Audit Ch. 4, Ch. 5, Ch. 6 & fraud / SU 3
Question: 114 Which of the following statements describes why a properly planned and performed audit may not detect a material misstatement due to fraud? A. Audit procedures that are effective for detecting an error may be ineffective for detecting fraud that is concealed through collusion. B. An audit is designed to provide reasonable assurance of detecting material errors, but there is no similar responsibility concerning material fraud. C. The factors considered in assessing the risk of material misstatement indicated an increased risk of intentional misstatements, but only a low risk of errors in the financial statements. D. The auditor did not consider factors influencing audit risk for account balances that have effects pervasive to the financial statements as a whole.
Answer (A) is correct. Absolute assurance is unattainable because of the characteristics of fraud and the limitations of audit evidence. Management may override controls in unpredictable ways or alter accounting records, and fraud may be concealed through collusion, falsifying documentation (including electronic approvals), or withholding evidence. Moreover, procedures that effectively detect an error (an unintentional misstatement) may not detect fraud (an intentional act that a perpetrator typically attempts to conceal).
Question: 36 Analytical procedures are required for which of the following? A. Audit planning. B. Tests of balances. C. Client retention decision. D. Internal control evaluation.
Answer (A) is correct. An audit plan based on the audit strategy must be developed and documented for all audit engagements. It includes the nature, timing, and extent of procedures expected to reduce audit risk to an acceptably low level. Thus, the audit plan includes a description of risk assessment procedures. Risk assessment procedures are performed to obtain an understanding of the entity and its environment, including its internal control, to identify and assess the risks of material misstatement (RMMs) at the levels of (1) the financial statements as a whole and (2) relevant assertions. Risk assessment procedures include (1) inquiries of management and others within the entity, (2) analytical procedures, and (3) observation and inspection. The auditor also may perform other appropriate procedures, such as inquiring of external parties (e.g., legal counsel) or reviewing externally generated information (e.g., financial publications). Analytical procedures may be applied not only as risk assessment procedures (analytical procedures used to plan the audit) but also as substantive procedures. These are procedures (tests of details and analytical procedures) designed to detect material misstatements at the assertion level.
**Question: 6 In assessing whether to accept a client for an audit engagement, a CPA should consider the Client's Business Risk--CPA's Business Risk** A. Yes--Yes B. Yes--No C. No--Yes D. No--No
Answer (A) is correct. Before accepting an engagement, the CPA should consider the risks of being associated with the client. Auditor business risk relates to potential loss or injury to the auditor's professional practice from litigation and adverse publicity from the relationship with the client. The successful outcome of an audit and the ability to control auditor business risk often depends on the client's business risk. The auditor's understanding of the entity's business risks increases the likelihood of identifying risks of material misstatement. Thus, QC 10 states that policies and procedures should be established regarding acceptance and continuance of clients and specific engagements. They should provide reasonable assurance that the firm will undertake or continue relationships only when it does not have information leading to the conclusion that the client lacks integrity.
**Question: 108 Which of the following characteristics most likely would heighten an auditor's concern about the risk of material misstatements arising from fraudulent financial reporting?** A. The entity's industry is experiencing declining customer demand. B. Employees who handle cash receipts are not bonded. C. Bank reconciliations usually include in-transit deposits. D. Equipment is often sold at a loss before being fully depreciated.
Answer (A) is correct. Certain risk factors are related to misstatements arising from fraudulent reporting. These factors may be grouped in three categories: (1) incentives or pressures, (2) opportunities, and (3) attitudes or rationalizations. One set of risk factors in the incentives or pressures category consists of threats to financial stability or profitability by economic, industry, or entity operating conditions. Examples are significant declines in customer demand and increasing business failures in either the industry or the overall economy (AU-C 240).
**Question: 106 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.
Answer (A) is correct. 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).
**Question: 42 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.
Answer (A) is correct. 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).
**Question: 100 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.
Answer (A) is correct. 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."
Question: 47 A client decides not to correct misstatements communicated by the auditor that collectively are not material and wants the auditor to issue the report based on the uncorrected numbers. Which of the following statements is correct regarding the financial statement presentation? A. The financial statements are free from material misstatement, and no disclosure is required in the notes to the financial statements. B. The financial statements are not in accordance with the applicable financial reporting framework. C. The financial statements contain uncorrected misstatements that should result in a qualified opinion. D. The financial statements are free from material misstatement, but disclosure of the proposed adjustments is required in the notes to the financial statements.
Answer (A) is correct. If the uncorrected misstatements are immaterial, by definition the financial statements are free from material misstatement, and an unmodified opinion may be expressed. However, the schedule of uncorrected misstatements must be included in the management representation letter, and management must assert that these uncorrected misstatements are individually and collectively immaterial.
**Question: 55 Which of the following is an example of an inherent risk that an auditor should consider?** A. Technological developments that may render inventory obsolete. B. Posting of unauthorized journal entries. C. An incorrect formula in a worksheet used to calculate a LIFO inventory reserve. D. Inaccurate physical inventory count.
Answer (A) is correct. Inherent risk is the susceptibility of a financial statement assertion to a material misstatement before consideration of any related controls. Inherent risk is higher for some assertions and related transactions, balances, and disclosures. For example, it may be higher for complex calculations or amounts with significant estimation uncertainty. Business risks also may affect inherent risk. For example, technological developments might make a product obsolete, causing inventory to be overstated.
**Question: 41 Audit risk at the assertion level consists of inherent risk, control risk, and detection risk. Which of the following statements is true?** A. Cash has a greater inherent risk than an inventory of coal because it is more susceptible to theft. B. The risk that material misstatement will not be timely prevented or detected by internal control can be reduced to zero by effective controls. C. Detection risk is a function of the efficiency of an auditing procedure. D. The existing levels of inherent risk, control risk, and detection risk can be changed at the discretion of the auditor.
Answer (A) is correct. 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. Some assertions and related balances or classes of transactions have greater inherent risk. Thus, cash has a greater inherent risk than less liquid assets.
Question: 13 Which of the following matters does an auditor usually communicate to management? A. Arrangements involving a predecessor auditor. B. Indications of adverse key financial ratios. C. An agreement regarding preliminary materiality thresholds. D. Identification of recurring operating losses.
Answer (A) is correct. It is necessary to obtain management's approval before contacting a predecessor auditor.
Question: 2 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.
Answer (A) is correct. 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.
**Question: 8 Before accepting an engagement to audit a new client, an auditor is required to** A. Make inquiries of the predecessor auditor after obtaining the consent of the prospective client. B. Obtain the prospective client's signature to the engagement letter. C. Prepare a memorandum setting forth the staffing requirements and documenting the preliminary audit plan. D. Discuss the management representation letter with the prospective client's audit committee.
Answer (A) is correct. The auditor should request management to authorize the predecessor to respond fully to inquires. The auditor should inquire about (1) reasons for the change in auditors, (2) disagreements with management about accounting policies and auditing procedures, (3) facts about management's integrity, (4) communications to those charged with governance about fraud or noncompliance, and (5) communications to those charged with governance or management about internal control problems (AU-C 210, Terms of Engagement).
Question: 43 Which of the following audit risk components may be assessed in nonquantitative terms? Control Risk--Detection Risk--Inherent Risk A. Yes-Yes-Yes B. No-Yes-Yes C. Yes-Yes-No D. Yes-No-Yes
Answer (A) is correct. The components of audit risk may be assessed in quantitative terms such as percentages or in nonquantitative terms that range, for example, from high to low.
**Question: 48 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.
Answer (A) is correct. 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.
**Question: 52 Misstatements discovered by the auditor were immaterial in the aggregate in prior years. Such misstatements should be** A. Considered in the evaluation of audit findings in the current year. B. Disclosed by the client in the current-year financial statements. C. Retested during the current-year tests of controls. D. Removed from the prior-year summary because they were immaterial.
Answer (A) is correct. The cumulative effect of immaterial uncorrected misstatements related to prior periods may have a material effect on the current period's financial statements.
Question: 58 In a financial statement audit of a nonissuer, an auditor would consider a judgmental misstatement to be a misstatement that A. Involves an estimate. B. Exists because of nonstatistical sampling performed by the auditor. C. Arises from a flaw in the accounting system. D. Arises from a routine calculation.
Answer (A) is correct. To assist the auditor in evaluating the effect of misstatements accumulated during the audit and in communicating misstatements to management and those charged with governance, the auditor may find it useful to distinguish between factual misstatements, judgmental misstatements, and projected misstatements. Judgmental misstatements are differences arising from the judgments of management about accounting estimates that the auditor considers unreasonable or the selection or application of accounting policies that the auditor considers inappropriate.
Question: 16 Which of the following is required documentation in an audit in accordance with auditing standards? A. A flowchart or narrative of the information system describing the recording and classification of transactions for financial reporting. B. An audit plan documenting the procedures to be used to reduce audit risk. C. A planning memorandum establishing the timing of the audit procedures and coordinating the assistance of entity personnel. D. An internal control questionnaire identifying policies and procedures that assure specific objectives will be achieved.
Answer (B) is correct. An audit plan should be developed and documented based on the overall audit strategy. This strategy, the audit plan, significant changes in them, and the reasons for changes are documented. The audit plan records the nature, timing, and extent of risk assessment procedures and further procedures performed at the assertion level to respond to assessed risks. It also records other planned procedures required by GAAS. Thus, the audit plan is a record of the planning of the audit procedures that can be reviewed prior to their performance (AU-C 300 and AS 2101).
**Question: 37 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.
Answer (B) is correct. 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).
**Question: 39 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.
Answer (B) is correct. 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).
Question: 125 During an audit, an auditor discovers a fraudulent expense reimbursement for a low-level manager. The auditor determines that this transaction is inconsequential and several similar transactions would not be material to the financial statements in the aggregate. Which of the following statements best describes the auditor's required response to the discovery? A. The auditor should fully investigate other transactions related to this manager to determine if fraud exists. B. The auditor should bring the transaction to the attention of an appropriate level of management. C. The auditor should report this finding to those charged with governance. D. The auditor's responsibility is satisfied by documenting that the single transaction is inconsequential.
Answer (B) is correct. Inconsequential fraud should be communicated to the appropriate level of management.
**Question: 7 Which of the following conditions most likely would pose the greatest risk in accepting a new audit engagement?** A. Staff will need to be rescheduled to cover this new client. B. There will be a client-imposed scope limitation. C. The firm will have to hire a specialist in one audit area. D. The client's financial reporting system has been in place for 10 years.
Answer (B) is correct. Matters to consider regarding integrity of management include indications of an inappropriate scope limitation (QC 10). It suggests that management will not be completely forthcoming with all necessary evidence to support the auditor's opinion.
Question: 29 Financial statement audit plans usually should be developed A. Prior to performing risk assessment procedures. B. After the auditor has established the overall audit strategy. C. After obtaining an understanding of the information and communication and control activities components of internal control. D. When the engagement letter is prepared.
Answer (B) is correct. Planning continues throughout the audit. It initially involves developing an overall audit strategy. The size and complexity of the entity, the auditor's experience with the entity, and the auditor's understanding of the entity and its environment (including internal control) affect planning. The auditor also should consider (1) characteristics of the engagement and reporting objectives; (2) appropriate materiality levels; (3) areas of high risk of material misstatement; (4) material client locations and the use of component auditors; (5) whether to seek evidence of the operating effectiveness of controls; (6) relevant entity-specific, industry, or financial developments; and (7) the audit resources required. The more detailed audit plan is developed after the formulation of the overall audit strategy.
Question: 46 When planning an audit, an auditor should A. Consider whether substantive procedures may be reduced based on the results of the internal control questionnaire. B. Determine materiality for the financial statements as a whole. C. Conclude whether changes in compliance with prescribed controls require a change in the reliance on controls. D. Prepare a preliminary draft of the management representation letter.
Answer (B) is correct. Planning involves establishing an overall audit strategy. For this purpose, the auditor determines materiality for the financial statements as a whole. Circumstances also may indicate that misstatements of classes of transactions, balances, or disclosures of lesser amounts could influence the economic decisions of users. In those cases, the auditor also determines materiality for particular classes of transactions, balances, and disclosures.
**Question: 54 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.
Answer (B) is correct. 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.
Question: 40 Which of the following would an auditor most likely use in determining the auditor's preliminary judgment about materiality for the financial statements as a whole? A. The anticipated sample size of the planned substantive procedures. B. The entity's year-to-date financial results and position. C. The results of the internal control questionnaire. D. The contents of the representation letter.
Answer (B) is correct. The auditor's judgment about materiality for the financial statements as a whole might be based on benchmarks used as starting points. Examples are (1) categories of reported income (profit before tax, total revenue, gross profit, and total expenses), (2) total equity, and (3) net asset value. For profit-oriented entities, pretax profit from continuing operations is often used. The financial data for the benchmark usually includes (1) prior-period information, (2) period-to-date information, (3) budgets, or (4) forecasts. But recognition should be given to the effect of major changes in the entity's circumstances (for example, a significant merger) and relevant changes in the economy as a whole or the industry in which the entity operates (AU-C 320 and AS 2105).
**Question: 28 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.
Answer (B) is correct. 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.
**Question: 105 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.
Answer (B) is correct. 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).
Question: 44 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.
Answer (B) is correct. 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.
Question: 66 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.
Answer (B) is correct. The risk assessment process is the entity's identification, analysis, and management of risks relevant to preparation of financial statements.
Question: 1 **An auditor is required to establish an understanding with a client regarding the services to be performed for each engagement. For an auditor of a nonissuer, this understanding generally includes** A. The auditor's responsibility for determining the preliminary judgments about materiality and audit risk factors. B. Management's responsibility for identifying mitigating factors when the auditor has doubt about the entity's ability to continue as a going concern. C. The auditor's responsibility for ensuring that management and those charged with governance are aware of any significant deficiencies or material weaknesses in control that come to the auditor's attention. D. Management's responsibility for providing the auditor with an assessment of the risks of material misstatement due to fraud.
Answer (C) is correct. An auditor should accept an engagement only when the basis for audit performance is agreed through (1) establishing whether the preconditions for an audit exist and (2) confirming that the auditor and management (and, possibly, those charged with governance) have a common understanding of the terms of engagement. The agreement typically is documented in an engagement letter (AU-C 210). An engagement letter for a nonissuer should indicate that a financial statement audit is not designed to provide assurance on internal control. However, the auditor is responsible for ensuring that management and those charged with governance are aware of any significant deficiencies or material weaknesses in control that come to his or her attention.
**Question: 50 Which of the following types of risks most likely would increase if accounts receivable are confirmed 3 months before year end?** A. Inherent. B. Control. C. Detection. D. Business.
Answer (C) is correct. Audit risk consists of (1) the risks of material misstatement (inherent risk combined with control risk) and (2) detection risk. The RMMs are the entity's risks, and detection risk is the auditor's risk. Detection risk is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a material misstatement. It is a function of the effectiveness of an audit procedure and its application by the auditor. Detection risk is the only component of audit risk that can be changed at the auditor's discretion. An auditor who performs procedures at an interim date should cover the remaining period. The longer the remaining period, the greater the detection risk resulting from performing procedures at an interim date.
Question: 15 **Which of the following activities would be most helpful to a CPA in deciding whether to accept a new audit client?** A. Reviewing industry benchmarking data. B. Considering the client's compensation methods. C. Evaluating the CPA's ability to properly service the client. D. Evaluating the most recent peer review of the client's previous auditor.
Answer (C) is correct. Before deciding whether to accept a new audit client, the CPA should assess his or her competence to perform the audit. A member should complete professional services according to professional standards and with reasonable care and diligence. Competence means that the member has the technical qualifications and the ability to supervise and evaluate the work. It relates to knowledge of standards, techniques, and technical subject matter and to the ability to exercise sound judgment. In some cases, additional research and consultation is a normal part of performing services. However, if a member cannot gain sufficient competence, (s)he should suggest the engagenent of someone competent.
Question: 5 **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.
Answer (C) is correct. 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).
Question: 25 Audit planning for an initial audit most likely includes A. Determining the opinion to be expressed. B. Obtaining an engagement letter prepared by the auditee. C. Performing procedures involving opening balances. D. Selecting a sample of invoices for comparison with shipping reports.
Answer (C) is correct. First-year audits involve additional planning considerations. Examples are (1) communication with the predecessor auditor, (2) audit procedures regarding opening balances, (3) assignment of firm personnel with appropriate qualifications, and (4) procedures required by the firm's system of quality control for initial engagements.
Question: 21 Which of the following is an auditor least likely to perform in planning a financial statement audit? A. Coordinating the assistance of entity personnel in data preparation. B. Discussing matters that may affect the audit with firm personnel responsible for non-audit services to the entity. C. Selecting a sample of vendors' invoices for comparison with receiving reports. D. Reading the current year's interim financial statements.
Answer (C) is correct. Selecting a sample of vendors' invoices for comparison with receiving reports is a test of details (a substantive procedure). It is a further audit procedure performed to test relevant assertions.
Question: 11 **Upon discovering material misstatements in a client's financial statements that the client would not revise, a predecessor auditor withdrew from the engagement. If asked by the auditor about the termination of the engagement, the predecessor auditor should** A. State that (s)he found material misstatements that the client would not revise. B. Suggest that the auditor ask the client. C. Suggest that the auditor obtain the client's permission to discuss the reasons. D. Indicate that a misunderstanding occurred.
Answer (C) is correct. The auditor must obtain the client's permission before the predecessor auditor may discuss the reasons for termination of the previous relationship (AU-C 210 and AU-C 510). Furthermore, a member of the AICPA in public practice must not disclose confidential client information without the specific consent of the client.
Question: 60 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.
Answer (C) is correct. 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.
Question: 103 **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.
Answer (C) is correct. 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).
Question: 4 The scope and nature of an auditor's contractual obligation to a client is ordinarily set forth in the A. Management representation letter. B. Scope paragraph of the auditor's report. C. Engagement letter. D. Introductory paragraph of the auditor's report.
Answer (C) is correct. 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. An engagement letter should be sent by the CPA to the prospective client on each engagement, audit or otherwise.
Question: 26 Which of the following factors does a CPA ordinarily consider in the planning stage of an audit engagement? I. Financial statement accounts likely to contain a misstatement. II. Conditions that require extension of audit tests. A. I only. B. II only. C. Both I and II. D. Neither I nor II.
Answer (C) is correct. When planning an audit, the auditor should consider, among other things, the financial statement accounts likely to require adjustment and the conditions that require extension or modification of audit procedures (e.g., risk of material misstatement).
**Question: 53 If new information becomes available that could require a reevaluation of the quantitative level of materiality applied during an audit of an issuer, then the auditor should** A. Not change the materiality level once it has been established. B. Lower the materiality level, but not raise it. C. Raise the materiality level, but not lower it. D. Raise or lower the materiality level as appropriate to the situation.
Answer (D) is correct. According to the PCAOB, the auditor may need to reevaluate the established materiality level(s) and tolerable misstatement. Changes in the circumstances or additional information may indicate a substantial likelihood that misstatements of amounts that differ significantly from the materiality level(s) established initially could influence the judgment of a reasonable investor. The reevaluation of materiality levels may result in higher or lower amounts. If so, the auditor must determine whether risk assessments and audit procedures need to be modified.
Question: 23 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.
Answer (D) is correct. 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.
Question: 19 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.
Answer (D) is correct. 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.
**Question: 51 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.
Answer (D) is correct. 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).
Question: 110 Which of the following circumstances would an auditor most likely consider a risk factor relating to misstatements arising from fraudulent financial reporting? A. Several members of management have recently purchased additional shares of the entity's stock. B. Several members of the board of directors have recently sold shares of the entity's stock. C. The entity distributes financial forecasts to financial analysts that predict conservative operating results. D. Management is interested in maintaining the entity's earnings trend by using aggressive accounting practices.
Answer (D) is correct. Fraud risk factors relate to misstatements arising from (1) fraudulent financial reporting and (2) misappropriation of assets. Each of these categories may be further classified according to the three conditions that ordinarily exist when fraud occurs: (1) incentives or pressures, (2) opportunities, and (3) attitudes or rationalizations. For example, excessive pressure may exist to meet the expectations of third parties (e.g., analysts, investors, and creditors) regarding profitability or trends (AU-C 240).
**Question: 107 Which of the following circumstances most likely will cause an auditor to consider whether material misstatements due to fraud exist in an entity's financial statements?** A. Management places little emphasis on meeting earnings projections of external parties. B. The board of directors oversees the financial reporting process and internal control. C. Control deficiencies previously communicated to management are not corrected. D. Transactions selected for testing are not supported by proper documentation.
Answer (D) is correct. Fraud risk factors relate to misstatements arising from (1) fraudulent financial reporting and (2) misappropriation of assets. Each of these categories may be further classified according to the three conditions that ordinarily exist when fraud occurs: (1) incentives/pressures, (2) opportunities, and (3) attitudes/rationalizations. For example, an opportunity for misappropriation of assets may arise because of inadequate control over assets. This fraud risk factor is reflected by a lack of timely and appropriate documentation of transactions, such as credit memos for returns of goods.
Question: 113 During the consideration of fraud in a financial statement audit, the auditor should identify and assess risks that may result in material misstatements due to fraud. This assessment A. Must state an overall judgment about whether an identified risk is high, medium, or low. B. Requires an observation that the three fraud conditions are present. C. Follows the auditor's determination that the related controls are operating effectively. D. Is based on evaluating whether the entity's related controls have been suitably designed and implemented.
Answer (D) is correct. Identified and assessed fraud risks are treated as significant risks. Thus, the auditor obtains an understanding of the related controls relevant to the risks. This process includes evaluating whether the controls have been suitably designed and implemented to mitigate the fraud risks.
Question: 38 **Some account balances, such as those for pensions or leases, are the results of complex calculations. The susceptibility to material misstatements in these types of accounts is defined as** A. Audit risk. B. Detection risk. C. Sampling risk. D. Inherent risk.
Answer (D) is correct. Inherent risk is the susceptibility of an assertion about a transaction class, account balance, or disclosure that could be material, individually or in the aggregate, before consideration of any related controls. This risk is greater for some assertions and related balances, classes, or disclosures, than others. For example, complex calculations are more likely to be misstated than simple ones. Inherent risk exists independently of the audit (AU-C 200 and AS 1101).
Question: 56 Based on new information gained during an audit of a nonissuer, an auditor determines that it is necessary to modify materiality for the financial statements as a whole. In this circumstance, which of the following statements is accurate? A. The auditor is required to reperform audit procedures already completed on the audit using the revised materiality. B. The auditor should consider disclaiming an opinion due to a scope limitation. C. The revision of materiality at the financial statement level will not affect the planned nature and timing of audit procedures, only the extent of those procedures. D. Materiality levels for particular classes of transactions, account balances, or disclosures might also need to be revised.
Answer (D) is correct. Materiality for the financial statements as a whole and, if applicable, the materiality level or levels for particular classes of transactions, account balances, or disclosures may need to be revised. Performance materiality also may need to be revised. Revision may result from a change in circumstances that occurred during the audit, new information, or a change in the auditor's understanding of the entity and its operations after performing further audit procedures.
Question: 22 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.
Answer (D) is correct. 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.
Question: 20 In developing an audit plan, an auditor should A. Determine whether the allowance for sampling risk exceeds the achieved upper precision limit. B. Evaluate findings from substantive procedures performed at interim dates. C. Consider whether the inquiry of the client's attorney identifies any litigation, claims, or assessments not disclosed in the financial statements. D. Perform risk assessment procedures.
Answer (D) is correct. The audit plan is based on the overall audit strategy. It describes (1) the nature and extent of risk assessment procedures; (2) the nature, timing, and extent of further audit procedures at the assertion level; and (3) other procedures required by GAAS. Risk assessment procedures are performed to obtain an understanding of the entity and its environment (including its internal control). Their purpose is to identify and assess the risks of material misstatement (whether due to fraud or error) at the financial statement and relevant assertion levels.
**Question: 101 Which of the following is a true statement about an auditor's responsibility regarding consideration of fraud in a financial statement audit?** A. The auditor should consider the client's internal control and plan and perform the audit to provide absolute assurance of detecting all material misstatements. B. The auditor should assess the risk that errors may cause the financial statements to contain any misstatements and determine whether the necessary controls are prescribed and are being followed satisfactorily. C. The auditor should consider the types of misstatements that could occur and perform tests on 100% of the information subject to misstatement. D. The auditor should assess the risks of material misstatement due to fraud.
Answer (D) is correct. The auditor assesses the identified risks of material misstatement due to fraud at the statement and assertion levels. The assessment is ongoing after the initial assessment. The assessed risks are treated as significant. Thus, to the extent not done previously, the auditor should obtain an understanding of the relevant controls. The understanding includes evaluating whether they are suitably designed, have been implemented, and reduce the risks.
Question: 12 Which of the following is correct regarding the communication between successor and predecessor auditors? A. The successor and predecessor auditors should communicate with each other in writing regarding potential problems. B. The successor auditor should contact the predecessor auditor prior to proposing an audit engagement. C. The client should be present during the communications between the predecessor auditor and the successor auditor. D. The successor auditor should request permission from the prospective client to make an inquiry of the predecessor auditor.
Answer (D) is correct. The auditor should communicate with the predecessor auditor before final acceptance of the engagement. The predecessor is expected to respond promptly and, absent unusual circumstances, fully.The auditor is responsible for initiating the communication. The Code of Professional Conduct protects the confidentiality of client information. Thus, the auditor and the predecessor auditor should obtain client permission to have discussions about the integrity of management as well as pertinent audit-related issues.
Question: 62 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.
Answer (D) is correct. 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.
Question: 32 The element of the audit-planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the A. Evidence to be gathered to provide a sufficient basis for the auditor's opinion. B. Procedures to be undertaken to discover litigation, claims, and assessments. C. Pending legal matters to be included in the inquiry of the client's attorney. D. Timing of inventory observation procedures to be performed.
Answer (D) is correct. The client is responsible for taking the physical inventory. The auditor is responsible for observing this process and performing test counts. The audit procedures are dependent upon management's plans. Thus, the auditor must coordinate the collection of this evidence with management.
Question: 3 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.
Answer (D) is correct. 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.
**Question: 65 An auditor most likely obtains an understanding of a new client to** A. Make constructive suggestions concerning improvements to the client's internal control. B. Develop an attitude of professional skepticism concerning management's financial statement assertions. C. Evaluate whether the aggregation of known misstatements causes the financial statements taken as a whole to be materially misstated. D. Identify areas of audit emphasis.
Answer (D) is correct. The understanding provides a basis for assessing risks of material misstatement and responding to them in the exercise of professional judgment. For example, the auditor needs to identify areas that need special audit consideration, such as complex or unusual transactions or related-party transactions.
