Audit Midterm
The shareholders of a bank sue Karen Frank, CPA, for malpractice due to an audit failure that preceded the bank's financial failure. The jury determines that Frank is 60% at fault and that management is 40% at fault. The bank has no financial resources, nor does its management. Under joint and several liability, what is the likely percentage of damages that Frank will ensue?
100%
Which of the following statements is false regarding planning analytical procedures?
A frequently used planning analytical procedure is regression analysis.
Which statement is false?
A misstatement is an error, only intentional, that exists in a transaction or financial statement account balance
Which of the following is not a common incentive for fraudulent financial reporting?
A new car to be purchased solely with sufficient personal funds.
Which of the following factors is not an example of a risk relevant to the client continuance decision?
Advocacy threat.
How can ratio analysis and industry comparisons help the auditor plan the audit?
All of these correctly describe how ratio analysis and industry comparisons help the auditor plan the audit
Which of these statements is correct regarding internal and external documentation?
All things being equal, external documentary evidence is considered more reliable than internally generated evidence, External documentary evidence is generally more reliable when provided by independent, knowledgeable external parties, Examples of external documentation are original vendor invoices that are in the client's possession and confirmations sent directly to the auditors by third parties. Internal documentary evidence can be very reliable when it is developed within a strong internal control environment. (ALL)
Which of the following statements describes a purpose of an audit program?
An audit program is used to specify the procedures to be performed in obtaining audit evidence, An audit program is used to record the completion of each audit step, An audit program is useful for monitoring the progress of the audit, (ALL OF THESE STATEMENTS DESCRIBE A PURPOSE OF AN AUDIT PROGRAM)
Which of these parties involved in preparing and auditing financial statements provides oversight of the reporting process and other parties?
Audit committee
Which of the following is not an incentive to pursue litigation against audit firms?
Audit firm clients will get very little money from a suit due to high lawyer fees
Professional skepticism requires all of the following except:
Being easily convinced by alternative explanations
Which of the following statements is false?
Breach of contract occurs when a person competently performs a contractual duty.
Which of the following statements is false?
Common law is responsible for the creation of the Sarbanes-Oxley Act of 2002
Which of the following factors is not a reason that audit firms experience litigation for business failures, rather than audit failures?
Contingent-fee compensation for audit firms.
What are the components of internal control per COSO's Internal Control-Integrated Framework?
Control environment, risk assessment, control activities, information and communication, and monitoring.
Which one of the following components of internal control over financial reporting sets the tone for the organization?
Control environment.
Which explanation best describes how inherent risk relates to internal controls?
Controls exist to address the inherent risk of material misstatement. Therefore, it would be impossible to evaluate the effectiveness of controls without first knowing the risks, or bad outcomes, that the controls are designed to mitigate.
Which of the following procedures would an auditor typically perform first when assessing the reasonableness of management's estimate of its pension liability?
Develop an understanding of management's process for developing the estimate.
An auditor determines that management integrity is high, the risk of material misstatement is low, and the client's internal controls are effective. Which of the following conclusions can be reached regarding the need to obtain direct evidence about the account balances?
Direct evidence can be limited to material account balances, and the extent of testing should be sufficient to corroborate the auditor's assessment of low risk.
Which of these is a safeguard to independence created by the audit firm as articulated in the AICPA's independence conceptual framework?
Disciplinary mechanisms to promote compliance with independence policies and procedures
Which of the following statements is false regarding the risk assessment component of internal control?
Economic changes would not be considered a risk that needs to be analyzed as part of the risk assessment process
Which of the following is not a broad key principle of effective corporate governance articulated in the 2010 report of the NYSE?
Effective corporate governance should be integrated with significant incentives for top management and viewed as a compliance obligation.
Which of these is not a purpose of an audit program?
Ensuring standardization according to professional standards of risk factors such as accounts receivable.
Which of the following is not one of the most common approaches that perpetrators use to commit fraudulent financial reporting?
Erroneously changing document templates leading to incorrect information.
You are an auditor faced with the following scenario: The company is doing better than its competitors. Although sales are about the same as competitors, net income is significantly more. Management attributes the greater profitability to better control of expenses. Using professional skepticism, you would look into the following other potential explanations except:
Excessive focus on effective corporate governance
Which of the following is not a party involved in corporate governance?
External Auditors
Which of the following definitions is true
Factual misstatement—A misstatement that has been specifically identified and about which there is no doubt, Projected misstatement—The auditor's best estimate of the misstatement in a given population based on projecting the sample results to the population, Tolerable misstatement—A monetary amount set by the auditor in respect of which the auditor seeks to obtain an appropriate level of assurance that the monetary amount set by the auditor is not exceeded by the actual misstatement in the population, Expected misstatement—The level of misstatement that the auditor expects to detect, (ALL)
A classic inventory fraud involves management understating ending inventory, thereby yielding a reduction in cost of goods sold and an overstatement of profitability.
False
A high level of detection risk means that the audit firm is willing to accept a low risk of not detecting a material misstatement.
False
All errors that auditors make in performing an audit are examples of ordinary negligence.
False
As part of monitoring, an organization will select either ongoing evaluations or separate evaluations, but not both.
False
Benford's Law helps predict frequency patterns of deviations of controls
False
Detection risk is the susceptibility of an assertion to a material misstatement before consideration of related controls.
False
In rights theory, the highest order rights are those granted by the government, such as civil rights, legal rights, rights to own property, and license privileges.
False
Independence in fact means that a third party with knowledge of the auditor's relationship with the client would consider the auditor to be independent whereas independence in appearance means the auditor is unbiased and objective.
False
Litigation costs are the largest single cost faced by audit firms
False
Negligence occurs when a person fails to perform a contractual duty.
False
Only organizations in high-risk industries face a risk that they will not achieve their objective of reliable financial reporting.
False
Only voluntary departures from a firm's portfolio impact the portfolio of client changes
False
Per the AICPA Code, independence would be impaired if his or her immediate family member were employed by the audit client in any capacity or personnel level.
False
Risk assessment procedures provide sufficient appropriate audit evidence on which to base an audit opinion.
False
Substantive analytical procedures are required on every audit.
False
The U.S. Supreme Court defines materiality as "the magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement."
False
The auditor bases materiality solely on quantitative factors.
False
The auditor should use a standardized audit program, without any modifications, for all clients.
False
The interests of users of financial statements coincide. Public companies should use accounting principles that result in higher levels of reported income
False
The nature of risk response refers to the sufficiency and appropriateness of evidence that is necessary given the risk of material misstatement and the level of acceptable audit risk.
False
The purpose of internal control is to provide absolute assurance that an organization will achieve its objective of reliable financial reporting.
False
The responsibility of the external auditor to detect material fraud includes unveiling cleverly implemented frauds
False
There is not much overlap; i.e., things in common among the auditing standards set by the PCAOB, AICPA, and IAASB
False
To win a claim against the auditor, third parties suing under common law must generally prove that they suffered a loss, that the loss was due to lack of reliance on misleading financial statements, and that the auditor knowingly participated in the financial misrepresentation.
False
Top-stratum items are population items whose book values exceed the sampling interval and are therefore excluded from the sample.
False
One of the five drivers of the FRC's Audit Quality Framework is audit firm culture. Which of the following is not one of the other four elements?
Familiarity with the client's board of directors
Which of the following statements related to rights theory is false?
Fourth-order rights include one's essential interests or personal tastes.
Which statement is false?
If control risk is assessed as low, the auditor cannot plan on relying on the controls to increase substantive procedures for account balances.
Which of these statements is false?
If expected misstatement is smaller than tolerable misstatement, sampling is not appropriate unless it is used to estimate the size of the required adjustment to the account balance
Why would an auditor need to use an outside specialist when performing an audit?
In cases in which the valuation is intangible, To obtain audit evidence for certain accounts, auditors may need to rely on work performed by an outside specialist/expert, To make legal interpretations, (All)
Refer to Exhibit 8.4 and determine which of the following statements is true.
In nonstatistical sampling, sample size is determined by auditor judgment, In statistical sampling, the sample must be randomly selected to give each unit in the population an equal chance to be included in the sample, In nonstatistical sampling, evaluation is based on auditor judgment and projections are based on sample results, In statistical sampling, the auditor is required to define acceptable risk in advance, ALL
Internal control benefits the organization in all of the following ways except:
Increases the number of surprises faced by the market concerning the company's stock
The auditor is gathering evidence to test the assertion that the client's capitalization of leased equipment assets is properly valued. Which of the following sources of evidence will the auditor generally find to be of the highest quality (most reliable and relevant)?
Inspection of documents, including the lease contract and recalculation of capitalized amount and current amortization
Which of the following is not an important element of internal control as defined by COSO's Internal Control-Integrated Framework?
Intentional misapplication of accounting principles.
Which of the following statements is true of the tolerable rate of deviation?
It is a rate of deviation set by the auditor in respect of which the auditor seeks to obtain an appropriate level of assurance that the rate of deviation set is not exceeded by the actual rate of deviation in the population, This term is sometimes referred to as the tolerable failure rate, The auditor's tolerable rate of deviation is the level at which the control's failure to operate would cause the auditor to conclude that the control is not effective and would likely change the auditor's planned assessment of control risk in performing tests of account balances, ALL
In management's assessment of controls, a sample revealed that there was no required approval to procure material. For about 62% of a company's procured materials, 17% had no authorization. The reason given: The lack of approval was the rush to procure material in a timely fashion to meet a contract requirement. If these unauthorized procurements have a material balance, all of the following are possible deficiencies, except:
It may lead to incorrect cash balances
Which of these is not true regarding the special function performed by the external auditing profession?
It serves the interests of client management rather than the public
Which of the following statements regarding client acceptance/continuance decisions is false?
It would not be appropriate for audit firms to perform background checks on management of a potential client
What are some of the various risk assessment procedures that the auditor can perform to obtain evidence about inherent risk relating to the operations of a company?
Make management inquiries and tour the client's plant and operations.
Which of these correctly represents Phase I of the audit opinion formulation process?
Making client acceptance and continuance decisions
According to the text, which are the two types of misstatements that are relevant to auditors' consideration of fraud?
Misstatements arising from misappropriation of assets and from fraudulent financial reporting
Which term is defined as "the failure to exercise reasonable care, thereby causing harm to another or to property"?
Ordinary negligence
Which of the following statements is true concerning performance materiality?
Performance materiality is set less than overall materiality and helps the auditor determine the extent of audit evidence to obtain
Which of the following statements is false?
Performance materiality is the materiality amount that the auditor uses in in determining whether the financial statements overall are materially correct.
Which of the following procedures is least likely to be performed during Phase V of the audit opinion formulation process?
Performance of preliminary analytical review procedures.
Audit quality involves which of the following?
Performing an audit in accordance with GAAS to provide reasonable assurance that the audited financial statements and related disclosures are presented in accordance with GAAP and providing assurance that those financial statements are not materially misstated whether due to errors or fraud
Which of the following represents the calculation of the sampling interval?
Population size - Sample size
Which of the following information should be included in audit documentation?
Procedures performed., Audit evidence examined, Conclusions reached with respect to relevant financial statement assertions, (ALL OF THIS INFORMATION SHOULD BE INCLUDED)
Which of the following types of transactions did WorldCom management engage in as part of that company's fraudulent financial reporting scheme?
Recorded barter transactions as sales., Used restructuring reserves from prior acquisitions to decrease expenses, Capitalized line costs rather than expensed them., (ALL OF THEM)
Which of the following is not a threat to auditor independence?
Regulatory interest threat.
What two audit evidence characteristics determine the appropriateness of audit evidence?
Relevance and reliability
Which of the following factors does not create a demand for external audit services?
Requirements of the state boards of accountancy.
The remedies for breach of contract include which of the following?
Requiring specific performance of the contract agreement, Granting an injunction to prohibit the auditor from doing certain acts, such as disclosing confidential information, Providing for recovery of amounts lost as a result of the breach, (ALL OF THESE)
Which of these guidelines helpful to maximizing the effectiveness of a brainstorming session is defined as, "Participants are encouraged to exchange ideas, further develop those ideas during the session, and to respect the opinions of others"
Respectful communication.
Which of the following accounts would not be included in the Acquisition and Payment for Long-Lived Assets Cycle?
Revenue
Which of these describes management's need for reliable financial statements?
Review performance, make operational decisions, and report results to capital markets.
Which of these is not a procedure an audit firm performs in making a decision to accept a potential client?
Review regulatory filings and inquire of management about any internal control deficiencies, Analyze client and industry financial statements to assess the possibility of business failure, Inquire of client and audit firm personnel whether there are any potential independence-impairing relationships, Assess the background and experience of the potential client's accounting personnel, (ALL)
Which of these is the definition of client business risk?
Risks affecting the business operations and potential outcomes of an organization's activities.
Which statement is false regarding the use of sampling and data analytics tools by auditors?
Sampling involves looking at all of the transactions that occurred during the period under audit
Which of these is the correct definition of sampling units?
Sampling units refer to the individual items making up the population.
What is simple random sampling?
Selecting a random sample by matching random numbers generated by a computer or selected from a random-number table with, for example, document numbers such as an invoice or a purchase order
Audit committee activities and responsibilities include which of the following?
Selecting the external audit firm
Which of the following is not a sanction available to the SEC when auditors found to be unqualified, unethical, or in willful violation of any provision of the federal securities laws can be disciplined by the SEC?
Six months public service
Which of the following would be the best example of the first principle associated with monitoring?
Software to automate the review of all payment transactions and identify anomalies
Which of these relates to the PCAOB standards?
Standards apply to audits of US public companies
Which statement best explains the factors that affect evidence sufficiency?
Sufficiency is the measure of the quantity of audit evidence
Which of these would be not be considered a factor outside the control of the external auditor that affects audit quality?
Systems for making client acceptance decisions
Refer to Exhibit 2.5. The Sarbanes-Oxley Act enacted which of the following provisions relevant to auditors and the audit opinion formulation process?
The PCAOB was established, and it has the power to conduct inspections of public company audits.
Which of the following statement is false?
The SEC Act of 1934 requires filing annual reports within 30 to 60 days of year's end, besides communicating other significant events as they take place.
Which of the following is not part of management's fraud risk assessment process?
The assessment considers the role of the external auditor in preventing fraud
Which of these statements is true about the audit opinion formulation process presented in this chapter?
The audit opinion formulation process is based on the premise that management has responsibility to prepare the financial statements and maintain internal control over financial reporting.
Which of the following occurs if the risk of material misstatement decreases?
The auditor can accept a higher detection risk and still achieve an acceptable level of audit risk.
Assume that the auditor sets audit risk at 1%. What is the most appropriate interpretation of this level of audit risk?
The auditor is willing to take only a 1% chance of expressing an audit opinion that the financial statements are fairly presented when they are materially misstated.
Which of the following statements is false about the testing selection by auditors?
The auditor usually chooses the same test items as management
The auditor is testing the completeness assertion. Which of the following statements is true regarding the auditor's work?
The auditor would perform a process referred to as tracing
An audit client applied for a bank loan from First Bank. In connection with the loan application, the client engaged its auditor to audit its financial statements, and the auditor issued an unqualified opinion. Based on those statements, First Bank loaned money to the client. Shortly thereafter, the client filed for bankruptcy, and First Bank sued the auditor for damages. The audit documentation showed negligence and possible other misconduct in performing the audit. Which of these scenarios is not possible?
The bank is an identified user if it can be shown that the auditor knew that the audit was done for the primary purpose of obtaining a loan from First Bank, If fraud is proven, First Bank would likely win the lawsuit, If First Bank can prove the auditor was reckless (or grossly negligence) in conducting the audit, a jury might find that the auditor's conduct was so gross that the auditor should be held liable to First Bank, (ALL OF THESE SCENARIOS ARE POSSIBLE)
All of the following are defenses that the auditor can use against a breach of contract suit except
The client provided the auditor with accurate documentation.
What is the primary difference between fraud and error in financial statement reporting?
The intent to deceive
A company has a loan committee. It meets quarterly to approve, on an ex-post basis, all loans over $300 million (top 5% for this institution). Which of the following is not a risk factor indicative of poor corporate governance for this potential audit client?
The loan committee is made up of competent, financial savvy members
Which of these is not a principle representing the fundamental concepts of the control environment component?
The organization demonstrates a commitment to integrity and relevant values, The organization holds individuals accountable for their internal control responsibilities in the pursuit of objectives, The organization demonstrates a commitment to attract, develop, and retain competent individuals in alignment with objectives, The board of directors demonstrates independence from management and exercises oversight of the development and performance of internal control, (ALL OF THESE are principles representing the fundamental concepts of the control environment component)
Which of the following is not a principle associated with risk assessment
The organization holds individuals accountable for their risk assessment responsibilities
Which of the following is not a principle associated with the information and communication component of internal control?
The organization obtains or generates and uses relevant, quality information to support the functioning of internal control, The organization communicates with external parties regarding matters affecting the functioning of internal control, The organization internally communicates information, including objectives and responsibilities for internal control, necessary to support the functioning of internal control, ( ALL OF THESE are principles associated with the information and communication component of internal control)
With regard to client acceptance/continuance decisions, which of the following is false?
The primary driver of the client acceptance/continuance decision is the level of audit fees that the audit firm can charge to the client.
Which of the following represent possible audit documentation?
The record of audit procedures performed, A memorandum of understanding, Correspondence, (ALL)
Assume that an organization asserts that it has $35 million in net accounts receivable. For which of the following is management correctly asserting with respect to net accounts receivable?
The recorded accounts receivable exist at the balance sheet date and relate to valid sales
Refer to Exhibit 8.2 and determine which of the following phrases matches this definition. The risk that the auditor will conclude that internal controls are effective when internal controls are actually not effective.
The risk of incorrect acceptance of internal control reliability
In attributes sampling, which of the following will not affect the determination of sample size?
The risk of incorrect rejection of book value
In a financial statement audit, what controls will an auditor test?
The risk of material misstatement, Both entity-wide and transaction controls for testing, Risks associated with significant accounts, disclosures, and relevant assertions, (ALL)
Which of the following correctly defines nonsampling risk?
The risk that the auditor reaches an erroneous conclusion for any reason not related to sampling risk
Assume that an organization sells software. The sales contracts with the customers often have nonstandard terms that impact the timing of revenue recognition. Thus, there is a risk that revenue may be recorded inappropriately. To mitigate that risk, the organization has implemented a policy that requires all nonstandard contracts greater than $1 million to be reviewed on a timely basis by an experienced and competent revenue accountant for appropriate accounting, prior to the recording of revenue. Management tested this control and found several instances in which the control was not working. Management has classified this deficiency as a material weakness. Which of the following best describes the conclusion made by management?
There is a reasonable possibility that a material misstatement could occur.
Which of the following is not a major fraud finding provided in COSO studies
There is low involvement in frauds by CEOs and/or CFOs.
Which of the following is a common rationalization for fraudulent financial reporting?
This is a one-time transaction and it will allow the company to get through the current financial crisis, but I'll never do it again.
A procedure that involves only inspection of documentation is usually considered to be of lower quality than a procedure involving reperformance
True
According to the PCAOB General Auditing standards, an ordinary audit of financial statements by the independent auditor is the expression of an opinion on the fairness with which they present, in all material respects, financial position, results of operations, and its cash flows in conformity with generally accepted accounting principles.
True
An audit program details the audit procedures to be completed before providing the audit opinion(s).
True
An example of a related-party transaction might be an exchange of property between an entity and an organization in which the entity has part ownership, such as a joint venture
True
An example of an attribute of interest to an auditor would be evidence that the client has matched vendor invoice details with the purchase order and receiving report before payment approval and noted that they match before authorizing a payment for the goods received.
True
An important change resulting from the Sarbanes-Oxley Act is that auditors are no longer allowed to provide most consulting services for their public company audit clients.
True
An organization's accounting system is part of its information and communication component of internal control
True
Audit quality is achieved when the audit is performed in accordance with GAAS and when it provides reasonable assurance that the financial statements have been presented in accordance with GAAP and are not materially misstated due to errors or fraud.
True
Auditors need to understand the processes used by management in developing estimates, including how management reviews the results of the estimates for reasonableness.
True
Block sampling involves selecting a sample that consists of contiguous population items, such as selecting transactions by day or week.
True
Control activities are performed within processes (e.g., segregation of duties required in processing cash receipt transactions) and over the technology environment.
True
Determining whether internal control is effective requires an assessment of whether each of the five internal control components, and their principles, are present and operating effectively.
True
Examples of breach of contract include violating client confidentiality, failing to provide the audit report on time, and failing to discover material error or material employee fraud.
True
Existing clients for which the audit firm provided services in the preceding period are evaluated by the audit firm and by the individual engagement partner at the completion of the audit to determine whether the audit firm should continue to provide services again in the next period. This process by which this evaluation occurs is called the client continuance decision.
True
If engagement risk is higher, the auditor will set audit risk at a low level (e.g., 1%), whereas the auditor might be willing to set audit risk at a higher level (e.g., 5%) for a client with lower engagement risk.
True
In conducting a substantive audit, the auditor uses only substantive procedures, and does not rely on tests of internal controls.
True
In contract breach, one of the remedies is to grant an injunction to prohibit the auditor from performing certain acts (e.g., disclosing confidential information).
True
In the Enron fraud, one of the ways that management covered up the fraud was to shift debt off the balance sheet to SPEs
True
It is critical that the audit documentation is complete and shows the audit was conducted with due professional care in case the audit is challenged in a liability case.
True
No more than two of the PCAOB board members may be CPAs to assure users of financial statements that this important regulator is representing the broad interests of users rather than preferences of the external audit profession.
True
One example of the circumstances in which the auditor might use MUS includes accounts receivable confirmations when credit balances are not significant.
True
One of the most rigorous approaches to substantive analytical procedures is regression analysis.
True
Performance materiality is an amount less than overall materiality and helps the auditor determine the extent of audit evidence needed.
True
Sampling can be used for both tests of controls and substantive tests of account balances and assertions
True
Substantive procedures include substantive analytical procedures and tests of details.
True
The auditor needs to understand a client's internal controls in order to anticipate the types of material misstatements that may occur in the financial statements and then develop sufficient audit procedures to determine whether those misstatements exist in the financial statements.
True
The expectations gap includes a misperception by shareholders that they are entitled to recover losses on investments for which the auditor provided an unqualified opinion on the financial statements
True
The objective of external auditing is to provide opinions on the reliability of the financial statements and provide opinions on internal control effectiveness.
True
The relationship between sales and cost of sales could easily be manipulated if the client does not have good internal controls and/or if the inherent risk of misstatement of the accounts is high.
True
The sample size of a MUS sample is a function of the following factors: (1) the risk of incorrect acceptance, (2) the ratio of expected misstatement to tolerable misstatement, and (3) the ratio of tolerable misstatement to the population.
True
The term corporate governance mosaic refers to the fact that each of the parties involved in corporate governance has complementary roles and specific responsibilities; no one party is completely responsible.
True
The three elements of the fraud triangle include incentive, opportunity, and rationalization.
True
The three laws most relevant to auditor liability include common law, contract law, and statutory law
True
When the total estimated misstatement exceeds the tolerable misstatement, the auditor has available several possible courses of action. Two of the options are expanding the sample or changing the audit objective to estimating the correct value.
True
When comparing an auditor's liability to third parties for negligence, which case approach do you think is best for the auditor?
Ultramares, because the auditor is liable for negligence only to third parties who are the primary beneficiaries of the audit and named in the engagement letter.
Which of the following statements is true?
Unless an independent audit can provide reasonable assurance that financial information has not been materially misstated because of fraud, it has little, if any, value to society,Repeated revelations of accounting scandals and audit failures related to undetected frauds have seriously damaged public confidence in external auditors, A strong ethical tone at the top of an organization that permeates corporate culture is essential in mitigating the risk of fraud, (ALL OF THEM)
Which of the following statements is false regarding the nature, timing, and extent of risk responses?
When the risk of material misstatement is low, the auditor conducts the audit procedures closer to year-end, on an unannounced basis, and includes more elements of unpredictability in the procedures.
In deciding to perform analytical procedures as a substantive audit procedure, the auditor considers which of the following most often?
Whether the relationships among the data are logical and justified by current economic conditions
Ensuring standardization according to professional standards of risk factors such as accounts receivable.
Which population and sampling unit should be tested, and what characteristics should be examined, How many items should be selected for audit testing, Which items should be included in the sample, What inferences can be made about the overall population from the sample, (All)
Which of the following transactions would be least likely to be a related-party transaction?
Writing off obsolete inventory prior to year-end.
