Auditing Exam 2

A primary objective of procedures performed to obtain an understanding of internal control is to provide the auditors with: A) Knowledge necessary to determine the nature, timing, and extent of further audit procedures. B) Audit evidence to use in reducing detection risk. C) A basis for modifying tests of controls. D) An evaluation of the consistency of application of management policies.

A) Knowledge necessary to determine the nature, timing, and extent of further audit procedures. Because the auditors' purposes for considering internal control are to obtain the necessary knowledge to (a) assess the risks of material misstatement, and (b) to determine the nature, timing, and extent of the tests to be performed, answer (1) is correct.

Which of the following is NOT a function of audit working papers? A. Assist management in illustrating that the financial statements are in accordance with generally accepted account principles B. Assist audit team members responsible for supervision in reviewing the work C. Assist auditors in planning future engagements D. Assist peer reviews and inspectors in performing their roles

A. Assist management in illustrating that the financial statements are in accordance with generally accepted accounting principles

What best describes the purpose of the auditors' consideration of internal control in a financial statement audit for a nonpublic company? A. To determine the nature, timing, and extent of audit testing B. To make recommendations to the client regarding improvements in internal control C. To train new auditors on accounting and control systems D. To identify opportunities for fraud within the client's operations

A. To determine the nature, timing, and extent of audit testing

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? A. To increase the efficiency of the audit by eliminating the need for other audit procedures B. To remind the client's management of its primary responsibility for the financial statements C. To document in the audit working papers the client's responses to certain verbal inquiries made by the auditors during the engagement D. To provide evidence in those areas dependent upon management's future intentions

A. To increase the efficiency of the audit by eliminating the need for other audit procedures

Which of the following is not ordinarily a procedure for documenting an auditor's understanding of internal control for planning purposes? A) Checklist B) Confirmation C) Flowchart D) Questionnaire

B) Confirmation

Effective internal control in a small company that has an insufficient number of employees to permit proper separation of responsibilities can be improved by: A) Employment of temporary personnel to aid in the separation of duties. B) Direct participation by the owner in key record keeping and control activities of the business. C) Engaging a CPA to perform monthly write-up work. D) Delegation of full, clear-cut responsibility for a separate major transaction cycle to each employee.

B) Direct participation by the owner in key record keeping and control activities of the business. Involvement of the owner in key control functions should be a major step toward preventing material errors or defalcations. Answer (1) would not be cost-effective. Answer (3) would provide some measure of control, but not as much as would daily participation by the owner. If it were feasible to hire additional employees, it would be cheaper to hire permanent employees rather than temporary. The need for internal control is permanent. Answer (4) would weaken, not strengthen internal control.

In what section of the audit working papers would a long-term lease agreement be filed? A. Current working paper file B. Permanent working paper file C. Lead schedule file D. Corroborating documents file

B. Permanent working paper file

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

B. The substance of related party transaction may differ from their form

Analytical procedures are most likely to detect: A. Weakness of a material nature of internal control B. Unusual transactions C. Noncompliance with prescribed control activities D. Improper separation of accounting and other financial duties

B. Unusual transactions

Which of the following is not an advantage of establishing an enterprise risk management system within an organization? A) Reduces operational surprises. B) Provides integrated responses to multiple risks. C) Eliminates all risks. D) Identifies opportunities.

C) Eliminates all risks. An enterprise risk management system cannot eliminate all risks.

Controls over financial reporting are often classified as preventative, detective, or corrective. Which of the following is an example of a detective control? A) Segregation of duties over cash disbursements. B) Requiring approval of purchase transactions. C) Preparing bank reconciliations. D) Maintaining backup copies of key transactions.

C) Preparing bank reconciliations. Preparing bank reconciliations will detect a variety of misstatements related to cash and is a detective control in the sense that it does not prevent the misstatement from occurring, but may detect it. Answers (1) and (2) are incorrect because segregating duties and requiring approvals are primarily designed to prevent occurrence of misstatements. Answer (4) is incorrect because the primary purpose of keeping backup copies of key transactions (or all transactions) is to prevent loss of information in the event of an information system failure and hence a corrective control.

An auditor may compensate for a weakness in internal control by increasing the extent of: A) Tests of controls. B) Detection risk. C) Substantive tests of details. D) Inherent risk.

C) Substantive tests of details. An increase in the substantive procedures will decrease detection risk, and thereby compensate for the increased level of control risk due to a weakness in internal control. Answer (1) is incorrect because if the weakness exists, increasing the extent of tests will only provide more evidence on the weakness—not evidence that compensates for the weakness. Answers (2) and (4) are incorrect because a decrease in detection risk or inherent risk, not an increase, would compensate. Also, in the case of inherent risk, it may not be possible to change the assessment since it is a function of the firm's environment.

When the auditors are performing a first-time internal control audit in accordance with the Sarbanes-Oxley Act and PCAOB standards, they must: A) Modify their report for any significant deficiencies identified. B) Use a "bottom-up" approach to identify controls to test. C) Test controls for all significant accounts. D) Perform a separate assessment of controls over operations

C) Test controls for all significant accounts. In an audit of internal control performed under PCAOB standards, the auditors must test controls for all significant accounts.

Which of the following is NOT a primary approach to auditing an accounting estimate? A. Review and test management's process for developing the estimate B. Review subsequent transactions C. Confirm the amounts D. Develop an independent estimate

C. Confirm the amounts

An entity's ongoing monitoring activities often include: A) Periodic audits by internal auditors. B) The audit of the annual financial statements. C) Approval of cash disbursements. D) Management review of weekly performance reports.

D) Management review of weekly performance reports. Management review of weekly performance reports is an ongoing monitoring activity that may detect errors or fraud. Answer (1) is incorrect because while periodic audits by internal audit represent a monitoring activity, they are best classified as separate evaluations, and not ongoing monitoring activities. Answer (2) is incorrect because the audit of the annual financial statements is the function of the external auditors. Answer (3) is incorrect because approvals of cash disbursements represent a control activity.

Which of the following business characteristics is NOT indicative of high inherent risk? A. Operating results that are highly sensitive to economic factors B. Large likely misstatements detected in prior audits C. Substantial turnover of management D. A large amount of assets

D. A large amount of assets

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: A. Client is not familiar the professional certification, personal reputation, or particular competence of the specialist B. Auditors, as a result of the specialist's findings, give a qualified opinion on the financial statements C. Client understands the auditors' corroborative use of the specialist's findings in relation to the representations in the financial statements D. Auditors, as a result of the specialist's findings, decide to indicate a division of responsibility with the specialist

D. Auditors, as a result of the specialist's findings, give a qualified opinion on the financial statements

Which of the following is NOT a financial statement assertion made by management? A. Existence of recorded assets and liabilities B. Completeness of recorded assets and liabilities C. Valuation of assets and liabilities D. Effectiveness of internal control

D. Effectiveness of internal control

Which of the following symbols indicate that a file has been consulted?

trapezoid to a triangle with a <-> in between it

When a CPA decides that the work performed by internal auditors may have an effect on the nature, timing, and extent of the CPA's procedures, the CPA should consider the competence and objectivity of the internal auditors. Relative to objectivity, the CPA should: A) Consider the organizational level to which the internal auditors report the results of their work. B) Review the internal auditors' work. C) Consider the qualifications of the internal audit staff. D) Review the training program in effect for the internal audit staff.

A) Consider the organizational level to which the internal auditors report the results of their work. The internal auditors' objectivity refers to their relative independence from the organizational units they have been evaluating. This may best be determined by considering the organizational level to which the internal auditors report. The other answers address the issues of the internal auditors' competence, not objectivity.

To have an adequate basis to issue a management report on internal control under Section 404(a) of the Sarbanes-Oxley Act, management must do all of the following, except: A) Establish internal control with no material weakness. B) Accept responsibility for the effectiveness of internal control. C) Evaluate the effectiveness of internal control using suitable control criteria. D) Support the evaluation with sufficient evidence.

A) Establish internal control with no material weakness. Management may issue a report on internal control regardless of whether the system has a material weakness.

Which of the following would be least likely to be considered an objective of internal control? A) Checking the accuracy and reliability of accounting data. B) Detecting management fraud. C) Encouraging adherence to managerial policies. D) Safeguarding assets.

B) Detecting management fraud. Detecting management fraud is generally not considered to be an objective of internal control. In fact, one of the inherent limitations of internal control is that it is subject to override by management. All of the other answers represent valid objectives of internal control.

Of the following, which is the least reliable type of audit evidence? A. Confirmations mailed by outsiders to the auditors B. Correspondence between the auditors and suppliers C. Copies of sales invoices inspected by the auditors D. Canceled checks returned in the year-end bank statement directly to the client

C. Copies of sales invoices inspected by the auditors

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: A. Remain silent on the matter since it is an internal matter of auditing firm B. Note that the assistant auditor is completely dissociated from responsibility for the auditors' opinion C. Document the additional work required since all disagreements of this type will require expanded substantive procedures D. Document the assistant auditor's position and how the difference of opinion was resolved

D. Document the assistant auditor's position and how the difference of opinion was resolved

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

D. Support the auditor's opinion