Module 2: Engagement Planning, Obtaining an Understanding of the Client and Assessing Risks

What is an auditor's responsibility who discovers management involved in what is financially immaterial fraud? a. Report the fraud to the audit committee. b. Report the fraud to the Public Company Oversight Board. c. Report the fraud to a level of management at least one below those involved in the fraud. d. Determine that the amounts involved are immaterial, and if so, there is no reporting responsibility.

(a) The requirement is to determine an auditor's reporting responsibility when he or she has discovered that management is involved in a financially immaterial fraud. Answer (a) is correct because AU-C 240 requires that all management fraud, regardless of materiality, be reported to the audit committee. Answer (b) is incorrect because fraud is not directly reported to the Public Company Accounting Oversight Board. Answer (c) is incorrect because if anything, in addition to the audit committee, the fraud is reported to a level of management at least one level above those involved in a fraud. Answer (d) is incorrect because there is a reporting responsibility for financially immaterial management fraud.

If specific information comes to an auditor's attention that implies noncompliance with laws that could result in a material, but indirect effect on the financial statements, the auditor should next a. Apply audit procedures specifically directed to ascertaining whether noncompliance has occurred. b. Seek the advice of an informed expert qualified to practice law as to possible contingent liabilities. c. Report the matter to an appropriate level of management at least one level above those involved. d. Discuss the evidence with the client's audit committee, or others with equivalent authority and responsibility

(a) The requirement is to determine an auditor's responsibility when information comes to his/her attention that implies the existence of possible illegal acts with a material, but indirect effect on the financial statements. Answer (a) is correct because AU-C 250 requires the auditor to apply audit procedures specifically designed to determine whether an illegal act has occurred when such information comes to his/her attention. Answers (b), (c), and (d) are all incorrect because they represent procedures the auditor would perform after initial procedures had confirmed the existence of the possible illegal act(s).

Which of the following is correct concerning performance materiality on an audit? a. It will ordinarily be less than financial statement materiality. b. It should be established at beginning of an audit and not be revised thereafter. c. It should be established at separate amounts for the various financial statements. d. It need not be documented in the working papers

(a) The requirement is to determine the correct statement with respect to performance materiality on an audit. Answer (a) is correct because performance materiality is largely established to help provide assurance that several immaterial misstatements do not combine to a material undetected amount of misstatement; accordingly, it ordinarily is established at a level lower than that of materiality for the financial statements. Answer (b) is incorrect because performance materiality may be revised throughout the audit, particularly when circumstances depart from those which had been expected while planning the audit. Answer (c) is incorrect because performance materiality is ordinarily established for the financial statements as a whole, and if applicable, materiality levels for particular classes of transactions, account balances, or disclosures. Answer (d) is incorrect because performance materiality must be documented in the working papers.

Should an auditor communicate the following matters to those charged with governance of an audit client? Significant audit adjustments recorded by the entity//Management's consultation with other accountants about significant accounting matters a. Yes //Yes b. Yes //No c. No //Yes d. No //No

(a) The requirement is to determine the information that an auditor should communicate to those charged with corporate governance. Answer (a) is correct because both significant audit adjustments and management's consultation with other accountants about significant accounting matters should be communicated to an audit committee. See AU-C 260 for these and other matters that should be so communicated.

Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding a. Disagreements the predecessor had with the client concerning auditing procedures and accounting principles. b. The predecessor's evaluation of matters of continuing accounting significance. c. The degree of cooperation the predecessor received concerning the inquiry of the client's lawyer. d. The predecessor's assessments of inherent risk and judgments about materiality.

(a) The requirement is to determine the nature of the inquiries that a successor auditor should make of the predecessor auditor prior to accepting an audit engagement. Answer (a) is correct because the inquiries should include specific questions to management on (1) disagreements with management as to auditing procedures and accounting principles (answer [a]), (2) facts that might bear on the integrity of management and (3) the predecessor's understanding as to the reasons for the change of auditors. Answers (b), (c), and (d) are incorrect because, if made at all, they will be after the engagement has been accepted.

The audit plan generally is modified when a. Results of tests of control differ from expectations. b. An engagement letter has been signed by the auditor and the client. c. A significant deficiency has been communicated to the audit committee of the board of directors. d. The search for unrecorded liabilities has been performed and obtained results as had been expected during the planning of the audit.

(a) The requirement is to determine the situation that will ordinarily result in modification of the audit plan. Answer (a) is correct because results which differ from expectations may be expected to lead to modification of planned substantive procedures. Answer (b) is incorrect because the signing of the engagement letter is unlikely to result in a change in the audit plan. Answer (c) is incorrect because the communication itself of a significant deficiency is unlikely to result in a change to the audit plan. Answer (d) is incorrect because audit expected results obtained by such a procedure are unlikely to result in a change to the audit plan, since the plan is already based on expected results.

An engagement letter should ordinarily include information on the objectives of the engagement and CPA responsibilities// Client responsibilities //Limitation of engagement a. Yes //Yes //Yes b. Yes// No// Yes c. Yes //No //No d. No// No// No

(a) The requirement is to determine what types of items are ordinarily included in an engagement letter in addition to the objectives of the engagement. Answer (a) is correct because AU-C 210 also requires inclusion of information on CPA responsibilities, client responsibilities, and limitations of the engagement.

At which stage(s) of the audit may fraud risk factors be identified? Planning //Obtaining understanding //Conducting fieldwork a. Yes// Yes//Yes b. Yes //Yes //No c. Yes// No //No d. No //Yes// Yes

(a) The requirement is to determine when audit risk factors may be identified. Answer (a) is correct because AU-C 240 states that fraud risk factors may be identified during planning, obtaining an understanding, or while conducting fieldwork; in addition, they may be identified while considering acceptance or continuance of clients and engagements.

Audits of financial statements are designed to obtain assurance of detecting misstatement due to Errors /Fraudulent financial reporting /Misappropriation of assets a. Yes /Yes /Yes b. Yes /Yes /No c. Yes /No /Yes d. No /Yes /No

(a) The requirement is to determine whether audits are designed to provide reasonable assurance of detecting misstatements due to errors, fraudulent financial reporting, and/or misappropriation of assets. Answer (a) is correct because AU-C 240 requires that an audit obtain reasonable assurance that material misstatements, whether caused by error or fraud, be detected. Fraudulent financial reporting and the misappropriation of assets are the two major types of fraud with which an audit is relevant.

Which of the following matters is an auditor required to communicate to an entity's audit committee? I. Disagreements with management about matters significant to the entity's financial statements that have been satisfactorily resolved. II. Initial selection of significant accounting policies in emerging areas that lack authoritative guidance. a. I only. b. II only. c. Both I and II. d. Neither I nor II.

(a) The requirement is to determine whether disagreements with management and initial selection of significant accounting policies need to be communicated to those charged with corporate governance. Answer (a) is correct because disagreements should be communicated directly to those charged with corporate governance. Answer (b) is incorrect because direct communication by the auditor is not required for selection of accounting principles. Management may engage in this communication with those charged with corporate governance. Answer (c) is incorrect because the auditor only needs to make sure that management has communicated with the committee concerning initial selection of significant accounting policies in emerging areas that lack authoritative guidance. Answer (d) is incorrect because disagreements should be communicated directly to those charged with corporate governance.

On an audit engagement performed by a CPA firm with one office, at the minimum, knowledge of the relevant professional accounting and auditing standards should be held by a. The auditor with final responsibility for the audit. b. All professionals working upon the audit. c. All professionals working upon the audit and the partner in charge of the CPA firm. d. All professionals working in the office.

(a) The requirement is to determine who, at a minimum, must have knowledge of the relevant professional accounting and auditing standards when an audit is being performed. Answer (a) is correct because AU-C 200 requires that, at a minimum, the auditor with final responsibility have such knowledge. Answers (b), (c), and (d) are all incorrect because they suggest a higher minimum requirement

In using the work of a specialist, an auditor may refer to the specialist in the auditor's report if, as a result of the specialist's findings, the auditor a. Becomes aware of conditions causing substantial doubt about the entity's ability to continue as a going concern. b. Desires to disclose the specialist's findings, which imply that a more thorough audit was performed. c. Is able to corroborate another specialist's earlier findings that were consistent with management's representations. d. Discovers significant deficiencies in the design of the entity's internal control that management does not correct.

(a) The requirement is to identify a circumstance in which an auditor may refer to the findings of a specialist in the auditor's report. Answer (a) is correct because the auditor may refer to the specialist when the specialist's findings result in inclusion of an explanatory paragraph to an audit report, in this case on going concern status. Answers (b), (c), and (d) are all incorrect because a specialist is only referred to in an audit report when that specialist's findings identify a circumstance requiring modification of the audit report. Auditors do not modify audit reports to simply inform the user that a specialist was involved.

A primary purpose of performing analytical procedures as risk assessment procedures is to identify the existence of a. Unusual transactions and events. b. Illegal acts that went undetected because of internal control weaknesses. c. Related-party transactions. d. Recorded transactions that were not properly authorized.

(a) The requirement is to identify a primary purpose of performing analytical procedures during an audit's risk assessment. Answer (a) is correct because analytical procedures used during risk assessment may enhance the auditor's understanding of the client's business and signifi cant transactions and events that have occurred since the prior audit and also may help to identify the existence of unusual transactions or events and amounts, ratios, and trends that might indicate matters that have audit implications. Answers (b), (c), and (d) are all incorrect because while analytical procedures may lead to the discovery of illegal acts, relatedparty transactions, and unauthorized transactions, this is not the primary objective

When the auditor believes a misstatement is or may be the result of fraud but that the effect of the misstatement is not material to the financial statements, which of the following steps is required? a. Consider the implications for other aspects of the audit. b. Resign from the audit. c. Commence a fraud examination. d. Contact regulatory authorities.

(a) The requirement is to identify an auditor's responsibility when he or she believes that a misstatement is or may be the result of fraud, but that the effect of the misstatements is immaterial to the financial statements. Answer (a) is correct because AU-C 240 states that in such circumstances the auditor should evaluate the implications of the fraud, especially those dealing with the organizational position of the person(s) involved.

5. As the acceptable level of detection risk decreases, the assurance directly provided from a. Substantive tests should increase. b. Substantive tests should decrease. c. Tests of controls should increase. d. Tests of controls should decrease

(a) The requirement is to identify an effect of a decrease in the acceptable level of detection risk. Answer (a) is correct because as the acceptable level of detection risk decreases, the assurance provided from substantive tests should increase. To gain this increased assurance the auditors may (1) change the nature of substantive tests to more effective procedures (e.g., use independent parties outside the entity rather than those within the entity), (2) change the timing of substantive tests (e.g., perform them at year-end rather than at an interim date), and (3) change the extent of substantive tests (e.g., take a larger sample). Answer (b) is incorrect because the assurance provided from substantive tests increases, it does not decrease. Answers (c) and (d) are incorrect because the acceptable level of detection risk is based largely on the assessed levels of control risk and inherent risk. Accordingly, any tests of controls will already have been performed.

Which of the following are considered further audit procedures that may be designed after assessing the risks of material misstatement? Substantive tests of details //Risk assessment procedures a. Yes// Yes b. Yes// No c. No// Yes d. No// No

(b) The requirement is to identify whether substantive tests of details and/or risk assessment procedures are considered further audit procedures that may be designed after assessing the risks of material misstatement. Further audit procedures are composed of substantive procedures (tests of details and analytical procedures) and tests of controls. Answer (b) is correct because while substantive tests of details are further audit procedures, risk assessment procedures are not. Answer (a) is incorrect because risk assessment procedures are not further audit procedures. Answer (c) is incorrect because substantive tests of details are further audit procedures and because risk assessment procedures are not. Answer (d) is incorrect because substantive tests of details are further audit procedures.

B.4. Developing an Overall Strategy Which of the following is most likely to require special planning considerations related to asset valuation? a. Inventory is comprised of diamond rings. b. The client has recently purchased an expensive copy machine. c. Assets costing less than $250 are expensed even when the expected life exceeds one year. d. Accelerated depreciation methods are used for amortizing the costs of factory equipment.

(a) The requirement is to identify the area that is most likely to require special audit planning considerations. Answer (a) is correct because an inventory comprised of diamond rings is likely to require that the auditor plan ahead to involve a specialist to assist in valuation issues. Answer (b) is incorrect because valuation of an asset such as a new copy machine is not ordinarily expected to provide valuation difficulties. Answer (c) is incorrect because the expensing purchases of such small assets is ordinarily acceptable due to the immateriality of the transactions. Answer (d) is incorrect because accelerated depreciation methods are ordinarily acceptable

Individuals who commit fraud are ordinarily able to rationalize the act and also have an Incentive// Opportunity a. Yes //Yes b. Yes// No c. No //Yes d. No//No

(a) The requirement is to identify the attributes ordinarily present when individuals commit fraud. Answer (a) is correct because AU-C 240 suggests that the three conditions generally present when fraud occurs are that individuals have an (1) incentive or pressure, (2) opportunity, and (3) ability to rationalize. Answers (b), (c), and (d) are all incorrect because they suggest that one of the three elements is not ordinarily present.

A.1. Financial Statement Assertions Financial statement assertions are established for account balances, Classes of transactions/ Disclosures a.) Yes/Yes b.) Yes/No c.) No/Yes d.) No/No

(a) The requirement is to identify the categories of financial statement assertions. Answer (a) is correct because the professional standards establish fi nancial statement assertions for account balances, classes of transactions and disclosures. Answer (b) is incorrect because financial statement assertions are established for disclosures. Answer (c) is incorrect because financial statement assertions are established for classes of transactions. Answer (d) is incorrect because financial statement assertions are established for both classes of transactions and disclosures

D.2. Using the Work of a Specialist Which of the following statements is correct concerning an auditor's use of the work of a specialist? a. The work of a specialist who is related to the client may be acceptable under certain circumstances. b. If an auditor believes that the determinations made by a specialist are unreasonable, only a qualified opinion may be issued. c. If there is a material difference between a specialist's findings and the assertions in the financial statements, only an adverse opinion may be issued. d. An auditor may not use a specialist in the determination of physical characteristics relating to inventories.

(a) The requirement is to identify the correct statement concerning an auditor's use of the work of a specialist. Answer (a) is correct because the work of a specialist who is related to the client may be acceptable under certain circumstances. Answer (b) is incorrect because if the auditor believes that the findings of the specialist are unreasonable, it is generally appropriate to obtain the findings of another specialist. Answer (c) is incorrect because a material difference between a specialist's findings and those included in the financial statements may result in the need for an explanatory paragraph, a qualified opinion, a disclaimer, or an adverse opinion. Answer (d) is incorrect because an auditor may use a specialist in the determination of various physical characteristics of assets.

Which of the following statements is correct relating to the auditor's consideration of fraud? a. The auditor's interest in fraud consideration relates to fraudulent acts that cause a material misstatement of financial statements. b. A primary factor that distinguishes fraud from error is that fraud is always intentional, while errors are generally, but not always, intentional. c. Fraud always involves a pressure or incentive to commit fraud, and a misappropriation of assets. d. While an auditor should be aware of the possibility of fraud, management, and not the auditor, is responsible for detecting fraud.

(a) The requirement is to identify the correct statements relating to the auditor's consideration of fraud. Answer (a) is correct because AU-C 240 states that the auditor's interest relates to fraudulent acts that cause a material misstatement of financial statements. Answer (b) is incorrect because errors are unintentional. Answer (c) is incorrect because fraud does not necessarily involve the misappropriation of assets (it may involve fraudulent financial reporting). Answer (d) is incorrect because an auditor must design an audit to obtain reasonable assurance of detecting misstatements, regardless of whether they are caused by errors or fraud.

A.4. Errors and Fraud Which of the following is an example of fraudulent financial reporting? a. Company management changes inventory count tags and overstates ending inventory, while understating cost of goods sold. b. The treasurer diverts customer payments to his personal due, concealing his actions by debiting an expense account, thus overstating expenses. c. An employee steals inventory and the "shrinkage" is recorded in cost of goods sold. d. An employee steals small tools from the company and neglects to return them; the cost is reported as a miscellaneous operating expense.

(a) The requirement is to identify the example of fraudulent fi nancial reporting. Answer (a) is correct because fraudulent fi nancial reporting involves intentional misstatements or omissions of amounts or disclosures in financial statements to deceive financial statement users and changing the inventory count tags results in such a misstatement. Answers (b), (c), and (d) are all incorrect because they represent the misappropriation of assets. See AU-C 240, which divides fraudulent activities into misstatement arising from fraudulent financial reporting and misstatements arising from misappropriation of assets (sometimes referred to as defalcation)

Which of the following factors or conditions is an auditor least likely to plan an audit to discover? a. Financial pressures affecting employees. b. High turnover of senior management. c. Inadequate monitoring of significant controls. d. Inability to generate positive cash flows from operations.

(a) The requirement is to identify the factor or condition that an audit is least likely to be planned to discover. Answer (a) is correct because it represents a financial stress, and auditors are not required to plan audits to discover information that is indicative of financial stress of employees or adverse relationships between the entity and its employees. Answers (b), (c), and (d) are all incorrect because they represent examples of risk factors that should be considered in an audit and are included in AU-C 240.

After fieldwork audit procedures are completed, a partner of the CPA fi rm who has not been involved in the audit performs a second or wrap-up working paper review. This second review usually focuses on a. The fair presentation of the financial statements in conformity with GAAP. b. Fraud involving the client's management and its employees. c. The materiality of the adjusting entries proposed by the audit staff. d. The communication of internal control weaknesses to the client's audit committee.

(a) The requirement is to identify the focus of a final wrap-up review performed by a second partner who has not been involved in the audit. Answer (a) is correct because this second or "cold" review aims at determining whether the financial statements result in fair presentation in conformity with GAAP and with whether sufficient appropriate evidence has been obtained. Answer (b) is incorrect because most frequently fraud involving the client's management and its employees have not been discovered and, even if they have been, the focus of the review is still on the fairness of presentation of the financial statements. Answers (c) and (d) are incorrect because decisions on materiality and communications with the audit committee are only two of the many matters the review may address in an effort to address fairness of presentation of the financial statements.

Which of the following is least likely to be included in an auditor's inquiry of management while obtaining information to identify the risks of material misstatement due to fraud? a. Are financial reporting operations controlled by and limited to one location? b. Does it have knowledge of fraud or suspect fraud? c. Does it have programs to mitigate fraud risks? d. Has it reported to the audit committee the nature of the company's internal control?

(a) The requirement is to identify the least likely inquiry of management relating to identifying the risk of material misstatement due to fraud. Answer (a) is correct because financial operations of many companies are not ordinarily controlled by and limited to one location. Answers (b), (c), and (d) are all incorrect because they are included in AU-C 240 as inquiries that should be made of management.

Which of the following matters is generally included in an auditor's engagement letter? a. Management's responsibility for the entity's compliance with laws and regulations. b. The factors to be considered in setting preliminary judgments about materiality. c. Management's vicarious liability for illegal acts committed by its employees. d. The auditor's responsibility to search for significant internal control deficiencies.

(a) The requirement is to identify the matter generally included in an auditor's engagement letter. Answer (a) is correct because AU-C 210, which outlines requirements for engagement letters, indicates that an engagement letter should include an indication that management is responsible for identifying and ensuring that the company complies with the laws and regulations applicable to its activities. Answer (b) is incorrect because such detailed information on materiality is not generally included in an engagement letter. Answer (c) is incorrect because management liability (if any) for illegal acts committed by employees is not generally included in an engagement letter. Answer (d) is incorrect because while an auditor is required to obtain an understanding of internal control, he or she is not required to search for significant internal control deficiencies

Which of the following is most likely to be a response to the auditor's assessment that the risk of material misstatement due to fraud for the existence of inventory is high? a. Observe test counts of inventory at certain locations on an unannounced basis. b. Perform analytical procedures rather than taking test counts. c. Request that inventories be counted prior to year-end. d. Request that inventory counts at the various locations be counted on different dates so as to allow the same auditor to be present at every count.

(a) The requirement is to identify the most likely response to the auditor's assessment that the risk of material misstatement due to fraud for the existence of inventory is high. Answer (a) is correct because observing test counts of inventory on an unannounced basis will provide evidence as to whether record inventory exists. Answer (b) is incorrect because replacing test counts with analytical procedures is not likely to be particularly effective. Answers (c) and (d) are incorrect because the inventories might well be counted at year-end, all on the same date, rather than prior to year-end and at differing dates.

Which of the following is most likely to be an example of fraud? a. Defalcations occurring due to invalid electronic approvals. b. Mistakes in the application of accounting principles. c. Mistakes in processing data. d. Unreasonable accounting estimates arising from oversight.

(a) The requirement is to identify the reply that is most likely to be an example of fraud. Answer (a) is most likely, since "defalcation" is another term for misstatements arising from misappropriation of assets, a major type of fraud. Answers (b), (c), and (d) are all incorrect because mistakes in the application of accounting principles or in processing data, and unreasonable accounting estimates arising from oversight are examples of misstatements rather than fraud.

Which of the following is correct concerning requirements about auditor communications about fraud? a. Fraud that involves senior management should be reported directly to the audit committee regardless of the amount involved. b. Fraud with a material effect on the financial statements should be reported directly by the auditor to the Securities and Exchange Commission. c. Fraud with a material effect on the financial statements should ordinarily be disclosed by the auditor through use of an "emphasis of a matter" paragraph added to the audit report. d. The auditor has no responsibility to disclose fraud outside the entity under any circumstances.

(a) The requirement is to identify the reply which represents an auditor communication responsibility relating to fraud. Answer (a) is correct because all fraud involving senior management should be reported directly to the audit committee. Answer (b) is incorrect because auditors are only required to report fraud to the Securities and Exchange Commission under particular circumstances. Answer (c) is incorrect because auditors do not ordinarily disclose fraud through use of an "emphasis of a matter" paragraph added to their report. Answer (d) is incorrect because under certain circumstances auditors must disclose fraud outside the entity

Which of the following relatively small misstatements most likely could have a material effect on an entity's financial statements? a. An illegal payment to a foreign official that was not recorded. b. A piece of obsolete office equipment that was not retired. c. A petty cash fund disbursement that was not properly authorized. d. An uncollectible account receivable that was not written off.

(a) The requirement is to identify the small misstatement that is most likely to have a material effect on an entity's financial statements. Answer (a) is correct because an illegal payment of an otherwise immaterial amount may be material if there is a reasonable possibility that it may lead to a material contingent liability or a material loss of revenue.

B.7. Timing of Audit Procedures With respect to planning an audit, which of the following statements is always true? a. It is acceptable to perform a portion of the audit of a continuing audit client at interim dates. b. An engagement should not be accepted after the client's year-end. c. An inventory count must be observed at year-end. d. Final staffing decisions must be made prior to completion of the planning stage.

(a) The requirement is to identify the statement that is always true with respect to planning an audit. Answer (a) is correct because it is acceptable for an auditor to perform a certain portion of the audit at an interim date; for example, performing a portion of planning prior to year-end is always acceptable for a continuing client. Also, when a new client has engaged an auditor prior to year-end, a portion of the audit may be conducted prior to year-end. Answer (b) is incorrect because an engagement may be accepted after the client's year-end. Answer (c) is incorrect because alternative procedures may be possible when an inventory count was not observed at year-end. Answer (d) is incorrect because final staffing decisions need not be made prior to completion of the planning stage of an audit

C.1. Communicate with Predecessor Auditors Ordinarily, the predecessor auditor permits the successor auditor to review the predecessor's working paper analyses relating to Contingencies //Balance sheet accounts a. Yes //Yes b. Yes //No c. No //Yes d. No //No

(a) The requirement is to identify whether a predecessor auditor should permit a successor auditor to review working paper analyses relating to contingencies, balance sheet accounts, or both. Answer (a) is correct because AU-C 210 states that a predecessor auditor should ordinarily permit the successor to review working papers, including documentation of planning, internal control, audit results, and other matters of continuing accounting and auditing significance, such as the working paper analysis of balance sheet accounts and those relating to contingencies.

Under Statements on Auditing Standards, which of the following would be classified as an error? a. Misappropriation of assets for the benefit of management. b. Misinterpretation by management of facts that existed when the financial statements were prepared. c. Preparation of records by employees to cover a fraudulent scheme. d. Intentional omission of the recording of a transaction to benefit a third party.

(b) Errors refer to unintentional mistakes in financial statements such as misinterpretation of facts. Answers (a), (c), and (d) all represent fraud which are defined as intentional distortions of financial statements.

A.2. Audit Risk 3. As the acceptable level of detection risk decreases, an auditor may a. Reduce substantive testing by relying on the assessments of inherent risk and control risk. b. Postpone the planned timing of substantive tests from interim dates to the year-end. c. Eliminate the assessed level of inherent risk from consideration as a planning factor. d. Lower the assessed level of control risk from the maximum level to below the maximum.

(b) The requirement is to determine a likely auditor reaction to a decreased acceptable level of detection risk. Answer (b) is correct because postponement of interim substantive tests to year-end decreases detection risk by reducing the risk for the period subsequent to the performance of those tests; other approaches to decreasing detection risk include changing to more effective substantive tests and increasing their extent. Answer (a) is incorrect because increased, not reduced, substantive testing is required. Answer (c) is incorrect because inherent risk must be considered in planning, either by itself or in combination with control risk. Answer (d) is incorrect because tests of controls must be performed to reduce the assessed level of control risk.

On the basis of the audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would a. Decrease substantive testing. b. Decrease detection risk. c. Increase inherent risk. d. Increase materiality levels

(b) The requirement is to determine the best way for an auditor to achieve an overall audit risk level when the audit evidence relating to control risk indicates the need to increase its assessed level. Answer (b) is correct because a decrease in detection risk will allow the auditor achieve an overall audit risk level substantially the same as planned. Answer (a) is incorrect because a decrease in substantive testing will increase, not decrease, detection risk and thereby increase audit risk. Answer (c) is incorrect because an increase in inherent risk will also increase audit risk. Answer (d) is incorrect because there appears to be no justifi cation for increasing materiality levels beyond those used in planning the audit.

An auditor who discovers that client employees have committed an illegal act that has a material effect on the client's financial statements most likely would withdraw from the engagement if a. The illegal act is a violation of generally accepted accounting principles. b. The client does not take the remedial action that the auditor considers necessary. c. The illegal act was committed during a prior year that was not audited. d. The auditor has already assessed control risk at the maximum level.

(b) The requirement is to determine the circumstance in which it is most likely that a CPA would withdraw from an audit engagement after having discovered that client employees have committed an illegal act. Answer (b) is correct because the auditor may conclude that withdrawal is necessary when the client does not take the remedial action, even when the illegal act is not material to the financial statements. Answers (a) and (c) are incorrect because whether generally accepted accounting principles have been violated and whether the illegal act occurred during a prior year that was not audited may or may not have an effect on the decision to withdraw from the engagement. Answer (d) is incorrect because the assessed level of control risk will not have a direct relationship on the decision to withdraw from the engagement

C. Obtain an Understanding of the Entity and Its Environment To obtain an understanding of a continuing client's business, an auditor most likely would a. Perform tests of details of transactions and balances. b. Review prior year working papers and the permanent fi le for the client. c. Read current issues of specialized industry journals. d. Reevaluate the client's internal control environment.

(b) The requirement is to determine the manner in which an auditor plans an audit of a continuing client. Answer (b) is correct because a review of prior year working papers and the permanent fi le may provide useful information about the nature of the business, organizational structure, operating characteristics, and transactions that may require special attention. Answer (a) is incorrect because tests of details of transactions and balances occur subsequent to planning. Answer (c) is incorrect because while reading specialized industry journals will help the auditor to obtain a better understanding of the client's industry, it is likely to be less helpful than reviewing the working papers. Answer (d) is incorrect because a reevaluation of the client's internal control environment occurs subsequent to the ordinal planning of the audit

E. Required Communication to Those Charged with Governance In identifying matters for communication with those charged with governance of an audit client, an auditor most likely would ask management whether a. The turnover in the accounting department was unusually high. b. It consulted with another CPA fi rm about accounting matters. c. There were any subsequent events of which the auditor was unaware. d. It agreed with the auditor's assessed level of control risk.

(b) The requirement is to determine the matter that an auditor would communicate to those charged with governance. Answer (b) is correct because AU-C 260 requires that when the auditor is aware of such consultation with another CPA, s/ he should discuss with the audit committee his/her views about significant matters that were the subject of such consultation; accordingly, such a discussion with management is to be expected. While the information suggested in answers (a), (c), and (d) may all be communicated to the audit committee, they are not included as required disclosures under AU-C 260. See AU-C 260 for the various matters that must be communicated to those charged with governance.

Relationship between control risk and detection risk is ordinarily a. Parallel. b. Inverse. c. Direct. d. Equal.

(b) The requirement is to determine the relationship between control risk and detection risk. Inverse is correct because as control risk increases (decreases) detection risk must decrease (increase).

An attitude that includes a questioning mind and a critical assessment of audit evidence is referred to as a. Due professional care. b. Professional skepticism. c. Reasonable assurance. d. Supervision.

(b) The requirement is to determine which concept requires an attitude that includes a questioning mind and a critical assessment of audit evidence. Answer (b) is correct because AU-C 200 states that professional skepticism includes these qualities. Answer (a) is incorrect because due professional care is a broader concept that concerns what the independent auditor does and how well he or she does it. Answer (c) is incorrect because reasonable assurance is based on the concept that an auditor is not an insurer and his or her report does not provide absolute assurance. Answer (d) is incorrect because supervision involves the directing of the efforts of assistants who are involved in accomplishing the objectives of the audit and determining whether those objectives were accomplished.

The audit work performed by each assistant should be reviewed to determine whether it was adequately performed and to evaluate whether the a. Auditor's system of quality control has been maintained at a high level. b. Results are consistent with the conclusions to be presented in the auditor's report. c. Audit procedures performed are approved in the professional standards. d. Audit has been performed by persons having adequate technical training and proficiency as auditors.

(b) The requirement is to determine why the work of each assistant should be reviewed. Answer (b) is correct because AU-C 300 suggests that the work performed by each assistant should be reviewed to determine whether it was adequately performed and to evaluate whether the results are consistent with the conclusions to be presented in the auditor's report. Answer (a) is incorrect because CPA firms, not individual auditors within the firms, have systems of quality control. Answer (c) is incorrect because the professional standards do not in general approve specific audit procedures. Answer (d) is incorrect because while determining that the audit has been performed by persons having adequate technical training and proficiency as auditors is important, it should be addressed prior to the commencement of fi eldwork

Under the Private Securities Litigation Reform Act of 1995, Baker, CPA, reported certain uncorrected illegal acts to Supermart's board of directors. Baker believed that failure to take remedial action would warrant a qualified audit opinion because the illegal acts had a material effect on Supermart's financial statements. Supermart failed to take appropriate remedial action and the board of directors refused to inform the SEC that it had received such notification from Baker. Under these circumstances, Baker is required to a. Resign from the audit engagement within ten business days. b. Deliver a report concerning the illegal acts to the SEC within one business day. c. Notify the stockholders that the financial statements are materially misstated. d. Withhold an audit opinion until Supermart takes appropriate remedial action.

(b) The requirement is to identify a CPA's responsibility under the Securities Litigation Reform Act of 1995 for uncorrected illegal acts which have been communicated to the board of directors which refuses to inform the SEC of their existence. Answer (b) is correct because CPAs are required under the law to deliver a report on those illegal acts to the SEC within one business day in such circumstances. Answer (a) in incorrect because there is no requirement to resign, although the auditor may decide to do so. Answer (c) is incorrect because the Act sets up reporting to the SEC, not to the stockholders. Answer (d) is incorrect because withholding of the audit opinion is not suggested in the Act.

A company's gross margin percentage increased in 20X2. This is consistent with which of the following occurring in 20X2? a. An increase in the tax rate on income. b. An increase in units sold. c. A decrease in the rate of sales commissions paid to sales personnel. d. Outsourcing of a part of the manufacturing process which resulted in no additional costs.

(b) The requirement is to identify which reply is consistent with an increase in a company's gross margin percentage ([sales - cost of goods sold] / sales). Answer (b) is correct because fixed overhead costs will not increase with the increase in units—thus allowing costs of goods sold to increase less proportionately to the increase in units sold. Answers (a) and (c) are incorrect because income taxes and sales commissions are not included in the gross margin calculation. Answer (d) is incorrect because cost of goods sold should remain the same due to the outsourcing.

The most likely explanation why the auditor's examination cannot reasonably be expected to bring noncompliance with all laws by the client to the auditor's attention is that a. Illegal acts are perpetrated by management override of internal control. b. Illegal acts by clients often relate to operating aspects rather than accounting aspects. c. The client's internal control may be so strong that the auditor performs only minimal substantive testing. d. Illegal acts may be perpetrated by the only person in the client's organization with access to both assets and the accounting records.

(b) The requirement is to identify a reason why audits cannot reasonably be expected to bring all illegal acts to the auditor's attention. Answer (b) is correct because illegal acts relating to the operating aspects of an entity are often highly specialized and complex and often are far removed from the events and transactions reflected in financial statements. Answer (a) is partially correct since management override represents a limitation of the effectiveness of internal control. Yet, auditors are more likely to identify such transactions because they relate to events and transactions reflected in the financial statements. Answer (c) is incorrect because many illegal acts are not subject to the client's internal control. Answer (d) is incorrect because illegal acts may be perpetrated without access to both assets and accounting records.

B.3. Preliminary Engagement Activities The auditor should document the understanding established with a client through a(n) a. Oral communication with the client. b. Written communication with the client. c. Written or oral communication with the client. d. Completely detailed audit plan.

(b) The requirement is to identify form(s) of documentation of the understanding obtained with a client. Answer (b) is correct because the professional standards require that an auditor document the understanding through a written communication with the client. Answer (a) is incorrect because an oral communication is not sufficient. Answer (c) is incorrect because the communication should be in writing. Answer (d) is incorrect because the understanding is not documented in a completely detailed audit plan—a term of questionable meaning.

C.2. Consideration of Internal Control Which of the following procedures would an auditor most likely perform in planning a financial statement audit? a. Inquiring of the client's legal counsel concerning pending litigation. b. Comparing the financial statements to anticipated results. c. Examining computer generated exception reports to verify the effectiveness of internal control. d. Searching for unauthorized transactions that may aid in detecting unrecorded liabilities

(b) The requirement is to identify the audit procedure that an auditor will most likely perform during risk assessment for a financial statement audit. Answer (b) is correct because AU-C 315 requires that an auditor perform analytical procedures such as comparing the financial statements to anticipated results during the planning stage of an audit. Answers (a), (c), and (d) are all incorrect because these procedures will all occur subsequent to planning.

Which of the following best describes what is meant by the term "fraud risk factor?" a. Factors whose presence indicates that the risk of fraud is high. b. Factors whose presence often have been observed in circumstances where frauds have occurred. c. Factors whose presence requires modification of planned audit procedures. d. Material weaknesses identified during an audit.

(b) The requirement is to identify the best description of what is meant by a "fraud risk factor." Answer (b) is correct because AU-C 240 suggests that while fraud risk factors do not necessarily indicate the existence of fraud, they often have been observed in circumstances where frauds have occurred. Answer (a) is incorrect because the risk of fraud may or may not be high when a risk factor is present. Answer (c) is incorrect because the current audit plan may in many circumstances appropriately address a fraud risk factor. Answer (d) is incorrect because a fraud risk factor may or may not represent a material weakness.

In using the work of a specialist, an auditor referred to the specialist's findings in the auditor's report. This would be an appropriate reporting practice if the a. Client is not familiar with the professional certification, personal reputation, or particular competence of the specialist. b. Auditor, as a result of the specialist's findings, adds an explanatory paragraph emphasizing a matter regarding the financial statements. c. Client understands the auditor's corroborative use of the specialist's findings in relation to the representations in the financial statements. d. Auditor, as a result of the specialist's findings, decides to indicate a division of responsibility with the specialist.

(b) The requirement is to identify the circumstance in which an auditor may appropriately refer to the findings of a specialist. Answer (b) is correct because an auditor may refer to a specialist when the report is being modified due to the specialist's findings. Answers (a) and (c) are incorrect because a client's familiarity with a specialist or understanding of the auditor's use of the findings of a specialist does not result in modification of the audit report. Answer (d) is incorrect because an auditor does not divide responsibility with a specialist.

Management's attitude toward aggressive financial reporting and its emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when a. External policies established by parties outside the entity affect its accounting practices. b. Management is dominated by one individual who is also a shareholder. c. Internal auditors have direct access to the board of directors and the entity's management. d. The audit committee is active in overseeing the entity's financial reporting policies

(b) The requirement is to identify the circumstance in which it is most likely that management's attitude toward aggressive financial reporting and toward meeting projected profit goals would most likely significantly influence an entity's control environment. Answer (b) is correct because when management is dominated by one individual, that individual may be able to follow overly aggressive accounting principles.

Which of the following statements is correct about an auditor's required communication with those charged with governance of an audit client? a. Any matters communicated to the entity's audit committee also are required to be communicated to the entity's management. b. The auditor is required to inform those charged with governance about significant misstatements discovered by the auditor and subsequently corrected by management. c. Disagreements with management about the application of accounting principles are required to be communicated in writing to those charged with governance. d. Weaknesses in internal control previously reported to those charged with governance need not be recommunicated.

(b) The requirement is to identify the correct statement about an auditor's required communication with those charged with governance. Answer (b) is correct because the communication must include significant misstatements discovered, even if corrected by management. Answer (a) is incorrect because while such communications may be communicated to management, there is no such requirement. Answer (c) is incorrect because disagreements with management, as well as the other required disclosures, may be communicated either orally or in writing. Answer (d) is incorrect because an auditor must recommunicate such weaknesses in internal control. Also, see AU-C 260 for the matters communicated to those charged with governance.

Which of the following statements is correct concerning an auditor's required communication with those charged with governance of an audit client? a. This communication is required to occur before the auditor's report on the financial statements is issued. b. This communication should include discussion of any significant disagreements with management concerning the financial statements. c. Any significant matter communicated to the audit committee also should be communicated to management. d. Significant audit adjustments proposed by the auditor and recorded by management need not be communicated to those charged with governance.

(b) The requirement is to identify the correct statement concerning an auditor's required communication with those charged with governance. Answer (b) is correct because the communication should include such information on disagreements. See AU-C 260 for this and other required communications with those charged with governance. Answer (a) is incorrect because the communication may occur before or after issuance of the auditor's report. Answer (c) is incorrect because not all matters need be communicated to management. Answer (d) is incorrect because significant adjustments need to be communicated to those charged with governance.

Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding the predecessor's a. Opinion of any subsequent events occurring since the predecessor's audit report was issued. b. Understanding as to the reasons for the change of auditors. c. Awareness of the consistency in the application of GAAP between periods. d. Evaluation of all matters of continuing accounting significance.

(b) The requirement is to identify the correct statement regarding a successor auditor's inquiries of the predecessor auditor. Answer (b) is correct because the successor should request information such as (1) facts that might bear on the integrity of management, (2) disagreements with management as to accounting principles, auditing procedures, or other significant matters, and (3) the predecessor's understanding of the reasons for the change of auditors. Answers (a), (c), and (d) all relate to matters not required to be discussed prior to accepting an audit engagement.

An auditor would least likely initiate a discussion with those charged with governance of an audit client concerning a. The methods used to account for significant unusual transactions. b. The maximum dollar amount of misstatements that could exist without causing the financial statements to be materially misstated. c. Indications of fraud and illegal acts committed by a corporate officer that were discovered by the auditor. d. Disagreements with management as to accounting principles that were resolved during the current year's audit.

(b) The requirement is to identify the discussion that it is least likely that an auditor will initiate with those charged with governance. Answer (b) is correct because auditors do not generally initiate a discussion on materiality, although they do occasionally respond to such questions. See AU-C 260 for auditor communications with those charged with governance.

Which of the following factors would most likely cause a CPA to decide not to accept a new audit engagement? a. The CPA's lack of understanding of the prospective client's internal auditor's computer-assisted audit techniques. b. Management's disregard of its responsibility to maintain an adequate internal control environment. c. The CPA's inability to determine whether related-party transactions were consummated on terms equivalent to arm's-length transactions. d. Management's refusal to permit the CPA to perform substantive tests before the year-end.

(b) The requirement is to identify the factor most likely to cause a CPA to decide not to accept a new audit engagement. Answer (b) is correct because a certain level of internal control is essential for fi nancial statement reporting, and management's disregard in this area may lead the CPA to reject the engagement. Answer (a) is incorrect both because a CPA may not need an understanding of the prospective client's internal auditor's computer-assisted audit technique to form an opinion on the fi nancial statements, and because if such understanding is necessary, it can be obtained subsequent to engagement acceptance. Answer (c) is incorrect because AU-C 550 indicates that a CPA often will be unable to determine whether related-party transactions were consummated on terms equivalent to arm's-length transactions. Answer (d) is incorrect because while management's refusal to permit the performance of substantive tests before the year-end may present a problem, the auditor may be able to effectively perform such tests after year-end.

Which of the following illegal acts should an audit be designed to obtain reasonable assurance of detecting? a. Securities purchased by relatives of management based on knowledge of inside information. b. Accrual and billing of an improper amount of revenue under government contracts. c. Violations of antitrust laws. d. Price fixing.

(b) The requirement is to identify the illegal act that an audit should be designed to obtain reasonable assurance of detecting. Answer (b) is correct because the accrual and billing of an improper amount of revenue under government contracts is an illegal act with a direct effect on the determination of financial statement amounts, and audits are designed to detect such illegal acts. Answers (a), (c), and (d) are all incorrect because they represent illegal acts with an indirect financial statement effect and an audit provides no assurance that such acts will be detected or that any contingent liabilities that may result will be disclosed. See AU-C 250 for detailed guidance on auditor responsibility with respect to direct and indirect illegal acts

A CPA wishes to determine how various publicly held companies have complied with the disclosure requirements of a new financial accounting standard. Which of the following information sources would the CPA most likely consult for information? a. AICPA Codification of Statements on Auditing Standards. b. AICPA Accounting Trends and Techniques. c. SEC Quality Control Review. d. SEC Statement 10-K Guide

(b) The requirement is to identify the information source that a CPA would most likely consult for information on how various publicly held companies have complied with the disclosure requirements of a new financial accounting standard. Answer (b) is correct because AICPA Accounting Trends and Techniques, which is issued annually, summarizes such disclosures of 600 industrial and merchandising corporations. Answer (a) is incorrect because the AICPA Codification of Statements on Auditing Standards codifies the various Statements on Auditing Standards and does not include information on individual company compliance with disclosure requirements. Answer (c) is incorrect because Quality Control Review standards are established by the AICPA and because they do not include information on individual company compliance with disclosure requirements. Answer (d) is incorrect because Form 10-K itself provides information on preparing Form10-K and this form does not include information on individual company compliance with disclosure requirements.

A.3. Materiality Which of the following would an auditor most likely use in determining the auditor's preliminary judgment about materiality? a. The anticipated sample size of the planned substantive tests. b. The entity's annualized interim financial statements. c. The results of the internal control questionnaire. d. The contents of the management representation letter

(b) The requirement is to identify the information that an auditor would most likely use in determining a preliminary judgment about materiality. Answer (b) is correct because many materiality measures relate to an annual figure (e.g., net income, sales). Answer (a) is incorrect because the preliminary judgment about materiality is a factor used in determining the anticipated sample size, not the reverse as suggested by the reply. Answers (c) and (d) are incorrect because materiality will not normally be affected by the results of the internal control questionnaire or the contents of the management representation letters

C.3. Supervision Requirements The in-charge auditor most likely would have a supervisory responsibility to explain to the staff assistants a. That immaterial fraud is not to be reported to the client's audit committee. b. How the results of various auditing procedures performed by the assistants should be evaluated. c. What benefits may be attained by the assistants' adherence to established time budgets. d. Why certain documents are being transferred from the current file to the permanent file.

(b) The requirement is to identify the information that is most likely to be communicated by a supervisor to staff assistants. Answer (b) is correct because staff assistants must be aware of how their procedures should be evaluated in order to perform these procedures effectively. Answer (a) is incorrect because some immaterial fraud may be reported to the client's audit committee. Answer (c) is incorrect because the emphasis in an audit must be on performing the audit effectively and not merely on adhering to time budgets. Answer (d) is incorrect because decisions regarding transferring documents from the current file to the permanent file are generally of less importance than the procedure suggested by answer (b).

B.2. Establishing an Understanding with the Client (Engagement Letters) a client regarding the services to be performed for each engagement. This understanding generally includes a. Management's responsibility for errors and the illegal activities of employees that may cause material misstatement. b. The auditor's responsibility for ensuring that the audit committee is aware of any significant deficiencies in internal control that come to the auditor's attention. c. Management's responsibility for providing the auditor with an assessment of the risk of material misstatement due to fraud. d. The auditor's responsibility for determining preliminary judgments about materiality and audit risk factors.

(b) The requirement is to identify the item ordinarily included when an auditor establishes an understanding with a client regarding the services to be performed. Answer (b) is correct because auditing standards require that an auditor ensure that the audit committee is aware of any signifiant deficiencies which come to the CPA's attention. Answer (a) is incorrect because while an understanding will include a statement that management is responsible for the entity's financial statements, an explicit statement about errors and illegal activities of employees is not ordinarily included. Answer (c) in incorrect because management does not provide the auditor with an assessment of the risk of material misstatement due to fraud. Answer (d) is incorrect because no such statement about an auditor's responsibility for determining preliminary judgments about materiality and audit risk factors is ordinarily included in establishing an understanding. See AU-C 210 for information on establishing an understanding with a client.

Holding other planning considerations equal, a decrease in the amount of misstatement in a class of transactions that an auditor could tolerate most likely would cause the auditor to a. Apply the planned substantive tests prior to the balance sheet date. b. Perform the planned auditing procedures closer to the balance sheet date. c. Increase the assessed level of control risk for relevant financial statement assertions. d. Decrease the extent of auditing procedures to be applied to the class of transactions.

(b) The requirement is to identify the most likely effect of a decrease in the tolerable amount of misstatement (tolerable misstatement) in a class of transactions. Answer (b) is correct because auditing standards state that decreasing the tolerable amount of misstatement will require the auditor to do one or more of the following: (1) perform auditing procedures closer to the balance sheet date (answer [b]); (2) select a more effective auditing procedure; or (3) increase the extent of a particular auditing procedure. Answer (a) is incorrect because in such a circumstance substantive tests are more likely to be performed at or after the balance sheet date than prior to the balance sheet date. Answer (c) is incorrect because decreasing the tolerable amount of misstatement will not necessarily lead to an increase in the assessed level of control risk. Answer (d) is incorrect because the ext

Which of the following is most likely to be presumed to represent fraud risk on an audit? a. Capitalization of repairs and maintenance into the property, plant, and equipment asset account. b. Improper revenue recognition. c. Improper interest expense accrual. d. Introduction of significant new products

(b) The requirement is to identify the most likely fraud risk factor on an audit. Answer (b) is correct because the possibility of improper revenue recognition is ordinarily presumed on audits. Answers (a), (c), and (d) all represent potential risks, but risks that are not ordinarily presumed on an audit. See AU-C 240 for information on the auditor's responsibility for the consideration of fraud in a financial statement audit.

Which of the following is most likely to be an overall response to fraud risks identified in an audit? a. Supervise members of the audit team less closely and rely more upon judgment. b. Use less predictable audit procedures. c. Only use certified public accountants on the engagement. d. Place increased emphasis on the audit of objective transactions rather than subjective transactions.

(b) The requirement is to identify the most likely response when a risk of fraud has been identified on an audit. Answer (b) is correct because AU-C 240 indicates that overall responses to the risk of material misstatements due to fraud include (1) assigning personnel with particular skills relating to the area and considering the necessary extent of supervision to the audit, (2) increasing the consideration of management's selection and application of accounting principles, and (3) making audit procedures less predictable. Answer (a) is incorrect because closer supervision, not less close supervision, is more likely to be appropriate. Answer (c) is incorrect because individuals with specialized skills may be needed who are not CPAs. Answer (d) is incorrect because subjective transactions (e.g., accounting estimates) often provide more risk than objective transactions.

When issuing an unmodified opinion, the auditor who evaluates the audit findings should be satisfied that the a. Amount of known misstatement is documented in the management representation letter. b. Estimate of the total likely misstatement is less than a material amount. c. Amount of known misstatement is acknowledged and recorded by the client. d. Estimate of the total likely misstatement includes the adjusting entries already recorded by the client.

(b) The requirement is to identify the necessary condition for an auditor to be able to issue an unmodified opinion. Answer (b) is correct because if the estimate of likely misstatement is equal to or greater than a material amount a material departure from generally accepted accounting principles exists and thus AU-C 705 requires either a qualifi ed or adverse opinion in such circumstances. Answer (a) is incorrect because the amount of known misstatement (if any) need not be documented in the management representation letter. Answer (c) is incorrect because it ordinarily is not necessary for the client to acknowledge and record immaterial known misstatements. Answer (d) is incorrect because the total likely misstatement need not include the adjusting entries already recorded by the client

Which of the following is least likely to be considered a risk assessment procedure? a. Analytical procedures. b. Confirmation of ending accounts receivable. c. Inspection of documents. d. Observation of the performance of certain accounting procedures

(b) The requirement is to identify the procedure that is least likely to be considered a risk assessment procedure. Answer (b) is correct because confirmation is a substantive test, rather than a risk assessment procedure. Answers (a), (b), and (c) are all risk assessment procedures, as are certain inquiries of others outside the entity.

When performing a financial statement audit, auditors are required to explicitly assess the risk of material misstatement due to a. Errors. b. Fraud. c. Illegal acts. d. Business risk.

(b) The requirement is to identify the risk relating to material misstatement that auditors are required to assess. Answer (b) is correct because auditors must specifically assess the risk of material misstatements due to fraud and consider that assessment in designing the audit procedures to be performed. Answer (a) is incorrect because while AU-C 315 also requires an assessment of the overall risk of material misstatement (whether caused by error or fraud) there is no requirement to explicitly assess the risk of material misstatement due to errors. Answer (c) is incorrect because the auditor need not explicitly assess the risk of misstatement due to illegal acts. Answer (d) is incorrect because no assessment of business risk is required.

4. The risk that an auditor will conclude, based on substantive tests, that a material misstatement does not exist in an account balance when, in fact, such misstatement does exist is referred to as a. Sampling risk. b. Detection risk. c. Nonsampling risk. d. Inherent risk.

(b) The requirement is to identify the risk that an auditor will conclude, based on substantive tests, that a material error does not exist in an account balance when, in fact, such error does exist. Answer (b) is correct because detection risk is the risk that the auditor will not detect a material misstatement that exists in an assertion. Detection risk may be viewed in terms of two components (1) the risk that analytical procedures and other relevant substantive tests would fail to detect misstatements equal to tolerable misstatement, and (2) the allowable risk of incorrect acceptance for the substantive tests of details. Answer (a) is incorrect because sampling risk arises from the possibility that, when a test of controls or a substantive test is restricted to a sample, the auditor's conclusions may be different from the conclusions he or she would reach if the tests were applied in the same way to all items in the account balance or class of transactions. When related to substantive tests sampling risk is only a part of the risk that the auditor's substantive tests will not detect a material misstatement. Answer (c) is incorrect because nonsampling risk includes only those aspects of audit risk that are not due to sampling. Answer (d) is incorrect because inherent risk is the susceptibility of an assertion to a material misstatement, assuming that there are no related controls

Which of the following statements is not correct about materiality? a. The concept of materiality recognizes that some matters are important for fair presentation of financial statements in conformity with GAAP, while other matters are not important. b. An auditor considers materiality for planning purposes in terms of the largest aggregate level of misstatements that could be material to any one of the financial statements. c. Materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and qualitative judgments. d. An auditor's consideration of materiality is influenced by the auditor's perception of the needs of a reasonable person who will rely on the financial statements.

(b) The requirement is to identify the statement that is not correct concerning materiality. Answer (b) is the proper reply because the auditor considers materiality for planning purposes in terms of the smallest, not the largest, aggregate amount of misstatement that could be material to any one of the financial statements. Answers (a), (c), and (d) all represent correct statements about materiality.

The most difficult type of misstatement to detect is fraud based on a. The overrecording of transactions. b. The nonrecording of transactions. c. Recorded transactions in subsidiaries. d. Related-party receivables

(b) The requirement is to identify the type of fraudulent misstatement that is most difficult to detect. Answer (b) is correct because transactions that have not been recorded are generally considered most difficult because there is no general starting point for the auditor in the consideration of the transaction. Answers (a), (c), and (d) all represent recorded transactions which, when audited, are in general easier to detect.

Inherent risk and control risk differ from detection risk in that they a. Arise from the misapplication of auditing procedures. b. May be assessed in either quantitative or nonquantitative terms. c. Exist independently of the financial statement audit. d. Can be changed at the auditor's discretion.

(c) The requirement is to determine a manner in which inherent risk and control risk differ from detection risk. Answer (c) is correct because inherent risk and control risk exist independently of the audit of the financial statements as functions of the client and its environment, whereas detection risk relates to the auditor's procedures and can be changed at his or her discretion. Answer (a) is incorrect because inherent risk and control risk are functions of the client and its environment and do not arise from misapplication of auditing procedures. Answer (b) is incorrect because inherent risk, control risk and detection risk may each be assessed in either quantitative or nonquantitative terms. Answer (d) is incorrect because inherent risk and control risk are functions of the client and its environment, they cannot be changed at the auditor's discretion. However, the assessed levels of inherent and control risk (not addressed in this question) may be affected by auditor decisions relating to the cost of gathering evidence to substantiate assessed levels below the maximum

B.5. The Audit Plan An auditor should design the audit plan so that a. All material transactions will be selected for substantive testing. b. Substantive tests prior to the balance sheet date will be minimized. c. The audit procedures selected will achieve specific audit objectives. d. Each account balance will be tested under either tests of controls or tests of transactions.

(c) The requirement is to determine the correct statement regarding to an audit plan. Answer (c) is correct because an audit plan sets forth in detail the audit procedures that are necessary to accomplish the objectives of the audit. Answer (a) is incorrect because audit plans address topics beyond selecting material transactions and this is not their primary focus. Answer (b) is incorrect because a program may include numerous substantive tests to be performed prior to the balance sheet date. Answer (d) is incorrect because immaterial accounts often are not tested and because tests of transactions, tests of balances, and analytical procedures are used to test account balances; account balances are not directly tested through tests of controls

C.4. Analytical Procedures Analytical procedures used during risk assessment in an audit should focus on a. Reducing the scope of tests of controls and substantive tests. b. Providing assurance that potential material misstatements will be identified. c. Enhancing the auditor's understanding of the client's business. d. Assessing the adequacy of the available evidence.

(c) The requirement is to determine the proper focus of analytical procedures used during risk assessment of an audit. Answer (c) is correct because analytical procedures used during risk assessment may enhance the auditor's understanding of the client's business and significant transactions and events that have occurred since the prior audit and also may help to identify the existence of unusual transactions or events and amounts, ratios, and trends that might indicate matters that have audit implications.

Arrangements concerning which of the following are least likely to be included in engagement letter? a. A predecessor auditor. b. Fees and billing. c. CPA investment in client securities. d. Other services to be provided in addition to the audit.

(c) The requirement is to determine the reply which is least likely to be included in an engagement letter. Answer (c) is correct because AU-C 210, which provides information on obtaining an understanding with the client, does not suggest any arrangement concerning CPA investment in client securities; indeed such investments are prohibited by the Code of Professional Conduct. Answers (a), (b), and (d) all represent arrangements which AU-C 210 suggests may be included in an engagement letter (or other form of understanding with a client)

Which of the following conditions identified during fieldwork of an audit is most likely to affect the auditor's assessment of the risk of misstatement due to fraud? a. Checks for significant amounts outstanding at yearend. b. Computer generated documents. c. Missing documents. d. Year-end adjusting journal entries

(c) The requirement is to determine the reply which represents information most likely to affect the auditor's assessment of the risk of misstatement due to fraud. Answer (c) is correct because AU-C 240 states that missing documents may be indicative of fraud. Answer (a) is incorrect because checks for significant amounts are normally expected to be outstanding at year-end. Answer (b) is incorrect because almost all audits involve computer generated documents and their existence is not considered a condition indicating possible fraud. Answer (d) is incorrect because while last minute adjustments that significantly affect financial results may be considered indicative of possible fraud, year-end adjusting journal entries alone are to be expected.

During the annual audit of Ajax Corp., a publicly held company, Jones, CPA, a continuing auditor, determined that illegal political contributions had been made during each of the past seven years, including the year under audit. Jones notified the board of directors about the illegal contributions, but they refused to take any action because the amounts involved were immaterial to the financial statements. Jones should reconsider the intended degree of reliance to be placed on the a. Letter of audit inquiry to the client's attorney. b. Prior years' audit plan. c. Management representation letter. d. Preliminary judgment about materiality levels.

(c) The requirement is to determine what an auditor might reconsider when a client's board of directors has refused to take any action relating to an auditor's disclosure that the company has made immaterial illegal contributions. Answer (c) is correct because in such a circumstance the failure to take remedial action may cause an auditor to decrease reliance on management representations. Answer (a) is incorrect because the reply by the attorney is likely to disclose any claims, litigation or assessments that the client has improperly omitted from the letter of audit inquiry. Answer (b) is incorrect because the prior years' audit plans are not being relied upon for this year's audit. Answer (d) is incorrect because the preliminary judgment about materiality levels would not be expected to change.

Professional skepticism requires that an auditor assume that management is a. Honest, in the absence of fraud risk factors. b. Dishonest until completion of audit tests. c. Neither honest nor dishonest. d. Offering reasonable assurance of honesty.

(c) The requirement is to determine what presumption concerning management's honesty that professional skepticism requires. Answer (c) is correct because professional skepticism requires that an auditor neither assume dishonesty nor unquestioned honesty. Answers (a) and (b) are incorrect because neither honesty in the absence of fraud risk factor nor dishonesty are assumed. Answer (d) is incorrect because the concept of reasonable assurance is not directed towards management's honesty.

A successor auditor should request the new client to authorize the predecessor auditor to allow a review of the predecessor's Engagement letter //Working papers a. Yes //Yes b. Yes// No c. No //Yes d. No //No

(c) The requirement is to determine whether a successor auditor should request a new client to authorize the predecessor auditor to allow a review of the predecessor's engagement letter, working papers, or both. Answer (c) is correct because AU-C 510 states that it is advisable that a successor auditor request to be allowed to review the predecessor's working papers.

. Which of the following audit risk components may be assessed in nonquantitative terms? Control risk /Detection risk/ Inherent risk a. Yes /Yes /No b. Yes /No /Yes c. Yes /Yes /Yes d. No /Yes /Yes

(c) The requirement is to determine whether inherent risk, control risk, and detection risk may be assessed in nonquantitative terms. Answer (c) is correct because all of these risks may be assessed in either quantitative terms such as percentages, or nonquantitative terms such as a range from a minimum to a maximum.

Which of the following is not a specialist upon whose work an auditor may rely? a. Actuary. b. Appraiser. c. Internal auditor. d. Engineer.

(c) The requirement is to determine which individual is not considered a specialist upon whose work an independent auditor may rely. The professional standards relating to using the work of a specialist do not apply to using the work of an internal auditor. Answers (a), (b), and (d), actuary, appraiser, and engineer, respectively, are all examples of specialists per the professional standards. Note here that the question and its reply do not imply that a CPA cannot use the work of an internal auditor. What is being suggested is that an internal auditor is not considered a specialist under the professional standards

Which of the following characteristics most likely would heighten an auditor's concern about the risk of intentional manipulation of financial statements? a. Turnover of senior accounting personnel is low. b. Insiders recently purchased additional shares of the entity's stock. c. Management places substantial emphasis on meeting earnings projections. d. The rate of change in the entity's industry is slow

(c) The requirement is to identify the characteristic most likely to heighten an auditor's concern about the risk of intentional manipulation of financial statements. Answer (c) is correct because the placement of substantial emphasis on meeting earnings projections is considered a risk factor. Answer (a) is incorrect because high turnover, not low turnover, is considered a risk factor. Answer (b) is incorrect because insider purchases of additional shares of stock are less likely to be indicative of intentional manipulation of the financial statements than is undue emphasis on meeting earnings projections. Answer (d) is incorrect because a rapid rate of change in an industry, not a slow rate, is considered a risk factor

Which of the following factors most likely would influence an auditor's determination of the auditability of an entity's financial statements? a. The complexity of the accounting system. b. The existence of related-party transactions. c. The adequacy of the accounting records. d. The operating effectiveness of control |procedures.

(c) The requirement is to identify the factor that most likely would influence an auditor's determination of the auditability of an entity's financial statements. Answer (c) is correct because inadequate accounting records may cause an auditor to conclude that it is unlikely that suffi cient appropriate evidence will be available to support an opinion on the financial statements; accordingly, an auditor may determine that the financial statements are not auditable. Answer (a) is incorrect because an auditor should be able to obtain the knowledge necessary to audit a complex accounting system. Answer (b) is incorrect because while related-party transactions may raise transaction valuation issues due to the lack of an "arm's-length transaction," the problem is normally not so severe as to make the entity not auditable. Answer (d) is incorrect because a lack of operating effectiveness of controls may often be overcome through an increase in the scope of substantive tests.

Which of the following would an auditor most likely use in determining the auditor's preliminary judgment about materiality? a. The results of the initial assessment of control risk. b. The anticipated sample size for planned substantive tests. c. The entity's financial statements of the prior year. d. The assertions that are embodied in the financial statements.

(c) The requirement is to identify the information that an auditor would be most likely to use in making a preliminary judgment about materiality. Answer (c) is correct because auditors often choose to use a measure relating to the prior year's financial statements (e.g., a percentage of total assets, net income, or revenue) to arrive at a preliminary judgment about materiality. Answer (a) is incorrect because materiality is based on the magnitude of an omission or misstatement and not on the initial assessment of control risk. Answer (b) is incorrect because while an auditor's materiality judgment will affect the anticipated sample size for planned substantive tests, sample size does not affect the materiality judgment. Answer (d) is incorrect because the assertions embodied in the financial statements remain the same from one audit to another

Which of the following documentation is not required for an audit in accordance with generally accepted auditing standards? a. A written audit plan setting forth the procedures necessary to accomplish the audit's objectives. b. An indication that the accounting records agree or reconcile with the financial statements. c. A client engagement letter that summarizes the timing and details of the auditor's planned fieldwork. d. The assessment of the risks of material misstatement

(c) The requirement is to identify the item for which the generally accepted auditing standards do not require documentation. Answer (c) is correct because while a CPA fi rm will include an engagement letter in the working papers, it will not detail the auditor's planned fieldwork. Answer (a) is incorrect because SAS 300 requires a written audit plan. Answer (b) is incorrect because AU-C 230 requires that the working papers document the agreement or reconciliation of the accounting records with the financial statements. Answer (d) is incorrect because AU-C 315 requires the auditor to document the assessment of the risks of material misstatement.

Which of the following procedures would an auditor least likely perform while obtaining an understanding of a client in a financial statement audit? a. Coordinating the assistance of entity personnel in data preparation. b. Discussing matters that may affect the audit with fi rm personnel responsible for nonaudit services to the entity. c. Selecting a sample of vendors' invoices for comparison to receiving reports. d. Reading the current year's interim financial statements.

(c) The requirement is to identify the least likely procedure to be performed in planning a financial statement audit. Answer (c) is correct because selecting a sample of vendors' invoices for comparison to receiving reports will occur normally as a part of the evidence accumulation process, not as a part of the planning of an audit. Answer (a) is incorrect because coordination of the assistance of entity personnel in data preparation occurs during planning. Answer (b) is incorrect because while planning the audit, CPAs may discuss matters that affect the audit with fi rm personnel responsible for providing nonaudit services to the entity. Answer (d) is incorrect because any available current year interim financial statements will be read during the planning stage.

Which of the following most accurately summarizes what is meant by the term "material misstatement?" a. Fraud and direct-effect illegal acts. b. Fraud involving senior management and material fraud. c. Material error, material fraud, and certain illegal acts. d. Material error and material illegal acts

(c) The requirement is to identify the meaning of the term "material misstatement" when used in the professional standards. Answer (c) is correct because AU-C 240 states that a material misstatement may occur due to errors, fraud, and illegal acts with a direct effect on financial statement amounts

During the initial planning phase of an audit, a CPA most likely would a. Identify specific internal control activities that are likely to prevent fraud. b. Evaluate the reasonableness of the client's accounting estimates. c. Discuss the timing of the audit procedures with the client's management. d. Inquire of the client's attorney as to whether any unrecorded claims are probable of assertion.

(c) The requirement is to identify the most likely procedure during the initial planning phase of an audit. Answer (c) is correct because during initial planning the timing of procedures will be discussed due to the need for client assistance with many of these procedures. Answer (a) is incorrect because the timing of audit procedures will occur subsequent to the initial planning stage of an audit. Answer (b) is incorrect because the evaluation of reasonableness of the client's accounting estimates will occur after planning—see AU-C 540. Answer (d) is incorrect because the inquiry of a client's attorney will occur subsequently to initial planning— see AU-C 501.

Which of the following is most likely to be considered a risk factor relating to fraudulent financial reporting? a. Domination of management by top executives. b. Large amounts of cash processed. c. Negative cash flows from operations. d. Small high-dollar inventory items.

(c) The requirement is to identify the most likely risk factor relating to fraudulent financial reporting. Answer (c) is correct because negative cash flows from operations may result in pressure upon management to overstate the results of operations. Answer (a) is incorrect because one would expect a company's top executives to dominate management— domination by one or a few might be considered a risk factor. Answers (b) and (d) are incorrect because large amounts of cash being processed and small high-dollar inventory items are more directly related to the misappropriation of assets than they are to fraudulent financial reporting.

D.1. Assess the Risks of Material Misstatement and Design Further Audit Procedures—Overall Approach While assessing the risks of material misstatement auditors identify risks, relate risk to what could go wrong, consider the magnitude of risks and a. Assess the risk of misstatements due to illegal acts. b. Consider the complexity of the transactions involved. c. Consider the likelihood that the risks could result in material misstatements. d. Determine materiality levels.

(c) The requirement is to identify the next step in assessing the risks of material misstatement after auditors identify risks, relate risks to what could go wrong, and consider the magnitude of risks. Answer (c) is correct because the professional standards suggest that auditors should then consider the likelihood that risks involved could result in material misstatements. Answer (a) is incorrect because the assessment is not limited to illegal acts. Answer (b) is incorrect because the complexity of transactions is not next to be considered. Answer (d) is incorrect because determining materiality levels occurs prior to this stage of the audit.

B. Audit Planning Which of the following would be least likely to be considered an audit planning procedure? a. Use an engagement letter. b. Develop the overall audit strategy. c. Perform risk assessment. d. Develop the audit plan.

(c) The requirement is to identify the procedure least likely to be considered an audit planning procedure. Answer (c) is correct because performing the risk assessment occurs subsequent to audit planning. Answer (a) is incorrect because an engagement letter is used to establish an understanding with the client, and this is a planning procedure. Answer (b) is incorrect because auditors develop the overall audit strategy during audit planning. Answer (d) is incorrect because the audit plan is developed during planning.

Because of the risk of material misstatement, an audit of financial statements in accordance with generally accepted auditing standards should be planned and performed with an attitude of a. Objective judgment. b. Independent integrity. c. Professional skepticism. d. Impartial conservatism

(c) The requirement is to identify the proper attitude of an auditor who is performing an audit in accordance with generally accepted auditing standards. Answer (c) is correct because the auditor should plan and perform the audit with an attitude of professional skepticism, recognizing that the application of the auditing procedures may produce evidence indicating the possibility of misstatements due to errors or fraud. Answer (a) is incorrect because while the CPA must exhibit objective judgment, "professional skepticism" more accurately summarizes the proper attitude during an audit. Answer (b) is incorrect because while a CPA must be independent and have integrity, this is not the "attitude" used to plan and perform the audit. Answer (d) is incorrect because the audit is not planned and performed with impartial conservatism.

The following summarizes your client's inventory turnover for Years 1 and 2. Year 1 (inventory turnover 7.00) Year 2 (Inventory turnover 6.00) This change is most consistent with a. A number of expense items were erroneously included in cost of goods sold (but not in ending inventory). b. While inventory levels remained the same in Year 2, total sales increased and a higher percentage of customers are paying their accounts. c. Although sales for Year 2 were the same as for Year 1, inventory is a bit higher than normal because the last month of year 2's sales were lower than anticipated. d. The year-end physical inventory count omitted a number of significant items. A periodic accounting inventory system is in use.

(c) The requirement is to identify the reply that is most consistent with a decrease in the inventory turnover (cost of goods sold / inventory). Answer (c) is correct because an increase in inventory with no change in cost of goods sold will decrease the ratio. Answer (a) is incorrect because an increase in cost of goods sold will increase the ratio. Answer (b) is incorrect because the increased sales would be expected to increase the turnover ratio in year 2 since the increased sales, with no increase in inventory levels, results in an increase in the inventory turnover (through an increase in cost of goods sold), not a decrease—more clients paying their accounts does not directly affect the ratio. Answer (d) is incorrect because this will increase the turnover ratio since cost of goods sold will be overstated and inventory will be understated

The accounts receivable turnover ratio increased during 20X2. This is consistent with: a. Items shipped on consignment during December were recorded as credit sales; no cash receipts have yet been received on these consignments. b. The company increased credit sales by 10% by allowing more lenient credit terms—30 days are now allowed whereas previously only 20 days were allowed. c. A major credit sale on which title passed as of December 31, 20X2 was recorded in January of 20X3. d. Sales for each month are approximately 25% higher than those of the preceding year

(c) The requirement is to identify the reply which is consistent with an increase in the accounts receivable turnover ratio (credit sales / accounts receivable). Answer (c) is correct because not including the sale in either the 20X2 sales or year-end accounts receivable increases the ratio. For example, assume that the actual total year sales are $100,000 and yearend receivables are $20,000—a turnover of 5—when the sale, assume for $5,000, is included in 20X2. Subtracting the $5,000 from 20X2 sales and receivables results in a turnover ratio of 6.33 ($95,000 / $15,000)—an increase. Answer (a) is incorrect because the consignment increases the numerator and denominator by an equal amount—this decreases the ratio. Answer (b) is incorrect because the denominator of the ratio is likely to increase disproportionately when 30 days rather than 20 days are allowed—this results in a decrease in the ratio. Answer (d) is incorrect because one would expect a pro-rata increase in

A.5. Laws and Regulations An auditor who discovers that a client's employees have paid small bribes to public officials most likely would withdraw from the engagement if the a. Client receives financial assistance from a federal government agency. b. Evidence that is necessary to prove that the illegal acts were committed does not exist. c. Employees' actions affect the auditor's ability to rely on management's representations. d. Notes to the financial statements fail to disclose the employees' actions.

(c) The requirement is to identify the situation in which an auditor would be most likely to withdraw from an engagement when he or she has discovered that a client's employees have paid small bribes to public officials. Answer (c) is correct because AU-C 250 states that resignation should be considered when an illegal act does not receive proper remedial action, because such inaction may affect the auditor's ability to rely on management representations and the effects of continued association with the client. Answer (a) is incorrect because the receipt of federal funds in such a situation is not as likely to result in auditor withdrawal as is answer (c). Answer (b) is incorrect because it seems inconsistent with the premise of the question in that, if no evidence exists, the auditor is unlikely to know that bribes have been paid. Answer (d) is incorrect because such small bribes will not ordinarily need to be disclosed. Alternatively, if the auditor believes that there is such a need, the lack of such disclosure represents a departure from generally accepted accounting principles and either a qualified or adverse opinion is appropriate.

In using the work of a specialist, an understanding should exist among the auditor, the client, and the specialist as to the nature of the specialist's work. The documentation of this understanding should cover a. A statement that the specialist assumes no responsibility to update the specialist's report for future events or circumstances. b. The conditions under which a division of responsibility may be necessary. c. The specialist's understanding of the auditor's corroborative use of the specialist's findings. d. The auditor's disclaimer as to whether the specialist's findings corroborate the representations in the financial statements.

(c) The requirement is to identify the statement that an auditor must document when using the work of a specialist. Answer (c) is correct because the specialist's understanding of the auditor's corroborative use of his or her findings must be documented. See AU-C 620 for this and other documentation requirements. Answer (a) is incorrect because no statement concerning an update of the specialist's report is required to be documented. Answer (b) is incorrect because a division of responsibility relates to circumstances in which other auditors, not specialists, are involved. Answer (d) is incorrect because an auditor will not normally issue a disclaimer related to whether the specialist's findings corroborate the representations in the financial statements. The specialist's report is only referred to when there is a material difference between the specialist's findings and the representations in the financial statements. See AU-C 620 for information on the effect of a specialist's work on an auditor's report.

When considering fraud risk factors relating to management's characteristics, which of the following is least likely to indicate a risk of possible misstatement due to fraud? a. Failure to correct known significant deficiency on a timely basis. b. Nonfinancial management's preoccupation with the selection of accounting principles. c. Significant portion of management's compensation represented by bonuses based upon achieving unduly aggressive operating results. d. Use of unusually conservative accounting practices.

(d) The requirement is to identify the least likely indicator of a risk of possible misstatement due to fraud. Answer (d) is correct because one would expect unusually aggressive, rather than unusually conservative accounting practices to indicate a risk of misstatement due to fraud. Answers (a), (b), and (c) are all incorrect because they represent risk factors explicitly included in AU-C 240, which provides guidance on fraud. 27. (c)

Which of the following nonfinancial information would an auditor most likely consider in performing analytical procedures during risk assessment? a. Turnover of personnel in the accounting department. b. Objectivity of audit committee members. c. Square footage of selling space. d. Management's plans to repurchase stock.

(c) The requirement is to identify the type of nonfinancial information an auditor would most likely consider in performing analytical procedures during the risk assessment phase of an audit. Answer (c) is correct because the square footage of selling space may be used in considering the overall reasonableness of sales. Answer (a) is incorrect because while the turnover of personnel in the accounting department may provide a measure of risk relating to the accounting function, it is not ordinarily used in performing analytical procedures. Similarly, answer (b) is incorrect because while the objectivity of audit committee members is an important consideration, it is not ordinarily used in performing analytical procedures. Answer (d) is also incorrect because management's plans to repurchase stock is not directly related to analytical procedures. See AU-C 315 and AU-C 520 for information on analytical procedures.

In an audit of a nonissuer (nonpublic) company, the auditors identify significant risks. These risks often a. Involve routine, high-volume transactions. b. Do not require special audit attention. c. Involve items with lower levels of inherent risk. d. Involve judgmental matters.

(d) Answer (d) is correct because significant risks often involve accounting estimates or complex accounting that involves significant judgments. Answer (a) is incorrect because routine, high-volume transactions typically have lower risk. Answer (b) is incorrect because significant risks do require special audit attention. Answer (c) is incorrect because significant risks involve items with high levels of inherent risk.

What assurance does the auditor provide that misstatements due to errors, fraud, and direct effect illegal acts that are material to the financial statements will be detected? Errors //Fraud //Direct effect of illegal acts a. Limited //Negative //Limited b. Limited// Limited //Reasonable c. Reasonable //Limited //Limited d. Reasonable //Reasonable //Reasonable

(d) The requirement is to identify the level of assurance an auditor provides with respect to detection of material errors, fraud, and direct effect illegal acts. Answer (d) is correct because AU-C 200 requires the auditor to design the audit to provide reasonable assurance of detecting material errors, fraud and direct effect illegal acts. (A "direct effect" illegal act is one that would have an effect on the determination of financial statement amounts.)

In auditing the financial statements of Star Corp., Land discovered information leading Land to believe that Star's prior year's financial statements, which were audited by Tell, require substantial revisions. Under these circumstances, Land should a. Notify Star's audit committee and stockholders that the prior year's financial statements cannot be relied on. b. Request Star to reissue the prior year's financial statements with the appropriate revisions. c. Notify Tell about the information and make inquiries about the integrity of Star's management. d. Request Star to arrange a meeting among the three parties to resolve the matter.

(d) The requirement is to determine a successor auditor's responsibility when financial statements audited by a predecessor auditor are found to require substantial revisions. Answer (d) is correct because when a successor auditor becomes aware of information that indicates that financial statements reported on by the predecessor may require revision, the successor should request that the client arrange a meeting among the three parties to discuss and attempt to resolve the matter. Answer (a) is incorrect because the successor is not required to notify the audit committee and stockholders. Answer (b) is incorrect because the client should fi rst communicate with the predecessor before revising the financial statements. Answer (c) is incorrect because a meeting of the three parties is arranged by the client and because the situation may or may not have anything to do with the integrity of management.

Audit plans should be designed so that a. Most of the required procedures can be performed as interim work. b. Inherent risk is assessed at a sufficiently low level. c. The auditor can make constructive suggestions to management. d. The audit evidence gathered supports the auditor's conclusions.

(d) The requirement is to determine the manner in which audit plans should be designed. Answer (d) is correct because an audit plan should be designed so that the audit evidence gathered is sufficient to support the auditor's conclusions. Answer (a) is incorrect because, often, most audit procedures will not be performed as interim work. Answer (b) is incorrect because inherent risk need not be assessed at a low level. Answer (c) is incorrect because while providing constructive suggestions to management is desirable, the audit plan is not based on developing constructive suggestions.

In designing written audit plans, an auditor should establish specific audit objectives that relate primarily to the a. Timing of audit procedures. b. Cost-benefit of gathering evidence. c. Selected audit techniques. d. Financial statement assertions.

(d) The requirement is to determine what specific audit objectives are addressed when designing an audit plan. Answer (d) is correct because in obtaining evidence in support of financial statement assertions, the auditor develops specific audit objectives in the light of those assertions. Answers (a), (b), and (c) are all incorrect because these replies do not relate specifically to the audit objectives as do the financial statement assertions.

An auditor obtains knowledge about a new client's business and its industry to a. Make constructive suggestions concerning improvements to the client's internal control. b. Develop an attitude of professional skepticism concerning management's financial statement assertions. c. Evaluate whether the aggregation of known misstatements causes the financial statements taken as a whole to be materially misstated. d. Understand the events and transactions that may have an effect on the client's financial statements.

(d) The requirement is to determine why an auditor obtains knowledge about a new client's business and its industry. Answer (d) is correct because obtaining a level of knowledge of the client's business and industry enables the CPA to obtain an understanding of the events, transactions, and practices that, in the CPA's judgment, may have a significant effect on the financial statements. Answer (a) is incorrect because providing constructive suggestions is a secondary, and not the primary, reason for obtaining knowledge about a client's business and industry. Answer (b) is incorrect because while a CPA must develop an attitude of professional skepticism concerning a client, this attitude is not obtained by obtaining knowledge about the client's business and industry. Answer (c) is incorrect because in-formation on the business and industry of a client will provide only limited information in determining whether financial statements are materially misstated, and numerous other factors are considered in evaluating audit findings.

B.1 Communicate with Predecessor Auditors Before accepting an engagement to audit a new client, a CPA is required to obtain a. An understanding of the prospective client's industry and business. b. The prospective client's signature to the engagement letter. c. A preliminary understanding of the prospective client's control environment. d. The prospective client's consent to make inquiries of the predecessor auditor, if any

(d) The requirement is to identify a requirement prior to accepting an engagement to audit a new client. Answer (d) is correct because AU-C 210 requires that an auditor attempt to obtain client permission to contact the predecessor prior to accepting a new engagement. Answers (a), (b), and (c) are incorrect because they may all be obtained subsequent to accepting an engagement.

Which of the following statements reflects an auditor's responsibility for detecting misstatements due to errors and fraud? a. An auditor is responsible for detecting employee errors and simple fraud, but not for discovering fraud involving employee collusion or management override. b. An auditor should plan the audit to detect misstatements due to errors and fraud that are caused by departures from GAAP. c. An auditor is not responsible for detecting misstatements due to errors and fraud unless the application of GAAS would result in such detection. d. An auditor should design the audit to provide reasonable assurance of detecting misstatements due to errors and fraud that are material to the financial statements.

(d) The requirement is to identify an auditor's responsibility for detecting errors and fraud. Answer (d) is correct because AU-C 200 requires that an auditor design the audit to provide reasonable assurance of detecting misstatements due to errors and fraud that are material to the financial statements. Answer (a) is incorrect because audits provide reasonable assurance of detecting material errors and fraud. Answer (b) is incorrect because it doesn't restrict the responsibility to material errors and fraud. Answer (c) is incorrect because it is less precise than answer (d), which includes the AU-C 200 responsibility on errors and fraud.

Which of the following statements best describes the auditor's responsibility to detect conditions relating to financial stress of employees or adverse relationships between a company and its employees? a. The auditor is required to plan the audit to detect these conditions on all audits. b. These conditions relate to fraudulent financial reporting, and an auditor is required to plan the audit to detect these conditions when the client is exposed to a risk of misappropriation of assets. c. The auditor is required to plan the audit to detect these conditions whenever they may result in misstatements. d. The auditor is not required to plan the audit to discover these conditions, but should consider them if he or she becomes aware of them during the audit.

(d) The requirement is to identify an auditor's responsibility for detecting financial stress of employees or adverse relationships between a company and its employees. Answer (d) is correct because AU-C 240 states that, while the auditor is not required to plan the audit to discover information that is indicative of financial stress of employees or adverse relationships between the company and its employees, such conditions must be considered when an auditor becomes aware of them. Answers (a), (b), and (c) are all incorrect because the auditor does not plan the audit to detect these conditions.

Disclosure of fraud to parties other than a client's senior management and its audit committee or board of directors ordinarily is not part of an auditor's responsibility. However, to which of the following outside parties may a duty to disclose fraud exist? To the SEC when the client reports an auditor change// To a successor auditor when the successor makes appropriate inquiries //To a government funding agency from which the client receives financial assistance a. Yes //Yes //No b. Yes //No //Yes c. No //Yes// Yes d. Yes// Yes //Yes

(d) The requirement is to identify the circumstances in which an auditor may have a responsibility to disclose fraud to parties other than a client's senior management and its audit committee or board of directors. Answer (d) is correct because AU-C 240 states that such a responsibility may exist to the SEC when there has been an auditor change to a successor auditor or to comply with SEC 1995 Private Securities Reform Act communication requirement, when the successor auditor makes inquiries, and to a government agency from which the client receives financial assistance. In addition, that section states that an auditor may have such a disclosure responsibility in response to a subpoena, a circumstance not considered in this question.

An auditor who discovers that a client's employees paid small bribes to municipal officials most likely would withdraw from the engagement if a. The payments violated the client's policies regarding the prevention of illegal acts. b. The client receives financial assistance from a federal government agency. c. Documentation that is necessary to prove that the bribes were paid does not exist. d. Management fails to take the appropriate remedial action.

(d) The requirement is to identify the circumstances relating to the discovery of the payment of small bribes to municipal officials that is most likely to cause an auditor to withdraw from an engagement. Answer (d) is correct because AU-C 250 states that management failure to take the appropriate remedial action is particularly problematical since it may affect the auditor's ability to rely on management representation and may therefore lead to withdrawal. Answers (a), (b), and (c) all represent circumstances which the auditor will consider, but are not ordinarily considered as serious as failure to take the appropriate remedial action.

The element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the a. Evidence to be gathered to provide a sufficient basis for the auditor's opinion. b. Procedures to be undertaken to discover litigation, claims, and assessments. c. Pending legal matters to be included in the inquiry of the client's attorney. d. Timing of inventory observation procedures to be performed.

(d) The requirement is to identify the element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy. Answer (d) is correct because the auditor will ordinarily observe the counting of inventory and this will require a degree of coordination between the performance of audit procedures and client count procedures. Answer (a) is incorrect because the client will not determine the evidence to be gathered to provide a sufficient basis for the auditor's opinion. Answers (b) and (c) are incorrect because these procedures will be determined subsequent to implementation of the audit strategy.

Which of the following factors most likely would cause a CPA to not accept a new audit engagement? a. The prospective client has already completed its physical inventory count. b. The CPA lacks an understanding of the prospective client's operation and industry. c. The CPA is unable to review the predecessor auditor's working papers. d. The prospective client is unwilling to make all financial records available to the CPA.

(d) The requirement is to identify the factor most likely to cause a CPA not to accept a new audit engagement. Answer (d) is correct because a part of the understanding an auditor must obtain with a client is that management is responsible for making all financial records and related information available. Accordingly, if the client refuses to make such information available the auditor is unlikely to accept the audit client. Answer (a) is incorrect because a circumstance-imposed scope limitations such as completion of the physical inventory count results in a situation in which the auditor may consider using alternative procedures (including making some test counts) to determine whether inventory counts are proper. Answer (b) is incorrect because an auditor may obtain an understanding of the client's operations and industry while performing the audit. Answer (c) is incorrect because while a review of the predecessor auditor's working papers is ordinarily desirable, it is not required.

Which of the following factors would most likely heighten an auditor's concern about the risk of fraudulent financial reporting? a. Large amounts of liquid assets that are easily convertible into cash. b. Low growth and profitability as compared to other entities in the same industry. c. Financial management's participation in the initial selection of accounting principles. d. An overly complex organizational structure involving unusual lines of authority.

(d) The requirement is to identify the factor most likely to heighten an auditor's concern about the risk of fraudulent financial reporting. Answer (d) is correct because AU-C 240, which presents a variety of risk factors, suggests that an overly complex organizational structure is such a risk factor. Answer (a) is incorrect because large amounts of liquid assets that are easily convertible into cash represent more of a risk relating to misappropriation of assets rather than to fraudulent financial reporting. Answer (b) is incorrect because high growth, rather than low growth, is considered a risk factor. Answer (c) is incorrect because one would expect financial management's participation in the initial selection of accounting principles.

Which of the following is least likely to be required on an audit? a. Test appropriateness of journal entries and adjustment. b. Review accounting estimates for biases. c. Evaluate the business rationale for significant unusual transactions. d. Make a legal determination of whether fraud has occurred.

(d) The requirement is to identify the procedure least likely to be required on an audit. Answer (d) is correct because fraud is a broad legal concept and auditors do not make legal determinations of whether fraud has occurred. Answers (a), (b), and (c) are incorrect because considering journal entries, estimates, and unusual transactions are ordinarily required audit procedures to address the risk of management override of controls. See AU-C 240 for information on the auditor's responsibility for the consideration of fraud in a financial statement audit.

An auditor is unable to obtain absolute assurance that misstatements due to fraud will be detected for all of the following except a. Employee collusion. b. Falsified documentation. c. Need to apply professional judgment in evaluating fraud risk factors. d. Professional skepticism.

(d) The requirement is to identify the reply which is not a reason why auditors are unable to obtain absolute assurance that misstatements due to fraud will be detected. Answer (d) is correct because while an auditor must exercise professional skepticism when performing an audit it does not represent a limitation that makes is impossible to obtain absolute assurance. Answers (a), (b), and (c) are all incorrect because they represent factors considered in the professional literature for providing reasonable, and not absolute assurance.

Which of the following statements is correct about the auditor's use of the work of a specialist? a. The specialist should not have an understanding of the auditor's corroborative use of the specialist's findings. b. The auditor is required to perform substantive procedures to verify the specialist's assumptions and findings. c. The client should not have an understanding of the nature of the work to be performed by the specialist. d. The auditor should obtain an understanding of the methods and assumptions used by the specialist.

(d) The requirement is to identify the statement that is correct about the auditor's use of the work of a specialist. Answer (d) is correct because the auditor should obtain an understanding of the nature of the work performed by the specialist. Answer (a) is incorrect because ordinarily a specialist will have a basic understanding of the auditor's corroborative use of the findings. Answer (b) is incorrect because the auditor need not perform substantive procedures to verify the specialist's assumptions and findings. Answer (c) is incorrect because the client may have an understanding of the nature of the work performed by the specialist. See AU-C 620 for information on the auditor's use of the work of a specialist

Which of the following statements would least likely appear in an auditor's engagement letter? a. Fees for our services are based on our regular per diem rates, plus travel and other out-of-pocket expenses. b. During the course of our audit we may observe opportunities for economy in, or improved controls over, your operations. c. Our engagement is subject to the risk that material misstatements or fraud, if they exist, will not be detected. d. After performing our preliminary analytical procedures we will discuss with you the other procedures we consider necessary to complete the engagement.

(d) The requirement is to identify the statement that is least likely to appear in an auditor's engagement letter. Answer (d) is correct because auditors ordinarily will not discuss with management the details of procedures that are necessary to perform the audit. Answers (a), (b), and (c) are incorrect because engagement letters will include a statement on the risk of not detecting material errors and fraud, and may include information on fees and observed opportunities for economy

Which of the following is a function of the risks of material misstatement and detection risk? a. Internal control. b. Corroborating evidence. c. Quality control. d. Audit risk.

(d) The requirement is to identify which reply is a function of the risks of material misstatement and detection risk. Answer (d) is correct because audit risk is the risk that auditor expresses an inappropriate audit opinion when the financial statements are misstated, and it is a function of the risks of material misstatement and detection risk. Answer (a) is incorrect because while a consideration of internal control is required during an audit, internal control is not a function of these risks. Answer (b) is incorrect because while corroborating evidence is obtained to measure these risks, it is not a function of them. Answer (c) is incorrect because quality control relates to requirements placed upon the CPAs while conducting an audit

2. Which of the following is not a fi nancial statement assertion relating to account balances? a. Completeness. b. Existence. c. Rights and obligations. d. Valuation and competence.

d) The requirement is to identify the item that is not a financial statement assertion relating to account balances. Answer (d) is correct because valuation and allocation is an account balance assertion, not valuation and competence. Answer (a) is incorrect because completeness is an assertion relating to account balances. Answer (b) is incorrect because existence is an assertion relating to account balances. Answer (c) is incorrect because rights and obligations is an assertion relating to account balances