Chapter 4

Independent auditors who consider fraud in the course of financial statement audits are well-advised to quantify "materiality" in terms of

A cumulative amount of misstatement of assets or income over several years past and current that might mislead investors in relation to the latest financial statements under audit

An auditor assesses the risk of material misstatement because it

Affects the level of detection risk that the auditor may accept

What statement concerning noncompliance by clients is correct

An auditor's responsibility to detect noncompliance that has a direct and material effect on the financial statements is the same as that errors and frauds

An auditor's analytical procedures indicate a lower than expected return on an equity method investment. This situation most likely could have been caused by

An error in recording amortization of the excess of the investor's cost over the investment's underlying book value

What would not likely be found in the minutes of the board of directors

Approval of a new desktop computer for the controller

For audits of financial statements made in accordance with generally accepted auditing standards, the use of analytical procedures is required to some extent.

As a substantive test: No In the final review stage: yes

The acceptance level of detection risk is inversely related to the

Assurance provided by substantive tests

The auditor uses the assessed level of risk of material misstatement to determine the acceptable level of detection risk for financial statement assertions. As the acceptable level of detection risk decreases, the auditor may do one or more of the following except change the

Assurances provided by substantive tests to a lower level

The probability that an audit team will give an inappropriate opinion on financial statements best describes

Audit risk

The existence of audit risk is recognized by the statement in the auditor's standard report that the

Auditor obtains reasonable assurance about whether the financial statements are free of material misstatement

What statement best describes auditors' responsibility to detect errors and frauds

Auditors should design an audit to provide reasonable assurance of detecting errors and frauds that are material to the financial statements

Sources of financial and nonfinancial data in do not include

Bureau of Labor statistics

Horizontal analysis refers to

Changes in financial statement numbers and ratios across several years

What analytical procedure most likely would be used during the planning stage of an audit

Comparing current-year to prior-year sales volumes

What is not required by AU 240, "Consideration of Fraud in a Financial Statement Audit"?

Conduct inquiries of shareholders as to their views about the risks of fraud and their knowledge of any fraud or suspected fraud

Based on 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

Decrease detection risk

According to auditing standards, external auditors' responsibilities for indirect noncompliance do not include

Designing audit procedures to detect noncompliance in the absence of specific information brought to the auditors' attention

The risk that an auditor's procedures will lead to the conclusion that a material misstatement does not exist in an account balance when, in fact, such misstatement actually exists is

Detection risk

If control risk increases, and all other risks in the audit risk model stay constant except the one referred to below, what statement is correct

Detection risk will decrease

An audit team uses the assessed risk of material misstatement to

Determine the acceptable level of detection risk for financial statement assertions

Jones, CPA, is auditing the financial statements of XYZ Retailing Inc. What assurance does Jones provide that direct effect noncompliance that is material to XYZ's financial statements, and noncompliance that has a material, but indirect effect on the financial statements will be detected?

Direct effect noncompliance: Reasonable Indirect effect noncompliance: None

Analytical procedures used in planning an audit should focus on

Enhancing the auditor's understanding of the client's business

What assurance does the auditor provide that errors, frauds, and direct effect noncompliance that are material to the financial statements will be detectd

Errors: Reasonable Frauds: Reasonable Direct Effect Noncompliance: Reasonable

When an auditor becomes aware of possible noncompliance by a client, the auditor should obtain an understanding of the nature of the act to

Evaluate the effect on the financial statements

The risk of material misstatement differs from detection risk in that it

Exists independently of the financial statement audit

When an auditor increases the planned assessed level of control risk because certain control activities were determined to be ineffective, the auditor most likely increase the

Extent of substantive tests of details

External auditors are responsible

For reporting immaterial frauds to a level of management at least one level above the people involved

Inherent risk and control risk differ from detection risk in that inherent risk and control risk are

Functions of the client and its environment whereas detection risk is not

Certain conditions and circumstances are often present when management fraud occurs. What is not such a condition or circumstance

High liquidity

In the planning stage, analytical procedures are used to

Identify potential problem areas

Analytical procedures are audit methods of evaluating financial statement accounts by studying and comparing relationships among financial and nonfinancial data. The primary purpose of analytical procedures conducted during the planning stages is to

Identify unusual conditions that deserve additional audit effort

If fictitious credit sales were recorded, and the fictitious accounts receivable were later directly written off as bad debt expense

Income would not be misstated

What is an acceptable response to fraud risks related to sales that were identified in an audit

Increase the assessment of detection risk for sales

If an auditor encounters significant risks at the client the auditor should do everything except

Inform the SEC

Inherent risk and control risk differ from detection risk in what ways

Inherent risk and control risk exist independently of the audit

Management fraud generally refers to

Intentional distortions of financial statements

What accounts tend to be most predictable for purposes of analytical procedures

Interest expense

Managing Business Risk is the responsibility of

Management

The major emphasis in GAAS related to consideration of fraud in a financial statement audit (AU 240) is on

Management fraud

Experience has shown that the many large fraudulent transactions can be found in

Non-routine, nonsystematic journal entries

Analytical procedures are most appropriate when testing what type of transactions

Operating expense transactions

Assume that application of analytical procedures revealed significant unexplained differences between recorded amounts and the expectations (estimates) developed by the auditor. If management is unable to provide an acceptable explanation, the auditor should

Perform additional audit procedures to investigate the matter further

Inherent risk is the

Probability that material misstatements have occurred in transactions entering the accounting system used to develop financial statements

What would not be considered an analytical procedure

Projecting a deviation rate by comparing the results of a statistical sample with the actual population characteristics

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. What best characterizes the mind-set that the audit team should maintain during this discussion?

Questioning

When determining the inherent risk related to an account balance, an auditor theoretically does not explicitly consider the

Related internal control policies and procedures

If not already performed during the overall review stage of the audit, the auditor should perform analytical procedures relating to what transaction cycles

Revenue

Generally accepted auditing standards states that analytical procedures

Should be applied in the planning and final review stages of the audit and can be used as a substantive test during the audit

In auditing related party transactions, an auditor ordinarily places primary emphasis on

The adequacy of the disclosure of the related party transactions

An auditor who discovers that client employees have committed an illegal act that has a material effect on the client's financial statements most likely would withdraw from the engagement if

The client does not take the remedial action that the auditor considers necessary

What pieces of information discovered by an auditor when performing substantive tests of account balances would most likely raise red flags about the possible existence of material fraudulent financial reporting

The client's estimate of the allowance for doubtful accounts is lower than the auditor's independent evaluation of the allowance

What information that comes to an auditor's attention most likely would raise a question about the occurrence of illegal acts

The discovery of unexplained payments made to government employees

While performing an audit of the financial statements of a company for the year ended December 31, year 1, the auditor notes that the company's sales increased substantially in December, year 1, with a corresponding decrease in January, year 2. In assessing the risk of fraudulent financial reporting or misappropriation of assets, what should be the auditor's initial indication about the potential for fraud in sales revenue?

There is a broad indication of financial reporting fraud

Auditors would use the Enterprise Risk Model

To evaluate management's risk assessment

Auditors use brainstorming

To heighten the audit team's awareness of fraud potential

The purpose of an audit strategy is

To set the scope, timing, and direction for auditing each relevant assertion

While performing interim audit procedures of accounts receivable, numerous unexpected errors are found resulting in a change of risk assessment. What audit responses would be most appropriate?

Use more experienced audit team members to perform year-end testing

The type of financial analysis that expresses balance sheet accounts as percentages of total assets is know as

Vertical analysis

When fraud risk is significant, and management cooperation is unsatisfactory, the auditors will most likely

Withdraw from the engagement

If tests of controls induce the auditor to change the assessed level of control risk for Property Plant & Equipment from 50% to 100%, and audit risk (6%) and inherent risk remain constant, the acceptable level of detection risk

Would most likely change from 30% to 15%