audit ch. 5 & 6

Successor auditors need to communicate with predecessor auditors ______ accepting the engagement. before 2. ___________ must ask management to authorize the predecessor auditors to discuss confidential information. Successor auditors 3. If predecessor auditors refuse communication, successor auditors _______ accept the engagement. can 4. Communication between predecessor and successor auditors aids in evaluating the ______ of management. integrity 5. Shopping for accounting principles is ______by Sarbanes-Oxley. discouraged

1. Audit standards require discussion prior to engagement acceptance. 2. The successor auditors must ask management of the prospective client to authorize the predecessor auditors to respond fully to the successor's inquiries. 3. Successor auditors can accept an engagement after attempting discussion, but this may give rise to concern. 4. Successor auditors can learn about management integrity when communicating with the predecessor auditors. 5. Sarbanes-Oxley discourages the concept of shopping for accounting principles.

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

A large amount of assets by itself is not indicative of high inherent risk. Operating results highly sensitive to economic factors, large past misstatements, and turnover of management all represent characteristics that may indicate high inherent risk.

Three conditions generally are present when fraud occurs. Select the one below that is not one of those conditions. Multiple Choice Incentive or pressure. Opportunity. Supervisory position.Correct Attitude.

AICPA AU-C 240 (PCAOB 316) outlines the three factors generally necessary for fraud as (1) incentive or pressure, (2) opportunity, and (3) attitude. Being in a supervisory position is not one of those conditions, although it may provide the individual an opportunity to commit fraud.

In planning and performing an audit, auditors are concerned about risk factors for two distinct types of fraud: fraudulent financial reporting and misappropriation of assets. Which of the following is a risk factor for misappropriation of assets? Multiple Choice Generous performance-based compensation systems. Management preoccupation with increased financial performance. An unreliable accounting system.Correct Strained relationships between management and the auditors.

An unreliable accounting system provides an opportunity for an individual to misappropriate assets. The other items create risks of fraudulent financial reporting.

Analytical procedures are most likely to detect: Multiple Choice Weaknesses of a material nature in internal control. Unusual transactions.Correct Noncompliance with prescribed control activities. Improper separation of accounting and other financial duties.

Analytical procedures are effective in isolating unusual transactions because such transactions may represent a change in a relationship being investigated. Analytical procedures are not typically considered to be tests of internal control, although in certain circumstances they might reveal errors caused by weaknesses in the internal control.

The risk that the auditors will conclude, based on substantive procedures, that a material misstatement does not exist in an account balance when, in fact, such misstatement does exist is referred to as Multiple Choice Business risk. Engagement risk. Control risk. Detection risk.Correct

Detection risk is the risk that the auditor will conclude, based on substantive procedures, that a material misstatement does not exist in an account balance, when, in fact, such misstatement does exist.

Which of the following is not an objective that is intended to be achieved by proper audit documentation? Multiple Choice Assisting in the planning and performance of the engagement. Comparing actual time spent on the engagement to engagement budgets.Correct Retaining a record of matters that may be of continuing significance in future audits. Enable supervisors to direct and supervise the engagement.

Internal time sheets maintained by the engagement team do not constitute audit documentation. Audit documentation assists in the planning and performance of an engagement by keeping a record of what has been done and what conclusions have been drawn, which will affect any additional audit procedures to be performed. Documentation will include significant matters that were detected and which can be carried forward to future engagements when they have continuing significance. Documentation assists supervisors by providing a record of work performed and conclusions drawn, which can be evaluated by the supervisor to determine what, if any, additional work need be performed.

What is the most likely rationalization for theft or fraud by employees? Multiple Choice Valuable inventory is left unattended. Needlessly complex transactions. Stock options that expire soon after the release of financial statements. Perceived mistreatment by management.Correct

Perceived mistreatment by management enables a perpetrator to rationalize theft or fraud. Unattended inventory and needlessly complex transactions provide opportunities for someone to commit fraud, but these factors do not affect one's ability to rationalize its commission. Stock options due to expire shortly after financial statements are issued create an incentive to overstate results in order to increase the value of the options, but it does not provide a rationalization.

What is the most likely opportunity for theft or fraud by employees? Multiple Choice The belief that the theft is a common practice. Needlessly complex transactions.Correct Access to assets that are easily traced. Stock options that expire soon after the release of financial statements.

When transactions are complex, many individuals within the entity will not understand the intricacies and, as a result, it becomes easier to deceive others, creating an opportunity to commit fraud. Ineffective oversight by governance also creates an opportunity for individuals to commit fraud but does not provide an incentive. A belief that the theft is a common practice is a rationalization, not an opportunity. Access to assets that are easily traced tend to result in apprehension and prosecution of the perpetrator of a theft, discouraging such theft. Stock options are due to expire shortly after financial statements are issued create an incentive to overstate results in order to increase the value of the options, but it does not provide an opportunity.

Which of the following are components of the risk of material misstatement (RMM) and can be expressed in both quantitative and qualitative terms? Control Risk Detection Risk Inherent Risk a. No No Yes b. Yes Yes Yes c. Yes No Yes d. Yes Yes No

c

Which of the following statements regarding fraud is not true? Multiple Choice Professional skepticism requires that an audit team begin an engagement with a conscious recognition of the possibility of material misstatement due to fraud. Fraud resulting in material misstatement may not involve direct personal financial gain to the person(s) committing the fraud. The dollar amount involved is what distinguishes fraud from error. Correct The Fraud Triangle consists of Incentive, Opportunity, and Rationalization.

Fraud is an intentional act committed, whereas error is unintentional; dollar amount involved is not what distinguishes them. A fraud scheme will only be successful if all characteristics of the fraud triangle are present, incentive, opportunity, and rationalization, but the incentive is not always personal gain and may be pressure exerted on the perpetrator. In an audit, the CPA is required to apply professional skepticism and maintain the belief that the financial statements may be materially misstated due to fraud.

Which of the following should the auditors obtain from the predecessor auditors before accepting an audit engagement? Multiple Choice Analysis of balance sheet accounts. Analysis of income statement accounts. All matters of continuing accounting significance. Facts that might bear on the integrity of management.Correct

Before accepting an engagement the possible successor should ask questions about the integrity of management, disagreements with management, and the reasons for the change in auditors. All of the other replies are incorrect because they represent information that the successor may wish to obtain after accepting the engagement.

Which of the following best describes what is meant by the term "fraud risk factor"? Multiple Choice Factors that, when present, indicate that risk exists. Factors often observed in circumstances where frauds have occurred.Correct Factors that, when present, require modification of planned audit procedures. Weaknesses in internal control identified during an audit.

Fraud risk factors are factors that have been observed in circumstances in which fraud has occurred. The fraud risk factors were identified by researchers and practitioners through analyses of many past frauds. Yet, none of the factors was always present in the various individual cases included in the analyses. Answer (1) is incorrect because in any particular circumstance, the existence of a fraud risk factor may or may not indicate that in that circumstance the risk of fraud is high. Answer (3) is incorrect because the existence of a fraud risk factor may not require modification of planned audit procedures (e.g., the audit plan may already have audit procedures that consider the factor). Answer (4) is incorrect because a fraud risk factor may or may not be a significant deficiency.

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

Less predictable audit procedures are likely to be used when fraud risks are high. SAS 99 also suggest that the auditors have increased skepticism, assign more skilled staff, and consider further management's selection and application of accounting principles. Answer (1) is incorrect because supervision of members of the audit team will be more closer, not less. Answer (3) is incorrect because team members may or may not be CPAs (e.g., a fraud specialist who is not a CPA might be added to the team). Answer (4) is incorrect because subjective, rather than objective transactions may often be emphasized—depending upon the nature of the fraud risks identified.

Which of the following should not normally be included in the engagement letter for an audit? Multiple Choice A description of the responsibilities of client personnel to provide assistance. An indication of the amount of the audit fee. A description of the limitations of an audit.. A listing of the client's branch offices selected for testing.

Management should not be informed about which branches were selected for testing at all or at least not until just before testing is to be done.

Auditors will apply tests of details to accomplish which of the following? Multiple Choice Compliance with generally accepted accounting principles. Evaluating the operating effectiveness of management's policies and procedures. Detecting material misstatements affecting the financial statements.Correct Determining whether or not the accounting system is reliable.

Tests of details are tests of account balances and classes of transactions and are designed to provide evidence to the auditor that the items reported are fairly presented and are free of material misstatement. Tests of details are performed to comply with GAAS, not GAAP. Evaluating the operating effectiveness of policies and procedures and determining if the accounting system is reliable are part of the understanding of internal control obtained by the auditor and involves tests of controls more than tests of details.

The primary objective of tests of details of transactions performed as substantive procedures is to: Multiple Choice Comply with generally accepted auditing standards. Attain assurance about the reliability of the accounting system. Detect material misstatements in the financial statements.Correct Evaluate whether management's policies and procedures are operating effectively.

The objective of tests of details of transactions performed as substantive procedures is to detect material misstatements in the financial statements as transactions are tested to determine whether they have been properly recorded.

In deciding whether to accept a prospective audit client, which of the following would have the biggest impact on the auditor's decision? Multiple Choice The auditor is not familiar with the industry in which the client operates. The client's predecessor auditor indicated that the client's management lacks integrity.Correct The client's accounting department is staffed by two people who perform many overlapping duties that should be segregated. The client's controller is a former manager of the auditing firm.

The primary objective of a CPA firm's client and engagement continuance and acceptance policies is to avoid association with a client whose management lacks integrity. As a result, any knowledge of management lacking integrity would prevent an auditor from accepting an engagement. An auditor may accept a client in an industry they are not familiar with provided they obtain the understanding and knowledge required prior to starting the audit (a). A lack of segregation of duties is a control deficiency that will affect the nature, timing, and scope of the procedures the auditor performs, but it would not prevent the auditor from accepting the engagement (c). It is acceptable to accept a client who employs a former employee of the auditing firm provided the independence requirements have been complied with (d).

Which of the following statements would be least likely to be included in an audit engagement letter? The fees for our services will be at our regular per diem rates plus out-of-pocket expenses. We will provide you with a list of schedules and information needed by our staff during the audit. We will not disclose any advice provided under the terms of this engagement letter to third parties unless instructed to do so. Our audit will be conducted with the objective of our expressing an opinion on the financial statements.

We will not disclose any advice provided under the terms of this engagement letter to third parties unless instructed to do so. An audit engagement letter is required to indicate the objective and scope of the engagement, which is ultimately the expression of an opinion. It will ordinarily include information about fees and assistance the auditor will require from the client, such as the preparation of schedules or the provision of documents. An indication that advice will not be shared with third parties is not appropriate for an audit, which is not designed to provide advice for the client, and would be more likely included in an engagement letter for a tax or consulting engagement.