Audit HW2 (3.1-3.5, 4)
Which of the following auditing procedures most likely would assist an auditor in identifying related party transactions?
A Vouching accounting records for recurring transactions recorded just after the balance sheet date. B Inspecting correspondence with lawyers for evidence of unreported contingent liabilities. C Reviewing confirmations of loans receivable and payable. Answer C is correct. An auditor should be alert during the audit for related party information. Thus, the auditor should inspect records and documents, especially (1) bank and legal confirmations, (2) minutes of meetings of shareholders and directors, and (3) any other records or documents considered necessary. Other records and documents may include third-party confirmations. D Performing analytical procedures for indications of possible financial difficulties.
Which of the following is required documentation in an audit in accordance with auditing standards?
A A flowchart or narrative of the information system describing the recording and classification of transactions for financial reporting. B A planning memorandum establishing the timing of the audit procedures and coordinating the assistance of entity personnel. C An audit plan documenting the procedures to be used to reduce audit risk. Answer C is correct. An audit plan should be developed and documented based on the overall audit strategy. This strategy, the audit plan, significant changes in them, and the reasons for changes are documented. The audit plan records the nature, timing, and extent of risk assessment procedures and further procedures performed at the assertion level to respond to assessed risks. It also records other planned procedures required by GAAS. Thus, the audit plan is a record of the planning of the audit procedures that can be reviewed prior to their performance (AU-C 300 and AS No. 9). D An internal control questionnaire identifying policies and procedures that assure specific objectives will be achieved.
For a reporting entity that has participated in related party transactions that are material, disclosure in the GAAP-based financial statements should include
A A reference to deficiencies in the entity's internal control. B Details of the transactions within major classifications. C The nature of the relationship and the terms and manner of settlement. Answer C is correct. Disclosure in GAAP-based financial statements of a reporting entity that has participated in material related party transactions should include (1) the nature of the relationship; (2) a description of the transactions; (3) the dollar value of the transactions; (4) the amounts due from or to related parties; and (5) if not otherwise apparent, the terms and manner of settlement. D A statement to the effect that a transaction was consummated on terms equivalent to those that prevail in arm's-length transactions.
The company being audited has an internal auditor that is both competent and objective. The auditor wants to assign tasks for the internal auditor to perform. Under these circumstances, the auditor may
A Allow the internal auditor to perform tests of internal controls. Answer A is correct. The auditor may request direct assistance from the internal auditor when performing the audit. Thus, the auditor may appropriately request the internal auditor's assistance in obtaining the understanding of internal control, performing tests of controls, or performing substantive procedures. The internal auditor may provide assistance in all phases of the audit if (1) the internal auditor's competence and objectivity have been assessed, and (2) the auditor supervises, reviews, evaluates, and tests the work performed by the internal auditor to the extent appropriate. B Allow the internal auditor to perform analytical procedures but not be involved with any tests of details. C Not assign any task to the internal auditor because of the internal auditor's lack of independence. D Allow the internal auditor to audit a major subsidiary of the company.
Which of the following is not considered an auditor's specialist?
A Appraiser. B Actuary. C Internal auditor. Answer C is correct. For the purposes of AU-C 620, an auditor's specialist is an individual or organization possessing expertise in a field other than accounting or auditing. The external auditor should consider the work of internal auditors but should not deem them to be specialists in the sense contemplated by AU-C 620. D Tax attorney.
An auditor may refer to and identify an auditor's external specialist in the auditor's report if the
A Auditor expresses a disclaimer of an opinion as a result of the specialist's findings. Answer A is correct. The auditor may refer to an auditor's external specialist only if the opinion is modified. A modified opinion is a qualified opinion, adverse opinion, or a disclaimer of opinion. The reference is made because it is relevant to understanding the modification. An auditor's report with such a reference should state that it does not reduce the auditor's responsibility (AU-C 620). B Specialist's work provides the auditor greater assurance of reliability. C Auditor wishes to indicate a division of responsibility. D Specialist lacks objectivity with regard to the client.
An auditor who uses the work of an auditor's external specialist may refer to and identify the specialist in the auditor's report if the
A Auditor expresses a qualified opinion or an adverse opinion related to the work of the specialist. Answer A is correct. The auditor may refer to an auditor's external specialist only if the opinion is modified. A modified opinion is a qualified opinion, adverse opinion, or a disclaimer of opinion. The reference is made because it is relevant to understanding the modification. An auditor's report with such a reference should state that it does not reduce the auditor's responsibility (AU-C 620). B Specialist is management's specialist. C Auditor indicates a division of responsibility related to the work of the specialist. D Specialist's work provides the auditor greater assurance of reliability.
Which of the following events most likely indicates the existence of related parties?
A Borrowing a large sum of money at a variable rate of interest. B Making a loan without scheduled terms for repayment of the funds. Answer B is correct. The following suggest possible related party transactions: (1) exchanging property for similar property in a nonmonetary transaction, (2) borrowing or lending at rates significantly above or below market rates, (3) selling realty at a price materially different from its appraised value, and (4) making loans with no scheduled repayment terms. C Selling real estate at a price that differs significantly from its carrying amount. D Discussing merger terms with a company that is a major competitor.
Analytical procedures are required for which of the following?
A Client retention decision. B Tests of balances. C Internal control evaluation. D Audit planning. Answer D is correct. An audit plan based on the audit strategy must be developed and documented for all audit engagements. It includes the nature, timing, and extent of procedures expected to reduce audit risk to an acceptably low level. Thus, the audit plan includes a description of risk assessment procedures. Risk assessment procedures are performed to obtain an understanding of the entity and its environment, including its internal control, to identify and assess the risks of material misstatement (RMMs) at the levels of (1) the financial statements as a whole and (2) relevant assertions. Risk assessment procedures include (1) inquiries of management and others within the entity, (2) analytical procedures, and (3) observation and inspection. The auditor also may perform other appropriate procedures, such as inquiring of external parties (e.g., legal counsel) or reviewing externally generated information (e.g., financial publications). Analytical procedures may be applied not only as risk assessment procedures (analytical procedures used to plan the audit) but also as substantive procedures. These are procedures (tests of details and analytical procedures) designed to detect material misstatements at the assertion level.
When one auditor succeeds another, the auditor should request the
A Client to authorize the predecessor auditor to allow a review of the predecessor auditor's audit documentation. Answer A is correct. The Code of Professional Conduct protects the confidentiality of client information. Hence, the auditor should seek the client's specific consent for the predecessor auditor to respond fully to the auditor's inquiries. The auditor should communicate with the predecessor to determine whether to accept the engagement (AU-C 210). If the engagement is accepted, the audit may be facilitated by making specific inquiries of the predecessor and by reviewing the predecessor's audit documentation. The auditor also should request the client to authorize this review. B Client to instruct its lawyer to send a letter of audit inquiry concerning the status of the prior year's litigation, claims, and assessments. C Predecessor auditor to submit a list of internal control related matters noted in an audit but have not been corrected. D Predecessor auditor to update the prior year's report to the date of the change of auditors.
Which of the following would be considered an analytical procedure?
A Comparing inventory balances to recent sales activities. Answer A is correct. Analytical procedures are evaluations of financial data made by a study of plausible relationships among financial and nonfinancial data. Comparing inventory balances with recent sales activities is a study of a plausible relationship between these activities. B Reconciling physical counts to perpetual records and general ledger balances. C Testing purchasing, shipping, and receiving cutoff activities. D Projecting the deviation rate of a statistical sample to the population.
Which of the following most likely would indicate the existence of related parties?
A Depending on a single product for the success of the entity. B Writing down obsolete inventory just before year end. C Failing to correct previously identified internal control deficiencies. D Borrowing money at an interest rate significantly below the market rate. Answer D is correct. The following suggest possible related party transactions: (1) exchanging property for similar property in a nonmonetary transaction, (2) borrowing or lending at rates significantly above or below market rates, (3) selling realty at a price materially different from its appraised value, and (4) making loans with no scheduled repayment terms.
An auditor's engagement letter most likely would include a statement that
A Describes the auditor's responsibility to evaluate going-concern issues. B Explains the analytical procedures that the auditor expects to apply. C Lists potential significant deficiencies in internal control discovered during the prior-year's audit. D Limits the auditor's responsibility to detect fraud and error. Answer D is correct. 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. Because of the inherent limitations of the audit and of internal control, the risk of not detecting some material misstatements, whether due to fraud or error, is unavoidable. This risk exists even if the audit is in accordance with GAAS.
An auditor most likely will use analytical procedures to form an overall conclusion to
A Determine whether additional audit evidence may be needed. Answer A is correct. Analytical procedures should be used to assist the audit to form an overall conclusion. The purpose of those procedures is to determine whether the statements are consistent with the auditor's understanding of the entity (AU-C 520). When analytical procedures reveal inconsistent fluctuations or relationships or significant differences, the auditor should investigate the results. Thus, the auditor should (1) make inquires of management, (2) corroborate the responses with other audit evidence, and (3) perform other necessary procedures. B Identify auditing procedures omitted by the staff accountants. C Enhance the auditor's understanding of subsequent events. D Evaluate the effectiveness of the internal control activities.
Which of the following steps should be performed first in applying analytical procedures?
A Determine whether the difference between the expectation and the recorded amount is reasonable. B Develop an expectation of a balance or ratio by using relationships that are expected to exist. Answer B is correct. Analytical procedures are evaluations of financial information made by a study of plausible relationships among financial and nonfinancial data using models that range from simple to complex. Plausible relationships among data are reasonably expected to exist and continue in the absence of known conditions to the contrary. The first step is to develop an expectation. C Investigate and evaluate significant differences from the expectation. D Compare the client's recorded balance or ratio with the expectation.
After identifying related party transactions, an auditor most likely would
A Discuss the implications of the transactions with third parties, such as the entity's attorneys and bankers. B Substantiate that the transactions were consummated on terms equivalent to those prevailing in arm's-length transactions. C Determine whether the transactions were approved by the board of directors or other appropriate officials. Answer C is correct. After identifying significant related party transactions outside the normal course of business, an auditor should obtain evidence that they have been appropriately authorized and approved by management, those charged with governance, or (in a proper case) the shareholders. Appropriate authorization and approval reduce but do not eliminate the risks of material misstatement due to fraud or error (AU-C 550). D Ascertain whether the transactions would have occurred if the parties had not been related.
If the auditors decide that it is efficient to consider how the work performed by the internal auditors may affect the nature, timing, and extent of audit procedures, they should assess the internal auditors'
A Efficiency and experience. B Independence and review skills. C Competence and objectivity. Answer C is correct. If the auditors decide that it is efficient to consider how the internal auditors' work may affect the nature, timing, and extent of audit procedures, the competence and objectivity of the internal auditors should be assessed. Assessing competence involves obtaining information about (1) education and experience; (2) professional certification and CPE; (3) audit policies, programs, and procedures; (4) practices regarding assignment of internal auditors; (5) supervision and review of their activities; (6) quality of audit documentation, reports, and recommendations; and (7) evaluation of internal auditors' performance. Assessing objectivity includes obtaining information about (1) organizational status (the level to which the internal auditors report, access to those charged with governance, and whether these individuals oversee employment decisions related to the internal auditors) and (2) policies to maintain internal auditors' objectivity concerning the areas audited (AU-C 610). D Training and supervisory skills.
In assessing the competence of internal auditors, an independent CPA most likely would obtain information about the
A Entity's ability to continue as a going concern for a reasonable period of time. B Quality of the internal auditors' working paper documentation. Answer B is correct. In assessing the competence of an internal auditor, the CPA should consider such factors as (1) educational level and professional experience; (2) professional certification and continuing education; (3) audit policies, programs, and procedures; (4) departmental practices regarding assignments; (5) quality of working paper documentation, reports, and recommendations; and (6) evaluation of the internal auditor's performance. C Policies limiting internal auditors from communication with the audit committee. D Influence of management on the scope of the internal auditors' duties.
An internal auditor would least likely provide direct assistance to the auditor in
A Evaluating accounting estimates. Answer A is correct. The auditor has the ultimate responsibility to express an opinion on the financial statements. Judgments about (1) assessments of the risks of material misstatement, (2) materiality of misstatements, (3) sufficiency of tests performed, (4) evaluation of significant accounting estimates, and (5) other matters affecting the auditor's report always should be those of the auditor. B Performing tests of controls. C Performing substantive procedures. D Obtaining an understanding of internal control.
Which of the following procedures would an auditor most likely include in the initial planning of a financial statement audit?
A Examining documents to detect noncompliance with laws and regulations having a material effect on the financial statements. B Considering whether the client's accounting estimates are reasonable in the circumstances. C Obtaining a written representation letter from the client's management. D Determining the extent of involvement of the client's internal auditors. Answer D is correct. AU-C 610, The Auditor's Consideration of the Internal Audit Function in an Audit of Financial Statements, states that the independent auditor should obtain an understanding of the internal audit function when obtaining an understanding of a client's internal control. The understanding should be sufficient to identify internal audit activities relevant to audit planning. Thus, an internal audit function is one of many factors to be considered in determining the nature, timing, and extent of audit procedures.
An auditor would be most likely to consider modifying an otherwise unmodified opinion if the client's financial statements include a note on related party transactions
A Explaining the business purpose of the sale of real property to a related party. B Presenting the dollar volume of related party transactions and the effects of any change in the method of establishing terms from that used in the prior period. C Representing without substantiation that certain related party transactions were consummated on terms equivalent to those obtainable in transactions with unrelated parties. Answer C is correct. It is most often not possible to determine whether a particular transaction would have occurred if the parties had not been related or what the terms and manner of settlement would have been. Accordingly, assertions about such matters are difficult to substantiate. The auditor may (1) believe that the assertion is unsubstantiated or (2) not be able to obtain sufficient appropriate evidence. In these cases, the auditor considers the implications for the audit, including whether to modify the opinion (AU-C 550 and AS No. 18). (S)he should consider including in the report a comment to that effect and expressing a qualified or adverse opinion. D Disclosing compensating balance arrangements maintained for the benefit of related parties.
Auditing standards require that sufficient appropriate evidence be obtained by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit. The substantive evidence required may be obtained, in part, through
A Flowcharting internal control. B Analytical procedures. Answer B is correct. Analytical procedures are evaluations of financial information made by a study and comparison of the relationships among data. The premise is that certain relationships prevail in the absence of known conditions to the contrary. Analytical procedures may be, but are not required to be, used as substantive procedures (along with tests of details) to provide sufficient appropriate evidence about specific financial statement assertions related to account balances or classes of transactions. C Audit documentation. D Proper planning of the audit engagement.
An auditor compares annual revenues and expenses with similar amounts from the prior year and investigates all changes exceeding 10%. This procedure most likely could indicate that
A Fourth quarter payroll taxes were properly accrued and recorded, but were not paid until early in the subsequent year. B Notice of an increase in property tax rates was received by management, but was not recorded until early in the subsequent year. C Unrealized gains from increases in the value of available-for-sale securities were recorded in the income account for trading securities. Answer C is correct. Unrealized gains from increases in the value of available-for-sale securities should be recorded directly in other comprehensive income (a component of equity). Unrealized gains from increases in the value of trading securities should be included in income. Thus, a more-than-10% increase in income could have been caused by improper accounting for available-for-sale securities. D The annual provision for uncollectible accounts expense was inadequate because of worsening economic conditions.
A primary objective of analytical procedures used to form an overall conclusion is to
A Gather evidence from tests of details to corroborate financial statement assertions. B Determine whether the financial statements are consistent with the auditor's understanding. Answer B is correct. Analytical procedures should be applied to form an overall conclusion near the end of the audit. They may include reading the statements and considering (1) the adequacy of evidence regarding previously identified unusual or unexpected balances and (2) unusual or unexpected balances or relationships not previously noted. C Identify account balances that represent specific risks relevant to the audit. D Detect fraud that may cause the financial statements to be misstated.
The work of internal auditors may affect the independent auditor's I. Procedures performed in obtaining an understanding of internal control II. Procedures performed in assessing the risks of material misstatement III. Substantive procedures performed in gathering direct evidence
A II and III only. B I and III only. C I and II only. D I, II, and III. Answer D is correct. The internal audit function is part of the client's internal control. The auditor should obtain an understanding of this function when obtaining an understanding of internal control. The auditor also may use the internal auditors to provide direct assistance under certain conditions. A primary purpose of internal auditors is to review, assess, and monitor internal control. Thus, their work is relevant to the understanding of internal control and the assessment of risk. Moreover, some procedures performed by internal auditors, such as confirmations, may provide direct evidence about material misstatements.
Which of the following matters does an auditor usually include in the engagement letter?
A Indications of negative cash flows from operating activities. B Arrangements regarding fees and billing. Answer B is correct. The engagement letter documents the terms of the auditor's agreement with management or those charged with governance. It includes (1) the objective and scope of the audit; (2) the responsibilities of the auditor and management; (3) the inherent limitations of the audit and internal control; (4) the financial reporting framework; (5) the expected form and content of reports; and (6) other relevant information, such as fee arrangements, billings, and assistance by the client's staff (AU-C 210). C Analytical procedures that the auditor plans to perform. D Identification of working capital deficiencies.
When assessing an internal auditor's objectivity, an auditor should
A Inquire about the internal auditor's educational background and professional certification. B Review the internal auditor's working papers. C Consider the organizational level to which the internal auditor reports. Answer C is correct. If the auditors decide that it is efficient to consider how the internal auditors' work may affect the nature, timing, and extent of audit procedures, the competence and objectivity of the internal auditors should be assessed. Assessing objectivity includes obtaining information about organizational status (the level to which the internal auditors report), including whether (1) they report to an officer of sufficient status, (2) they have access to those charged with governance, and (3) these individuals oversee employment decisions related to the internal auditors. The auditor also considers policies to maintain internal auditors' objectivity regarding the areas audited. D Evaluate the adequacy of the internal auditor's audit programs.
Hill Corporation has hired Jones, a CPA, to audit its financial statements for year end. Jones, when searching for related party transactions, should seek information to obtain an understanding about each of Hill's subsidiary's relationships because
A Intercompany transactions may have been consummated on terms equivalent to arm's-length transactions. B This would permit the audit of Hill's interentity account balances to be performed as of concurrent dates. C Some of these transactions may not have taken place if the parties had not been related. D Hill's business structure might be designed in such a way as to deliberately obscure related party transactions. Answer D is correct. Under U.S. GAAP, transactions between a parent and its subsidiaries are related party transactions. Thus, Jones should obtain an understanding of Hill's subsidiary relationships to assess whether Hill's ownership and governance structures were designed to obscure related party transactions. The auditor's risk assessment procedures should inquire about (1) the identity of related parties, (2) the relationship of the entity with each party, (3) whether transactions with them have occurred, and (4) the nature and purpose of the transactions. Jones also should be aware that business structure and operating style are occasionally deliberately designed to obscure related party transactions.
When assessing the internal auditors' competence, the auditor should obtain information about the
A Internal auditors' access to records and information that is considered sensitive. B Organizational level to which the internal auditors report. C Educational background and professional certification of the internal auditors. Answer C is correct. If the auditor decides that it is efficient to consider how the internal auditors' work may affect the nature, timing, and extent of audit procedures, the competence and objectivity of the internal auditors should be assessed. The factors in assessing the competence of internal auditors include (1) educational level and experience; (2) professional certification and continuing education; (3) audit policies, programs, and procedures; (4) practices regarding assignment of internal auditors; (5) supervision and review; (6) quality of working paper documentation, reports, and recommendations; and (7) performance evaluation. D Policies prohibiting the internal auditors from auditing areas where relatives are employed.
Which of the following factors most likely would lead a CPA to conclude that a potential audit engagement should not be accepted?
A Internal control activities requiring the separation of duties are subject to management override. B There are significant related party transactions that management claims occurred in the ordinary course of business. C Management continues to employ an inefficient system of information technology to record financial transactions. D It is unlikely that sufficient appropriate evidence is available to support an opinion on the financial statements. Answer D is correct. The terms of the engagement should include management's responsibility to provide access to all information and persons deemed necessary to the audit. Depending on the pervasiveness of the potential effects of the inability to obtain sufficient appropriate evidence, the result may be a qualification of the opinion or a disclaimer of an opinion if the engagement is accepted.
An auditor intends to use the work of an actuary. Under these circumstances, the auditor
A Is required to disclose the relationship in the auditor's report. B Is not permitted to rely on the actuary's work. C Should assess the actuary's competence and objectivity. Answer C is correct. When deciding whether to use an auditor's specialist, the auditor should evaluate whether the auditor's specialist has the needed competence, capabilities, and objectivity. For an external specialist, the evaluation should include inquiries about threats to objectivity (AU-C 620). Consideration should be given to the specialist's professional certification, license, or other recognition of competence and the specialist's reputation and standing. D Should communicate this matter to the audit committee.
Which of the following procedures would an auditor most likely perform in the planning stage of an audit?
A Make a preliminary judgment about materiality. Answer A is correct. Materiality should be established for planning purposes. The concept of materiality recognizes that some but not all matters are important for fair presentation of the financial statements. The auditor is responsible for planning and performing the audit to obtain reasonable assurance that material misstatements are detected. B Obtain written representations from management that there are no unrecorded transactions. C Communicate management's initial selection of accounting policies to the audit committee. D Confirm a sample of the entity's accounts payable with known creditors.
Which of the following procedures would a CPA most likely perform in the planning stage of a financial statement audit?
A Make inquiries of the client's attorney regarding pending and threatened litigation and assessments. B Obtain representations from management regarding the availability of all financial records. C Compare recorded financial information with anticipated results from budgets and forecasts. Answer C is correct. Analytical procedures are required to be used as risk assessment procedures (analytical procedures used to plan the audit) in all financial statement audits. Analytical procedures are evaluations of financial statement information made by a study of plausible relationships among financial and nonfinancial data using models that range from simple to complex. Plausible relationships among data are reasonably expected to exist and continue in the absence of known conditions to the contrary. Analytical procedures also include investigating fluctuations or relationships that are (1) inconsistent with other information or (2) differ significantly from expectations. D Communicate with those charged with governance about the prior year's audit adjustments.
Before accepting an engagement to audit a new client, an auditor is required to
A Make inquiries of the predecessor auditor after obtaining the consent of the prospective client. Answer A is correct. The auditor should request management to authorize the predecessor to respond fully to inquires. The auditor should inquire about (1) reasons for the change in auditors, (2) disagreements with management about accounting policies and auditing procedures, (3) facts being on management's integrity, (4) communications to those charged with governance about fraud or noncompliance, and (5) communications to those charged with governance or management about internal control problems (AU-C 210, Terms of Engagement). B Discuss the management representation letter with the prospective client's audit committee. C Prepare a memorandum setting forth the staffing requirements and documenting the preliminary audit plan. D Obtain the prospective client's signature to the engagement letter.
In assessing the competence of an internal auditor, an independent CPA most likely would obtain information about the
A Organization's commitment to integrity and ethical values. B Quality of the internal auditor's documentation. Answer B is correct. In assessing the competence of an internal auditor, the auditor should consider such factors as (1) educational level and professional experience; (2) professional certification and continuing education; (3) audit policies, programs, and procedures; (4) supervision and review of the internal auditor's activities; (5) practices regarding assignments; (6) quality of documentation, reports, and recommendations; and (7) evaluation of the internal auditor's performance. C Influence of management on the scope of the internal auditor's duties. D Organizational levels to which the internal auditor reports.
Which of the following statements is correct regarding the predictability of analytical procedures in a financial statement audit?
A Relationships involving only balance sheet accounts tend to be more predictable than relationships involving income statement accounts. B Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts. Answer B is correct. Analytical procedures are evaluations of financial information made by a study of plausible relationships among financial and nonfinancial data using models that range from simple to complex. Plausible relationships among data are reasonably expected to exist and continue in the absence of known conditions to the contrary. Relationships in stable environments are more predictable than those in unstable environments, and income statement amounts tend to be more predictable than balance sheet amounts. The reason is that income statement amounts are based on transactions over a period of time, but balance sheet amounts are for a moment in time. Also, amounts subject to management discretion tend to be less predictable. C Relationships involving transactions subject to management discretion tend to be more predictable than automated transactions. D Relationships in a dynamic environment tend to be more predictable than relationships in a stable environment.
If not already done to form an overall conclusion, the auditor should perform analytical procedures relating to which of the following transaction cycles?
A Revenue. Answer A is correct. Revenue is an account for which expectations can be developed by the auditor. It is a key account that should be predictable. B Payroll. C Purchasing. D Inventory.
In connection with the audit of financial statements by an auditor, the client suggests that members of the internal audit staff be used to minimize audit costs. For which of the following tasks may the auditor most appropriately request direct assistance from the internal audit staff?
A Selection of accounts receivable for confirmation, based upon the internal auditor's judgment as to how many accounts and which accounts will provide sufficient coverage. B Determination of the adequacy of the allowance for doubtful accounts. C Assessment of the risks of material misstatement relevant to accounts receivable and sales. D Preparation of schedules for negative accounts receivable responses. Answer D is correct. Internal auditors may provide direct assistance in performing both substantive procedures and tests of controls provided that the auditor assesses their competence and objectivity; supervises, reviews, evaluates, and tests their work; and makes all judgments regarding matters that affect the report on the financial statements. Preparing schedules for negative accounts receivable responses is a clerical activity related to a substantive procedure that an internal auditor may perform under the supervision of the auditor.
Transactions indicative of the existence of related parties include all of the following except
A Selling real estate at a price significantly different from the appraised value. B Selling real estate at a price significantly different from the carrying amount. Answer B is correct. Real estate's fair value is normally significantly higher than its carrying amount. The longer that real estate is held, the more likely that its fair value differs from its carrying amount. A difference between the carrying amount and fair value does not indicate the existence of related parties. It is an occurrence in the normal course of business. C Making loans with no scheduled terms for repayment. D Borrowing or lending interest-free or at a rate significantly different from prevailing market rates at the time of the transaction.
An auditor compared the current-year gross margin with the prior-year gross margin to determine if cost of sales is reasonable. What type of audit procedure was performed?
A Test of controls. B Test of transactions. C Analytical procedures. Answer C is correct. 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. D Test of details.
Which of the following factors most likely would cause a CPA to decide not to accept a new audit engagement?
A The CPA's lack of understanding of the prospective client's internal auditor's computer-assisted audit techniques. B Management's disregard of its responsibility to maintain an adequate internal control environment. Answer B is correct. The control environment is the foundation for all other control components. It provides discipline and structure, sets the tone of the organization, and influences the control consciousness of employees. A precondition of an audit is management's acknowledgment of its responsibilities for internal control relevant to financial reporting. Internal control should enable the preparation and fair presentation of financial statements that are free from material misstatement due to fraud or error. However, management's disregard of this responsibility may raise doubts about the auditability of the financial statements and the integrity of management. C Management's refusal to permit the CPA to perform substantive procedures before year end. D The CPA's inability to determine whether related-party transactions were consummated on terms equivalent to arm's-length transactions.
Which of the following statements concerning the auditor's use of the work of an auditor's external specialist is true?
A The auditor's specialist need not have an understanding of the extent of the auditor's use of the specialist's work. B The auditor's specialist may be identified in the auditor's report only when the auditor expresses an unmodified opinion. C If the auditor believes that the determinations made by the auditor's specialist are unreasonable, only a qualified opinion may be expressed. D The auditor's specialist should observe the same confidentiality requirements as the auditor. Answer D is correct. An agreement between the auditor and the auditor's external specialist generally is documented in an engagement letter. A matter that should be included is the need for the confidentiality provisions of the relevant ethical requirements that apply to the auditor to also apply to the specialist. For example, a member of the AICPA may use a third-party service provider to render professional services to clients. The member should have a contract with the third-party service provider to maintain the confidentiality of the information (Ethics Ruling). Other requirements may be imposed by law or regulation.
Which of the following factors most likely would assist an auditor in assessing the objectivity of the internal auditor?
A The organizational status of the director of internal audit. Answer A is correct. If the auditors decide that it is efficient to consider how the internal auditors' work may affect the nature, timing, and extent of audit procedures, the competence and objectivity of the internal auditors should be assessed. Assessing objectivity includes obtaining information about organizational status (the level to which the internal auditors report), including whether (1) they report to an officer of sufficient status, (2) they have access to those charged with governance, and (3) these individuals oversee employment decisions related to the internal auditors. The auditor also considers policies to maintain internal auditors' objectivity regarding the areas audited. B The professional certifications of the internal audit staff. C The consistency of the internal audit reports with the results of work performed. D The appropriateness of internal audit conclusions in the circumstances.
Which of the following factors most likely would cause a CPA to not accept a new audit engagement?
A The prospective client is unwilling to make all financial records available to the CPA. Answer A is correct. The terms of the engagement should include management's responsibility to provide access to all information and persons deemed necessary to the audit. If the prospective client is unwilling to make all financial records available to the CPA, the result may be a scope limitation that would require qualification of the opinion or a disclaimer of an opinion should the engagement be accepted. B The prospective client has already completed its physical inventory count. C The CPA lacks an understanding of the prospective client's operations and industry. D The CPA is unable to review the predecessor auditor's audit documentation.
Before accepting an engagement to audit a new client, a CPA is required to obtain
A The prospective client's signature to a written engagement letter. B The prospective client's consent to make inquiries of the predecessor, if any. Answer B is correct. The auditor should communicate with the predecessor auditor before accepting the engagement. Initiation of the communication is the responsibility of the auditor. Moreover, the auditor should seek permission from the prospective client to inquire of the predecessor before final engagement acceptance. Thus, the auditor should ask the client to authorize the predecessor to make a full response. C An assessment of fraud risk factors likely to cause material misstatements. D An understanding of the prospective client's industry and business.
An auditor is required to obtain an understanding of the entity's business, including business cycles and reasons for business fluctuations. What is the audit purpose most directly served by obtaining this understanding?
A To assist the auditor to accurately interpret information obtained during an audit. Answer A is correct. The auditor performs risk assessment procedures to obtain an understanding of the entity and its environment, including its internal control, to assess the risks of material misstatement. The understanding addresses, for example, (1) the nature of the entity; (2) transactions, balances, and disclosures; (3) objectives, strategies, and business risks; (4) accounting practices; and (5) financial performance. This understanding is necessary for the auditor to interpret the audit evidence obtained and to determine its sufficiency and appropriateness. B To enable the auditor to accurately identify significant deficiencies and material weaknesses. C To decide whether it will be necessary to perform analytical procedures. D To allow the auditor to more accurately perform tests of controls.
In auditing related party transactions, an auditor ordinarily places primary emphasis on
A Verifying the valuation of the related party transactions. B The probability that related party transactions will recur. C Confirming the existence of the related parties. D The adequacy of the disclosure of the related party transactions. Answer D is correct. Accounting principles ordinarily do not require transactions with related parties to be accounted for differently from those with unrelated parties. Primary emphasis should be on the adequacy of disclosure.
The understanding with the client regarding a financial statement audit generally includes which of the following matters?
A. The responsibilities of the auditor. Answer A is correct. The auditor should establish an understanding with the client through a written communication regarding the services to be performed. The objectives and limitations of the audit as well as the responsibilities of the auditor and management should be described in a contract stated in an engagement letter. B The expected opinion to be issued. C The contingency fee structure. D The preliminary judgment about materiality.
