of the illegal act on the financial statements C) contact the local law enforcement officials regarding potential criminal wrongdoing D) consider the impact of the illegal act on the relationship with the company's management

: C Terms: Illegal acts Diff: Moderate Objective: LO 6-3 AACSB: Reflective

5) Management makes the following assertions about account balances: A) existence, completeness, classification and cutoff. B) existence, accuracy, classification and rights and obligations. C) existence, completeness, valuation and allocation, and rights and obligations. D) existence, completeness, rights and obligations, and cutoff.

: C Terms: Management assertions Diff: Challenging Objective: LO 6-8 AACSB: Reflective

3) International auditing standards and U.S. GAAP classify assertions into three categories. Which of the following is not a category of assertions that management makes about the accounting information in financial statements? A) assertions about classes of transactions for the period under audit B) assertions about account balances at period end C) assertions about the quality of source documents used to prepare the financial statements D) assertions about presentation and disclosure

: C Terms: Management assertions Diff: Easy Objective: LO 6-8 AACSB: Reflective

9) With increases in the complexity of transactions and the need for expanded disclosures about these transactions, assertions about the ________ have increased in importance. A) existence B) account balances C) presentation and disclosure D) classes of transactions

: C Terms: Management assertions Diff: Easy Objective: LO 6-8 AACSB: Reflective

27) Another term for misappropriation of assets is A) management fraud. B) collusion. C) employee fraud. D) illegal acts.

: C Terms: Misappropriation of assets Diff: Easy Objective: LO 6-3 AACSB: Reflective

17) Misappropriation of assets A) is generally committed by company management. B) harms the users of the financial statements by providing them incorrect financial data for their decision making. C) causes harm to stockholders because the assets are no longer available to their rightful owners. D) causes the financial statements to be misstated since the misappropriation usually involves material amounts.

: C Terms: Misappropriation of assets Diff: Moderate Objective: LO 6-3 AACSB: Reflective

21) When the auditor identifies or suspects noncompliance with laws and regulations, the auditor A) should discuss the matter with those whom they believe committed the illegal act. B) begin communication with the FASB in accordance with PCAOB regulations. C) may disclaim an opinion on the basis of scope limitations if he is precluded by management from obtaining sufficient appropriate evidence. D) should withdraw from the engagement.

: C Terms: Noncompliance with laws and regulations Diff: Moderate Objective: LO 6-3 AACSB: Reflective

7) Determining that the footnote disclosures related to long-term debt are accurate is an example of the ________ audit objective. A) occurrence B) completeness C) presentation and disclosure D) classification and understandability

: C Terms: Presentation and disclosure-related objectives Diff: Easy Objective: LO 6-10 AACSB: Reflective

2) Which of the following is not a step in the professional judgment process? A) make the decision B) perform the analysis C) determine the type of audit opinion D) review and document the rationale for the conclusion

: C Terms: Professional judgment process Diff: Moderate Objective: LO 6-5 AACSB: Reflective

5) One of the characteristics of professional skepticism is_______, which is a desire to investigate beyond the obvious. A) self-esteem B) an interpersonal understanding C) a search for knowledge D) a questioning mindset

: C Terms: Professional skepticism Diff: Moderate Objective: LO 6-4 AACSB: Reflective

4) Which of the following statements is true of a public company's financial statements? A) Sarbanes-Oxley requires only the CEO to certify the financial statements. B) Sarbanes-Oxley requires only the CFO to certify the financial statements. C) Sarbanes-Oxley requires both the CEO and CFO to certify the financial statements. D) Sarbanes-Oxley requires neither the CEO nor the CFO to certify the financial statements.

: C Terms: Public company's financial statements Diff: Easy Objective: LO 6-2 AACSB: Reflective

3) The posting and summarization audit objective is the auditor's counterpart to management's assertion of A) occurrence. B) completeness. C) accuracy. D) classification.

: C Terms: Transaction-related audit objectives Diff: Moderate Objective: LO 6-9 AACSB: Reflective

5) After the auditor has completed all audit procedures, it is necessary to combine the information obtained to reach an overall conclusion as to whether the financial statements are fairly presented. This is a highly subjective process that relies heavily on A) generally accepted auditing standards. B) the AICPA's Code of Professional Conduct. C) generally accepted accounting principles. D) the auditor's professional judgment.

: D Terms: After auditor completed all audit procedures Diff: Moderate Objective: LO 6-11 AACSB: Reflective

20) When the auditor becomes aware of or suspects noncompliance with laws and regulations A) the auditor should evaluate the effects of the noncompliance on other aspects of the audit. B) the auditor should discuss the matter with management at a level above those suspected of the noncompliance. C) the auditor should obtain additional information to evaluate the possible effects on the financial statements. D) all of the above

: D Terms: Audit procedures when noncompliance is identified or suspected Diff: Moderate Objective: LO 6-3 AACSB: Reflective

12) If the auditor were responsible for making certain that all of management's assertions in the financial statements were absolutely correct, A) bankruptcies could no longer occur. B) bankruptcies would be reduced to a very small number. C) audits would be much easier to complete. D) audits would not be economically practical.

: D Terms: Auditor responsible for making certain that all of management's assertions were absolutely correct Diff: Moderate Objective: LO 6-3 AACSB: Reflective

3) Auditors accumulate evidence to A) defend themselves in the event of a lawsuit. B) determine if the financial statements are correct. C) satisfy the requirements of the Securities Acts of 1933 and 1934. D) reach a conclusion about the fairness of the financial statements.

: D Terms: Auditors accumulate evidence Diff: Easy Objective: LO 6-1 AACSB: Reflective

6) Which of the following statements is not true? A) Balance-related audit objectives are applied to ending account balances. B) Transaction-related audit objectives are applied to classes of transactions. C) Balance-related audit objectives are applied to the ending balance in balance sheet accounts. D) Balance-related audit objectives are applied to both beginning and ending balances in balance sheet accounts.

: D Terms: Balance-related and transaction-related audit objectives Diff: Moderate Objective: LO 6-10 AACSB: Reflective

2) Which of the following statements is not correct? A) There are many ways an auditor can accumulate evidence to meet overall audit objectives. B) Sufficient appropriate evidence must be accumulated to meet the auditor's professional responsibility. C) It is appropriate to minimize the cost of accumulating evidence. D) Gathering evidence and minimizing costs are equally important considerations that affect the approach the auditor selects.

: D Terms: Considerations for accumulating evidence Diff: Moderate Objective: LO 6-11 AACSB: Reflective

5) In describing the cycle approach to segmenting an audit, which of the following statements is not true? A) All general ledger accounts and journals are included at least once. B) Some journals and general ledger accounts are included in more than one cycle. C) The "capital acquisition and repayment" cycle is closely related to the "acquisition of goods and services and payment" cycle. D) The "inventory and warehousing" cycle may be audited at any time during the engagement since it is unrelated to the other cycles.

: D Terms: Cycle approach to segmenting an audit Diff: Challenging Objective: LO 6-6 AACSB: Reflective

8) Which of the following management assertions is not associated with classes of transactions and events? A) occurrence B) classification C) accuracy D) rights and obligations

: D Terms: Management assertion not associated with transaction-related audit objectives Diff: Moderate Objective: LO 6-8 AACSB: Reflective

14) Which of the following statements is usually true? A) Materiality is easy to quantify. B) Fraudulent financial statements are often easy for the auditor to detect, especially when there is collusion among management. C) Reasonable assurance is a low level of assurance that the financial statements are free from material misstatement. D) An item is considered material if it would likely have changed or influenced the decisions of a reasonable person using the statements.

: D Terms: Materiality Diff: Moderate Objective: LO 6-3 AACSB: Reflective

6.5 Learning Objective 6-5 1) The starting point to effective professional judgment begins with A) gathering the facts. B) identifying alternatives. C) identifying relevant literature. D) identifying and defining the issue.

: D Terms: Professional judgment process Diff: Easy Objective: LO 6-5 AACSB: Reflective

4) A questioning mindset A) means the auditor must prove every statement that management makes to them. B) means the auditor should approach the audit with a "do not trust anyone" mental outlook. C) assures that the auditor will only accept honest clients. D) means the auditor should approach the audit with a "trust but verify" mental outlook.

: D Terms: Professional skepticism Diff: Moderate Objective: LO 6-4 AACSB: Reflective

2) Which of the following is not one of the reasons that auditors provide only reasonable assurance on the financial statements? A) The auditor commonly examines a sample, rather than the entire population of transactions. B) Accounting presentations contain complex estimates which involve uncertainty. C) Fraudulently prepared financial statements are often difficult to detect. D) Auditors believe that reasonable assurance is sufficient in the vast majority of cases.

: D Terms: Reasons auditors provide only reasonable assurance on financial statements Diff: Easy Objective: LO 6-3 AACSB: Reflective

2) The term audit objective refers to all of the following except for A) transaction-related audit objectives. B) presentation and disclosure-related audit objectives. C) balance-related audit objectives. D) cycle-related audit objectives.

: D Terms: Setting audit objectives Diff: Easy Objective: LO 6-7 AACSB: Reflective

6) Direct, written communication with the client's customers to identify whether a receivable exists is an example of a(n) A) substantive test of transactions. B) test of controls. C) analytical procedure. D) test of details of balances.

: D Terms: Tests of details of balances Diff: Moderate Objective: LO 6-11 AACSB: Reflective

2) If a short-term note payable is included in the accounts payable balance on the financial statement, there is a violation of the A) completeness assertion. B) existence assertion. C) cutoff assertion. D) classification assertion.

: D Terms: Violation of assertions Diff: Easy Objective: LO 6-8 AACSB: Reflective

6) Auditors should be alert for potential judgment tendencies, traps, and biases that may impact their decision making process. Identify and define four of these judgment tendencies. Then, for each judgment tendency, suggest a way to avoid or mitigate the tendency.

: The judgment tendencies and strategies to avoid or mitigate the tendencies are: 1. Confirmation: the tendency to put more weight on information that is consistent with initial beliefs or preferences 2. Overconfidence: the tendency to overestimate one's own abilities to perform tasks or to make accurate assessments of risks or other judgments and decisions 3. Anchoring: the tendency to make assessments by starting from an initial value and then adjusting insufficiently away from the initial value 4. Availability: the tendency to consider information that is easily retrievable or what's easily accessible as being more likely or more relevant Strategy to avoid or mitigate the tendency: 1. Confirmation: Make the opposing case and consider alternative explanations. Consider potentially disconfirming or conflicting information 2. Overconfidence: Challenge opinions and experts. Challenge underlying assumptions. 3. Anchoring: Solicit input from others. Consider management bias, including the potential for fraud or material misstatement. 4. Availability: Consider why something comes to mind. Obtain and consider objective data. Consult with others and take the opposing case. Terms: Professional judgment; strategies to mitigate common judgment tendencies Diff: Challenging Objective: LO 6-5 AACSB: Reflective

30) Discuss the differences between errors, frauds, and illegal acts. Give an example of each.

: The primary difference between errors and frauds is that errors are unintentional misstatements of the financial statements, whereas frauds are intentional misstatements. Illegal acts are violations of laws or government regulations, other than frauds. An example of an error is a mathematical mistake when footing the columns in the sales journal. An example of a fraud is the creation of fictitious accounts receivable. An example of an illegal act is the dumping of toxic waste in violation of the federal environmental protection laws. Terms: Errors, frauds, and illegal acts Diff: Easy Objective: LO 6-3 AACSB: Reflective

8) An important balance-related audit objective is realizable value. Describe the purpose of this audit objective, what it is concerned with, and give an example.

: The purpose of this audit objective is to make sure that assets are included on the balance sheet at the amounts estimated to be realized. It is concerned with whether an account balance has been reduced for declines from historical cost or when accounting standards require a fair value accounting treatment for the account. It is concerned with valuation and allocation. It generally applies only to asset accounts, although some liabilities are recorded at fair value. Examples include the allowance for uncollectible accounts, and write-downs of inventory for obsolescence. Terms: Balance-related objective of realizable value Diff: Challenging Objective: LO 6-10 AACSB: Reflective

8) Recent academic research on the topic of professional skepticism suggests that there are six characteristics to skepticism. List and briefly describe each of these characteristics.

: The six characteristics of skepticism are: 1. Questioning mindset — a disposition to inquiry with some sense of doubt 2. Suspension of judgment — withholding judgment until appropriate evidence is obtained 3. Search for knowledge — a desire to investigate beyond the obvious, with a desire to corroborate 4. Interpersonal understanding — recognition that people's motivations and perceptions can lead them to provide biased or misleading information 5. Autonomy — the self-direction, moral independence, and conviction to decide for oneself, rather than accepting the claims of others 6. Self-esteem — the self-confidence to resist persuasion and to challenge assumptions or conclusions. Terms: Professional skepticism Diff: Moderate Objective: LO 6-4 AACSB: Reflective

8) Auditors generally use a financial statement cycle approach when performing a financial statement audit. Describe the transaction flow, using specific examples, from journals to financial statements that produce financial statements.

: Transactions-sales, cash receipts, acquisition of goods/services, cash disbursements, payroll services and disbursements, and allocation and adjustments Journals-sales, cash receipts, acquisitions, cash disbursements, payroll, and general General ledger and subsidiary ledgers to General ledger trial balance to financial statements Terms: Financial statement cycle approach when performing a financial statement audit Diff: Moderate Objective: LO 6-6 AACSB: Reflective

31) Discuss the actions an auditor should take when an illegal act is identified or suspected.

: When an auditor discovers or suspects noncompliance with a law or regulation (illegal act), unless the matters involved are inconsequential, the auditor should: 1. Obtain an understanding of the nature and circumstances of the act. Additional information should be obtained to evaluate the possible effects on the financial statements. The auditor should discuss the matter with management at a level above those involved with the suspected noncompliance, and, when appropriate, those charged with governance. If the auditor is precluded by management or those charged with governance from obtaining sufficient appropriate evidence to provide sufficient information that supports that the entity is in compliance with the laws and regulations, and the auditor believes the effect of the noncompliance may be material to the financial statements, the auditor should consider the need to obtain legal advice. The auditor should also evaluate the effects of the noncompliance on other aspects of the audit. 2. Communicate with those charged with governance matters involving noncompliance with laws and regulations that came to the auditor's attention during the course of the audit. If the matter is believed to be intentional and material, it should be communicated to those charged with governance, such as the board of directors, as soon as practicable. 3. Identify whether a responsibility exists to report the identified or suspected noncompliance to parties outside the entity, such as regulatory authorities. 4. If the noncompliance has a material effect and has not been adequately reflected in the financial statements, the auditor should express a qualified or adverse opinion. If the auditor has been precluded by management from obtaining sufficient appropriate evidence to determine if the noncompliance is material, the auditor should express a qualified opinion or disclaim an opinion. Terms: Actions auditor should take when auditor discovers illegal act Diff: Moderate Objective: LO 6-3 AACSB: Reflective

5) In the context of the audit of sales, distinguish between the occurrence and completeness transaction-related audit objectives. State the effect on the sales account (overstatement or understatement) of a violation of each objective.

: When testing the occurrence objective for sales, the auditor's focus is on whether the sales that have been recorded in the sales journal actually occurred. In contrast, tests of the completeness objective are concerned with determining whether all sales that actually occurred have been recorded in the sales journal. Violations of the occurrence objective result in overstatements of sales; violations of the completeness objective result in understatements of sales. Terms: General and specific audit objectives Diff: Challenging Objective: LO 6-9 AACSB: Reflective

2) Auditors may identify conditions during fieldwork that change or support a judgment about the initial assessment of fraud risks. Which of the following is not a condition which should alert an auditor that the initial assessment should be changed? A) The subsidiary ledger agrees with the general ledger. B) discrepancies in the accounting records C) unusual relationships between the auditor and management D) missing or conflicting evidence

A Terms: Alert auditor to change initial assessment of fraud risks Diff: Moderate Objective: LO 10-5 AACSB:

4) Analytical procedures A) performed during the audit planning phase generally use aggregate data. B) are never performed during the testing phase of an audit. C) are declining in importance as a type of audit evidence. D) performed during the audit planning stage help the auditor take a final objective look at the audited financial statements.

A Terms: Analytical procedures Diff: Moderate Objective: LO 7-5 AACSB:

3) When performing planning analytical procedures for a client the auditor detected that the gross profit percentage had declined by 50% from the previous year to the year currently under audit. The auditor should A) investigate the possibility the client may have made an error in their cost of goods sold computation. B) assist management in developing greater cost efficiencies in their product line. C) prepare a going concern opinion for the client. D) advise the client to have extensive disclosure to alleviate investor concerns.

A Terms: Analytical procedures in planning phase Diff: Challenging Objective: LO 8-4 AACSB:

3) Audit documentation A) should identify the items tested when the audit procedures involve sampling of transactions or balances. B) does not aid in the preparation of the tax return since accounting and tax rules differ. C) is another term for the audit program. D) should not be given to anyone outside the audit firm, even if a subpoena has been issued.

A Terms: Audit documentation Diff: Moderate Objective: LO 7-7 AACSB:

7) A(n) ________ is a supporting schedule that supports a specific amount and is normally expected to tie the amount recorded in the client's records to another source of information. A) reconciliation of amounts B) analysis C) summary of procedures D) informational document

A Terms: Audit documentation; supporting schedules Diff: Moderate Objective: LO 7-8 AACSB:

1) Auditors must make decisions regarding what evidence to gather and how much to accumulate. Which of the following is a decision that must be made by auditors related to evidence? A) Sample size Timing of audit procedures Yes Yes B) Sample size Timing of audit procedures No No C) Sample size Timing of audit procedures Yes No D) Sample size Timing of audit procedures No Yes

A Terms: Audit evidence decisions Diff: Easy Objective: LO 7-2 AACSB:

4) Audit evidence obtained directly by the auditor will not be reliable if A) the auditor lacks the competence to evaluate the evidence. B) it is provided by the client's attorney. C) the client denies its veracity. D) it is impossible for the auditor to obtain additional corroboratory evidence.

A Terms: Audit evidence obtained directly by auditor Diff: Easy Objective: LO 7-3 AACSB:

6) Audit procedures can result in significant, unexpected differences. The auditor should investigate further if A) Significant differences are not expected but do exist Significant differences are expected but do not exist Yes Yes B) Significant differences are not expected but do exist Significant differences are expected but do not exist No No C) Significant differences are not expected but do exist Significant differences are expected but do not exist Yes No D) Significant differences are not expected but do exist Significant differences are expected but do not exist No Yes

A Terms: Audit procedures result in significant differences Diff: Easy Objective: LO 7-4 AACSB:

15) ________ generally provide the most reliable evidence. A) Confirmations B) Recalculations C) Reperformances D) Observations

A Terms: Audit process Diff: Moderate Objective: LO 7-4 AACSB:

3) As part of the brainstorming sessions, auditors are directed to emphasize A) How management could perpetrate and conceal fraudulent financial reporting The audit team's response to potential fraud risks Yes Yes B) How management could perpetrate and conceal fraudulent financial reporting The audit team's response to potential fraud risks No No C) How management could perpetrate and conceal fraudulent financial reporting The audit team's response to potential fraud risks Yes No D) How management could perpetrate and conceal fraudulent financial reporting The audit team's response to potential fraud risks No Yes

A Terms: Auditors directed to emphasize in brainstorming sessions Diff: Moderate Objective: LO 10-3 AACSB:

3) Industry comparisons can be used as A) an aid to understanding the client's business. B) an indicator of errors. C) an indicator of fraud. D) an aid to internal controls.

A Terms: Benefit of industry comparisons Diff: Moderate Objective: LO 7-5 AACSB:

3) Which of the following is a category of fraud? A) Fraudulent financial reporting Misappropriation of assets Yes Yes B) Fraudulent financial reporting Misappropriation of assets No No C) Fraudulent financial reporting Misappropriation of assets Yes No D) Fraudulent financial reporting Misappropriation of assets No Yes

A Terms: Category of fraud Diff: Easy Objective: LO 10-1 AACSB:

11) Certain types of misstatements are likely to be more important than other types to users, even if the dollar amounts are the same. Which of the following demonstrates this? A) Amounts involving frauds are considered more important than errors of equal amount. Misstatements that are otherwise immaterial may be material if they affect a trend in earnings. Yes Yes B) Amounts involving frauds are considered more important than errors of equal amount. Misstatements that are otherwise immaterial may be material if they affect a trend in earnings. No No C) Amounts involving frauds are considered more important than errors of equal amount. Misstatements that are otherwise immaterial may be material if they affect a trend in earnings. Yes No D) Amounts involving frauds are considered more important than errors of equal amount. Misstatements that are otherwise immaterial may be material if they affect a trend in earnings. No Yes

A Terms: Certain types of misstatements are likely more important than other types Diff: Moderate Objective: LO 8-6 AACSB:

5) The auditor uses knowledge gained from the understanding of the client's business and industry to assess A) client business risk. B) control risk. C) inherent risk. D) audit risk.

A Terms: Client business risk Diff: Challenging Objective: LO 8-1 AACSB:

7) Which of the following is an accurate statement regarding a company's ability to meet its long-term debt obligations? A) If the debt-to-equity ratio is too high, it may indicate that the company has used up its borrowing capacity. B) If the debt-to-equity ratio is too high, it may mean that available leverage is not being used to the owners' benefit. C) The times interest earned ratio indicates if a company can make its principal and interest payments. D) The key ratios that are used to measure a long-term solvency are debt to equity, return on assets, and times interest earned.

A Terms: Common financial ratios; long-term debt obligations Diff: Moderate Objective: LO 7-6 AACSB:

2) A benefit obtained from using industry averages is that it provides a(n) A) benchmark to compare the company's results. B) indication where errors exist in the statements. C) benchmark to be used in evaluating a client's budgets. D) comparison of "what is" with "what should be."

A Terms: Comparing client data with industry averages Diff: Moderate Objective: LO 7-5 AACSB:

10) When comparing client data with similar prior-period data, A) if there has been no significant changes in the client's operations in the current year, much of the detail making up the totals in the financial statements should remain unchanged. B) comparison of details must take the form of details over time. C) comparing totals with previous years considers growth in the business activity. D) percent relationships fail to consider declines in the business activity.

A Terms: Comparison of client data with similar prior-period data Diff: Moderate Objective: LO 7-5 AACSB:

7) Which of the following is not one of the elements to prevent, deter, and detect fraud according to the AICPA? A) performing analytical procedures B) culture of honesty and high ethics C) management's responsibility to evaluate risks of fraud D) audit committee oversight

A Terms: Corporate governance oversight to reduce fraud risks Diff: Moderate Objective: LO 10-4 AACSB:

10) Which of the following best describes the corporate minutes of an entity? A) official record of the meetings of the board of directors and the stockholders B) unofficial record of the meeting of the board of directors C) official record of management meeting with investors and creditors of the company D) unofficial record of the board of directors meetings

A Terms: Corporate minutes Diff: Easy Objective: LO 8-3 AACSB:

10.5 Learning Objective 10-5 1) As part of designing and performing procedures to address management override of controls, auditors must perform which of the following procedures? A) Examine journal entries for evidence of possible misstatements due to fraud Review accounting estimates for biases Yes Yes B) Examine journal entries for evidence of possible misstatements due to fraud Review accounting estimates for biases No No C) Examine journal entries for evidence of possible misstatements due to fraud Review accounting estimates for biases Yes No D) Examine journal entries for evidence of possible misstatements due to fraud Review accounting estimates for biases No Yes

A Terms: Designing and performing procedures to address override controls Diff: Moderate Objective: LO 10-5 AACSB:

 1) One of the purposes of an engagement letter is to avoid misunderstandings with the client. This is important for A) Engagement objectives Engagement limitations Yes Yes B) Engagement objectives Engagement limitations No No C) Engagement objectives Engagement limitations Yes No D) Engagement objectives Engagement limitations No Yes

A Terms: Engagement letter Diff: Easy Objective: LO 8-2 AACSB:

22) Which is usually included in an engagement letter? A) The objectives of the engagement Identification of the financial reporting framework used by management Yes Yes B) The objectives of the engagement Identification of the financial reporting framework used by management No No C) The objectives of the engagement Identification of the financial reporting framework used by management Yes No D) The objectives of the engagement Identification of the financial reporting framework used by management No Yes

A Terms: Engagement letter Diff: Moderate Objective: LO 8-2 AACSB:

19) Evidence is usually more persuasive for balance sheet accounts when it is obtained A) as close to the balance sheet date as possible. B) only from transactions occurring on the balance sheet date. C) from various times throughout the client's year. D) from the time period when transactions in that account were most numerous during the fiscal period.

A Terms: Evidence is more persuasive for balance sheet accounts Diff: Challenging Objective: LO 7-3 AACSB:

2) Which of the following ratios is not a measure of a company's short-term debt paying ability? A) accounts receivable turnover B) cash ratio C) current ratio D) quick ratio

A Terms: Financial ratios; short-term debt paying ability Diff: Moderate Objective: LO 7-6 AACSB:

4) Fraud is more prevalent in smaller businesses and not-for-profit organizations because it is more difficult for them to maintain A) adequate separation of duties. B) adequate compensation. C) adequate financial reporting standards. D) adequate supervisory boards.

A Terms: Fraud more prevalent in smaller business and not-for-profit organizations Diff: Moderate Objective: LO 10-2 AACSB:

3) When the auditor identifies risk at the assertion level, A) the auditor may need to obtain audit evidence that is more reliable and relevant. B) the auditor may choose to conduct substantive testing during interim periods rather than at the end of the period. C) the auditor may decrease the sample size. D) both a and b

A Terms: Fraud risk Diff: Moderate Objective: LO 10-5 AACSB:

 1) Which of the following are elements of the fraud triangle? A) Attitudes/rationalization Risk Factors Opportunities Yes No Yes B) Attitudes/rationalization Risk Factors Opportunities No Yes Yes C) Attitudes/rationalization Risk Factors Opportunities Yes No No D) Attitudes/rationalization Risk Factors Opportunities No Yes No

A Terms: Fraud triangle Diff: Easy Objective: LO 10-2 AACSB:

11) Which of the following is an accurate statement regarding assets and fraud risk? A) Companies will often capitalize repairs as fixed assets. B) Since fixed assets are often large, there is little theft of fixed assets. C) Intangible assets are recorded at cost and valuation issues therefore are not a fraud risk. D) Since companies have few fixed assets, there is no need for them to be periodically inventoried.

A Terms: Fraudulent financial reporting risk; assets Diff: Moderate Objective: LO 10-6 AACSB:

11) Which of the following would the auditor be most concerned about regarding a heightened risk of intentional misstatement? A) Senior management emphasizes that it is very important to beat analyst estimates of earnings every reporting period. B) Senior management emphasizes that budgeted amounts for expenses are to be achieved for each reporting period or explained in the variance analysis report. C) Senior management emphasizes that job rotation is a worthwhile corporate objective. D) Senior management emphasizes that job evaluations are based on performance.

A Terms: Heightened risk of intentional misstatement Diff: Easy Objective: LO 10-2 AACSB:

5) An auditor uses ________ inquiry to corroborate or contradict prior information. A) assessment B) declarative C) interrogative D) informational

A Terms: Inquiry used to ascertain whether information already obtained is correct Diff: Moderate Objective: LO 10-7 AACSB:

2) Which of the following is least likely to uncover fraud? A) external auditors B) internal auditors C) internal controls D) management

A Terms: Lease likely to uncover of fraud risks Diff: Moderate Objective: LO 10-7 AACSB:

9) Which of the following forms of evidence would be least persuasive in forming the auditor's opinion about marketable securities and other investments held by the company? A) responses to auditor's questions by the president and controller regarding the investments account B) correspondence with a stockbroker regarding the quantity of client's investments held in street name by the broker C) minutes of the board of directors authorizing the purchase of stock as an investment D) the auditor's count of marketable securities

A Terms: Least persuasive form of evidence Diff: Moderate Objective: LO 7-3 AACSB:

3) Likely misstatements can result from A) Computation of the sampling error for the cash account Differences between management's and an auditor's judgment about account balances Projections of misstatements based on an auditor's tests of a sample from a population No Yes Yes B) Computation of the sampling error for the cash account Differences between management's and an auditor's judgment about account balances Projections of misstatements based on an auditor's tests of a sample from a population Yes Yes No C) Computation of the sampling error for the cash account Differences between management's and an auditor's judgment about account balances Projections of misstatements based on an auditor's tests of a sample from a population No No Yes D) Computation of the sampling error for the cash account Differences between management's and an auditor's judgment about account balances Projections of misstatements based on an auditor's tests of a sample from a population Yes No No

A Terms: Likely misstatements result from Diff: Moderate Objective: LO 8-8 AACSB:

6) Which of the following are major difficulties auditors face when allocating materiality to balance sheet accounts? A) Certain accounts contain more misstatements than others. Only overstatements need be considered. Audit costs can affect allocation. Yes No Yes B) Certain accounts contain more misstatements than others. Only overstatements need be considered. Audit costs can affect allocation. Yes Yes No C) Certain accounts contain more misstatements than others. Only overstatements need be considered. Audit costs can affect allocation. Yes Yes Yes D) Certain accounts contain more misstatements than others. Only overstatements need be considered. Audit costs can affect allocation. No Yes No

A Terms: Major difficulties auditors face when allocating materiality to balance sheet accounts Diff: Moderate Objective: LO 8-7 AACSB:

6) Management is responsible for A) Identifying and measuring fraud risks Taking steps to mitigate identified risks Yes Yes B) Identifying and measuring fraud risks Taking steps to mitigate identified risks No No C) Identifying and measuring fraud risks Taking steps to mitigate identified risks Yes No D) Identifying and measuring fraud risks Taking steps to mitigate identified risks No Yes

A Terms: Management responsibilities for fraud risks Diff: Moderate Objective: LO 10-4 AACSB:

2) Which of the following is part of planning? A) Set materiality for the financial statements as a whole. B) Estimate total misstatement in the segment. C) Estimate the combined misstatement. D) Compare the combined estimated with preliminary judgment.

A Terms: Materiality during the planning phase Diff: Moderate Objective: LO 8-5 AACSB:

13) Lewis Corporation has a few large accounts receivable that total one million dollars, whereas Clark Corporation has many small accounts receivable that total one million dollars. Misstatement in any one account is more significant for Lewis corporation because of the concept of A) materiality. B) audit risk. C) reasonable assurance. D) comparative analysis.

A Terms: Misstatements Diff: Challenging Objective: LO 8-6 AACSB:

3) Research indicates that the most effective way to prevent and deter fraud is to A) implement programs and controls that are based on core values embraced by the company. B) hire highly ethical employees. C) communicate expectations to all employees on an annual basis. D) terminate employees who are suspected of committing fraud.

A Terms: Most effective way to prevent and deter fraud Diff: Moderate Objective: LO 10-4 AACSB:

12) Which of the following normally signs the engagement letter for an audit of a private company? A) management B) board of directors representative C) audit committee representative D) corporate treasurer

A Terms: Normally signs engagement letter for audit of private company Diff: Moderate Objective: LO 8-2 AACSB:

9) Which of the following is a correct statement regarding performance materiality? A) Determining performance materiality is necessary because auditors accumulate evidence by segments. B) The level of performance materiality does not affect the amount of evidence needed. C) Performance materiality cannot vary for different classes of transactions. D) Performance materiality is required for public companies, but not for private companies.

A Terms: Performance materiality Diff: Challenging Objective: LO 8-7 AACSB:

13) When analyzing a client's performance measurement system, A) ratio analysis and benchmarking against key competitors are utilized. B) only income statement numbers are used. C) inherent risk of financial statement misstatements may be decreased if the performance measurement system encourages aggressive accounting. D) the auditor is likely to decrease the extent of testing if the client has set unreasonable objectives.

A Terms: Performance measurement system Diff: Moderate Objective: LO 8-3 AACSB:

4) The permanent files included as part of audit documentation do not normally include A) a copy of the current and prior years' audit programs. B) copies of articles of incorporation, bylaws and contracts. C) information related to the understanding of internal control. D) results of analytical procedures from prior years.

A Terms: Permanent file Diff: Moderate Objective: LO 7-8 AACSB:

2) Auditors generally allocate the preliminary judgment about materiality to the: A) balance sheet only. B) income statement only. C) income statement and balance sheet. D) statement of cash flows.

A Terms: Preliminary materiality allocation Diff: Easy Objective: LO 8-7 AACSB:

1) Which of the following is true statement regarding professional skepticism? A) Auditors reject most potential clients perceived as lacking honesty and integrity. B) If the auditor has past experience with a client, they can assume the client is honest. C) Material frauds occur in most of the audits of financial statements. D) Professional skepticism is required only during the planning phase.

A Terms: Professional skepticism when auditing a client Diff: Moderate Objective: LO 10-3 AACSB:

1) Which of the following is the best reason for management to emphasize fraud prevention and deterrence? A) It is often more effective and economical for companies to focus on fraud prevention and deterrence rather than on fraud detection. B) Collusion is impossible to detect. C) The AICPA requires management to implement a fraud prevention program. D) All of the above are equally valid reasons.

A Terms: Reason for management to emphasize fraud prevention and deterrence Diff: Moderate Objective: LO 10-4 AACSB:

2) The auditor is likely to accumulate more evidence when the audit is for a company A) Which has large amounts of debt Which is to be sold in the near future Yes Yes B) Which has large amounts of debt Which is to be sold in the near future No No C) Which has large amounts of debt Which is to be sold in the near future Yes No D) Which has large amounts of debt Which is to be sold in the near future No Yes

A Terms: Reasons for an audit and audit evidence Diff: Easy Objective: LO 8-2 AACSB:

11) The written communication stating the auditor cannot guarantee that all acts of fraud will be discovered is found in the A) engagement letter. B) representation letter. C) responsibility letter. D) client letter.

A Terms: Reasons for an audit and audit evidence Diff: Moderate Objective: LO 8-2 AACSB:

9) Which of the following would most likely not be classified as a related-party transaction? A) an advance of one week's salary to an employee B) sales of merchandise between affiliated companies C) loans or credit sales to the principal owner of the client company D) exchanges of equipment between two companies owned by the same person

A Terms: Related party transactions Diff: Challenging Objective: LO 8-3 AACSB:

6) A related party transaction may be indicated when another company A) subsidizes certain operating expenses of the company. B) purchases its securities at their fair value. C) loans to company at market rates. D) has had a distributor relationship with the company for 10 years.

A Terms: Related party transactions Diff: Moderate Objective: LO 8-3 AACSB:

6) Which of the following statements regarding the relevance of evidence is correct? A) To be relevant, evidence must pertain to the audit objective of the evidence. B) To be relevant, evidence must be persuasive. C) To be relevant, evidence must relate to multiple audit objectives. D) To be relevant, evidence must be derived from a system including effective internal controls.

A Terms: Relevance of evidence Diff: Easy Objective: LO 7-3 AACSB:

8) Who is responsible for setting the "tone at the top"? A) management B) PCAOB C) audit committee D) SEC

A Terms: Responsibility for setting tone at the top Diff: Easy Objective: LO 10-4 AACSB:

6) Two of the most useful warning signals that can indicate that revenue fraud is occurring are A) analytical procedures and documentary discrepancies. B) analytical procedures and misappropriation of assets. C) documentary discrepancies and vague responses to inquiries. D) missing audit evidence and vague responses to inquiries.

A Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 10-6 AACSB:

12) When setting a preliminary judgment about materiality, A) more evidence is required for a low dollar amount than for a high dollar amount. B) less evidence is required for a low dollar amount than for a high dollar amount. C) the same amount of evidence is required for either low or high dollar amounts. D) there is no relationship between materiality and the dollar amount of evidence needed.

A Terms: Setting preliminary judgment about materiality Diff: Challenging Objective: LO 8-6 AACSB:

4) In what order should the following steps occur? A. Set preliminary judgment of materiality and performance materiality. B. Understand the clients business and industry. C. Perform preliminary analytical procedures. D. Accept the client and perform initial audit planning. A) D, B, C, A B) B, A, C, D C) B, D, A, C D) D, C, B, A

A Terms: Steps in planning an audit and designing an audit approach Diff: Moderate Objective: LO 8-1 AACSB:

2) The first phase in planning an audit and designing an audit approach is to A) accept the client and perform initial audit planning. B) set the preliminary judgment of materiality. C) understand the client's business and industry. D) perform preliminary audit procedures.

A Terms: Steps in planning an audit and designing an audit approach Diff: Moderate Objective: LO 8-1 AACSB:

5) A successor auditor may perform which of the following for a new audit client? A) Speak to local attorneys, banks and other businesses regarding the company's reputation Speak to the predecessor auditors about disagreements they had with management Yes Yes B) Speak to local attorneys, banks and other businesses regarding the company's reputation Speak to the predecessor auditors about disagreements they had with management No No C) Speak to local attorneys, banks and other businesses regarding the company's reputation Speak to the predecessor auditors about disagreements they had with management Yes No D) Speak to local attorneys, banks and other businesses regarding the company's reputation Speak to the predecessor auditors about disagreements they had with management No Yes

A Terms: Successor auditor may perform communication for new audit client Diff: Moderate Objective: LO 8-2 AACSB:

2) When can audit procedures be performed? A) Prior to the fiscal year-end of the client Subsequent to the fiscal year-end of the client Yes Yes B) Prior to the fiscal year-end of the client Subsequent to the fiscal year-end of the client No No C) Prior to the fiscal year-end of the client Subsequent to the fiscal year-end of the client Yes No D) Prior to the fiscal year-end of the client Subsequent to the fiscal year-end of the client No Yes

A Terms: Timing of audit procedures Diff: Easy Objective: LO 7-2 AACSB:

5) The evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data is the definition of A) analytical procedures. B) tests of transactions. C) tests of balances. D) auditing.

A Terms: Types of audit evidence; analytical procedures Diff: Easy Objective: LO 7-4 AACSB:

19) Physical examination A) is a direct means of verifying that an asset really exists. B) is sufficient evidence to verify that the existing assets are owned by the client. C) can be used for both tangible assets and documents. D) is not generally a reliable type of audit evidence.

A Terms: Types of audit evidence; physical examination Diff: Moderate Objective: LO 7-4 AACSB:

8) When the auditor uses the audit procedure vouching she is primarily concerned with which of the following audit objectives when testing classes of transactions? A) occurrence B) completeness C) authorization D) classification

A Terms: Vouching as an audit procedure Diff: Moderate Objective: LO 7-4 AACSB:

14) Define the term "related party" and discuss why an auditor should identify the client's related parties early in the audit.

A related party is an affiliated company, principal owner of the client company, or any other party with which the client deals, where one of the parties can influence the management or operating policies of the other. Transactions with related parties are important to auditors because accounting standards require that they be disclosed in the financial statements. Auditors need to be aware of who the client's related parties are early in the audit to enable the auditor to identify related-party transactions, especially those that have not been disclosed. Terms: Related parties Diff: Easy Objective: LO 8-3 AACSB:

20) Which of the following statements is not true? A) Inherent risk is inversely related to the amount of audit evidence whereas detection risk is directly related to the amount of audit evidence required. B) Inherent risk is directly related to evidence whereas detection risk is inversely related to the amount of audit evidence required. C) Inherent risk is the susceptibility of the financial statements to material error, assuming no internal controls. D) Inherent risk and control risk are assessed by the auditor and function independently of the financial statement audit.

A) Inherent risk is inversely related to the amount of audit evidence whereas detection risk is directly related to the amount of audit evidence required.

Which of the following is not a risk factor that the auditor should take into account when considering the possibility of fraudulent financial reporting at an audit client? A) Significant accounting estimates are not difficult for the auditor to verify and justify. B) Board members' personal net worth is threatened if the entity's financial performance does not meet market expectations. C) Increasing business complexity occurs as a result of numerous recent acquisitions. D) Information technology personnel are found to be not keeping up with the latest trends in internal controls and data security.

A) Significant accounting estimates are not difficult for the auditor to verify and justify.

1) If an auditor believes the chance of financial failure is high and there is a corresponding increase in business risk for the auditor, acceptable audit risk would likely A) be reduced. B) be increased. C) remain the same. D) be calculated using a computerized statistical package.

A) be reduced.

1) Which of the following would not increase the risks of material misstatement at the overall financial statement level? A) effective oversight by the board of directors B) deficiencies in management's integrity C) inadequate accounting systems D) all of the above

A) effective oversight by the board of directors

13) To what extent do auditors typically rely on internal controls of their public company clients? A) extensively B) only very little C) infrequently D) never

A) extensively

9) If planned detection risk is reduced, the amount of evidence the auditor accumulates will A) increase. B) decrease. C) remain unchanged. D) be indeterminate.

A) increase.

11) Inherent risk is often high for an account such as A) inventory. B) land. C) capital stock. D) notes payable.

A) inventory.

1) When taken together, the concepts of risk and materiality in auditing A) measure the uncertainty of amounts of a given magnitude. B) measure uncertainty only. C) measure magnitude only. D) measure inherent risk.

A) measure the uncertainty of amounts of a given magnitude.

2) Auditors begin their assessments of inherent risk during audit planning. Which of the following would not help in assessing inherent risk during the planning phase? A) obtaining client's agreement on the engagement letter B) obtaining knowledge about the client's business and industry C) touring the client's plant and offices D) identifying related parties

A) obtaining client's agreement on the engagement letter

2) When management has an adequate level of integrity for the auditor to accept the engagement but cannot be regarded as completely honest in all dealings, auditors normally A) reduce acceptable audit risk and increase inherent risk. B) reduce inherent risk and control risk. C) increase inherent risk and control risk. D) increase acceptable audit risk and reduce inherent risk.

A) reduce acceptable audit risk and increase inherent risk.

10) Explain why it is necessary to allocate the preliminary judgment about materiality to individual accounts (segments) in the financial statements. Also explain why allocating to balance sheet accounts is more common than allocating to income statement accounts.

Allocating the preliminary judgment about materiality to individual accounts (segments) is necessary because evidence is accumulated for accounts (segments) rather than for the financial statements as a whole. Allocating to accounts (segments) establishes a tolerable misstatement amount for each account, which helps the auditor decide the appropriate audit evidence to accumulate for each account. Most practitioners allocate materiality to balance sheet accounts rather than income statement accounts because most income statement misstatements have an equal effect on the balance sheet due to the nature of double-entry accounting. Because there are fewer balance sheet accounts than income statement accounts in most audits, and because most audit procedures focus on balance sheet accounts, materiality should be allocated only to balance sheet accounts. Terms: Allocation of the preliminary judgment about materiality Diff: Moderate Objective: LO 8-7 AACSB:

9) When determining sufficient and appropriate audit evidence in order to form an opinion on the client's financial statements the auditor compiles audit documentation to support the opinion. The largest portion of audit documentation will include detailed supporting schedules prepared by the client or the auditor in support of specific accounts on the financial statements. Two types of supporting schedules are analysis and reconciliation of amounts. Discuss those two schedules and give an example for each schedule.

Analysis: designed to show the activity in a general ledger account during the entire period under audit, tying together the beginning and ending balances. Examples: marketable securities, property, plant and equipment, long-term debt, equity accounts. Reconciliation of amounts: Supports a specific amount and is normally expected to tie the amount recorded in the client's records to another source of information. Examples: the reconciliation of cash balances with bank statements, the reconciliation of subsidiary accounts receivable balances with confirmations from customers, and the reconciliation of accounts payable balances with vendors' statements. (Note : students were only required to give one example) Terms: Audit documentation; supporting schedules Diff: Moderate Objective: LO 7-8 AACSB:

12) State the three phases of the audit where analytical procedures can be performed and describe the specific procedures performed in each phase.

Analytical procedures: can be performed during the following audit phases: • Planning phase — Auditing procedures are required during this phase. They are performed as part of the risk assessment procedures to understand the client's business and to assist in determining the nature, extent, and timing of audit procedures. • Testing phase — Analytical procedures done during this phase are substantive tests in support of account balances. These procedures are often done in conjunction with other audit procedures. • Completion phase — Analytical procedures are required to be performed during this phase. Such tests serve as a final review for material misstatements or financial problems and help the auditor take a final "objective look" at the audited financial statements. Terms: Purposes of analytical procedures Diff: Challenging Objective: LO 7-5 AACSB:

23) ________ is the auditor's examination of the client's documents and records to substantiate that the information is included in the financial statements. A) Inspection B) Recalculation C) Observation D) Verification

Answer: A Terms: Types of audit evidence; inspection Diff: Moderate Objective: LO 7-4 AACSB:

4) Which of the following is not one of the four decisions about what evidence to gather and how much of it to accumulate? A) which audit procedures to use B) which accounts must agree to the general ledger C) when to perform the procedures D) what sample size to select for a given procedure

Answer: B Terms: Audit evidence and audit procedures Diff: Easy Objective: LO 7-2 AACSB: Analytic thinking

2) Which of the following is not a characteristic of the reliability of evidence? A) effectiveness of client internal controls B) education of auditor C) independence of information provider D) timeliness

Answer: B Terms: Characteristics of reliable evidence Diff: Easy Objective: LO 7-3 AACSB:

6) A company's long-term solvency A) can be measured by the gross profit percentage. B) depends on the success of its operations and on its ability to raise capital for expansion. C) can be measured by the days to collect receivables ratio. D) depends on its ability to generate cash for the payment of dividends.

Answer: B Terms: Common financial ratios Diff: Moderate Objective: LO 7-6 AACSB:

5) When making audit evidence decisions, A) the auditor decides which items in the population to test before determining the sample size. B) the sample size for any given procedure must remain constant from audit to audit. C) audit engagement software can assist the auditor in making evidence decisions. D) the auditor is required to use the sample sizes that are determined by the PCAOB.

Answer: C Terms: Audit evidence and sample size Diff: Moderate Objective: LO 7-2 AACSB:

4) Which account is used in the current ratio but not the quick ratio? A) marketable securities B) accounts payable C) accounts receivable D) inventory

Answer: D Terms: Financial ratios; short-term debt paying ability Diff: Moderate Objective: LO 7-6 AACSB:

23) Why is the appropriateness of audit evidence obtained by the auditor important in forming an audit opinion? Describe the qualities information should have to be considered appropriate by the auditor.

Appropriateness is a measure of the quality of evidence. Audit evidence that is considered appropriate contains the characteristics of relevance and reliability. Relevant evidence relates to the assertion being tested. Reliability refers to the degree to which evidence can be believable or worthy of trust. Terms: Appropriateness of audit evidence Diff: Moderate Objective: LO 7-3 AACSB:

4) Auditors are required to perform certain procedures in every audit to address the risk of management override of internal controls. What are these procedures?

Auditing procedures require the following to be performed to address the risk of management override of controls: • Examine journal entries and other adjustments for evidence of possible misstatements due to fraud. • Review accounting estimates for bias. • Evaluate the business rationale for significant unusual transactions. Terms: Audit procedures required to address the risk of management override of internal controls Diff: Moderate Objective: LO 10-5 AACSB:

30) Discuss the required communications between predecessor and successor auditors.

Auditing standards require a successor auditor to communicate with the predecessor auditor whenever accepting a client that has been previously audited. The purpose of the communication is to help the successor auditor evaluate whether to accept the engagement. While the burden of initiating the communication rests on the successor auditor, the predecessor auditor must respond to the request for information. However, because of the requirements related to confidentiality, the predecessor must obtain the former client's permission prior to providing information to the successor. Terms: Required communications between predecessor and successor auditors Diff: Moderate Objective: LO 8-2 AACSB:

8) Discuss the need for maintaining professional skepticism during an audit.

Auditing standards require that the audit be planned and performed with an attitude of professional skepticism in all aspects of the engagement, recognizing the possibility that a material misstatement could exist regardless of the auditor's prior experience with the integrity and honesty of client management and those charged with governance. In practice, maintaining this attitude can be difficult because, despite some recent high-profile financial statement frauds, material frauds are infrequent compared to the number of audits of financial statements conducted annually. Terms: Professional skepticism Diff: Moderate Objective: LO 10-3 AACSB:

9) Briefly discuss the brainstorming session required by current auditing standards. Be sure to include a list of ideas that should be addressed in the session.

Auditing standards require the audit team to conduct discussions to share insights from more experienced audit team members and to "brainstorm" ideas that address several ideas. The ideas that should be discussed are: • How and where the entity's financial statements might be susceptible to material misstatements due to fraud. This includes known external and internal factors affecting the entity that might (1) create an incentive or pressure for management to commit fraud (2) provide the opportunity for fraud to be perpetrated, including the risk of management override of internal controls, and (3) indicate a culture or environment that enables management to rationalize fraudulent acts. • How management could perpetrate and conceal fraudulent financial reporting. • How assets of the entity could be misappropriated. • How the auditor might respond to the susceptibility of material misstatements due to fraud. Terms: Brainstorming session required by auditing standards Diff: Moderate Objective: LO 10-3 AACSB:

15) What documents do auditors routinely obtain to aid in their understanding of a client's governance system? Briefly discuss each of these documents.

Auditors commonly obtain the company's organizational structure, code of ethics, and the minutes of meetings of the board of directors and shareholders. To gain an understanding of the client's governance system, the auditor should understand how the board and the audit committee exercise oversight, including consideration of the company's code of ethics and evaluation of the corporate minutes. Companies frequently communicate the entity's values and ethical standards through policy statements and codes of conduct. The corporate minutes are the official record of the meetings of the board of directors and stockholders. They include summaries of the most important topics discussed and decisions made at the board meetings. Terms: Documents for client's governance system Diff: Moderate Objective: LO 8-3 AACSB:

28) One purpose of performing analytical procedures in the planning phase of an audit is to assess the client's financial condition. Explain how the assessment of a client's financial condition can affect the auditor's decisions concerning evidence accumulation in later phases of the audit.

Auditors must obtain knowledge about a client's industry and business as a part of planning an audit. By conducting analytical procedures in which the current year's unaudited information is compared with prior years' audited information or industry data, changes are highlighted. These changes can represent important trends or specific events, all of which will influence audit planning. The use of analytical procedures is often a useful indicator for determining whether the client company has financial problems and if substantial doubt exists about the entity's ability to continue as a going concern. Certain analytical procedures can help the auditor assess the likelihood of failure. If a higher-than-normal ratio of long-term debt to net worth is combined with a lower-than-average ratio of profits to total assets, a relatively high risk of financial failure may be indicated. Not only will such conditions affect the audit plan, they may indicate that substantial doubt exists about the entity's ability to continue as a going concern, which requires an emphasis-of-matter explanatory paragraph in the audit report. Terms: Analytical procedures Diff: Moderate Objective: LO 7-4 AACSB:

1) A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued is the A) inherent risk. B) acceptable audit risk. C) statistical risk. D) financial risk.

B Terms: Acceptable audit risk Diff: Easy Objective: LO 8-1 AACSB:

8) When allocating materiality, most practitioners choose to allocate to A) the income statement accounts because they are more important. B) the balance sheet accounts because most audits focus on the balance sheet. C) both balance sheet and income statement accounts because there could be errors on either. D) all of the financial statements because it is required by GAAS.

B Terms: Allocating materiality Diff: Challenging Objective: LO 8-7 AACSB:

3) Which of the following is an incorrect statement regarding the allocation of the preliminary judgment about materiality to balance sheet accounts? A) Auditors expect certain accounts to have more misstatements than others. B) The allocation has virtually no effect on audit costs because the auditor must collect sufficient appropriate audit evidence. C) Auditors expect to identify overstatements as well as understatements in the accounts. D) Relative audit costs affect the allocation.

B Terms: Allocation of preliminary judgment about materiality Diff: Moderate Objective: LO 8-7 AACSB:

11) Which of the following is accurate regarding the comparison of client data? A) Since budgets are only projections, auditors can ignore the differences between budgeted and actual results. B) One approach to overcome the limitations of industry averages is to compare the client to one or more benchmark firms in the industry. C) It is impractical to relate one account balance to another balance sheet or income statement account. D) it is extremely difficult to get industry data for comparative purposes.

B Terms: Analytical analysis; comparison of client and industry data Diff: Moderate Objective: LO 7-5 AACSB:

5) Analytical procedures performed during the planning phase of the audit A) are used as a substantive test in support of account balances. B) are used to assist in determining the nature, extent, and timing of audit procedures C) are used to detect fraud. D) are mandatory only for public companies.

B Terms: Analytical procedures in planning phase Diff: Moderate Objective: LO 7-5 AACSB:

1) Analytical procedures are so important that they are required during the A) planning and test of control phases. B) planning and completion phases. C) test of control and completion phases. D) planning, test of control, and completion phases.

B Terms: Analytical procedures required Diff: Moderate Objective: LO 7-5 AACSB:

10) Analytical procedures must be used during which phase(s) of the audit? A) Test of Controls Planning Completion Yes Yes Yes B) Test of Controls Planning Completion No Yes Yes C) Test of Controls Planning Completion Yes No No D) Test of Controls Planning Completion No No No

B Terms: Analytical procedures used during phases of the audit Diff: Moderate Objective: LO 7-4 AACSB:

6) Analytical procedures performed during the completion stage of the audit A) help the auditor understand the client's business and industry. B) are typically performed by a senior partner with extensive knowledge of the client's business. C) help the auditor identify significant matters requiring special attention later in the engagement. D) all of the above

B Terms: Analytical procedures; Completion stage of audit Diff: Moderate Objective: LO 7-5 AACSB:

5) Appropriateness of evidence is a measure of the A) quantity of evidence. B) quality of evidence. C) sufficiency of evidence. D) meaning of evidence.

B Terms: Appropriateness of audit evidence Diff: Easy Objective: LO 7-3 AACSB:

11) For audit evidence to be compelling to the auditor it must be sufficient and appropriate. Which statement below is not correct regarding the appropriateness of audit evidence? A) The more effective the internal control system, the more assurance it provides the auditor about the reliability of financial reporting by the client. B) An auditor's opinion, to be economically useful and profitable to the auditing firm needs to be formed within a reasonable time and based on evidence obtained that assures profits for the auditing firm. C) Evidence obtained from independent sources outside the entity is generally more reliable than evidence secured solely within the entity. D) The independent auditor's direct personal knowledge, obtained through inquiry, observation and inspection, is generally more persuasive than information obtained indirectly.

B Terms: Appropriateness of audit evidence Diff: Moderate Objective: LO 7-3 AACSB:

7) When assessing fraud risk, A) fraud risk is assessed only at the overall financial statement level. B) the auditor's assessment of fraud risk should be ongoing throughout the audit. C) if the auditor concludes that there is a risk of material misstatement due to fraud, auditing standards require that the risks be treated as pervasive. D) auditing standards require that the auditor presume there is a risk of fraud in the inventory account.

B Terms: Assessment against a defendant of the full loss suffered by a plaintiff Diff: Moderate Objective: LO 10-3 AACSB:

5) When assessing the risk for fraud, the auditor must be cognizant of the fact that A) the existence of fraud risk factors means fraud exists. B) analytical procedures must be performed on revenue accounts. C) horizontal analysis is not useful in helping to determine unusual financial statement relationships. D) the auditor cannot make inquiries about fraud to company personnel who have no financial statement responsibilities.

B Terms: Assessment of fraud risk Diff: Moderate Objective: LO 10-3 AACSB:

5) Supporting schedules A) must be prepared by the auditor. B) make up the largest portion of audit documentation. C) must consist of either reconciliation of amounts or substantive analytical procedures. D) all of the above

B Terms: Audit documentation; supporting schedules Diff: Moderate Objective: LO 7-8 AACSB:

18) Which of the following statements is not a correct statement regarding audit evidence? A) Evidence obtained from an independent source outside the client organization is more reliable than that obtained from within. B) Documentary evidence is more reliable when it is received by the auditor indirectly rather than directly. C) Documents that originate outside the company are considered more reliable than those that originate within the client's organization. D) External evidence, such as communications from banks, is generally regarded as more reliable than answers obtained from inquiries of the client.

B Terms: Audit evidence Diff: Challenging Objective: LO 7-3 AACSB:

3) A(n) ________ is the detailed instruction that explains the audit evidence to be obtained during the audit. A) audit objective B) audit procedure C) audit assertion D) audit program

B Terms: Audit evidence and audit procedures Diff: Easy Objective: LO 7-2 AACSB: Analytic thinking

4) Audit documentation of the evidence gathered by the auditor should meet which of the following criteria? A) Workpapers are prepared in sufficient detail so that they can be given to the client for future reference. B) The content is sufficient to provide support for the auditor's opinion, including the auditor's representation as to compliance with auditing standards. C) Audit evidence is principally gathered to determine if the client's financial statements, as prepared by management, can be relied upon to make managerial decisions about the firm. D) Audit evidence as displayed in the workpapers is primarily performed to protect the auditing firm in the case of a lawsuit by investors.

B Terms: Audit evidence gathered by auditors meets which criteria Diff: Moderate Objective: LO 7-7 AACSB:

1) Audit evidence has two primary qualities for the auditor; relevance and reliability. Given the choices below, which provides the auditor with the most reliable audit evidence? A) general ledger account balances B) confirmation of accounts receivable balance received from a customer C) internal memo explaining the issuance of a credit memo D) copy of month-end adjusting entries

B Terms: Audit evidence qualities of relevance and reliability Diff: Easy Objective: LO 7-3 AACSB: Analytic thinking

7.8 Learning Objective 7-8 1) When preparing and organizing audit files, A) the rules established by the SEC and PCAOB must be followed. B) a lead schedule contains the detailed accounts from the general ledger making up the line item on the trial balance. C) a working trial balance is considered part of the permanent file. D) the audit program is not part of the audit files.

B Terms: Audit files Diff: Moderate Objective: LO 7-8 AACSB:

25) You are auditing the company's purchasing process for goods and services. You are primarily concerned with the company not recording all purchase transactions. Which audit procedure below would be the most effective audit procedure in this case? A) vouching from the accounts payable account to the vendor invoices B) tracing vendor invoices to recorded amounts in the accounts payable account C) confirmation accounts payable recorded amounts D) reconciling the accounts payable subsidiary ledger to the accounts payable account

B Terms: Audit procedure for recording all purchase transactions Diff: Challenging Objective: LO 7-4 AACSB:

22) The auditor is concerned that a client is failing to bill customers for shipments. An audit procedure that would gather relevant evidence would be to A) select a sample of duplicate sales invoices and trace each to related shipping documents. B) trace a sample of shipping documents to related duplicate sales invoices. C) trace a sample of Sales Journal entries to the Accounts Receivable subsidiary ledger. D) compare the total of the Schedule of Accounts Receivable with the balance of the Accounts Receivable account in the general ledger.

B Terms: Audit procedure to gather relevant evidence that client fails to bill Diff: Challenging Objective: LO 7-4 AACSB: Analytic thinking

15) The preliminary audit strategy A) is set before the auditor understands the client's reasons for the audit. B) guides the development of the audit plan. C) is determined after the engagement staffing is set. D) is the detailed steps to be followed for the substantive audit tests.

B Terms: Audit strategy Diff: Moderate Objective: LO 8-2 AACSB:

7) With whom should the auditor communicate whenever he or she determines that senior management fraud may be present, even if the matter might be considered inconsequential? A) PCAOB B) audit committee C) an appropriate level of management that is at least one level above those involved D) the internal auditors

B Terms: Auditor communicates with whom when senior management fraud may be present Diff: Moderate Objective: LO 10-7 AACSB:

3) Which of the following is not a category of inquiry used by auditors? A) assessment inquiry B) declarative inquiry C) interrogative inquiry D) informational inquiry

B Terms: Category of inquiry used by auditors Diff: Moderate Objective: LO 10-7 AACSB:

9) Which ratio is computed by dividing operating income by net sales? A) gross profit percent B) profit margin C) return on sales D) return on assets

B Terms: Common financial ratios Diff: Moderate Objective: LO 7-6 AACSB:

5) To determine accounts receivable turnover, net sales is divided by A) beginning net accounts receivable. B) average gross receivables. C) cost of goods sold. D) 365 days.

B Terms: Common financial ratios Diff: Moderate Objective: LO 7-6 AACSB: Analytic thinking

9) Which of the following statements is true regarding communications between predecessor and successor auditors? A) The burden of initiating the communication rests with the predecessor. B) The predecessor's response can be limited to stating that no information will be provided. C) The predecessor should communicate with the successor only if the client is public. D) The predecessor auditor of a public company does not need permission from the client before communicating with the successor auditor.

B Terms: Communications between predecessor and successor auditors Diff: Moderate Objective: LO 8-2 AACSB:

18) Indicate whether confirmation of accounts receivable and accounts payable, provided they each are significant accounts, is required or optional. A) Accounts Receivable Accounts Payable Required Required B) Accounts Receivable Accounts Payable Required Optional C) Accounts Receivable Accounts Payable Optional Required D) Accounts Receivable Accounts Payable Optional Optional

B Terms: Confirmation of accounts receivable and accounts payable Diff: Moderate Objective: LO 7-4 AACSB:

16) When practical and reasonable, U.S. auditing standards require the confirmation of A) individual transactions between organizations, such as sales transactions. B) accounts receivable. C) fixed asset additions. D) payroll expenses.

B Terms: Confirmations Diff: Moderate Objective: LO 7-4 AACSB:

17) To be considered reliable evidence, confirmations must be controlled by A) the client's employee responsible for accounts receivable. B) the external auditor. C) the client's internal audit department. D) the client's controller or CFO.

B Terms: Confirmations controlled to be considered reliable evidence Diff: Challenging Objective: LO 7-4 AACSB:

1) Which of the following best defines fraud in a financial statement auditing context? A) Fraud is an unintentional misstatement of the financial statements. B) Fraud is an intentional misstatement of the financial statements. C) Fraud is either an intentional or unintentional misstatement of the financial statements, depending on materiality. D) Fraud is either an intentional or unintentional misstatement of the financial statements, depending on consistency.

B Terms: Definition of fraud in financial statement auditing Diff: Easy Objective: LO 10-1 AACSB:

1) Auditors are ________ to document the known and likely misstatements in the financial statements under audit. A) permitted B) required C) not allowed D) strongly encouraged

B Terms: Documenting known and likely misstatements Diff: Easy Objective: LO 8-8 AACSB:

25) Which is usually included in the engagement letter? A) The projected type of opinion on the financial statement to be audited Name(s) of the client personnel responsible for supplying the auditor with information Yes Yes B) The projected type of opinion on the financial statement to be audited Name(s) of the client personnel responsible for supplying the auditor with information No No C) The projected type of opinion on the financial statement to be audited Name(s) of the client personnel responsible for supplying the auditor with information Yes No D) The projected type of opinion on the financial statement to be audited Name(s) of the client personnel responsible for supplying the auditor with information No Yes

B Terms: Engagement letter Diff: Moderate Objective: LO 8-2 AACSB:

26) Which is usually included in the engagement letter? A) List of audit procedures to be used in inventory observation The auditors' assessment of audit risk Yes Yes B) List of audit procedures to be used in inventory observation The auditors' assessment of audit risk No No C) List of audit procedures to be used in inventory observation The auditors' assessment of audit risk Yes No D) List of audit procedures to be used in inventory observation The auditors' assessment of audit risk No Yes

B Terms: Engagement letter Diff: Moderate Objective: LO 8-2 AACSB:

4) When evaluating the audit findings, the auditor should be satisfied that the A) amount of known misstatement is documented in the management representation letter. B) estimate of the total known and likely misstatements is less than a material amount. C) estimate of the total likely misstatement includes sample error. D) amount of known misstatement is acknowledged and recorded by the client.

B Terms: Evaluating audit findings and materiality Diff: Challenging Objective: LO 8-8 AACSB:

3) An example of an external document that provides reliable information for the auditor is: a(n) A) employees' time report. B) bank statement. C) purchase order for company purchases. D) carbon copies of a check.

B Terms: External document Diff: Easy Objective: LO 7-4 AACSB:

5) Which of the following is a factor that relates to incentives or pressures to commit fraudulent financial reporting? A) significant accounting estimates involving subjective judgments B) excessive pressure for management to meet debt repayment requirements C) management's practice of making overly aggressive forecasts D) high turnover of accounting, internal audit, and information technology staff

B Terms: Factor that relates to incentives or pressures to commit fraudulent financial reporting Diff: Moderate Objective: LO 10-2 AACSB:

8) Which of the following is a factor that relates to incentives/pressures to misappropriate assets? A) weak internal controls B) significant personal financial obligations C) management's practice of making overly aggressive forecasts D) anger and fear

B Terms: Factor that relates to incentives to misappropriate assets Diff: Moderate Objective: LO 10-2 AACSB:

9) The five steps in applying materiality are listed below in random order. 1. Estimate the combined misstatement. 2. Estimate the total misstatement in the segment. 3. Set materiality for the financial statements as a whole. 4. Determine performance materiality. 5. Compare combined estimate with preliminary judgment about materiality. The first three steps in correct sequence would be A) 1, 2, 5 B) 3, 4, 2 C) 2, 1, 5 D) 3, 2, 4

B Terms: Five steps in applying materiality Diff: Moderate Objective: LO 8-6 AACSB:

1) To address heightened risks of fraud, the auditor can do all of the following except A) use specialists to assist in evaluating the accuracy and reasonableness of management's key estimates. B) decrease the amount of substantive tests. C) use ACL or IDEA to search for fictitious revenue transactions. D) use EXCEL to perform analytical procedures at the disaggregated level.

B Terms: Fraud risk Diff: Moderate Objective: LO 10-7 AACSB:

4) Most cases of fraudulent reporting involve A) inadequate disclosures. B) an overstatement of income. C) an overstatement of liabilities. D) an overstatement of expenses.

B Terms: Fraudulent financial reporting Diff: Easy Objective: LO 10-1 AACSB:

3) If an auditor establishes a relatively high level for materiality, then the auditor will A) accumulate more evidence than if a lower level had been set. B) accumulate less evidence than if a lower level had been set. C) accumulate approximately the same evidence as would be the case were materiality lower. D) accumulate an undetermined amount of evidence.

B Terms: High level for materiality Diff: Easy Objective: LO 8-6 AACSB:

3) Initial audit planning involves four matters. Which of the following is not one of these? A) Develop an overall audit strategy. B) Request that bank balances be confirmed. C) Schedule engagement staff and audit specialists. D) Identify the client's reason for the audit.

B Terms: Initial audit planning Diff: Easy Objective: LO 8-2 AACSB:

2) Companies may intentionally understate earnings when income is high to create ________ that may be used in future years to increase earnings. A) income smoothing B) cookie jar reserves C) cash D) sales

B Terms: Intentionally understate earnings; Reserve earnings Diff: Easy Objective: LO 10-1 AACSB:

4) Which is a liquidity activity ratio? A) profit margin B) inventory turnover C) return on assets D) times interest earned

B Terms: Liquidity ratio Diff: Moderate Objective: LO 8-4 AACSB:

10) Which of the following statements is not correct? A) Materiality is a relative rather than an absolute concept. B) The most important base used as the criterion for deciding materiality is total assets. C) Qualitative factors as well as quantitative factors affect materiality. D) Given equal dollar amounts, frauds are usually considered more important than errors.

B Terms: Materiality Diff: Moderate Objective: LO 8-6 AACSB:

8) An auditor should examine minutes of the board of directors' meetings A) through the date of the financial statements. B) through the date of the audit report. C) only at the beginning of the audit. D) on a test basis.

B Terms: Minutes of the board of directors' meetings Diff: Moderate Objective: LO 8-3 AACSB:

10) Which of the following is an accurate statement regarding the misappropriation of assets? A) In most cases, the amounts involved are material to the financial statements. B) Misappropriation of assets can easily increase in size over time and can lead to significant reputational harm. C) Management should not be concerned about minor misappropriations. D) Asset misappropriation schemes are less common than fraudulent financial statement schemes.

B Terms: Misappropriation of assets Diff: Moderate Objective: LO 10-1 AACSB:

7) Misappropriation of assets is normally perpetrated by A) members of the board of directors. B) employees at lower levels of the organization. C) management of the company. D) the internal auditors.

B Terms: Misappropriation of assets normally; perpetrators Diff: Easy Objective: LO 10-1 AACSB:

13) Which of the following is the most objective type of evidence? A) a letter written by the client's attorney discussing the likely outcome of outstanding lawsuits B) the physical count of securities and cash C) inquiries of the credit manager about the collectability of noncurrent accounts receivable D) observation of cobwebs on some inventory bins

B Terms: Most objective type of audit evidence Diff: Moderate Objective: LO 7-3 AACSB:

20) When developing the overall strategy for the audit, the auditor will A) decide whether to accept a new client. B) determine if any audit specialists will be required. C) identify why the auditor needs an audit. D) obtain an engagement letter.

B Terms: Overall strategy for the audit Diff: Challenging Objective: LO 8-2 AACSB:

5) Which party has the primary responsibility to oversee an organization's financial reporting and internal control process? A) the board of directors B) the audit committee C) management of the company D) the financial statement auditors

B Terms: Party with primary responsibility to oversee organization's financial reporting and internal control processes Diff: Moderate Objective: LO 10-4 AACSB:

10) Which of the following statements is not correct? A) It is possible to vary the sample size from one unit to 100% of the items in the population. B) Cost is an adequate justification for not gathering an adequate sample size. C) The decision of how many items to test must be made by the auditor for each audit procedure. D) The sample size for any given procedure is likely to vary from audit to audit.

B Terms: Persuasive audit evidence Diff: Moderate Objective: LO 7-3 AACSB:

10) The purpose of an engagement letter is to A) document the CPA firm's responsibility to external users of the audited financial statements. B) document the terms of the engagement. C) notify the audit staff of an upcoming engagement so that personnel scheduling can be facilitated. D) emphasize management's responsibility for approving the audit program.

B Terms: Purpose of engagement letter Diff: Moderate Objective: LO 8-2 AACSB:

16) The purpose of the requirement in having communication between the predecessor and successor auditors is to A) allow the predecessor to disclose information which would otherwise be confidential. B) help the successor auditor to evaluate whether to accept the engagement. C) help the client by facilitating the change of auditors. D) ensure the predecessor collects all unpaid fees prior to a change in auditor.

B Terms: Purpose of having communication between predecessor and successor audit Diff: Challenging Objective: LO 8-2 AACSB:

11) Related party A) transactions must be disclosed in the footnotes even if the amounts are immaterial. B) disclosures include the nature of the related party relationship and a description of the transaction. C) transactions are considered arm's-length transactions. D) disclosures are required only for public companies.

B Terms: Related party transactions Diff: Moderate Objective: LO 8-3 AACSB:

8) Which of the following is a correct statement regarding the misappropriation of receipts involving revenue? A) One of the easiest frauds to detect is when a sale is not recorded and the cash from the sale is stolen. B) If a customer's payment is stolen, regular billing of unpaid accounts can uncover the fraud unless the fraud perpetrator does something to hide the theft. C) Misappropriation of cash receipts is generally as material as fraudulent reporting of revenues. D) Analytical procedures can detect relatively small thefts of sales and related cash receipts.

B Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 10-6 AACSB:

9) According to the Association of Certified Fraud Examiners, the average company loses ________ percent of its revenues to fraud. A) one B) five C) ten D) fifteen

B Terms: Revenues lost to fraud Diff: Moderate Objective: LO 10-1 AACSB:

2) Most auditors assess the risk of material misstatement as high for related parties and related-party transactions because A) of the unique classification of related-party transactions required on the balance sheet. B) of the lack of independence between the parties. C) of the unique classification of related-party transactions required on the income statement. D) it is required by generally accepted accounting principles.

B Terms: Risk of material misstatement assessed high for related party transactions Diff: Easy Objective: LO 8-3 AACSB:

11) Auditors may decide to replace tests of details with analytical procedures when possible because the A) analytical procedures are more reliable. B) analytical procedures are considerably less expensive. C) analytical procedures are more persuasive. D) tests of details are more difficult to interpret.

B Terms: Tests of details of balances; Substantive analytical procedures Diff: Moderate Objective: LO 7-4 AACSB:

7) When the auditor uses tracing as an audit procedure for tests of transactions, she is primarily concerned with which audit objective? A) occurrence B) completeness C) cutoff D) classification

B Terms: Tracing as an audit procedure Diff: Moderate Objective: LO 7-4 AACSB:

1) Calculating the gross margin for the current audit year as a percent of sales and comparing it with previous years is what type of evidence? A) physical examination B) analytical procedures C) observation D) inquiry

B Terms: Vouching as an audit procedure Diff: Easy Objective: LO 7-4 AACSB:

7) A written understanding detailing what the auditor expects from the client in performing an audit will normally be expressed in the A) management letter requested by the auditor. B) engagement letter. C) audit Plan. D) audit Strategy for the client.

B Terms: Written understanding detailing what auditor will do and what auditor expects from client in performing audit Diff: Moderate Objective: LO 8-2 AACSB:

4) Which of the following is an accurate statement regarding inherent risk? A) The profession has established guidelines for setting inherent risk. B) Auditors are generally conservative in setting inherent risk. C) Factors impacting inherent risk will affect all cycles, balances, and disclosures. D) Inherent risk has no impact on the amount of evidence gathered.

B) Auditors are generally conservative in setting inherent risk.

12) Inherent risk and control risk A) are inversely related to each other. B) are inversely related to detection risk. C) are directly related to detection risk. D) are directly related to audit risk.

B) are inversely related to detection risk.

Based on audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would A) increase materiality levels. B) decrease detection risk. C) decrease substantive testing. D) increase inherent risk.

B) decrease detection risk.

6) If the auditor decides to reduce acceptable audit risk, planned detection risk A) increases. B) decreases. C) stay the same. D) cannot be determined.

B) decreases.

4) Risk of material misstatement at the assertion level A) is only relevant to account balances. B) determines the nature, timing, and extent of further audit procedures. C) refers to risks that are pervasive to the financial statements as a whole. D) consists of business risk and inherent risk.

B) determines the nature, timing, and extent of further audit procedures.

4) The measurement of the auditor's assessment of the susceptibility of an assertion to material misstatement, before considering the effectiveness of related internal controls is defined as A) audit risk. B) inherent risk. C) sampling risk. D) detection risk.

B) inherent risk.

3) When using the audit risk model, A) auditors find it relatively easy to measure the components of the model. B) many auditors use broad and subjective measurement terms. C) auditors find it easy to measure the amount of evidence implied by a given planned detection risk. D) auditors are only concerned with understating accounts.

B) many auditors use broad and subjective measurement terms.

14) Auditors typically rely on internal controls of their private company clients A) only as needed to complete the audit and satisfy Sarbanes-Oxley requirements. B) only if the controls are determined to be effective. C) only if the client asks an auditor to test controls. D) only if the controls are sufficient to increase control risk to an acceptable level.

B) only if the controls are determined to be effective.

2) Which of the following will generally be considered a significant risk? A) a sale to a customer B) the determination of the amount of bad debt expense C) the purchase of inventory D) obtaining a loan from the bank

B) the determination of the amount of bad debt expense

9) Which of the following is not a weakness of using industry averages for auditing? A) The industry data are broad averages. B) Different companies follow different accounting methods. C) They can be helpful in identifying potential misstatements. D) All of the above are weaknesses.

C Terms: Analytical analysis; comparison of client and industry data Diff: Moderate Objective: LO 7-5 AACSB:

7) Substantive analytical procedures performed during the testing phase of the audit A) are required under generally accepted auditing standards. B) are always done independently from other audit procedures. C) are used as a substantive test in support of account balances. D) do not need to be documented in the working papers.

C Terms: Analytical procedures in stages of audit Diff: Moderate Objective: LO 7-5 AACSB:

8) The two characteristics of the appropriateness of evidence are A) relevance and timeliness. B) relevance and accuracy. C) relevance and reliability. D) reliability and accuracy.

C Terms: Appropriateness of audit evidence Diff: Easy Objective: LO 7-3 AACSB:

2) Audit documents A) are kept by the client for easy reference for their accounting staff. B) should be considered as a substitute for the clients accounting records. C) are designed to facilitate the review and supervision of the work performed by the audit team by a reviewing partner. D) prepared during the engagement are the property of the client once the audit bill is paid.

C Terms: Audit documentation Diff: Moderate Objective: LO 7-7 AACSB:

2) Audit documentation should possess certain characteristics. Which of the following is true regarding those characteristics? A) Audit documentation should be indexed and cross-referenced Audit documentation should be organized to benefit the client's staff Yes Yes B) Audit documentation should be indexed and cross-referenced Audit documentation should be organized to benefit the client's staff No No C) Audit documentation should be indexed and cross-referenced Audit documentation should be organized to benefit the client's staff Yes No D) Audit documentation should be indexed and cross-referenced Audit documentation should be organized to benefit the client's staff No Yes

C Terms: Audit documentation characteristics Diff: Moderate Objective: LO 7-8 AACSB:

6) What type of supporting schedule is designed to show detailed tests performed, does not tie in to the general ledger, but must state a positive or negative conclusion about the objective of the test? A) outside documentation B) reconciliation of amounts C) examination of supporting documents D) substantive analytical procedures

C Terms: Audit documentation; supporting schedules Diff: Moderate Objective: LO 7-8 AACSB:

12) Which of the following is a correct statement regarding audit evidence? A) A large sample of evidence provided by an independent party is always considered persuasive evidence. B) A small sample of only one or two pieces of highly appropriate evidence is always considered persuasive evidence. C) The auditor must obtain a sufficient amount of relevant and reliable evidence to form an opinion on the fairness of the financial statements. D) Evidence is usually more reliable for balance sheet accounts when it is obtained within six months of the balance sheet date.

C Terms: Audit evidence Diff: Moderate Objective: LO 7-3 AACSB:

20) Which of the following statements is true? A) Evidence must be relevant to all of the audit objectives. B) If evidence is subjective, it cannot be reliable. C) Evidence obtained directly by the auditor may not be reliable if the auditor lacks the qualifications to evaluate the evidence. D) The persuasiveness of evidence can be evaluated after considering its sufficiency.

C Terms: Audit process Diff: Moderate Objective: LO 7-3 AACSB:

13) The two major factors affecting acceptable audit risk are A) inherent risk and the intended uses of the financial statements. B) control risk and the intended uses of the financial statements. C) the likely statement users and their intended uses of the statements. D) the audit firm and the intended uses of the statements

C Terms: Audit risk Diff: Moderate Objective: LO 8-2 AACSB:

6) Auditing standards ________ that the basis used to determine the preliminary judgment about materiality be documented in the audit files. A) permit B) do not allow C) require D) strongly encourage

C Terms: Auditing standards; Preliminary judgment about materiality documented Diff: Easy Objective: LO 8-6 AACSB:

2) When the auditor uses supporting evidence for amounts posted to account balances with documentary evidence, that process is called A) inquiry. B) confirmation. C) vouching. D) physical examination.

C Terms: Auditor develops supporting evidence for amounts posted with documentary evidence Diff: Easy Objective: LO 7-4 AACSB:

2) Company management is often under pressure to increase revenue and/or net income. One approach is to use a "bill and hold" arrangement. This is an example of which of the following? A) significant accounting estimates B) fictitious revenue recorded C) premature revenue recognized D) alteration of cutoff documents

C Terms: Bill and hold arrangement to increase revenue and/or net income Diff: Moderate Objective: LO 10-6 AACSB:

9) According to a KPMG survey, most fraud perpetrators A) are over the age of 65. B) work on the assembly line. C) have worked for the company for over ten years. D) are female.

C Terms: Characteristics of fraud perpetrators Diff: Moderate Objective: LO 10-2 AACSB:

7) Which of the following is an accurate statement regarding a public company's code of ethics? A) A code of ethics is required under The Foreign Corrupt Practices Act. B) A code of ethics is required only for mid-level managers and below. C) The SEC requires companies to disclose amendments and waivers to the code of ethics for the CEO, CFO and principal accounting officer. D) The PCAOB requires companies to review their code of ethics every five years.

C Terms: Code of ethics Diff: Moderate Objective: LO 8-3 AACSB:

8) Which ratio do auditors find useful for assessing misstatements in sales, cost of goods sold, accounts receivable, and inventory? A) earnings per share B) profit margin C) gross profit percent D) current ratio

C Terms: Common financial ratios Diff: Moderate Objective: LO 7-6 AACSB:

7) Two determinants of the persuasiveness of evidence are A) competence and sufficiency. B) relevance and reliability. C) appropriateness and sufficiency. D) independence and effectiveness.

C Terms: Determinants of persuasiveness of evidence Diff: Easy Objective: LO 7-3 AACSB:

1) Auditing standards require that auditors document A) specific risks of fraud identified at the financial statement level, but not at the assertion level. B) all conversations with management. C) results of the procedures performed to address the risk of management override of controls. D) all of the above.

C Terms: Documenting fraud assessment Diff: Moderate Objective: LO 10-8 AACSB:

5) Which of the following statements is false? A) Either an overstatement of an asset account or an understatement of a liability account would have the same effect on the income statement. B) A misclassification in the balance sheet will have no effect on operating income. C) Either an overstatement of an asset account or an overstatement of a liability account would have the same effect on the income statement. D) Either an understatement of an asset account or an overstatement of a liability account would have the same effect on the income statement.

C Terms: Effects of misstatements Diff: Moderate Objective: LO 8-7 AACSB:

23) Which is usually included in an engagement letter? A) The financial statements are the responsibility of the company's management Ratios to be used by the auditor in the planning phase Yes Yes B) The financial statements are the responsibility of the company's management Ratios to be used by the auditor in the planning phase No No C) The financial statements are the responsibility of the company's management Ratios to be used by the auditor in the planning phase Yes No D) The financial statements are the responsibility of the company's management Ratios to be used by the auditor in the planning phase No Yes

C Terms: Engagement letter Diff: Moderate Objective: LO 8-2 AACSB:

24) When may the auditor refer to a specialist in the audit report? A) Only if the specialist's report results in a modification of the audit opinion Only if the specialist assisted in the audit of an account material to the financial statements Yes Yes B) Only if the specialist's report results in a modification of the audit opinion Only if the specialist assisted in the audit of an account material to the financial statements No No C) Only if the specialist's report results in a modification of the audit opinion Only if the specialist assisted in the audit of an account material to the financial statements Yes No D) Only if the specialist's report results in a modification of the audit opinion Only if the specialist assisted in the audit of an account material to the financial statements No Yes

C Terms: Engagement letter Diff: Moderate Objective: LO 8-2 AACSB:

14) An engagement letter sent to a publicly held audit client usually would not include a(n) A) reference to the auditor's responsibility for the detection of errors or irregularities. B) estimation of the time to be spent on the audit work by audit staff and management. C) statement that management advisory services would be made available upon request. D) reference to management's responsibility for the financial statements.

C Terms: Engagement letter sent to publicly held client Diff: Challenging Objective: LO 8-2 AACSB:

16) Evidence is generally considered appropriate when A) it has been obtained by random selection. B) there is enough of it to afford a reasonable basis for an opinion on financial statements. C) it is relevant to the audit objective being tested. D) it consists of written statements made by managers of the company under audit.

C Terms: Evidence considered appropriate Diff: Moderate Objective: LO 7-3 AACSB:

4) An example of a document the auditor receives from the client, but which was prepared by someone outside the client's organization is a A) confirmation. B) sales invoice. C) vendor invoice. D) bank reconciliation.

C Terms: External document Diff: Easy Objective: LO 7-4 AACSB:

12) Which of the following is a risk factor related to opportunities and financial statement fraud? A) ineffective communication of company values B) promotions inconsistent with expectations C) significant related-party transactions D) adverse relationships between management and employees

C Terms: Factor relates to opportunities to commit fraudulent financial reporting Diff: Easy Objective: LO 10-2 AACSB:

3) Which of the following is not a factor that relates to opportunities to commit fraudulent financial reporting? A) lack of controls related to the calculation and approval of accounting estimates B) ineffective oversight of financial reporting by the board of directors C) management's set of ethical values D) high turnover of accounting, internal audit, and information technology staff

C Terms: Factor relates to opportunities to commit fraudulent financial reporting Diff: Moderate Objective: LO 10-2 AACSB:

6) Which of the following is a factor that relates to attitudes or rationalization to misappropriate assets? A) significant accounting estimates involving subjective judgments B) excessive pressure for management to meet debt repayment requirements C) a sense of superiority by executives D) high turnover of accounting, internal audit and information technology staff

C Terms: Factor that relates to incentives to misappropriate assets Diff: Moderate Objective: LO 10-2 AACSB:

2) Although the financial statements of all companies are potentially subject to manipulation, the risk is greater for companies that A) are heavily regulated. B) have low amounts of debt. C) have to make significant judgments for accounting estimates. D) operate in stable economic environments.

C Terms: Financial statement manipulation risk is elevated Diff: Easy Objective: LO 10-2 AACSB:

6) Which of the following is a form of earnings management in which revenues and expenses are shifted between periods to reduce fluctuations in earnings? A) fraudulent financial reporting B) expense smoothing C) income smoothing D) Each of the above is correct.

C Terms: Form of earnings management Diff: Easy Objective: LO 10-1 AACSB:

4) Fraud awareness training should be A) broad and all-encompassing. B) extensive and include details for all functional areas. C) specifically related to the employee's job responsibility. D) focused on employees understanding the importance of ethics.

C Terms: Fraud awareness training Diff: Moderate Objective: LO 10-4 AACSB:

9) When analyzing accounts for fraud risk, A) companies will generally attempt to overstate accounts payable and net income. B) the inventory account is generally not susceptible to fraud since the auditor must verify the existence of the inventory. C) payroll is rarely a significant risk for fraudulent financial reporting. D) fixed assets are rarely stolen because of their large size.

C Terms: Fraud risk Diff: Moderate Objective: LO 10-6 AACSB:

13) Relating to opportunities, why do most people commit fraud? A) They need to fund an extravagant lifestyle. B) They feel a sense of superiority. C) There are weak internal controls. D) They need to meet pre-specified business targets.

C Terms: Fraud risk conditions and opportunity Diff: Moderate Objective: LO 10-2 AACSB:

5) ________ is fraud that involves theft of an entity's assets. A) Fraudulent financial reporting B) A "cookie jar" reserve C) Misappropriation of assets D) Income smoothing

C Terms: Fraud that involves theft of entity's assets Diff: Easy Objective: LO 10-1 AACSB:

10) In the fraud triangle, fraudulent financial reporting and misappropriation of assets A) share little in common. B) share most of the same risk factors. C) share the same three conditions of the fraud triangle. D) share most of the same conditions. of the fraud triangle.

C Terms: Fraud triangle Diff: Moderate Objective: LO 10-2 AACSB:

8) Fraudulent financial reporting A) always involves inadequate disclosures. B) can be intentional or unintentional. C) can involve understating net income in order to reduce income taxes. D) all of the above

C Terms: Fraudulent financial reporting Diff: Easy Objective: LO 10-1 AACSB:

10) When dealing with fraudulent financial reporting risk for accounts payable, A) companies will generally tend to overstate accounts payable. B) it is difficult for the auditor to verify if all liabilities have been recorded if prenumbered receiving reports are used. C) companies have used fictitious reductions to accounts payable to overstate net income. D) accounts payable is rarely a significant risk area for fraudulent financial reporting.

C Terms: Fraudulent financial reporting risk; accounts payable Diff: Moderate Objective: LO 10-6 AACSB:

3) A company is concerned with the theft of cash after the sale has been recorded. One way in which fraudsters conceal the theft is by a process called "lapping." Which of the following best describes lapping? A) reduce the customer's account by recording a sales return B) write off the customer's account C) apply the payment from another customer to the customer's account D) reduce the customer's account by recording a sales allowance

C Terms: Lapping; Theft of cash Diff: Moderate Objective: LO 10-6 AACSB:

7) When allocating performance materiality, A) it is easy to predict in advance which accounts are most likely to be misstated. B) only overstatements need to be considered. C) professional judgment is critical. D) the sum of all the performance materiality levels cannot exceed the preliminary judgment about materiality.

C Terms: Major difficulties auditors face when allocating materiality to balance sheet accounts Diff: Moderate Objective: LO 8-7 AACSB:

 1) Auditing standards define ________ as the magnitude of misstatements that individually, or when aggregated with other misstatements, could reasonably be expected to influence the economic decisions of users made on the basis of the financial statements. A) fraud B) inherent risk C) materiality D) significant

C Terms: Materiality Diff: Easy Objective: LO 8-5 AACSB:

2) ________ misstatements are those where the auditor can determine the amount of the misstatement in the account. A) Potential B) Likely C) Known D) Projected

C Terms: Misstatements where auditor can determine the amount Diff: Moderate Objective: LO 8-8 AACSB:

1) Which of the following is an accurate statement regarding audit evidence? A) Responses to the auditor's questions by client employees is considered highly persuasive evidence. B) Audit evidence should provide an absolute level of assurance. C) The auditor uses evidence to determine whether the statements are fairly presented. D) All evidence must be highly persuasive.

C Terms: Nature of audit evidence Diff: Easy Objective: LO 7-1 AACSB:

4) Smith, CPA, has requested permission to communicate with the predecessor auditor in order to review certain workpapers for high risk accounts for a new audit client. The new audit client's refusal to allow this communication to occur would impact Smith's decision concerning A) the auditor's ability to design audit tests. B) possible scope exception due to lack of access. C) the desirability of accepting the prospective engagement. D) violation of the GAAP rules concerning consistency and comparability of financial information.

C Terms: New audit clients refusal to allow communication between predecessor and successor auditors Diff: Easy Objective: LO 8-2 AACSB:

2) Which of the following parties is responsible for implementing internal controls to minimize the likelihood of fraud? A) external auditors B) audit committee members C) management D) Committee of Sponsoring Organizations

C Terms: Party responsible for implementing internal controls to minimize likelihood of fraud Diff: Moderate Objective: LO 10-4 AACSB:

3) The permanent audit file would usually include the A) client's working trial balance. B) summary of the risk assessment procedures performed. C) organizational chart of the company's employees. D) summary of the auditors test of controls for the current years audit.

C Terms: Permanent file Diff: Challenging Objective: LO 7-8 AACSB:

17) Given the economic and time constraints in which auditors can collect evidence regarding management assertions about the financial statements, the auditor normally gathers evidence that is A) irrefutable. B) conclusive. C) persuasive. D) completely convincing.

C Terms: Persuasive audit evidence Diff: Moderate Objective: LO 7-3 AACSB:

17) The predecessor auditor is required to respond to the request of the successor auditor for information, but the response can be limited to stating that no information will be provided when A) the predecessor auditor has poor relations with the successor auditor. B) the client is dissatisfied with the predecessor's work. C) there are actual or potential legal problems between the client and the predecessor. D) the predecessor believes that the client lacks integrity.

C Terms: Predecessor auditor respond to request of successor auditor for information Diff: Challenging Objective: LO 8-2 AACSB:

1) Which of the following is a correct statement regarding analytical procedures? A) A major strength in using industry ratios for auditing is the difference between the nature of the client's financial information and that of the firms making up the industry totals. B) Common-size financial statements display all items as a percentage change from a base year. C) In identifying areas of specific risk, the auditor is likely to focus on the liquidity activity ratios. D) In order to look for a misstatement in the allowance for bad debts, the auditor should divide gross sales by sales returns and allowances.

C Terms: Preliminary analytical procedures Diff: Moderate Objective: LO 8-4 AACSB:

1) Audit standards require the auditor to consider materiality early in the audit. Which statement(s) regarding preliminary materiality are true? I. Preliminary materiality may change during the engagement. II. Preliminary materiality is the maximum amount by which the auditor believes the financials could be misstated and still not affect the decisions of reasonable users. A) I only B) II only C) both I and II D) neither I nor II

C Terms: Preliminary materiality assessment Diff: Easy Objective: LO 8-6 AACSB:

5) Which of the following is the primary basis used to decide materiality for a profit-oriented entity? A) net sales B) net assets C) net income before tax D) all of the above

C Terms: Primary basis to decide materiality for a for-profit entity Diff: Easy Objective: LO 8-6 AACSB:

7.7 Learning Objective 7-7 1) Which of the following best describes one of the primary objectives of audit documentation? A) defend against claims of a deficient audit B) provide a basis for reviewing the work of subordinates C) provide reasonable assurance that the audit was conducted in accordance with auditing standards D) provide additional support of recorded amounts to the client

C Terms: Primary objective of audit documentation Diff: Moderate Objective: LO 7-7 AACSB:

14) The primary purpose of audit procedures is to A) detect all errors or fraudulent activities as well as illegal activities. B) comply with auditing standards promulgated by the PCAOB for publicly held clients. C) gather corroborative audit evidence about management's assertions regarding the client's financial statements. D) determine the amount of errors in the balance sheet accounts in order to adjust the accounts to actual.

C Terms: Primary purpose of audit procedures Diff: Moderate Objective: LO 7-4 AACSB:

2) Why do auditors establish a preliminary judgment about materiality? A) to determine the appropriate level of staff to assign to the audit B) so the client can know what records to make available to the auditor C) to help plan the appropriate evidence to accumulate D) to finalize the control risk assessment

C Terms: Purpose to establish preliminary judgment about materiality Diff: Easy Objective: LO 8-6 AACSB:

8) Qualitative factors can affect an auditor's assessment of materiality. Which of the following statements is true? I. Misstatements that are otherwise immaterial may be material if they affect earnings trends. II. Misstatements that are otherwise minor may be material if there are possible consequences arising from contractual obligations. A) I only B) II only C) I and II D) neither I nor II

C Terms: Qualitative factors can affect auditor's assessment of materiality Diff: Easy Objective: LO 8-6 AACSB:

4) The auditor determines that Matthews Company occupies the 3rd floor of an office tower for which it pays no rent. The most likely explanation is A) they got lucky the landlord hasn't noticed the lack of payments. B) the landlord has weak internal controls over billings. C) a related party transaction in which a major shareholder owns the office tower. D) Matthews Company is engaging in fraudulent activities.

C Terms: Related party transactions Diff: Challenging Objective: LO 8-3 AACSB: Analytic thinking 5) An official record of meetings of the board of directors and stockholders is included in the corporate A) bylaws. B) charter. C) minutes. D) license. Answer: C Terms: Official record of meetings of board of directors and stockholders Diff: Easy Objective: LO 8-3 AACSB:

6) When the auditor suspects that fraud may be present, auditing standards require the auditor to A) terminate the engagement with sufficient notice given to the client. B) issue an adverse opinion or a disclaimer of opinion. C) obtain additional evidence to determine whether material fraud has occurred. D) re-issue the engagement letter.

C Terms: Requirements of auditor when fraud is suspected Diff: Moderate Objective: LO 10-7 AACSB:

7) Fictitious revenues A) increase accounts receivable turnover. B) understate the gross margin percentage. C) lower accounts receivable turnover. D) have no impact on the gross margin percentage.

C Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 10-6 AACSB:

4) Which of the following questions is the auditor not required to ask company management when assessing fraud risk? A) Does management have knowledge of any fraud or suspected fraud within the company? B) What is the nature of the fraud risks identified by management? C) Is management using all assets effectively? D) What internal controls have been implemented to address the fraud risks?

C Terms: Sources of information to assess fraud risks; inquiries of management Diff: Moderate Objective: LO 10-3 AACSB:

10.6 Learning Objective 10-6 1) Auditing standards specifically require auditors to identify ________ as a fraud risk in most audits. A) overstated assets B) understated liabilities C) revenue recognition D) overstated expenses

C Terms: Specific fraud risk areas Diff: Moderate Objective: LO 10-6 AACSB:

14) Which items affect the sufficiency of evidence when choosing a sample? A) Selecting items with a high likelihood of misstatement The randomness of the items selected Yes Yes B) Selecting items with a high likelihood of misstatement The randomness of the items selected No No C) Selecting items with a high likelihood of misstatement The randomness of the items selected Yes No D) Selecting items with a high likelihood of misstatement The randomness of the items selected No Yes

C Terms: Sufficiency of evidence when choosing a sample Diff: Moderate Objective: LO 7-3 AACSB:

18) Which of the following best expresses the understanding of the terms of the engagement that exist between the client and the CPA firm? A) Management asserts there are no errors, material or immaterial, in the general ledger. B) Auditors assert that the primary audit goal is audit efficiency. C) Auditors assert that their primary responsibility is to plan and perform the audit in order to provide reasonable assurance as to the detection of material misstatement due to error or fraud. D) Management asserts that they will provide the auditor with a risk assessment as to material misstatements due to errors or fraud in the company's financial statements.

C Terms: Understand responsibilities of the auditor and company for the audit Diff: Challenging Objective: LO 8-2 AACSB:

1) In order to obtain an understanding of the client's business, the audit firm will consider A) inherent and control risk of the client. B) audit risk to the CPA firm. C) the client's business risk and the risk of material misstatements in the financial statements. D) the CPA firm's potential ongoing revenue from the audit client.

C Terms: Understanding the client's business and industry Diff: Moderate Objective: LO 8-3 AACSB:

9) When auditors use documentation to support recorded transactions and amounts, the process is usually called A) tracing. B) confirmations. C) vouching. D) reperformance.

C Terms: Vouching as an audit procedure Diff: Moderate Objective: LO 7-4 AACSB:

15) Which is a true statement about audit risk? A) Audit risk measures the risk that a material misstatement could occur and not be detected by internal control. B) When auditors decide on a higher acceptable audit risk, they want to be more certain that the financial statements are not materially misstated. C) Audit assurance is the complement of acceptable audit risk. D) There is an inverse relationship between acceptable audit risk and planned detection risk.

C) Audit assurance is the complement of acceptable audit risk.

4) ________ is the risk that the auditor or audit firm will suffer harm after the audit is finished, even though the audit report was correct. A) Inherent risk B) Audit risk C) Engagement risk D) Control risk

C) Engagement risk

10) Planned detection risk I. determines the amount of substantive evidence the auditor plans to accumulate. II. is dependent on audit risk, inherent risk, and control risk. A) I only B) II only C) I and II D) neither I nor II

C) I and II

2) Auditors respond to risk primarily by I. changing the extent of testing. II. changing the types of audit procedures. A) I only B) II only C) I and II D) neither I nor II

C) I and II

1) Which of the following statements regarding inherent risk is correct? A) Inherent risk is unaffected by the auditor's experience with client's organization. B) Most auditors set a low inherent risk in the first year of an audit and increase it if experience shows that it was incorrect. C) Most auditors set a high inherent risk in the first year of an audit and reduce it in subsequent years as they gain more knowledge about the company. D) Inherent risk is dependent upon the strengths in client's internal control system.

C) Most auditors set a high inherent risk in the first year of an audit and reduce it in subsequent years as they gain more knowledge about the company.

18) Which of the following is a correct relationship? A) Acceptable audit risk and planned detection risk have an inverse relationship. B) Control risk and planned detection risk have a direct relationship. C) Planned detection risk and inherent risk have an inverse relationship. D) All of the above are correct relationships.

C) Planned detection risk and inherent risk have an inverse relationship.

2) Which of the following is a correct statement? A) There is no relationship between materiality and risk in auditing. B) Risk is a measure of magnitude or size. C) The combination of performance materiality and the audit risk model factors determines planned audit evidence. D) Performance materiality is part of the audit risk model.

C) The combination of performance materiality and the audit risk model factors determines planned audit evidence.

8) Auditors frequently refer to the terms audit assurance, overall assurance, and level of assurance instead of A) detection risk. B) audit report risk. C) acceptable audit risk. D) inherent risk.

C) acceptable audit risk.

17) When assessing risk, it is important to remember that A) for acceptable audit risk, the SEC decides the risk the CPA firm should take for public clients. B) inherent risk can be changed by the auditor. C) detection risk can only be determined after audit risk, inherent risk, and control risk are determined. D) control risk is determined by company management since they are responsible for internal control.

C) detection risk can only be determined after audit risk, inherent risk, and control risk are determined.

3) Which of the following is not a primary consideration when assessing inherent risk? A) nature of client's business B) existence of related parties C) effectiveness of internal controls D) susceptibility to misappropriation of assets

C) effectiveness of internal controls

2) Risk assessment procedures include A) a required discussion among the staff members of the audit and the client regarding material misstatements in the financial statement. B) determination of the type of audit opinion to issue. C) observation of the entity's operations. D) assessing acceptable audit risk.

C) observation of the entity's operations.

2) The auditor's responsibility section in an audit report states that "...the standards require that we plan and perform the audit to obtain ________ assurance about whether the financial statements are free of material misstatement." What type of assurance is given? A) immediate B) limited C) reasonable D) absolute

C) reasonable

16) The risk of material misstatement refers to A) control risk and acceptable audit risk. B) inherent risk. C) the combination of inherent risk and control risk. D) inherent risk and audit risk.

C) the combination of inherent risk and control risk.

1) The amount(s) set by the auditor at less than the materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole is referred to as A) the materiality range. B) the error range. C) tolerable materiality. D) performance materiality.

D Terms: Allocate preliminary judgment about materiality to account balances Diff: Easy Objective: LO 8-7 AACSB:

4) Which of the following statements is true concerning the allocation of preliminary materiality? A) It is necessary to allocate preliminary materiality to financial statements as a whole rather than by segments. B) Preliminary materiality should be allocated to income statement accounts only. C) Preliminary materiality is required by the SEC. D) The PCAOB term used when preliminary materiality is allocated to segments is tolerable misstatement.

D Terms: Allocation of preliminary materiality Diff: Moderate Objective: LO 8-7 AACSB:

7) Amounts involving fraud are usually considered ________ important than unintentional errors of equal dollar amounts. A) less B) no less C) no more D) more

D Terms: Amounts involving fraud Diff: Easy Objective: LO 8-6 AACSB:

26) Which of the following discoveries through the use of analytical procedures would most likely indicate a relatively high risk of financial failure? A) a decline in gross margin percentages B) an increase in the balance in fixed assets C) an increase in the ratio of allowance for uncollectible accounts to gross accounts receivable, while at the same time accounts receivable turnover also decreased D) a higher than normal ratio of long-term debt to net worth as well as a lower than average ratio of profits to total assets

D Terms: Analytical procedures Diff: Challenging Objective: LO 7-4 AACSB:

8) Auditors compare client data with A) industry data. B) client-determined expected results. C) similar prior-period data. D) all of the above.

D Terms: Analytical procedures Diff: Easy Objective: LO 7-5 AACSB:

2) Which of the following would not be classified as an analytical procedure? A) benchmarking the company's profitability ratios against others in the industry B) preparing common size financial statements C) calculating income statement account balances as a percent of sales when the level of sales has changed from the prior year D) reconciling fixed asset dispositions with the fixed asset ledger

D Terms: Analytical procedures Diff: Moderate Objective: LO 8-4 AACSB:

4) Analytical procedures can be very effective in detecting inventory fraud. Which of the following analytical procedures would not be useful in detecting fraud? A) gross margin percentage B) inventory turnover C) cost of sales percentage D) accounts receivable turnover

D Terms: Analytical procedures to detect inventory fraud Diff: Challenging Objective: LO 10-6 AACSB:

8) Which type of supporting schedule is designed to show the activity in a general ledger account during the entire period under audit? A) trial balance B) reconciliation of amounts C) summary of procedures D) analysis

D Terms: Audit documentation; supporting schedules Diff: Moderate Objective: LO 7-8 AACSB:

12) Auditors should understand client objectives related to A) reliability of financial reporting. B) effectiveness and efficiency of operations. C) compliance with laws and regulations. D) all of the above.

D Terms: Client objectives and strategies Diff: Moderate Objective: LO 8-3 AACSB:

20) Which of the following is not a correct combination of terms and related type of audit evidence? A) inquire — inquiries of client B) count — physical examination C) recompute — recalculation D) read — documentation

D Terms: Combination of terms and related audit evidence Diff: Moderate Objective: LO 7-4 AACSB:

21) Which of the following statements relating to the competence of evidential matter is always true? A) Evidence from outside an enterprise is always reliable. B) Accounting data developed under satisfactory conditions of internal control is not reliable. C) Oral representations made by management are not reliable evidence. D) Evidence must be both reliable and relevant to be considered appropriate.

D Terms: Competence of evidential matter Diff: Challenging Objective: LO 7-3 AACSB:

27) Which of the following statements is correct regarding the costs involved in obtaining evidence? A) Physical examination is usually the least expensive type of audit evidence Cost of obtaining evidence may be a factor in deciding whether to obtain that evidence Yes Yes B) Physical examination is usually the least expensive type of audit evidence Cost of obtaining evidence may be a factor in deciding whether to obtain that evidence No No C) Physical examination is usually the least expensive type of audit evidence Cost of obtaining evidence may be a factor in deciding whether to obtain that evidence Yes No D) Physical examination is usually the least expensive type of audit evidence Cost of obtaining evidence may be a factor in deciding whether to obtain that evidence No Yes

D Terms: Costs of obtaining audit evidence Diff: Challenging Objective: LO 7-4 AACSB:

2) Upon discovering information that indicates a material misstatement due to fraud may have occurred, auditors should A) acquire additional evidence as needed. B) thoroughly probe the issues. C) consult with other team members. D) all of the above

D Terms: Criteria by which an auditor evaluates information Diff: Easy Objective: LO 10-3 AACSB:

12) Factors that determine the auditor's willingness to accept a document as reliable evidence include A) whether it is internal or external. B) whether it was created and processed under conditions of effective internal control. C) whether it is an original document or a photocopy. D) all of the above.

D Terms: Documents as reliable audit evidence Diff: Moderate Objective: LO 7-4 AACSB:

9) An effective code of conduct should contain the company's policies regarding A) conflicts of interests. B) kickbacks. C) gifts and entertainment. D) all of the above.

D Terms: Elements of code of conduct Diff: Moderate Objective: LO 10-4 AACSB:

21) Which is usually included in an engagement letter? A) Estimate of hours required to complete audit Dollar estimate of fees to be billed to the client Yes Yes B) Estimate of hours required to complete audit Dollar estimate of fees to be billed to the client No No C) Estimate of hours required to complete audit Dollar estimate of fees to be billed to the client Yes No D) Estimate of hours required to complete audit Dollar estimate of fees to be billed to the client No Yes

D Terms: Engagement letter Diff: Moderate Objective: LO 8-2 AACSB:

7) Which of the following is not a factor that relates to opportunities to misappropriate assets? A) inadequate internal controls over assets B) presence of large amounts of cash on hand C) inappropriate segregation of duties or independent checks on performance D) adverse relationships between management and employees

D Terms: Factor that relates to opportunities to misappropriate assets Diff: Moderate Objective: LO 10-2 AACSB:

3) Which financial ratio is computed by dividing current assets by current liabilities? A) quick ratio B) debt to equity C) accounts receivable turnover D) current ratio

D Terms: Financial ratios; short-term debt paying ability Diff: Moderate Objective: LO 7-6 AACSB: Analytic thinking 

8) Most frauds are detected by A) a confession by the fraudster. B) IT controls. C) law enforcement. D) a tip.

D Terms: Fraud detection methods Diff: Moderate Objective: LO 10-7 AACSB:

4) ________ inquiry is used to obtain information about facts and details that the auditor does not have, usually about past or current events or processes. A) Assessment B) Declarative C) Interrogative D) Informational

D Terms: Inquiry used when auditor seeks responses Diff: Moderate Objective: LO 10-7 AACSB:

6) When dealing with audit risk, A) audit risk should not be a factor when determining if a new client should be accepted. B) audits with a low acceptable audit risk generally result in lower audit fees. C) if management of a company has a reputation of integrity, but is also known to take aggressive financial risks, the auditor should not accept the company as a new client. D) if the auditor concludes that acceptable audit risk is low, but the client is still acceptable, the auditor may still accept the engagement but increase the fee proposed to the client.

D Terms: Lower acceptable audit risk Diff: Challenging Objective: LO 8-2 AACSB:

3) When dealing with materiality, A) if the client refuses to correct a material misstatement, the auditor is required to adjust the financial statements. B) management is responsible for determining whether financial statements are materially misstated. C) materiality must be determined as as percentage of sales. D) the auditor must bring any material misstatements to the client's attention.

D Terms: Materiality Diff: Easy Objective: LO 8-5 AACSB:

14) When determining materiality, A) the preliminary judgment about materiality can be increased, but not decreased during the audit. B) auditing standards provide specific materiality guidelines to practitioners. C) only one benchmark can be used. D) the application of guidelines requires considerable professional judgment.

D Terms: Materiality Diff: Moderate Objective: LO 8-6 AACSB:

4) ________ materiality is materiality for segments of the audit. A) Segment B) Individual C) Financial statement D) Performance

D Terms: Performance materiality Diff: Moderate Objective: LO 8-5 AACSB:

4) Which of the following is a reason that the auditors may change the preliminary judgment about materiality? A) The auditors decide that the preliminary judgment was too large. B) The auditors decide that the preliminary judgment was too small. C) Client circumstance may have changed due to qualitative events. D) all of the above

D Terms: Preliminary judgments about materiality Diff: Moderate Objective: LO 8-6 AACSB:

15) Determine which of the following is most correct statement regarding the reliability of audit evidence. A) Information that is indirectly obtained from external sources is the most reliable audit evidence. B) Reliability of audit evidence is dependent upon the evidence being subjective. C) Reliability of evidence refers to the amount of evidence obtained. D) If internal controls are effective, evidence obtained is more reliable than when the controls are not effective.

D Terms: Reliability of audit evidence Diff: Moderate Objective: LO 7-3 AACSB:

8) For public companies, the ________ is responsible for hiring the auditor as required by the Sarbanes-Oxley Act. A) client's management B) client's chief executive officer C) client's chief financial officer D) client's audit committee

D Terms: Responsibility for agreeing nonaudit services for a public company audit client Diff: Moderate Objective: LO 8-2 AACSB:

5) When dealing with revenue frauds, A) the most egregious form of revenue fraud involves premature revenue recognition. B) premature revenue recognition involves recognizing the revenue after the accounting standards requirements have been met. C) premature revenue recognition is the same as cutoff errors. D) side agreements can modify the terms of the sales transaction and should be analyzed carefully.

D Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 10-6 AACSB:

3) _______ is the risk that the financial statements contain a material misstatement due to fraud or error prior to the audit. A) Inherent risk B) Client business risk C) Acceptable audit risk D) Risk of material misstatement

D Terms: Risk of material misstatements Diff: Easy Objective: LO 8-1 AACSB:

19) When selecting staff for the audit engagement A) only staff members who are CPAs should be assigned to the audit. B) only managers and above need to have appropriate competence and capabilities to perform the audit. C) continuity of staff members from year to year should not be a factor. D) staff assigned to the audit must be knowledgeable about the client's industry.

D Terms: Selection of audit staff for engagement Diff: Easy Objective: LO 8-2 AACSB:

6) Which of the following is not a likely source of information to assess fraud risks? A) communications among audit team members B) inquiries of management C) analytical procedures D) consideration of fraud risks discovered during recent audits of other clients

D Terms: Source of information to assess fraud risks Diff: Challenging Objective: LO 10-3 AACSB:

3) The auditor must gather sufficient and appropriate evidence during the course of the audit. Sufficient evidence must A) be well documented and cross-referenced in the audit documents. B) be based on sources that are external to company. C) provide evidence that prove or disprove an audit objective/assertion. D) be persuasive enough to enable the auditor to issue an audit report.

D Terms: Sufficient evidence Diff: Easy Objective: LO 7-3 AACSB:

24) When the auditor scans the sales journal looking for large and unusual transactions, he is gathering what type of evidence? A) inspection B) recalculation C) physical examination D) analytical procedures

D Terms: Types of audit evidence; analytical procedures Diff: Moderate Objective: LO 7-4 AACSB:

21) Which of the following is a correct statement regarding confirmations? A) Confirmations can be in oral or written form. B) Electronic confirmations are not acceptable under generally accepted auditing standards. C) Confirmations are generally used in the audit of fixed asset additions. D) Auditors consider alternative evidence available when determining if confirmations should be used.

D Terms: Types of audit evidence; confirmations Diff: Moderate Objective: LO 7-4 AACSB:

13) "Physical examination" is the inspection or count by the auditor of items such as A) cash, inventory, and payroll timecards. B) cash, inventory, canceled checks, and sales documents. C) cash, inventory, canceled checks, and tangible fixed assets. D) cash, inventory, securities, notes receivable, and tangible fixed assets.

D Terms: Types of audit evidence; physical examination Diff: Moderate Objective: LO 7-4 AACSB:

3) A tour of the client's facilities provides the auditor an opportunity to A) meet key personnel. B) observe operations. C) assess physical safeguards over assets. D) all of the above

D Terms: Understand responsibilities of the auditor and company for the audit Diff: Moderate Objective: LO 8-3 AACSB:

7.6 Learning Objective 7-6 1) Financial ratios A) are used during the planning and final review phases of the audit. B) can be linked to the trial balance so that calculations are automatically updated as adjustments are made. C) should be compared to previous years and industry averages. D) all of the above

D Terms: Use of financial ratios Diff: Moderate Objective: LO 7-6 AACSB:

1) Which of the following is true regarding audit risk for segments? A) Control risk must be assessed at the same level for all accounts. B) Factors affecting inherent risk do not differ from account to account. C) Acceptable audit risk is ordinarily assessed by the auditor during the substantive test of balances phase and is held constant for each major cycle and account. D) In some cases, a lower acceptable audit risk may be more appropriate for one account than for others.

D) In some cases, a lower acceptable audit risk may be more appropriate for one account than for others.

3) ________ risk represents the auditor's assessment of the susceptibility of an assertion to material misstatement, before considering the effectiveness of the client's internal control. A) Material B) Account balance C) Control D) Inherent

D) Inherent

1) Risk assessment procedures include inquiries of management and others by the auditor. As part of these procedures, the auditor should talk to A) internal auditors. B) board of directors. C) individuals involved with regulatory compliance. D) all of the above

D) all of the above.

3) When the auditor is attempting to determine the extent to which external users rely on a client's financial statements, they may consider several factors except for A) client size. B) concentration of ownership. C) nature and amounts of liabilities. D) assessment of detection risk.

D) assessment of detection risk.

1) When considering the risk of misstatement due to fraud, A) the risk of not detecting a material misstatement due to fraud is lower than the risk of not detecting a misstatement due to error. B) the risk is only made at the financial statement level. C) auditing standards require the auditor to presume that risk of fraud exist in expense transactions. D) auditing standards outline procedures the auditor should perform to obtain information from management about their consideration of fraud.

D) auditing standards outline procedures the auditor should perform to obtain information from management about their consideration of fraud.

21) An auditor who audits a business cycle that has low inherent risk should A) increase the amount of audit evidence gathered. B) assign more experienced staff to that area. C) expand planning procedures. D) do none of the above.

D) do none of the above.

7) Inherent risk is ________ related to planned detection risk and ________ related to the amount of audit evidence. A) directly; inversely B) directly; directly C) inversely; inversely D) inversely; directly

D) inversely; directly

5) The risk that audit evidence for an audit objective will fail to detect misstatements exceeding performance materiality levels is A) audit risk. B) control risk. C) inherent risk. D) planned detection risk.

D) planned detection risk.

1) A ________ risk represents an identified and assessed risk of material misstatement that, in the auditor's professional judgment, requires special audit consideration. A) material B) substantial C) financial statement D) significant

D) significant

3) When dealing with audit risk, A) auditors cannot accept any level of risk in performing the audit function. B) most risks that auditors encounter are relatively easy to measure. C) the audit risk model is only used for classes of transactions. D) the audit risk model helps the auditor to decide how much and what types of evidence to accumulate.

D) the audit risk model helps the auditor to decide how much and what types of evidence to accumulate.

19) In a financial statement audit, inherent risk is evaluated to help an auditor asses which of the following? A) the internal audit department's objectivity in reporting a material misstatement of a financial statement assertion it detects to the audit committee B) the risk the internal control system will not detect a material misstatement of a financial statement assertion C) the risk that the audit procedures implemented will not detect a material misstatement of a financial statement assertion D) the susceptibility of a financial statement assertion to a material misstatement assuming there are no related controls

D) the susceptibility of a financial statement assertion to a material misstatement assuming there are no related controls

16) What are three factors that have increased the importance of obtaining an understanding of a client's business and industry? How can an auditor obtain this understanding?

Factors that have increased the importance of obtaining an understanding of a client's business and industry include: • Recent significant declines in economic conditions around the world are likely to significantly increase a client's business risks. Auditors need to understand the nature of the client's business to understand the impact of major economic downturns on the client's financial statements and ability to continue as a going concern. • Information technology connects client companies with major customers and suppliers. As a result, auditors need greater knowledge about major customers and suppliers and the related risks. That connectivity also exposes the client to potential cyber risks that the auditor should consider. • Companies have expanded operations globally, often through joint ventures and strategic alliances. • Information technology affects internal client processes, improving the quality and timeliness of accounting information. • The increased importance of human capital and other intangible assets has increased accounting complexity and the importance of management judgments and estimates. • Many clients have invested in complex financial instruments which may have declined in value, require complex accounting treatments, and often involve unknown counterparties who may create unexpected financial risks for the client. Auditors consider these factors using a strategic approach to understand the client's business. The auditor can obtain a good understanding of the client's business and industry through various means. Terms: Factors that increase the importance of obtaining an understanding of a client's business and industry Diff: Challenging Objective: LO 8-3 AACSB:

11) Define fraud and distinguish between the two main categories of fraud.

In the context of financial statement auditing, fraud is defined as an intentional misstatement of the financial statements. The two main categories of fraud are fraudulent financial reporting and misappropriation of assets. Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users of the financial statements. Misappropriation of assets involve theft of an entity's assets. Terms: Fraud and main categories Diff: Easy Objective: LO 10-1 AACSB:

15) List and briefly describe examples of risk factors for each condition of fraud for fraudulent financial reporting.

Incentives/Pressures: 1. Financial stability or profitability is threatened by economic, industry, or entity operating conditions. 2. Excessive pressure for management to meet debt repayment or other debt covenant requirements. 3. Management or the board of directors' personal net worth is materially threatened by the entity's financial performance. Opportunities: 1. Significant accounting estimates involve subjective judgments or uncertainties that are difficult to verify. 2. Ineffective board of director or audit committee oversight over financial reporting. 3. High turnover or ineffective accounting, internal audit, or information technology staff. 4. Deficient internal controls. 5. Significant related party transactions. Attitudes/Rationalization: 1. Inappropriate or ineffective communication and support of the entity's values. 2. Known history of violations of securities laws and other laws and regulations. 3. Management's practice of making overly aggressive or unrealistic forecasts to analysts, creditors, and other third parties. Terms: Risk factors for conditions of fraud Diff: Challenging Objective: LO 10-2 AACSB:

34) Distinguish between internal documentation and external documentation as types of audit evidence. Give two examples of each. Which type is considered more reliable?

Internal documentation involves the auditor's examination of documents that have been prepared and used within the client's organization and are retained without ever going to an outside party. Examples would include duplicate sales invoices, employees' time reports, and inventory receiving reports. External documentation involves the auditor's examination of documents that have been in the hands of someone outside the client's organization. Examples include vendors' invoices, cancelled checks, cancelled notes payable, and insurance policies. External documents are regarded as more reliable evidence than internal documents. Terms: Internal and external documentation; Reliability of evidence Diff: Moderate Objective: LO 7-4 AACSB:

10) The basis for preparing financial statements for companies is the general ledger. As soon as possible the auditor obtains the general ledger accounts of the client and prepares a working trial balance. Discuss the audit documentation in the current file that relates to the working trial balance. Include a description of lead and support schedules in your answer.

Lead Schedules-each line item on the working trial balance is supported by a lead schedule, containing the detailed accounts from the general ledger making up the line item in the working trial balance Support Schedules-each detailed account of the lead schedule is supported by proper schedules supporting the audit work performed and the conclusions reached by the auditors Terms: Supporting schedules Diff: Moderate Objective: LO 7-8 AACSB:

32) Discuss four of the matters that should be specified in an engagement letter.

Matters that should be specified in the engagement letter include: • the objectives of the engagement • the responsibilities of the auditor and management • identification of the financial reporting framework used by management • reference to the expected form and content of the audit report • the engagement's limitation • an agreement as to any other services to be provided • restrictions to be imposed on the auditor's work • deadlines for completing the audit • assistance to be provided by the client's personnel in obtaining records and documents and schedules to be prepared for the auditor • agreement on fees • auditor cannot guarantee that all acts of fraud will be discovered Terms: Items included in engagement letter Diff: Moderate Objective: LO 8-2 AACSB:

11) Senior management is responsible for promoting a culture of honesty and ethics. Describe what that implies for the organization.

Note: responses with examples may vary Management cannot act one way and expect others in the company to behave differently. Through its actions and communications, management can show that dishonest or unethical behavior is not tolerated, even if the results benefit the company. For example, statements by management about the absolute need to meet operating and financial targets create undue pressures that may lead employees to commit fraud to achieve them. In contrast, statements indicating management's desire to aggressively pursue the entity's goals and targets while at the same time requiring honest and ethical actions to achieve those goals, clearly indicates to employees that integrity is a requirement. Whichever course management pursues, its actions establish the "tone at the top." Terms: Management responsibility for promoting a culture of honesty and ethics Diff: Challenging Objective: LO 10-4 AACSB:

11) Auditor's allocate the preliminary judgment about materiality to financial statement segments rather than by financial statements as a whole. What is the term for the auditor's allocation of preliminary misstatement to account balances? What are three difficulties auditors face when allocating materiality to balance sheet accounts?

Performance materiality is the term for the auditor's allocation of the preliminary judgment of materiality to any given account balance. The three difficulties auditors face when allocating the preliminary materiality to account balances are: 1. Auditors expect certain accounts to have more misstatement than others. 2. Both overstatements and understatements must be considered. 3. Audit costs can affect the allocation. Terms: Allocation of preliminary misstatement to account balances and difficulties that auditors face allocating preliminary materiality judgment to account balances Diff: Moderate Objective: LO 8-7 AACSB:

16) Due to qualitative factors, certain types of misstatements are likely to be more important to users than others, even if the dollar amounts are the same. Identify two qualitative factors that might significantly affect an auditor's materiality judgment, and give an example of each.

Qualitative factors that affect an auditor's materiality judgment include: • Amounts involving fraud. Amounts involving fraud are usually considered more important than unintentional errors of equal dollar amounts because fraud reflects on the honesty and reliability of the management or other personnel involved. For example, an intentional misstatement of inventory would be more important to users than a clerical error in inventory of the same amount. • Misstatements affecting contractual obligations. Misstatements that are otherwise minor may be material if there are possible consequences arising from contractual obligations. For example, if a misstatement causes a required minimum working capital balance to exceed the minimum, when the correct balance is less than the minimum, this misstatement likely would be important to users. • Amounts affecting a trend in earnings. Amounts that are otherwise immaterial may be material if they affect a trend in earnings. An example is if reported income has increased three percent annually for the past five years but income for the current year has declined one percent, that change may be material. Similarly, a misstatement that would cause a loss to be reported as a profit may be of concern. Terms: Qualitative factors that affect auditor's materiality judgment Diff: Moderate Objective: LO 8-6 AACSB:

5) List the five steps in applying materiality in an audit.

Step 1. Set materiality for the financial statements as a whole. Step 2. Determine performance materiality. Step 3. Estimate total misstatement in segment. Step 4. Estimate the combined misstatement. Step 5. Compare combined estimate with preliminary or revised judgment about materiality. Terms: Five steps in applying materiality Diff: Challenging Objective: LO 8-8 AACSB:

27) Discuss the factors an auditor should consider before accepting a company as an audit client.

The auditor should investigate and consider the prospective client's standing in the business community, financial stability, management's integrity, and relations with its bankers, attorneys, and previous CPA firm. The auditor should also determine whether he or she possesses the required competence and independence to do the audit. Terms: Factors to consider before accepting audit client Diff: Easy Objective: LO 8-2 AACSB:

10) Describe the five sources of information gathered to assess fraud risks.

The five sources of information to assess fraud risk are: • Communications among audit team members. The following ideas should be "brainstormed" (1) How and where the entity's financial statements might be susceptible to material misstatements due to fraud, including known external and internal factors that might (a) create an incentive or pressure for management to commit fraud, (b) provide the opportunity for fraud to be perpetrated, and (c) indicate a culture or environment that enables management to rationalize fraudulent acts. (2) How management could perpetrate and conceal fraudulent financial reporting. (3) How anyone might misappropriate assets of the entity. (4) How the auditor might respond to the susceptibility of material misstatements due to fraud. • Inquiries of management. These inquiries should address whether management has knowledge of any fraud or suspected fraud within the company. Auditors should also inquire about management's process of assessing fraud risks, the nature of fraud risks identified by management, any internal controls implemented to address those risks, and any information about fraud risks and related controls that management has reported to the audit committee or others charged with governance. • Risk factors. The auditor must evaluate whether fraud risk factors indicate incentives or pressures to perpetrate fraud, opportunities to carry out fraud, or attitudes or rationalizations used to justify a fraudulent action. • Analytical procedures. Auditors must perform analytical procedures during the planning and completion phases of the audit to help identify unusual transaction or events that might indicate the presence of material misstatements in the financial statements. Analytical procedures include ratio analysis, horizontal analysis, and vertical analysis. • Other procedures. Auditors should consider all information they have obtained in any phase or part of the audit as they assess the risk of fraud. Information about management's integrity and honesty, inquires and analytical procedures, and information considered in assessing inherent and control risks, may lead to auditor concerns about the likelihood of misstatements due to fraud. Terms: Sources of information to assess fraud risks; inquiries of management Diff: Challenging Objective: LO 10-3 AACSB:

28) Discuss the primary purpose of an audit engagement letter. Is an engagement letter required?

The purpose of an audit engagement letter is to establish a clear understanding between the auditor and the client regarding the terms of the engagement. An engagement is required for both public and private company audits. Terms: Reasons for an audit and audit evidence Diff: Easy Objective: LO 8-2 AACSB:

24) The reliability of evidence refers to the degree to which evidence is considered believable or trustworthy. There are six factors that affect the reliability of audit evidence. One factor is the independence of the provider; i.e., evidence obtained from a source outside the client company is more reliable than that obtained within. Identify and discuss any two of the remaining five factors.

The remaining four factors that affect the reliability of evidence are: • Effectiveness of client's internal control. When a client's internal controls are effective, evidence obtained from the client is more reliable than when controls are not effective. • Auditor's direct knowledge. Evidence obtained directly by the auditor is more reliable than information obtained indirectly. • Qualifications of individuals providing the information. Although the source of the information may be independent, the evidence will not be reliable unless the individual providing it is qualified to do so. Also, evidence obtained directly by the auditor many not be reliable if the auditor lacks the qualifications to evaluate the evidence. • Degree of objectivity. Objective evidence is more reliable than evidence that requires considerable judgment to determine whether it is correct. • Timeliness — The timeliness of audit evidence can refer either to when it is accumulated or to the period covered by the audit. Evidence is usually more reliable for balance sheet accounts when it is obtained as close to the balance sheet date as possible. Terms: Reliability of evidence Diff: Challenging Objective: LO 7-3 AACSB:

15) Audit standards require the auditor to consider the combined amount of misstatement early in the audit. This is known as preliminary materiality judgment. List and discuss the three main factors that affect an auditor's preliminary judgment about materiality.

The three main factors that affect an auditor's judgment about materiality are: • Materiality is a relative rather than an absolute concept. A misstatement of a given size might be material for a small company, whereas the same dollar misstatement could be immaterial for a larger one. • Benchmarks are needed for evaluating materiality. Because materiality is relative, it is necessary to have benchmarks for establishing whether misstatements are material. Net income before taxes is normally the most commonly used benchmark, but other possible benchmarks include current assets, total assets, current liabilities, and owners' equity. • Qualitative factors also affect materiality. Certain types of misstatements are likely to be more important to users than others, even if the dollar amounts are the same, such as misstatements involving frauds. Terms: Factors that affect auditor's preliminary judgment Diff: Moderate Objective: LO 8-6 AACSB:

12) List the three main types of revenue manipulations employed to commit fraudulent financial reporting and give an example for each type.

The three main types of revenue manipulation are: • Fictitious revenues — preparation of fictitious documentary evidence for sales and reduction of inventory. • Premature revenue recognition — bill and hold; side agreements; unlimited right of return. • Manipulation of adjustments to revenues — adjustments to the sales and returns allowance account, i.e., not recording returns; also, understating the estimate for bad debts which reduces the bad debt expense and understates the allowance for doubtful accounts. Terms: Types of revenue manipulation Diff: Moderate Objective: LO 10-6 AACSB:

17) There are three primary reasons for obtaining a thorough understanding of the client's industry and external environment. What are these reasons?

The three reasons are: • Risks associated with specific industries may affect the auditor's assessment of client business risk and acceptable audit risk. • Many risks are typically common to all clients in certain industries. Familiarity with those risks aids the auditor in determining their relevance to the client when assessing client business risk and risk of material misstatement. • Many industries have unique accounting requirements that the auditor must understand to evaluate whether the client's financial statements are in accordance with accounting standards. Terms: Primary reasons for obtaining understanding client's industry and external environment Diff: Moderate Objective: LO 8-3 AACSB:

31) Discuss several reasons why an auditor may not wish to continue a relationship with an existing audit client.

There are a number of reasons an auditor may choose not to continue a relationship with an existing client. Examples include: 1. previous conflicts over the appropriate scope of the audit, the type of opinion to issue, unpaid fees, or other matters 2. management integrity may be deemed to be insufficient 3. legal action initiated by either the auditor or client related to prior audit services 4. the presence of excessive risk which could result in financial failure of the client or lawsuits against the audit firm Terms: Reasons auditor may not wish to continue relationship with existing audit client Diff: Moderate Objective: LO 8-2 AACSB:

29) Discuss the essential activities involved in the initial planning of an audit.

There are four essential activities involved in the initial planning of an audit. These are: 1. Client acceptance or continuation. In the case of a new client, the auditor must determine whether the client is one with which they wish to be associated with. In the case of a continuing client, an auditor must determine whether continuing the relationship is appropriate and in the firm's best interest. 2. The auditor should identify why the client wants or needs an audit. The auditor should determine the reason for the audit as soon as practical. The remainder of the planning activities may be impacted by the client's reason for requesting the audit. 3. Obtain an understanding with the client about the terms of the engagement. An understanding with the client should be obtained to avoid misunderstandings. Auditors are required to obtain an understanding with their clients. This understanding must be written. 4. Develop an overall audit strategy. The strategy should consider the reasons for the audit, including engagement staffing and any required audit specialists. Setting a strategy helps the auditor determine the resources required for the engagement. Terms: Essential activities involved in initial planning of audit Diff: Moderate Objective: LO 8-2 AACSB:

9) What types of inquiry techniques might an auditor use when making inquiries of client personnel? What are the uses of each technique?

There are three main types of inquiry available for use by auditors. These are informational inquiry, assessment inquiry, and interrogative inquiry. Informational inquiry is used to obtain information about facts and details that the auditor does not have. Assessment inquiry is used to corroborate or contradict prior information. Interrogative inquiry is often used when the auditor seeks responses from an individual about his or her knowledge of an event or circumstances. It is often used to determine if the individual is being deceptive or purposely omitting disclosure of key knowledge of facts, events, or circumstances. This type of inquiry is often confrontational in nature. Terms: Inquiry techniques Diff: Challenging Objective: LO 10-7 AACSB:

6) There are three main reasons why an auditor should properly plan audit engagements. Discuss each of these reasons.

Three reasons why an auditor should properly plan audit engagements are: • To enable the auditor to obtain sufficient competent evidence for the circumstances. This is essential for minimizing legal liability and maintaining a good reputation in the business community. • To help keep audit costs reasonable. Given the competitive auditing environment, keeping costs reasonable helps the firm obtain and retain clients. • To avoid misunderstandings with the client. This is important for good client relations. Terms: Reasons auditor should properly plan audit engagement Diff: Moderate Objective: LO 8-1 AACSB:

13) The most common fraud in the acquisition and payment cycle is for the perpetrator to issue payments to fictitious vendors and deposit the cash in fictitious accounts. What procedures could the company take to prevent this type of fraud?

• Allowing payments to be made only to approved vendors • Detailed review of legitimacy of approved vendors • Careful review of document authorizing the acquisition • Segregation of duties between authorizing payments and authorizing the acquisition • Canceling supporting documents to prevent their use as support for multiple payments Terms: Procedures to prevent fraud in the acquisition and payment cycle Diff: Challenging Objective: LO 10-6 AACSB:

14) List and briefly describe the three conditions for fraud.

• Incentives/pressures — Management or other employees have incentives or pressures to commit fraud. • Opportunities — Circumstances provide opportunities for management or employees to commit fraud. • Attitudes/Rationalization — An attitude, character, or set of ethical values exists that allows management or employees to intentionally commit a dishonest act, or they are in an environment that imposes sufficient pressure that causes them to rationalize committing a dishonest act. Terms: Conditions for fraud Diff: Moderate Objective: LO 10-2 AACSB: