audit chapter 4

Which of the following is true of the influence of significant accounts and classes of transactions on inherent risk? A. When determination of account balance is objective, the inherent risk is low. B. When the transactions are routine and relatively homogenous, the inherent risk is high. C. When the account has high volume of transactions, the inherent risk is low. D. When the determination of an account balance is subjective, the inherent risk is low.

A. When determination of account balance is objective, the inherent risk is low.

Should the client have internal controls in place to ensure related parties are being identified? A. Yes, and the client is required to disclose them. B. No, not necessarily. C. Yes, but the client in under no obligation to disclose them. D. None of these answer choices are correct.

A. Yes, and the client is required to disclose them.

Clients that prepare financial statements _______ are more likely to have well-established closing procedures than clients that prepare financial statements _______. A. monthly; annually B. annually; monthly C. half-yearly; monthly D. annually; half-yearly

A. monthly; annually

In a period of recession in a particular industry, the auditor would typically spend more time on which of the following accounts? A. Purchase discounts B. Allowance for doubtful accounts C. Preferred stock D. Equity method investment account with a noncontrolling interest in a subsidiary

B. Allowance for doubtful accounts

The use of IT in accounting processes includes _________. A. customer acquisition B. transaction initiation C. employee performance reviews D. interviewing accounting personnel

B. transaction initiation

What is the typical means by which an auditor outlines the details of the engagement, and communicates this to the client's management? A. An audit plan B. Audit working papers C. Engagement letter D. Risk assessment

C. Engagement letter

Analytical procedures are conducted during the risk assessment phase of the audit to ________. A. highlight normal fluctuations in accounts B. aid in the elimination of risk C. identify accounts at risk of material misstatement D. complete the audit work

C. identify accounts at risk of material misstatement

Common factors that influence inherent risk are ________. A. importers and exporters B. major suppliers C. discounts D. all of the above

D. all of the above

Which of the following are processes used by a client when finalizing the accounts for an accounting period? A. Closing procedures B. Analytical procedures C. Audit strategies D. Assurance services

A. Closing procedures

Which of the following describes the board of directors of a company? A. Represent the shareholders of the company. B. Ensure the company is run to benefit the employees. C. Are all full-time employees of the company. D. Do not include the chief executive officer.

A. Represent the shareholders of the company.

An indicator that the auditor might need to adopt extended audit procedures would be best evidenced by __________. A. an unusual fluctuation in gross profit margin last year B. net sales is increasing approximately 3% per year C. a new competitor has entered the client's industry D. the client's current ratio has decreased slightly

A. an unusual fluctuation in gross profit margin last year

A comparison of account balances to a single line item, such as total assets, is termed ________. A. common-size analysis B. trend analysis C. substantive procedures D. compliance audit

A. common-size analysis

A member of a company board is _________. A. either an executive or non-executive director B. always an executive director C. always a non-executive director D. none of these answer choices are correct

A. either an executive or non-executive director

The term that specifically refers to the use of computers to process, record, and store financial reporting data and other information is ________. A. information technology B. analytical procedures C. audit data analytics D. trend analysis

A. information technology

For illegal acts that have a material but indirect effect on the financial statements, the auditor's responsibility _______ performing specified audit procedures that may identify noncompliance. A. is limited to B. goes beyond C. does not include D. none of these answer choices are correct

A. is limited to

A company's ability to meet its needs for cash in the short terms is called ________. A. liquidity B. profitability C. materiality D. due professional care

A. liquidity

When the economy is poor, a fall in profits can easily be explained to shareholders when most companies in the industry are also experiencing a decline in earnings; therefore, therefore when the economy is poor there is a tendency within an entity to _______. A. maximize write-offs B. maximize profits C. minimize revenues D. minimize profits

A. maximize write-offs

Non-executive directors should ideally be _________. A. objective and knowledgeable about the industry B. employed by the client firm C. from an unrelated industry, to ensure maximum objectiveness D. expected to have the same level of knowledge about the company as executive directors

A. objective and knowledgeable about the industry

Sustainable cash flows from operations are those that are adjusted for _______ influences. A. one-time B. unexpected C. seasonal D. annual

A. one-time

The cash flows provided, or used, by _______ activities indicate a company's ability to generate cash. A. operating B. investing C. financing D. all of these answer choices are correct

A. operating

Market price per share divided by earnings per share equals ________. A. price-earnings ratio B. current ratio C. acid test ratio D. debt to equity ratio

A. price-earnings ratio

The term _______ refers to an affiliate, principal owner, manager, or other party that is not independent of the entity. A. related party B. primary beneficiary C. third party D. other beneficiary

A. related party

Reading contracts or other agreements related to ________ transactions is one of the ways in which auditors identify related parties. A. significant unusual B. usual insignificant C. insignificant but unusual D. usual but significant

A. significant unusual

If an auditor is attempting to access the long-term viability of the client firm as a going concern, the auditor should attempt to calculate _________. A. solvency ratios B. liquidity ratios C. price-earnings multiples D. weighted average cost of capital

A. solvency ratios

To be meaningful, the cash flow from operations amount should be adjusted for any one-time influences on cash flow from operations to determine _______ cash flow from operations. A. sustainable B. unexpected C. seasonal D. one-time

A. sustainable

Ability of cash flows from operations to cover current debt and dividends = ________. A. sustainable cash flow from operations/ (current portion of financing debt + dividends) B. (sustainable cash flow from operations/ current portion of financing debt) - dividends C. (current portion of financing debt + dividends)/ sustainable cash flow from operations D. current portion of financing debt + (dividends/ sustainable cash flow from operations)

A. sustainable cash flow from operations/ (current portion of financing debt + dividends)

An auditor is always particularly concerned with a metric that measures how long it takes the client firm to purchase inventory, sell the inventory, and collect the associated receivable. This metric is commonly referred to as _________. A. the gross operating cycle B. the financing cycle C. the investing cycle D. the inventory cycle

A. the gross operating cycle

Auditors of private companies that do not have an audit committee or even a board of directors should communicate with _________. A. those charged with governance B. executive directors C. non-executive directors D. none of these answer choices are correct

A. those charged with governance

In addition to the annual financial statements, clients often prepare ________ financial statements. A. semi-monthly B. biweekly C. quarterly D. triennial

C. quarterly

If an auditor was interested in determining a client firm's ability to generate income from its investments, the best ratio to calculate would be _________. A. the times interest earned B. debt to assets ratio C. return on assets D. return on equity

C. return on assets

Inherent risk related to closing procedures would generally be increased when _______. A. a client is found to have strong closing procedures, and sound internal control practices relating to closing B. no errors and omissions are located when auditing the closing process C. staff assigned to deal with closing procedures are relatively inexperienced D. the closing process is relatively straightforward

C. staff assigned to deal with closing procedures are relatively inexperienced

An auditor is concerned about short-term interest payment obligations due to a recent major bond issue of the client. A ratio the auditor should consider determining is _________. A. debt-equity ratio B. quick (acid test) ratio C. times interest earned ratio D. short term payment ratio

C. times interest earned ratio

The concept of inherent risk is most closely tied to the idea of _________. A. global risk B. audit risk C. underlying business risks D. currency risk

C. underlying business risks

Which factors would likely increase an auditor's concern pertaining to risk of fraudulent financial reporting? A. Excessive amount of liquid assets that could easily be converted to cash. B. Low profitability/growth with respect to competitors in the same industry. C. Management participation in selection of accounting methods and principles. D. An extremely confusing and overly complex institutional structure, with blurred lines of authority.

D. An extremely confusing and overly complex institutional structure, with blurred lines of authority.

When scrutinizing a statement of cash flows in an attempt to gain a better understanding of the client, which would be most surprising to an auditor? A. An increase in accounts receivable B. A decrease in payables C. Negative investing cash flows D. Negative operating cash flows

D. Negative operating cash flows

Which of the following is/are among the procedures used by auditors to identify related parties? A. Review financial statements of competitors. B. Trace inventory quantities from the floor to the ledger. C. Gain an understanding of the industry. D. Review correspondence from the client's advisors, such as attorneys or consultants.

D. Review correspondence from the client's advisors, such as attorneys or consultants.

The audit committee is responsible for the ________ of the auditors. A. oversight and appointment B. appointment and compensation C. oversight and compensation D. all of the above

D. all of the above

Which of these scenarios would cause the auditor to initiate special planning procedures? A. The client's inventory contains very specialized, hard to value items. B. Not all assets belonging to the company have been properly asset tagged. C. Management are forthright in their dealings with the auditors. D. The client recently repurchased outstanding stock.

A. The client's inventory contains very specialized, hard to value items.

Which of the following equals earnings per share (EPS)? A. Profit divided by weighted average common stock shares issued B. Market price per share divided by earnings per share C. Operating cash flow divided by outstanding shares D. Cost of sales divided by average inventory

A. Profit divided by weighted average common stock shares issued

Which of the following indicates the ability of a company to generate income from its average investment in total assets? A. Return on assets B. Return of stockholders' equity C. Gross profit margin D. Profit margin

A. Return on assets

Which of the following common profitability ratios indicates the ability of a company to generate income from the funds invested by its common stockholders? A. Return on stockholders' equity B. Return on assets C. Profit margin D. Gross profit margin

A. Return on stockholders' equity

Which of the following acts directs that the audit committee members should be independent members of the board of directors, not executive directors or otherwise affiliated with the issuer? A. Sarbanes Oxley Act of 2002 B. Securities Act of 1933 C. Securities Exchange Act of 1934 D. Foreign Corrupt Practices Act of 1977

A. Sarbanes Oxley Act of 2002

If an auditor is considering accepting a client in an industry that is unfamiliar to the auditor, the auditor should _________. A. not accept the engagement B. attempt to learn all matters that would materially pertain to the entity's business C. issue a disclaimer of opinion D. rely on the opinion of specialists the auditor hires

B. attempt to learn all matters that would materially pertain to the entity's business

Which of the following are an evaluation of financial information by studying plausible relationships among both financial and non-financial data? A. Analytical procedures B. Closing procedures C. Trend analyses D. Common-size analyses

A. Analytical procedures

Which of the following choices would indicate an appropriate change in the auditor's approach to the audit, when an increased level of risk is present in a certain area? A. Assignment of personnel with specialized skills for the area of increased risk B. Assigning less audit staff to the engagement C. Withdraw from the audit D. Obtain management assurances in writing pertaining to the increased area of risk

A. Assignment of personnel with specialized skills for the area of increased risk

Which of the following reflects the earnings return on each issued share? A. Earnings Per Share B. Cash Earnings Per Share C. Price-Earnings Ratio D. Current Ratio

A. Earnings Per Share

Which of the following factors indicate higher inherent risks? A. Industry subject to changing trends B. Demand is not seasonal C. Industry has low chance of technological obsolescence D. Steady profitability

A. Industry subject to changing trends

Which of the following refers to measurements, agreed to beforehand, that can be quantified and reflect the success factors of an organization? A. Key Performance Indicators B. Acid-test ratio C. Current ratio D. Price-earnings ratio

A. Key Performance Indicators

Which of the following equals cash earnings per share (CEPS)? A. Operating cash flow divided by outstanding shares B. Profit divided by weighted average common stock shares issued C. Market price per share divided by earnings per share D. Market price per share divided by operating cash flow

A. Operating cash flow divided by outstanding shares

Which of the following elements would normally be included in an auditor's engagement letter? A. Potential limitations of the audit engagement. B. Responsibility of management for any and all illegal acts perpetrated by its employees. C. Initial judgments pertaining to materiality. D. Whether or not the auditor will attempt to obtain negative assurance with respect to management's compliance with laws and regulations.

A. Potential limitations of the audit engagement.

If the management of an entity is close to breaching a debt covenant that requires maintaining a certain current ratio, management may have an incentive to ________. A. either overstate current assets or understate current liabilities B. understate either current assets or current liabilities C. overstate either current assets or current liabilities D. either understate current assets or overstate current liabilities

A. either overstate current assets or understate current liabilities

If an auditor suspects management is overriding controls relating to the closing process, the auditor should _________. A. extend audit procedures to carefully check adjusting and allocating entries that are prepared at the end of the period B. extend audit procedures to check all balance sheet accounts C. obtain management's written representation in lieu of further audit procedures D. make these audit procedures the focus of the audit engagement

A. extend audit procedures to carefully check adjusting and allocating entries that are prepared at the end of the period

The ultimate responsibility for the financial reporting process rests with the _______, but the efficiency of achieving this goal is improved by the _______. A. full board; audit committee B. audit committee; executive directors C. non-executive directors; audit committee D. executive directors; full board

A. full board; audit committee

Generally speaking, the existence of related party transactions ________. A. increases inherent risk and should be investigated further B. decreases inherent risk and should be investigated further C. is illegal and should be reported to the Securities and Exchange Commission D. is not worth of further investigation

A. increases inherent risk and should be investigated further

Corporate governance may be best thought of as _________. A. the people, systems, and processes within companies used to ensure that companies are well-managed B. the level of control exerted by senior management C. a subsidiary entity that is controlled by a parent company D. Corporate donations to political parties and non-profit entities

A. the people, systems, and processes within companies used to ensure that companies are well-managed

A comparison of account balances over time constitutes _______ analysis. A. trend B. common-size C. ratio D. time series

A. trend

In the context of fraudulent financial reporting, which would most likely represent a risk factor? A. Low employee turnover at senior management levels B. High degree of competition in the particular industry C. The structure of the company includes subsidiary companies D. Revenue expectations from management have increased slightly from the prior year

B. High degree of competition in the particular industry

With respect to Key Performance Indicators, auditors should ________. A. disregard them as they would be unrelated to the audit B. ask management to provide a detailed explanation of which KPIs are of the most importance to them so that related audit procedures can be planned C. assign the task of investigation to the internal audit function D. assign new KPIs to the client as a result of the audit process

B. ask management to provide a detailed explanation of which KPIs are of the most importance to them so that related audit procedures can be planned

During the risk assessment phase, the audit team should gain an understanding of the client's procedures for __________. A. identifying related parties and authorizing transactions with related parties. B. authorizing transactions with related parties and disclosing the relationships and transactions in the financial statements. C. authorizing transactions with related parties. D. All of the above are correct.

B. authorizing transactions with related parties and disclosing the relationships and transactions in the financial statements.

Generally speaking, client firms engaged in international trade would be considered to have __________. A. lower inherent risk B. higher inherent risk C. lower control risk D. less complicated operations

B. higher inherent risk

Assuming a lack of internal control in a client's system, the risk of material misstatement is known as? A. Audit risk B. Detection risk C. Inherent risk D. Client risk

C. Inherent risk

When the auditor is considering the risk of material misstatement, they will attempt to identify major risks, determine how these risks could relate to fraud or error, consider the importance of the risks, and ______. A. notify management of these risks B. attempt to immediately resolve any identified risks C. determine the probability that the identified risks might result in material misstatements D. determine who is responsible for each identified risk

C. determine the probability that the identified risks might result in material misstatements

Initial agreements and understandings between the client and auditors should be documented and set forth in a(n) ________. A. legal letter B. confirmation letter C. engagement letter D. informal memorandum

C. engagement letter

The Price-earnings (PE) ratio could best be defined as __________. A. value of the stock on the open market B. closely related to the dividend discount model C. how much a stockholder is willing to pay per dollar of earnings D. what dividend percentage payout the stock pays

C. how much a stockholder is willing to pay per dollar of earnings

A common risk relating to closing entries is that _______. A. permanent accounts are often closed by mistake B. temporary accounts are often closed by mistake C. management may override controls relating to adjusting and closing entries D. temporary accounts, if closed, will carry a balance over to the subsequent accounting period

C. management may override controls relating to adjusting and closing entries

An auditor has determined that a client's 'days in receivables' ratio has slowly increased over the last three years. Which of the following could be a possible reason for this? A. The client has hired a collection agency which is extremely efficient at collecting. B. The receivables have been secured as collateral for a recent capital asset purchase. C. The accounts receivable department has implemented a new IT system, making collections much quicker and more efficient. D. The accounts receivable turnover ratio has decreased due to poor internal controls related to credit granting procedures.

D. The accounts receivable turnover ratio has decreased due to poor internal controls related to credit granting procedures.

Of the following scenarios, which would most likely result in an audit firm not accepting an engagement? A. Some internal controls related to credit granting procedures are not operating effectively. B. IT systems and architecture are antiquated and not capable of current processing and recording requirements. C. Significant related party transactions, of which the auditor has been advised, are a routine part of business. D. The client has advised that the auditor will be unable to confirm certain inventories with no valid reason given.

D. The client has advised that the auditor will be unable to confirm certain inventories with no valid reason given.