ACCT 451, quiz 2-1

Assign each of the following items to either the audit strategy or the audit plan.

1. Document that the audit team will send accounts receivable confirmations Audit plan 2. Describe which controls will be tested Audit plan 3. Determine the basis of reporting for the financial statements Audit strategy 4. Determine materiality levels Audit strategy 5. Describe the methods to obtain an understanding of the entity and its environment sufficient to assess the risk of material misstatement Audit plan 6. Assign audit team personnel Audit strategy 7. Determine dates for fieldwork Audit strategy 8. Record which audit team members will perform which specific procedures Audit plan 9. Document the industry-specific reporting requirements Audit strategy 10. Budget audit team hours to high-risk areas Audit strategy The audit strategy determines the characteristics of the engagement that defines its scope, allows the auditor to determine key dates and reporting objectives, and considers factors such as materiality and preliminary identification of areas where there may be a higher risk of material misstatement. The audit strategy helps the auditor assign resources. The audit plan, however, is more detailed than the audit strategy and includes the nature, timing, and extent of audit procedures to be performed by audit team members in order to obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level.

Use the company profile for Aquatic Jet Products to answer the questions in the table below.

1. Finished goods are sold primarily to independent marine stores throughout the United States. No The potential clients—independent marine stores—do not appear to represent a business risk of interest to the independent auditor. 2. Tough new federal emissions regulations further threaten industry profitability. Yes Inherent risk increases with the company understanding and implementing new regulations. These regulations threaten profitability and may provide incentive for fraud to occur. 3. The company's bank, wary of declining trends, has placed strict new covenants on the company's renewed line of credit. Yes One of the risks of increased fraud is a change in loan covenants. 4. The prior audit firm is upset that they have lost the audit. No AU-C 210 provides guidance concerning communication between predecessor and successor auditors. A predecessor's discontent concerning the loss of the audit is unlikely to provide a risk of misstatement. 5. A senior accountant from the prior audit firm has taken an accounting position with the company. No It is unlikely that a position accepted by an accountant from the prior audit firm would provide a risk of misstatement. 6. Finished watercraft inventory is kept in an open lot outside the Florida facility. Yes Inventory being kept in an open lot increases the risk of theft. 7. In your tour of the office, you overhear two clerical employees complaining about their rate of pay. No Employees who are dissatisfied with their employer's policies are more likely to have a rationalization to commit fraud. However, without more information about the specific role that these clerical employees play in the company, the auditor cannot conclude that the risk of material misstatement—and therefore audit risk—is greater.

Bond, CPA, is considering audit risk at the financial statement level in planning the audit of Toxic Waste Disposal (TWD) Company's financial statements for the year ended December 31, 20X1. TWD is a privately owned entity that contracts with municipal governments to remove environmental wastes. Audit risk at the financial statement level is influenced by the risk of material misstatement, which may be indicated by a combination of factors related to management, the industry, and the entity.

1. This was the first year in five years that TWD operated at a profit, because the municipalities received increased federal and state funding for environmental purposes. The audit risk would: decrease. 2. TWD's Board of Directors is controlled by Mead, the majority stockholder, who also acts as the chief executive officer. The audit risk would: increase. 3. The internal auditor reports to the controller and the controller reports to Mead. The audit risk would: increase. 4. The accounting department has experienced a high rate of turnover of key personnel. The audit risk would: increase. 5. TWD's bank has a loan officer who meets regularly with TWD's CEO and controller to monitor TWD's financial performance. The audit risk would: decrease. 6. TWD's employees are paid biweekly. The audit risk would: have no effect. 7. Bond has audited TWD for five years. The audit risk would: decrease.

Bond pt. II

8. During 20X1, TWD changed its method of preparing its financial statements from the cash basis to generally accepted accounting principles. The audit risk would: increase. 9. During 20X1, TWD sold half of its controlling interest in United Equipment Leasing (UEL) Co. TWD retained significant interest in UEL. The audit risk would: increase. 10. During 20X1, litigation filed against TWD five years previous alleging that TWD discharged pollutants into state waterways was dropped by the state. Loss contingency disclosures that TWD included in prior years' financial statements are being removed for the 20X1 financial statements. The audit risk would: decrease. 11. During December 20X1, TWD signed a contract to lease disposal equipment from an entity owned by Mead's parents. This related party transaction is not disclosed in TWD's notes to its 20X1 financial statements. The audit risk would: increase. 12. During December 20X1, TWD increased its casualty insurance coverage on several pieces of sophisticated machinery from historical cost to replacement cost. The audit risk would: have no effect. 13. Inquiries about the substantial increase in revenue TWD recorded in the fourth quarter of 20X1 disclosed a new policy. TWD guaranteed to several municipalities that it would refund the federal and state funding paid to TWD if any municipality fails federal or state site cleanup inspection in 20X2. The audit risk would: increase. 14. An initial public offering of TWD's stock is planned for late 20X2. The audit risk would: increase.

What paragraph in the auditing professional standards states that the auditor should obtain a level of knowledge of the entity's business that includes relevant controls that relate to risk?

AU-C 315.27 states that the auditor should "identify risks throughout the process of obtaining an understanding of the entity and its environment, including relevant controls that relate to the risks, by considering the classes of transactions, account balances, and disclosures (including the quantitative and qualitative aspects of such disclosures) in the financial statements."

An accountant was asked by a potential client to perform a compilation of its financial statements. The accountant is not familiar with the industry in which the client operates. In this situation, which of the following actions is the accountant most likely to take?

Accept the engagement and obtain an adequate level of knowledge about the industry because An accountant can accept a compilation engagement with no previous experience in the client's industry. The accountant is then responsible for acquiring an adequate level of knowledge of the industry's accounting principles and practices. Requesting an industry consultant to assist the accountant is not necessary. In the above scenario, the accountant is not required to decline the engagement but should accept the engagement and then obtain knowledge of industry practices and related accounting principles. The accountant does not need to postpone accepting the engagement; he or she can still accept the engagement but must acquire adequate knowledge during the compilation engagement.

An information system is composed of which of the following components?

All of the answer choices are correct. (information technology infrastructure, software used to process the org's data, people who operate the system and perform its functions)

Which of the following is required documentation in an audit in accordance with generally accepted auditing standards?

An audit plan setting forth in detail the procedures necessary to accomplish the engagement's objectives because An audit plan setting forth in detail the procedures necessary to accomplish the engagement objectives is required documentation in an audit performed in accordance with generally accepted auditing standards. A program is essential to plan and supervise audit assistants. Documentation of the accounting system and internal control should be performed; however, the form of documentation is not specified (flowchart, narrative, questionnaire, memo, etc.). The use of a documented audit planning memorandum establishing the timing of the audit procedures and coordination of the assistance of entity personnel is up to the auditor's judgment.

What is the overall primary objective of developing a detailed audit plan on a financial statement audit?

Design procedures to reduce risk to an acceptably low level.

Which of the following would most likely be associated with obtaining an understanding of relevant industry, regulatory, and other external factors when satisfying the obligation to understand the entity and its environment on an audit?

Key interest rates and availability of financing because The auditor should obtain an understanding of relevant industry, regulatory, and other external factors. The industry in which the entity operates may be subject to specific risks of material misstatement arising from the nature of the business, the degree of regulation, or other external forces (such as political, economic, social, technical, and competitive). Key interest rates (i.e., discount rate, federal funds rate, etc.) would represent external factors that could affect the entity and the industry but are not specific to the entity. The other answer choices (nature of revenue sources, geographic dispersion of operations, and key suppliers) are internal business operation considerations.

Which of the following procedures is usually the first step in reviewing the financial statements of a nonissuer?

Obtain a general understanding of the entity's organization, its operating characteristics, and its products or services. because A review does not involve obtaining an understanding of internal control, assessing control risk (assessing the operating efficiency of the entity's internal control activities), assessing fraud risks (assessing the risk of material misstatement arising from fraudulent financial reporting and the misappropriation of assets), making preliminary judgments about risk and materiality to determine the scope and nature of the procedures to be performed, or testing accounting records to obtain corroborating evidence. These procedures are performed in an audit.

Which of the following procedures would an auditor least likely perform in planning a financial statement audit?

Selecting a sample of vendor invoices for comparison to receiving reports because Audit planning involves developing an overall strategy for the expected conduct, organization, and staffing of the audit. All of the answer choices involve steps that would be taken during audit planning except "selecting a sample of vendor invoices for comparison to receiving reports." This activity would occur during substantive testing.

An auditor decides to perform substantive tests on a client's property and equipment balance as of an interim date. The auditor has not obtained evidence about the operating effectiveness of relevant controls. What additional work must be performed to extend the audit conclusions from the interim date to the balance sheet date?

Substantive procedures for the period between the interim date and the balance sheet date because Substantive procedures are performed to detect material misstatements at the relevant assertion level, and include tests of details of classes of transactions, account balances, and disclosures and substantive analytical procedures. The auditor may perform substantive procedures at an interim date or at period-end. When substantive procedures are performed at an interim date, the auditor should perform further substantive procedures or substantive procedures combined with tests of controls to cover the remaining period that provide a reasonable basis for extending the audit conclusions from the interim date to the period-end.

Which of the following is an example of an inherent risk that an auditor should consider?

Technological developments that may render inventory obsolete because Inherent risk is the risk posed by an error or omission in a financial statement, which could be material, due to a factor other than a failure of control. Inherent risk usually occurs when transactions are complex or in situations that require a high degree of judgment. External circumstances that give rise to business risks also influence inherent risk (such as technological developments or a decline in customers).

An auditor reviews a client's accounting policies and procedures when considering which of the following planning matters?

Understanding the client's operations and business

An auditor who performed analytical procedures that compared current-year financial information to the comparable prior period noted a significant increase in net income. Given this result, which of the following expectations of recorded amounts would be unreasonable?

a decrease in retained earnings because A significant increase in net income would be reflected as an increase, not a decrease, in retained earnings, as would other increases in revenue or decreases in expenses, such as cost of goods sold. A decrease in notes payable would be due to paying off the debt, which would primarily affect the balance sheet; however, interest expense would decrease with less debt, thereby increasing net income and retained earnings. Accounts payable is generally the result of expenses or purchases of inventory. An increase in net income could result from a decrease in expenses, and as a result, a corresponding decrease in accounts payable would not be unexpected.

The permanent file of an auditor's working papers generally would not include:

a working trial balance because In general, working papers include documentation (such as a working trial balance) that the accounting records agree with the reported financial statements for the year(s) being examined. The working trial balance changes each year and would not be included in the permanent file. The permanent files of the working papers include copies of the client's long-term contracts and agreements and auditor-prepared documentation that will benefit the audit in future years, such as bond indenture agreements, lease agreements, and a flowchart of the internal control.

Which of the following factors most likely would influence an auditor's determination of the auditability of an entity's financial statements?

adequacy of accounting records because The determination of the auditability of an entity is one of the first matters the auditor considers in the initial planning for an audit engagement and before accepting it. One of the requisites of auditability is the availability of adequate, i.e., sufficient, reliable accounting records. Without adequate accounting records, auditors may not be able to obtain sufficient appropriate audit evidence to support an opinion on the entity's financial statements. In planning the audit, the auditor considers the methods used by the entity to accumulate, process, and review accounting information because such methods influence the design of internal control, another critical audit concern. The other answer choices—the complexity of the accounting system, the existence of related party transactions, and the operating effectiveness of controls—relate more to the auditor's consideration of the nature, timing, and extent of audit procedures that will be required (e.g., whether any extension or modification of audit testing will be necessary).

If an accountant has no previous experience in the prospective client's industry, he or she may obtain the required level of knowledge through which of the following?

all of the above (AICPA guides, industry publications, & f.s' of other entities in the industry) In addition, the accountant may consult textbooks and periodicals, appropriate continuing education, or other individuals knowledgeable about the industry.

An information system adds value to an organization by improving all of the following except:

customer relations by providing product cost information to wholesalers.

A written audit plan is required to be prepared by an auditor for:

every audit because In planning the audit, the auditor should consider the nature, extent, and timing of work to be performed and should prepare a written audit plan to respond to the risk of material misstatement for each relevant assertion for each significant audit area.

In designing a written audit plan, an auditor should establish specific audit objectives that relate primarily to the:

financial statement assertions because: In designing a written audit plan, specific audit objectives should be established. Audit objectives are related primarily to financial statement assertions, which can be classified according to the following broad categories: Occurrence Completeness Accuracy Cutoff Classification Existence Rights and obligations Valuation and allocation Audit procedures that will achieve the audit objectives are detailed in the audit plan. The timing of audit procedures and the cost-benefit of gathering evidence are considered in audit planning. Audit techniques are selected in performing the audit work.

When reviewing the financial statements of a nonissuer in accordance with the Statements on Standards for Accounting and Review Services (SSARS), an accountant's procedures should include:

inquiring into actions taken at meetings of the board of directors. because An inquiry within the organization, such as actions taken at meetings of the board of directors, is a procedure performed in a review. Reviews in accordance with SSARS do not require an accountant to obtain an understanding of internal control. Applying substantive tests of transactions is an audit procedure and is not required as part of a review. While the accountant should ask management about fraud, suspected fraud, or allegations of fraud, special tests to detect fraud of a substantive nature are not required.

After obtaining an understanding of the entity and its environment and assessing the risk of material misstatement, an auditor decided to perform tests of controls. The auditor most likely decided that:

it would be efficient to perform tests of controls that would result in a reduction in planned substantive tests. because At this early stage, the auditor develops only a general idea of which tests of internal controls and which substantive tests will be performed. Prior years' workpapers are reviewed, general business and economic conditions are examined, interim financial statements are studied, and the scope of the engagement is discussed with the client. The timing of the audit is set both with the client and with audit personnel. The other items described are all performed well after the initial planning phase of an audit.

ABC, Inc., assessed overall risks of MIS systems projects on two standard criteria: technology used and design structure. The following systems projects have been assessed on these risk criteria. Which of the following projects holds the highest risk to ABC?

new tech and sketchy structure because To function effectively as an interdependent feedback tool for management, a management information system (MIS) must be "usable." Key elements of an MIS include timeliness, accuracy, consistency, and relevance. The usefulness of the MIS is reduced if one or more of these elements are compromised. A "sketchy" structure by itself would make a particular alternative more risky. Additionally, introducing new technology is riskier than continuing to use existing technology.

The procedure of an accountant obtaining a general level of knowledge of the accounting principles and practices of the entity's industry is:

required for both a compilation and review.

Which of the following would most likely be associated with obtaining an understanding of relevant internal factors when satisfying the obligation to understand the entity and its environment on an audit?

rev rec practices because The auditor should obtain an understanding of the nature of the entity. The nature of an entity refers to the entity's operations, its ownership and governance, the types of investments that it is making and plans to make, the way that the entity is structured, and how it is financed. The entity may have a complex structure with subsidiaries or other component units in multiple locations. The other answer choices (regulatory requirements, taxation, and environmental regulations) are related to external factors.

To obtain an understanding of a continuing client's business in planning an audit, an auditor most likely would:

review PY wp's and the permanent file for the client.

In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an auditor most likely would:

review the entity's descriptions of inventory policies and procedures. because To understand internal control, an auditor needs to read or hear a description of the policies and procedures that describe the controls used. Tests of details (substantive tests), such as performing analytical procedures and test counts, will determine the accuracy of account balances but will do little to help an auditor understand an internal control structure concerning inventory balances. An auditor most likely would review the entity's descriptions of inventory policies and procedures.

Audit plans should be designed so that:

the audit evidence gathered supports the auditor's conclusions. because The purpose of the audit is to obtain sufficient appropriate audit evidence to support the auditor's opinion regarding the fair presentation of the financial statements. Thus, the audit plan should provide the detail of the audit procedures that will accomplish audit objectives and provide audit evidence to support the auditor's conclusions. The decision to perform audit procedures at interim periods rather than at year-end considers the increased audit risk and cost-effectiveness of interim testing. Inherent risk (and control risk) is assessed by the auditor; the actual levels of risk are not subject to change or control through the use of audit plans. Such assessment is performed as part of the planning process to determine the content of the audit plan (the nature, timing, and extent of audit work to be performed). Constructive suggestions to management result from matters which came to the auditor's attention during the performance of audit work (as detailed in the audit plans). The auditor is not obligated to search for, and audit plans are not designed to detect such matters.

An auditor should design the written audit plan so that:

the audit procedures selected will achieve specific audit objectives. because An auditor should design the written audit plan so that the audit procedures selected will achieve specific audit objectives. An audit plan is a step-by-step plan of audit procedures to be carried out by the auditor in verifying financial statement items or in making tests of transactions. It should be designed to gather the evidence that underlies the auditor's opinion and should achieve specific audit objectives. Although most significant/material transactions will be reviewed or analyzed, there is no requirement that all be tested.

Knowledge of the client's "industry, regulatory, and other factors" includes an understanding of all of the following, except:

the entity's accounting policies and procedures. because The auditor's understanding of the entity and its environment consists of an understanding of the following aspects: Industry, regulatory, and other external factors Nature of the entity Objectives and strategies and the related business risks that may result in a material misstatement of the financial statements Measurement and review of the entity's financial performance Internal control, which includes the selection and application of accounting policies The relevant industry, regulatory, and other external factors include industry conditions, such as the competitive environment, supplier and customer relationships, and technological developments; the regulatory environment, which encompasses, among other matters, relevant accounting pronouncements, the legal and political environment, and environmental requirements affecting the industry and the entity; and other external factors, such as general economic conditions. The only choice that does not fit into the category of industry, regulatory, and other external factors is "the entity's accounting policies and procedures."

An information system should fulfill all of the following functions except:

transform info into data because An information system should transform data into information, not the other way around. Once data is collected, it is the job of the information system to transform that data so it can be used by management to make decisions.

When compiling the financial statements of a nonissuer, an accountant should:

understand the accounting principles and practices of the entity's industry. because A compilation engagement does not involve performing inquiry (for example, of key employees regarding related parties and subsequent events), analytical procedures (such as ratio analyses), or any other procedures performed in a review. During a compilation, the accountant will not obtain an understanding of internal control, assess fraud risk, test accounting records (reviewing agreements with financial institutions for restrictions on cash balances), or perform any procedures normally performed in an audit. The accountant must, however, possess an understanding of the industry in which the client operates, including the accounting principles and practices generally used in the industry.

An auditor obtains knowledge about a new client's business and its industry to:

understand the events and transactions that may have an effect on the client's financial statements. because In planning the audit, the auditor should obtain knowledge of a new client's business and its industry. The purpose of obtaining this knowledge is to assist the auditor in understanding the events and transactions that may affect the client's financial statements. Specific business and industry knowledge will focus the auditor to: identify areas where additional audit procedures or a high level of professional judgment may be necessary: Are the account balances that are determined by estimation, and assumptions used, reasonable? Is the accounting principle used appropriate? and Are disclosures adequate? consider industry issues: economic conditions, government regulations, changes in technology, specialized accounting practices, etc.