Auditing Ch 6

NFB is a continuing audit client. Effect on Risks of Material Misstatement (Increase or Decrease)

Decrease

Which of the following best describes what is meant by the term "fraud risk factor"? (1)Factors that, when present, indicate that risk exists. (2)Factors often observed in circumstances where frauds have occurred. (3)Factors that, when present, require modification of planned audit procedures. (4)Weaknesses in internal control identified during an audit.

(2) Factors often observed in circumstances where frauds have occurred. Fraud risk factors are factors that have been observed in circumstances in which fraud has occurred. The fraud risk factors were identified by researchers and practitioners through analyses of many past frauds. Yet, none of the factors was always present in the various individual cases included in the analyses. Answer (1) is incorrect because in any particular circumstance, the existence of a fraud risk factor may or may not indicate that in that circumstance the risk of fraud is high. Answer (3) is incorrect because the existence of a fraud risk factor may not require modification of planned audit procedures (e.g., the audit plan may already have audit procedures that consider the factor). Answer (4) is incorrect because a fraud risk factor may or may not be a significant deficiency.

The audit committee of a company must be made up of: (1)Representatives from the client's management, investors, suppliers, and customers. (2)The audit partner, the chief financial officer, the legal counsel, and at least one outsider. (3)Representatives of the major equity interests, such as preferred and common stockholders. (4)Members of the board of directors who are not officers or employees.

(4) Members of the board of directors who are not officers or employees. Members of the audit committee should be independent of management. Therefore, the individuals should be board members who are not employees or officers, and who have not relationship with management that might impair their objectivity.

Which of the following is an effective audit planning and control procedure that helps prevent misunderstandings and inefficient use of audit personnel? Arrange to make copies, for inclusion in the working papers, of those client supporting documents examined by the auditors. Arrange to provide the client with copies of the audit plans to be used during the audit. Arrange a preliminary conference with the client to discuss audit objectives, fees, timing, and other information. Arrange to have the auditors prepare and post any necessary adjusting or reclassification entries prior to final closing.

Arrange a preliminary conference with the client to discuss audit objectives, fees, timing, and other information.

NFB operates in a growing, prosperous area and has remained profitable over the years. Effect on Risks of Material Misstatement (Increase or Decrease)

Decrease

CPAs cannot ethically refuse to provide auditing services to any prospective client which the CPAs are competent to audit, if the prospective client is willing to pay the CPAs' standard audit fees. True False

F

Completeness of an asset account can best be established by vouching recorded entries in the asset account. True False

F

One basic reason that audit plans usually focus on balance sheet accounts is because users of financial statements are likely to rely more heavily upon the balance sheet than the other financial statements. True False

F

Substantive procedures are generally completed before the auditors assess control risk. True False

F

The more recommendations made in the management letter, the less effort the auditors must devote to substantive procedures. True False

F

The substantive procedures portion of the audit plan generally is organized around income statement accounts. True False

F

Which of the following is least likely to be considered a risk assessment procedure in a financial statement audit? Analytical procedures. Inquiries of management. Observation and inspection relating to client activities. Tests of controls.

Tests of controls.

The risk that the auditors will conclude, based on substantive procedures, that a material misstatement does not exist in an account balance when, in fact, such misstatement does exist is referred to as (1)Business risk. (2)Engagement risk. (3)Control risk. (4)Detection risk.

(4) Detection risk. Detection risk is the risk that the auditor will conclude, based on substantive procedures, that a material misstatement does not exist in an account balance, when, in fact, such misstatement does exist.

The audit plan generally should be modified if the auditors revise their estimate of risk for the engagement. True False

T

Successor auditors are required by professional standards to attempt certain inquiries of the predecessors before accepting a new audit client. True False

T

Tests of controls are designed to determine whether the client's controls are operating effectively. True False

T

Which of the following is most likely to be an overall response to fraud risks identified in an audit? (1)Supervise members of the audit team less closely and rely more upon judgment. (2)Use less predictable audit procedures. (3)Use only certified public accountants on the engagement. (4)Place increased emphasis on the audit of objective transactions rather than subjective transactions.

(2) Use less predictable audit procedures. Less predictable audit procedures are likely to be used when fraud risks are high. SAS 99 also suggest that the auditors have increased skepticism, assign more skilled staff, and consider further management's selection and application of accounting principles. Answer (1) is incorrect because supervision of members of the audit team will be closer, not less. Answer (3) is incorrect because team members may or may not be CPAs (e.g., a fraud specialist who is not a CPA might be added to the team). Answer (d) is incorrect because subjective, rather than objective transactions may often be emphasized—depending upon the nature of the fraud risks identified.

In planning and performing an audit, auditors are concerned about risk factors for two distinct types of fraud: fraudulent financial reporting and misappropriation of assets. Which of the following is a risk factor for misappropriation of assets? (1)Generous performance-based compensation systems. (2)Management preoccupation with increased financial performance. (3)An unreliable accounting system. (4)Strained relationships between management and the auditors.

(3) An unreliable accounting system. An unreliable accounting system provides an opportunity for an individual to misappropriate assets. The other items create risks of fraudulent financial reporting.

The primary objective of tests of details of transactions performed as substantive procedures is to: (1)Comply with generally accepted auditing standards. (2)Attain assurance about the reliability of the accounting system. (3)Detect material misstatements in the financial statements. (4)Evaluate whether management's policies and procedures are operating effectively.

(3) Detect material misstatements in the financial statements. The objective of tests of details of transactions performed as substantive procedures is to detect material misstatements in the financial statements as transactions are tested to determine whether they have been properly recorded.

Which of the following elements underlies the application of generally accepted auditing standards, particularly the standards of fieldwork and reporting? (1)Adequate disclosure. (2)Quality control. (3)Materiality and audit risk. (4)Client acceptance.

(3) Materiality and audit risk. Materiality and audit risk underly the application of generally accepted auditing standard in that so many audit decisions are affected by the amount used as a materiality measure and the level of audit risk assumed on the engagement.

Which portion of an audit is least likely to be completed before the balance sheet date? (1)Tests of controls. (2)Issuance of an engagement letter. (3)Substantive procedures. (4)Assessment of control risk.

(3) Substantive procedures. Substantive procedures substantiate the account balances as of the balance sheet date and therefore cannot be completed prior to that date. The other items pertain to the operation of the system during the year under audit and could be completed in the interim period.

Three conditions generally are present when fraud occurs. Select the one below that is not one of those conditions. (1)Incentive or pressure. (2)Opportunity. (3)Supervisory position. (4)Attitude.

(3) Supervisory position. AICPA AU-C 240 (PCAOB 316) outlines the three functions generally necessary for fraud as (1) incentive or pressure, (2) opportunity, and (3) attitude. Being in a supervisory position is not one of those conditions, although it may provide the individual an opportunity to commit fraud.

Which of the following should not normally be included in the engagement letter for an audit? (1) A description of the responsibilities of client personnel to provide assistance. (2) An indication of the amount of the audit fee. (3) A description of the limitations of an audit. (4) A listing of the client's branch offices selected for testing.

(4) A listing of the client's branch offices selected for testing. Management should not be informed about which branches were selected for testing at all or at least not until just before testing is to be done.

Which of the following should the auditors obtain from the predecessor auditors before accepting an audit engagement? (1)Analysis of balance sheet accounts. (2)Analysis of income statement accounts. (3)All matters of continuing accounting significance. (4)Facts that might bear on the integrity of management.

(4) Facts that might bear on the integrity of management. Before accepting an engagement the possible successor should ask questions about the integrity of management, disagreements with management, and the reasons for the change in auditors. All of the other replies are incorrect because they represent information that the successor may wish to obtain after accepting the engagement.

As one step in testing sales transactions, a CPA traces a random sample of sales journal entries to debits in the accounts receivable subsidiary ledger. This test provides evidence as to whether: (1)Each recorded sale represents a bona fide transaction. (2)All sales have been recorded in the sales journal. (3)All debit entries in the accounts receivable subsidiary ledger are properly supported by sales journal entries. (4)Recorded sales have been properly posted to customer accounts.

(4) Recorded sales have been properly posted to customer accounts. Because entries in the sales journal represent recorded sales, tracing entries from it to debits in the accounts receivable ledger provides evidence on whether recorded sales have been properly posted to customer accounts.

Which of the following topics is not normally included in an engagement letter? The auditors' responsibilities with respect to the audit. A request that the client sign a copy of the letter. Client responsibilities regarding the audit. A schedule of individual audit team member billing rates.

A schedule of individual audit team member billing rates.

Which of the following is the best example of a substantive procedure? Examining a sample of cash disbursements to test whether expenses have been properly approved. Confirming balances of accounts receivable. Comparing signatures on checks to a list of authorized check signers. Flowcharting a client's cash receipts system.

Confirming balances of accounts receivable.

Government regulation and overview of the banking industry is extensive and effective Effect on Risks of Material Misstatement (Increase or Decrease)

Decrease

Analytical procedures are optional procedures that may be useful to the auditors during the risk assessment stage of the audit. True False

F

Auditors should never spend more time on an audit than is called for in a conscientiously developed time budget. True False

F

NFB's board of directors is controlled by Smith, the majority stockholder, who also acts as the chief executive officer. Effect on Risks of Material Misstatement (Increase or Decrease)

Increase

The banking industry has been significantly impacted by the downturn in the economy in recent years. Effect on Risks of Material Misstatement (Increase or Decrease)

Increase

Government regulation and overview of the banking industry is extensive and effective Create a Risk of Fraud? (yes or no)

No

NFB is a continuing audit client. Create a Risk of Fraud? (yes or no)

No

NFB operates in a growing, prosperous area and has remained profitable over the years. Create a Risk of Fraud? (yes or no)

No

A declining industry with increasing business failures is an industry condition that is indicative of increased risk of fraudulent financial reporting. True False

T

A documented audit plan is required on all audits. True False

T

A systems approach to an audit emphasizes tests of controls. True False

T

An audit plan includes procedures for verifying the client's cutoff of transactions to be included in the financial statements of the current period. True False

T

An audit plan should indicate which auditing procedures have been completed and which remain to be done. True False

T

An engagement letter represents a written contract between the auditors and the client. True False

T

Audit risk is the risk of issuing an inappropriate opinion because the auditors' procedures fail to detect a material misstatement in the financial statements. True False

T

Auditors are required to specifically assess the risk of material misstatement of the financial statements due to fraud on every audit. True False

T

Since characteristics differ with every audit engagement, the auditors should tailor the audit plan to the particular engagement. True False

T

Which of the following statements is not correct regarding the auditor's determination of materiality? It is the smallest amount of misstatement that would probably influence the judgment of a reasonable person relying upon the financial statements. Auditing standards require auditors to consider materiality in planning the audit. The planning level of materiality will normally be the larger of the amount considered for the balance sheet versus the income statement. The appropriate financial statement base for computing materiality may vary based on the nature of the client's business.

The planning level of materiality will normally be the larger of the amount considered for the balance sheet versus the income statement.

Which of the following is the most likely first step the auditors would perform at the beginning of an initial audit engagement? Prepare a rough draft of the financial statements and of the auditors' report. Consider internal control. Tour the client's facilities and review the general records. Consult with and review the work of the predecessor auditors prior to discussing the engagement with the client management.

Tour the client's facilities and review the general records.

NFB's board of directors is controlled by Smith, the majority stockholder, who also acts as the chief executive officer. Create a Risk of Fraud? (yes or no)

Yes

The banking industry has been significantly impacted by the downturn in the economy in recent years. Create a Risk of Fraud? (yes or no)

Yes

The portions of the auditors' audit plans relating to internal control are generally organized around the: major transaction cycles. substantive procedures. analytical procedures. inherent risk assessment.

major transaction cycles.

A successor auditor should attempt communication with a predecessor auditor: prior to accepting the engagement. after the engagement has been accepted. both prior to acceptance of the engagement and after the engagement has been accepted. is not required to do so.

prior to accepting the engagement.