Audit Ch. 7-11 Q's

What is the purpose of the client's performance measurement system? How might that system be useful to the auditor? Give examples of key performance indicators for the following businesses: (1) A chain of retail clothing stores; (2) an Internet portal; (3) a hotel chain.

(1) Increase Sales (2) Increase sight hits (3) Increase average occupancy

Which of the following statements describes why a properly designed and executed audit may not detect a material misstatement in the financial statements resulting from fraud? 1. Audit procedures that are effective for detecting an unintentional misstatement may be ineffective for an intentional misstatement that is concealed through collusion. 2. An audit is designed to provide reasonable assurance of detecting material errors, but there is no similar responsibility concerning fraud. 3. The factors considered in assessing control risk indicated an increased risk of intentional misstatements, but only a low risk of unintentional errors in the financial statements. 4. The auditor did not consider factors influencing audit risk for account balances that have effects pervasive to the financial statements as a whole.

1. Audit procedures that are effective for detecting an unintentional misstatement may be ineffective for an intentional misstatement that is concealed through collusion.

After making a preliminary assessment fo the risk of material misstatement during planning and beginning to apply audit procedures, an auditor determines that this risk is actually higher than anticipated. Which would be the most likely effect of this finding on the auditor's desired level of detection risk and the overall level of audit risk, as compared to the levels originally planned? (Auditor's Desired Level of Detection Risk and Overall Level of Audit Risk respectively) 1. Decrease, Same 2. Increase, Same 3. Same, Higher 4. Decrease, Lower

1. Decrease, Same

Which of the following is least likely to be included in the auditor's engagement letter? 1. Details about the preliminary audit strategy 2. Overview of the objectives of the engagement 3. Statement that management is responsible for the financial statements 4. Description of the level of assurance obtained when conducting the audit

1. Details about the preliminary audit strategy

As lower acceptable levels of both audit risk and materiality are established, the auditor should plan more work on individual accounts to 1. Find smaller misstatements 2. Find larger misstatements 3. Increase the performance materiality in the accounts 4. Increase inherent risk in the accounts

1. Find smaller misstatements

A client decides not to record an auditor's proposed adjustments that collectively are not material and wants the auditor to issue the report based on the unadjusted numbers. Which of the following statements is correct regarding the financial statement presentation? 1. The financial statements are free from material misstatement, and no disclosure is required in the notes to the financial statements. 2. The financial statements do not conform with generally accepted accounting principles (GAAP). 3. The financial statements contain unadjusted misstatements that should result in a qualified opinion. 4. The financial statements are free from material misstatement, but disclosure of the proposed adjustment is required in the notes to the financial statements.

1. The financial statements are free from material misstatement, and no disclosure is required in the notes to the financial statements.

Which of the following procedures would a CPA most likely perform during the planning stage of the audit? 1. Evaluate the reasonableness of management's allowance for doubtful accounts 2. Determine areas where there is a higher risk of material misstatement 3. Evaluate the significance of uncorrected misstatements 4. Confirm a sample of accounts receivable

2. Determine areas where there is a higher risk of material misstatement

Dan, CPA, has been engaged to audit Modern Home, a manufacturing company that specializes in furniture. Which of the following matters related to the year under audit would most likely result in an increase of inherent risk? 1. The furniture industry has experienced an overall increase in demand 2. Modern Home recently engaged in a complex derivative transaction 3. Modern Home experienced an increase in working capital 4. Modern Home purchased expensive new equipment in the current year

2. Modern Home recently engaged in a complex derivative transaction

Which of the following circumstances most likely would cause the auditor to suspect that there are material misstatements in the entity's financial statements? 1. The entity's management places no emphasis on meeting publicized earnings projections. 2. Significant differences between the physical inventory count and the accounting records are not investigated 3. Monthly bank reconciliations ordinarily include several large outstanding checks. 4. Cash transactions are electronically processed and recorded, leaving no paper audit trail.

2. Significant differences between the physical inventory count and the accounting records are not investigated

Which of the following circumstances would most likely pose the greatest risk in accepting a new audit engagement? 1. Staff will need to be rescheduled to cover this new client 2. There will be a client-imposed scope limitation 3. The firm will have to hire a specialist in one audit area 4. The client's financial reporting system has been in place for 10 years.

2. There will be a client-imposed scope limitation

In considering materiality for planning purposes an auditor believes that misstatements aggregating $10,000 will have a material effect on an entity's income statement, but that misstatements will have to aggregate $20,000 to materially affect the balance sheet. Ordinarily, it is appropriate to design audit procedures that are expected to detect misstatements that aggregate 1. $20,000 2. $15,000 3. $10,000 4. $30,000

3. $10,000

A successor auditor's inquiries of the predecessor auditor should include questions regarding 1. the number of engagement personnel the predecessor assigned to the engagement 2. The assessment of the objectivity of the client's internal audit function 3. Communications to management and those charged with governance regarding significant deficiencies in internal control 4. The response rate for confirmations of accounts receivable

3. Communications to management and those charged with governance regarding significant deficiencies in internal control

Inherent risk and control risk differ from planned detection risk in that they 1. Arise from the misapplication of auditing procedures 2. May be assessed in either quantitative or non quantitative terms 3. Exist independently of the financial statement audit 4. Can be changed at the auditor's discretion

3. Exist independently of the financial statement audit 4. Can be changed at the auditor's discretion

Some account balances, such as those for pensions and leases, are the result of complex calculations. The susceptibility to material misstatements in these types of accounts is defined as 1. Audit risk 2. Detection risk 3. Inherent risk 4. Sampling risk

3. Inherent risk

Which of the following procedures would a CPA least likely perform during the planning stage of the audit? 1. Determine the timing of tests 2. Take a tour of the client's facilities 3. Perform inquiries of outside legal counsel regarding pending litigation 4. Determine the effect of information technology on the audit

3. Perform inquiries of outside legal counsel regarding pending litigation

In which of the following circumstances would an auditor of an issuer be least likely to reevaluate established materiality levels? 1. The materiality level was established based on preliminary financial statement amounts that differ significantly from actual amounts. 2. The client disposed of a major portion of the client's business 3. The client released third-quarter results before the SEC-prescribed deadline 4. Significant new contractual arrangements draw attention to a particular aspect of a client's business that is separately disclosed in the financial statements.

3. The client released third-quarter results before the SEC-prescribed deadline

Which of the following does not increase the need for sufficient appropriate audit evidence? 1. A lower acceptable level of detection risk 2. An increase in the assessed control risk 3. A lower acceptable audit risk 4. A decrease in the assessed inherent risk

4. A decrease in the assessed inherent risk

Analytical procedures used in planning an audit should focus on identifying 1. Material weaknesses in internal control 2. The predictability of financial data from individual transactions 3. The various assertions that are embodied in the financial statements 4. Areas that may represent specific risks relevant to the audit

4. Areas that may represent specific risks relevant to the audit

Which of the following will most likely indicate the existence of related parties? 1. Writing down obsolete inventory prior to year end 2. Failing to correct deficiencies in the client's internal control 3. An unexplained increase in gross margin 4. Borrowing money at a rate significantly below the market rate

4. Borrowing money at a rate significantly below the market rate

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 is referred to as 1. Sampling risk 2. Inherent risk 3. Control risk 4. Detection risk

4. Detection risk

A successor would most likely make specific inquiries of the predecessor auditor regarding 1. Specialized accounting principles of the client's industry 2. The competency of the client's internal audit staff 3. The uncertainty inherent in applying sampling procedures 4. Disagreements with management as to auditing procedures

4. Disagreements with management as to auditing procedures

An auditor may compensate for a high assessed level of control risk by increasing the 1. Level of detection risk 2. Extent of tests of controls 3. Preliminary judgement of acceptable audit risk 4. Extent of substantive tests

4. Extent of substantive tests

Which one of the following statements is correct concerning the concept of materiality? 1. Materiality is determined by reference to guidelines established by the AICPA. 2. Materiality depends only on the dollar amount of an item relative to other items in the financial statements 3. Materiality depends on the nature of an item rather than the dollar amount 4. Materiality is a matter of professional judgment

4. Materiality is a matter of professional judgment

Prior to, or in conjunction with, the information-gathering procedures for an audit, audit team members should discuss the potential for material misstatement due to fraud. Which of the following best characterizes the mindset that the audit team should maintain during this discussion? 1. Presumptive 2. Judgmental 3. Criticizing 4. Questioning

4. Questioning

When approached to perform an audit for the first time, the CPA should make inquiries of the predecessor auditor. This is a necessary procedure because the predecessor may be able to provide the successor with information that will assist the successor in determining whether 1. The predecessor's work should be used 2. The company follows the policy of rotating its auditors 3. In the predecessor's opinion, internal control of the company has been satisfactory 4. The engagement should be accepted

4. The engagement should be accepted

8-18 Assume that Xinran Wang, CPA, is using 5% of net income before taxes, current assets, or current liabilities as her major guideline for evaluating materiality. What qualitative factors should she also consider in deciding whether misstatements may be material?

8-18?

8-20 Assume a company with the following balance sheet accounts: You are concerned only about overstatements of of owner's equity. Set performance materiality for the three relevant accounts such that the preliminary judgment about materiality does not exceed $5,000. Justify your answer. Cash $10,000 Fixed Assets $60,000 Total $70,000 Long-term Loans $30,000 M. Johnson Proprietor $40,000 Total $70,000

8-20?

What is the primary purpose of analytical procedures performed during the completion phase of the audit?

A final review to identify any oversights. Enhances overall understanding.

Define what is meant by a related party. What are the auditor's responsibilities for related parties and related party transactions?

A related party is defined as an affiliate company, principal owner of the client company, or any other party with which a client deals, where one of the parties can influence the management of operating policies of the other. (smaller, relatives, other companies the owner is a partner or associated with. Bigger, partners, shareholders, etc.) A related party transaction is any transaction between the client and a related party.

Describe how the use of audit data analytics might increase both the effectiveness and efficiency of the audit.

ADA quickly evaluates data giving the auditor a list of items that are seen as risks. This allows the auditor to focus his time on these items that have been marked as risks. And not waist time on the analysis. It also goes through the information with the black and white basis of a computer removing the human error element.

Explain what is meant by the term acceptable audit risk. What is its relevance to evidence accumulation?

Acceptable audit risk is the risk of there being material misstatements that the auditor did not discover that the auditor is okay with. The higher the acceptable audit risk the lower the amount of evidence required and vice versa.

Define fraudulent financial reporting and give two examples that illustrate fraudulent financial reporting

An intentional misstatement or omission of amounts or disclosures with the intent to deceive users. i.e. Capitalization as fixed assets which should have been expensed, and overstatement of income by omitting accounts payable and other liabilities, accelerating the recognition of revenue.

Distinguish between attention-directing analytical procedures and those intended to eliminate or reduce detailed substantive procedures.

Attention directing analytical procedures happens when unexpected, significant differences are found between the present year's unaudited financial statements and other data which is used in comparison. Ratios, additional procedures to see what we want to spend more time on. Confirm our understanding of the financial statements. reduces need for more detailed audit procedures. When the analytical procedure discloses no usual fluctuations, the effect is minimized. In that case the analytical procedure could be used for directing and reducing the substantive tests, which depends on the consequences of the test. Simple procedure as comparing the present year account balance to the previous year balance of each account is more attention directing than the complex analytical procedures.

Identify two types of information in the client's minutes of the board of directors meetings that are likely to be relevant to the auditor. Explain why it is important to read the minutes early in the engagement.

Authorizations, Compensation of officers, new contracts and agreements, acquisitions of property, loans, and dividend payments.

Explain why inherent risk is set for audit objectives for segments (classes of transactions, balances, and related disclosures) rather than for the overall audit. What is the effect on the amount of evidence the auditor must accumulate when inherent risk is increased from medium to high for an audit objective?

Because different areas of an audit may have higher risk than others and by having different levels of risk for these areas it allows the auditor to focus more or less on those areas. The amount of evidence needed increases.

Why is it important to distinguish the auditor's assessment of the risk of material misstatement due to fraud from the assessment of the risk of material misstatement due to error?

Because there is more risk that the auditor will not find misstatements due to fraud as they are purposefully concealed unlike that due to error.

Explain why auditors need an understanding of the client's industry. What information sources are commonly used by auditors to learn about the client's industry?

Better understanding of an industry is helpful in: Risks associated with specific industries my affect the auditor's assessment of client business risk and acceptable audit risk. Familiarity with specific industries aids the auditor in determining their relevance to the client when assessing client business risk and risk of material misstatement. Unique accounting requirements pertaining to a specific industry. Helps the auditor to understand and evaluate the accuracy of a client's financial statements. They can learn through: Tour a Client's Facilities and Operations Identify Related Parties Code of Ethics Minutes of Meetings

Auditors have not been successful in measuring the components of the audit risk model. How is it possible to use the model in a meaningful way without a precise way of measuring the risk?

By using determinants such as high, medium, or low rather than exact numbers.

Provide two examples of factors that might increase the risk of material misstatement at the overall financial statement level.

Deficiency in Management's integrity or competence, ineffective oversight by the board of directors, or inadequate accounting systems and records.

What three auditor actions are required to address the potential for management override of controls?

Examine journal entries and other adjustments for evidence of possible misstatements due to fraud. Review account estimates for biases. And evaluate the business rationale for significant unusual transactions.

Gale Gordon, CPA, has found ratio and trend analysis relatively useless as a tool in conducting audits. For several engagements, he computed the industry ratios for his clients and compared them with industry averages. For most engagements, the client's business was significantly different from the industry data, and the client automatically explained away any discrepancies by attributing them to the unique nature of its operations. In cases in which the client had more than one branch in different industries, Gordon found the ratio analysis to be no help at all. How can Gordon improve the quality of his analytical procedures?

He could improve the quality of the analytical tests by the following: Making the internal comparison to the ratios of the previous years or to the forecast of the budget In the cases where the client has more than one branch in various industries, then computing the ratios of every branch and then comparing them to the ratios of the industry.

What should the audit team consider in its planning discussion about fraud risk?

How and where they believe the entity's financial statements, including disclosures, might be susceptible to material misstatement due to fraud. This should include consideration of known external and internal factors affecting the entity that might - create an incentive or pressure for management to commit fraud. - provide the opportunity for fraud to be perpetrated, including the risk of management override of internal controls. - indicate a culture or environment that enables management to rationalize fraudulent acts. How management could perpetrate and conceal fraudulent financial reporting. How anyone might miss-appropriate assets of the entity. How the auditor might respond to the susceptibility of material misstatements due to fraud.

Which parts of the eight parts of the planning phase of an audit involve the evaluation of risk?

Identify significant risks due to fraud or error Asses inherent risk Understand internal control and assess control risk

Discuss the similarities and differences between evidence in a legal case and evidence in an audit of financial statements

In both it is the basis for drawing conclusions. Audits rely upon the evidence alone, while in a Legal case there are witnesses and other parties involved.

Give examples of risk factors for fraudulent financial reporting for each of the three fraud conditions: incentives/pressures, opportunities, and attitudes/rationalization.

Incentives/Pressures: Financial stability or profitability is threatened, Excessive pressure for management to meed debt repayment or other debt covenant requirements, and Management or the board of directors' personal net worth is materially threatened by the entity's financial performance. Opportunities: Significant accounting estimates involve subjective judgements or uncertainties that are difficult to verify, Ineffective oversight over financial reporting, High turnover or ineffective staff, Deficient internal controls, complex business structure, and significant related-party transactions. Attitudes/Rationalization: Inappropriate or ineffective communication and support of the entity's values, Known history of violations of security laws or other regulations, and management's practice of making unrealistic forcasts to outside parties.

Give examples of risk factors for misappropriation of assets for each of the three fraud conditions: incentives/pressures, opportunities, and attitudes/rationalization.

Incentives/Pressures: Personal financial obligations create pressure for those with access to cash or other assets susceptible to theft to misappropriate those assets. Opportunities: Presence of large amounts of cash on hand or inventory items that are small, of high value, or are in high demand. Attitudes/Rationalizations: Disregard for the need to monitor or reduce risk of misappropriating assets.

In addition to inquiring of individuals among management who are involved in financial reporting positions, such as the CFO and controller, which additional individuals should you consider making inquiries of as part of your risk assessment procedures? Be sure to described how those individuals might be helpful to you in assessing risks of material misstatement.

Individuals involved in the governance of the company. (Board of directors, audit committee, internal auditors, etc.) Help with assessing overall client business risk. Insider knowledge that may help the auditor identify heightened risks of material misstatements. Insight into oversight provided by the board of directors and others, which is an important aspect of internal controls.

Name the three categories of inquiry and describe the purpose of each when used by an auditor to obtain additional information about and suspected fraud.

Information Inquiry - To obtain information about facts and details that the auditor does not have, usually about past or current events or processes. Assessment Inquiry - To corroborate or contradict prior information. Interrogative Inquiry - To determine whether the individual is being deceptive or purposefully omitting disclosure of key knowledge of facts, events, or circumstances.

Describe which two factors of the audit risk model relate to the risk of material misstatement at the assertion level

Inherent Risk and Control Risk

Describe the types of procedures auditors perform as part of their risk assessment procedures.

Inquiries of management and others within the entity Analytical procedures Observation and inspection Discussion among engagement team members Other risk assessment procedures

Auditing standards require that the engagement team members engage in discussion about the susceptibility of the financial statements to the risk of fraud. How does this discussion relate to the required discussion about the risk of material misstatement?

Material misstatements can be due to fraud or errors. Should happen together concurrently.

Define the meaning of the term materiality as it is used in accounting and auditing. What is the relationship between materiality and the phrase obtain reasonable assurance used in the auditor's report?

Materiality is the amount of a misstatement or omission in the accounting information, making it probable that the judgment of the reasonable individual relying on the information must have been influenced or changed by the misstatement or omission. "obtain reasonable assurance" means the auditor does not guarantee the fair presentation of the financial statements. There remains a certain risk that they contain material misstatement.

At the completion of every audit, Roger Morris, CPA, calculates a large number of ratios and trends for comparison which industry averages and prior-year calculations. He believes the calculations are worth the relatively small cost of doing them because they provide him with an excellent overview of the client's operations. If the ratios are out of line, Morris discusses the reasons with the client and often makes suggestions on how to bring the ratio back in line in the future. In some cases, these discussions with management have been the basis for management consulting engagements. Discuss the major strengths and shortcomings of Morris's use of ratio and trend analysis?

More interested in using them to increase possible income making opportunities, rather than in increasing the efficiency/effectiveness of the audit. Possibly harmed his independence.

When a CPA has accepted an engagement from a new client who is a manufacturer, it is customary for the CPA to tour the client's plant facilities. Discuss the ways in which the CPA's observations made during the course of the plant tour will be of help in planning and conducting the audit.

Obsolescence of inventory, both W-I-P & ending inventory. It gives them an idea of their processes and procedures as well as some of their controls. It also gives them an idea of the layout of the operations.

Assume that you are concerned that your client has recorded revenues that did not occur. What audit objective would you assess as having a high risk of material misstatement?

Occurence

Explain the causes of an increased or decreased planned detection risk

Planned Detection risk is increased if AAR (acceptable audit risk) increases, and/or Inherent Risk and/or Control Risk decrease. And decreases vice versa.

Describe what is meant by an audit program for accounts receivable. What four things should be included in an audit program?

Procedure for audit, Sample size, Items that are to be selected, Timing.

What are the characteristics of a confirmation? Distinguish between a confirmation and external documents

Receipt, From independent third party, Oral or written response, Request by the auditor. Confirmation is prepared specifically for the auditor and originates from an external source. External documents is in the hands of the client and prepared by an external party for use in the client's day-to-day operations.

Identify the most important reasons for performing analytical procedures.

Reduction of the detailed tests of an audit Assesment of the organization's ability for continuing as a going concern Indication of the presence of probable misstatements in the financial statements Provide evidence to Account balances

Identify the three categories of client objectives. Indicate how each objective may affect the auditor's assessment of risk of material misstatement and need for evidence accumulation

Reliability of financial reporting Effectiveness and efficiency of operations Compliance with laws and regulations

Why is it important for the auditor to consider the risk of material misstatement at the overall financial statement level?

Risks at the financial statement level increase the likelihood of risks of material misstatement across a number of accounts and assertions for those accounts.

Identify the two factors that determine the persuasiveness of evidence. How are these two factors related to audit procedures, sample size, items to select, and timing?

Sufficiency (Enough, quality, representative) and Appropriateness(relevance & reliability).

Who is considered the client when auditing public companies?

The Audit Committee

What are the responsibilities of the successor and predecessor auditors when a company is changing auditors?

The Successor has the responsibility to contact the Predecessor about a client and it is the Predecessor's responsibility to respond. The Predecessor, however, can only pass along information with the permission of the client.

Explain why there is an inverse relationship between planned detection risk and the amount of evidence an auditor collects for a specific audit objective.

The more evidence accumulated the lower planned audit risk becomes and vice versa. This is due to the fact that the accumulation of evidence decreases risk?

The two components of professional skepticism are a questioning mind and a critical assessment of the audit evidence. How do these components help an auditor distinguish an unintentional misstatement from an intentional (fraudulent) misstatement?

The more evidence you are able to gather the better you can determine whether it is fraud or an unintentional error. Experience comes into play as well.

Explain the circumstances when the auditor should revise the components of the audit risk model and the effect of the revisions on planned detection risk and planned evidence.

When the evidence accumulated during the audit shows that the original assessment of inherent risk was too high or too low. Should use care when exercising.

List the four major evidence decisions that must be made on every audit

Which procedures of audit are to be used What would be the sample size for the given procedure What items are to be selected from the population When the procedure of audit is to be performed

What constitutes a significant risk?

an identified and assessed risk of material misstatement that, in the auditor's professional judgment, requires special audit consideration. Likely to be included in public company audit reports as critical audit matters.

Explain how audit risk and materiality are related and why they need to be considered together in planning and audit.

audit risk is used in determining the amount to be considered as material.

Describe the types of overall responses by auditors to address fraud risk.

discuss the findings with management (obtain management's views and insight), consider whether the controls in place are deficient, assign more experienced personnel to the audit, and consider Management's choice of acct principles.

Distinguish between internal documentation and external documentation as audit evidence and give three examples of each

internal documentation consists of documentation from the client while external is that recieved from an outside source. Internal - Financial Statements, Invoices, Shipping receipts, Inventory, timecards. External - Bank Varification, Confirmations, insurance policies, Canceled N/P

In recent years, globalization of business and factors such as technological destruction, tax reform, trade policies, and changing demographics in the workforce cause uncertainty and volatility in stocks and bond markets. Why might it be important for you to consider current economic and other events as part of planning an audit?

knowledge of these changes can help the auditor identify possible risk areas as well as give an idea of whether or not the company will continue as a going concern.

Identify three verbal and three nonverbal cues that may be observed when making inquiries of an individual who is being deceitful.

Extensive use of modifiers, such as "generally", "usually", "often", etc.; Frequent rephrasing by the interviewee of the auditor's question; and filler terms, such as "um", "well," "to tell the truth," etc. Cross their arms or legs, Show signs of having a dry mouth, avoid eye contact.

How will the conduct of an audit of a medium-size company be affected by the company's being a small part of a large conglomerate as compared with being a separate entity?

For one related to a conglomerate the materiality judgement is based on the conglomerate, while if not it is based on the company alone. Unless it is part of a conglomerate, but the auditor is only giving an opinion on the one company in which case it would follow as if it were not part of the conglomerate.

Define misappropriation of assets and give two examples of misappropriation of assets

Fraud that involves the theft of an entity's assets by employees of the company. i.e. Embezzlement, theft of actual assets (pharmaceuticals stolen and resold).

Discuss the importance of the control environment, or (setting the tone at the top," in establishing a culture of honesty and integrity in a company.

Management leading by example sets the tone for the company and is a foundation they can use to build a more detailed code of conduct. It helps reinforce the values. Employees tend to follow the example of management rather than the old "do as I say, not as I do"

Why is it important that an auditor develop an expectation of the account balance when performing substantive analytical procedures about the reasonableness of an account balance? What are the audit documentation requirements when performing substantive analytical procedure?

It allows the auditor to better recognize discrepancies or at least have a benchmark to compare to. The working paper containing any calculations made by the auditor to create a comparable number.

What are the benefits derived from planning audits?

It enables the auditor to obtain sufficient appropriate evidence for the circumstances Help keep the audit costs reasonable Avoid misunderstandings with the client

What is meant by using benchmarks for setting a preliminary judgement about materiality? How will those benchmarks differ for the audit of a manufacturing company and a government unit such as a school district?

It gives the auditor a range for deciding how in-depth their audit needs to go into specific areas. Different industries have different areas that pose more risk and the Benchmark must be set in relation to that information.

Provide two examples of when an auditor might set a lower level of performance materiality for a particular class of transactions, account balance, or disclosure.

It is a more risky are. or a lower misstatement would have more effect on the company than the same in a different area.

Explain why materiality is important but difficult to apply in practice

It is important in showing the affect of the financial statements. It is difficult as the professional standards of audit offer little guidance regarding the applicability of materiality. Thus it is the professional judgment of the auditor in application of materiality.

Define what is meant by inherent risk. Identify four factors that are associated with higher inherent risk in audits.

It measures the auditor's assessment of the susceptibility of an assertion to material misstatement, before considering the effectiveness of related internal controls. Nature of the business of the client Previous audit results Repeat vs. original engagement Related parties Judgment required for correctly recording the transactions Non routine transactions

Explain the effect of extensive misstatements found in the prior year's audit on inherent risk, planned detection risk, and planned audit evidence

It will increase Planned detection risk for the current year as well as the amount of evidence required for the areas those misstatements were found in.

Auditors are required to make inquiries of individuals in the company when gathering information to assess fraud risk. Identify those with whom the auditor must make inquiries.

Management and others within the company, The audit committee or others charged with governance, Internal auditors, and Those whose duties lay outside of financial reporting.

Distinguish management's responsibility from the audit committee's responsibility for designing and implementing anti fraud programs and. Controls within a company.

Management is responsible for identifying and measuring fraud risks, taking steps to mitigate identified risks, and monitoring internal controls that prevent and detect fraud. The audit committee's responsibility is to oversee the organization's financial reporting and internal control process.

For the audit of Radline Manufacturing Company, the audit partner asks you to carefully read the new mortgage contract with the First National Bank and abstract all pertinent information. List the information in a mortgage that is likely to be relevant to the auditor.

The amount of the Mortgage as a whole as well as the amounts and frequency (dates) of the payments. The interest rate on the mortgage. The Bank's information that the mortgage is through for confirmations.

Explain the relationship between acceptable audit risk and the legal liability of auditors.

The auditor is liable for material misstatements they miss so those with higher acceptable audit risk also have higher likelihood of legal liability related to the audit.

Assume materiality for the financial statements as a whole is $100,000 and performance materiality for accounts receivable is set at $40,000. If the auditor finds one receivable that is overstated by $55,000, what should the auditor do?

The auditor should use more analytical procedures to find the reason for the overstatement.

Explain why the auditor can be persuaded only with a reasonable level of assurance, rather than convinced, that financial statements are correct?

The cost of accumulating evidence and the evidence is usually not reliable enough for the auditor to be convinced of complete correctness.

Your client, Harper Company, has a contractual commitment as a part of a bond indenture to maintain a current ratio of 2.0. If the ratio falls below that level on the balance sheet date, the entire bond becomes payable immediately. In the current year, the client's financial statements show that the ratio has dropped from 2.6 to 2.05 over the past year. How should this situation affect your audit plan?

The drop indicates a liquidity problem. The auditor should pay special attention to determining the ratio of 2.05 as management might have been driven to hide a lower ratio. They will do this by increasing procedures for testing all the current liabilities for cutoff and possible understatement.

Auditing standards require that the engagement team members engage in discussion about the risk of material misstatement. Describe the nature of this required discussion and who should be involved

The engagement partner and key members of the engagement team should be involved. It should consist of the exchange of ideas/brainstorming about the risks and how/where the financial statements, including related disclosures, might be susceptible to material misstatements, whether due to fraud or error.

What is the purpose of an engagement letter? What subjects should be covered in such a letter?

The purpose of an engagement letter is to lay out what the accounting firm is engaged to do and the responsibilities of the company in connection with the engagement. No guarantee that all fraud will be discovered.

Describe what is meant by an audit procedure. Why is it important for audit procedures to be carefully worded?

The thorough instructions for the collection of the type of audit evidence that has to be obtained. As the procedures of audit are the instructions that need to be followed for collecting the evidence, they should be worded carefully for making sure that the instructions are clear.

Explain why liquidity activity ratios ratios are useful to auditors.

They are useful in discovering a companies ability to pay off it's liabilities and determining whether or not the company will continue as a going concern.

How should the auditor consider risks related to revenue recognition when assessing the risk of material misstatement due to fraud?

They should presume it to be significant unless the auditor determines that the presumption is not applicable to that particular audit.

What types of inquiries should the auditor make when considering the risk of material misstatement due to fraud?

They should presume it to be significant unless the auditor determines that the presumption is not applicable to that particular audit.

You go through the drive-through window of a fast food restaurant and notice a sign that reads, " Your meal is free if we fail to give you a receipt." Why would the restaurant post this sign?

To prevent employees from making the food giving it to you and pocketing the cash without recording the sale.

What do auditing standards require the auditor to consider when assessing the risk of material misstatements in revenue?

To recognize it as a fraud risk. Different accounts that relate to revenue, A/R, Cash, etc. Any journal entries and their related support documentation.

Describe examples of characteristics fo transactions and balances that might cause an auditor to determine that a risk of material misstatement is a significant risk

Unusual transactions such as: unusually large or small, infrequent in occurrence.