Audit - Chapter 5

E. Rights and obligations

2 The company legally owns the assets.

Which of the following is not a function of audit working papers? (1)Assist management in illustrating that the financial statements are in accordance with generally accepted accounting principles. (2)Assist audit team members responsible for supervision in reviewing the work. (3)Assist auditors in planning future engagements. (4)Assist peer reviewers and inspectors in performing their roles.

(1) The audit working papers are not prepared to assist management in illustrating that the financial statements are in accordance with generally accepted accounting principles. The other three replies are functions of audit working papers.

In what section of the audit working papers would a long-term lease agreement be filed? (1)Current working paper file. (2)Permanent working paper file. (3)Lead schedule file. (4)Corroborating documents file.

(2) Relatively unchanging data, such as a long‐term lease agreement, is placed in the permanent working paper file.

C. Determine whether disbursements are properly approved.

2. Tests of controls

A. Completeness

3 All assets have been recorded.

A. Prepare a flowchart of internal control over sales.

3. Risk assessment procedures (other than analytical procedures)

D. Confirm accounts receivable.

4. Test of details of account balances, transactions, or disclosures

F. Valuation

5 Assets are recorded at proper amounts.

D. Presentation and disclosure

6 Assets are properly classified.

Of the following, which is the least reliable type of audit evidence? (1)Confirmations mailed by outsiders to the auditors. (2)Correspondence between the auditors and suppliers. (3)Copies of sales invoices inspected by the auditors. (4)Canceled checks returned in the year-end bank statement directly to the client.

(3) Copies of sales invoices represent internally generated evidence, which is considered least reliable. Confirmations mailed by outsiders and correspondence between the auditor and suppliers represent more reliable externally generated evidence. Canceled checks, although internally generated, are considered reliable because they bear the endorsement of the payee and a perforation or stamp indicating payment by the bank.

Which of the following statements best describes why auditors investigate related party transactions? (1)Related party transactions generally are illegal acts. (2)The substance of related party transactions may differ from their form. (3)All related party transactions must be eliminated as a step in preparing consolidated financial statements. (4)Related party transactions are a form of management fraud.

(2) According to the definition of "related parties," one party may be able to influence the other to the extent that the two parties do not pursue their own separate interests in conducting transactions. Thus, a risk exists that the substance of related party transactions may differ from their form.

Analytical procedures are most likely to detect: (1)Weaknesses of a material nature in internal control. (2)Unusual transactions. (3)Noncompliance with prescribed control activities. (4)Improper separation of accounting and other financial duties.

(2) Analytical procedures are effective in isolating unusual transactions because such transactions may represent a change in a relationship being investigated. Analytical procedures are not typically considered to be tests of internal control, although in certain circumstances they might reveal errors caused by weaknesses

In using the work of a specialist, the auditors referred to the specialist's findings in their report. This would be an appropriate reporting practice if the: (1)Client is not familiar with the professional certification, personal reputation, or particular competence of the specialist. (2)Auditors, as a result of the specialist's findings, give a qualified opinion on the financial statements. (3)Client understands the auditors' corroborative use of the specialist's findings in relation to the representations in the financial statements. (4)Auditors, as a result of the specialist's findings, decide to indicate a division of responsibility with the specialist.

(2) The work of a specialist is only referred to in circumstances in which those findings do not support the representations made by management in the financial statements, thus causing the auditors to modify their report.

Which of the following is not a primary approach to auditing an accounting estimate? (1)Review and test management's process for developing the estimate. (2)Review subsequent transactions. (3)Confirm the amounts. (4)Develop an independent estimate.

(3) Auditors use three basic approaches for auditing accounting estimates— reviewing management's process, reviewing subsequent transactions, and developing an independent estimate. Confirmation is not a basic approach for auditing most accounting estimates.

A primary purpose of the audit working papers is to: (1)Aid the auditors by providing a list of required procedures. (2)Provide a point of reference for future audit engagements. (3)Support the underlying concepts included in the preparation of the basic financial statements. (4)Support the auditors' opinion.

(4) A primary purpose of audit working papers is to provide documented evidence that the auditors had a firm basis for their report.

The effectiveness of internal control is not a financial statement assertion made by management. (1)Existence of recorded assets and liabilities. (2)Completeness of recorded assets and liabilities. (3)Valuation of assets and liabilities. (4)Effectiveness of internal control.

(4) The effectiveness of internal control is not a financial statement assertion madeby management.

A difference of opinion concerning accounting and auditing matters relative to a particular phase of the audit arises between an assistant auditor and the auditor responsible for the engagement. After appropriate consultation, the assistant auditor asks to be disassociated from the resolution of the matter. The working papers would probably: (1)Remain silent on the matter since it is an internal matter of the auditing firm. (2)Note that the assistant auditor is completely dissociated from responsibility for the auditors' opinion. (3)Document the additional work required, since all disagreements of this type will require expanded substantive procedures. (4)Document the assistant auditor's position and how the difference of opinion was resolved.

(4) When a difference of opinion cannot be resolved, the working papers should be expanded to document the various positions and to describe how the difference of opinion was resolved.

The cost of analytical procedures in terms of time needed to perform, when compared to other tests, is ordinarily considered: (1)Low. (2)High. (3)Identical. (4)Indeterminate.

1 Low.

C. Existence and occurrence

1 There is such an asset.

B. Calculate the ratio of bad debt expense to credit sales.

1. Analytical procedures

E. Compare current financial information with comparable prior periods.

1. Analytical procedures

In developing an expectation for analytical procedures, the auditors are least likely to consider: (1)Financial information for comparable prior periods. (2)Relationships between financial information and relevant nonfinancial data. (3)Anticipated costs of audit completion. (4)Relationships among elements of financial information within a period.

3 Anticipated costs of audit completion

Analytical procedures performed near the end of the audit to assist the auditor in forming an overall conclusion on the financial statements are aimed primarily at: (1)Gathering evidence concerning account balances that have not changed from the prior year. (2)Retesting internal control procedures. (3)Considering unusual or unexpected account balances that were not previously identified. (4)Performing a test of transactions to corroborate management's financial statement assertions.

3 Considering unusual or unexpected account balances that were not previously identified.

What type of analytical procedure would an auditor most likely use in developing relationships among balance sheet accounts? (1)Trend analysis. (2)A detailed test of balance analysis. (3)Ratio analysis. (4)Risk analysis.

3 Ratio analysis.

B. Cutoff

4 Transactions are recorded in the correct accounting period.

State whether each of the following statements is correct or incorrect concerning audit risk and its components—inherent risk, control risk, and detection risk. Absent any other changes, an increase in the risk of material misstatement results in an increase in audit risk.

Correct.

State whether each of the following statements is correct or incorrect concerning audit risk and its components—inherent risk, control risk, and detection risk. Both inherent risk and control risk exist independently of the audit of financial statements.

Correct.

State whether each of the following statements is correct or incorrect concerning audit risk and its components—inherent risk, control risk, and detection risk. Inherent risk is the possibility of material misstatement before considering the client's internal control.

Correct.

State whether each of the following statements is correct or incorrect concerning audit risk and its components—inherent risk, control risk, and detection risk. Detection risk does not exist when no audit is performed.

Correct. Detection risk is a function of the audit and its procedures. If there is no audit there is no measure of detection risk.

State whether each of the following statements is correct or incorrect concerning audit risk and its components—inherent risk, control risk, and detection risk. Inherent risk is the possibility of material misstatement before considering the client's internal control.

Incorrect. A decrease in control risk, absent other changes, results in a decrease in the risk of material misstatement

State whether each of the following statements is correct or incorrect concerning audit risk and its components—inherent risk, control risk, and detection risk. Audit risk refers to the possibility that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially or immaterially misstated.

Incorrect. The error is the "or immaterially." Audit risk deals with material misstatements.

State whether each of the following statements is correct or incorrect concerning audit risk and its components—inherent risk, control risk, and detection risk. The risk of material misstatement is composed of the three components of audit risk.

Incorrect. The risk of material misstatements composed of inherent risk and detection risk.

State whether each of the following statements is correct or incorrect concerning audit risk and its components—inherent risk, control risk, and detection risk. Rather than restrict detection risk through the performance of more substantive procedures, auditors assess it.

Incorrect. This is backwards. Auditors restrict detection risk through the performance of more substantive procedures. Auditors assess inherent risk and control risk.

Assertion A. Completeness B. Cutoff C. Existence and occurrence D. Presentation and disclosure E. Rights and obligations F. Valuation

Statement 1. There is such an asset. 2. The company legally owns the assets. 3. All assets have been recorded. 4. Transactions are recorded in the correct accounting period. 5. Assets are recorded at proper amounts. 6. Assets are properly classified.

Audit Procedure A. Prepare a flowchart of internal control over sales. B. Calculate the ratio of bad debt expense to credit sales. C. Determine whether disbursements are properly approved. D. Confirm accounts receivable. E. Compare current financial information with comparable prior periods.

Type of Audit Procedure 1. Analytical procedures 2. Tests of controls 3. Risk assessment procedures (other than analytical procedures) 4. Test of details of account balances, transactions, or disclosures

As part of their audit, auditors obtain a representation letter from their client. Which of the following is not a valid purpose of such a letter? (1)To increase the efficiency of the audit by eliminating the need for other audit procedures. (2)To remind the client's management of its primary responsibility for the financial statements. (3)To document in the audit working papers the client's responses to certain verbal inquiries made by the auditors during the engagement. (4)To provide evidence in those areas dependent upon management's future intentions.

(1) A client letter of representations may never be used as a substitute for other appropriate auditing procedures.

Which of the following business characteristics is not indicative of high inherent risk? (1)Operating results that are highly sensitive to economic factors. (2)Large likely misstatements detected in prior audits. (3)Substantial turnover of management. (4)A large amount of assets.

(4) A large amount of assets by itself is not indicative of high inherent risk. Operating results highly sensitive to economic factors, large past misstatements, and turnover of management all represent characteristics that may indicate high inherent risk.

Performing analytical procedures may help an auditor to: (1)Achieve audit objectives related to a particular assertion. (2)Develop an effective system of quality control. (3)Meet PCAOB requirements that analytical procedures be performed relating to every major account. (4)Increase the level of detection risk.

1 Achieve audit objectives related to a particular assertion.

Which of the following is not a financial statement assertion made by management?

Effectiveness of internal control. The effectiveness of internal control is not a financial statement assertion made by management.