Auditing Chapter 6

If predecessor auditors refuse communication, successor auditors _______ accept the engagement.

Can

Establish the existence of asset

Cash can be verified by physical inspection

Analytical procedures

Comparing a client's unaudited results for the year with last year's audited results

Assume the following general flow of documents in an accounting system. Reply to the following question: "Source Documents --> Journals --> Ledgers" Tracing from source documents to journals most directly tests: Completeness (understatements). Existence (overstatements).

Completeness (understatements).

An initial public offering of TWD's stock is planned for late 20X2. (Increase, Decrease or No Effect)

Increase

During 20X1, TWD changed its method of preparing its financial statements from the cash basis to generally accepted accounting principles. (Increase, Decrease or No Effect)

Increase

Interest rates have been very volatile recently. (Increase or Decrease/ Yes or No)

Increase/Yes

Management at the bank's branch offices has authority for directing and controlling NFB's operations and is compensated based on branch profitability. (Increase or Decrease/ Yes or No)

Increase/Yes

Determine the appropriate financial statement presentation and disclosure of the asset

Reviewing subsequent events is an important step

Establish that the company has rights to the asset

Rights to cash can be verified by sending confirmation

Performing certain audit procedures at an interim date, rather than at the balance sheet date, results in additional __________ that must be controlled by the auditors.

Risk

________assessment procedures are performed when obtaining an understanding of the client.

Risk

Completeness

The assertion most directly related to the "did it all get included".

Engagement Letter

The purpose of this document is to avoid misunderstandings between the auditors and the client.

Materiality in planning and performing an audit.

The relationship between materiality used for planning versus evaluation purposes

Inherent Risk

The risk of material misstatement of an assertion about an account without considering internal control.

Which of the following is correct concerning audit plans? Plans are required for public company audits, but not for non-public company audits. They are often revised throughout the audit. It is essential that the audit engagement team perform every audit step. They are generally less detailed than are audit engagement letters.

They are often revised throughout the audit.

A cutoff test that relates to plant assets typically affects __________.

Balance Sheet

Which of the following risk factors indicates an increased risk of misappropriation of assets? High turnover of senior management. Strained relationships between management and auditors. Overly complex organizational structure. Lack of mandatory vacations for employees performing key functions.

Lack of mandatory vacations for employees performing key functions.

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

Members of the board of directors who are not officers or employees.

During December 20X1, TWD increased its casualty insurance coverage on several pieces of sophisticated machinery from historical cost to replacement cost. (Increase, Decrease or No Effect)

No Effect

TWD's employees are paid biweekly. (Increase, Decrease or No Effect)

No Effect

Because documents like checks, shipping documents, and receiving reports are usually _______, it is easier for auditors to verify cutoff.

Numbered

Audit _______ begins with determining the requirements for the engagement.

Planning

Consideration of fraud in a financial statement audit

Possible risk factors related to misappropriation of assets

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

Recorded sales have been properly posted to customer accounts.

The final step of an audit is issuing the audit ________.

Report

Assertions

Representations by management that are communicated, explicitly or implicitly, in the financial statements.

Consideration of laws and regulations

Requirements relating to identifying violations of occupational safety and health regulations

The amount appearing as an asset on a financial statement is usually the accumulation of many ________ items.

Smaller

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

Substantive procedures.

___________ must ask management to authorize the predecessor auditors to discuss confidential information.

Successor Auditprs

Audit procedures that are focused on the effectiveness of internal control are called __________.

Test of Control

Consideration of fraud in a financial statement audit

The importance of considering the possibility of overstated revenues (e.g., through premature revenue recognition)

Consideration of fraud in a financial statement audit

The need to "brainstorm" among audit team members about how accounts could be intentionally misstated

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

Use less predictable audit procedures.

Determine the appropriate valuation of the assets

Vouch the cost of acquisition to paid checks

Tracing of a transaction from source documents to the accounting records is generally an audit procedure that is designed to establish: completeness. valuation. existence. rights.

completeness.

The authenticity and accuracy of an account receivable may be tested by __________ with the debtor, or by vouching entries in the account to supporting documents.

confirmation

Audit risk at the account balance level consists of three components: (1) __________, (2) control risk and (3) detection risk.

inherent risk

Hawkins, CPA, requested permission to communicate with the predecessor auditors of a prospective client. The prospective client's refusal to permit this will bear directly on Hawkins' decision concerning the: adequacy of the preplanned audit plan. ability to establish consistency in application of accounting principles between years. apparent scope limitation. integrity of management.

integrity of management.

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

major transaction cycles.

The auditors must assess the risk of material misstatement of financial statements due to the two types of fraud, fraudulent financial reporting and __________.

misappropriation of assets

A successor auditor should attempt communication with a predecessor auditor: prior to accepting the engagement. after the engagement has been accepted. both prior to acceptance of the engagement and after the engagement has been accepted. only if the successor auditor desires to do so.

prior to accepting the engagement.

Tests of balances and transactions designed to detect material misstatements are called __________.

substantive procedures (tests)

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

Detect material misstatements in the financial statements.

Tests of controls are performed to determine whether key controls operate __________.

Effectively

NFB's formula has consistently underestimated the allowance for loan losses in current years. (Increase or Decrease/ Yes or No)

Increase/Yes

The banking industry has been significantly impacted by the downturn in the economy in recent years. (Increase or Decrease/ Yes or No)

Increase/Yes

Rights and obligations

The assertion most directly related to the question of ownership of an asset.

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

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

TWD's bank has a loan officer who meets regularly with TWD's CEO and controller to monitor TWD's financial performance. (Increase, Decrease or No Effect)

Decrease

Management has been receptive to Green's suggestions relating to accounting adjustments. (Increase or Decrease/ Yes or No)

Decrease/No

NFB operates in a growing, prosperous area and has remained profitable over the years. (Increase or Decrease/ Yes or No)

Decrease/No

The accounting department has experienced little turnover in personnel during the five years Green has audited NFB. (Increase or Decrease/ Yes or No)

Decrease/No

Understanding the entity and its environment and assessing the risks of material misstatement

Details on considering design effectiveness of controls

Which of the following is most likely to be included in an auditor's inquiry of management while obtaining information to identify the risk of material misstatement due to fraud? Are financial reporting operations controlled by and limited to one location? Does management have knowledge of fraud or suspect fraud? Has the possibility of management override been assessed? Does the company have insurance against all forms of fraud?

Does management have knowledge of fraud or suspect fraud?

During December 20X1, TWD signed a contract to lease disposal equipment from an entity owned by Janice Mead's parents. This related party transaction is not disclosed in TWD's notes to the 20X1 financial statements. (Increase, Decrease or No Effect)

Increase

TWD has such a strong financial presence in its industry to allow it often to dictate the terms or conditions of transactions with its suppliers. (Increase, Decrease or No Effect)

Increase

TWD's Board of Directors is controlled by Janice Mead, the majority stockholder, who also acts as the chief executive officer. (Increase, Decrease or No Effect)

Increase

During 20X1, NFB increased the efficiency of its accounting operations by installing a new, sophisticated computer system. (Increase or Decrease/ Yes or No)

Increase/Yes

NFB's board of directors is controlled by Smith, the majority stockholder, who also acts as the chief executive officer. (Increase or Decrease/ Yes or No)

Increase/Yes

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

Materiality and audit risk

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

Tests of controls.

Valuation or allocation

The client had a significant amount of damaged goods that were presented at cost.

Cutoff

The client recorded year-end sales in the subsequent year.

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

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

An audit committee's responsibilities normally would not include: discussing the meaning and significance of audited financial statements. discussing problems and experience with independent auditors in completing the audit of annual financial statements. nominating the independent auditors. discussing all details of the audit plans of the independent auditors.

discussing all details of the audit plans of the independent auditors.

The internal auditor reports directly to Harris, a minority shareholder, who also acts as chairman of the board's audit committee. (Increase or Decrease/ Yes or No)

Decrease/No

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

Factors often observed in circumstances where frauds have occurred.

During 20X1, litigation filed against TWD from an action 10 years ago that alleged that TWD discharged pollutants into state waterways was dropped by the state. Loss contingency disclosures that TWD included in prior years' financial statements are being removed from the 20X1 financial statements. (Increase, Decrease or No Effect)

Decrease

Establish completeness of the recorded assets

Examining shipping documents helps to determine if assets are properly recorded

Auditors may use audit ______ to test clerical accuracy.

Software

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

Supervisory position.

Presentation and disclosure

The client failed to describe in the financial statements significant debt restrictions.

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

A schedule of individual audit team member billing rates.

Time Budget

An estimate of the time required to perform each step in the audit.

Significant Risk

An identified risk that requires special audit consideration.

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

An unreliable accounting system.

Audit Risk

At the overall engagement level, this is the risk that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated.

The __________ provides an overview which includes the nature, timing and extent of procedures to be performed in an audit.

Audit Plan

Which of the following is a basic tool used by the auditors to control the audit work and review the progress of the audit? Time and expense summary. Engagement letter. Progress flowchart. Audit plan.

Audit plan.

Verify the cutoff of transactions

Auditors examine transactions just before and just after year end

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

Confirming balances of accounts receivable.

Which of the following is most likely to be an overall response to fraud risks identified in an audit? Decrease the use of professional skepticism and increase the use of internally generated evidence. Use predictable, well-established audit procedures. Consider further management's selection and application of significant accounting principles. Supervise members of the audit team less closely and rely more upon judgment.

Consider further management's selection and application of significant accounting principles.

The term __________ refers to the process of determining that transactions are reflected in the proper accounting period.

Cutoff

Because municipalities have received increased federal and state funding for environmental purposes, TWD returned to profitability for the first year following three years with losses. (Increase, Decrease or No Effect)

Decrease

Government regulation and overview of the banking industry is extensive and effective. (Increase or Decrease/ Yes or No)

Decrease/No

NFB is a continuing audit client. (Increase or Decrease/ Yes or No)

Decrease/No

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

Detection risk.

Shopping for accounting principles is ______by Sarbanes-Oxley.

Discouraged

Assume the following general flow of documents in an accounting system. Reply to the following question: "Source Documents --> Journals --> Ledgers" The auditors are concerned about transactions that have been recorded for improper amounts. Which procedure would be most effective? (1) Trace from source documents to journals. (2) Vouch from journals to source documents. Either (1) or (2).

Either (1) or (2).

Assume the following general flow of documents in an accounting system. Reply to the following question: "Source Documents --> Journals --> Ledgers" Vouching from journals (or ledgers) to source documents most directly tests: Completeness (understatements). Existence (overstatements).

Existence (overstatements).

Fair values can be evaluated by comparing to prices on _______ markets.

Existing

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

Facts that might bear on the integrity of management.

Related Parties

Hanmei, Inc., has transactions with the corporation president's brother

During 20X1, TWD sold one-half of its controlling interest in United Equipment Leasing (UEL) Co. TWD retained significant influence over UEL. (Increase, Decrease or No Effect)

Increase

During December 20X1, TWD completed a barter transaction with a municipality. TWD removed waste from the municipally owned site and acquired title to another contaminated site at below market price. TWD intends to service this new site in 20X2. (Increase, Decrease or No Effect)

Increase

Inquiries about the substantial increase in revenue TWD recorded in the fourth quarter of 20X1 disclosed a new operating policy. TWD guaranteed to several municipalities that it would refund the federal and state funding paid to TWD if any municipality fails a federal or state site clean-up inspection in 20X2. (Increase, Decrease or No Effect)

Increase

The accounting department has experienced a high rate of turnover of key personnel. (Increase, Decrease or No Effect)

Increase

The internal auditor reports to the controller and the controller reports to Janice Mead.

Increase

_______risk is the risk of material misstatement of an assertion without considering internal control.

Inherent

Communication between predecessor and successor auditors aids in evaluating the ______ of management.

Integrity

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

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

Successor auditors need to communicate with predecessor auditors ______ accepting the engagement.

Before

Assume the following general flow of documents in an accounting system. Reply to the following question: "Source Documents --> Journals --> Ledgers" The auditors are concerned about source documents that reflect valid transactions that have not been recorded in the journals. Which procedure would be most effective? (1) Trace from source documents to journals. (2) Vouch from journals to source documents. Either (1) or (2).

(1) Trace from source documents to journals.

Assume the following general flow of documents in an accounting system. Reply to the following question: "Source Documents --> Journals --> Ledgers" The auditors are concerned about transactions that have been recorded in the journals (and subsequently in the ledgers) that are not valid—that is, a transaction is recorded, but it did not actually occur (e.g., a fraudulent overstatement of sales). Which procedure would be most effective? (1) Trace from source documents to journals. (2) Vouch from journals to source documents. Either (1) or (2).

(2) Vouch from journals to source documents.

Read the stages of an audit listed below and put them in the correct order.

1) Plan the Audit 2) Obtain an understanding of the client and its environment, including internal control 3) Assess the risks of misstatement and design further audit procedures 4) Perform further audit procedures 5) Complete the audit 6) Form an opinion and issue the audit report

Audit Plan

A description of the nature, timing, and extent of the audit procedures to be performed.

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

A listing of the client's branch offices selected for testing.

Business Risk

A risk that threatens management's ability to achieve the organization's objectives.

The __________ of SEC registrants selects the company's audit firm.

audit committee

Assertions are __________ that are set forth in the financial statements.

representations of management