Chapter 5 Audit

Which of the following are components of the risk of misstatement? Account Risk - Assertion Risk - Detection Risk A. Yes,Yes, Yes B. Yes, Yes, No C. Yes, No, No D. No, No, No

D. No, No, No

A difference of opinion concerning accounting and auditing matters relative to a particular phase of the audit arises between an assistant auditor and the auditor responsible for the engagement. After appropriate consultation, the assistant auditor asks to be disassociated from the resolution of the matter. The working papers would probably: (1) Remain silent on the matter since it is an internal matter of the auditing firm. (2) Note that the assistant auditor is completely dissociated from responsibility for the auditors' opinion. (3) Document the additional work required because all disagreements of this type will require expanded substantive procedures. (4) Document the assistant auditor's position and how the difference of opinion was resolved.

Document the assistant auditor's position and how the difference of opinion was resolved.

Evaluate the following statement: A canceled check is not considered particularly reliable evidence because the check was prepared within the client's organization.

Incorrect-the check was processed externally by two organizations1) who it was written too2) banking system

As part of the verification of accounts receivable as of the balance sheet date, the auditors might inspect copies of sales invoices. Similarly, as part of the verification of accounts payable, the auditors might inspect purchase invoices. Which of these two types of invoices do you think represents the stronger type of evidence? Why?

Sales invoices are made by company, so purchase invoices are more reliable (come from third party)

A primary purpose of the audit working papers is to: (1) Aid the auditors by providing a list of required procedures. (2) Provide a point of reference for future audit engagements. (3) Support the underlying concepts included in the preparation of the basic financial statements. (4) Support the auditors' opinion.

Support the auditors' opinion.

"Use of data analytics is likely to increase the use of sampling and eliminate the audit of all items in a population." Comment on the accuracy of this quotation.

The statement is inaccurate in that in many areas of the audit the use of data analytics may lead to auditing entire populations (e.g., authorization of sales, authorization of warranty work) more frequently than had been done in the past.

Which of the following statements best describes why auditors investigate related party transactions? (1) Related party transactions generally are illegal acts. (2) The substance of related party transactions may differ from their form. (3) All related party transactions must be eliminated as a step in preparing consolidated financial statements. (4) Related party transactions are a form of management fraud.

The substance of related party transactions may differ from their form.

"The best means of verification of cash, inventory, office equipment, and nearly all other assets is a physical count of the units; only a physical count gives the auditors complete assurance as to the accuracy of the amounts listed on the balance sheet." Evaluate this statement.

This statement is not true because physical count does not take into account the valuation assertion. You can count an inventory item but without the known fair value of that item, the verified cannot be estimated. The same goes with rights to an asset, just because the item is on the books, does not mean that the item actually belongs to the company. Confirmation from an external party should verify that the asset is actually owned by the client.

As part of their audit, auditors obtain a representation letter from their client. Which of the following is not a valid purpose of such a letter? (1) To increase the efficiency of the audit by eliminating the need for other audit procedures. (2) To remind the client's management of its primary responsibility for the financial statements. (3) To document in the audit working papers the client's responses to certain verbal inquiries made by the auditors during the engagement. (4) To provide evidence in those areas dependent upon management's future intentions.

To increase the efficiency of the audit by eliminating the need for other audit procedures.

Which of the following best describes the problem with the use of published industry averages for analytical procedures? A. Lack of comparability. B. Lack of sufficiency. C. Lack of accuracy. D. Lack of availability.

A. Lack of comparability.

Which transaction would not necessarily be considered a related party transaction? A. Payment of the chief executive's salary. B. Purchases from another corporation that is controlled by the corporation's chief stockholder. C. Loan from the corporation to a major stockholder. D. Sale of land to the corporation by the spouse of a director.

A. Payment of the chief executive's salary.

Provide an example in which a data analytics technique applied in financial statement auditing could serve as both a test of a control and a substantive procedure.

Any solution addressing both effectiveness of operation of a control and substantiating an account balance is appropriate. For example, testing a control over authorization of sales returns and allowances may result in evidence addressing the appropriate valuation of overall revenues.

Which of the following is not a basic approach often used by auditors to evaluate the reasonableness of accounting estimates? A. Confirmation of totals. B. Review of management's process of development. C. Independent development of an estimate. D. Review of subsequent events.

A. Confirmation of totals.

In using the work of a specialist, the auditors referred to the specialist's findings in their report. This would be an appropriate reporting practice if the: (1) Client is not familiar with the professional certification, personal reputation, or particular competence of the specialist. (2) Auditors, as a result of the specialist's findings, give a qualified opinion on the financial statements. (3) Client understands the auditors' corroborative use of the specialist's findings in relation to the representations in the financial statements. (4) Auditors, as a result of the specialist's findings, decide to indicate a division of responsibility with the specialist.

Auditors, as a result of the specialist's findings, give a qualified opinion on the financial statements.

Which of the following is not a financial statement assertion made by management? (1) Existence of recorded assets and liabilities. (2) Completeness of recorded assets and liabilities. (3) Valuation of assets and liabilities. (4) Effectiveness of internal control.

Effectiveness of internal control.

5-2. Identify and describe the two components of the risk of material misstatement.

Inherent risk - the possibility of material misstatement of an assertion before considering the client's internal control. Control risk - the risk that a material misstatement could occur in a relevant assertion and not be prevented or detected on a timely basis by the client's internal control.

In what section of the audit working papers would a long-term lease agreement be filed? (1) Current working paper file. (2) Permanent working paper file. (3) Lead schedule file. (4) Corroborating documents file.

Permanent working paper file.

When in the course of an audit might the auditors find it useful to apply analytical procedures?

Through different times during the engagement, Early panning stages, field work, final overview.

Analytical procedures are most likely to detect: (1) Weaknesses of a material nature in internal control. (2) Unusual transactions. (3) Noncompliance with prescribed control activities. (4) Improper separation of accounting and other financial duties.

Unusual transactions.

Distinguish among routine, non-routine, and estimation transactions. Include an example of each.

- Routine transactions involve recurring financial activities recorded in the accounting records in the normal course of business. Examples include sales transactions, purchase transactions, cash disbursements, cash receipts, and payroll transactions. - Non-routine transactions involve activities that occur only periodically. Examples include taking physical inventories, calculating depreciation, and consolidating financial results. - Estimation transactions are financial reporting activities that involve creating an accounting estimate. Examples include estimating the allowance for uncollectible accounts, estimating warranty reserves, and assessing assets for impairment

Which of the following business characteristics is not indicative of high inherent risk? (1) Operating results that are highly sensitive to economic factors. (2) Large likely misstatements detected in prior audits. (3) Substantial turnover of management. (4) A large amount of assets.

A large amount of assets.

An independent auditor finds that the client purchased land owned by an officer of the company for an amount in excess of its asking price. This finding indicates the existence of: A. Management fraud. B. Related party transactions. C. Window dressing. D. Weak internal control.

B. Related party transactions.

What ultimately determines the specific audit procedures necessary to provide independent auditors with a reasonable basis for the expression of an opinion? A. The audit time budget. B. The auditors' judgment. C. Generally accepted accounting quality standards. D. The auditors' working papers.

B. The auditors' judgment.

Distinguish between the components of audit risk that the auditors gather evidence to assess versus the component of audit risk that they collect evidence to restrict.

Because inherent risk and control risk are a result of characteristics of the client and its internal controls, auditors assess them. Because detection risk is a function of the effectiveness of the audit procedures used to gather evidence, it is restricted to the appropriate level based on the scope of procedures performed.

Further audit procedures include: Risk assessment procedures - Tests of controls A. Yes, Yes B. Yes, No C. No, Yes D. No, No

C. No, Yes

Which of the following is not a primary approach to auditing an accounting estimate? (1) Review and test management's process for developing the estimate. (2) Review subsequent transactions. (3) Confirm the amounts. (4) Develop an independent estimate.

Confirm the amounts.

Seeking and treating as more persuasive information that is consistent with one's initial beliefs describes which cognitive bias? (1) Overconfidence bias. (2) Confirmation bias. (3) Persuasiveness bias. (4) Availability bias.

Confirmation bias.

Of the following, which is the least reliable type of audit evidence? (1) Confirmations mailed by outsiders to the auditors. (2) Correspondence between the auditors and suppliers. (3) Copies of sales invoices inspected by the auditors. (4) Canceled checks returned in the year-end bank statement directly to the client.

Copies of sales invoices inspected by the auditors.

In a conversation with you, Mark Rogers, CPA, claims that both the sufficiency and the appropriateness of audit evidence are a matter of judgment in every audit. Do you agree? Explain.

In the absence of appropriate quantity of audit evidence necessary in a specific audit, the sufficiency of audit evidence is considered a matter of judgment. (Auditors judgment on the sufficiency of evidence is based on these factors) - The strength of client internal control - The inherent risk of the audit - The level of materiality to the audit - The existence of related party transactions - The quantity of evidence is proportional to the quality of evidence. Appropriateness measures the quality of audit evidence. It measures both the reliability and relevance of the evidence. The reliability and relevance of the evidence depends upon the source of the evidence and not on auditors judgment.

5-3. Define inherent risk. Can the auditors reduce inherent risk by performing audit procedures?

Inherent risk refers to the possibility of material misstatement of an assertion before considering the client's internal control. Since it exists independently of the auditors, the auditors cannot "reduce" inherent risk. Rather, they gather evidence that allows them to make an accurate assessment of the existing inherent risk

5-1. Describe the relationship between detection risk and audit risk

Like audit risk, detection risk does not assess detection risk, rather it makes auditors seek to restrict it through the performance of substantive procedures