Audit Final Study Guide
If an auditor of an issuer examines purchase orders obtained from the issuer to verify proper authorization of transactions, then the auditor is conducting
An inspection. Inspection is the examination of records or documents, whether internal or external, in paper, electronic, or other media. The auditor performs inspection of documents to verify proper authorization of transactions.
An auditor attended a physical counting of inventory. This procedure relates most closely to which assertion about account balances?
Existence. Attending a physical counting of inventory is a generally accepted auditing procedure. Through appropriate observation, tests, and inquiries, the auditor should become satisfied about the effectiveness of the client's inventory-taking procedures and the reliability of the client's representations (AU-C 550). One of the auditor's substantive procedures is physical examination of inventory. This procedure tests the existence assertion for account balances.
In developing written audit plans, an auditor should design specific audit procedures that relate primarily to the
Financial statement assertions. Most audit work consists of obtaining and evaluating evidence about relevant financial statement assertions. They are management representations embodied in the financial statements that are used by the auditor to consider the types of possible material misstatements.
Which of the following procedures would an auditor most likely use to identify unusual yearend transactions?
Performing analytical procedures. Analytical procedures should be applied to identify unusual relationships, items, and transactions.
Which of the following factors would most likely cause an auditor not to accept a new audit engagement?
Concluding that the entity's management probably lacks integrity. CPA firms should have policies and procedures to determine whether to accept or continue a client or to perform a specific engagement. The firm's policies and procedures should provide reasonable assurance that it (1) has considered the integrity of the client and the risks involved, (2) is competent, (3) has the necessary capabilities and resources, and (4) is able to comply with applicable requirements (QC 10).
The risk that an auditor's procedures will lead to the conclusion that a material misstatement does not exist in an account balance when, in fact, such misstatement does exist is
Detection risk. Detection risk is the risk that the procedures performed to reduce audit risk to an acceptably low level will not detect a misstatement that exists and could be material individually or combined with other misstatements (AU-C 200 and AS 1101).
The objective of analytical procedures performed as risk assessment procedures is to
Enhance the auditor's understanding of the client's business. Analytical procedures applied as risk assessment procedures may (1) improve the understanding of the client's business and significant transactions and events and (2) identify unusual transactions or events and amounts, ratios, and trends that might indicate matters with audit ramifications (AU-C 315).
Which rule is not included in the Code of Professional Conduct?
Incompatible Occupations No explicit prohibition of incompatible occupations currently exists. A member, however, should not engage in any activity that creates a conflict of interest with the client.
Which of the following might be considered confidential client information and should not be disclosed under the AICPA Code of Professional Conduct?
Information that a certain company is a client if the CPA's practice is limited to bankruptcy matters. Under the Confidential Client Information Rule, a member in public practice cannot disclose confidential client information without the client's specific consent. However, revealing the name of a client is permissible unless the disclosure constitutes a release of confidential information, for example, if the CPA's practice is limited to bankruptcy matters.
For which of the following audit tests would an auditor most likely use attribute sampling?
Inspecting employee time cards for proper approval by supervisors. The auditor uses attribute sampling to test the effectiveness of controls. Attribute sampling enables the auditor to estimate the occurrence rate of deviations and to determine its relation to the tolerable deviation rate. Thus, a control, such as proper approval of time cards by supervisors, can be tested for effectiveness using attribute sampling.
The ultimate purpose of understanding internal control is to contribute to the auditor's evaluation of the risk that
Material misstatements may exist in the financial statements. The understanding of internal control assists the auditor to (1) identify types of potential misstatements; (2) consider factors that affect the RMMs; and (3) design the nature, timing, and extent of further audit procedures (AU-C 315 and AS 2110).
The audit risk against which the auditor and those who rely on his or her opinion require reasonable protection is a combination of two separate risks at the assertion level. The first risk (consisting of inherent risk and control risk) is that balances, classes of transactions, or disclosures contain material misstatements. The second is that
Material misstatements that occur will not be detected by the audit. Audit risk is a function of the risks of material misstatement and detection risk. Detection risk is the risk that the procedures performed to reduce audit risk to an acceptably low level will not detect a misstatement that exists and could be material individually or combined with other misstatements. The auditor assesses the risk of material misstatement after obtaining an understanding of the entity and its environment, including its internal control. It exists at the overall financial statement level and assertion level. The RMM at the assertion level consists of inherent risk and control risk. Some auditors use a mathematical model based on the relationships of the components of audit risk to arrive at an acceptable level of detection risk. For example, it reflects that the acceptable detection risk has an inverse relationship with the RMMs at the assertion level (AU-C 200 and AS 1101).
One of the primary roles of an audit plan (program) is to
Document the engagement's objectives, scope, timing, and resource allocations. According to The IIA's Performance Standard 2200, the internal auditor must develop and document a plan for each engagement, including its objectives, scope, timing, and resource allocations. The plan also must consider the organization's strategies, objectives, and risks relevant to the engagement.
Appropriate audit evidence is best defined as evidence that
Is relevant and reliable in providing support for the conclusions on which the opinion is based. Appropriateness is the measure of the quality of audit evidence, that is, its relevance and its reliability in providing support for the conclusions on which the opinion is based.
Which of the following items is an example of an inherent limitation in an internal control system?
. Human error in decision making. Because of its inherent limitations, internal control can be designed and operated to provide only reasonable assurance that the entity's objectives are met. Thus, (1) human judgment is faulty, (2) controls may fail because of human error, (3) manual or automated controls can be circumvented by collusion, and (4) management may inappropriately override internal control. Moreover, custom, culture, the corporate governance system, and an effective control environment are not absolute deterrents to fraud. For example, if the nature of management incentives increases the RMMs, the effectiveness of controls may be reduced. A factor that is an inherent limitation of an audit as well as internal control is the need to balance benefit and cost. Although the ability to provide only reasonable assurance is a primary design criterion for internal control, the precise measurement of costs and benefits is not feasible. However, costs should not exceed the benefits of control. Thus, the cost constraint limits internal control.
If an auditor wishes to decrease the acceptable level of audit risk, which of the following changes in the substantive procedures performed will not effectively provide greater assurance?
A change in the timing of substantive procedures from year-end to interim dates. A lower acceptable level of audit risk increases the assurance to be provided by substantive procedures. To obtain greater assurance, the auditor may change the nature, timing, or extent of substantive procedures. For example, as the risks of material misstatement increase, the auditor is more likely to perform substantial procedures at period-end rather than interim dates. This change reduces the risk of not detecting material misstatements that may exist at period-end (AU-C 330).
Which of the following is least likely to indicate the need to increase the assurance provided by substantive testing?
A decrease in the assessed inherent risk. Substantive procedures are performed to detect material misstatements in management's assertions. The nature, timing, and extent of substantive procedures are determined by the acceptable level of audit risk. For a given audit risk, the acceptable detection risk is inversely related to the assessed risks of material misstatement. The assessed RMMs are combined assessments of control risk and inherent risk. Thus, a decrease in the assessed inherent risk (1) decreases the assessed RMMs for a given assessed control risk, (2) increases the acceptable detection risk, and (3) does not indicate a need for more persuasive audit evidence (AU-C-200).
Assume that an auditor includes the following in his or her report: "Because of the unavailability of evidence regarding the uncertainty involving the collectibility of the advance, we are unable to express an opinion." This language constitutes
A disclaimer of opinion. A disclaimer of opinion states that the auditor does not express an opinion. When disclaiming an opinion, the auditor should include a separate paragraph stating the reasons for the disclaimer. A disclaimer of opinion is expressed when (1) the auditor cannot obtain sufficient appropriate evidence regarding management's assertions about the uncertainty, and (2) the 30 © 2018 Gleim Publications Inc. possible effects of undetected misstatements are material and pervasive.
Which of the following statements about internal control is true?
A limitation of internal control is that management makes judgments about the extent of controls it implements Because of inherent limitations, internal control, no matter how effective, can provide only reasonable assurance about achieving the entity's objectives. For example, when management designs and implements controls, it makes judgments about the nature and extent of (1) controls it implements and (2) the risks it assumes (AU-C 315).
The auditor is most likely to disclaim an opinion because of
A management-imposed limitation. An inability to obtain sufficient appropriate evidence may result from (1) circumstances beyond the control of the entity, (2) circumstances related to the nature or the timing of the work, or (3) a management-imposed limitation. They result in either a qualified opinion or a disclaimer (AU-C 705)
An auditor expresses an adverse opinion if
A misstatement is material and pervasive. When the effects on the financial statements of a material misstatement are pervasive, the auditor expresses an adverse opinion. Pervasive effects are not confined to specific elements, accounts, or items of the financial statements. If they are confined, they represent a substantial proportion of the statements
The refusal of a client's legal counsel to provide a representation on the legality of a particular act committed by the client is ordinarily
A scope limitation. Legal counsel's refusal either orally or in writing to provide the requested information may be a scope limitation sufficient to preclude an unmodified opinion. The reason is that the letter of inquiry to the client's legal counsel is the primary means of corroborating management's representations about litigation, claims, and assessments. However, a statement in the letter such as, "It would be inappropriate for this firm to respond to a general inquiry relating to the existence of unasserted possible claims and assessments," is not considered a scope limitation. The quoted language is based on the preamble of the American Bar Association's statement of policy regarding lawyers' responses to auditors' requests for information.
Under the ethical standards of the profession, which of the following situations involving nondependent members of an auditor's family is most likely to impair the independence of an individual participating in an audit engagement?
A spouse's employment with a client The immediate family (spouse, spousal equivalent, or a dependent) of a covered member (such as an individual on the attest engagement team or who is able to influence the engagement) is subject to the Independence Rule. Under that Rule, independence is impaired if, during the period covered by the financial statements or during the engagement, a firm partner or professional employee (including an immediate family member of such an individual) was also associated with the client as an officer, director, employee, promoter, underwriter, voting trustee, or member of management. However, independence is not impaired solely because of an immediate family member's employment by the client in a nonkey position.
The accounting department reports the accounts payable balance as $175,000. You are willing to accept that balance if it is within $15,000 of the actual balance. Using a variables sampling plan, you compute a 95% confidence interval of $173,000 to $190,000. You would therefore
Accept the $175,000 balance because the confidence interval is within the materiality limits. The auditor is willing to accept the carrying amount if it is within $15,000 (the tolerable misstatement) of the population value. The sample mean used to estimate the population value must be $181,500 [($173,000 + $190,000) ÷ 2] because it is at the midpoint of the computed (achieved) confidence interval (precision). This interval is based on a precision (± $8,500) that is well within the tolerable misstatement (materiality limits) of ± $15,000. Thus, the auditor should accept the $175,000 value. The interval based on tolerable misstatement and the narrower achieved precision limits contain this value.
Substantive auditing procedures are performed by the auditor to substantiate that
Account balances are not materially misstated. Substantive procedures are designed to detect material misstatements in the financial statement assertions. They consist of (1) tests of details of classes of transactions, account balances, and disclosures and (2) analytical procedures. The auditor performs substantive procedures to restrict audit risk to an acceptable level.
If the objective of a test of details is to detect overstatements of sales, the auditor should compare transactions in the
Accounting records with the source documents. Overstatements of sales likely result from entries with no supporting documentation. The proper direction of testing is to sample entries in the sales account and vouch them to the shipping documents. The source documents represent the valid sales.
The U.S. Tax Court ruled in favor of Defendant Co. after year end but before completion of the audit. Litigation involved deductions claimed on prior years' tax returns. The company had credited accrued taxes payable at year end for the full amount sought by the IRS. The IRS will not appeal the ruling. What is the effect of this event on the year-end statements?
Adjustment of the financial statements. The ruling of the Tax Court provides additional evidence about conditions that existed at the date of the financial statements and affects the estimates used in their preparation. Consequently, the settlement in the subsequent events period for an amount different from that recorded requires the client to adjust the statements.
During the audit of internal controls integrated with the audit of the financial statements, the auditor discovered a material weakness in internal control. The auditor most likely will express a(n)
Adverse opinion on internal control. Material weaknesses are significant control deficiencies that result in more than a remote chance that a material misstatement will result in the financial statements. A material weakness requires the auditor to express an adverse opinion on the effectiveness of internal control.
An entity's financial statements as a whole are not fairly presented in accordance with accounting principles generally accepted in the United States of America. Accordingly, the auditor must express a(n)
Adverse opinion. An adverse opinion states that, because of the significance of the matter(s) described in a separate paragraph, the financial statements are not fairly presented in accordance with the applicable financial reporting framework. The separate paragraph should, as appropriate, include (1) the quantified financial effects of the misstatement (if practicable), (2) an explanation of how narrative disclosures were misstated, or (3) omitted information (if practicable).
Which of the following statements would least likely appear in an auditor's engagement letter?
After performing our preliminary analytical procedures, we will discuss with you the other procedures we consider necessary to complete the engagement. The terms of the engagement should be documented in an engagement letter that states the (1) objective and scope of the audit, (2) responsibilities of the auditor and management, (3) inherent limitations of the audit and internal control, (4) applicable financial reporting framework, and (5) expected form and content of audit reports. But the engagement letter does not describe the specific evidence collection process to be completed by the auditor.
Which of the following procedures is considered a test of controls?
An auditor interviews and observes appropriate personnel to determine segregation of duties. When the auditor observes the operation of a control, (s)he can evaluate its effectiveness at a moment in time. Observing that different personnel perform appropriate duties provides evidence of proper segregation.
All of the following are true regarding an entity's ability to continue as a going concern except
An auditor should resign from the audit if doubt exists about the entity's ability to continue as a going concern An auditor does not need to resign from a financial statement audit because of doubt about an entity's ability to continue as a going concern. The auditor should assess the possible financial statement effects and the adequacy of disclosure regarding the doubt and determine the implications for the auditor's report.
Which of the following professional services is considered an attest engagement?
An engagement to report on compliance with statutory requirements. In an attest engagement, a practitioner issues an examination, a review, or an agreed-upon procedures report on subject matter (or an assertion about subject matter) that is the responsibility of another party (AT-C 105). Thus, attest engagements are not limited to traditional financial statement audits. For example, attest services may extend to management's compliance with specified requirements or the effectiveness of internal control over compliance.
Control activities constitute one of the five components of internal control described in the COSO model. Control activities do not encompass
An internal auditing function The COSO model describes control activities as policies and procedures that help ensure that management directives are carried out. They are intended to ensure that necessary actions are taken to address risks to achieve the entity's objectives. Control activities have various objectives and are applied at various organizational and functional levels. However, an internal auditing function is part of the monitoring component.
Garden Apartments, Inc., completed construction and began to rent a 250-unit apartment complex on November 25, Year 1. During December, 75 units were leased, and an additional 125 units were leased in January Year 2. During the month of November Year 1, the company charged to expense $23,000 for the cost of advertising, a grand opening party, and the advertising agency fee for planning the promotional campaign. As a part of the campaign, all tenants signing leases received gifts. At June 30, Year 2, the balance sheet reflected $15,200 of deferred costs associated with these gifts, and a note stated that the costs were being amortized over the life of the related lease. During the audit of the financial statements of Garden Apartments, Inc., for the year ended June 30, Year 2, no facts other than those above came to the auditor's attention that might preclude expression of an unmodified opinion. The report on the financial statements should contain
An unmodified opinion. Advertising and promotion costs ordinarily should be expensed, and the direct costs of leasing the apartments may be capitalized and expensed over the lives of the leases. These transactions were accounted for in conformity with GAAP, and an unmodified opinion is appropriate.
When obtaining an understanding of internal control in a financial statement audit, the independent external auditor is primarily concerned with
Assessing the risk of material misstatement. The auditor must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement and to design the nature, timing, and extent of further audit procedures
The acceptable level of detection risk is inversely related to the
Assurance provided by substantive procedures. For a given audit risk, the acceptable detection risk is inversely related to the assessed risks of material misstatement. As the RMMs increase, the acceptable detection risk decreases, and the auditor requires more persuasive audit evidence. The auditor may (1) change the types of audit procedures and their combination, e.g., confirming the terms of a contract as well as inspecting it; (2) change the timing of substantive procedures, such as from an interim date to year end; or (3) change the extent of testing, such as by using a larger sample (AU-C 330 and AS 2301)
Herman is the new independent external auditor for Bettina Company. Herman's predecessor was Travis. In these circumstances, Herman should
Attempt to communicate with Travis The auditor should communicate with the predecessor auditor. Communication should be made only after obtaining the client's permission, and the auditor should request that management authorize the predecessor to respond fully to the auditor's inquiries.
An auditor is concerned with completing various phases of the audit after the balance sheet date. This subsequent period extends to the date of the
Auditor's report. Subsequent events procedures should be performed to cover the period from the date of the financial statements to the date of the auditor's report (or as near as practicable to it) (AU-C 560).
An auditor wishes to determine whether the finished goods perpetual inventory records are being properly updated for completed production. To accomplish this, the auditor traces inventory quantity and cost records from production reports to perpetual inventory records, using an appropriate sample size based on a 95% confidence level, an estimated error rate of 4%, and a desired precision of +2%. If the error rate in the sample is, as expected, 4%, and 2,000 production reports were posted to perpetual inventory records during the year, the auditor can be 95% sure that the number incorrectly posted was
Between 40 and 120. The estimated error rate equals 4%, and the desired precision is 2%. Thus, the precision, or confidence interval, is 4% ± 2%, or 2% to 6%. The auditor can state with 95% confidence that between 2% and 6% of the reports are incorrectly posted. That percentage range corresponds to between 40 and 120 reports.
Which of the following procedures would an auditor most likely perform in searching for unrecorded payables?
Compare cash payments made after the balance sheet date with the accounts payable trial balance. Tracing subsequent payments to recorded payables is a primary procedure to match payments (checks issued) after year end with the related payables. Checks should be issued only for recorded payables. Any checks that cannot be matched are likely indications of unrecorded liabilities. Management may want to delay recording of liabilities to improve the current ratio. However, unrecorded accounts payable still must be paid, and financial statements that fail to report all liabilities at year end are misstated.
According to the PCAOB auditing standards, audit planning most likely includes
Considering appropriate materiality levels Planning involves establishing an overall audit strategy. For this purpose, the auditor determines materiality for the financial statements as a whole. Circumstances also may indicate that misstatements of classes of transactions, balances, or disclosures of lesser amounts could influence the economic decisions of users. In those cases, the auditor also determines materiality for particular classes of transactions, balances, and disclosures (AS 2101).
The design or operation of a control may not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis. According to AU-C 265, this circumstance is a
Control deficiency. A control deficiency may arise either in the design or operation of a control. It is the lowest level of deficiency identified in the standards. A design deficiency results when (1) a necessary control is missing or (2) a control operating as designed does not meet the control objective. An operating deficiency results when (1) a properly designed control does not function as designed, or (2) the person performing the control does not have the authority or competence to perform it effectively.
Which result of an analytical procedure suggests the existence of obsolete merchandise?
Decrease in the inventory turnover rate. Inventory turnover is equal to cost of sales divided by average inventory. If inventory is increasing at a faster rate than sales, the turnover rate decreases and suggests a buildup of unsalable inventory.
Which of the following types of risks most likely would increase if accounts receivable are confirmed 3 months before year end?
Detection. Audit risk consists of (1) the risks of material misstatement (inherent risk combined with control risk) and (2) detection risk. The RMMs are the entity's risks, and detection risk is the auditor's risk. Detection risk is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a material misstatement. It is a function of the effectiveness of an audit procedure and its application by the auditor. Detection risk is the only component of audit risk that can be changed at the auditor's discretion. An auditor who performs procedures at an interim date should cover the remaining period. The longer the remaining period, the greater the detection risk resulting from performing procedures at an interim date.
Each time an auditor draws a conclusion based on evidence from a sample, an additional risk, i.e., sampling risk, is introduced. An example of sampling risk is
Drawing an erroneous conclusion from sample data. Sampling risk is the risk that the auditor's conclusion based on a sample may differ from the conclusion if the same audit procedure were applied to every item in the population. Sampling risk can result in two types of erroneous conclusions: those affecting effectiveness or those affecting efficiency (AU-C 530).
As the assessed risks of material misstatement change, the acceptable level of audit risk also changes, and the auditor must alter substantive procedures accordingly. If the RMMs are sufficiently low, the acceptable level of audit risk increases, and the auditor is least likely to
Eliminate all substantive procedures for all assertions. Although the inverse relationship between the RMMs and audit risk may permit the auditor to change the nature or the timing of substantive procedures or limit their extent, ordinarily the assessed RMMs cannot be sufficiently low to eliminate the need to perform any substantive procedures to restrict audit risk for all of the assertions relevant to significant account balances, transaction classes, or disclosures.
The single most effective control established to avoid allowing any person to be in a position to perpetrate and then conceal errors or fraud is to
Establish separate functional responsibilities for asset custody, recordkeeping, and authorization. One person should not be responsible for all phases of a transaction, i.e., for authorization, recording, and custodianship of the related assets. These duties should be performed by separate individuals to reduce the opportunities for any person to be in a position to both perpetrate and conceal errors or fraud in the normal course of his or her duties. Separating functional responsibilities permits one person to review the work of others, which serves as a deterrent to errors and fraud. To override the control of separation of incompatible responsibilities requires collusion.
An appropriate audit procedure for testing the year-end cutoff for unrecorded purchases is
Examining shipment date and terms of shipment on vendor invoices received prior and subsequent to year end In general, a cutoff ensures that transactions are recorded in the appropriate period. A proper purchase cutoff is intended to assure inclusion of the goods in inventory and the recognition of a liability in the period in which the client acquired title to the goods. The appropriate procedure is to trace receiving and shipping documents for several days prior to and after year end.
If an auditor is unable to observe the year-end physical inventory count but has become satisfied about the balance through the use of alternative auditing procedures, (s)he should
Express an unmodified opinion with no reference to the alternative procedures performed An unmodified opinion is possible only if the auditor concludes that (1) the statements are not materially misstated, and (2) (s)he can obtain sufficient appropriate audit evidence. Thus, if attendance at physical inventory counting is not practicable, the auditor should modify the opinion. However, if (s)he can obtain sufficient appropriate audit evidence about the existence and condition of inventory by performing alternative audit procedures, an unmodified opinion may be expressed.
Which of the following most accurately describes the process of a walkthrough?
Following a transaction from its origination until it is reflected in the financial statements. Performing walkthroughs will frequently be the most effective way of achieving the objectives in testing controls. In performing a walkthrough, the auditor follows a transaction from origination through the company's processes, including information systems, until it is reflected in the company's financial records, using the same documents and information technology that company personnel use. Walkthrough procedures usually include a combination of inquiry, observation, inspection of relevant documentation, and reperformance of controls.
The primary purpose of an internal control questionnaire is to
Gain an understanding of the controls. An internal control questionnaire consists of a series of questions about the firm's controls designed to prevent or detect errors or fraud. Answers to the questions help the auditor to identify specific controls relevant to specific assertions and to design tests of controls to evaluate the effectiveness of their design and operation. An understanding of the controls consists of evaluating the effectiveness of their design and whether they have been implemented.
Which of the following issues related to internal control over financial reporting are required to be communicated in writing to management and those charged with governance? I. Deficiencies in internal control II. Significant deficiencies III. Material weaknesses
II and III only. Only those control deficiencies considered to be significant deficiencies or material weaknesses are required to be communicated in writing to management and those charged with governance. (But certain deficiencies should not be reported directly to management.) Other control deficiencies that merit management's attention should be reported to management orally or in writing. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of their assigned functions, to prevent misstatements or detect and correct them on a timely basis. A significant deficiency is a deficiency, or combination of deficiencies, in internal control that is less severe than a material weakness but merits attention by those charged with governance. A material weakness is a deficiency, or combination of deficiencies, in internal control that results in a reasonable possibility that a material misstatement of the financial statements will not be prevented, or detected and corrected, on a timely basis. A reasonable possibility means that the probability of the event is more than remote.
Late in December, Tech Products Company sold available-for-sale securities that had appreciated in value and then repurchased them the same day. The sale and purchase transactions resulted in a large gain. Without the gain, the company would have reported a loss for the year. Which statement with respect to the auditor is true?
If the sale and repurchase are disclosed, an unmodified opinion should be expressed. Unrealized holding gains and losses on available-for-sale securities are recorded in other comprehensive income. Thus, to include the appreciation in the determination of net income, the company had to sell the securities. Because a transaction occurred, the proper accounting is to record the gain realized on the sale. Although management has indulged in obvious windowdressing, an unmodified opinion may still be expressed if disclosure is adequate to prevent the financial statements from being misleading.
In which of the following circumstances would an auditor usually choose between expressing a qualified opinion or disclaiming an opinion?
Inability to obtain sufficient appropriate audit evidence. Scope limitations may require a qualification of the opinion or a disclaimer. The choice depends on whether the possible effects of undetected misstatements are material and pervasive.
In an audit of financial statements, substantive procedures
Include analytical procedures and tests of details of both balances and transactions. Substantive procedures are designed to detect material misstatements in the financial statement assertions. They consist of analytical procedures and tests of details. The auditor performs substantive procedures to restrict audit risk to an acceptable level.
After issuing an auditor's report, an auditor has no obligation to make continuing inquiries about audited financial statements unless
Information that existed at the report date and may affect the report comes to the auditor's attention. Although the auditor may need to extend subsequent events procedures when issuers make filings under the Securities Act of 1933 (AU-C 925, Filings with the U.S. Securities and Exchange Commission Under the Securities Act of 1933), (s)he ordinarily need not apply any procedures after the date of the report. However, facts may be discovered by the auditor after the report release date that, if known at that date, might have caused the auditor to revise the report. In this case, the auditor should (1) discuss the matter with management and (2) determine whether the statements should be revised and, if so, how management intends to address the matter in the statements (AU-C 560).
Some account balances, such as those for pensions or leases, are the results of complex calculations. The susceptibility to material misstatements in these types of accounts is defined as
Inherent risk Inherent risk is the susceptibility of an assertion about a transaction class, account balance, or disclosure that could be material, individually or in the aggregate, before consideration of any related controls. This risk is greater for some assertions and related balances, classes, or disclosures, than others. For example, complex calculations are more likely to be misstated than simple ones. Inherent risk exists independently of the audit (AU-C 200 and AS 1101)
Which of the following procedures would provide the most reliable audit evidence?
Inspection of bank statements obtained directly from the client's financial institution. When documentation is prepared solely by client personnel, its reliability is less than that prepared by the auditor or an independent party. Ordinarily, the most reliable documentation is created outside the entity and has never been within the client's control, e.g., statements obtained from the bank, letters from attorneys, and letters from insurance brokers.
Future events may cause an entity to cease to continue as a going concern. Relative to these future events, the auditor
Is not responsible for their prediction. The auditor cannot predict future conditions or events that may interfere with the entity's ability to continue as a going concern for a reasonable period. The ability to detect material misstatements resulting from future conditions or events is subject to inherent limitations. Thus, lack of a report reference to a substantial going concern doubt is not a guarantee the entity will continue as a going concern for a reasonable period. The auditor's responsibility is to conclude on, based on the audit evidence, whether (1) management's use of the going concern basis of accounting is appropriate and (2) substantial doubt exists. The auditor also must evaluate the financial statement effects and the adequacy of disclosure.
If all other factors in a sampling plan are held constant, changing the acceptable audit risk from 5% to 3% will cause the sample size to be
Larger. Decreasing the level of acceptable audit risk from 5% to 3% will increase the confidence level from 95% to 97%. Thus, the sample size will increase.
If a company's external auditor expresses an unmodified opinion as a result of the audit of the company's financial statements, readers of the audit report can assume that
Material issues about the application of accounting principles were resolved to the satisfaction of the external auditor. When the statements are materially misstated, the auditor should express a qualified or adverse opinion (AU-C 700).
Contract law is the basis for the legal liability at common law of an auditor to his or her client. From which of the following may the auditor's liability arise?
Negligence, gross negligence, or fraudulent actions by the auditor. An auditor's liability to a client arises from their contract, which is documented in the audit engagement letter. The auditor is obligated to carry out the contract (perform the audit) by exercising reasonable care. (S)he will be liable to the client for any negligence or fraud.
] An auditor observed that a client mails monthly statements to customers. Subsequently, the auditor reviewed evidence of follow-up on the errors reported by the customers. This test of controls was most likely performed to support management's financial statement assertion(s) of -Classification and Understandability -Rights and Obligations
No Yes The rights and obligations assertion applies to account balances. It relates to whether (1) the related assets are the rights of the entity and (2) the related liabilities are the obligations of the entity at the balance sheet date. Observation of the mailing of monthly statements and the correction of reported errors provides evidence that controls may be effective in ensuring that receivables are genuine. However, the test of controls performed provide little or no evidence about whether particular financial statement components are properly presented and described, and disclosures are clear.
The auditor failed to recognize a deviation included in a sample intended to test controls related to a transaction process. This failure best reflects
Nonsampling risk Nonsampling risk is the risk that the auditor may draw an erroneous conclusion for any reason not related to sampling risk. Examples include the use of inappropriate audit procedures or misinterpretation of audit evidence and failure to recognize a misstatement or deviation. Nonsampling risk may be reduced to an acceptable level through such factors as adequate planning and proper conduct of a firm's audit practice in accordance with the quality control standards (AU-C 530).
Which of the following procedures concerning accounts receivable is an auditor most likely to perform to obtain evidence in support of the effectiveness of controls?
Observing an entity's employee prepare the schedule of past due accounts receivable. To test the effectiveness of controls, an auditor performs procedures such as inquiry, observation, inspection, recalculation, and reperformance of a control. Thus, observing an entity's employee prepare the schedule of past due accounts receivable provides evidence of the effectiveness of certain controls over accounts receivable
In developing an audit plan, an auditor should
Perform risk assessment procedures The audit plan is based on the overall audit strategy. It describes (1) the nature and extent of risk assessment procedures; (2) the nature, timing, and extent of further audit procedures at the assertion level; and (3) other procedures required by GAAS. Risk assessment procedures are performed to obtain an understanding of the entity and its environment (including its internal control). Their purpose is to identify and assess the risks of material misstatement (whether due to fraud or error) at the financial statement and relevant assertion levels.
Which of the following procedures would be most appropriate for testing the completeness assertion as it applies to inventory?
Performing cutoff procedures for shipping and receiving. Testing the cutoff to consider the transfer of title of inventory in shipping and receiving is appropriate for testing the completeness assertion. The terms, FOB shipping point versus FOB destination, should be evaluated to assure that the goods were recorded in the proper period.
Which of the following most completely describes how independence has been defined by the accounting profession?
Possessing the ability to act with integrity and objectivity. Integrity, objectivity, and independence are overlapping concepts. Integrity requires honesty and candor within the limits of confidentiality. It also requires, among other things, observation of the Principle of objectivity and independence. Objectivity is impartiality, intellectual honesty, and freedom from conflicts of interest. Independence precludes relationships that "may appear to impair objectivity in rendering attestation services." Thus, in rendering services, a member in public practice should be independent in appearance as well as in fact.
A client is in the process of acquiring another company. The auditor has been requested to verify that cash for the company being acquired is properly stated. The audit technique that will yield the most persuasive evidence is
Preparation and review of standard bank confirmation inquiries The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used by auditors to confirm the deposit balance held by the bank for a client. In addition, this confirmation requests loan information, such as a description of the collateral securing the loan.
Which of the following section(s) of the Code of Professional Conduct is (are) aspirational only?
Principles The AICPA Code contains two sections: Principles and Rules. The principles are goaloriented. The rules provide more specific guidance. The principles call for an unswerving commitment to honorable behavior, but are not mandatory. Members who fail to comply with the rules, however, may face disciplinary action.
Audit documentation
Provides evidence that the audit was performed in accordance with GAAS. The objectives of audit documentation are to provide (1) a sufficient and appropriate record of the basis of the auditor's report and (2) evidence that the audit was performed in accordance with GAAS and other requirements. Audit documentation is the record of (1) the audit procedures performed, (2) relevant evidence obtained, and (3) conclusions reached.
When the financial statements of a nonissuer contain a misstatement, the effect of which is material but not pervasive, the auditor should
Qualify the opinion and include a basis for qualified opinion paragraph that describes the matter resulting in the qualification. When the financial statements are materially misstated, but the effects are not pervasive, the auditor should express a qualified opinion. The report should contain a basis for qualified opinion paragraph preceding the opinion paragraph. If the material misstatement relates to specific amounts, the basis paragraph should describe and quantify the financial effects, if practicable. If the misstatement relates to narrative disclosures, the auditor should include an explanation. If the misstatement relates to an omission of required information, the auditor should describe the nature of the information and, if practicable, include the information. The opinion paragraph should refer to the basis paragraph.
A number of factors influence the sample size for a substantive test of details of an account balance. All other factors being equal, which of the following would lead to a larger sample size? A. A lower assessed risk of material misstatement.
Smaller measure of tolerable misstatement. Holding the risk of incorrect acceptance constant, a reduction in acceptable tolerable misstatement would require the auditor to select a larger sample. The larger sample would reduce the allowance for sampling risk.
In preparing a sampling plan for an inventory pricing test, which of the following describes an advantage of statistical sampling over nonstatistical sampling?
Statistical sampling provides a quantitative measure of sampling risk. The results of statistical (probability) sampling are objective and subject to the laws of probability. Thus, sampling risk can be quantified and controlled, and the degree of reliability desired (the confidence level) can be specified. Sampling risk is the risk that the conclusion based on a sample may differ from the conclusion based on applying the same audit procedure to all items in the population.
Analytical procedures can best be categorized as
Substantive procedures. Substantive procedures are designed to detect material misstatements at the assertion level. According to AU-C 520, Analytical Procedures, analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. They involve comparisons of recorded amounts, or ratios developed from recorded amounts, to expectations developed by the auditor.
In which of the following circumstances would a CPA who audits XM Corporation lack independence?
The CPA and XM's president each owns 25% of FOB Corporation, a closely held company. Independence is impaired if, during the period of the professional engagement, "a covered member had a joint, closely held investment that was material to the covered member." A joint, closely held investment by the member and the client (or its officers, directors, or an owner with significant influence) enables them to control the investee entity or property.
An audit client sells 15 to 20 units of product annually. A large portion of the annual sales occur in the last month of the fiscal year. Annual sales have not materially changed over the past 5 years. Which of the following approaches would be most effective concerning the timing of audit procedures for revenue?
The auditor should inspect transactions occurring in the last month of the fiscal year and review the related sale contracts to determine that revenue was posted in the proper period. Tests of the details of transactions at year end are most effective given that total sales consist mostly of a few transactions. Also, because most occur in the last month of the year, the auditor should establish that management made a proper cutoff.
Which of the following statements best describes the distinction between the auditor's responsibilities and management's responsibilities?
The auditor's responsibility is confined to expressing an opinion, but the financial statements remain the responsibility of management The auditor is responsible for the opinion on financial statements, but management is responsible for the representations made in the financial statements.
Samples to test controls are intended to provide a basis for an auditor to conclude whether
The controls are operating effectively Tests of controls obtain evidence about the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level. Tests of controls address (1) how they were applied at relevant times during the period, (2) by whom or by what means they were applied, and (3) the consistency of their application during the period. Prior to performing tests of controls, the auditor evaluates whether they are suitably designed to prevent, or detect and correct, material misstatements in relevant assertions (AU-C 330).
Under which of the following circumstances would a disclaimer of opinion not be appropriate?
The financial statements fail to contain adequate disclosure concerning related party transactions. A disclaimer is inappropriate when the financial statements contain material departures from the applicable financial reporting framework. Inadequacy of the disclosures required by the applicable financial reporting framework is such a departure. Because U.S. GAAP require certain disclosures about related party transactions, the inadequacy of such disclosures is a basis for expressing a qualified or an adverse opinion
Which of the following is not a true statement about audit documentation?
The nature and extent of documentation depend on the risks of material misstatement. The form, content, and extent of documentation are determined by such factors as the following: -Risks of material misstatement identified -Extent of judgment involved in performing the work and evaluating the results -Nature of the auditing procedures -Significance of the evidence obtained -Nature and extent of exceptions identified -Need to document a conclusion or the basis for a conclusion not readily determinable from other documentation of the work
A purpose of a management representation letter is to reduce
The possibility of a misunderstanding concerning management's responsibility for the financial statements. Management's written representations should be in the form of a representation letter addressed to the auditor. The auditor should have possession of the letter before release of the auditor's report. Among other things, the auditor should request that management provide a written representation that it has met its responsibilities stated in the terms of the audit engagement. These responsibilities include those for (1) the preparation and fair presentation of the statements in accordance with the applicable reporting framework and (2) the design, implementation, and maintenance of the relevant internal control.
A letter of inquiry to an entity's external legal counsel is
The primary means for obtaining corroborating evidence for information provided by management concerning litigation, claims, and assessments. Evidence obtained from the entity's in-house legal counsel may provide necessary corroboration. However, internal evidence is not a substitute for information external legal counsel can provide
As a result of control testing, a CPA has decided to reduce control risk. What is the impact on substantive testing sample size if all other factors remain constant?
The sample size would be lower. As the assessed level of control risk decreases, the auditor's allowable risk of incorrect acceptance for the substantive tests of details increases. Thus, the required sample size decreases
Inherent risk is
The susceptibility of an assertion to a material misstatement before consideration of related internal controls. Inherent risk is the susceptibility of an assertion about a class of transaction, account balance, or disclosure to a misstatement that could be material, individually or in the aggregate, before consideration of any related controls. This risk is greater for some assertions and related balances or classes than others. For example, complex calculations are more likely to be misstated than simple ones, and cash is more likely to be stolen than an inventory of coal. Inherent risk exists independently of the audit.
Auditors are often concerned with the possibility of overstatement of sales and receivables. However, management may also have reasons for understating these balances. Which of the following would explain understatement of sales and receivables?
To avoid paying taxes State sales taxes and federal and state income taxes are based upon sales or profits, respectively. Management may attempt to reduce or avoid tax liability by not recording and reporting all sales and receivables.
An external auditor discovers that a payroll supervisor of the firm being audited has misappropriated $10,000. The firm's total assets and before-tax net income are $14 million and $3 million, respectively. Assuming no other issues affect the report, the external auditor's report will most likely contain a(n)
Unmodified opinion. The auditor is likely to express an unmodified opinion for two reasons. First, the misappropriated amount is immaterial relative to assets and income. Second, as long as the misappropriation is accounted for properly, the financial statements will be fairly presented.
In evaluating the adequacy of the allowance for doubtful accounts, an auditor most likely reviews the entity's aging of receivables to support management's financial statement assertion of
Valuation and allocation. Assertions about valuation and allocation concern whether financial statement components have been included at appropriate amounts in accordance with the applicable financial reporting framework. For example, management asserts that trade accounts receivable are stated at net realizable value (gross accounts receivable minus allowance for uncollectible accounts). Aging the receivables is a procedure for assessing the reasonableness of the allowance.
An auditor performs a test to determine whether all merchandise for which the client was billed was received. The population for this test consists of all
Vendors' invoices. Vendors' invoices are the billing documents received by the client. They describe the items purchased, the amounts due, and the payment terms. The auditor should trace these invoices to the related receiving reports.
The Acts Discreditable Rule states that a member shall not commit an act discreditable to the profession. Which of the following is not considered such an act?
Withholding as a result of nonpayment of fees for a completed engagement certain information already contained in the client's books and records The member's duty to return such information is not absolute. If fees for a completed engagement have not been paid, it may be withheld. The member's duty is absolute with regard to client records. The duty is conditional upon payment of fees with respect to information such as adjusting, closing, combining, or consolidating entries or information normally found in books of original entry and general or subsidiary ledgers.
An auditor may express a qualified opinion because of a(n) -Material mistatement of the financial statements -Any change in the principles of accounting -Inability to obtain sufficient appropriate evidence
Yes No Yes A qualified opinion is expressed when the financial statements are misstated and the effects are material but not pervasive. Also, a qualified opinion is expressed when the auditor is unable to obtain sufficient appropriate audit evidence and the possible effects are material but not pervasive. Moreover, the comparability of the statements between periods may be materially affected by a change in accounting principle. In these circumstances, the auditor should evaluate whether the change is appropriate. If so, the auditor should include an emphasisofmatter paragraph describing the change without modifying the opinion
An engagement letter is used primarily to
ensure a clear contractual understanding of the services to be provided by the CPA. The auditor should agree with management or those charged with governance upon the terms of the engagement. The auditor accepts the engagement only if (1) the preconditions for an audit are present and (2) a common understanding of the terms has been reached. The preconditions are (1) use of an acceptable accounting framework and (2) agreement on the premise of the audit. The premise relates to the fundamental responsibilities of management and, if appropriate, those charged with governance. The terms of the engagement should be documented in an engagement letter that states the (1) objective and scope of the audit, (2) responsibilities of the auditor and management, (3) inherent limitations of the audit and internal control, (4) applicable financial reporting framework, and (5) expected form and content of audit reports. An engagement letter should be sent by the CPA to the prospective client on each engagement, audit or otherwise. If the client agrees to the terms by signing a copy of the letter and returning it to the CPA, a contract is formed.
