Auditing Test 3

List the five steps in applying materiality in an audit

1. Set materiality for the financial statement as a whole 2. Determine performance materiality 3. Estimate total misstatement in segment 4. Estimate the combined misstatement 5. Compare combined estimate with preliminary or revised judgement about materiality

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

A) Determining performance materiality is necessary because auditors accumulate evidence by segments

Which of the following factors may increase risks to an organization? A) Geographic dispersion of company operations AND presence of new information technologies B) Neither geographic dispersion of company operations NOR presence of new information technologies C) Just geographic dispersion of company operations D) Just presence of new information technologies

A) Geographic dispersion of company operations AND presence of new information technologies

Internal controls are not designed to provide reasonable assurance that A) all frauds will be detected B) transactions are executed in accordance with management's authorization C) the company's resources are use efficiently and effectively D) company personnel comply with applicable rules and regulations

A) all frauds will be detected

The Sarbanes-Oxley Act requires A) all public companies to issue reports on internal controls B) all public companies to define adequate internal controls C) the auditor of public companies to design effective internal controls D) the auditor of public companies to withdraw from an engagement if internal controls are weak

A) all public companies to issue reports on internal controls

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

A) an advance of one week's salary to an employee

The primary emphasis by auditors is on controls over A) classes of transactions B) account balances C) both A and B, because they are equally important D) both A and B, because they vary from client to client

A) classes of transactions

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

A) client business risk

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

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

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

A) investigate the possibility the client may have made an error in their cost of goods sold computation

To obtain an understanding of an entity's control environment, an auditor should concentrate on the substance of management's policies and procedures rather than their form because A) management may establish appropriate policies and procedures but not act on them B) the board of directors may not be aware of management's attitude toward the control environment C) the auditor may believe that the policies and procedures are inappropriate for that particular entity D) the policies and procedures may be so weak that no reliance is contemplated by the auditor

A) management may establish appropriate policies and procedures but not act on them

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

A) materiality

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

A) more evidence is required for a low dollar amount than for a high dollar amount

Which of the following components of the control environment define the existing lines of responsibility and authority? A) organizational structure B) management philosophy and operating style C) human resource policies and practices D) management integrity and ethical values

A) organizational structure

In performing the audit of internal control over financial reporting, the auditor emphasizes internal control over classes of transactions because A) the accuracy of accounting system outputs depends heavily on the accuracy of inputs and processing B) the class of transaction is where most fraud schemes occur C) account balances are less important to the auditor then the changes in the account balances D) classes of transactions tests are the most efficient manner to compensate for inherent risk

A) the accuracy of accounting system outputs depends heavily on the accuracy of inputs and processing

Which of the following is an accurate statement regarding the auditor's responsibility for understanding internal control? A) transaction-related audit objectives typically have no impact on the rights and obligations objectives B) transaction-related audit objectives typically have a significant impact on the balance-related audit objective of realizable value C) auditors generally emphasize internal control over account balances rather than classes of transactions D) auditors and management are both equally concerned about controls that affect the efficiency and effectiveness of company operationgs

A) transaction-related audit objectives typically have no impact on the rights and obligations objectives

Authorizations can be either general or specific. Which of the following is not an example of a general authorization? A) automatic reorder points for raw materials inventory B) a sales manager's authorization for a sales return C) credit limits for various classes of customers D) a sales price list for merchandise

B) a sales manager's authorizations of a sales return

It is important for the CPA to consider the competence of the client's personnel because their competence has a direct impact upon the A) cost/benefit relationship of the system of internal control B) achievement of the objectives of internal control C) comparison of recorded accountability with assets D) timing of the tests to be performed

B) achievement of the objectives of internal control

When considering internal controls A) auditors can ignore controls affecting internal management information B) auditors are concerned with the client's internal controls over the safeguarding of assets if they affect the financial statements C) management is responsible for understanding and testing internal control over financial reporting D) companies must use the COSO framework to establish internal controls

B) auditors are concerned with the client's internal controls over the safeguarding of assets if they affect the financial statements

Proper segregation of functional responsibilities calls for separation of A) authorization, execution and payment B) authorization, recording and custody C) custody, execution and reporting D) authorization, payment and recording

B) authorization, recording, and custody

Internal controls A) are implemented by and are the responsibility of the auditors B) consist of policies and procedures designed to provide reasonable assurance that the company achieves its objectives and goals C) guarantee that the company complies with all laws and regulations D) only apply to SEC companies

B) consist of policies and procedures designed to provide reasonable assurance that the company achieves its objectives and goals

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

B) decrease detection risk

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

B) determine if any audit specialists will be required

Which of the following statements is most correct with respect to separation of duties? A) a person who has temporary or permanent custody of an asset should account for that asset B) employees who authorize transactions should not have custody of related assets C) employees who open cash receipts should record the amounts in the subsidiary ledgers D) employees who authorize transactions should be recording responsibility for these transactions

B) employees who authorize transactions should not have custody of related assets

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

B) estimate of the total known and likely misstatements is less than a material amount

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

B) help the successor auditor to evaluate whether to accept the engagement

Which of the following deals with ongoing or periodic assessment of the quality of internal control by management? A) verifying activities B) monitoring activities C) oversight activities D) management activities

B) monitoring activities

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

B) the balance sheet accounts because most audits focus on the balance sheet

The auditors primary purpose in auditing the client's system of internal control over financial reporting is A) to prevent fraudulent financial statements from being issued to the public B) to evaluate the effectiveness of the company's internal control over all relevant assertions in the financial statements C) to report to management that the internal controls are effective in preventing misstatements from appearing on the financial statements D) to efficiently conduct the Audit of Financial Statements

B) to evaluate the effectiveness of the company's internal controls over all relevant assertions in the financial statements

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

C) Audit assurance is the complement of acceptable audit risk

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

C) Auditors assert that their primary responsibility is to plan and perform the audit in order to provide reasonable assurance as to the detection of material misstatement due to error or fraud

The internal controls framework used by most US companies is the _______ framework A) FASB B) PCAOB C) COSO D) SEC

C) COSO

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

C) a related party transaction in which a major shareholder owns the office tower

Which of the following is not one of the subcomponents of the control environment? A) management's philosophy and operating style B) organizational structure C) adequate separation of duties D) commitment to competence

C) adequate separation of duties

Which of the following is a risk assessment principle? A) accountability B) use relevant, quality information to support the functioning of internal controls C) consider the potential for fraud D) develop general controls over technology

C) consider the potential for fraud

Without an effective ________, the other components of the COSO framework are unlikely to result in effective internal control, regardless of their quality A) risk assessment policy B) monitoring policy C) control environment D) system of control activities

C) control environment

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

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

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

C) effectiveness of internal controls

If a company has an effective internal audit department A) the internal auditors can express an opinion on the fairness of the financial statements B) their work cannot be used by the external auditors per PCAOB Standard 5 C) it can reduce external audit costs by providing direct assistance to the external auditors D) the internal auditors must be CPAs in order for the external auditors to rely on their work

C) it can reduce external audit costs by providing direct assistance to the external auditors

Which of the following is a correct relationship? A) acceptable audit risk and planned detection risk have an inverse relationship B) control risk and planned detection risk have a direct relationship C) planned detection risk and inherent risk have an inverse relationship D) all of the above are correct relationships

C) planned detection risk and inherent risk have an inverse relationship

Which of the following controls prevent and detect errors while transaction data are processed? A) software B) application C) processing D) transaction

C) processing

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

C) statement that management advisory services would be made available upon request

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

C) the combination of inherent risk and control risk

An auditor should consider two key issues when obtaining an understanding of a client's internal controls. These issues are A) the effectiveness and efficiency of the controls B) the frequency and effectiveness of the controls C) the design and operating effectiveness of the controls D) the implementation and operating effectiveness of the controls

C) the design and operating effectiveness of the controls

Which of the following best describes the purpose of control activities? A) the actions, policies and procedures that reflect the overall attitudes of management B) the identification and analysis of risks relevant to the preparation of financial statements C) the policies and procedures that help ensure that necessary actions are taken to address risks to the achievement of the entity's objectives D) activities that deal with the ongoing assessment of the quality of internal control by managements

C) the policies and procedures that help ensure that necessary actions are taken to address risks to the achievement of the entity's objectives

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

C) there are actual or potential legal problems between the client and the predecessor

External financial statement auditors must obtain evidence regarding what attributes of an internal audit department if the external auditors intend to rely on IA's work? A) Integrity B) Objectivity C) Competence D) All of the above

D) All of the above

Which of the following best described an entity's accounting information and communication system? A) Monitor transactions, record and process transactions, initiate transactions B) None C) Just monitor transactions D) Record and process transactions, initiate transactions

D) Record and process transactions, initiate transactions

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

D) accounts receivable turnover

Typical controls developed for manual systems which are still important in IT systems include A) management's authorization of transactions B) competent personnel C) adequate preparation of input source documents D) all of the above

D) all of the above

Which of the following is an accurate segment regarding control activities? A) as the level of complexity of IT systems increases, the separation of duties often becomes blurred B) Segregation of duties would be violated if the same person authorizes the payment of a vendor's invoice and also approves the disbursement of funds to pay the bill C) The most important type of protective measure for safeguarding assets and records is the use of physical precautions D) all of the above

D) all of the above

The _____ is helpful in preventing classification errors if it accurately describes which type of transaction should be in each account A) general ledger B) general journal C) trial balance D) chart of accounts

D) chart of accounts

Internal controls can never be regarded as completely effective. Even if the company personnel could design an ideal system, its effectiveness depends on the A) adequacy of the computer systems B) proper implementation by management C) ability of the internal audit staff to maintain it D) competency and dependability of the people using it

D) competency and dependability of the people using it

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

D) consideration of fraud risks discovered during recent audits of other clients

Of the following statements about internal controls, which one is least likely to be correct? A) no one person should be responsible for the custodial responsibility and the recording responsibility for an asset B) transactions must be properly authorized before such transactions are processed C) because of the cost-benefit relationship, a client may apply controls on a test basis D) control procedures reasonably ensure that collusion among employees cannot occur

D) control procedures reasonably ensure that collusion among employees cannot occur

Which of the following is correct with respect to the design and use of business documents? A) the documents should be in paper format B) documents should be designed for a single purpose to avoid confusion in their use C) documents should be design to be understandable only by those who use them D) documents should be pre-numbered consecutively to facilitate control over missing documents

D) documents should be pre-numbered consecutively to facilitate control over missing documents

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

D) if the auditor concludes that acceptable audit risk is low, but the client is still acceptable, the auditor may still accept the engagement but increase the audit fee

Hanlon Corp. maintains a large internal audit staff that reports directly to the accounting department. Audit reports prepared by the internal auditors indicate that the system is functioning as it should and that the accounting records are reliable. An independent auditor will probably A) eliminate tests of controls B) increase the depth of the study and evaluation of administrative controls C) avoid duplicating the work performed by the internal audit staff D) place limited reliance on the work performed by the internal audit staff

D) place limited reliance on the work performed by the internal audit staff

To promote operational efficiency, the internal audit department would ideally report to A) line management B) the PCAOB C) the Chief Accounting Officer D) the audit committee

D) the audit committee

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

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

Under Dodd-Frank federal financial reform legislation, all public companies are required to obtain an audit report on internal control over financial reporting (T/F)

False

As acceptable audit risk is decreased the likely cost of conducting an audit increases (T/F)

True

Audit committee oversight also serves as a deterrent to fraud by senior management (T/F)

True

Staff assigned to an audit engagement must be knowledgeable about the client's industry (T/F)

True

To maximize audit efficiency, the auditor should allocate less tolerable misstatement to accounts that can be verified by using low-cost audit procedures, such as analytical procedures, than to accounts that are more costly to audit (T/F)

True