Audit Midterm

[1] In gathering evidence in the performance of substantive procedures, the auditor most likely A. Uses the test month approach. B. Relies on persuasive rather than conclusive evidence in the majority of cases. C. Considers the client's documentary evidence less reliable than evidence gathered orally by inquiry of management. D. Expresses an adverse opinion if (s)he has substantial doubt as to any assertion of material significance.

A. Selecting specific months for detail testing is not required. "Test month approach" is a nonsense term. B. To be appropriate, audit evidence should be relevant and reliable. Also, because of the inherent limitations of the audit, most audit evidence is persuasive rather than conclusive. However, although the cost of obtaining evidence and its usefulness should be rationally related, the matter of difficulty, time, or cost is not in itself a valid basis for (1) omitting a procedure when no alternative exists or (2) being satisfied with less than persuasive evidence. C. Documentary evidence is more reliable than evidence obtained orally. For example, a written record of a meeting made when the meeting occurred is more reliable than a subsequent oral statement of the matters discussed. D. The auditor must be convinced that the financial statements as a whole are not presented fairly before (s)he expresses an adverse opinion.

[1] Which of the following would be least likely to be comparable between similar corporations in the same industry line of business? A. Earnings per share. B. Return on total assets before interest and taxes. C. Accounts receivable turnover. D. Operating cycle.

The correct answer is A. A. Similar companies in the same industry that are equally profitable may have quite different earnings per share because of differences in shares outstanding and in other aspects of their capital structures. B. Similar firms should have comparable returns on total assets. C. Accounts receivable turnover is ordinarily comparable for firms in the same industry. D. Operating cycles are ordinarily comparable for firms in the same industry.

[1] It would not be appropriate for the auditor to initiate discussion with the audit committee concerning A. The extent to which the work of internal auditors will influence the scope of the audit. B. Details of the procedures that the auditor intends to apply. C. The extent to which change in the company's organization will influence the scope of the audit. D. Details of potential problems that the auditor believes might cause a qualified opinion.

The correct answer is B. A. AU-C 260, Communication with those Charged with Governance, requires auditors to make certain communications with those responsible for oversight of the financial reporting process. For example, the auditor should communicate the auditor's responsibilities for the audit. One such responsibility is the understanding of internal control. An auditor must obtain an understanding of the internal audit function as part of obtaining the understanding of internal control (AU-C 610). B. The auditor should communicate an overview of the scope and timing of the audit to those charged with governance. But the auditor should not communicate the nature and timing of detailed audit procedures. The auditor exercises professional judgment in determining the appropriate procedures. To remain independent, (s)he must not subordinate this judgment to others. Also, audit testing is done on a sample basis, and management should not have knowledge of how samples are selected. With such knowledge, the audit process may be circumvented. C. The audit scope is a legitimate subject for discussion with those charged with governance. D. Potential problems should be discussed with those charged with governance.

[1] In developing written audit plans, an auditor should design specific audit procedures that relate primarily to the A. Timing of the audit. B. Costs and benefits of gathering evidence. C. Financial statements as a whole. D. Financial statement assertions.

The correct answer is D. A. Timing is important in developing audit plans, but it is not the primary basis for determining the audit procedures to be performed. B. The costs and benefits of gathering evidence are important to the auditor but are not the primary basis for determining the audit procedures to be performed. C. Most audit procedures are performed at the assertion level. D. Most audit work consists of obtaining and evaluating evidence about relevant financial statement assertions. They are management representations embodied in the financial statements that are used by the auditor to consider the types of possible material misstatements.

[1] A pervasive characteristic of a CPA's role in a consulting services engagement is that of being a(n) A. Objective advisor. B. Independent practitioner. C. Computer specialist. D. Confidential reviewer.

[1] The correct answer is A. A. A consulting services practitioner should serve the client's interest by seeking to accomplish the objectives established by the understanding with the client while maintaining integrity and objectivity. B. Independence is not a requirement for consulting services. C. A consultant need not be a computer specialist to develop findings and provide recommendations. D. A review is an attestation service.

[1] Advertising or other forms of solicitation that are false, misleading, or deceptive are not in the public interest, and AICPA members in public practice shall not seek to obtain clients in such a manner. Such activities include all the following except those that A. Indicate the CPA's educational and professional attainments. B. Imply the ability to influence a court. C. Claim to be able to save the taxpayer 20% of a determined tax liability. D. Create unjustified expectations of favorable results.

[1] The correct answer is A. A. Advertising and solicitation are acceptable if they do not involve falsehood or deception. B. Advertisement of influence over courts, tribunals, regulatory agencies, or a similar body or official is deceptive. C. A correct amount of tax liability exists, and a claim to save a taxpayer part of that amount is deceptive. D. Creating false and unjustified expectations of favorable results is misleading.

[1] You have been assigned to audit the maintenance department of an organization. Which of the following is likely to produce the least reliable audit evidence? A. Notes on discussions with mechanics in the maintenance operation. B. A schedule comparing actual maintenance expenses with budgeted expenses and those of the prior period and disclosing important differences. C. A narrative covering review of user reports on maintenance service. D. An analysis of changes in certain maintenance department ratios.

[1] The correct answer is A. A. Although representations by personnel of the auditee are evidence, auditor observation and analysis of documents provide more reliable evidence. B. The comparison provides more reliable evidence relative to the maintenance department's operations. Such documentary evidence is presumably prepared independently of the audited department. C. Reports by users of maintenance services are likewise independent evidence. They are of interest to internal auditors because they bear on the quality of performance. D. Analytical procedures are typically considered more reliable than representations by client personnel.

[1] The objective of performing analytical procedures as risk assessment procedures in an audit is to identify A. Unusual transactions and events. B. Noncompliance with laws and regulations that went undetected because of internal control weaknesses. C. Related party transactions. D. Recorded transactions that were not properly authorized.

[1] The correct answer is A. A. Analytical procedures applied as risk assessment procedures may (1) improve the understanding of the client's business and significant transactions and events and (2) identify unusual transactions or events and amounts, ratios, and trends that might indicate matters with audit ramifications (AU-C 315). B. The objectives of performing analytical procedures as risk assessment procedures in an audit are to (1) obtain an understanding of the entity and its environment, including internal control, and (2) assess the risks of material misstatement. C. Although the auditor should evaluate disclosures about related party transactions, analytical procedures performed as risk assessment procedures do not necessarily detect such transactions. D. Tests of controls are necessary to determine whether transactions were properly authorized.

[1] Certain individuals may have an attitude, character, or set of values that permit them to rationalize fraud. Moreover, individuals may have an incentive or be under pressure to commit fraud, or circumstances may provide an opportunity. The auditor's concern about the risk of material misstatements due to fraud is least likely to be increased if management A. Consists of many individuals that make operating and financing decisions. B. Commits to unduly aggressive forecasts. C. Has an excessive interest in increasing the entity's stock price through use of unduly aggressive accounting practices. D. Is interested in inappropriate means of minimizing reported earnings for tax-motivated reasons.

[1] The correct answer is A. A. Domination of the decision process by one individual or a small group (an opportunity to commit fraud) is a fraud risk factor. In that case, compensating controls, e.g., effective oversight by the audit committee, reduce risk (AU-C 240, Appendix). B. A commitment to third parties to achieve unduly aggressive or clearly unrealistic forecasts is a fraud risk factor that reflects an attitude or rationalization permitting fraudulent financial reporting. C. An excessive interest in improving the entity's stock price or earnings trend is a fraud risk factor that reflects an attitude or rationalization permitting fraudulent financial reporting. D. An interest in inappropriate means of minimizing earnings for tax purposes is a fraud risk factor that reflects an attitude or rationalization permitting fraudulent financial reporting.

[1] Early appointment of the auditor enables preliminary work to be performed by the auditor. This benefits the client because it permits the audit to be performed in A. A more efficient manner. B. A more thorough manner. C. Accordance with quality control standards. D. Accordance with generally accepted auditing standards.

[1] The correct answer is A. A. Early appointment of the auditor is advantageous to both the auditor and the client. Early appointment aids the auditor in planning the work, especially that to be done before the end of the year. The client benefits from more efficient scheduling of the audit and an early completion of the work after the end of the fiscal year. B. Thoroughness is directly related to the requirement to collect sufficient appropriate evidence, not to the time of appointment. C. Adherence to quality control standards is necessary regardless of the time of appointment. D. Adherence to GAAS is necessary regardless of the time of appointment.

[1] To test the effectiveness of controls, an auditor ordinarily selects from a variety of techniques, including A. Inquiry and analytical procedures. B. Reperformance and observation. C. Comparison and confirmation. D. Inspection and verification.

[1] The correct answer is B. A. Analytical procedures are more closely associated with substantive procedures. B. Inquiry alone is not sufficient to test the operating effectiveness of controls. Other audit procedures performed in combination with inquiry may include inspection, recalculation, and reperformance of a control that pertains to an assertion. C. Comparison and confirmation are more closely associated with substantive procedures. D. Verification is more closely associated with substantive procedures.

[1] The acceptable level of detection risk is inversely related to the A. Assurance provided by substantive procedures. B. Risk of misapplying auditing procedures. C. Preliminary judgment about materiality levels. D. Risk of failing to discover material misstatements.

[1] The correct answer is A. A. For a given audit risk, the acceptable detection risk is inversely related to the assessed risks of material misstatement. As the RMMs increase, the acceptable detection risk decreases, and the auditor requires more persuasive audit evidence. The auditor may (1) change the types of audit procedures and their combination, e.g., confirming the terms of a contract as well as inspecting it; (2) change the timing of substantive procedures, such as from an interim date to year end; or (3) change the extent of testing, such as by using a larger sample (AU-C 330 and AS 2301). B. Detection risk, not the acceptable level of detection risk, relates directly to the risk of misapplying auditing procedures. As the effectiveness of audit procedures increases, e.g., because of adequate planning, proper assignment of personnel, and supervisory review, the risk of misapplication and detection risk decrease. C. Preliminary judgments about materiality levels are used by the auditor to determine the acceptable level of audit risk. Materiality and overall audit risk are inversely related. However, detection risk is just one component of audit risk. D. The lower the acceptable level of detection risk, the greater the required persuasiveness of audit evidence. Given this additional assurance, the risk of failing to detect material misstatements (detection risk) should be decreased. Accordingly, the relationship of acceptable detection risk and the risk of failing to detect material misstatements is direct.

[1] What is the definition of fraud in an audit of financial statements? A. An intentional act that results in a material misstatement in financial statements that are the subject of an audit. B. The unintentional misapplication of accounting principles relating to amounts, classification, manner of presentation, or disclosure. C. An intentional act that results in a material weakness in financial statements that are the subject of an audit. D. Management's inability to design and implement programs and controls to prevent, deter, and detect material misstatements.

[1] The correct answer is A. A. Fraud is an "intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception that results in a misstatement in financial statements that are the subject of an audit." B. Fraud consists of an intentional act. An unintentional act would be considered an error rather than fraud. C. Fraud is an intentional misstatement, not a material weakness. D. Management's inability to design and implement programs is not fraud.

[1] A CPA is required to comply with the provisions of Statements on Standards for Attestation Engagements when engaged to A. Provide assurance on investment performance statistics prepared by an investment company on established criteria. B. Issue a letter for an underwriter, also known as a comfort letter, to a broker or dealer of securities. C. Compile financial statements in conformity with a comprehensive basis of accounting other than GAAP. D. Communicate with an audit committee regarding management's consultations with another CPA.

[1] The correct answer is A. A. SSAEs apply only to attest engagements for which no specific standards (e.g., SASs or SSARSs) apply. In an attest engagement, a practitioner is engaged to issue or does issue an examination, a review, or an agreed-upon procedures report on subject matter, or an assertion about the subject matter, that is the responsibility of another party. Moreover, the practitioner must state a conclusion about the subject matter or the assertion in relation to the criteria against which the subject matter was evaluated in the report. Attest services traditionally have been limited to expressing an opinion on historical financial statements on the basis of an audit in accordance with U.S. GAAP. But CPAs increasingly provide assurance on representations other than historical statements and in forms other than an opinion. B. SASs apply to letters for underwriters and certain other requesting parties (AU-C 920). C. SSARSs apply to compilations of financial statements in conformity with a comprehensive basis of accounting other than GAAP, also known as a special purpose framework (AR-C 80). D. SASs apply to an auditor's communications with those charged with governance (AU-C 260).

[1] Analytical procedures can best be categorized as A. Substantive procedures. B. Tests of controls. C. Qualitative tests. D. Budget comparisons.

[1] The correct answer is A. A. Substantive procedures are designed to detect material misstatements at the assertion level. According to AU-C 520, Analytical Procedures, analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. They involve comparisons of recorded amounts, or ratios developed from recorded amounts, to expectations developed by the auditor. B. Tests of controls are used to evaluate the operating effectiveness of controls. C. Analytical procedures tend to be quantitative even when nonfinancial information is considered. D. Budget comparisons are only one of many types of analytical procedures.

[1] The profession's ethical standards most likely are violated when a CPA represents that specific consulting services will be performed for a stated fee and it is apparent at the time of the representation that the A. Actual fee would be substantially higher. B. Actual fee would be substantially lower than the fees charged by other CPAs for comparable services. C. CPA would not be independent. D. Fee was a competitive bid.

[1] The correct answer is A. A. The Code prohibits forms of solicitation that are false, misleading, or deceptive. A representation that specific services will be performed for a stated fee, when it is likely at the time that the actual fee will be substantially higher, is a prohibited form of solicitation. B. A CPA is permitted to charge lower fees than other CPAs. C. Independence is required in an audit, but not for consulting services. D. Competitive bids for consulting services are allowed.

[1] CPAs are required to complete engagements competently. Competence includes all of the following except A. An unbiased mental attitude. B. The technical qualifications of the CPA's staff. C. The capacity to exercise judgment. D. The ability to research subject matter and consult with others.

[1] The correct answer is A. A. The Code requires the CPA to maintain an unbiased mental attitude. A member in public practice must be independent in the performance of professional services as required by standards issued by bodies designated by Council. B. Competence relates both to knowledge of the profession's standards, techniques, and the technical subject matter involved, and to the ability to exercise sound judgment in applying such knowledge in the performance of professional services. C. Competence includes the ability to exercise sound judgment in applying knowledge in the performance of services. D. In some cases, additional research or consultation with others does not ordinarily represent a lack of competence, but rather is a normal part of the performance of professional services.

Audit committees have been identified as a major factor in promoting independence in both internal and external auditors. Which of the following is the most important limitation on the effectiveness of audit committees? A. Audit committees are composed of independent directors. However, those directors may have close personal and professional friendships with management. B. Audit committee members are compensated by the organization and thus favor a shareholder's view. C. Audit committees devote most of their efforts to external audit concerns and do not pay much attention to internal auditing and the overall control environment. D. Audit committee members do not normally have degrees in the accounting or auditing fields.

[1] The correct answer is A. A. The audit committee is a subcommittee of outside directors who are independent of corporate management. The Sarbanes-Oxley Act of 2002 requires members of audit committees of issuers to be independent. The act precludes audit committee members from (1) accepting any consulting, advisory, or other compensatory fee from the issuer or (2) being an affiliated person of the issuer or any subsidiary of it. The purpose of the audit committee is to help keep external and internal auditors independent of management and to ensure that the directors are exercising due care. However, if independence is impaired by personal and professional relationships, the effectiveness of the audit committee may be limited. B. The compensation audit committee members receive is usually minimal. They should be independent and therefore not limited to a shareholder's perspective. C. Although audit committees are concerned with external audits, they also devote attention to the internal auditing function. D. Not all audit committee members need degrees or experience in accounting or auditing for the committee to function effectively. However, the Sarbanes-Oxley Act of 2002 requires at least one member of the audit committee of an issuer to be a financial expert.

[1] Which of the following statements about audit evidence is true? A. To be appropriate, audit evidence should be either persuasive or relevant but need not be both. B. The sufficiency and appropriateness of audit evidence is a matter of professional judgment. C. The difficulty and expense of obtaining audit evidence about an account balance is a valid basis for omitting the test. D. A client's accounting records can be sufficient audit evidence to support the financial statements.

[1] The correct answer is A. A. The audit of the income statement focuses on the propriety of handling transactions because most income statement accounts represent large volumes of transactions. The audit of the balance sheet concentrates on verification of account balances. B. All transactions must be authorized. C. The auditor is equally concerned with the costs reflected in the income statement and the balance sheet. D. Cutoffs to verify that only current period transactions are reflected apply to both statements.

[1] An auditor's engagement letter most likely will include A. Management's acknowledgment of its responsibility for maintaining effective internal control. B. The auditor's preliminary assessment of the risk factors relating to misstatements arising from fraudulent financial reporting. C. A reminder that management is responsible for illegal acts committed by employees. D. A request for permission to contact the client's lawyer for assistance in identifying litigation, claims, and assessments.

[1] The correct answer is A. A. The auditor should agree with management on the terms of the engagement. The terms should be documented in an engagement letter. Among the matters addressed are management's responsibility for designing, implementing, and maintaining internal control relevant to preparing and fairly presenting financial statements that are free of material misstatement, whether due to fraud or error. B. The auditor assesses risks relating to misstatements arising from fraudulent financial reporting during the engagement. C. Management is responsible for compliance with laws and regulations applicable to its activities. It is also responsible for acts of employees attributable to the entity. However, it is not responsible for other noncompliance by employees. D. A request for permission to contact the client's lawyer for assistance in identifying litigation, claims, and assessments is made during the audit.

[1] Madison Corporation has a few large accounts receivable that total $1,000,000. Nassau Corporation has a great number of small accounts receivable that also total $1,000,000. The importance of a misstatement in any one account is therefore greater for Madison than for Nassau. This is an example of the auditor's concept of A. Materiality. B. Comparative analysis. C. Reasonable assurance. D. Audit risk.

[1] The correct answer is A. A. The concept of materiality requires the auditor to evaluate the relative importance of items to users of financial statements. In an entity with few but large accounts receivable, the individual accounts are relatively more important and the possibility of material misstatement is greater than in an entity with many small accounts. B. Comparative analysis is a term that is associated with analytical procedures. C. In an audit of financial statements, reasonable assurance is a high, not absolute, level of assurance. The auditor must obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. Moreover, reasonable assurance is mentioned in the auditor's responsibility section in the report. D. Audit risk is the risk of expressing an inappropriate opinion on materially misstated financial statements.

[1] According to the profession's ethical standards, an auditor would be considered independent in which of the following instances? A. The auditor's checking account, which is fully insured by a federal agency, is held at a client financial institution. B. The auditor is also an attorney who advises the client as its general counsel. C. A member donates service as CFO of a charitable organization that is a client during the period covered by the financial statements. D. The client owes the auditor fees for two consecutive annual audits.

[1] The correct answer is A. A. The independence of a member or a member's firm is not impaired if the member's depository relationship (checking, savings, certificates of deposit, money market accounts) is fully insured by a state or federal deposit insurance agency. Moreover, uninsured amounts do not impair independence if they are immaterial. B. A member may perform other nonattest services in appropriate circumstances. However, certain general activities in the performance of these other services are deemed to impair independence, for example, serving the client as its stock transfer or escrow agent, registrar, general counsel, or the equivalent. Such service constitutes making management decisions or performing management functions. C. Independence is impaired if, during the period covered by the financial statements or during the period of the professional engagement, a partner or professional employee of the firm was simultaneously associated with the client as an officer, for example, as a CFO. D. Independence is impaired if fees for client services for previous audits remain unpaid when the current year's report is issued. This amount is viewed as a loan to the client.

[1] The Conceptual Framework for AICPA Independence Standards A. Adopts a risk-based approach to analysis of independence matters. B. Defines independence of mind as avoiding circumstances in which reasonable persons would conclude that integrity or objectivity has been compromised. C. Describes threats to independence as circumstances that impair independence. D. States that safeguards must eliminate threats to independence to be considered effective.

[1] The correct answer is A. A. The risk-based approach evaluates the risk that a CPA is not independent or is perceived by a reasonable and informed third party with knowledge of all relevant information as not independent. That risk must be reduced to an acceptable level to establish independence. Risk is acceptable when threats are acceptable. They may be acceptable because of the types of threats and their potential effect. Moreover, threats may be sufficiently mitigated or eliminated by safeguards. Threats are acceptable when it is not reasonable to expect that they will compromise professional judgment. B. Independence of mind "permits a member to perform an attest service without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism." Independence in appearance is the "avoidance of circumstances that would cause a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, to reasonably conclude that the integrity, objectivity, or professional skepticism of a firm or a member of the attest engagement team had been compromised." C. Threats to independence are circumstances that could cause impairment (an effective extinguishment of independence). Whether impairment occurs depends on (1) the nature of the threat, (2) whether it is reasonable to expect the threat to compromise professional judgment, and (3) the effectiveness of specific safeguards. D. Safeguards are controls that mitigate or eliminate threats to independence. They are effective if they eliminate the threat or reduce to an acceptable level the threat's potential to impair independence.

[1] Analytical procedures enable the auditor to predict the balance or quantity of an item under audit. Information to develop this estimate can be obtained from all of the following except A. Tracing transactions through the system to determine whether procedures are being applied as prescribed. B. Comparison of financial data with data for comparable prior periods, anticipated results (e.g., budgets and forecasts), and similar data for the industry in which the entity operates. C. Study of the relationships of elements of financial data that would be expected to conform to a predictable pattern based upon the entity's experience. D. Study of the relationships of financial data with relevant nonfinancial data.

[1] The correct answer is A. A. Tracing transactions through the system is a test of controls directed toward the operating effectiveness of internal control, not an analytical procedure. B. The basic premise of analytical procedures is that plausible relationships among data may be reasonably expected to exist and continue in the absence of known conditions to the contrary. Well-drafted budgets and forecasts prepared at the beginning of the year should therefore be compared with actual results, and client information should be compared with data for the industry in which the client operates. C. The auditor should expect financial ratios and relationships to exist and to remain relatively stable in the absence of reasons for variation. D. Financial information is related to nonfinancial information; e.g., salary expense should be related to the number of hours worked.

[1] When management refuses to disclose material noncompliance with laws and regulations identified by the independent auditor, the independent auditor may be charged with violating the AICPA Code of Professional Conduct for A. Disclaiming an opinion. B. Withdrawing from the engagement. C. Failing to uncover the illegal activities during prior audits. D. Reporting these activities to those charged with governance.

[1] The correct answer is A. A. When the auditor concludes that noncompliance is material and has not been appropriately disclosed or accounted for, a normal disclaimer of opinion is not suitable. The auditor should disclose the problem in a report that includes either a qualified or an adverse opinion. If management or those charged with governance do not accept a modified opinion, the auditor may withdraw from the engagement. Moreover, the auditor may, in some circumstances, have a duty of disclosure outside the entity, e.g., in a report to the SEC on Form 8-K or in a response to a subpoena. The Private Securities Litigation Reform Act of 1995 also may apply. B. Under AU-C 250, Consideration of Laws and Regulations in an Audit of Financial Statements, withdrawal may be warranted in certain cases. C. Audits in compliance with GAAS cannot ensure detection of all noncompliance. D. The auditor should notify those charged with governance about noncompliance.

[1] Based on the Code of Professional Conduct, a CPA A. May not, upon leaving a firm, take any of the firm's client files without permission. B. Is not associated with unaudited interim reports issued by clients even if the CPA's name is listed in the report. C. Cannot undertake the responsibility of supervising and evaluating the work of specialists. D. May disclose currently used Uniform CPA Examination questions.

[1] The correct answer is A. A. When the relationship of a member of the AICPA with a firm is terminated, and the member was not an owner of the firm, unless permitted by contract, the member may not take or retain originals or copies from the firm's client files or proprietary information without permission. Such behavior is an act discreditable. B. A member is associated with financial statements when (s)he has consented to the use of his or her name in a report, document, or written communication containing the statements. C. CPAs must be able to define the tasks to be performed by specialists and evaluate the results. D. Solicitation or knowing disclosure of currently used CPA examination questions is an act discreditable.

[1] A major purpose of the auditor's report on financial statements is to A. Assure investors of the complete accuracy of the financial statements. B. Clarify for the public the nature of the auditor's responsibility and performance. C. Deter creditors from extending loans in high-risk situations. D. Describe the specific auditing procedures undertaken to gather evidence for the opinion.

[1] The correct answer is B. A. An auditor's opinion provides no assurance of complete accuracy. The report explicitly states that an audit provides "reasonable assurance." B. One of the highest priorities of the AICPA has been to reduce the gap between the nature of the auditor's responsibility and performance and the public's perception of the audit function. The auditor's report issued in accordance with auditing standards clarifies the role of the auditor with the intention of diminishing the gap. C. The sole purpose of the auditor's report is to express an opinion on the fairness of presentation of the financial statements. The report provides some of the information upon which users of the statements may make informed decisions, but it does not substitute for the judgment of users or accept responsibility for the assertions contained in the statements. D. The auditor's responsibility section provides only a brief, general explanation of what an audit involves.

[1] Which of the following statements is true concerning analytical procedures used as risk assessment procedures? A. Analytical procedures usually involve comparisons of ratios developed from recorded amounts with assertions developed by management. B. Analytical procedures used as risk assessment procedures ordinarily use data aggregated at a high level. C. Analytical procedures can replace tests of controls in gathering evidence to support the assessed level of control risk. D. Analytical procedures are more efficient, but not more effective, than tests of details and transactions.

[1] The correct answer is B. A. Analytical procedures involve comparisons of recorded amounts, or ratios developed from recorded amounts, with expectations developed by the auditor. B. Analytical procedures used as risk assessment procedures may use data aggregated at a high level. C. Tests of controls are required if controls will be relied on. Analytical procedures are used as substantive procedures but not as tests of controls. D. For many assertions, analytical procedures may not be as effective or efficient as tests of details in providing the desired level of assurance.

[1] Which of the following ultimately determines the specific audit procedures necessary to provide an independent auditor with a reasonable basis for the expression of an opinion? A. The audit plan. B. The auditor's judgment. C. Auditing standards. D. The audit documentation.

[1] The correct answer is B. A. Audit plans are usually modified during the engagement to adapt to audit evidence as it is gathered. B. The auditor's professional judgment must determine the necessary audit plans and the specific audit procedures that will gather sufficient appropriate evidence to reduce audit risk to an acceptably low level and enable the auditor to draw reasonable conclusions on which to base the opinion. C. Auditing standards, whether established by the AICPA's ASB or the PCAOB, are general objectives that are concerned with the quality of the auditor's performance. D. Audit documentation demonstrates that the auditor has carried out the procedures (s)he has deemed necessary. The documentation does not determine the procedures undertaken.

[1] The concepts of audit risk and materiality are interrelated and must be considered together by the auditor. Which of the following is true? A. Audit risk is the risk that the auditor may unknowingly express a modified opinion when, in fact, the financial statements are fairly stated. B. The phrase in the auditor's report "present fairly, in all material respects, in accordance with accounting principles generally accepted in the United States of America" indicates the auditor's belief that the financial statements as a whole are not materially misstated. C. If misstatements are not important individually but are important in the aggregate, the concept of materiality does not apply. D. Material fraud but not material errors cause financial statements to be materially misstated.

[1] The correct answer is B. A. Audit risk is the risk that the auditor expresses an inappropriate opinion on financial statements that are materially misstated. For the purposes of GAAS, audit risk does not include the ordinarily insignificant risk that the auditor may modify the opinion when the statements are not materially misstated. B. The opinion paragraph of the auditor's report explicitly refers to materiality. Hence, financial statements that are presented fairly, in all material respects, in accordance with the applicable financial reporting framework are not materially misstated. Material misstatement can result from fraud or error. C. The concept of materiality recognizes that some misstatements, either individually or in the aggregate, are important for the fair presentation of financial statements. Qualitative as well as quantitative factors affect materiality judgments. This concept is consistent with an SEC Staff Accounting Bulletin, which also states, "A matter is 'material' if there is substantial likelihood that a reasonable person would consider it important" (SAB 99). D. Both material errors and material fraud cause financial statements to be materially misstated.

[1] Which of the following would be considered an analytical procedure? A. Examining a sample of paid vendors' invoices for proper approval by an authorized supervisor. B. Developing the current year's expected net sales based on the entity's sales trend of prior years. C. Projecting a deviation rate by comparing the results of a sample with the actual population characteristics. D. Evaluating management's plans for dealing with the adverse effects of recurring operating losses.

[1] The correct answer is B. A. Examining a sample of paid vendors' invoices for proper approval by an authorized supervisor involves inspection of documents as a test of controls. B. Analytical procedures are evaluations of financial information made by a study of plausible relationships among financial and nonfinancial data using models that range from simple to complex. Plausible relationships among data are reasonably expected to exist and continue in the absence of known conditions to the contrary. Thus, the auditor develops expectations or predictions of recorded balances or ratios using certain sources of information. For example, the auditor may use financial information from comparable prior periods to estimate sales based on prior-year amounts and their trend. C. Use of sampling to project a deviation rate for a control is not an analytical procedure. D. Evaluating management's plans for dealing with the adverse effects of recurring operating losses is done to determine whether a substantial doubt exists about the entity's ability to continue as a going concern for a reasonable period. For U.S. GAAP, this period is 1 year after the date that the financial statements are issued or are available to be issued. The plans evaluated are operational, not financial accounting matters.

[1] Three conditions are generally present in the client's organization when fraud occurs. Those conditions include each of the following except a(n) A. Incentive or pressure to commit fraud. B. Professional skepticism about the likelihood of fraud. C. Opportunity to commit fraud. D. Attitude or rationalization about the act of fraud.

[1] The correct answer is B. A. Incentives for, or pressures on, management or others to commit fraud ordinarily exist (whether or not observable) when fraud occurs. B. The auditor, not the client, should conduct the audit with professional skepticism. Professional skepticism is an "attitude that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to fraud or error, and critical assessment of audit evidence" (AU-C 200). C. The opportunity to commit fraud ordinarily exists (whether or not observable) when fraud occurs. D. An attitude or rationalization that justifies the fraud ordinarily exists (whether or not observable) when fraud occurs.

[1] CPA who has a direct financial interest in a nonclient having a material investment in the CPA's audit client A. Lacks independence only if the CPA's investment in the nonclient is material. B. Lacks independence only if the CPA can exercise significant influence over the nonclient. C. Lacks independence. D. Does not lack independence.

[1] The correct answer is C. A. An immaterial direct interest impairs independence when the nonclient investor has a material interest in the client investee. B. The ability to exert significant influence is relevant only when the nonclient investor's interest in the client investee is immaterial. C. If the investment by the nonclient in the client is material, any direct or material indirect financial interest a covered member has in the nonclient will impair independence. Thus, whenever the CPA has a direct financial interest, materiality is not an issue and the CPA lacks independence. D. Independence is impaired.

[1] As the acceptable level of detection risk decreases, an auditor may change the A. Timing of substantive tests by performing them at an interim date rather than at year-end. B. Nature of substantive procedures from a less effective to a more effective procedure. C. Timing of tests of controls by performing them at several dates rather than at one time. D. Assessed level of inherent risk to a higher amount.

[1] The correct answer is B. A. More assurance is provided by testing at year-end. B. For a given audit risk, the acceptable detection risk is inversely related to the assessed risks of material misstatement. As the RMMs increase, the acceptable detection risk decreases, and the auditor requires more persuasive audit evidence. The auditor may (1) change the types of audit procedures and their combination, e.g., confirming the terms of a contract as well as inspecting it; (2) change the timing of substantive procedures, such as from an interim date to year end; or (3) change the extent of testing, such as by using a larger sample (AU-C 330 and AS 2301). C. The auditor tests controls when (s)he wishes to rely on them to reduce the risks of material misstatement (the combined inherent risk and control risk). The resulting assessment is then used to determine the acceptable level of detection risk. D. The assessed level of inherent risk affects the acceptable level of detection risk but not vice versa.

[1] Which of the following is the most reliable analytical approach to verification of the year-end financial statement balances of a wholesale business? A. Verify depreciation expense by multiplying the depreciable asset balances by one divided by the depreciation rate. B. Verify commission expense by multiplying sales revenue by the company's standard commission rate. C. Verify interest expense, which includes imputed interest, by multiplying noncurrent debt balances by the year-end prevailing interest rate. D. Verify FICA tax liability by multiplying total payroll costs by the FICA contribution rate in effect during the year.

[1] The correct answer is B. A. One divided by the life of the asset is the formula for the straight-line depreciation rate per year. However, the client may use depreciation methods other than straight line. B. If the wholesaler uses a standard commission rate, commission expense should be related to sales revenue. The auditor should also compare actual with budgeted and prior year amounts. C. Interest expense is not related to the prevailing rate but to contracted and imputed rates. D. FICA tax is withheld from individual wages up to a ceiling amount. No tax liability exists for amounts above the ceiling, so the test will probably overstate the liability.

[1] The ultimate purpose of understanding internal control is to contribute to the auditor's evaluation of the risk that A. Tests of controls may fail to identify controls relevant to assertions. B. Material misstatements may exist in the financial statements. C. Specified controls requiring segregation of duties may be circumvented by collusion. D. Entity policies may be overridden by senior management.

[1] The correct answer is B. A. Tests of controls are performed when (1) the auditor's risk assessment is based on an expectation of the operating effectiveness of controls, or (2) substantive procedures alone cannot provide sufficient appropriate evidence at the relevant assertion level about operating effectiveness. An auditor must identify controls relevant to specific assertions before testing such controls. B. The understanding of internal control assists the auditor to (1) identify types of potential misstatements; (2) consider factors that affect the RMMs; and (3) design the nature, timing, and extent of further audit procedures (AU-C 315 and AS 2110). C. Collusion is an inherent limitation of internal control. D. Management override is an inherent limitation of internal control.

[1] A CPA wishes to determine how various issuers have complied with the disclosure requirements of a new financial accounting standard. Which of the following information sources would the CPA most likely consult for this information? A. AICPA Codification of Statements on Auditing Standards. B. AICPA Accounting Trends and Techniques. C. PCAOB Inspection Reports. D. SEC Statement 10-K Guide.

[1] The correct answer is B. A. The AICPA Codification of Statements on Auditing Standards contains U.S. generally accepted auditing standards (GAAS). B. Practical guidance for accounting and auditing engagements can be found in various nonauthoritative publications. An example is Accounting Trends and Techniques, which describes current practice regarding corporate financial accounting and disclosure policies. It is a useful source for practitioners in industry and public practice. This annual AICPA publication is based on a survey of the annual financial reports of over 600 public companies. C. Although quality control extends to adherence to GAAP, the PCAOB Inspection Reports do not provide information about prevalent practice regarding compliance with particular disclosure requirements. D. The actual Form 10-K filings by public companies, which contain audited financial statements, are more useful than the guidance information provided by the SEC.

Notes that are included with financial statements are the responsibility of the A. Securities and Exchange Commission. B. Company's management. C. Independent auditor. D. Internal auditor.

[1] The correct answer is B. A. The SEC is responsible for ensuring that firms comply with federal securities laws. B. The notes are considered part of the basic financial statements. Because management has the primary responsibility for the financial statements, it also has the primary responsibility for the fairness of information included in notes. C. The independent external auditor is responsible for expressing an opinion on the fairness of the financial statements. D. The internal auditor advises management.

[1] Which of the following professional services is considered an attest engagement? A. A consulting service engagement to provide computer advice to a client. B. An engagement to report on compliance with statutory requirements. C. An income tax engagement to prepare federal and state tax returns. D. The compilation of an engagement to provide a peer review for another CPA firm.

[1] The correct answer is B. A. The attestation standards explicitly do not apply to consulting services in which the practitioner provides advice or recommendations to a client. B. In an attest engagement, a practitioner issues an examination, a review, or an agreed-upon procedures report on subject matter (or an assertion about subject matter) that is the responsibility of another party (AT-C 105). Thus, attest engagements are not limited to traditional financial statement audits. For example, attest services may extend to management's compliance with specified requirements or the effectiveness of internal control over compliance. C. Tax return preparation is not an attest service according to the attestation standards. D. Peer reviews essentially are evaluations of quality control. They are performed to meet the practice-monitoring requirements applicable to public accounting firms. They are not attest engagements.

[1] The objective of the audit of GAAP-based financial statements is to A. Make suggestions as to the form or content of the financial statements or to draft them in whole or in part. B. Express an opinion on the fairness with which the statements present financial position, results of operations, and cash flows in accordance with generally accepted accounting principles. C. Ensure adoption of sound accounting policies and the establishment and maintenance of internal control. D. Express an opinion on the accuracy with which the statements present financial position, results of operations, and cash flows in accordance with generally accepted accounting principles.

[1] The correct answer is B. A. The auditor may make suggestions about the statements or help prepare them, but (s)he is responsible only for expressing an opinion as to their fairness. The statements remain the representations of management. B. Based on an audit, the auditor expresses an opinion (or a disclaimer of opinion) on the fairness, in all material respects, of the presentation of financial statements, i.e., on whether they will be misleading to users. C. Management is responsible for adopting sound accounting policies and establishing and maintaining internal control. D. The auditor expresses an opinion on the fairness of financial statements, not their accuracy.

[1] When determining whether uncorrected misstatements are material, individually or in the aggregate, an auditor of a nonissuer would consider each of the following, except A. The particular circumstances of each misstatement. B. The cost of correcting the misstatements. C. The effect of uncorrected misstatements related to prior periods. D. The size and nature of the misstatements.

[1] The correct answer is B. A. The auditor should consider the particular circumstances of each misstatement. B. The auditor should determine whether uncorrected misstatements are material, individually or in the aggregate. The auditor should consider the size and nature of misstatements relative to (1) classes of transactions, account balances, or disclosures and (2) the financial statements as a whole. The auditor also considers the circumstances of each misstatement and the effect of uncorrected misstatements in prior periods on the relevant classes of transactions, etc. However, the authoritative guidance does not address the cost of correcting the misstatements. C. The auditor should consider the effect of uncorrected misstatements related to prior periods on (1) classes of transactions, account balances, or disclosures and (2) the financial statements as a whole. D. The auditor should consider the size and nature of the misstatements relative to (1) classes of transactions, account balances, or disclosures and (2) the financial statements as a whole.

[1] The audit risk against which the auditor and those who rely on his or her opinion require reasonable protection is a combination of two separate risks at the assertion level. The first risk (consisting of inherent risk and control risk) is that balances, classes of transactions, or disclosures contain material misstatements. The second is that A. The auditor will reject a correct account balance as incorrect. B. Material misstatements that occur will not be detected by the audit. C. The auditor will apply an inappropriate audit procedure. D. The auditor will apply an inappropriate measure of audit materiality.

[1] The correct answer is B. A. The components of audit risk are inherent risk, control risk, and detection risk. B. Audit risk is a function of the risks of material misstatement and detection risk. Detection risk is the risk that the procedures performed to reduce audit risk to an acceptably low level will not detect a misstatement that exists and could be material individually or combined with other misstatements. The auditor assesses the risk of material misstatement after obtaining an understanding of the entity and its environment, including its internal control. It exists at the overall financial statement level and assertion level. The RMM at the assertion level consists of inherent risk and control risk. Some auditors use a mathematical model based on the relationships of the components of audit risk to arrive at an acceptable level of detection risk. For example, it reflects that the acceptable detection risk has an inverse relationship with the RMMs at the assertion level (AU-C 200 and AS 1101). C. The components of audit risk are inherent risk, control risk, and detection risk. D. The components of audit risk are inherent risk, control risk, and detection risk.

[1] The components of internal control include A. Monitoring of controls that sets the tone of the organization. B. A process of managing risks relevant to preparing financial statements. C. A control environment consisting of policies and procedures to help ensure that management directives are carried out. D. Control activities that identify, capture, and exchange information.

[1] The correct answer is B. A. The control environment sets the tone of the organization, influencing the control consciousness of its people. B. The risk assessment process is the entity's identification, analysis, and management of risks relevant to preparation of financial statements. C. Control activities are policies and procedures to help ensure that management directives are carried out. D. The information system, including related business processes, identifies, captures, and exchanges information in a form and time frame that enables people to carry out their responsibilities.

Users of an issuer's financial statements demand independent audits because A. Users demand assurance that fraud does not exist. B. Management may not be objective in reporting. C. Users expect auditors to correct management errors. D. Management relies on the auditor to improve internal control.

[1] The correct answer is B. A. The independent auditor is ultimately concerned with the fair presentation of the financial statements, not only the detection of fraud. However, the auditor should obtain reasonable assurance that material misstatements are detected. B. Management and financial statement users may have an adversarial relationship because their interests in the firm are different. The independent auditor provides assurance that the financial statements are not biased for or against any interest. C. Management is responsible for error correction. D. Poorly designed internal control is not necessarily inconsistent with a fair presentation of the financial statements. However, AS 2201 issued by the Public Company Accounting Oversight Board (PCAOB) requires an auditor's opinion on internal control in conjunction with the opinion on the financial statements of issuers.

[1] Which of the following presumptions is least likely to relate to the reliability of audit evidence? A. The more effective internal control is, the more assurance it provides about the accounting data and financial statements. B. An auditor's opinion is formed within a reasonable time to achieve a balance between benefit and cost. C. Evidence obtained from independent sources outside the entity is more reliable than evidence secured solely within the entity. D. The auditor's direct personal knowledge obtained through observation and inspection is more persuasive than information obtained indirectly.

[1] The correct answer is B. A. The more effective internal control is, the more assurance it provides about the reliability of the accounting data and financial statements. B. Appropriate audit evidence is relevant and reliable. Evidence is usually more reliable when it (1) is obtained from independent sources; (2) is generated internally under effective internal control; (3) is obtained directly by the auditor; (4) is in documentary form, whether paper, electronic, or other medium; and (5) consists of original documents. However, the need for (1) reporting to be timely and (2) maintaining a balance between benefit and cost are inherent limitations of the audit. Thus, for the opinion to be relevant, it must be formed within a reasonable period of time. C. Evidence obtained from independent sources outside an entity provides greater assurance of reliability than evidence secured solely within the entity. D. The auditor's direct personal knowledge obtained through physical examination, observation, computation, and inspection is more persuasive than information obtained indirectly.

[1] Which of the following is a false statement about the relationship of financial statement assertions and audit procedures? A. The relationship between financial statement assertions and audit procedures should be one- to-one. B. Audit procedures should be developed in light of financial statement assertions about the financial statement components. C. Selection of tests of financial statement assertions should depend upon the understanding of internal control. D. The auditor should resolve any substantial doubt about any of management's relevant financial statement assertions.

[1] The correct answer is B. A. To be appropriate, audit evidence should be relevant and reliable. Also, because of the inherent limitations of the audit, most audit evidence is persuasive rather than conclusive. B. The auditor exercises professional judgment when forming a conclusion about whether sufficient appropriate audit evidence has been obtained to reduce audit risk to an acceptably low level. Sufficiency measures the quantity of audit evidence. Appropriateness measures its quality (relevance and reliability). To form this conclusion, the auditor considers all relevant evidence, regardless of whether it corroborates or contradicts the assertions in the statements. C. Although the cost of obtaining evidence and its usefulness should be rationally related, the matter of difficulty, time, or cost is not in itself a valid basis for (1) omitting a procedure when no alternative exists or (2) being satisfied with less than persuasive evidence. D. Accounting records should be supported by corroborating information.

[1] 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. A decrease in costs of goods sold as a percentage of sales. B. A decrease in accounts payable. C. A decrease in retained earnings. D. A decrease in notes payable.

[1] The correct answer is C. A. A decrease in the cost of goods sold as a percentage of sales is congruent with an increase in net income. B. A decrease in accounts payable will have an insignificant effect on net income. C. An increase in net income results either in an increase in retained earnings or in unchanged retained earnings if the entire amount of net income is used to pay dividends. Retained earnings is not expected to decrease given an increase in net income. D. A decrease in notes payable will have an insignificant effect on net income.

[1] Which of the following services provides the least assurance regarding the fairness of financial statements? A. Review. B. Audit. C. Compilation. D. Attestation.

[1] The correct answer is C. A. A review provides limited, also known as negative, assurance. B. An audit provides the highest level of assurance. C. During a compilation, neither analytical procedures nor tests of balances and transactions are performed. Thus, no assurance can be expressed regarding the fairness of the financial statements. D. Attestation services include reviews and examinations, each having their respective assurance levels.

[1] Because of the risk of material misstatement due to fraud, an audit of financial statements in accordance with generally accepted auditing standards should be planned and performed with an attitude of A. Objective judgment. B. Integrity. C. Professional skepticism. D. Impartial conservatism.

[1] The correct answer is C. A. Although objective judgment is a quality appropriate for practitioners, it is not required to be applied specifically in an audit. B. Although independent integrity is a quality appropriate for practitioners, it is not required to be applied specifically in an audit. C. The auditor should maintain professional skepticism throughout the audit. Professional skepticism is an "attitude that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to fraud or error, and critical assessment of audit evidence" (AU-C 200). D. GAAS do not require conservatism.

[1] According to professional standards, analytical procedures are least likely to be applied to A. Test disclosures about reportable operating segments. B. Review financial statements or interim financial information. C. Compile financial statements. D. Assist in forming an overall conclusion.

[1] The correct answer is C. A. An auditor should consider applying analytical procedures consisting of comparisons of information about segments with comparable information for the prior year and with budgeted information. B. Analytical procedures ordinarily should be applied in a review of interim financial information (AU-C 930, Interim Financial Information) and in a review of financial statements of a nonissuer (AR-C 90). C. AR-C 80, Compilation of Financial Statements, states that no audit procedures need be applied in a compilation of financial statements. The accountant is required only to read the financial statements to identify obvious material misstatements. D. Analytical procedures should be applied as risk assessment procedures and to assist in forming an overall conclusion.

[1] Analytical procedures in which current financial statements are compared with budgets or previous statements are primarily intended to determine the A. Adequacy of financial statement disclosure. B. Existence of specific misstatements or omissions. C. Overall reasonableness of statement contents. D. Use of an erroneous or inappropriate estimate.

[1] The correct answer is C. A. Analytical procedures are not concerned with the adequacy of financial statement disclosure. B. Analytical procedures used when comparing current financial statements with budgets or previous statements do not primarily determine the existence of specific misstatements or omissions. C. Analytical procedures used to compare current financial statements with budgets or previous statements are completed primarily in the planning stage of the audit. The auditor employs analytical procedures in this manner to determine the overall reasonableness of the financial statements. If any unusual relationships or unexpected results are found, further investigation is then completed. D. Analytical procedures used when comparing current financial statements with budgets or previous statements do not primarily determine the use of an inappropriate or erroneous estimate.

[1] Which of the following is a step in an auditor's decision to rely on internal controls? A. Apply analytical procedures to both financial data and nonfinancial information to detect conditions that may indicate weak controls. B. Perform tests of details of transactions and account balances to identify potential fraud and error. C. Identify specific controls that are likely to prevent, or detect and correct, material misstatements and perform tests of controls. D. Document that the additional audit effort to perform tests of controls exceeds the potential reduction in substantive testing.

[1] The correct answer is C. A. Analytical procedures are substantive procedures. The auditor should perform tests of controls to rely on internal controls. B. Tests of details are substantive procedures. The auditor should perform tests of controls to rely on internal controls. C. An auditor should obtain an understanding of controls relevant to the audit. Thus, the auditor should evaluate their design and determine whether they have been implemented. The evaluation of design considers whether the controls can effectively prevent, or detect and correct, material misstatements (AU-C 315 and AS 2110). The auditor then tests relevant controls to obtain sufficient appropriate evidence about their operating effectiveness if (1) the auditor intends to rely on them in determining the nature, timing, and extent of substantive procedures, or (2) substantive procedures alone cannot provide sufficient appropriate evidence at the relevant assertion level (AU-C 330 and AS 2301). D. If the effort to perform tests of controls exceeds the potential reduction in substantive testing, the auditor need not rely on controls.

[1] Analytical procedures performed to assist in forming an overall conclusion suggest that several accounts have unexpected relationships. The results of these procedures most likely indicate that A. Misstatements exist in the relevant account balances. B. Internal control activities are not operating effectively. C. Additional audit procedures are required. D. The communication with the audit committee should be revised.

[1] The correct answer is C. A. Analytical procedures can identify unexpected relationships but not their causes. B. Tests of controls are conducted to determine the effectiveness of their design and operation. C. Analytical procedures used to form an overall conclusion ordinarily include reading the financial statements and considering (1) the adequacy of evidence regarding unusual or unexpected balances detected during the audit and (2) such balances or relationships not detected previously. If analytical procedures detect a previously unrecognized risk of material misstatement, the auditor must revise the assessments of the RMMs and modify the further planned procedures. Inconsistent fluctuations or relationships or significant differences should result in (1) inquiries of management, (2) corroboration of responses with other audit evidence, and (3) performance of any necessary other procedures. Moreover, the RMM due to fraud should be considered. D. Until the auditor determines the cause of the unexpected relationships, the auditor does not know whether the communication with the audit committee should be revised.

[1] Analytical procedures used as risk assessment procedures should A. Focus on forming an overall conclusion. B. Provide a basis for the opinion. C. Address the risk of material misstatement of revenue due to fraudulent financial reporting. D. Assist in evaluating controls.

[1] The correct answer is C. A. Analytical procedures performed near the end of the audit assist in forming an overall conclusion about the consistency of the statements with the auditor's understanding of the entity. B. Risk assessment procedures do not by themselves provide a basis for the opinion. C. The audit plan includes a description of risk assessment procedures directed toward the risks of material misstatement (RMMs), whether due to fraud or error. The RMM is the combined assessment of inherent risk and control risk. Risk assessment procedures are performed to obtain an understanding of the entity and its environment, including its internal control, to assess the RMMs at the levels of (1) the financial statements as a whole and (2) relevant assertions about classes of transactions, account balances, and disclosures. They include (1) inquiries of management and others in the entity, (2) analytical procedures (also called analytical procedures used to plan the audit), and (3) observation and inspection (AU-C 315). The auditor specifically assesses the RMMs due to fraud at the financial statement and assertion levels. Moreover, the auditor should presume that risks of fraud exist in revenue recognition (AU-C 240). D. Analytical procedures are used as substantive procedures, not tests of the operating effectiveness of controls at the assertion level. They are designed to detect material misstatements at the assertion level.

[1] Which of the following is an effective audit planning and control procedure that helps prevent misunderstandings and inefficient use of audit personnel? A. Make copies of those client supporting documents examined by the auditor for inclusion in the audit documentation. B. Provide the client with copies of the audit plans to be used during the audit. C. Arrange a preliminary conference with the client to discuss audit objectives, fees, timing, and other information. D. Arrange to have the auditor prepare and post any necessary adjusting or reclassification entries prior to final closing.

[1] The correct answer is C. A. Copies of client supporting documents are made during the audit itself, not during the planning stages. Also, not all documents need to be copied. B. The client should not be told which audit procedures are going to be used. Such information might be misused to circumvent the audit. C. A preliminary conference with the client to discuss various audit objectives, fees, timing, the reports to be prepared, the use of client personnel, etc., is an appropriate procedure to prevent misunderstandings during the audit. The arrangement should be documented in the engagement letter. D. The client (not the auditor) must prepare and post adjusting or reclassification entries.

[1] Which of the following legal situations would be considered to impair the auditor's independence? A. An expressed intention by the current management to commence litigation against the auditor alleging deficiencies in audit work for the client, although the auditor considers that there is only a remote possibility that such a claim will be filed. B. Actual litigation by the auditor against the client for an amount not material to the auditor or to the financial statements of the client arising out of disputes as to billings for consulting services. C. Actual litigation by the auditor against the current management alleging management fraud or deceit. D. Actual litigation by the client against the auditor for an amount not material to the auditor or to the financial statements of the client arising out of disputes as to billings for tax services.

[1] The correct answer is C. A. Independence is impaired if the auditor concludes that it is probable that such a claim will be filed. B. If the litigation is related to an engagement not requiring independence, such as consulting services, impairment does not necessarily result unless the amount in controversy is material to one of the litigants. C. The following are situations in which actual or threatened litigation impairs independence: (1) litigation has begun alleging deficient audit work; (2) litigation has begun alleging fraud or deceit by current management; and (3) management has expressed an intention to commence litigation alleging deficient audit work, and the auditor concludes that it is probable that such a claim will be filed. D. If the litigation is related to an engagement not requiring independence, such as tax services, impairment does not necessarily result unless the amount in controversy is material to one of the litigants.

[1] Observation is considered a reliable audit procedure but one that is limited in usefulness. However, it is used in a number of different audit situations. Which of the following statements is true regarding observation as an audit technique? A. It is the most effective audit methodology to use in filling out internal control questionnaires. B. It is the most persuasive methodology to learn how transactions are really processed during the period under audit. C. It is most persuasive about the performance of a process but is limited to the moment in time at which the observation takes place. D. It is the most persuasive audit technique for determining if fraud has occurred.

[1] The correct answer is C. A. Interviews are the most effective method to fill out questionnaires. The interview results should be supplemented with observations. B. Observation provides information on how transactions are processed at one moment in time, not how they are processed throughout the period under audit investigation. C. Observation consists of looking at a process or procedure being performed by others. It provides audit evidence about the process or procedure but is limited to that moment in time by the fact that the act of being observed may affect how the process or procedure is performed. D. The auditor very seldom is able to observe a fraud.

[1] Analytical procedures are most appropriate when testing which of the following types of transactions? A. Payroll and benefit liabilities. B. Acquisitions and disposals of fixed assets. C. Operating expense transactions. D. Noncurrent debt transactions.

[1] The correct answer is C. A. Payroll and benefit liabilities are balance sheet accounts and not as predictable as, for example, payroll expense. B. Acquisitions and disposals of fixed assets relate to balance sheet accounts, which are not typically as predictable as income statement accounts. C. Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts. Income statement accounts represent transactions over a period of time, but balance sheet accounts represent an amount at a moment in time. Thus, operating expense transactions are likely to be more predictable than balance sheet accounts. D. Noncurrent debt transactions relate to balance sheet accounts, which are not typically as predictable as income statement accounts.

[1] Which of the following procedures is the auditor most likely to perform after accepting an initial audit engagement? A. Prepare a rough draft of the financial statement and of the auditor's report. B. Assess control risk for the assertions embodied in the financial statements. C. Tour the client's facilities. D. Consult with and review the work of the predecessor auditor prior to discussing the engagement with the client management.

[1] The correct answer is C. A. Preparing the report is one of the last steps performed in the engagement. B. The auditor must obtain an understanding of internal control before assessing control risk. C. The auditor performs risk assessment procedures to obtain an understanding of the entity and its environment, including internal control. They include (1) inquiries within the entity, (2) analytical procedures, and (3) observation and inspection. An example of observation and inspection is touring the client's facilities. D. Consulting with the predecessor auditor should be completed before accepting the engagement. The auditor should request permission from the client to make appropriate inquires (AU-C 210).

[1] The risks of material misstatement (RMMs) should be assessed in terms of A. Specific controls. B. Types of potential fraud. C. Financial statement assertions. D. Control environment factors.

[1] The correct answer is C. A. Relevant controls should relate to the identified RMMs, and the RMMs are identified and assessed at the financial statement and relevant assertion levels. B. The auditor should use information obtained from the understanding to identify types of potential misstatements. C. The auditor's objective is to identify and assess the RMMs, whether due to fraud or error, at the financial statement and relevant assertion levels. This objective is achieved through understanding the entity and its environment, including its internal control. The understanding provides a basis for designing and implementing responses to the assessed RMMs (AU-C 315 and AS 2110). D. The auditor considers the control environment in assessing the RMMs but does not assess risk in terms of control environment factors.

[1] Which AICPA Conduct Rule applies only to members in the practice of public accounting? A. General Standards. B. Accounting Principles. C. Independence. D. Compliance with Standards.

[1] The correct answer is C. A. The General Standards Rule also applies to members in business. B. The Accounting Principles Rule also applies to members in business. C. The Independence Rule states, "A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council." The scope of services addressed is broader than the expression of opinions on financial statements. Thus, it applies to such professional services as reviews, reports on prospective financial information, and reports on other attestation engagements. D. The Compliance with Standards Rule also applies to members in business.

[1] An auditor of a nonissuer exercising professional skepticism with respect to the risks of material misstatement due to fraud will most appropriately A. Adopt an attitude of acceptance unless evidence indicates otherwise. B. Authenticate documents used as audit evidence. C. Consider the reliability of information to be used as audit evidence. D. Assess the entity's document-retention controls before using documents as audit evidence.

[1] The correct answer is C. A. The auditor should consider the reliability of audit evidence before accepting it. B. The auditor should consider the reliability of the information to be used as audit evidence. However, an audit rarely involves the authentication of documentation, nor is the auditor trained as or expected to be an expert in such authentication. C. Professional skepticism should be maintained in considering the risk of material misstatement due to fraud. When the auditor exercises professional skepticism with respect to the risks of material misstatement due to fraud, the auditor should consider the reliability of information to be used as audit evidence. D. An entity's document-retention policies may require the auditor to request retention of some information for the auditor's review or to perform audit procedures at a time when the information is available. However, the auditor typically does not assess retention controls when (s)he exercises professional skepticism with respect to fraud risk.

[1] Which of the following best describes why an independent auditor is asked to express an opinion on the fair presentation of financial statements? A. It is difficult to prepare financial statements that fairly present a company's financial position, results of operations, and cash flows without the expertise of an independent auditor. B. It is management's responsibility to seek available independent aid in the appraisal of the financial information shown in its financial statements. C. The opinion of an independent party is needed because a company may not be objective with respect to its own financial statements. D. It is a customary courtesy that all shareholders of a company receive an independent report on management's stewardship in managing the affairs of the business.

[1] The correct answer is C. A. The auditor's independence is vital to the performance of the attest function, not his or her preparation of financial statements. Indeed, for purposes of SEC reporting, preparing the financial statements may be considered an impairment of independence. Also, the assertions in the statements are the sole responsibility of management. B. Management does not seek an appraisal of the financial statements, only an opinion as to whether they are presented fairly. C. The opinion of a suitably qualified, independent, outside party lends credibility to the financial statements and provides some protection to third parties who may rely upon them when making investment decisions. The opinion contained in the audit report, which accompanies audited financial statements, is the result of the auditor's performance of the attest function, that is, the gathering of evidence during the audit and the issuance of an opinion on the fairness of the presentation of the statements. D. Although the distribution of information to shareholders is customary, it is not the primary reason for an auditor's report.

[1] Audit documentation that records the procedures used by the auditor to gather evidence should be A. Considered the primary support for the financial statements being audited. B. Viewed as the connecting link between the books of account and the financial statements. C. Designed to meet the circumstances of the particular engagement. D. Destroyed when the audited entity ceases to be a client.

[1] The correct answer is C. A. The financial statements are primarily supported by the client's accounting records. B. Audit documentation is not a part of, or substitute for, the client's accounting records. C. Audit documentation should be designed to meet the circumstances of a particular engagement. Audit documentation should provide (1) a sufficient and appropriate record of the basis for the auditor's report and (2) evidence that the audit was planned and performed in accordance with GAAS (AU-C 230). D. The auditor should retain audit documentation for a period sufficient to meet the needs of his or her practice and to satisfy any applicable legal or regulatory requirements of records retention. For issuers, audit documentation should be maintained for at least 7 years from the date of the release of the audit report.

[1] Which of the following factors would most likely cause an auditor not to accept a new audit engagement? A. An inadequate understanding of the entity's internal controls. B. The close proximity to the end of the entity's fiscal year. C. Concluding that the entity's management probably lacks integrity. D. An inability to perform preliminary analytical procedures before assessing control risk.

[1] The correct answer is C. A. The understanding of the entity's internal controls is obtained subsequent to the acceptance of the engagement. B. Although early appointment is preferable, an independent auditor may accept an engagement near or after the close of the fiscal year. C. CPA firms should have policies and procedures to determine whether to accept or continue a client or to perform a specific engagement. The firm's policies and procedures should provide reasonable assurance that it (1) has considered the integrity of the client and the risks involved, (2) is competent, (3) has the necessary capabilities and resources, and (4) is able to comply with applicable requirements (QC 10). D. Analytical procedures are performed after the acceptance of the engagement.

[1] The appearance of independence of a CPA, or that CPA's firm, is most likely to be impaired if the CPA A. Provides appraisal, valuation, or actuarial services for an attest client. B. Joins a trade association, which is an attest client, and serves in a nonmanagement capacity. C. Accepts a token gift from an attest client. D. Serves as an executor and trustee of the estate of an individual who owned the majority of the stock of a closely held client corporation.

[1] The correct answer is D. A. A member who performs other nonattest services for an attest client must meet certain conditions to be considered independent. Thus, a member who provides appraisal, valuation, or actuarial services for a nonissuer attest client should meet the general requirements, e.g., (1) not assuming management responsibilities and (2) documenting an understanding with the client. Furthermore, performing these services should not involve a significant degree of uncertainty. Accordingly, the member may perform such services if certain requirements are met. For example, an actuarial valuation of a pension liability does not impair independence because it ordinarily produces reasonably consistent results. B. Independence is not impaired, provided the CPA does not participate in management. C. A token gift does not impair independence. However, a CPA who accepts more than a token gift, even with the knowledge of the member's firm, appears to lack independence. D. Independence is impaired with regard to the client if, during the period of the professional engagement, a covered member was a trustee of any trust or executor or administrator of any estate if such trust or estate had or was committed to acquire any direct or material indirect financial interest in the client, and the value of the estate's holdings in the client exceeded 10% of the estate's assets. Mere designation as a trustee or executor does not impair independence, but actual service does.

[1] Which of the following is usually included or shown in the audit documentation? A. The procedures used by the auditor to verify the personal financial status of members of the client's management team. B. Analyses that are designed to be a part of, or a substitute for, the client's accounting records. C. Excerpts from authoritative pronouncements that support the underlying generally accepted accounting principles used in preparing the financial statements. D. A summary of how significant findings were addressed.

[1] The correct answer is D. A. Although the auditor should consider incentives or pressures for the client's management to commit fraud, the personal financial status of managers is normally not verified. B. Audit documentation is not to be regarded as a part of, or a substitute for, the client's accounting records (AU-C 230). C. Management, not the auditor, must document and support the general acceptability of the accounting principles used by the client. D. Auditors may document a summary, or completion memorandum, describing the significant findings or issues identified and how they were addressed. This summary facilitates (1) reviews of the audit documentation, (2) the auditor's consideration of significant findings and issues, and (3) determination of whether any individual audit objective cannot be achieved that will prevent achievement of the overall audit objectives.

[1] 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 does exist is A. Audit risk. B. Inherent risk. C. Control risk. D. Detection risk.

[1] The correct answer is D. A. Audit risk is a function of the risks of material misstatement and detection risks. The RMM consists of inherent risk and control risk, which are not affected by the auditor's procedures. B. Inherent risk is the susceptibility of an assertion about a transaction class, account balance, or disclosure that could be material, individually or combined with other misstatements, before consideration of any related controls. C. Control risk is the risk that internal control will not timely prevent, or detect and correct, a material misstatement that could occur in an assertion. D. Detection risk is the risk that the procedures performed to reduce audit risk to an acceptably low level will not detect a misstatement that exists and could be material individually or combined with other misstatements (AU-C 200 and AS 1101).

[1] The AICPA Code of Professional Conduct does not include enforceable Rules of Conduct on which of the following? A. Independence and integrity and objectivity. B. Professional competence and due professional care. C. Accounting principles. D. Responsibilities to colleagues.

[1] The correct answer is D. A. Enforceable Rules of Conduct include (1) independence and (2) integrity and objectivity. B. Enforceable Rules of Conduct include (1) professional competence and (2) due professional care. C. Enforceable Rules of Conduct include accounting principles. D. The Code previously included two rules regarding colleagues, but they were deleted after threats of antitrust actions against the profession by the Federal Trade Commission and the U.S. Justice Department. The principles express the profession's recognition of its responsibilities to colleagues as well as to the public and clients, but adherence to them is not mandatory.

[1] According to the standards of the profession, which of the following events will require a CPA performing a consulting services engagement for a nonaudit client to withdraw from the engagement? I. The CPA has a conflict of interest that is disclosed to the client, and the client consents to the CPA's continuing the engagement. II. The CPA fails to obtain a written understanding from the client concerning the scope of the engagement. A. I only. B. II only. C. Both I and II. D. Neither I nor II.

[1] The correct answer is D. A. Neither a disclosed and consented to conflict of interest nor a lack of a written agreement concerning the scope of the engagement forces a CPA to withdraw from a consulting engagement for a nonaudit client. B. Neither a disclosed and consented to conflict of interest nor a lack of a written agreement concerning the scope of the engagement forces a CPA to withdraw from a consulting engagement for a nonaudit client. C. Neither a disclosed and consented to conflict of interest nor a lack of a written agreement concerning the scope of the engagement forces a CPA to withdraw from a consulting engagement for a nonaudit client. D. The additional general standards for consulting services require serving the client interest with integrity and objectivity. If a conflict of interest is disclosed and consented to, objectivity is not deemed to be impaired, and the professional service may be performed. In addition, an accountant may establish either a written or an oral understanding with the client regarding the scope of the engagement. Thus, an accountant need not withdraw from an engagement when the understanding of the scope of the engagement is not in writing.

[1] If an auditor of an issuer examines purchase orders obtained from the issuer to verify proper authorization of transactions, then the auditor is conducting A. A reperformance. B. A confirmation. C. An observation. D. An inspection.

[1] The correct answer is D. A. Reperformance is the independent execution of procedures or controls. The auditor cannot reperform the authorization process. B. Confirmations are substantive procedures. They are audit evidence obtained as direct written responses to the auditor from third parties. C. Observation is looking at a process or procedure being performed. Observation is not used in examining documents. D. Inspection is the examination of records or documents, whether internal or external, in paper, electronic, or other media. The auditor performs inspection of documents to verify proper authorization of transactions

[1] The auditor should establish an overall audit strategy. Which one of the following statements is most consistent with this requirement? A. The auditor should have appropriate proficiency to perform the audit. B. The auditor must be independent of the client. C. The auditor should communicate certain issues to those charged with governance. D. The auditor should plan the audit so that it will be performed effectively.

[1] The correct answer is D. A. The auditor should be proficient, but this requirement is not directly related to the audit strategy. B. The auditor must be independent regardless of the audit strategy. C. Communication to those charged with governance occurs during and after the audit. D. An audit plan is developed and documented based on the overall audit strategy. It is more detailed than the audit strategy because it includes the nature, timing, and extent of work to be performed. The plan includes (1) risk assessment procedures, (2) further audit procedures at the assertion level, and (3) other procedures to comply with GAAS.

[1] Richard, CPA, performs compilation services for Norton Corporation, a nonpublic entity. The compilation reports issued by Richard disclose lack of independence and are not used by third parties. Richard has accepted a commission from a software company for recommending its products to Norton. The commission agreement was disclosed to Norton. Richard also refers Norton to Cruz, CPA, who is more competent with respect to engagements involving the industry in which Norton operates. Cruz performs an audit of Norton's financial statements and subsequently remits to Richard a portion of the fee collected. The referral fee agreement was likewise disclosed to Norton. Richard accepts the fee. Who, if anyone, has violated the Code of Professional Conduct? A. Only Richard. B. Both Richard and Cruz. C. Only Cruz. D. Neither Richard nor Cruz.

[1] The correct answer is D. A. Richard has not violated the Code. B. Neither Richard nor Cruz has violated the Code. C. Cruz has not violated the Code. D. A commission is "compensation, except a referral fee, for recommending or referring any product or service to be supplied by another person" (FTC Order dated August 3, 1990). Receipt of a disclosed commission is prohibited only if the CPA performs for the client an audit, a review, a compilation when the report will be used by third parties and the report does not disclose the CPA's independence, or an examination of prospective financial information. A referral fee is "compensation for recommending or referring any service of a CPA to any person" (FTC Order cited above). Referral fees are allowed if they are disclosed to the client. Consequently, Richard has not violated the Code by accepting either the disclosed commission or the disclosed referral fee. Cruz has not violated the Code by paying the disclosed referral fee.

[1] Although the quantity and content of audit documentation vary with each engagement, an auditor's permanent files most likely include A. Schedules that support the current year's adjusting entries. B. Prior years' accounts receivable confirmations that were classified as exceptions. C. Documentation indicating that the audit work was adequately planned and supervised. D. Analyses of capital stock and other owners' equity accounts.

[1] The correct answer is D. A. Schedules that support the current year's adjusting entries are not carried forward in the permanent file. They are unlikely to have continuing significance. B. Prior years' accounts receivable confirmations that were classified as exceptions are not carried forward in the permanent file. They are unlikely to have continuing significance. C. Documentation indicating that the audit work was adequately planned and supervised is always included in the current files. D. The permanent section of audit documentation usually contains copies of important client documents. They may include (1) the articles of incorporation, stock options, contracts, and bylaws; (2) the engagement letter, the contract between the auditor and the client; (3) analyses from previous audits of accounts of special importance to the auditor, such as noncurrent debt, PP&E, and equity; and (4) information concerning internal control, e.g., flowcharts, organization charts, and questionnaires.

[1] Jaye B. Honest, CPA, was offered the engagement to audit Wicket Corporation for the year ended June 30, Year 3. She had served as a director of Wicket Corporation until June 30, Year 1, and her spouse currently owns 600 of the 10,000 outstanding shares of Wicket Corporation. Jaye disassociated from Wicket prior to being offered the engagement. Moreover, the engagement does not cover any period that includes Jaye's association or employment with Wicket. Under the AICPA Code of Professional Conduct, she should A. Accept the engagement. B. Let a partner from the same office accept and conduct the engagement. C. Refuse the engagement because she had served as a director. D. Refuse the engagement because of her spouse's stock ownership.

[1] The correct answer is D. A. She is not independent and should not accept the engagement. B. The term "covered member" includes a partner in the office in which the lead attest engagement partner primarily practices in connection with the engagement. C. If she has not served as a director during the period covered by the financial statements or during the period of the professional engagement, independence is not impaired by reason of prior association with the client as a director. D. According to the Code, independence is impaired if, during the period of the professional engagement, a covered member had or was committed to acquire any direct or material indirect financial interest in a client. With some exceptions, the immediate family (spouse, spousal equivalent, or dependent) of a covered member is subject to the Code. Thus, the CPA should refuse the engagement to audit the company because her spouse's stock ownership is a direct interest that is ascribed to her. Materiality is not an issue.

[1] Prior to beginning the field work on a new audit engagement in which a CPA does not possess expertise in the industry in which the client operates, the CPA should A. Reduce audit risk by lowering initial levels of materiality. B. Design special substantive procedures to compensate for the lack of industry expertise. C. Engage financial experts familiar with the nature of the industry. D. Perform risk assessment procedures.

[1] The correct answer is D. A. The auditor cannot make judgments about materiality levels until (s)he has a sufficient understanding of the entity. B. The auditor cannot design substantive procedures until (s)he has a sufficient understanding of the entity. C. The use of experts does not relieve the auditor of the responsibility to obtain an understanding of the entity. D. The auditor should obtain an understanding of the entity and its environment, including its internal control. For this purpose, the auditor performs the following risk assessment procedures: (1) inquiries of management and others within the entity, (2) analytical procedures, and (3) observation and inspection.

[1] Which of the following statements about evidence is true? A. Appropriate evidence supporting management's assertions should be conclusive rather than merely persuasive. B. Effective internal control contributes little to the reliability of the evidence created within the entity. C. The cost of obtaining evidence is not an important consideration to an auditor in deciding what evidence should be obtained. D. A client's accounting records cannot be considered sufficient appropriate audit evidence on which to base the auditor's opinion.

[1] The correct answer is D. A. The auditor must usually rely on evidence that is merely persuasive. B. The more effective internal control, the more assurance it provides about the reliability of the accounting data and financial statements. C. The auditor considers the cost of evidence relative to its usefulness. However, although the cost of obtaining evidence and its usefulness should be rationally related, the matter of difficulty, time, or cost is not in itself a valid basis for (1) omitting a procedure when no alternative exists or (2) being satisfied with less than persuasive evidence. D. Audit evidence consists of accounting records (initial entries and supporting records, such as ledgers, worksheets, and spreadsheets) and other information (minutes of meetings, confirmations, information obtained by inquiry, etc.). But accounting records alone do not provide sufficient appropriate evidence as a basis for an opinion on the financial statements.

[1] In planning the audit engagement, the auditor should consider each of the following except A. The auditor's independence. B. Risks of material misstatement due to fraud. C. Anticipated levels of audit risk and materiality. D. The kind of opinion (unmodified, qualified, or adverse) that is likely to be expressed.

[1] The correct answer is D. A. The auditor's preliminary engagement activities include evaluating his or her compliance with ethical standards, such as independence. B. During planning, engagement personnel are required to discuss how and where the financial statements may be susceptible to material misstatements due to fraud. C. The anticipated levels of audit risk and materiality should be considered during audit planning. D. Although the nature of the services expected to be rendered (e.g., a report on consolidated or consolidating financial statements or on compliance with contractual provisions) should be considered when establishing the understanding with the client, determining the kind of opinion to be expressed occurs after the completion of audit procedures.

[1] Which of the following statements would least likely appear in an auditor's engagement letter? A. Fees for our services are based on our regular per diem rates, plus travel and other out-of- pocket expenses. B. Management is responsible for making all financial records and related information available to us. C. Our engagement is subject to the risk that material fraud or errors, if they exist, will not be detected. D. After performing our preliminary analytical procedures, we will discuss with you the other procedures we consider necessary to complete the engagement.

[1] The correct answer is D. A. The engagement letter identifies the fees and the basis for those fees. B. Engagement letters include indicators of the understanding of management's responsibilities. C. The risk that material fraud or errors may exist and not be detected in the course of the audit should be addressed. D. The terms of the engagement should be documented in an engagement letter that states the (1) objective and scope of the audit, (2) responsibilities of the auditor and management, (3) inherent limitations of the audit and internal control, (4) applicable financial reporting framework, and (5) expected form and content of audit reports. But the engagement letter does not describe the specific evidence collection process to be completed by the auditor.

[1] The primary difference between an audit of the balance sheet and an audit of the income statement is that the audit of the income statement deals with the verification of A. Transactions. B. Authorizations. C. Costs. D. Cutoffs.

[[1] The correct answer is A. A. The audit of the income statement focuses on the propriety of handling transactions because most income statement accounts represent large volumes of transactions. The audit of the balance sheet concentrates on verification of account balances. B. All transactions must be authorized. C. The auditor is equally concerned with the costs reflected in the income statement and the balance sheet. D. Cutoffs to verify that only current period transactions are reflected apply to both statements.