Chapter 3
Materiality is a(n) __ concept.
relative
To detect material misstatements in a class of transactions, account balance and disclosure component of the financial statements, the auditor designs_____ ______.
substantive procedure
An amount or amounts that reduce to an appropriately low level the probability that the total of uncorrected and undetected misstatements that would result in material misstatement of the financial statements is____ _____.
tolerable misstatement
The amount of overall materiality used to plan and perform audit procedures at the account or disclosure level is called
tolerable misstatement
When an auditor is asked to accept a new client____
-the auditor must ask permission of the client before contacting the predecessor auditor -an entity acceptance questionnaire, checklist or memo is generally prepared to document the investigation
The terms of the audit engagement should include ______.
-the objectives of the engagement -management's responsibilities -limitations of the engagement -auditor's responsibilities
A dual-purpose test is
A procedure that serves as both a test of control and a substantive test of transactions.
Which of the following would most likely indicate the existence of related parties?
Borrowing money at an interest rate substantially below the prevailing market rate of interest.
Which of the following is not a factor that auditors should consider when evaluating the reliability of the internal audit function?
Composition
True or false: The extent of effort that goes into evaluating a new client is normally much less than the decision to continue with an existing client.
False - Greater
True or false: Both the PCAOB and ASB follow an auditor perspective in considering what is material.
False: Both follow a user perspective
A significant aspect of most audit engagements is the use of a(n) ______ specialist.
IT
For which laws and regulations does the auditor have the same responsibility as that for errors and fraud?
Laws and regulations that have a direct and material effect on the financial statements.
The audit committee of a company which is responsible for the appointment of the independent audit firm should consist of
Members of the board of directors who are not officers or employees.
Which of the following would NOT be a typical supervisory activity for an audit?
Perform detailed testing of the accounts payable account.
Which of the follow is not an inquiry that a successor auditor should make to a predecessor auditor?
The predecessor auditor's fee charged for audit work.
Which of the following statements is correct with regard to the predecessor-successor communications?
The successor auditor should obtain permission from the entity before contacting the predecessor auditor.
Materiality is assessed in terms of potential effect of a misstatement on decisions made by ______.
a reasonable user of financial statements
Auditors consider materiality from a reasonable user perspective and communicate to users that "the financial statements present fairly in ______ material respects.
all
When determining whether to use the work of the entity's internal auditors, the external auditor must obtain ______.
an understanding of the internal audit function
Once the audit strategy has been established, the auditor develops a more detailed
audit plan
Based on an understanding of the entity and environment, the auditor identifies those _______ risks that may result in material misstatements. (Enter only one word per blank.)
business
Auditors should consider laws and regulations that are generally recognized as having ______ effects on the determination of financial statement amounts.
direct and material
Violations of laws or regulations are referred to as_____ ______.
illegal acts
Auditor risk assessment procedures are used to ______.
obtain an understanding of the entity and its environment
If a company has income before taxes of $15,000,000 and the auditor decides that 7% of that amount would be material, what would be the overall materiality for the audit engagement.
$1,050,000
When should the evaluation of client continuance take place?
-At or near the completion of the audit. -When a significant event occurs.
Which of the following statements are correct?
-Overall financial statement materiality serves as a safety net. -The lower the tolerable misstatement, the more extensive the required audit testing. -Audits must be completed in a reasonable length of time at reasonable cost.
Which of the following statements are correct?
-Tests of controls check the operating effectiveness of controls. -Dual-purpose tests can improve audit efficiency. -Substantive tests of transactions are concerned with monetary misstatements.
Engagement team members performing supervisory activities should ______.
-inform engagement team members of their responsibilities -review the work of engagement team members
In documenting the overall audit strategy and audit plan, auditors should document the ______.
-nature of audit tests -timing of audit tests -extent of audit tests
If an entity has not previously been audited, the prospective auditor should ______.
-review the client's financial information before accepting the engagement or -carefully assess management integrity before accepting the engagement
The categories of substantive procedures are ______.
-substantive analytical procedures -tests of details
Traditionally, value added services have included ______.
-tax planning -internal reporting processes -system design and integration
Tests of details are usually categorized into ______.
-tests of details of account balances and disclosures -substantive test of transactions
Factors that should be considered in the determination of staffing requirements for an audit include ______.
-timing of the work -personnel availability -engagement size -engagement complexity
True or false: The audit team a public accounting firm uses for an engagement does not tend to vary from client to client.
False: Reason: Pubic account firms need to ensure that engagements are completed by auditors having the proper degree of technical training and proficiency given the circumstances of the entity.
True or false: If current year pretax income is not stable, auditors should not base materiality on an income measure.
False: While another benchmark(total assets or total revenue) may be preferable, normalized earnings may still be used.
Risk assessment, benchmarking and recommendations based on the assessment of business risk are all examples of _______-_______ services. (Enter only one word per blank.)
Value added
When the aggregated misstatement are greater than overall materiality the auditor should ______.
ask the entity to adjust the financial statements
In practice, auditors commonly set tolerable misstatement for each account at ______.
between 50% and 75% of overall materiality
When the aggregated misstatements are less than the overall materiality, the auditor can conclude that the financial statements are presented ______.
fairly
The purpose of setting____ ______ is to establish a scope for the audit procedures for the individual balance of disclosures.
tolerable misstatements
Which of the following statements regarding using an entity's internal audit function (IAF) during an external audit are correct?
-When internal auditors work directly for the auditor, the auditor should supervise their work. -Materiality and audit risk may determine reliance on the IAF's work. -Part of the IAF work may include confirming accounts receivables.
When net income is fluctuating, the auditor should consider basing materiality on ______
-a benchmark other than net income -normalized earnings for the past three years
A public accounting firm may disassociate itself from an auditing client due to ______.
-accounting issues -disputes over fees -auditing issues
Engagement letters may include: ______.
-arrangements regarding other services (e.g., assurance, tax, or consulting services) -any limitation of liability for the auditor or client -additional services to be provided relating to regulatory requirements -arrangements involving the use of specialists or internal auditors
In establishing the audit strategy, the auditor should ______.
-ascertain the reporting objectives to plan the timing of the audit -consider the factors that will determine the focus of the audit team's efforts -determine the scope of the engagement
When an auditor becomes aware of significant illegal acts, the auditor should make sure that ______ (is) are adequately informed.
-audit committee -those charged with governance
An auditor's independence would be considered impaired if the ______.
-client owes money to the auditor that has the characteristics of a loan -spouse of the auditor is an accounting supervisor for the entity
Information regarding related parties may be found in ______.
-conflict-of-interest statements from management and others -financial and reporting information provided to creditors, investors and regulators -minutes of the board of directors meetings
Generally, the three preliminary engagement activities are ______.
-determining the audit engagement team requirements -ensuring the audit team and firm are in compliance with ethical and independence requirements -establishing an understanding with the entity
When an auditor becomes aware of a possible illegal act, the auditor should ______.
-discuss the matter with the appropriate level of management -obtain an understanding of the nature of the act -evaluate its effect on the financial statements
An auditor may not accept a prospective client because the ______.
-entity has unusual business risks -client refuses to allow contact with the predecessor auditor
Steps that should be performed as part of audit planning activities include ______.
-establish materiality -assess business risk -consider violations of laws and regulations
When a prospective client refuses to permit the predecessor auditor to respond, the successor auditor should ______.
-have reservations about accepting the client
In deciding the appropriate percentage to apply to a selected materiality benchmark, the auditor would choose a lower percentage within the range for qualitative factors such as ______.
-high risk of fraud -material misstatements in prior years -the entity is close to violating a covenant in a loan agreement
Factors that would cause the auditor to use a lower percentage for tolerable misstatement include a ______.
-history of material weaknesses in internal control -high risk of misstatement within the account balance
If the auditor determines that the work of the internal audit function (IAF) can be used for purposes of the audit, the auditor must evaluate the ______.
-level of competence of the IAF -application by the IAF of a systematic and disciplined approach -quality control approach of the IAF
In relying on a specialist, the auditor should evaluate the specialist's ______.
-objectivity -competence -inputs used
Examples of tests of controls include ______.
-observation of the application of specific controls -inquiries of management, supervisory and staff personnel -inspecting documents, reports and electronic files -reperformance of the application of the control
Public accounting firms should ______.
-periodically evaluate whether to continue their relationship with current clients
Risk assessment procedures include ______.
-preliminary analytical procedures -observation and inspection -inquiries of management and others
During the documenting stage, the auditor ______.
-records how the entity is managing its risks -ensures that the identified risks have been addressed -compiles his or her knowledge about the entity's business objectives and strategies
According to ASB standards, when assessing materiality, users are assumed to ______.
-understand financial statements are prepared and audited to levels of materiality -make appropriate economic decisions on the basis of the financial statements -recognize uncertainties inherent in the measurement of amounts based on estimates
For public companies, a relative percentage for establishing overall materiality is typically __.
3% to 5% of income before taxes
When likely misstatements are greater than overall materiality, the auditor should
A) Request that the auditee adjust the financial statements. B) Issue an unqualified opinion. C) Modify the opinion if the auditee will not adjust the financial statements. ***D) Both a and c.
Which of the following factors most likely would cause a CPA to decide not to accept a new audit engagement?
Management's refusal to permit the CPA to perform substantive tests before the year-end.
When establishing an understanding with the entity regarding the terms of the engagement, all of the following should be discussed, except:
The agreed upon limits on auditor liability for an improper audit.
Which of the following should NOT be included in an engagement letter?
The type of audit opinion the auditor expects to issue to the client.
According to the text, the first step in applying materiality to an audit is
To determine a materiality level for the overall financial statements.
True or false: In some cases, fraud may consist of illegal acts.
True
Evaluations of financial information through analysis of plausible relationships among financial and non-financial data is the meaning of the term_____ ______.
analytical procedures
The investigation, if necessary, of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount are part of substantive______ ______.
analytical procedures
A subgroup of the board of directors that is responsible for the financial reporting and disclosure process is called the______ ______.
audit committee
For public companies, the auditor is required to establish an understanding of the terms of the audit engagement with the ______.
audit committee
Engagement planning involves all of the issues the auditor should consider in developing an overall____ _____ for conduction the audit.
audit strategy
An individual or organization possessing expertise in a field other than accounting or auditing whose work is used to assist the auditor in obtaining sufficient, appropriate evidence is defined by auditing standards as a(n)______ ______
auditor's specialist
When should the audit committee meet with external auditors to discuss the auditor's responsibilities and significant accounting policies?
before the engagement starts
The first phase of the audit process that relates to audit planning is ______.
client acceptance and continuance
Serving as a contract, the_______ ______ outlines responsiblities and prevents misunderstandings between the auditor and client.
engagement letter
The arrangements reached between the auditor and the entity are formalized in a(n)______ _______.
engagement letter
Overall responsibility for an audit engagement rests with the ______.
engagement partner
Auditor's responsibility for detecting illegal acts having a direct and material effect on the financial statements is the same as that for_______ and ______
errors, fraud
Substantive tests of transactions test for _____ or ____ in individual transactions.
errors, fraud
Information about an auditor's financial or business relationships with the firm's clients is documented by having all personnel complete an annual____ _____.
independence questionnaire
It is generally ______ for the auditor to simply subdivide materiality proportionally to each account
inefficient
When an entity operates in a highly regulated industry, the auditor would choose a _____ percentage in deciding the appropriate percentage to apply to a selected materiality benchmark.
lower
Work performed by the internal audit function ______ affect(s) the nature, timing and extent of audit procedures performed by the external auditors.
may
Auditing standards provide ______ assurance that illegal acts will be detected and that any contingent liability that may result will be disclosed.
no
Auditors can reduce audit risk to an acceptably low level by ______.
obtaining an understanding of the entity and its environment
Auditors should attempt to identify all related parties during the ______ phase of the audit.
planning
When a client has multiple locations, the auditor determines which locations or business units to audit and the extent of audit procedures to be performed during the ______ process.
planning
Ensuring that members of the audit team meet independence requirements generally take place as part of ______.
preliminary engagement activities
The auditor's consideration of materiality on an audit is a matter of ______.
professional judgement
Auditors should establish an understanding with the entity about the terms of the engagement to ______.
reduce the risk of misinterpretation between the two parties
Audit personnel should be provided with the names of identified_____ ______ so that transactions with them are identified and investigated.
related parties
Auditors should attempt to identify all _____ _____ because transactions with them may not be at "arm's length".
related parties
Ideally, the head of of internal auditing (chief audit executive) should ______.
report functionally to the audit committee and administratively to senior management
When auditing a company with multiple locations, the amount of audit attention devoted to various locations depends upon the ______.
risk of material misstatement
Tests of controls are performed to ______.
test the operating effectiveness of controls
Operating effectiveness is checked using ______.
tests of controls only
An auditor who receives evidence concerning material but indirect illegal acts should ______.
use audit procedures to determine whether the illegal acts have occurred
In establishing an understanding about the terms of the engagement with potential clients, ______ should be discussed.
using the work of internal auditors the role of the client's audit committee the engagement letter