Audit - SU 3 & 4
The auditor should consider certain factors in assessing the efficiency and effectiveness of analytical procedures as compared to tests of details. In determining whether and to what extent analytical procedures should be used, which of the following should the auditor consider? A)The nature of the assertion tested. B)Explanations provided by the client. C)Nonfinancial information that may affect financial information. D)Interrelationships of financial information.
A Analytical procedures may be effective when tests of details may not indicate potential misstatements. For example, they may be effective for testing the completeness assertion. By understanding the assertion, the auditor can develop analytical procedures that best test it. Why Incorrect: B) Explanations provided by the client only help to clarify accounting treatment choices. C) Nonfinancial information that may affect financial information is one of the sources of information used to apply analytical procedures. D) Interrelationships of financial information is the comparability of prior financial statements with the current financial statements and one of the sources of information used to apply analytical procedures.
Which of the following types of risk increases when an auditor performs substantive analytical audit procedures for financial statement accounts at an interim date? A) Detection. B) Inherent. C) Sampling. D) Control.
A Detection risk is the risk that procedures performed to reduce audit risk to an acceptably low level will not detect a material misstatement. It relates to the nature, timing, and extent of audit procedures and is therefore the auditor's risk. For example, performing an audit procedure at an interim date instead of year-end increases detection risk because of the need to cover the interim period. Why Incorrect: B) Inherent risk is the entity's risk. It is not affected by the nature, timing, or extent of the auditor's procedures. C) Sampling risk is the risk that the conclusion based on a sample may differ from the conclusion if the entire population is subjected to the same audit procedure. It is not affected by the timing of the procedure. D) Control risk is the entity's risk. It is not affected by the nature, timing, or extent of the auditor's procedures.
Which of the following procedures should an auditor most likely include in the planning of an audit of financial statements? A) Determining the need for specialized skills. B) Determining whether necessary controls have been implemented. C) Inquiring of the client's lawyer about litigation, claims, and assessments. D) Obtaining a written representation letter from management of the client.
A If specialized skills are needed, the auditor determines whether a professional with such skills is on the audit staff or an external specialist must be hired. For this purpose, the auditor should be able to (1) communicate the objectives of the work of the other professional, (2) evaluate whether the procedures performed meet the audit objectives, and (3) evaluate the results of those procedures (AU-C 300). Why Incorrect: B) Determining whether necessary controls have been implemented is done when obtaining the understanding of the entity and its environment, including its internal control. C) Inquiry of the client's lawyer is ordinarily done to corroborate evidence obtained from other procedures, for example, inquiries of management relevant to litigation, claims, and assessments. D) The representations should be dated as of the date of the auditor's report.
Which of the following factors most likely would assist an auditor in assessing the objectivity of the internal auditor? A) The organizational status of the director of internal audit. B) The consistency of the internal audit reports with the results of work performed. C) The professional certifications of the internal audit staff. D) The appropriateness of internal audit conclusions in the circumstances.
A If the external auditor plans to use the work of the internal auditors to obtain audit evidence or to provide direct assistance, the competence and objectivity should be evaluated. Objectivity is promoted when the internal auditors (1) report to those charged with governance rather than management, (2) are free of any conflicting responsibilities, (3) work without constraints, and (4) are members of professional organizations that obligate them to be objective. The external auditor should assess each of these factors in evaluating objectivity. Why Incorrect: B) The consistency of the internal audit reports relates to the competence of the internal auditors, but not their objectivity. C) Professional certifications relate to the competence of the internal auditors, but not their objectivity. D) The appropriateness of internal audit conclusions relates to the competence of the internal auditors, but not their objectivity.
Which of the following is an auditor least likely to perform in planning a financial statement audit? A) Selecting a sample of vendors' invoices for comparison with receiving reports. B) Discussing matters that may affect the audit with firm personnel responsible for non-audit services to the entity. C) Reading the current year's interim financial statements. D) Coordinating the assistance of entity personnel in data preparation.
A 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. Why Incorrect: B) Discussing matters that may affect the audit with entity personnel is a planning procedure. C) Reading the current year's interim financial statements is a planning procedure. D) Coordinating the assistance of entity personnel is a planning procedure.
Communications with management regarding the scope and timing of an audit engagement should A) Include discussions of planning elements to facilitate the performance of the audit. B) Not occur to avoid making procedures predictable. C) Describe the auditor's procedures in detail. D) Disclaim responsibility for opening balances in an initial audit.
A The auditor should discuss elements of planning with management to facilitate the performance of the audit. But the communication should not compromise the audit, for example, by making detailed procedures too predictable. Why Incorrect: B) The auditor should communicate with management to facilitate the performance of the audit but should not compromise the audit. C) If the auditor provides too many details regarding audit procedures, management may be able to circumvent the purpose of the procedures. D) Additional planning considerations for initial audits include audit procedures regarding opening balances to ensure that (1) they do not contain misstatements that materially affect the current period's financial statements and (2) accounting policies reflected in the opening balances have been consistently applied in the current period's financial statements.
Which of the following statements is true about related party transactions? A) The auditor should consider whether an identified related party transaction outside the normal course of business is appropriately accounted for and disclosed. B) In the absence of evidence to the contrary, related party transactions should be assumed to be outside the ordinary course of business. C) An auditor should substantiate that related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions. D) An auditor should determine whether a particular transaction would have occurred if the parties had not been related.
A The auditor should inspect any contracts or agreements to evaluate whether (1) the business purpose (or lack of a business purpose) implies that the transaction's intent was fraudulent, (2) the terms are consistent with management's explanations, and (3) the accounting and disclosure are appropriate. The auditor also should obtain evidence of appropriate authorization and approval. Why Incorrect: B) In the absence of contrary evidence, related party transactions are assumed to be in the ordinary course of business. C) The auditor should obtain sufficient appropriate evidence about a management assertion that related party transactions were conducted on terms equivalent to those that prevail in arm's-length transactions. Management is responsible for substantiating the assertion. The auditor evaluates management's support for the assertion. D) Determining whether a particular transaction would have occurred if the parties had not been related is ordinarily not an objective of the audit.
Which of the following matters does an auditor usually include in the engagement letter? A) Arrangements regarding fees and billing. B) Analytical procedures that the auditor plans to perform. C) Indications of negative cash flows from operating activities. D) Identification of working capital deficiencies.
A The engagement letter documents the terms of the auditor's agreement with management or those charged with governance. It includes (1) the objective and scope of the audit; (2) the responsibilities of the auditor and management; (3) the inherent limitations of the audit and internal control; (4) the financial reporting framework; (5) the expected form and content of reports; and (6) other relevant information, such as fee arrangements, billings, and assistance by the client's staff (AU-C 210). Why Incorrect: B) The auditor determines the procedures to be performed. They are not part of an agreement with the client. C) Indications of negative cash flows from operating activities are not terms of the engagement. They may or may not be identified during the audit. D) Identification of working capital deficiencies is not a term of the engagement.
The scope and nature of an auditor's contractual obligation to a client is ordinarily set forth in the A) Engagement letter. B) Introductory paragraph of the auditor's report. C) Management representation letter. D) Scope paragraph of the auditor's report.
A 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. Why Incorrect: B) The introductory paragraph (1) identifies the auditee, (2) states that the financial statements were audited, (3) identifies the title of each statement, and (4) specifies the date or period of each statement. C) An auditor obtains a written management representation letter to complement other procedures, but it is not part of the engagement letter. D) The auditor's report contains an auditor's responsibility section, not a scope paragraph. The engagement letter should state the form and content of audit reports, not audit reports.
In using the work of an auditor's external specialist, an agreement should exist between the auditor and the specialist as to the nature of the specialist's work. This agreement most likely should include A) The applicability of the same confidentiality requirements to the auditor and the specialist. B) A statement that the specialist assumes no responsibility to update the specialist's report for future events or circumstances. C) The conditions under which a division of responsibility may be necessary. D) The auditor's disclaimer as to whether the specialist's findings corroborate the representations in the financial statements.
A This answer is correct.The agreement should be documented and should cover (1) the nature, objectives, and scope of the work; (2) the roles of the auditor and specialist; (3) the nature, timing, and extent of communications between the auditor and specialist; and (4) the need for the specialist to observe confidentiality requirements. The agreement between the auditor and the auditor's external specialist generally is documented in an engagement letter. A matter that should be included is the need for the confidentiality provisions of the relevant ethical requirements that apply to the auditor also to apply to the specialist. For example, a member of the AICPA may use a third-party service provider to render professional services to clients. The member should have a contract with the third-party service provider to maintain the confidentiality of the information (Ethics Ruling). Other requirements may be imposed by law or regulation. Why Incorrect: B) The agreement need not contain a disclaimer about the specialist's responsibility to update the report. C) The auditor may not divide responsibility with the specialist. D) The agreement need not contain a disclaimer about whether the findings corroborate the representations.
Fact Pattern: During the annual audit of BCD Corp., an issuer, Smith, CPA, a continuing auditor, determined that illegal political contributions had been made during each of the past 7 years, including the year under audit. Smith notified the directors of BCD Corp. of the illegal contributions, but they refused to take any action because the amounts involved were immaterial to the financial statements. Because management took no action, Smith should A) Consider withdrawing from the engagement. B) Disregard the political contributions because the board of directors was notified and the amounts involved were immaterial. C) Report the illegal contributions to the Securities and Exchange Commission. D) Express a qualified opinion or an adverse opinion.
A Under AU-C 250, if the client does not take the remedial action considered necessary by the auditor, the auditor should consider withdrawal from the engagement even when the illegal act is not material. (S)he should weigh the effects on his or her ability to rely on management's representations and the possible results of continued association with the client. The auditor may also wish to seek legal advice. Why Incorrect: B)The auditor must consider withdrawal given that the directors took no action. C) Notifying others is ordinarily management's responsibility. However, when the auditor withdraws because of the client's failure to take remedial action, the entity may be required to report the auditor change on SEC Form 8-K. The failure may be a reportable disagreement concerning which the auditor will have a duty to notify parties outside the client. D) If the effects of the illegal act are not material, a modification of the opinion may not be necessary.
An auditor's analytical procedures most likely would be facilitated if the entity A) Corrects material weaknesses in internal control before the beginning of the audit. B) Uses a standard cost system that produces variance reports. C) Segregates obsolete inventory before the physical inventory count. D) Develops its data from sources solely within the entity.
B A comparison of anticipated results, such as budgets or forecasts prepared by management, with actual results is an analytical procedure. Thus, the use of standard costs and variance analysis facilitates the application of analytical procedures. Why Incorrect: A) The correction of material weaknesses is more likely to improve the reliability of the data examined in next year's audit. C) The segregation of obsolete inventory before physical counts assures that an accurate count of salable inventory can be achieved. D) Sources of information external to the organization are assumed to be more reliable.
Disclosure of possible fraud to parties other than the client's senior management and those charged with governance ordinarily is not part of an auditor's responsibility. However, to which of the following outside parties may a duty to disclose possible fraud exist? I. To the SEC when the client reports an auditor change II. To a successor auditor when the successor makes appropriate inquiries III. To a government funding agency from which the client receives financial assistance A) I and II. B) I, II, and III. C) I and III. D) II and III.
B A duty of disclosure to parties other than the client is imposed by a subpoena. It also may exist when the entity reports an auditor change to the SEC on Form 8-K. For example, the auditor may have withdrawn because the client failed to take appropriate remedial action, and the failure may be a "reportable event" or the source of a "disagreement." These requirements also apply to reports on material noncompliance with laws and regulations that may be mandated by the Securities Exchange Act of 1934. Under AU-C 210, a predecessor auditor should respond promptly and fully, except in unusual circumstances, to inquiries by the auditor if the prospective client gives its specific permission. Under Government Auditing Standards, an auditor may have a duty to report fraud directly if it involves assistance received from a governmental agency. For example, when management has not taken remedial action, and the auditee does not report the fraud as soon as practicable to the entity that provided the assistance, the auditor must report the matter to that entity. Why Incorrect: A,C,D) A duty of disclosure to parties other than the client may exist when the entity reports an auditor change to the SEC on Form 8-K, the client gives its specific permission for a predecessor auditor to respond to the successor auditor's inquiries, and the client receives financial assistance from a government agency.
A corporate balance sheet indicates that one of the corporate assets is a patent. An auditor will most likely obtain evidence regarding the continuing validity and existence of this patent by obtaining a written representation from A) A regional state patent office. B) A patent attorney. C) The patent inventor. D) The patent owner.
B A patent is an intangible asset representing a governmental grant of rights to an invention for a specified time. The lack of physical substance makes verifying its existence and ownership difficult. To obtain evidence of the continuing validity and existence of a patent, the auditor should obtain a written representation from an auditor's specialist. A patent attorney is an auditor's external specialist who has expertise not normally possessed by auditors. The attorney can perform the necessary research and express an opinion on which the auditor may reasonably rely. Why Incorrect: A) Patents are obtained from the Patent and Trademark Office of the Department of Commerce. C) The inventor may have no current knowledge of the status of the patent. D) The owner is usually the client. The auditor needs independent evidence to corroborate client representations.
Analytical procedures used as risk assessment procedures should focus on A)Documenting the risk factors relating to the susceptibility of assets to misappropriation. B)Enhancing the auditor's understanding of the transactions and events that have occurred since the last audit. C)Discovering uncorrected misstatements that should be communicated to those charged with governance. D)Identifying the internal control activities that could reduce the assessed risks of material misstatement.
B Analytical procedures applied as risk assessment procedures (analytical procedures used to plan the audit) at the beginning of the audit may improve the understanding of the client's business and significant transactions and events since the last audit. They also may identify unusual transactions or events and amounts, ratios, and trends that might indicate matters with audit implications (AU-C 315). Why Incorrect: A) Documentation of risk factors is completed after the risk assessment procedures are performed. C) Uncorrected misstatements relate to management's willingness to correct prior statements from previous audits. D) Analytical procedures will not identify specific control activities that could reduce the assessed risks of material misstatement.
A CPA is conducting the first audit of a nonissuer's financial statements. The CPA hopes to reduce the audit work by consulting with the predecessor auditor and reviewing the predecessor's audit documentation. This procedure is A)Unacceptable because the CPA should bring an independent viewpoint to a new engagement. B)Acceptable if the client and the predecessor auditor agree to it. C)Acceptable if the CPA refers in the audit report to reliance upon the predecessor auditor's work as part of the basis for the CPA's own opinion. D)Required if the CPA is to express an unmodified opinion.
B In an initial audit, the auditor should ask management to permit the predecessor auditor to (1) respond fully to inquiries and (2) allow a review of his or her audit documentation. In accordance with the ethical requirement for AICPA members to cooperate with each other, the predecessor auditor ordinarily agrees to these requests (AU-C 510). Why Incorrect: A) Reviewing the predecessor auditor's audit documentation does not affect the auditor's independence. C)In reporting on the audit, the auditor should not refer to the report or work of the predecessor auditor as the basis, in part, for the auditor's own opinion. These circumstances should be distinguished from the case in which an auditor refers to the audit of a component auditor. For example, the component auditor may have audited the financial statements of a subsidiary of the auditee not audited by the group auditor. Such a reference is a decision not to assume responsibility for the work of the component auditor (AU-C 600). D) The auditor is required only to request that management authorize the predecessor auditor to (1) respond fully to inquiries and (2) allow a review of his or her audit documentation.
Which of the following circumstances is most likely to cause an auditor to consider whether a material misstatement exists? A) Management places little emphasis on meeting earnings projections. B) Transactions selected for testing are not supported by proper documentation. C) Operating and financing decisions are dominated by many persons. D) The turnover of senior accounting personnel is exceptionally low.
B The auditor should be alert for conditions that suggest material misstatement. One condition that should raise doubt is the lack of support for recorded transactions. Why Incorrect: A) The auditor considers the risks of material misstatement to be greater if management places undue emphasis on meeting earnings projections. C) The auditor considers the risks of material misstatement to be greater if the decision processes are dominated by a single individual or small group. D) The auditor considers the risks of material misstatement to be greater if the turnover of senior accounting personnel is high.
Which of the following factors most likely would lead a CPA to conclude that a potential audit engagement should be rejected? A) The details of most recorded transactions are not available after a specified period of time. B) It is unlikely that sufficient appropriate audit evidence is available to support an opinion on the financial statements. C) Management has a reputation for consulting with several accounting firms about significant accounting issues. D) Internal control activities requiring the segregation of duties are subject to management override.
B The auditor should obtain sufficient appropriate audit evidence to draw reasonable conclusions on which to base the opinion. If the CPA is unable to obtain this evidence, the engagement most likely should be rejected. Why Incorrect: A) Retaining all transactional information indefinitely is not necessary to the audit if the transactions have been properly recorded. C) The potential for disagreements with management about the application of accounting principles is a concern. But consultation of management with other accounting firms regarding significant accounting issues is not, by itself, a reason to reject an audit engagement. D) Depending on the nature of the duties, management override of internal controls does not require rejection of the engagement. However, the issue should be considered in assessing the risk of material misstatement.
Which of the following statements most likely would be included in an engagement letter from an auditor to a client? A) The CPA firm will adjust the financial statements to correct misstatements before issuing a report. B) The CPA firm will involve information technology specialists in the performance of the audit. C) The CPA firm will provide absolute assurance about whether the financial statements are free of material misstatement. D) The CPA firm is responsible for ensuring that the client complies with applicable laws.
B The engagement letter should include the nature and limitations of the services to be performed. If the use of an auditor's specialist is expected, inclusion of this information in the letter is a courtesy that provides notice to the client. Why Incorrect: A) Adjustment of the financial statements is the responsibility of management. The auditor may suggest changes but has no authority to make corrections. C) An auditor provides only reasonable assurance that the financial statements are free of material misstatement. D) Complying with applicable laws is the responsibility of management.
An auditor may refer to and identify an auditor's external specialist in the auditor's report if the A) Specialist's work provides the auditor greater assurance of reliability. B) Auditor expresses a disclaimer of an opinion as a result of the specialist's findings. C)Auditor wishes to indicate a division of responsibility. D) Specialist lacks objectivity with regard to the client.
B) The auditor may refer to an auditor's external specialist only if the opinion is modified. A modified opinion is a qualified opinion, adverse opinion, or a disclaimer of opinion. The reference is made because it is relevant to understanding the modification. An auditor's report with such a reference should state that it does not reduce the auditor's responsibility (AU-C 620). Why Incorrect: A) The reference is solely to clarify the reason for the modification of the report. C) An auditor may decide not to assume responsibility for the audit of a component auditor. The auditor assumes responsibility for the work of an auditor's external specialist. D) The specialist's lack of objectivity is not a basis for the reference. But it affects the auditor's use of the specialist's work.
Hill, CPA, has been retained to audit the financial statements of Monday Co. Monday's predecessor auditor was Post, CPA, who has been notified by Monday that Post's services have been terminated. Under these circumstances, which party should initiate the communications between Hill and Post? A) Post, the predecessor auditor. B) Monday's controller or CFO. C) Hill, the auditor. D) The chair of Monday's board of directors.
C AU-C 210 indicates that the auditor should communicate with the predecessor auditor before accepting the engagement. Initiation of the communication is the responsibility of the auditor. Moreover, the auditor should seek permission from the prospective client to inquire of the predecessor before final engagement acceptance. Thus, the auditor should ask the client to authorize the predecessor to make a full response. Why Incorrect: A) Post, the predecessor auditor, need not initiate the communication. B) Monday's controller or CFO need not initiate the communication. D) The chair of Monday's board of directors need not initiate the communication.
When an auditor increases the assessed risks of material misstatement because certain control activities were determined to be ineffective, the auditor most likely would increase the A) Extent of tests of controls. B) Level of inherent risk. C) Extent of tests of details. D) Level of detection risk.
C 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). Why Incorrect: A) The extent of tests of controls is determined prior to assessing RMMs. B) The level of inherent risk is not affected by internal control. D) Increasing the assessed RMMs decreases the acceptable level of detection risk. Detection risk exists because an auditor may (1) use an inappropriate audit procedure, (2) misinterpret the results, (3) misapply an audit procedure, or (4) examine less than 100% of a transaction type or account balance.
An auditor should make specific and reasonable inquiries of the predecessor auditor regarding the predecessor's A) Methodology used in applying sampling techniques. B) Perception of the competency of and reliance on the client's internal audit function. C) Understanding of the reasons for the change in auditors. D) Opinion on subsequent events that have occurred since the balance sheet date.
C Inquiries should include (1) facts that are relevant to the integrity of management; (2) disagreements with management about accounting principles, audit procedures, or other similar matters; (3) communications to those charged with governance (e.g., the audit committee) about fraud and noncompliance with laws and regulations; (4) communications to management and those charged with governance about significant deficiencies and material weaknesses in internal control; and (5) the predecessor's understanding as to the reason for the change in auditors. Why Incorrect: A) The auditor's inquiries should be relevant to the decision whether to accept the engagement. However, the auditor may obtain information about the methodology used in applying sampling techniques by requesting the client to authorize the predecessor auditor to permit a review of the working papers. B) The predecessor's working papers should contain information about the perception of the competency of and reliance on the client's internal audit function. D)A review of the predecessor's working papers may provide information about subsequent events. The predecessor's report also may discuss material subsequent events if they have not been properly accounted for and disclosed by the client.
An auditor's inquiries of the predecessor auditor should include questions regarding A) The predecessor's evaluation of audit risk and judgment about materiality. B) Subsequent events that occurred since the predecessor's audit report was issued. C) The predecessor's understanding as to the reasons for the change in auditors. D) The predecessor's knowledge of accounting matters of continuing significance.
C Inquiries should include (1) facts that are relevant to the integrity of management; (2) disagreements with management about accounting principles, audit procedures, or other similar matters; (3) communications to those charged with governance (e.g., the audit committee) about fraud and noncompliance with laws and regulations; (4) communications to management and those charged with governance about significant deficiencies and material weaknesses in internal control; and (5) the predecessor's understanding as to the reason for the change in auditors. Why Incorrect: A) The predecessor's evaluation of audit risk and judgment about materiality are not applicable to the auditor's decision to accept the engagement. B) The predecessor is not responsible for events subsequent to his or her report. D) All matters of continuing accounting significance are not applicable to the auditor's decision to accept the engagement.
Which of the following procedures would an auditor most likely perform before auditing the balance sheet? A)Determine whether there are any liens or encumbrances on assets that have been pledged as collateral. B)Consider the client's plans and ability to meet imminent purchase commitments and cash flow obligations. C)Obtain an understanding of the client's internal control activities. D)Confirm with client's lawyer that all litigation probable of assertion has been disclosed to the auditor.
C Planning an audit initially requires developing an overall strategy and an audit plan. Planning includes obtaining an understanding of the entity and its environment, including its internal control, to identify and assess the risks of material misstatement (RMMs) of the financial statements, whether due to fraud or error. The understanding provides a basis for designing and implementing responses to the assessed RMMs. Risk assessment procedures are performed to obtain the understanding. They include (1) inquiries of management, appropriate individuals in the internal audit function, and others within the entity; (2) analytical procedures; and (3) observation and inspection. The plan also includes further procedures at the relevant assertion levels for material transaction classes, account balances, and disclosures. Thus, initial planning activities occur before procedures are applied to amounts reported in the balance sheet. Why Incorrect: A) The audit of the balance sheet includes procedures addressing security arrangements involving reported assets. B) The audit of the balance sheet includes procedures addressing (1) possible losses (liabilities) on firm, noncancelable purchase commitments and (2) cash balances. D) The audit of the balance sheet includes procedures addressing contingencies and contingent liabilities related to litigation, claims, and assessments.
As a result of analytical procedures, the independent auditor determines that the gross profit percentage has declined from 30% in the preceding year to 20% in the current year. The auditor should A)Evaluate management's performance in causing this decline. B)Document management's intentions with respect to plans for reversing this trend. C)Consider the possibility of a misstatement in the financial statements.D)Require note disclosure.
C The auditor should consider the possibility of a misstatement when (s)he has identified unexpected differences between recorded amounts and expectations. The auditor's judgments about materiality and the desired level of assurance determine the significance of the difference. Because a change of 10% is likely to be significant, the auditor should reconsider the expectations used and make inquiries of management. If the difference still cannot be explained, additional procedures should be performed. Why Incorrect: A) The independent auditor typically does not evaluate management's performance. B) An auditor appropriately considers management's plans for dealing with adverse conditions that create a substantial doubt about the ability of the entity to continue as a going concern (AU-C 570). In the absence of this doubt, however, the independent auditor's scope of work would not include consideration of management's plans to reverse a decline in the gross profit rate. D) Requiring disclosure is premature. The auditor must first determine the cause of the difference.
Which of the following factors has the least influence on an auditor's consideration of the reliability of data for purposes of analytical procedures? A) Whether the data were subjected to audit testing in the current or prior year. B) Whether the data were obtained from independent sources outside the entity or from sources within the entity. C) Whether the data were processed in a computer system or in a manual accounting system. D) Whether sources within the entity were independent of those who are responsible for the amount being audited.
C The consideration of the reliability of data should include sources of the data and the conditions under which the data were gathered. Whether (1) sources within the entity were independent of those who are responsible for the amount being audited, (2) the data were subjected to audit testing in the current or prior year, and (3) the data were obtained from independent sources outside the entity or from sources within the entity are more influential than the mode of processing. Other factors include whether the auditor's expectations were developed using data from a variety of sources and whether the data were developed under a reliable system with adequate controls. Why Incorrect: A) Whether sources within the entity were independent of those who are responsible for the amount being audited, whether the data were subjected to audit testing in the current or prior year, and whether the data were obtained from independent sources outside the entity or from sources within the entity are more influential than the other factor. B) Whether sources within the entity were independent of those who are responsible for the amount being audited, whether the data were subjected to audit testing in the current or prior year, and whether the data were obtained from independent sources outside the entity or from sources within the entity are more influential than the other factor. D) Whether sources within the entity were independent of those who are responsible for the amount being audited, whether the data were subjected to audit testing in the current or prior year, and whether the data were obtained from independent sources outside the entity or from sources within the entity are more influential than the other factor.
The work of internal auditors may affect the independent auditor's I. Procedures performed in obtaining an understanding of internal control II. Procedures performed in assessing the risks of material misstatement III. Substantive procedures performed in gathering direct evidence A) I and III only. B) I and II only. C) I, II, and III. D) II and III only.
C The internal audit function is part of the client's internal control. The auditor should obtain an understanding of this function when obtaining an understanding of internal control. The auditor also may use the internal auditors to provide direct assistance under certain conditions. A primary purpose of internal auditors is to review, assess, and monitor internal control. Thus, their work is relevant to the understanding of internal control and the assessment of risk. Moreover, some procedures performed by internal auditors, such as confirmations, may provide direct evidence about material misstatements. Why Incorrect: A) The internal auditor's work also may have an effect on the auditor's performance of procedures used to assess the risks of material misstatement. B) The internal auditor's work also may have an effect on the auditor's performance of substantive procedures. D) The internal auditor's work also may have an effect on the auditor's performance of procedures used to obtain an understanding of internal control.
After testing a client's internal control activities, an auditor discovers a number of significant deficiencies in the operation of a client's internal controls. Under these circumstances, the auditor most likely would A) Withdraw from the audit because the internal controls are ineffective. B) Issue a qualified opinion of this finding as part of the auditor's report. C) Increase the assessment of control risk and increase the extent of substantive tests. D) Issue a disclaimer of opinion about the internal controls as part of the auditor's report.
C When an auditor discovers significant deficiencies, the risk is higher that internal control will not timely prevent, or detect and correct, a material misstatement that could occur in an assertion. This discovery increases the assessment of the risks of material misstatement. The result is less reliance on tests of controls and more reliance on substantive procedures. Why Incorrect: A) The auditor is not required to withdraw from an audit when internal controls are ineffective. B) A qualified opinion is not appropriate. During this stage of the audit, the auditor has not yet performed substantive procedures. D) A disclaimer of opinion is not appropriate. During this stage of the audit, the auditor has not yet performed substantive procedures.
Which of the following steps should an auditor perform first to determine the existence of related parties? A) Examine invoices, contracts, and purchasing orders. B) Review proxy and other materials filed with the SEC. C) Inquire about the existence of related parties from management. D)Review the company's business structure.
C When obtaining an understanding of the entity's related party relationships and transactions, the auditor should inquire of management regarding (1) the identity of the entity's related parties, including changes from the prior period; (2) the relationships of the entity with those parties; and (3) the types and purposes of transactions with them. Why Incorrect: A) The auditor should be aware of the possibility of related parties when examining invoices, contracts, and purchasing orders. However, the first step should be to request a list from management. B) The auditor may review proxy and other materials filed with the SEC for possible related parties. However, the auditor should first request a list from management. D) The business structure can provide the auditor with expectations about the likelihood of related parties. However, the auditor should first request a list from management.
An auditor who discovers that a client's employees paid small bribes to municipal officials most likely would withdraw from the engagement if A) The client receives financial assistance from a federal government agency. B) Documentation that is necessary to prove that the bribes were paid does not exist. C) Management fails to take the appropriate remedial action. D) The payments violated the client's policies regarding the prevention of illegal acts.
C When the auditor concludes that an illegal act has or is likely to have occurred, (s)he should discuss the matter with the appropriate level of management and request that any necessary remedial actions be taken. If the alleged noncompliance has a material effect on the financial statements or the client does not take the remedial action that the auditor considers necessary, the auditor should express a qualified or adverse opinion, depending on the level of materiality, or withdraw from the engagement. Why Incorrect: A) In some cases, auditors may need to report fraud and illegal activities to appropriate officials, oversight bodies, or funding organizations, but this duty is not in itself a basis for withdrawal when illegal activities have been detected. B) If the auditor lacks sufficient information, the auditor usually disclaims an opinion. The auditor should then withdraw if the client refuses to accept the auditor's modified report. D) A violation of client policies regarding illegal activities by personnel does not necessitate a withdrawal from the engagement as long as management takes the proper remedial action proposed by the auditors.
B, the newly hired external auditor for P Corp., is planning an audit engagement. When reviewing the work of P's predecessor auditor, B identified several unusual circumstances requiring further clarification. B should speak with the predecessor auditor A) Only about initial balances. B) But not review audit documentation. C) After requesting permission from management for the predecessor auditor to respond fully. D) Although the Code of Professional Conduct does not require cooperation.
C When the prior-period statements were audited by a predecessor auditor, the auditor should request management to authorize the predecessor to (1) allow a review of audit documentation and (2) respond fully to inquiries by the auditor. Thus, the auditor is provided with information to assist in planning and performing the engagement. Why Incorrect: A) Among the matters subject to inquiry are the reasons for changing auditors, the integrity of management, and disagreements with management about accounting matters. B) The auditor should request management to authorize review of the predecessor's audit documentation. D) The Code states that members are responsible for cooperating with each other.
In performing interviews and examining documents related to preliminary work in a financial statement audit of a nonissuer, an auditor identifies a business risk associated with plans for a new product line. What should the auditor do as a result? A) Modify the scope of the engagement to include an analysis of the budget for the new product line and consider the new risk in conjunction with other risks after the budget items have been analyzed. B) Modify the financial statement disclosures to include the newly identified risk if it is likely that the new product line will have an adverse effect on the company's profitability. C) Analyze the newly identified risk in conjunction with economic circumstances related exclusively to the new product line and consider whether there is an immediate consequence for the risk of material misstatement for affected classes of transactions. D) Analyze the newly identified risk in conjunction with other known business risks and consider whether there is an immediate consequence for the risk of material misstatement at various levels of the audit.
D A business risk results from (1) significant factors that could adversely affect an entity's ability to achieve its objectives and execute its strategies or (2) setting inappropriate objectives and strategies. The auditor should obtain an understanding of the entity's objectives and strategies and the related business risks that may result in risks of material misstatement. For example, business risks may result from developing new products that may fail. The auditor considers the possible immediate consequence for the risk of material misstatement and whether the same risk has a longer term consequence given the entity's circumstances. Why Incorrect: A) Understanding the newly identified risk is done when obtaining an understanding of the entity and its environment. Thus, modifying the scope of the engagement is inappropriate until risk assessment procedures are completed. B) Only management can modify financial statement disclosures. C) The auditor should consider business risks in the context of industry, regulatory, and other external and internal factors.
Which of the following is the most reliable analytical approach to verification of the year-end financial statement balances of a wholesale business A)Verify interest expense, which includes imputed interest, by multiplying noncurrent debt balances by the year-end prevailing interest rate. B)Verify depreciation expense by multiplying the depreciable asset balances by one divided by the depreciation rate. C)Verify FICA tax liability by multiplying total payroll costs by the FICA contribution rate in effect during the year. D)Verify commission expense by multiplying sales revenue by the company's standard commission rate.
D If the wholesaler uses a standard commission rate, commission expense should be related to sales revenue. The auditor should also compare actual with budgeted and prior year amounts. Why Incorrect: A) Interest expense is not related to the prevailing rate but to contracted and imputed rates. B) One divided by the life of the asset is the formula for the straight-line depreciation rate per year. However, the client may use depreciation methods other than straight line. C) FICA tax is withheld from individual wages up to a ceiling amount. No tax liability exists for amounts above the ceiling, so the test will probably overstate the liability.
Which of the following matters does an auditor usually communicate to management? A) An agreement regarding preliminary materiality thresholds. B) Indications of adverse key financial ratios. C) Identification of recurring operating losses. D) Arrangements involving a predecessor auditor.
D It is necessary to obtain management's approval before contacting a predecessor auditor. Why Incorrect: A) Materiality is a judgment consideration of the auditor and should not be communicated to management. B) Management should be aware of operating aspects of the organization; thus, it is not the auditor's responsibility to communicate those issues to management. C) Management should be aware of operating aspects of the organization; thus, it is not the auditor's responsibility to communicate those issues to management.
If not already done to form an overall conclusion, the auditor should perform analytical procedures relating to which of the following transaction cycles? A) Purchasing. B) Inventory. C) Payroll. D)Revenue.
D Revenue is an account for which expectations can be developed by the auditor. It is a key account that should be predictable. Why Incorrect: A,B,C) Although analytical procedures may be useful, it is not as important as for revenue.
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 effect of uncorrected misstatements related to prior periods. B) The particular circumstances of each misstatement. C) The size and nature of the misstatements. D) The cost of correcting the misstatements.
D 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. Why Incorrect: A) The auditor should consider the effect of uncorrected misstatements related to prior periods on (1) classes of transactions, account balances, or disclosures and (2) the financial statements as a whole. B) The auditor should consider the particular circumstances of each misstatement. C) The auditor should consider the size and nature of the misstatements relative to (1) classes of transactions, account balances, or disclosures and (2) the financial statements as a whole.
Misstatements discovered by the auditor were immaterial in the aggregate in prior years. Such misstatements should be A) Retested during the current-year tests of controls. B) Disclosed by the client in the current-year financial statements. C) Removed from the prior-year summary because they were immaterial. D) Considered in the evaluation of audit findings in the current year.
D The cumulative effect of immaterial uncorrected misstatements related to prior periods may have a material effect on the current period's financial statements. Why Incorrect: A) Immaterial misstatements related to prior periods do not need to be retested during the current year. B) If the cumulative effect of immaterial uncorrected misstatements related to prior periods does not have a material effect on the current period, then it is not necessary to disclose the misstatements in the current year. C) The immaterial misstatements from prior years should be reported in prior-year summaries so they can be used in the current-year evaluation of audit findings.
For which of the following judgments may an independent auditor share responsibility with an entity's internal auditor who is assessed to be both competent and objective? Yes or No Assessment of Inherent Risk Assessment of Control Risk
No No The auditor may use the internal auditor to provide direct assistance in the audit as long as the auditor supervises, reviews, evaluates, and tests the work of the internal auditor. However, an internal auditor, regardless of his or her competence and objectivity, should never make judgments about the audit work being conducted. All judgments, including assessments of the risks of material misstatement (inherent and control risk), should be made by the auditor. Why Incorrect: Yes Yes) It is never appropriate for an internal auditor, regardless of competency and objectiveness, to make any judgments about the audit work being conducted. No Yes/ Yes No) It is never appropriate for an internal auditor to assess the RMMs, including the control risk component.
For all audits of financial statements made in accordance with generally accepted auditing standards, the auditor should apply analytical procedures to some extent as Yes or No Risk Assessment Procedures Substantive Procedures In the Review Stage
Yes No Yes The auditor obtains an understanding of the entity and its environment, including its internal control, to identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error. Risk assessment procedures are performed to obtain the understanding. They include (1) inquiries of management and others within the entity, (2) analytical procedures (analytical procedures used to plan the audit), and (3) observation and inspection. Substantive procedures are designed to detect material misstatements in assertions. They consist of tests of details and substantive analytical procedures. Analytical procedures are required to be used as risk assessment procedures (AU-C 315). However, the decision to use analytical procedures as substantive procedures is based on the auditor's judgment about their effectiveness and efficiency in reducing the risks of material misstatement to an acceptably low level (AU-C 520). Why Incorrect: No Yes No) Analytical procedures are required to be performed as risk assessment procedures. The auditor has discretion whether to use analytical procedures as substantive procedures.
