Chapter 4

1. Update or obtain information about the supervision and review of internal auditors' work. 2. Update or obtain information about the policies regarding the employment of relatives of internal auditors in audit-sensitive positions. 3. Evaluate evidence from a recent external quality review of the internal auditors. 4. Update or obtain information about the audit plans and procedures used by the internal auditors. 5. Evaluate the personal financial statements of the internal auditors. 6. Determine whether the internal auditors have direct access to the board of directors. 7. Update or obtain information about the professional certification of the internal auditors. 8. Update or obtain information about the continuing education programs provided to the internal auditors. 9. Consider information obtained in previous audits about the activities of internal auditors. 10. Consider whether the internal auditors are well paid. 1. The independent auditor should perform this procedure to test the competence and objectivity of the internal auditors. 2. The independent auditor should perform this procedure to test the competence but not the objectivity of the internal auditors 3. The independent auditor should perform this procedure to test the objectivity but not the competence of the internal auditors 4. The auditor would not perform this procedure

1. 1. The independent auditor should perform this procedure to test the competence and objectivity of the internal auditors. 2. 3. The independent auditor should perform this procedure to test the objectivity but not the competence of the internal auditors 3. 1. The independent auditor should perform this procedure to test the competence and objectivity of the internal auditors. 4. 2. The independent auditor should perform this procedure to test the competence but not the objectivity of the internal auditors 5. 4. The auditor would not perform this procedure 6. 3. The independent auditor should perform this procedure to test the objectivity but not the competence of the internal auditors 7. 2. The independent auditor should perform this procedure to test the competence but not the objectivity of the internal auditors 8. 2. The independent auditor should perform this procedure to test the competence but not the objectivity of the internal auditors 9. 1. The independent auditor should perform this procedure to test the competence and objectivity of the internal auditors. 10. 4. The auditor would not perform this procedure

1. The auditor's opinion is qualified based on the expert's findings. 2. The auditor determines that the work of the specialist is not adequate for the auditor's purpose. 3. The auditor evaluates the reputation of the specialist. 4. The auditor requests personal financial statements from the specialist. 5. The auditor's client owns significant mineral rights. 6. The auditor evaluates the objectivity of the specialist. 7. The audit staff lacks specialized skills necessary for the audit. 8. The auditor expresses an adverse opinion because a specialist was not able to provide the auditor with sufficient appropriate evidence. 1. A reason for an auditor to use a specialist 2. A condition for referring to a specialist in an auditor's report 3. A consideration in the auditor's selection of a specialist 4. A reason to perform additional audit procedures 5. An issue or condition that is not considered that is not considered by the auditor

1. A condition for referring to a specialist in an auditor's report 2. A reason to perform additional audit procedures 3. A consideration in the auditor's selection of a specialist 4. An issue or condition that is not considered by the auditor 5. A reason for an auditor to use a specialist 6. A consideration in the auditor's election of a specialist 7. A reason for an auditor to use a specialist 8. An issue or condition that is not considered by the auditor

When auditing related party transactions, an auditor places primary emphasis on 1. Assessing the risks of material misstatement of related party transactions. 2. Ascertaining the rights and obligations of the related parties. 3. Verifying the valuation of the related party transactions. 4. Confirming the existence of the related parties.

1. Assessing the risks of material misstatement of related party transactions Explanation: The auditor has a responsibility to perform audit procedures to identify, assess, and respond to the risks of material misstatement arising from the entity's failure to appropriately account for or disclose related party relationships, transactions, or balances.

If the auditors plan to use the work of the internal auditors to obtain audit evidence or to provide direct assistance, they should assess the internal auditors' 1. Competence and objectivity. 2. Training and supervisory skills. 3. Independence and review skills. 4. Efficiency and experience.

1. Competence and objectivity.

Which of the following procedures would a CPA most likely include in planning a financial statement audit? 1. Determine the extent of involvement of the client's internal auditors. 2. Ask the client's lawyer if contingencies have been recorded in conformity with GAAP. 3. Obtain a written representation letter from the client's management. 4. Scan the client's journals and ledgers to identify any unusual transactions.

1. Determine the extent of involvement of the client's internal auditors.

As part of risk assessment procedures for an audit of a nonissuer, an auditor would most likely perform which of the following procedures concerning related-party transactions? 1. Evaluate the entity's procedures for identifying related-party transactions. 2. Examine receiving and shipping records between the client and its affiliates. 3. Perform a direct test of related-party account balances. 4. Confirm related-party transaction amounts and terms with the other party.

1. Evaluate the entity's procedures for identifying related-party transactions. Explanation: Risk assessment procedures are performed to obtain an understanding of an entity and its internal controls. They include (1) inquiries, (2) analytical procedures, and (3) observation and inspection. Evaluating the entity's procedures for identifying related-party transactions can help an auditor not only determine the existence of related parties but also obtain an understanding of an entity's internal controls concerning related-party transactions.

1. Obtain an understanding of the business purpose of the transaction. 2. Review the extent and nature of business transacted with major customers, suppliers, borrowers, and lenders. 3. Request personal financial statements from each member of the board of directors. 4. Confirm the transaction amount and terms, including guarantees and other significant data, with the other parties. 5. Discuss significant information with intermediaries, such as banks or attorneys. 6. Consider whether unrecognized transactions are occurring, such as a major shareholder absorbing entity expenses. 7. Inspect and obtain satisfaction concerning the transferability and value of collateral. 8. Test for reasonableness the compilation of amounts to be disclosed or considered for disclosure. 9. Review accounting records for unusual or nonrecurring transactions, especially those occurring near the end of the period. 10. Request written representations from the largest suppliers. 1. Not typically performed relative to related party transactions 2. Determine existence of related parties 3. Identify related party transactions 4. Examine related party transactions

1. Examine related party transactions 2. Identify related party transactions 3. Not typically performed relative to related party transactions 4. Examine related party transactions 5. Examine related party transactions 6. Identify related party transactions 7. Examine related party transactions 8. Examine related party transactions 9. Identify related party transactions 10. Not typically performed relative to related party transactions

3. Ajacks purchased a derivative as a hedge in an interest-swap arrangement. The derivative's value is based on a market basket of mortgages. It is calculated using a formula developed by Ajacks. Uncertainty type 1. High estimation uncertainty 2. Low estimation uncertainty 3. Not an estimate

1. High estimation uncertainty Complex process, Entity-developed model used for fair value, Instrument not publicly traded, Inputs cannot be observed in the marketplace

2. Ajacks is party to a patent proceeding filed by a competitor. Ajacks has already estimated and recorded a loss for the predicted outcome. Uncertainty type 1. High estimation uncertainty 2. Low estimation uncertainty 3. Not an estimate

1. High estimation uncertainty Complex process, Related to litigation outcome, Inputs cannot be observed in the marketplace

In assessing the competence of a client's internal auditor, an auditor most likely would consider the 1. Internal auditor's compliance with professional internal auditing standards. 2. Results of ratio analysis that may identify unusual transactions and events. 3. Client's policies that limit the internal auditor's access to management salary data. 4. Evidence supporting a further reduction in the assessed risks of material misstatement.

1. Internal auditor's compliance with professional internal auditing standards. Explanation: The external auditor customarily inquires about the application of professional standards by the internal auditors. The external auditor should assess the competence and objectivity of the internal auditors. Compliance with the internal auditing standards developed by The Institute of Internal Auditors or by the Government Accountability Office is one measure of the competence and objectivity of internal auditors.

In assessing the competence of an internal auditor, an independent CPA most likely would obtain information about the 1. Quality of the internal auditor's documentation. 2. Organization's commitment to integrity and ethical values. 3. Influence of management on the scope of the internal auditor's duties. 4. Organizational levels to which the internal auditor reports.

1. Quality of the internal auditor's documentation. Explanation: 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.

When assessing the competence of the internal auditors, an auditor should obtain information about the 1. Quality of the internal auditors' working paper documentation. 2. Internal auditors' preliminary assessed risks of material misstatement. 3. Policies prohibiting internal auditors from auditing sensitive matters. 4. Organizational level to which the internal auditors report.

1. Quality of the internal auditors' working paper documentation.

Which of the following auditing procedures most likely would assist an auditor in identifying related party transactions? 1. Reviewing confirmations of loans receivable and payable. 2. Performing analytical procedures for indications of possible financial difficulties. 3. Inspecting correspondence with lawyers for evidence of unreported contingent liabilities. 4. Vouching accounting records for recurring transactions recorded just after the balance sheet date.

1. Reviewing confirmations of loans receivable and payable. Explanation: 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.

Which of the following events most likely would indicate the existence of related party transactions? 1. Selling real estate at a price that differs significantly from its appraised value. 2. Insuring the lives of key executives and listing the entity as beneficiary. 3. Making a loan with specific scheduled terms for repayment of the funds. 4. Granting stock options to key executives at favorable prices.

1. Selling real estate at a price that differs significantly from its appraised value.

Auditors should evaluate significant accounting estimates included in the financial statements. The auditor 1. Should understand how management developed the estimate but may adopt a variety of approaches to evaluating its reasonableness. 2. Should consider the hypothetical assumptions used by management to generate estimates. 3. Is responsible for events affecting the estimates only through the balance sheet date. 4. Must develop an independent point estimate to corroborate management's.

1. Should understand how management developed the estimate but may adopt a variety of approaches to evaluating its reasonableness. Explanation: n evaluating the reasonableness of an accounting estimate, the auditor should obtain an understanding of how it was developed. The auditor then may use one of several approaches, or a combination, to evaluate reasonableness. One approach is to review and test management's process. A second approach is to develop an independent expectation to corroborate the reasonableness of management's estimate. A third approach is to review subsequent events or transactions.

In evaluating the reasonableness of an entity's accounting estimates, an auditor normally is concerned about assumptions that are 1. Susceptible to bias. 2. Consistent with prior periods. 3. Insensitive to variations. 4. Similar to industry guidelines.

1. Susceptible to bias Explanation: In evaluating the reasonableness of an estimate, the auditor normally concentrates on key factors and assumptions that are (1) significant to the accounting estimate, (2) sensitive to variations, (3) deviations from historical patterns, and (4) subjective and susceptible to misstatement and bias.

Under which of the following circumstances would an auditor be considered to be using the work of a specialist? 1. The auditor engages a lawyer to interpret the provisions of a complex contract. 2. A tax expert employed by the auditor's CPA firm reviews the client's tax accruals. 3. The auditor makes inquiries of the client's lawyer regarding pending litigation. 4. The client engages an outside computer service organization to prepare its payroll.

1. The auditor engages a lawyer to interpret the provisions of a complex contract.

Which of the following statements is correct concerning an auditor's use of the work of an actuary in assessing a client's pension obligations? 1. The auditor is required to understand the objectives and scope of the actuary's work. 2. The actuary must be an internal specialist with a continuing relationship with the auditing firm. 3. The client is required to consent to the auditor's use of the actuary's work. 4. The reasonableness of the actuary's assumptions is strictly the auditor's responsibility.

1. The auditor is required to understand the objectives and scope of the actuary's work. Explanation: The auditor should obtain an understanding of the expertise of the auditor's specialist sufficient to (1) determine the nature, scope, and objectives of the work and (2) evaluate the adequacy of the work for the auditor's purposes.

Which of the following statements is true about related party transactions? 1. The auditor should consider whether an identified related party transaction outside the normal course of business is appropriately accounted for and disclosed. 2. An auditor should substantiate that related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions. 3. An auditor should determine whether a particular transaction would have occurred if the parties had not been related. 4. In the absence of evidence to the contrary, related party transactions should be assumed to be outside the ordinary course of business.

1. The auditor should consider whether an identified related party transaction outside the normal course of business is appropriately accounted for and disclosed.

Task A: To more thoroughly test controls relating to cutoff, Passive, CPAs, performed its own tests of controls and considered the results of internal audit procedures. Task B: Passive, CPAs, requested the internal auditors to perform the necessary procedures and assess the risk of material misstatement for the audit of cash. 1. The internal auditors may provide direct assistance to Passive for Task A only 2. The internal auditors may provide direct assistance to a Passive for Task B only 3. The internal auditors may provide direct assistance to Passive for both Tash A and Task B 4. The internal auditors may provide direct assistance to Passive for neither Task A nor Task B

1. The internal auditors may provide direct assistance to Passive for Task A only

What is the primary purpose of reviewing conflict-of-interest statements signed by members of management? 1. To identify transactions with related parties. 2. To consider limitations of internal control. 3. To assess control risk. 4. To obtain an understanding of business processes.

1. To identify transactions with related parties.

After audit procedures are completed, a partner of the CPA firm who has not been involved in the audit performs a second or wrap-up audit documentation review. This second review usually focuses on 1. Whether the financial statements are consistent with the auditor's understanding of the entity. 2. The communication of internal control weaknesses to those charged with governance. 3. The materiality of the adjusting entries proposed by the audit staff. 4. Fraud involving the client's management and its employees.

1. Whether the financial statements are consistent with the auditor's understanding of the entity.

A corporate balance sheet indicates that one of the corporate assets is a patent. An auditor will most likely obtain evidence regarding the continuing validity and existence of this patent by obtaining a written representation from 1. The patent owner. 2. A patent attorney. 3. A regional state patent office. 4.The patent inventor.

2. A patent attorney Explanation: A patent is an intangible asset representing a governmental grant of rights to an invention for a specified time. The lack of physical substance makes verifying its existence and ownership difficult. To obtain evidence of the continuing validity and existence of a patent, the auditor should obtain a written representation from an auditor's specialist. A patent attorney is an auditor's external specialist who has expertise not normally possessed by auditors. The attorney can perform the necessary research and express an opinion on which the auditor may reasonably rely.

A CPA is conducting the first audit of a nonissuer's financial statements. The CPA hopes to reduce the audit work by consulting with the predecessor auditor and reviewing the predecessor's audit documentation. This procedure is 1. Required if the CPA is to express an unmodified opinion. 2. Acceptable if the client and the predecessor auditor agree to it. 3. Unacceptable because the CPA should bring an independent viewpoint to a new engagement. 4. Acceptable if the CPA refers in the audit report to reliance upon the predecessor auditor's work as part of the basis for the CPA's own opinion.

2. Acceptable if the client and the predecessor auditor agree to it. Explanation: In an initial audit, the auditor should ask management to permit the predecessor auditor to (1) respond fully to inquiries and (2) allow a review of his or her audit documentation. In accordance with the ethical requirement for AICPA members to cooperate with each other, the predecessor auditor ordinarily agrees to these requests (AU-C 510).

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 1. Not assign any task to the internal auditor because of the internal auditor's lack of independence. 2. Allow the internal auditor to perform tests of internal controls. 3. Allow the internal auditor to audit a major subsidiary of the company. 4. Allow the internal auditor to perform analytical procedures but not be involved with any tests of details.

2. Allow the internal auditor to perform tests of internal control Explanation: 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.

The auditor's evaluation of the reasonableness of accounting estimates 1. Should be in the context of individual transactions. 2. Considers that management bases its judgment on both subjective and objective factors. 3. Will be unfavorable if the estimates in the financial statements are based on assumptions about future events and transactions. 4. Should be based on an attitude of conservatism.

2. Considers that management bases its judgment on both subjective and objective factors. Explanation: Estimates are based on both subjective and objective factors. Thus, control over estimates may be difficult to establish. Given the potential bias in the subjective factors, the auditor should adopt an attitude of professional skepticism toward both the subjective and objective factors.

After identifying related party transactions, an auditor most likely would 1. Ascertain whether the transactions would have occurred if the parties had not been related. 2. Determine whether the transactions were approved by the board of directors or other appropriate officials. 3. Substantiate that the transactions were consummated on terms equivalent to those prevailing in arm's-length transactions. 4. Discuss the implications of the transactions with third parties, such as the entity's attorneys and bankers.

2. Determine whether the transactions were approved by the board of directors or other appropriate officials. Explanation: 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).

When assessing the internal auditors' competence, the auditor should obtain information about the 1. Policies prohibiting the internal auditors from auditing areas where relatives are employed. 2. Educational background and professional certification of the internal auditors. 3. Organizational level to which the internal auditors report. 4. Internal auditors' access to records and information that is considered sensitive.

2. Educational background and professional certification of the internal auditors. Explanation: If the external auditor plans to use the work of the internal auditors to obtain audit evidence or to provide direct assistance, 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.

An internal auditor's work would most likely affect the nature, timing, and extent of an independent auditor's auditing procedures when the internal auditor's work relates to assertions about the 1. Valuation of intangible assets. 2. Existence of fixed asset additions. 3. Valuation of related party transactions. 4. Existence of contingencies.

2. Existence of fixed asset additions Explanation: Assertions may relate to material financial statement amounts for which the risks of material misstatement or the degree of subjectivity involved in the evaluation of the audit evidence is high. In these cases, reliance on the internal auditor is less effective. However, certain assertions may relate to less material financial statement amounts for which the risks of material misstatement or the degree of subjectivity involved is low. For example, the auditor may be able to rely on the internal auditor's work regarding assertions about the existence of cash, prepaid assets, and fixed asset additions.

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 1. I and II only. 2. I, II, and III. 3. II and III only. 4. I and III only.

2. I, II, and III.

George Karl, an auditor with extensive experience in the retail industry, is assigned to audit the reasonableness of accounting estimates in the Year 1 financial statements of Haas Company. Haas, which was formed in Year 1, markets fishing lures. Which of the following is the least important consideration for Karl's audit of the reasonableness of accounting estimates? 1. An inexperienced employee at Haas prepared the financial statements and was entirely responsible for the accounting estimates. 2. Karl has never been involved in an audit of a company that sells fishing lures. 3. The accounting estimates in the financial statements of Haas Company are based on numerous significant assumptions. 4. The accounting estimates in the financial statements are susceptible to significant estimation uncertainty.

2. Karl has never been involved in an audit of a company that sells fishing lures.

1. Ajacks has begun selling a new model of a product. At year end, it estimated the amount of warranty expense for the new model based on experience with the older model. Uncertainty type 1. High estimation uncertainty 2. Low estimation uncertainty 3. Not an estimate 1. Derived from data readily available, Estimate frequently made, Related to routine transactions 2. Amount not subject to an estimated value, Related to routine transactions, Complex process 3. Instrument not publicly traded, Complex process, Amount not subject to an estimated value 4. Derived from data readily available, related to litigation outcome, Related to routine transactions

2. Low estimation uncertainty Derived from data readily available, Estimate frequently made, Related to routine transactions

5. Ajacks records inventory at lower of cost or market, which includes issues related to inventory obsolescence. Unlike other years, a material write-down occured this year. Uncertainty type 1. High estimation uncertainty 2. Low estimation uncertainty 3. Not an estimate 1. Derived from data readily available, Estimate frequently made, Related to routine transactions 2. Amount not subject to an estimated value, Related to routine transactions, Complex process 3. Instrument not publicly traded, Complex process, Amount not subject to an estimated value 4. Derived from data readily available, related to litigation outcome, Related to routine transactions

2. Low estimation uncertainty Derived from data readily available, Estimate frequently made, Related to routine transactions

Auditors should obtain and evaluate sufficient appropriate evidence to support significant accounting estimates. Differences between the estimates best supported by the evidence and those in the financial statements 1. Are per se unreasonable and should be treated as material misstatements. 2. May be individually reasonable but collectively indicate possible bias. 3. May be individually unreasonable, but if they collectively indicate no bias, accumulation of the differences with other identified misstatements is not required. 4. Should arouse concern only when estimates are based on hypothetical assumptions or subjective factors.

2. May be individually reasonable but collectively indicate possible bias. Explanation: If the amount in the financial statements is not reasonable, it should be treated as fraud or error and accumulated with other identified misstatements. If the differences between the best estimates and those in the financial statements are individually reasonable but collectively indicate possible bias (for example, when the effect of each difference is to increase income), the auditor should reconsider the estimates as a whole.

In using the work of an auditor's external specialist, an auditor may refer to the specialist in the auditor's report if, as a result of the specialist's findings, the auditor 1. Corroborates another specialist's findings that were consistent with management's assertions. 2. Modifies the opinion because of a material misstatement with effects that are not pervasive. 3. Makes suggestions to management that are likely to improve the entity's internal control. 4. Adds a paragraph to the auditor's report to emphasize an unusually important subsequent event involving the specialist's findings.

2. Modifies the opinion because of a material misstatement with effects that are not pervasive. Explanation: 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).

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? 1. 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. 2. Preparation of schedules for negative accounts receivable responses. 3. Assessment of the risks of material misstatement relevant to accounts receivable and sales. 4. Determination of the adequacy of the allowance for doubtful accounts.

2. Preparation of schedules for negative accounts receivable responses Explanation: 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.

In assessing the competence of an internal auditor, an independent CPA most likely would obtain information about the 1. Organizational levels to which the internal auditor reports. 2. Quality of the internal auditor's documentation. 3. Influence of management on the scope of the internal auditor's duties. 4. Organization's commitment to integrity and ethical values.

2. Quality of the internal auditor's documentation.

In evaluating an entity's accounting estimates, one of the auditor's objectives is to determine whether the estimates are 1. Based on verifiable objective assumptions. 2. Reasonable in the circumstances. 3. Prepared in a satisfactory control environment. 4. Consistent with industry guidelines.

2. Reasonable in the circumstances Explanation: The auditor is responsible for evaluating the reasonableness of accounting estimates made by management in the context of the applicable reporting framework.

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 1. Disclosing compensating balance arrangements maintained for the benefit of related parties. 2. Representing without substantiation that certain related party transactions were consummated on terms equivalent to those obtainable in transactions with unrelated parties. 3.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. 4. Explaining the business purpose of the sale of real property to a related party.

2. Representing without substantiation that certain related party transactions were consummated on terms equivalent to those obtainable in transactions with unrelated parties. Explanation: 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 2410). (S)he should consider including in the report a comment to that effect and expressing a qualified or adverse opinion.

Which of the following events most likely would indicate the existence of related parties? 1. Granting stock options to key executives at favorable prices. 2. Selling real estate at a price significantly different from appraised value. 3. High turnover of senior management and members of the board of directors. 4. Failure to correct internal control weaknesses on a timely basis.

2. Selling real estate at a price significantly different from appraised value.

Transactions indicative of the existence of related parties include all of the following except 1. Borrowing or lending interest-free or at a rate significantly different from prevailing market rates at the time of the transaction. 2. Selling real estate at a price significantly different from the carrying amount. 3. Making loans with no scheduled terms for repayment. 4. Selling real estate at a price significantly different from the appraised value.

2. Selling real estate at a price significantly different from the carrying amount.

An auditor searching for related party transactions should obtain an understanding of each subsidiary's relationship to the total entity because 1. This may reveal whether particular transactions would have taken place if the parties had not been related. 2. The business structure may be deliberately designed to obscure related party transactions. 3. Interentity transactions may have been consummated on terms equivalent to arm's-length transactions. 4. This may permit the audit of interentity account balances to be performed as of concurrent dates.

2. The business structure may be deliberately designed to obscure related party transactions.

Task A: Passive, CPAs, wants to use the internal auditors' work to reduce audit risk to an acceptably low level so as to eliminate direct tests of the accuracy of accounts receivable. Accounts receivable is a large percentage of assets on the balance sheet. Task B: Passive, CPAs, wants to use the internal auditors to review the balance in the petty cash fund but is unable to supervise or review their work. 1. The internal auditors may provide direct assistance to Passive for Task A only 2. The internal auditors may provide direct assistance to a Passive for Task B only 3. The internal auditors may provide direct assistance to Passive for both Tash A and Task B 4. The internal auditors may provide direct assistance to Passive for neither Task A nor Task B

2. The internal auditors may provide direct assistance to a Passive for Task B only

For a reporting entity that has participated in related party transactions that are material, disclosure in the GAAP-based financial statements should include 1. A reference to deficiencies in the entity's internal control. 2. The nature of the relationship and the terms and manner of settlement. 3. A statement to the effect that a transaction was consummated on terms equivalent to those that prevail in arm's-length transactions. 4. Details of the transactions within major classifications.

2. The nature of the relationship and the terms and manner of settlement.

The independent auditor should understand the internal audit function as it relates to internal control because 1. The understanding of the internal audit function is an important substantive test to be performed by the independent auditor. 2. The work performed by internal auditors may be a factor in determining the nature, timing, and extent of the independent auditor's procedures. 3. The audit programs, audit documentation, and reports of internal auditors may often be used as a substitute for the work of the independent auditor's staff. 4. The procedures performed by the internal audit staff may eliminate the independent auditor's need for considering internal control.

2. The work performed by internal auditors may be a factor in determining the nature, timing, and extent of the independent auditor's procedures. Explanation: The auditor should obtain an understanding of the internal audit function when obtaining an understanding of the 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 might consider the procedures performed by the internal auditors because 1. Their work affects the cost-benefit trade-off. 2. They are employees whose work may affect the nature, timing, and extent of audit procedures. 3. Their degree of independence may be inferred from the nature of their work. 4. They are employees whose work must be reviewed during substantive testing.

2. They are employees whose work may affect the nature, timing, and extent of audit procedures.

In planning an audit, an auditor should document in the working papers the auditor's risk assessment of a material misstatement of the financial statements due to fraud. Which of the following should be included in workpaper documentation if risk factors are identified as being present? 1. Discussion of the risk factor with the client. 2. Those risk factors identified. 3. Investigation of the risk factor. 4. A copy of the report of the risk factor to the company's legal counsel.

2. Those risk factors identified.

When auditing related party transactions, an auditor places primary emphasis on 1. Confirming the existence of the related parties. 2. Verifying the valuation of the related party transactions. 3. Assessing the risks of material misstatement of related party transactions. 4. Ascertaining the rights and obligations of the related parties.

3. Assessing the risk of material misstatement of related party transactions Explanation: The auditor has a responsibility to perform audit procedures to identify, assess, and respond to the risks of material misstatement arising from the entity's failure to appropriately account for or disclose related party relationships, transactions, or balances.

A management's specialist most likely is useful to 1. Provide the auditor advice on technical accounting issues. 2. Add credibility to the financial statements. 3. Assist the client in preparing the financial statements. 4. Assist the auditor in collecting sufficient appropriate audit evidence.

3. Assist the client in preparing the financial statements. Explanation: A management's specialist is an individual or organization possessing expertise in a field other than accounting or auditing. The work in that field is used by the entity to assist in preparing the financial statements.

An auditor may refer to and identify an auditor's external specialist in the auditor's report if the 1. Specialist's work provides the auditor greater assurance of reliability. 2. Specialist lacks objectivity with regard to the client. 3. Auditor expresses a disclaimer of an opinion as a result of the specialist's findings. 4. Auditor wishes to indicate a division of responsibility.

3. Auditor expresses a disclaimer of an opinion as a result of the specialist's findings.

An auditor referred to the findings of an auditor's external specialist in the auditor's report. This may be an appropriate reporting practice if the 1. Auditor is not familiar with the professional certification, personal reputation, or particular competence of the specialist. 2. Auditor, as a result of the specialist's findings, adds a paragraph emphasizing a matter regarding the financial statements. 3. Auditor's report contains a qualified opinion. 4. Auditor, as a result of the specialist's findings, decides to indicate a division of responsibility with the specialist for the audit opinion.

3. Auditor's report contains a qualified opinion Explanation: The auditor refers to the work of an auditor's external specialist because it is relevant to a modification of the opinion. In these circumstances, the report should indicate that the reference does not reduce the auditor's responsibility for the opinion. If the auditor's report contains an unmodified opinion, the auditor should not refer to the work of an auditor's specialist (AU-C 620). A modified opinion is a qualified opinion, an adverse opinion, or a disclaimer of opinion (AU-C 705).

When assessing internal auditors' objectivity, an auditor should 1. Verify that the internal auditors' assessment of the risks of material misstatement is comparable to the auditor's assessment. 2. Review the internal auditors' reports to determine that their conclusions are consistent with the work performed. 3. Consider the policies that prohibit the internal auditors from auditing areas where they were recently assigned. 4. Evaluate the quality of the internal auditor

3. Consider the policies that prohibit the internal auditors from auditing areas where they were recently assigned. Explanation: If the external auditor plans to use the work of the internal auditors to obtain audit evidence or to provide direct assistance, the competence and objectivity should be evaluated. Objectivity is promoted when the internal auditors (1) report to those charged with governance rather than management, (2) are free of any conflicting responsibilities, (3) work without constraints, and (4) are members of professional organizations that obligate them to be objective. The external auditor should assess each of these factors in evaluating objectivity.

In assessing the objectivity of internal auditors, an independent auditor should 1. Examine documentary evidence of the work performed by the internal auditors. 2. Test a sample of the transactions and balances that the internal auditors examined. 3. Determine the organizational level to which the internal auditors report. 4. Evaluate the quality control program in effect for the internal auditors.

3. Determine the organizational level to which the internal auditors report.

As part of the audit of fair value estimates and disclosures, an auditor may need to test the entity's significant assumptions. In these circumstances, the auditor should 1. Verify that the entity has used its own assumptions, not those of marketplace participants. 2. Obtain sufficient evidence to express an opinion on the assumptions. 3. Evaluate whether the assumptions individually and as a whole form a reasonable basis for the fair value estimates. 4. Apply audit effort equally to all assumptions.

3. Evaluate whether the assumptions individually and as a whole form a reasonable basis for the fair value estimates. Explanation: Observable market prices are not always available for fair value estimates. In this case, the entity uses valuation methods based on the assumptions that the market would employ to estimate fair values, if obtainable without excessive cost. Accordingly, GAAS require the auditor to evaluate whether the significant assumptions form a reasonable basis for the estimates. Because assumptions often are interdependent and must be consistent with each other, the auditor should evaluate them independently and as a whole.

An internal auditor would least likely provide direct assistance to the auditor in 1. Performing tests of controls. 2. Obtaining an understanding of internal control. 3. Evaluating accounting estimates. 4. Performing substantive procedures.

3. Evaluating accounting estimates.

In which of the following circumstances is an auditor most likely to rely on work done by internal auditors? 1. If the internal auditors have concluded that the risk of material misstatement at the overall financial level is negligible. 2. For financial statement amounts determined largely or entirely on the basis of estimates made by management. 3. For financial statement amounts judged by the auditor to require little or no subjectively evaluated audit evidence. 4. If financial statement amounts are material and the degree of subjectivity in evaluating the audit evidence is high.

3. For financial statement amounts judged by the auditor to require little or no subjectively evaluated audit evidence. Explanation: The auditor should make all significant judgments. Thus, (s)he should use less of the internal auditors' work and perform more work directly in the following circumstances: (1) the more judgment is involved in planning and performing audit procedures or evaluating evidence, (2) the higher the assessed risk of material misstatement at the assertion level, (3) the less the internal auditors' organizational status and relevant policies and procedures support their objectivity, and (4) the lower their competence. Accordingly, the auditor is most likely to rely on the work of the internal audit function when little or no judgment is required to evaluate audit evidence.

An auditor's preliminary analysis of accounts receivable turnover revealed the following rates over these accounting periods: Year 3 - 4.3 Year 2 - 6.2 Year 1 - 7.3 Which of the following is the most likely cause of the decrease in accounts receivable turnover? 1. Shortening of due date terms. 2. Increased cash sales. 3. Liberalization of credit policy. 4. Increase in the cash discount offered.

3. Liberalization of credit policy

4. Ajacks records sales FOB shipping point. Cutoff for sales for the year is determined by evaluating shipping documents. Uncertainty type 1. High estimation uncertainty 2. Low estimation uncertainty 3. Not an estimate

3. Not an estimate Amount not subject to an estimated value, No need for an estimate

When performing procedures to identify and assess the risks of material misstatement for accounting estimates, the auditor should 1. Review transactions occurring prior to the date of the auditor's report that indicate variations from expectations. 2. Compare independent expectations with recorded estimates to assess management's process. 3. Obtain an understanding of how management developed its estimates. 4. Analyze historical data used in developing assumptions to determine whether the process is consistent.

3. Obtain an understanding of how management developed its estimates.

Buldger Retailing, Inc., has an internal auditing staff of four full-time auditors. The auditor has determined that the internal auditors are competent and objective. The auditor may share which of the following responsibilities with Buldger's internal auditors? 1. Judging the materiality of misstatements. 2. Assessing the risks of material misstatement. 3. Performing substantive procedures. 4. Evaluating sufficiency of tests performed.

3. Performing substantive procedures.

Which of the following procedures most likely could assist an auditor in identifying related party transactions? 1. Performing tests of controls concerning the segregation of duties. 2. Evaluating the reasonableness of management's accounting estimates. 3. Reviewing confirmations of compensating balance arrangements. 4. Scanning the accounting records for recurring transactions.

3. Reviewing confirmations of compensating balance arrangements Explanation: The auditor performs procedures to identify material transactions that may be indicative of previously undetermined relationships. These procedures include reviewing confirmations of compensating balance arrangements for indications that balances are or were maintained for or by related parties (AU-C 550 and AS 2410).

An auditor intends to use the work of an actuary. Under these circumstances, the auditor 1. Is required to disclose the relationship in the auditor's report. 2. Is not permitted to rely on the actuary's work. 3. Should assess the actuary's competence and objectivity. 4. Should communicate this matter to the audit committee.

3. Should assess the actuary's competence and objectivity.

An auditor most likely modifies the opinion if the entity's financial statements include a note on related party transactions 1. Disclosing loans to related parties at interest rates significantly below prevailing market rates. 2. Describing an exchange of real estate for similar property in a nonmonetary related party transaction. 3. Stating without substantiation that a particular related party transaction occurred on terms equivalent to those that would have prevailed in an arm's-length transaction. 4. Presenting the dollar volume of related party transactions and the effects of any change from prior periods in the method of establishing terms.

3. Stating without substantiation that a particular related party transaction occurred on terms equivalent to those that would have prevailed in an arm's-length transaction. Explanation: The auditor should obtain sufficient appropriate evidence about a management assertion that related party transactions were conducted on terms equivalent to those that prevail in arm's-length transactions. Management is responsible for substantiating the assertion. The auditor evaluates management's support for the assertion.

Task A: Passive, CPAs, seeks the assistance of the internal auditors in obtaining an understanding of internal control. Task B: While the client's employees performed the physical count of inventory, some of the internal auditors performed test counts in the warehouse under the supervision of Passive's auditors. 1. The internal auditors may provide direct assistance to Passive for Task A only 2. The internal auditors may provide direct assistance to a Passive for Task B only 3. The internal auditors may provide direct assistance to Passive for both Tash A and Task B 4. The internal auditors may provide direct assistance to Passive for neither Task A nor Task B

3. The internal auditors may provide direct assistance to Passive for both Task A and Task B

Which approach to planning, performing, supervising, reviewing, and documenting internal audit activities distinguishes it from other monitoring controls that may be performed within the entity? 1. An independent approach. 2. A balanced approach. 3. A fair and honest approach. 4. A systematic and disciplined approach.

4. A systematic and disciplined approach. Explanation: The application of a systematic and disciplined approach to planning, performing, supervising, reviewing, and documenting internal audit activities distinguishes it from other monitoring controls that may be performed within the entity.

The existence of a related party transaction may be indicated when another entity 1. Sells real estate to the corporation at a price that is comparable to its appraised value. 2. Lends to the corporation at a rate of interest equal to the current market rate. 3. Borrows from the corporation at a rate of interest equal to the current market rate. 4. Absorbs expenses of the corporation.

4. Absorbs expenses of the corporation.

In which of the following instances would it be appropriate for the auditor to refer to the work of an appraiser in the auditor's report? 1. A qualified opinion is expressed because of a matter unrelated to the work of the auditor's external specialist. 2. An unmodified opinion is expressed and no additional paragraph is added, but the auditor wishes to disclose the use of an auditor's specialist. 3. A disclaimer of opinion is expressed owing to a scope limitation imposed on the auditor by the auditor's external specialist. 4. An adverse opinion is expressed based on a difference of opinion between the client and the auditor's external specialist about the value of certain assets.

4. An adverse opinion is expressed based on a difference of opinion between the client and the auditor's external specialist about the value of certain assets.

When assessing an internal auditor's objectivity, the independent auditor should 1. Review the internal auditor's current audit plan, including the nature, timing, and extent of audit work. 2. Determine the educational level and the professional experience of the internal auditor. 3. Examine workpapers of the internal auditor to verify evidence of supervision and review. 4. Ascertain the organization level to which the internal audit function reports.

4. Ascertain the organization level to which the internal audit function reports. Explanation: Objectivity is the ability to perform tasks without bias and is judged by the function's organizational status and relevant policies and procedures that support objectivity. For example, objectivity is promoted when internal auditors (1) report to those charged with governance rather than management, (2) are free of any conflicting responsibilities, (3) work without constraints, and (4) are members of professional organizations that obligate them to be objective.

Which of the following actions should be taken by a CPA who has been asked to audit the financial statements of a company whose fiscal year has ended? 1. Request a signed management representation letter before accepting the engagement. 2. Inform the client of the need to express an adverse opinion because of the late engagement date. 3. Inform the client of the need to express a qualified opinion because of the late engagement date. 4. Ascertain whether circumstances are likely to permit the auditor to obtain sufficient appropriate evidence and express an unmodified opinion.

4. Ascertain whether circumstances are likely to permit the auditor to obtain sufficient appropriate evidence and express an unmodified opinion.

For which of the following judgments may an independent auditor share responsibility with an entity's internal auditor who is assessed to be both competent and objective? 1. Assessment of Inherent Risk - Yes Assessment of Control Risk - No 2. Assessment of Inherent Risk - Yes Assessment of Control Risk - Yes 3. Assessment of Inherent Risk - No Assessment of Control Risk - Yes 4. Assessment of Inherent Risk - No Assessment of Control Risk - No

4. Assessment of Inherent Risk - No Assessment of Control Risk - No

A management's specialist most likely is useful to 1. Assist the auditor in collecting sufficient appropriate audit evidence. 2. Provide the auditor advice on technical accounting issues. 3. Add credibility to the financial statements. 4. Assist the client in preparing the financial statements.

4. Assist the client in preparing the financial statements. Explanation: A management's specialist is an individual or organization possessing expertise in a field other than accounting or auditing. The work in that field is used by the entity to assist in preparing the financial statements.

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 1. Specialist is management's specialist. 2. Specialist's work provides the auditor greater assurance of reliability. 3. Auditor indicates a division of responsibility related to the work of the specialist. 4. Auditor expresses a qualified opinion or an adverse opinion related to the work of the specialist.

4. Auditor expresses a qualified opinion or an adverse opinion related to the work of the specialist.

Which of the following most likely would indicate the existence of related parties? 1. Depending on a single product for the success of the entity. 2. Writing down obsolete inventory just before year end. 3. Failing to correct previously identified internal control deficiencies. 4. Borrowing money at an interest rate significantly below the market rate.

4. Borrowing money at an interest rate significantly below the market rate.

In assessing the objectivity of internal auditors, an independent auditor should 1. Evaluate the quality control program in effect for the internal auditors. 2. Examine documentary evidence of the work performed by the internal auditors. 3. Test a sample of the transactions and balances that the internal auditors examined. 4. Determine the organizational level to which the internal auditors report.

4. Determine the organizational level to which the internal auditors report. Explanation: If the external auditor plans to use the work of the internal auditors to obtain audit evidence or to provide direct assistance, their competence and objectivity should be evaluated. Objectivity is promoted when the internal auditors (1) report to those charged with governance rather than management, (2) are free of any conflicting responsibilities, (3) work without constraints, and (4) are members of professional organizations that obligate them to be objective. The external auditor should assess each of these factors in evaluating objectivity.

Which of the following is not considered an auditor's specialist? 1. Tax attorney. 2. Appraiser. 3. Actuary. 4. Internal auditor.

4. Internal auditor Explanation: 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.

Which of the following events most likely indicates the existence of related parties? 1. Borrowing a large sum of money at a variable rate of interest. 2. Discussing merger terms with a company that is a major competitor. 3. Selling real estate at a price that differs significantly from its carrying amount. 4. Making a loan without scheduled terms for repayment of the funds.

4. Making a loan without scheduled terms for repayment of the funds. Explanation: 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.

For which of the following judgments may an independent auditor share responsibility with an entity's internal auditor who is assessed to be both competent and objective? 1. Materiality of Misstatements - Yes Evaluation of Significant Accounting Estimates - No 2. Materiality of Misstatements - No Evaluation of Significant Accounting Estimates - Yes 3. Materiality of Misstatements - Yes Evaluation of Significant Accounting Estimates - Yes 4. Materiality of Misstatements - No Evaluation of Significant Accounting Estimates - No

4. Materiality of Misstatements - No Evaluation of Significant Accounting Estimates - No Explanation: The responsibility to report on financial statements is solely the auditor's. It cannot be shared with internal auditors. Because the auditor has the ultimate responsibility to express an opinion on the financial statements, judgments about (1) assessments of RMMs, (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.

Auditors should obtain and evaluate sufficient appropriate evidence to support significant accounting estimates. Differences between the estimates best supported by the evidence and those in the financial statements 1. Are per se unreasonable and should be treated as material misstatements. 2. May be individually unreasonable, but if they collectively indicate no bias, accumulation of the differences with other identified misstatements is not required. 3. Should arouse concern only when estimates are based on hypothetical assumptions or subjective factors. 4. May be individually reasonable but collectively indicate possible bias.

4. May be individually reasonable but collectively indicate possible bias. Explanation: If the amount in the financial statements is not reasonable, it should be treated as fraud or error and accumulated with other identified misstatements. If the differences between the best estimates and those in the financial statements are individually reasonable but collectively indicate possible bias (for example, when the effect of each difference is to increase income), the auditor should reconsider the estimates as a whole.

Miller Retailing, Inc., maintains a staff of three full-time internal auditors. The independent auditor has found that they are competent and objective. Moreover, the work of the internal auditors is relevant to the audit, and it is efficient to consider how that work may affect the audit. The independent auditor most likely will 1. Not evaluate and test the work performed by the internal auditors. 2. Increase the extent of the procedures needed to reduce control risk to an acceptable level. 3. Decrease the extent of the tests of controls needed to restrict audit risk to the acceptable level. 4. Nevertheless need to make direct tests of assertions about material financial statement amounts for which the risks of material misstatement are high.

4. Nevertheless need to make direct tests of assertions about material financial statement amounts for which the risks of material misstatement are high.

During an audit, an internal auditor may provide direct assistance to an independent CPA in 1. Obtaining an Understanding of Internal Control - No Performing Tests of Controls - No Performing Substantive Tests - No 2. Obtaining an Understanding of Internal Control - Yes Performing Tests of Controls - No Performing Substantive Tests - No 3. Obtaining an Understanding of Internal Control - Yes Performing Tests of Controls - Yes Performing Substantive Tests - No 4. Obtaining an Understanding of Internal Control - Yes Performing Tests of Controls - Yes Performing Substantive Tests - Yes

4. Obtaining an Understanding of Internal Control - Yes Performing Tests of Controls - Yes Performing Substantive Tests - Yes Explanation: 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 (AU-C 610). The internal auditor may provide assistance in all phases of the audit as long as (1) the internal auditor's competence and objectivity have been tested, and (2) the independent auditor supervises, reviews, evaluates, and tests the work performed by the internal auditor to the extent appropriate.

Auditors try to identify predictable relationships when using analytical procedures. Relationships involving transactions from which of the following accounts most likely would yield the highest level of evidence? 1. Accounts payable. 2. Accounts receivable. 3. Advertising expense. 4. Payroll expense.

4. Payroll expense.

An auditor who uses the work of an auditor's external specialist may refer to the specialist in the auditor's report if the 1. The specialist's findings fully corroborate management's financial statement assertions. 2. Specialist's findings provide the auditor greater assurance of reliability about management's representations. 3. Auditor's use of the specialist's findings is different from that of prior years. 4. Reference is needed for an understanding of a modification of the opinion.

4. Reference is needed for an understanding of a modification of the opinion. Explanation: 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).

In auditing related party transactions, an auditor ordinarily places primary emphasis on 1. Verifying the valuation of the related party transactions. 2. Confirming the existence of the related parties. 3. The probability that related party transactions will recur. 4. The adequacy of the disclosure of the related party transactions.

4. The adequacy of the disclosure of the related party transactions Explanation: 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.

Which of the following factors would the independent auditor most likely consider in assessing the objectivity of an internal auditor? 1. The internal auditor has obtained the Certified Internal Auditor designation. 2. The internal auditor was previously an employee of the auditor's public accounting firm. 3. The internal auditor attends a number of comprehensive continuing professional education courses each year. 4. The audit committee reviews employment decisions related to the director of internal auditing.

4. The audit committee reviews employment decisions related to the director of internal auditing. Explanation: Objectivity is impartiality, intellectual honesty, and freedom from conflicts of interest. Factors that the independent auditor most likely considers in assessing the objectivity of an internal auditor include whether those charged with governance (e.g., the audit committee) oversee employment decisions related to internal auditing. Examples are hiring and compensation of the director of the internal audit function.

When a management's specialist has assumed full responsibility for taking the client's physical inventory, reliance on the specialist's work is acceptable if 1. The auditor is satisfied with the competence of the specialist. 2. The auditor's report contains a reference to the assumption of full responsibility by the specialist. 3. Circumstances made it impracticable or impossible for the auditor to test the work done by the specialist. 4. The auditor conducted the same audit tests and procedures as would have been applicable if the client employees took the physical inventory.

4. The auditor conducted the same audit tests and procedures as would have been applicable if the client employees took the physical inventory. Explanation: The auditor is responsible for the observation of inventories. The auditor performs this procedure whether the client or an external specialist takes the physical inventory. The auditor should (1) examine the specialist's program, (2) observe its procedures and controls, (3) make or observe some physical counts, (4) recompute calculations, and (5) test intervening transactions.

Which of the following statements is true about related party transactions? 1. In the absence of evidence to the contrary, related party transactions should be assumed to be outside the ordinary course of business. 2. An auditor should determine whether a particular transaction would have occurred if the parties had not been related. 3. An auditor should substantiate that related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions. 4. The auditor should consider whether an identified related party transaction outside the normal course of business is appropriately accounted for and disclosed.

4. The auditor should consider whether an identified related party transaction outside the normal course of business is appropriately accounted for and disclosed. Explanation: The auditor should inspect any contracts or agreements to evaluate whether (1) the business purpose (or lack of a business purpose) implies that the transaction's intent was fraudulent, (2) the terms are consistent with management's explanations, and (3) the accounting and disclosure are appropriate. The auditor also should obtain evidence of appropriate authorization and approval.

Which of the following statements is true about the use of the work of an auditor's specialist? 1. The specialist need not agree to the auditor's use of the specialist's findings. 2. The auditor is required to perform substantive procedures to verify the specialist's assumptions and findings. 3. The auditor must keep client information confidential, but the specialist is not obligated to do so. 4. The auditor should obtain an understanding of the methods and assumptions used by the specialist.

4. The auditor should obtain an understanding of the methods and assumptions used by the specialist. Explanation: AU-C 620, Using the Work of an Auditor's Specialist, states that the auditor should evaluate the adequacy of the work of the auditor's specialist. This process includes (1) obtaining an understanding of any significant assumptions and methods used by the specialist and (2) evaluating the relevance and reasonableness of those assumptions and methods in the circumstances and in relation to the auditor's other findings and conclusions.

Which of the following statements is correct regarding accounting estimates? 1. Accounting estimates should be used when data concerning past events can be accumulated in a timely, cost-effective manner. 2. An important accounting estimate is management's listing of accounts receivable greater than 90 days past due. 3. Accounting estimates should not be used when the outcome of future events related to the estimated item is unknown. 4. The auditor's objective is to evaluate whether accounting estimates are reasonable in the circumstances.

4. The auditor's objective is to evaluate whether accounting estimates are reasonable in the circumstances. Explanation: The auditor is responsible for evaluating the reasonableness of accounting estimates and the adequacy of disclosure.

Which of the following statements concerning the auditor's use of the work of an auditor's external specialist is true? 1. The auditor's specialist need not have an understanding of the extent of the auditor's use of the specialist's work. 2. If the auditor believes that the determinations made by the auditor's specialist are unreasonable, only a qualified opinion may be expressed. 3. The auditor's specialist may be identified in the auditor's report only when the auditor expresses an unmodified opinion. 4. The auditor's specialist should observe the same confidentiality requirements as the auditor.

4. The auditor's specialist should observe the same confidentiality requirements as the auditor. Explanation: 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.

An auditor searching for related party transactions should obtain an understanding of each subsidiary's relationship to the total entity because 1. This may permit the audit of interentity account balances to be performed as of concurrent dates. 2. Interentity transactions may have been consummated on terms equivalent to arm's-length transactions. 3. This may reveal whether particular transactions would have taken place if the parties had not been related. 4. The business structure may be deliberately designed to obscure related party transactions.

4. The business structure may be deliberately designed to obscure related party transactions. Explanation: The nature of related party relationships and transactions may result in greater risks of material misstatement than transactions with unrelated parties. Thus, related parties may operate through a complex set of relationships and structures, with increased complexity of related party transactions. For example, a transaction may involve multiple related parties in a consolidated group. Accordingly, in an audit of group statements, the group engagement team should request each component auditor to communicate with related parties not previously identified by group management or the group engagement team.

Which of the following factors most likely would assist an auditor in assessing the objectivity of the internal auditor? 1. The appropriateness of internal audit conclusions in the circumstances. 2. The professional certifications of the internal audit staff. 3. The consistency of the internal audit reports with the results of work performed. 4. The organizational status of the director of internal audit.

4. The organizational status of the director of internal audit. Explanation: If the external auditor plans to use the work of the internal auditors to obtain audit evidence or to provide direct assistance, the competence and objectivity should be evaluated. Objectivity is promoted when the internal auditors (1) report to those charged with governance rather than management, (2) are free of any conflicting responsibilities, (3) work without constraints, and (4) are members of professional organizations that obligate them to be objective. The external auditor should assess each of these factors in evaluating objectivity.

In assessing the competence and objectivity of an entity's internal auditor, an independent auditor would least likely consider information obtained from 1. Discussions with management personnel. 2. External quality reviews of the internal auditor's activities. 3. Previous experience with the internal auditor. 4. The results of analytical procedures.

4. The results of analytical procedures Explanation: Analytical procedures are evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data, using models that range from simple to complex. They are substantive procedures used by the auditor to gather evidence about the fairness of the financial statements.

During Year 2, the company hired several internal auditors to fill positions that had been vacant for 3 years. Which section of the auditing standards addresses the inquiries that the independent auditor of a nonissuer should make of the internal audit personnel regarding the risks of fraud? Enter your response in the answer fields below. Guidance on correctly structuring your response appears above and below the answer fields.

AU-C 240.19

David is the auditor of a client. He relies heavily on the work of the internal auditor. Which section of the AICPA's auditing standards describes the auditor's responsibility to report on the financial statements and whether that responsibility can be shared with the internal auditor? Enter your response in the answer fields below. Guidance on correctly structuring your response appears above and below the answer fields.

AU-C 610.09

Carrie, CPA, expects to express an unmodified opinion on the financial statements of a nonissuer client. She is considering including a reference to an auditor's specialist who was instrumental in collecting the evidence in support of the opinion. Which section of the generally accepted auditing standards best states the auditor's responsibility for referring to an auditor's specialist in a report expressing an unmodified opinion? Enter your response in the answer fields below. Guidance on correctly structuring your response appears above and below the answer fields.

AU-C 620.14