Topic 1 - Multiple Choice - What is Auditing and Why Does It Matter?

A common cause for unintentional misstatements is human judgment errors. a. True b. False

Answer: True This statement is true. Human judgment errors often lead to unintentional errors in the financial statements.

Attest services performed by an auditor can include analyzing prospective (forward-looking) financial information. a. true b. false

Answer: True This statement is true.

Which of the following best describes the type of assurance provided by a CPA when performing a *review* of financial statements? a. absolute assurance b. limited assurance c. reasonable assurance. d. none of the above.

Answer: b. Limited assurance The CPA provides limited assurance on the financial statements when performing a *review* of financial statements.

Which of the following is a distinguishing factor of attest services? a. a written report is issued b. the assurance is provided on subject matter that is someone else's responsibility c. Both of the above are distinguishing factors of attest services. d. Neither of the above are distinguishing factors of attest services.

Answer: c. Both of the above are distinguishing factors of attest services Attest services involve a written report being issued regarding a subject matter that is the responsibility of someone else. Hint: an attest service is a subset of assurance.

SysTrust and WebTrust are types of assurance services aimed at improving the quality of information relating to IT systems and websites. a. true b. false

Answer: true

The largest public accounting firms are referred to as the 'Big 4'. a. true b. false

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An individual who has worked for a public accounting firm for 3 years would most likely have which of the following titles? a. Senior (in charge) b. Partner c. Associate (staff) d. Manager

An individual who has worked for a public accounting firm for 3 years would most likely be a 'Senior'.

An unqualified (unmodified) audit opinion is a negative opinion regarding the financial statements indicating that the financial statements are not fairly stated. a. True b. False

Answer: False An unqualified (unmodified) audit opinion is positive in nature indicating that the auditor can state that they believe the financial statements are fairly stated without qualification.

When auditing financial statements, auditors seek to identify all misstatements in the financial statements, regardless of size. a. True b. False

Answer: False Auditors seek to identify only material misstatements. While they may identify misstatements that are not material in nature, they do not design their audit procedures to identify non-material misstatements.

Audits of financial statements provide absolute assurance that the financial statements are free of material misstatements. a. true b. false

Answer: False Audits of financial statements provide reasonable, but not absolute, assurance that the financial statements are free of material misstatement.

One example of a compilation service performed by a CPA is for the CPA to provide bookkeeping services to the client. a. true b. false

Answer: False Compilation services include using the client's data to prepare, or compile, financial statements. The auditor does not perform ongoing bookkeeping, they simply compile the client-recorded data into financial statements.

If there were no way to gain assurance regarding the accuracy of financial statement information provided by management, investors would typically assume it was high quality. a. True b. False

Answer: False Investors would typically assume average quality if they could not gain assurance regarding the accuracy of financial information.

The 'risk premium' is defined as the amount of risk that is optimal in a given audit setting. a. True b. False

Answer: False Risk premium is the difference between the return demanded by investors and the return that would be demanded in the absence of risk.

GAAS is the 'established criteria' used in an audit of financial statements. a. true b. false

Answer: False The established criteria used in the audit of financial statements is GAAP. While GAAS provides guidance to the auditor regarding how to carry out the financial statement audit, the client's financial statements are compared to GAAP.

The term 'assertion' refers to the process of carrying out the financial statement audit. a. true b. false

Answer: False The term 'assertion' refers to implicit or explicit claims made by management in the preparation of the financial statements.

Each of the Big 4 use the Limited Liability Company (LLC) form of business organization. a. true b. false

Answer: False This is false. Each of the Big 4 use the Limited Liability Partnership (LLP) form of business organization.

The U.S. Government has found that there is a lack of competition in the market for external audit services that is cause for concern. a. true b. false

Answer: False This is false. The studies performed by the U.S. government have found that there is no cause for concern at this time.

In the audit context moral hazard refers the the risk that, being sheltered from the majority of negative consequences, management may misstate the financial statements in order to profit from gains in the stock price. a. True b. False

Answer: True

Attest services involve the issuance of a report regarding the subject matter being examined. a. true b. false

Answer: True Attest services involve issuing a report regarding the subject matter examined.

Spending the time and money to provide high quality information to the public benefits both investors AND the company providing the information. a. True b. False

Answer: True High quality information benefits the public because it helps them make better investment decisions. It benefits the company by reducing its cost of capital due to lower risk premiums charged by investors and lenders.

Auditors provide value to the financial statements through both preventing and detecting material misstatements. a. True b. False

Answer: True Knowing that the auditor will be evaluating the financial statements will cause management to be more careful in preparing them, reducing the likelihood of both intentional and unintentional misstatements.

An auditor assesses management's compliance with a federal regulation and reports the results to interested users through a written report. This is an example of an attest service. a. true b. false

Answer: True This is an example of an attest service.

An audit failure occurs when the auditor reports to the public their opinion that the financial statements are free of material misstatements when the financial statements actually contain a material misstatement. a. true b. false

Answer: True This is the definition of an audit failure.

Most audit engagements include only one manager assigned to the audit engagement. a. true b. false

Answer: True This is true. Most engagements include one partner, one manager, one senior, and multiple associates (staff).

Even though there are 4 very large public accounting firms (the Big 4), very large clients are often limited to 2-3 firms to choose from for conducting their external audit. a. true b. false

Answer: True This is true. Since these large clients also obtain consulting and other services from the Big 4 firms and since firms that provide these services cannot also perform the external audit for the same client, clients are left with fewer firms to choose from for their financial statement audit.

The individual hired to perform an audit of a client's financial statements is often called the "external auditor." a. true b. false

Answer: True This statement is true.

A high quality audit of financial statements provides a high level of, but not absolute, assurance that the financial statements are free of material misstatement. a. true b. false

Answer: True This statement is true. Auditors seek to provide reasonable assurance, not absolute assurance.

Passing the CPA exam, or its equivalent in other countries, establishes only the minimum threshold of competence needed to conduct a high quality audit. a. true b. false

Answer: True This statement is true. Auditors should continue to learn throughout their careers in order to provide high quality audits.

One result of the market for lemons in the capital markets is that products sold by the companies are often more expensive. a. true b. false

Answer: True This statement is true. Companies in this environment have a more difficult time obtaining financing so they cannot invest in efficient manufacturing processes and often cannot take advantage of economies of scale causing products to be more expensive.

If an auditor is an expert in the industry her client operates in, she will provide a higher quality audit on average than an auditor who is not an expert in their client's industry. a. true b. false

Answer: True This statement is true. Knowing the client's industry well generally improves the quality of the audit.

Which of the following best describes the importance of audit quality to the financial statement audit? a. Higher audit quality results in more accurate financial statements as well as a higher level of trust from users of the financial statements b. Higher audit quality results in neither a higher level of trust from users of the financial statements nor more accurate financial statements c. Higher audit quality results in a higher level of trust from users of the financial statements, but not more accurate financial statements d. Higher audit quality results in more accurate financial statements, but not a higher level of trust from users of the financial statements

Answer: a. Higher audit quality results in more accurate financial statements as well as a higher level of trust from users of the financial statements High audit quality improves both the quality of the financial statements as well as the level of trust from users.

Which level of quality of information would eventually exist in the market for lemons assuming there was no way to gain assurance regarding the accuracy of the information? a. Low quality only b. High quality only c. Low, Medium, and High quality d. Medium and low quality only

Answer: a. Low quality only Eventually, all financial statements would be low quality since companies would not be willing to invest in above average information if they were paying the cost of capital associated with average quality information. Thus, the average would continue to decline until all information was low quality.

An audit is designed to identify which type of misstatements in the financial statements? a. Only material misstatements b. Only immaterial misstatements c. Both material and immaterial misstatements d. All internal control deficiencies

Answer: a. Only material misstatements The audit is designed to identify material misstatements. Auditors may identify immaterial misstatements in the process, but the audit is not designed specifically to identify immaterial misstatements.

Which of the following is not generally a cause of unintentional misstatements in the financial statements? a. Pressures for meeting analysts expectations b. Human judgment errors c. Unqualified client staff d. Weak internal controls

Answer: a. Pressures for meeting analysts expectations Pressures for meeting analysts expectations would most likely result in intentional misstatements rather than unintentional misstatements.

In the market for lemons example relating to automobiles, the only vehicles left in the market are low quality. What causes the decrease in the quality which ultimately leaves only low quality vehicles in the market? a. Sellers of high quality vehicles refuse to sell their vehicles at lower quality vehicle prices b. Buyers of vehicles think every vehicle is medium quality so all of the high quality vehicles get sold first c. Nobody will sell used vehicles anymore d. These are all reasons that only low quality vehicles remain in the market

Answer: a. Sellers of high quality vehicles refuse to sell their vehicles at lower quality vehicle prices Sellers of high quality vehicles refuse to sell their vehicles at prices below what their vehicle is worth, so they remove them from the market. The average quality of the vehicles continues to drop until only low quality vehicles remain.

A business is formed with the following characteristics: 1. The individual and the business are treated as a single entity. 2. There is no legal liability protection for the business owner This type of business is most likely which of the following: a. Sole proprietorship b. Limited Liability Company c. Limited Liability partnership d. Corporation e. General partnership

Answer: a. Sole proprietorship These characteristics describe a sole proprietorship.

Which of the following best describes the concept of materiality? a. An item is material if the client thinks it is important b. An item is material if it would impact the decisions made by users of the financial statements c. An item is material if the auditor cares about it d. An item is material if it is big

Answer: b. An item is material if it would impact the decisions made by users of the financial statements This is the definition of materiality in the context of a financial statement audit.

Small public accounting firms often do not perform audits of large multinational clients, but large firms frequently perform audits of very small clients. a. true b. false

Answer: b. False This statement is false. The large firms are usually too expensive for very small clients and are often unwilling to deploy their manpower to serve very small clients due to time constraints faced by the firms.

Which type of business organization do each of the Big 4 firms use? a. Corporation b. Limited Liability Partnership (LLP) c. Sole Proprietorship d. General Partnership e. Limited Liability Company (LLC)

Answer: b. Limited Liability Partnership (LLP) The Big 4 firms each use an LLP business form.

Which of the following best describes what is meant by the term 'risk premium'? a. The best interest rate available to the company when borrowing funds b. The amount charged by an investor or lender that exceeds what they would have charged in the absence of risk c. The highest level of risk that could be faced by an investor or creditor d. None of the above is a definition of risk premium

Answer: b. The amount charged by an investor or lender that exceeds what they would have charged in the absence of risk The risk premium is the amount charged by an investor or lender that exceeds what they would have charged in the absence of risk. It is essentially like an insurance premium they charge in to help cover any potential loss on their investment.

What is meant by being "objective" as it relates to the financial statement audit? a. the auditor has a goal or purpose in mind as they conduct the audit b. the auditor is unbiased and fair c. the auditor and their client have an adversarial relationship

Answer: b. The auditor is unbiased and fair Being objective means being impartial or unbiased in thought and action.

Which of the following is true regarding the relationship of assurance, attest, and audit services? a. Audit and assurance services are a subset of attest services b. Assurance and audit services are a subset of attest services c. Audit and attest services are a subset of assurance services d. Assurance and attest services are a subset of audit services

Answer: c. Audit and attest services are a subset of assurance services Audit and attest services are a subset of assurance services

What is the key distinction between audit services and attest services? a. audit services provide written reports to interested users while attest services do not b. Audits provide assurance regarding subject matter that is the responsibility of others while attest services do not. c. audits are limited to economic actions and events while attest services are not d. none of the above is a distinction between audits and attest services.

Answer: c. Audits are limited to economic actions and events while attest services are not Both audits and attest services provide written reports and both are regarding subject matter that is the responsibility of others.*However, only audits are limited to economic actions and events.*

Which of the following is the "established criteria" against which the financial statements in the United States are evaluated? a. GAAS b. PCAOB c. GAAP d. The COSO framework

Answer: c. GAAP GAAP is the established criteria used in the U.S. for an audit of financial statements. The COSO framework would be the established criteria used for an audit of internal controls over financial reporting.

The 'Big 4' accounting firms include each of the following except: a. Deloitte b. KPMG c. Grant Thornton d. Ernst & Young e. Each of the above is included in the 'Big 4'

Answer: c. Grant Thornton Grant Thornton is not part of the Big 4. The Big 4 firms consist of Deloitte, KPMG, Ernst & Young, and PriceWaterhouseCoopers.

Audit partners in the U.S. can serve a particular client for no more than _____ years consecutively. a. 3 years b. 5 years c. 7 years d. There is no limit on the length of time an audit partner can consecutively serve an audit client as long as she is independent from the client.

Answer: d. 5 years Audit partners are limited to serving a particular client for 5 years consecutively.

Which of the following is an example of an assurance service? a. audit of financial statements b. evaluation of client's IT systems and reporting on the findings to the public c. Evaluating and reporting on a client's internal controls d. All of the above are examples of assurance services.

Answer: d. All of the above are examples of assurance services Each of these is an example of a type of assurance service. Recall that audits and attest engagements are subsets of assurance services. Thus, some services will be assurance services, but not audit or attest services; but all services that are either audit or attest services are types of assurance services.

Which of the following best describes what is meant by professional skepticism? a. being skeptical of professionals b. dealing with skepticism by others in a professional manner c. assuming others are lying to you until you prove them right or wrong d. having a questioning mind without accusing others of wrong doing.

Answer: d. Having a questioning mind without accusing others of wrongdoing Professional skepticism includes having a questioning mind without accusing others of wrongdoing. It is similar to the concept used by Ronald Reagan to "Trust, but verify."

Which of the following is NOT a benefit of the pyramid hierarchy typically used in developing audit engagement teams. a. Less experienced individuals have access to mentors who teach and train them b. The cost efficiency of the audit is improved c. The work of less experienced auditors is reviewed by those with more experience, minimizing the risk of audit failure d. Individuals at all experience levels contribute equally and in the same ways

Answer: d. Individuals at all experience levels contribute equally and in the same ways Individuals at all experience levels do not contribute equally and in the same ways. Each level of experience bring different ways in which individuals contribute. In addition, some individuals contribute much more in terms of time than others.

Which of the following audit opinions expresses the auditor's conclusion that the financial statements are free of material misstatements? a. Adverse b. Disclaimer c. Qualified d. Unqualified

Answer: d. Unqualified The unqualified opinion (also refereed to as the unmodified opinion) expresses the auditor's opinion that the financial statements are free of material misstatements.

Which of the following is NOT one of the indicators of audit quality identified by the IAASB in its "Framework for Audit Quality"? a. understanding their role as an auditor b. exercising professional skepticism c. having experience in auditing a particular client. d. having the knowledge necessary to conduct a proper audit. e. each of the above is an indicator of audit quality identified by the IAASB.

Answer: e. Each of the above is an indicator of audit quality identified by the IAASB Each of these is an indicator of audit quality.

The individual hired to perform an audit of a client's financial statements is often called the "external auditor." a. true b. false

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