CHAPTER 6 Audit Planning, Understanding the Client, Assessing Risks, and Responding

Tracing from source documents to journals most directly tests: A. Completeness (understatements). B. Existence (overstatements).

A. Completeness (understatements).

Define Analytical procedures

Tests that involve comparisons of financial data for the current year to those of prior years, budgets, non-financial data, or industry averages. From a planning standpoint, analytical procedures help the auditors obtain an understanding of the client's business, identify financial statement amounts that appear to be affected by errors or fraud, or identify other potential problems.

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

B. Use less predictable audit procedures.

The audit committee of a company must be made up of: A. Representatives from the client's management, investors, suppliers, and customers. B. The audit partner, the chief financial officer, the legal counsel, and at least one outsider. C. Representatives of the major equity interests, such as preferred and common stockholders. D. Members of the board of directors who are not officers or employees.

D. Members of the board of directors who are not officers or employees.

Describe The Engagement letter

An agreement between the CPA firm and the client as to the terms of the audit engagement. The terms of the engagement should include (1) the objectives and scope of the audit, (2) auditor and management responsibilities, (3) inherent limitations of the audit, (4) the applicable financial reporting framework, and (5) the expected form and content of reports to be issued by the auditors.

Vouching from journals (or ledgers) to source documents most directly tests: A. Completeness (understatements). B. Existence (overstatements).

B. Existence (overstatements).

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

D. Facts that might bear on the integrity of management.

As one step in testing sales transactions, a CPA traces a random sample of sales journal entries to debits in the accounts receivable subsidiary ledger. This test provides evidence as to whether: A. Each recorded sale represents a bonafide transaction. B. All sales have been recorded in the sales journal. C. All debit entries in the accounts receivable subsidiary ledger are properly supported by sales journal entries. D. Recorded sales have been properly posted to customer accounts.

D. Recorded sales have been properly posted to customer accounts.

List the Conditions Indicative of Fraud

1. Discrepancies in the Accounting Records 2. Conflicting or Missing Evidence 3. Problematic or Unusual Relationships between the Auditors and Client

List the Relevant Assertion Level Risks

1. Existence and occurrence. 2. Rights and obligations. 3. Completeness. 4. Cutoff. 5. Valuation, allocation, and accuracy. 6. Presentation and disclosure.

LO 6-1 Describe the major steps in the audit process.

1. Plan the audit. 2. Obtain an understanding of the client and its environment, including internal control. 3. Assess the risks of misstatement and design further audit procedures. 4. Perform further audit procedures. 5. Complete the audit. 6. Form an opinion and issue the audit report.

Define Relevant assertion

A financial statement assertion that has a reasonable possibility of containing a misstatement or misstatements that would cause the financial statements to be materially misstated. The determination of whether an assertion is a relevant assertion is based on inherent risk, without regard to the effect of controls.

Definition (or Portion)Term A. Representations by management that are communicated, explicitly or implicitly, in the financial statements. B. A description of the nature, timing, and extent of the audit procedures to be performed. C. An estimate of the time required to perform each step in the audit. D. The purpose of this document is to avoid misunderstandings between the auditors and the client. E. The risk of material misstatement of an assertion about an account without considering internal control. F. At the overall engagement level, this is the risk that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated. G. An identified risk that requires special audit consideration. H. A risk that threatens management's ability to achieve the organization's objectives. TERMS: Audit plan Assertions Audit risk Representation letter Business risk Control risk Engagement letter Inherent risk Significant risk Survival risk Time budget

A. Assertions B. Audit Plan C. Time Budget D. Engagement Letter E. Inherent Risk F. Audit Risk G. Significant Risk H. Business Risk

The auditors are concerned about source documents that reflect valid transactions that have not been recorded in the journals. Which procedure would be most effective? A. Trace from source documents to journals. B. Vouch from journals to source documents. C. Either (1) or (2).

A. Trace from source documents to journals.

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

B. Factors often observed in circumstances where frauds have occurred.

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

B. Factors often observed in circumstances where frauds have occurred.

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

B. Use less predictable audit procedures.

The auditors are concerned about transactions that have been recorded in the journals (and subsequently in the ledgers) that are not valid—that is, a transaction is recorded, but it did not actually occur (e.g., a fraudulent overstatement of sales). Which procedure would be most effective? A. Trace from source documents to journals. B. Vouch from journals to source documents. C. Either (1) or (2).

B. Vouch from journals to source documents.

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? A. Generous performance-based compensation systems. B. Management preoccupation with increased financial performance. C. An unreliable accounting system. D. Strained relationships between management and competing companies.

C. An unreliable accounting system.

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

C. Detect material misstatements in the financial statements.

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

C. Detect material misstatements in the financial statements.

The auditors are concerned about transactions that have been recorded for improper amounts. Which procedure would be most effective? A. Trace from source documents to journals. B. Vouch from journals to source documents. C. Either (1) or (2).

C. Either (1) or (2).

Which of the following elements underlies the application of auditing standards, particularly those related to fieldwork and reporting? A. Adequate disclosure. B. Quality control. C. Materiality and audit risk. D. Client acceptance.

C. Materiality and audit risk.

Which of the following elements underlies the application of auditing standards, particularly those related to fieldwork and reporting? A. Adequate disclosure. B. Quality control. C. Materiality and audit risk. D. Client acceptance.

C. Materiality and audit risk.

Which portion of an audit is least likely to be completed before the balance sheet date? A. Tests of controls. B. Issuance of an engagement letter. C. Substantive procedures. D. Assessment of control risk.

C. Substantive procedures.

Which portion of an audit is least likely to be completed before the balance sheet date? A. Tests of controls. B. Issuance of an engagement letter. C. Substantive procedures. D. Assessment of control risk.

C. Substantive procedures.

Three conditions generally are present when fraud occurs. Select the one below that is not one of those conditions. A. Incentive or pressure. B. Opportunity. C. Supervisory position. D. Attitude.

C. Supervisory position.

Three conditions generally are present when fraud occurs. Select the one below that is not one of those conditions. A. Incentive or pressure. B. Opportunity. C. Supervisory position. D. Attitude.

C. Supervisory position.

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

D. A listing of the client's branch offices selected for testing.

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

D. A listing of the client's branch offices selected for testing.

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 A. Business risk. B. Engagement risk. C. Control risk. D. Detection risk.

D. Detection risk.

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 A. Business risk. B. Engagement risk. C. Control risk. D. Detection risk.

D. Detection risk.

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

D. Facts that might bear on the integrity of management.

The audit committee of a company must be made up of: A. Representatives from the client's management, investors, suppliers, and customers. B. The audit partner, the chief financial officer, the legal counsel, and at least one outsider. C. Representatives of the major equity interests, such as preferred and common stockholders. D. Members of the board of directors who are not officers or employees.

D. Members of the board of directors who are not officers or employees.

As one step in testing sales transactions, a CPA traces a random sample of sales journal entries to debits in the accounts receivable subsidiary ledger. This test provides evidence as to whether: A. Each recorded sale represents a bonafide transaction. B. All sales have been recorded in the sales journal. C. All debit entries in the accounts receivable subsidiary ledger are properly supported by sales journal entries. D. Recorded sales have been properly posted to customer accounts.

D. Recorded sales have been properly posted to customer accounts.

Describe Performance materiality

The amount (or amounts) set by the auditors at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the total of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole. It also refers to the amount (or amounts) set by the auditor at less than the materiality level for particular classes of transactions, balances, or disclosures.

describe Tolerable misstatement

The application of performance materiality to a particular sampling procedure. Tolerable misstatement is a monetary amount set by the auditors for a particular test to obtain an appropriate level of assurance from all the tests that the account is not materially misstated. Whereas the auditor may establish a level of performance materiality for an account (e.g., accounts receivable), the same or different tolerable misstatement levels may be established for each audit test performed for that account.

Describe Overall audit strategy

This strategy involves determining overall characteristics of the engagement that define its scope, determining the engagement's reporting objectives to plan the timing of procedures, and considering important factors that will determine the focus of the audit team's efforts. When the overall audit strategy has been established, the auditors start the development of a more detailed audit plan to address the various matters identified in the audit strategy.