Auditing Profession and Planning
An independent auditor is concerned about her responsibility for uncovering illegal acts that have been committed by an audit client. Which of the following statements is not true? A company records false sales in its financial statements in order to obtain a bank loan. Defalcation has occurred. One reason that an auditor might not be expected to discover all client illegal acts is that some of these acts may involve nonfinancial problems. One reason that an auditor might not be expected to discover all client illegal acts is that some of these acts may be well hidden from the auditors. A reporting company is guilty of polluting the local river and will be subjected to a heavy monetary fine if caught. This is an example of an indirect illegal act.
A company records false sales in its financial statements in order to obtain a bank loan. Defalcation has occurred. The manipulation of information to make a company look different than it actually is should be referred to as "fraudulent financial reporting." Defalcation is theft. An auditor is not expected to uncover all illegal acts for several reasons. For example, some problems (such as pollution) simply do not refer directly to financial reporting. In addition, the audit client will often make a concerted effort to hide illegal acts so that the auditor is unaware. Finally, a direct illegal act has already had an impact on the financial statements. An indirect illegal act will only impact the financial statements if the company is ever caught and punished.
In registering with the Public Company Accounting Oversight Board (PCAOB), a CPA firm must provide significant information. Which of the following is not a required disclosure? A list of all audit clients. Information about any criminal actions pending against the firm. The annual fees from each client that is an issuer of securities, divided between audit and non-audit services. A list of all accountants participating in the audit of each client that is an issuer of securities.
A list of all audit clients. The CPA firm only needs to provide a list of the audit clients who issue securities. If a company does not issue securities, it is not viewed as a public company and does not come under the jurisdiction of the PCAOB.
A basic objective of a CPA firm is to provide professional services to conform to professional standards. Reasonable assurance of achieving this basic objective is provided through: Continuing professional education. Compliance with generally accepted reporting standards. A system of peer review. A system of quality control.
A system of quality control. A CPA firm should establish adequate quality control policies and procedures to provide reasonable assurance that it follows professional standards on every engagement. The AICPA has issued Statements on Quality Control Standards , in order to provide CPA firms with guidance in establishing quality control policies.
In testing the existence assertion for an asset, an auditor ordinarily works from the Supporting evidence to the accounting records. Potentially unrecorded items to the financial statements. Financial statements to the potentially unrecorded items. Accounting records to the supporting evidence.
Accounting records to the supporting evidence. The existence assertion is concerned that all items recorded in the accounting records are valid (not fictitious). Therefore, the auditor is testing what has been recorded and the direction of the test is from the accounting records to the supporting documentation.
The assessed level of detection risk in an audit is inversely related to which of the following? Risk of failing to discover material misstatements. Assurance provided by substantive tests. Preliminary judgment about materiality levels. Risk of misapplying auditing procedures.
Assurance provided by substantive tests. Detection risk is the risk that the auditor's procedures will not detect an error in an account when in fact one exists. As the auditor's assurance that there are no errors in an account balance is increased by the application of substantive procedures, the auditor's assessment of detection risk will decrease.
All of the following sets of AICPA professional guidance contain both "presumptively mandatory" and "unconditional" professional requirements EXCEPT: Statements on Quality Control Standards Statements on Auditing Standards Auditing Statements of Position Statements on Standards for Accounting and Review Services
Auditing Statements of Position Auditing Statements of Position issued by the AICPA are considered interpretive publications and not auditing standards. While such guidance should be considered by auditors in public practice, this guidance does not contain requirements for auditors.
Charlie Chaucer has been in CPA practice for over 30 years and is well respected in the profession. He has been asked to speak about the AICPA's Code of Professional Conduct, but has not reviewed the independence guidelines in several years. When he notices the section about loans to and from clients, he becomes worried that his independence to a local client, Chipper Falls Credit Union, may be impaired. In which of the following scenarios would Charlie's independence be impaired under the AICPA's independence guidelines? Charlie has a car loan through Chipper Falls Credit union for his son's car, which is collateral for the loan. Charlie's mortgage on his home, which was obtained through Chipper Regional Bank, was sold to Chipper Falls Credit Union. Charlie's mortgage on a vacation home, on which Charlie has forgotten to make payments for the last several months, was obtained through Chipper Falls before Charlie became the credit union's auditor. None of the above
Charlie's mortgage on a vacation home, on which Charlie has forgotten to make payments for the last several months, was obtained through Chipper Falls before Charlie became the credit union's auditor. Because Charlie has failed to make payments on his loan, it no longer qualifies as a "grandfathered" loan under the AICPA guidelines. Therefore, his independence is impaired. The other loans listed are permitted under the independence guidelines because they are normal types of loans and do not create unusual situations or stress.
The Haynsworth CPA firm is auditing Agnestic Corporation. The auditors have come to the conclusion that certain illegal acts may have occurred during the year so that additional testing will be necessary. Which of the following is most likely to have led to this assessment? The design of the company's internal control policies and procedures has not been revised in four years. Related party transactions have occurred throughout the year. Confirmation of accounts receivable indicates that several recorded balances appear to be understated. Checks were written to "cash" during the year despite policies to the contrary.
Checks were written to "cash" during the year despite policies to the contrary. Internal control policies and procedures only need to be revised when they are no longer functioning as intended. A well-designed system might not need to be revised often. Related party transactions are common in many companies and do not, by themselves, indicate any type of illegal activities. Confirmation of receivables which show a pattern of overstatement can possibly indicate that money has been received and then stolen by company employees. However, understatements are more likely to occur because of slowness in posting new sales transactions. Checks should never be written to "cash" because documenting the use made of the money can be very difficult. Hence, checks can be written to "cash" to access money that will then be used for illegal activities.
Which of the following is an illustration of a liability to clients under common law? Federal government prosecutes auditor for knowingly issuing an incorrect audit report. Client sues auditor for not discovering a theft of assets by an employee. Bank sues auditor for not discovering that borrower's financial statements are misstated. Combined group of stockholders sue auditor for not discovering materially misstated financial statements.
Client sues auditor for not discovering a theft of assets by an employee. The client sues auditor for not discovering a theft of assets by an employee is an example of a liability under common law. Since the CPA had a duty to perform, which require him/her to exercise 'due profession care', the misappropriation of assets by one employee should have been uncovered through an audit program which revealed the lack of separation of duties with regard to the employee.
Cutoff tests designed to detect credit sales made before the end of the year that have been recorded in the subsequent year provide assurance about management's assertion of Presentation and disclosure. Existence or occurrence. Completeness. Rights and obligations.
Completeness. The completeness assertion means that nothing has been omitted from the financial statements that should be recorded during a particular period. By performing a cutoff test the auditor is searching for items that have been omitted from the financial statements of the current period.
Holly is joining the audit team of Big Minty Corporation. Her first assignment is to assist with the assessment of fraud risk during the audit planning stage. Under AICPA professional standards, Polly should perform all of the following procedures EXCEPT Designing the audit to detect all errors due to fraudulent financial reporting A discussion among the audit team about how and where the client's financial statements may be at risk for material misstatement due to fraud Designing the audit to provide reasonable assurance of detecting misstatements that are material to the financial statements, whether due to error or fraud Considering the potential for management override of internal controls
Designing the audit to detect all errors due to fraudulent financial reporting The audit must be designed to provide reasonable assurance that material misstatements, due to error or fraud, are detected. Considering management override of controls and the audit team discussion of fraud risk are to be performed during audit planning under AICPA standards.
During the initial planning phase of an audit, a CPA most likely would Inquire of the client's attorney as to whether any unrecorded claims are probable of assertion. Identify specific internal control activities that are likely to prevent fraud. Discuss the timing of the audit procedure with the client's management. Evaluate the reasonableness of the client's accounting estimates.
Discuss the timing of the audit procedure with the client's management. During the planning phase of an audit the CPA would most likely coordinate with client personnel, requiring a discussion of the timing of audit procedures, such as physical count of inventory.
The confirmation of accounts receivable provides evidence about management's assertion of rights and obligations. For what other assertion does the confirmation of accounts receivable balances provide primary evidence?
Existence. The existence (and occurrence) assertion refers to the validity of an item. When a customer replies to a confirmation request, the customer does apparently exist. If the customer did not exist the original confirmation would have been returned as undeliverable by the post office.
In designing the audit program, an auditor should establish specific audit objectives that relate primarily to the
Financial statement assertions. In obtaining audit evidence in support of financial statement assertions, the auditor must develop specific audit objectives related to those assertions.
An independent auditor carries out an audit to reduce the risk that there is a material misstatement in any of the five assertions made by management about the financial statements it has produced. If that risk can be reduced to an acceptably low level, the auditor provides reasonable assurance that the statements are presented fairly according to US generally accepted accounting principles. For which of the following does the auditor not have to seek to reduce the level of risk? Fraudulent financial reporting. Indirect illegal act. An error (an unintentional misstatement). Misappropriation
Indirect illegal act. An indirect illegal act is one where an illegal act has occurred but, to date, it has had no impact on any financial statement balance. Normally, if the company's action is discovered, the company will be subjected to a fine or some other type of punishment that will create a financial impact. Thus, an indirect illegal act is a type of contingency. However, because most such actions are outside of the scope of the auditor's work (and are usually well hidden by the perpetrator), the audit is not designed to reduce the level of risk for that type of problem.
In planning an audit of a new client, an auditor most likely would consider the methods used to process accounting information because such methods Affect the auditor's preliminary judgment about materiality levels. Assist in evaluating the planned audit objectives. Influence the design of internal control. Determine the auditor's acceptable level of audit risk.
Influence the design of internal control. Official standards state that the auditor should consider the methods the entity uses to process accounting information because such methods influence the design of the internal control structure. The extent to which computer processing is used in accounting applications, as well as the complexity of that processing, may also influence the nature, timing, and extent of audit procedures. The other answer choices are incorrect because materiality, audit objectives, and acceptable level of audit risk are not based on the methods used to process accounting information.
The treasurer of a company has stolen $10,000 in cash from the company. At the end of the year, he is afraid that he will be caught so he transfers $10,000 from one company bank account to another. He records the deposit on December 31 of the first year so that $10,000 cash is added. He does not record the withdrawal from the other account until January 1 of the second year. As a result, for one day, the company looks like it has $10,000 more than it really does. What is this deception called?
Kiting When money is moved from one account to another but the deposit and the withdrawal are recorded in different time periods to inflate the amount of cash being reported, the term "kiting" is used to identify that fraud.
Which of the following elements underlies the application of generally accepted auditing standards, particularly the standards of fieldwork and reporting? Adequate disclosure. Quality control. Materiality and audit risk. Client acceptance.
Materiality and audit risk. Audit planning involves developing an overall strategy related to collecting and evaluating the evidence to be obtained. By testing and understanding internal control, the auditors can assess whether it offers assurance that the financial statements will be free from material errors and fraud. These assessments enable the auditors to evaluate the risks of material misstatement of the financial statements.
With respect to the detection of illegal acts, which have an indirect effect on the financial statements, auditing standards state that the auditor provides: Assurance that they will be detected, if highly material. Assurance that they will be detected, if material. No assurance that they will be detected. The same reasonable assurance provided for other items.
No assurance that they will be detected. Illegal acts that have a material but indirect effect on the financial statements are those acts that are removed from transactions and events reflected in the financial statements. The auditor should be aware that they have occurred, although an audit provides no assurance that they will be detected.
he accounting firm of Light & Sabre, CPAs is a regional expert in auditing employee benefit plans. Light & Sabre is currently conducting the audit of the employee benefit plan of Je D'ai Corporation. Under the appropriate independence guidelines for auditors of such plans, a direct or material indirect financial interest in the plan is acceptable for which of the following individuals? Juan, a partner in an office in another city, who is not involved in the audit The firm, Light & Sabre Anakin, who is a junior auditor on the engagement None of the above
None of the above Department of Labor (DOL) guidelines are stricter than those of the AICPA. All of the parties indicated here are considered "members" under the DOL guidelines and are, therefore, prohibited from having any direct or indirect financial interest in the audited plan.
Which of the following procedures would an auditor perform to test the controls relating to management's assertion about the completeness of cash receipts for cash sales at a retail outlet? Observe the consistency of the employees' use of cash registers and tapes. Compare the cash balance in the general ledger with the bank confirmation request. Inquire about the employees' access to recorded but undeposited cash. Trace the deposit in the cash receipt journal to the cash balance in the general ledger.
Observe the consistency of the employees' use of cash registers and tapes. Assertions about completeness are tested by testing whether or not all cash is recorded. If the employees consistently use cash registers and tapes, it is probable that all the cash is recorded.
An auditor most likely would inspect loan agreements under which an entity's inventories are pledged to support management's financial statement assertion of: Presentation and disclosure. Valuation or allocation. Existence or occurrence. Completeness.
Presentation and disclosure. Assertions about presentation and disclosure deal with whether particular components of the financial statements are properly classified, described, and disclosed. An auditor would inspect loan agreements regarding pledged inventories to determine that management has adequately disclosed the security arrangements.
In auditing a client's retained earnings account, an auditor should determine whether there are any restrictions on retained earnings that result from loans, agreements, or state law. This procedure is designed to corroborate which financial statement assertion made by management? Valuation and allocation. Existence or occurrence. Presentation and disclosure. Rights and obligations.
Presentation and disclosure. Restriction on retained earnings should be disclosed in the financial statements. Therefore, the auditor is interested in knowing whether all of the needed information is being presented in the financial statements.
A CPA firm's personnel partner periodically studies the CPA firm's personnel advancement experience to ascertain whether individuals meeting stated criteria are assigned increased degrees of responsibility. This is evidence of the CPA firm's adherence to prescribed standards of Fieldwork. Supervision and review. Due professional care. Quality control.
Quality control. Quality control standards apply to auditors of both public and private companies. The PCAOB has adopted the AICPA's quality control standards. The following is a list of the 5 quality control elements. Quality control is a process to provide the firm with reasonable assurance that its personnel comply with the applicable professional standards. The elements of a system of quality control are: 1. independence, integrity and objectivity; 2. personnel management; 3. acceptance and continuation of clients; 4. engagement performance; and 5. monitoring. Due professional care and fieldwork relate to GAAS. Supervision and review is a component of Quality Control (the engagement performance element.)
The audit work performed by each assistant should be reviewed to determine whether it was adequately performed and to evaluate whether the
Results are consistent with the conclusions to be presented in the auditor's report. The first standard of field work requires supervision of assistants, if any. Supervision involves directing the efforts of assistants who are involved in accomplishing the objectives of the audit and determining whether those objectives were accomplished. An element of supervision is reviewing the work performed by each assistant to determine whether it was adequately performed and to evaluate whether the results are consistent with the conclusions to be presented in the auditor's report.
Which of the following is the basic fundamental concept that underlies the audit process? Skepticism. Materiality. Risk. All of the above.
Risk. Risk is the basic fundamental concept that underlies the audit process. It is the acceptance by auditors that there is some level of uncertainty in performing the audit function.
The element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the Schedules and analyses to be prepared by the client's staff. Methods of statistical sampling to be used in confirming accounts receivable. Pending legal matters to be included in the inquiry of the client's attorney. Evidence to be gathered to provide a sufficient basis for the auditor's opinion.
Schedules and analyses to be prepared by the client's staff. The other answers involve judgment by the auditor only and as such the decision process only involves the auditor. Schedules and analyses to be prepared by the client's staff, however, would necessarily have to involve the client since the client will be preparing the schedules.
Audit programs should be designed so that
The audit evidence gathered supports the auditor's conclusions. The fieldwork standards require that an audit program be designed so that sufficient evidence is gathered to support the auditor's conclusions.
When allocating materiality, most practitioners choose to allocate to: The income statement because they are most important. The balance sheet accounts because there are fewer. Both balance sheet and income statement accounts because there could be errors on either. All of the financial statements because they are all equally important.
The balance sheet accounts because there are fewer. Most practitioners allocate materiality to balance sheet rather than income statement accounts, because most income statement misstatements have an equal effect on the balance sheet due to the double-entry bookkeeping system. It is inappropriate to allocate the preliminary to both statements because doing so will result in double counting.
The risk of material misstatement refers to:
The combination of inherent risk and control risk. Inherent risk (IR) measures the auditor's assessment of the likelihood that there are material misstatements in a segment before considering the effectiveness of internal control. Control risk (CR) measures the auditor's assessment of whether the misstatement will be prevented or detected on a timely basis by the client's internal control. Multiplying IR by CR results in the combination referred to (SAS 107) as the risk of material misstatement.
The Peyton Company is being audited for the first time by Manning CPAs. The auditing firm is assessing the amount of risk that will be faced and is looking at several possible risk factors. Which of the following is least likely to be viewed as a significant risk associated with the audit of the financial statements? A new product line has just been introduced. The corporation considered expanding into Mexico and Canada but chose to keep operations within the United States. The company has recently switched over to a new computer system to manage its inventory balances. A new company just entered the market as a direct competitor of Peyton.
The corporation considered expanding into Mexico and Canada but chose to keep operations within the United States. Anything that is new will raise the level of risk because the auditor has to judge how well the company adapts to that change. Problems can include new employees, new systems, new products, new territories, new competitors, and new accounting pronouncements. Companies must be able to adapt to such changes and the risk that they will fail to do adequately is always a concern. However, the decision not to expand, even if that choice was a bad one, should not have an adverse impact on the risk of material misstatements in the financial statements.
Which of the following would an auditor most likely use in determining the auditor's preliminary judgment about materiality?
The entity's financial statements of the prior year. The auditor is directed by auditing standards to consider, among other things, prior periods' financial results and financial positions.
An auditor is analyzing documents created by a client company in connection with the purchase of a large warehouse. In studying the ten-year loan that was taken out to pay for the acquisition, the auditor discovers that the company must maintain a current ratio of at least 2-to-1 or the debt can be immediately called by the bank. The current ratio is well over 2-to-1 at the moment. What impact does this requirement have on the auditor's investigation of the financial statements? The loan must be recorded as a current liability rather than as a noncurrent liability. The requirement impacts the capitalized cost of the warehouse. The requirement impacts the book value reported for the liability. The requirement must be disclosed in the notes to the financial statements.
The requirement must be disclosed in the notes to the financial statements. Because the requirement has been met to date, no change is needed in any of the reported balances. However, the presentation of the financial statements is still in question; the information about the loan covenant must be properly disclosed. Because of the requirement, the auditor is concerned with the presentation and disclosure assertion in connection with the financial statements.
To succeed in an action against the auditor, the client company must be able to show that: There is a close causal connection between the auditor's behavior and the damages suffered by the client. The auditor was grossly negligent. The auditor was fraudulent. There was a written contract.
There is a close causal connection between the auditor's behavior and the damages suffered by the client. To succeed in an action against the auditor, the client must be able to show that: (1) the CPA had a duty to perform, (2) the CPA breached the contract, (3) the client suffered losses and (4) there is a close causal connection between the auditor's behavior and the damages suffered by the client.
The audit firm of Samson and Delilah is looking at the inventory procurement system of an audit client. The auditors have now made the determination that the inherent risk is higher than had originally been expected. Which of the following statements is most likely to be true? The company's internal control within this system is weaker than had been anticipated. The company's internal control within this system is stronger than had been anticipated. The auditors might have to increase the desired amount of detection risk to a higher level than originally anticipated. This discovery should have no impact on the desired level of audit risk for this particular system.
This discovery should have no impact on the desired level of audit risk for this particular system. Auditors typically assess inherent risk (the risk that a material misstatement might occur in accounting for a particular account or balance) and then assess control risk (the risk that a material misstatement that actually occurs will be able to get through the reporting company's internal control and wind up within the reported financial statements). The two assessments of inherent risk and control risk are independent. However, detection risk is the likelihood that a material misstatement that is created and gets through the internal control systems will also get through the testing by the independent auditor. If either inherent risk or control risk is especially high, then enough substantive testing must be done by the auditor so that detection risk is reduced low enough to compensate. In that way, even if inherent risk is high, the reduction of detection risk will offset that impact so that overall audit risk remains unchanged.
An auditor most likely would analyze inventory turnover rates to obtain evidence concerning management's assertions about Existence or occurrence. Valuation or allocation. Presentation and disclosure. Obligations and Rights.
Valuation or allocation. Assertions about valuation or allocation deal with whether asset, liability, revenue, and expense components have been included in the financial statements at appropriate amounts. An auditor would look at inventory turnover rates to determine if the inventory amount on the balance sheet and the cost of goods sold amount on the income statement are reasonable, in relation to each other.
An auditor concluded that no excessive costs for idle plant were charged to inventory. This conclusion most likely related to the auditor's objective to obtain evidence about the financial statement assertions regarding inventory, including presentation and disclosure and Valuation or allocation. Completeness. Existence. Obligations and Rights.
Valuation or allocation. Assertions about valuation or allocation deal with whether asset, liability, revenue, and expense components have been included in the financial statements at appropriate amounts. If the auditor is concluding that no excessive costs were charged to inventory, he or she has gathered evidence regarding valuation of amounts in the inventory account.
Darn Yarn Co. is audited by Scoop & Sweet, CPAs. Which of the following parties is not considered a "covered member" for purposes of the AICPA Code of Professional Conduct independence standards? Rob Jolly, who provides 40 hours of tax services to Darn Yarn every year Candy Cohen, a partner in the office of Scoop & Sweet from which the audit is conducted Van Wafer, a secretary who faxes, mails, and files audit documentation for the Darn Yarn audit, and other audits, as needed Brandy Carsen, human resources manager at Scoop & Sweet who determines pay raises for members of the audit team
Van Wafer, a secretary who faxes, mails, and files audit documentation for the Darn Yarn audit, and other audits, as needed Rob qualifies as a covered member, since he provides ten or more hours of non-attest services to the client. Candy is a partner in the same office and Brandy is in a position to influence the attest team, so both are covered members. Therefore, only Van, who performs only routine clerical duties, is not required to be independent under the provisions of the AICPA Code of Professional Conduct.
