Module 2: Multiple Choice

26. 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

26. ( 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.

A.4. Errors and Fraud 22. 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.

22. ( a) The requirement is to identify the example of fraudulent financial reporting. Answer (a) is correct because fraudulent financial 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).

23. 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.

23. ( 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 program 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.

24. 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. 25

24. ( 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.

25. 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.

25. ( 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.

27. 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.

27. ( 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.

28. 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.

28. ( 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.

29. 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.

29. ( 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.

30. 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.

30. (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.

31. 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.

31. ( 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.

32. 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 year end. b. Computer generated documents. c. Missing documents. d. Year-end adjusting journal entries.

32. ( 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.

41. 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.

41. (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.

33. 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.

33. ( 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.

34. 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.

34. ( 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.

35. 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.

35. (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.

36. 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.

36. (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.

37. 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 fi nancial assistance a. Yes Yes No b. Yes No Yes c. No Yes Yes d. Yes Yes Yes

37. (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.

38. 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.

38. (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.

39. What assurance does the auditor provide that misstatements due to errors, fraud, and direct effect illegal acts that are material to the fi nancial 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

39. (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.)

40. 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.

40. (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.

42. 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.

42. (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.

18. 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 (18. (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.)

A. Overview 1. Which of the following is a conceptual difference between the attestation standards and generally accepted auditing standards? a. The attestation standards do not apply to audits of historical financial statements, while the generally accepted auditing standards do. b. The requirement that the practitioner be independent in mental attitude is omitted from the attestation standards. c. The attestation standards do not permit an attest engagement to be part of a business acquisition study or a feasibility study. d. None of the standards of fieldwork in generally accepted auditing standards are included in the attestation standards.

a ((1. (a) The requirement is to identify a conceptual difference between the attestation standards and generally accepted auditing standards. Answer (a) is correct because AT 101 states that the attestation standards do not apply to audits of historical financial statements. Answer (b) is incorrect because an independent mental attitude is required for attestation engagements. Answer (c) is incorrect because an attest engagement may be related to a business acquisition study or a feasibility study. Answer (d) is incorrect because while there is no internal control fieldwork standard under the attestation standards, both a planning and an evidence standard of fieldwork are included.))

A.1. Financial Statement Assertions 6. 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 (6. (a) The requirement is to identify the categories of financial statement assertions. Answer (a) is correct because the professional standards establish financial 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.)

10. 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(10. (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.)

5. After fieldwork audit procedures are completed, a partner of the CPA firm 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(5. (a) The requirement is to identify the focus of a fi nal 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 suffi cient 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)

13. 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 (13. (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 justification for increasing materiality levels beyond those used in planning the audit.)

A.3. Materiality 15. 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 (15. (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.)

16. 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 (16. (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.)

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

b(14. (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).)

20. 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 fi nancial statement assertions. d. Decrease the extent of auditing procedures to be applied to the class of transactions.

b(20. (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 extent of auditing procedures will be increased, not decreased.)

21. 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(21. (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 qualified 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.)

A.2. Audit Risk 8. 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(8. (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.)

9. 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(9. (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.)

11. 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 (11. (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.)

12. 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 (12. (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.)

19. 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 (19. (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.)

3. Which of the following is most likely to be unique to the audit work of CPAs as compared to work performed by practitioners of other professions? a. Due professional care. b. Competence. c. Independence. d. Complex body of knowledge.

c (3. (c) The requirement is to identify the characteristic that is most likely to be unique to the audit work of CPAs as compared to work performed by practitioners of other professions. Answer (c) is correct because independence is absolutely required for the performance of audits; other professions do not in general require such independence. Answers (a), (b), and (d) are incorrect because the various professions require due professional care and competence and have a complex body of knowledge.)

17. 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 (17. (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.)

7. 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 (7. (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.)

2. Which of the following is not an attestation standard? a. Sufficient evidence shall be obtained to provide a reasonable basis for the conclusion that is expressed in the report. b. The report shall identify the subject matter on the assertion being reported on and state the character of the engagement. c. The work shall be adequately planned and assistants, if any, shall be properly supervised. d. A sufficient understanding of internal control shall be obtained to plan the engagement.

d(2. (d) The requirement is to identify the reply which is not an attestation standard. Answer (d) is correct because the attestation standards do not include a requirement that a sufficient understanding of internal control be obtained to plan the engagement. There is no internal control standard because the concept of internal control may not be relevant to certain assertions on which a CPA may be engaged to report (e.g., aspects of information about computer software). Answers (a), (b), and (c) are all incorrect because standards exist for evidence, reporting on the assertion or subject matter, and proper planning.)

4. The Public Company Accounting Oversight Board's third general standard states that due care is to be exercised in the performance of an audit. This standard is ordinarily interpreted to require a. Thorough review of the existing safeguards over access to assets and records. b. Limited review of the indications of employee fraud and illegal acts. c. Objective review of the adequacy of the technical training and proficiency of firm personnel. d. Critical review of the judgment exercised at every level of supervision.

d(4. (d) The requirement is to determine what is meant by the third general standard's requirement of due care in the performance of an audit. Answer (d) is correct because due care requires critical review at every level of supervision of the work done and the judgment exercised by those assisting in the audit. Answer (a) is incorrect because the due care standard does not directly address safeguards over access to assets and records. Answer (b) is incorrect because due care does not relate to a limited review of employee fraud and illegal acts. Answer (c) is incorrect because the first general standard addresses technical training and proficiency as an auditor.)