Exam 2 Questions

The term "substantive" comes from _______.

"substantiate," which means auditors gather evidence to verify the transactions, account balances, and disclosures provided by management in the financial statements

Which three of the following are included in common inherent limitation in internal control? (Select all that apply.)

- Collusion by two or more individuals to circumvent a control - Ineffective understanding of the purpose of a control - Human error that results in a breakdown in internal control

Which two of the following principles are within the monitoring component of the seventeen COSO principles of internal control? (Select all that apply.)

- The organization evaluates and communicates internal control deficiencies in a timely manner to those parties responsible for taking corrective action, including senior management and the board of directors, as appropriate. - The organization selects, develops, and performs ongoing and/or separate evaluations to ascertain whether the components of internal control are present and functioning.

It is important for an auditor to understand a public company's system of internal control in order to:

- audit internal control over financial reporting. - make a preliminary assessment of control risk. - develop an audit strategy. **All of these answer choices are correct.**

The types of substantive procedures discussed in this chapter include _______.

-Analytical procedures -Substantive tests to follow-up on notable items identified when performing audit data analytics -Tests of details of transactions and balances including audit data analytics (ADA) used as a substantive test **All of these answer choices are correct.**

How would increases in tolerable misstatement and assessed level of control risk affect the sample size in a substantive test of details? -Increase in tolerable misstatement -Increase in assessed level of control risk

-Decrease Sample Size -Increase Sample Size

Which of the following are causes of misstatements? (Select all that apply.)

-Inappropriate selection of accounting policies -Omission of an amount or disclosure -Incorrect accounting estimate caused by a misinterpretation of facts

Which of the following initial procedures do auditors perform before applying substantive procedures when auditing an account balance? (Select all that apply.)

-Obtain a trial balance or other detailed report for the account. -Scan the transactions in the account for unusual items. -Trace the beginning balance of the prepaid insurance account to the auditor's working papers from the prior year's audit.

Which of the following are indicators of possible management bias? (Select all that apply.)

-Selecting or developing significant assumptions that yield an estimate more favorable for management's objectives. -Changes in the method of making the accounting estimate that are based on subjective assumptions. -Selecting an estimate that indicates a pattern of optimism or pessimism.

In the context of the impact of risk of material misstatement (RMM) on the level of substantive testing, which of the following statements are true in the case of small sample sizes? (Select all that apply.)

-Substantive tests are less effective. -The combined assessed level of inherent risk and control risk is low. -The acceptable level of detection risk is high.

Which of the following are the conditions when limited tests of details of transactions occurring between the interim period and the year-end are necessary? (Select all that apply.)

-The entity's control environment has been assessed as effective. -Controls have been tested. -No significant changes in the control environment have occurred.

Which three of the following key issues are considered when planning an audit data analytics (ADA) application? (Select all that apply.)

-The overall purpose of the audit data analytics application and how it will contribute to the balance of the audit -Selection of financial statement items, accounts or disclosures, and related assertions to be audited -Selection of the audit population being analyzed or tested using audit data analytics

Audit data analytics can be used _______.

-as a risk assessment tool. -as a test of controls. -as a test of details. **All these answer choices are correct.**

An example of possible management bias would be _______.

-changes in the method of making the accounting estimate that are based on subjective assumptions -using management's own assumptions for fair value estimates when they are inconsistent with readily observable market assumptions -selecting or developing significant assumptions that yield an estimate more favorable for management's objectives **All of these answer choices are correct.**

An auditor is most likely to use audit data analytics (ADA) when _______.

-data is available that is relevant to an audit assertion of interest, whether as a risk assessment procedure or a substantive test. -the available data is reliable and comes from a strong system of internal controls. -the available data is relatively clean and does not require significant work to make it usable. **All of these answer choices are correct.**

At the outset of substantive testing, the auditor needs to _______.

-determine the population being tested -the assertion or assertions being tested -if the auditor is trying to estimate the total dollar value of the population, or the total amount of misstatement that might exist in the population **All of these answer choices are correct.**

When performing ADA as a risk assessment procedure, a notable item:

-is indicative of a risk of material misstatement not previously identified by the auditor. -is indicative of a higher risk of material misstatement than anticipated by the auditor. -provides information useful in designing procedures to address the risk of material misstatement. **All of these answer choices describe notable items.**

The auditor always needs to investigate any control exceptions (deviations) that he or she identifies during testing to find out, to the extent practical, _______.

-the causes and the amounts involved. -the financial statement accounts affected. -the potential effect on other audit procedures. **All of these answer choices are correct.**

The amount of estimation uncertainty is affected by _______.

-the nature of the accounting estimate -the subjectivity of the assumptions used to make the estimate -the extent to which a generally accepted method or model is available to aid in developing the estimate **All of these answer choices are correct.**

The auditor decides which controls to test by considering:

-the points at which fraud or error can occur. -the nature of controls implemented by management. -the significance of each control in achieving its control objective. -All of these answer choices are correct.

Which of the following would require the auditor to increase the level of control testing for a particular control?

A high degree of reliance is to be placed on the control to limit the amount of substantive testing required.

Which of the following best illustrates the concept of sampling risk?

A randomly chosen sample may not be representative of the population as a whole on the characteristic of interest.

What is a sampling unit?

A subset of population

In an audit of a nonissuer's financial statements, projected misstatement is

An auditor's best estimate of misstatements in a population extrapolated from misstatements identified in an audit sample.

Holding all other factors constant, which of the following factors results in an increase in sample size for substantive tests?

An increase in the desired level of assurance that the tolerable misstatement is not exceeded by the actual amount of misstatement in the population.

If an auditor of an issuer examines purchase orders obtained from the issuer to verify proper authorization of transactions, then the auditor is conducting

An inspection.

Which of the following refers to a sampling technique used to reach a conclusion about a population in terms of a rate (frequency) of occurrence?

Attribute sampling

Which of the following procedures would provide the most reliable audit evidence?

Audit evidence obtained from knowledgeable independent sources outside the client company is more reliable than audit evidence obtained from nonindependent sources.

Which of the following would not be a reason to increase the extent of a substantive test?

Auditors have time to test more items.

Which of the following represent a common categorization of control activities?

Authorization controls, performance reviews, information-processing controls, physical controls, and segregation of duties.

In a good system of segregation of duties, which of the following duties should be segregated?

Authorization of transactions, physical access to assets, and recording transactions.

After obtaining an understanding of an entity's internal control structure, an auditor may assess control risk at the maximum level for some assertions because the auditor

Believes the internal control policies and procedures are unlikely to be effective.

Assume that a company has a control deficiency regarding the processing of cash receipts. Reconciliation of cash accounts by a competent individual otherwise independent of the cash function might make the likelihood of a significant misstatement due to the control deficiency remote. In this situation, reconciliation may be referred to as what type of control?

Compensating.

During the audit the independent auditor identified the existence of a weakness in the client's internal control and communicated this finding in writing to the client's senior management and those charged with governance. The auditor should

Consider the effects of the condition on the audit.

Before applying principal substantive tests to the details of accounts at an interim date prior to the balance sheet date, an auditor should:

Consider whether the amounts of the year-end balances selected for interim testing are reasonably predictable.

Which assertion is typically related to income statement accounts rather than balance sheet accounts or presentation and disclosure?

Cutoff.

In obtaining an understanding of an entity's internal control relevant to audit planning, an auditor is required to obtain knowledge about the

Design of the controls pertaining to internal control components.

Which of the following situations increases the reliability of data being used for substantive analytical procedures?

During the prior-year audit, the data was subjected to audit testing.

Which of the following factors would most likely cause an auditor to use audit sampling versus audit data analytics?

Evidence to support the audit test is not available in electronic form.

The more judgment that is involved in conducting the substantive procedures and evaluating the results, the less documentation is needed.

False

When evidence is collected at an interim date, substantive tests are more effective.

False

Assessing control risk at below the maximum level most likely would involve

Identifying specific internal control structure policies and procedures relevant to specific assertions.

Which of the following can be used as both a risk assessment procedure and a substantive procedure for the audit of accounting estimates?

Inquire of management about the methods and assumptions used in developing the estimate.

An auditor is going to test the client's controls over bank reconciliations. The auditor will perform which of the following audit procedures for this test of controls?

Inquiry of the person performing the bank reconciliation and reperformance of the bank reconciliation procedure.

Which of the following procedures would provide the most reliable audit evidence?

Inspection of bank statements obtained directly from the client's financial institution.

What does COSO define as a process effected by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of the objectives related to operations, reporting and compliance?

Internal control

Which of the following situations would most likely preclude an auditor from performing substantive procedures during an interim period?

Internal controls are weak and the risk of material misstatement is high.

Which of the following best describes the distinguishing feature of statistical sampling?

It provides for measuring mathematically the degree of uncertainty that results from examining only a part of the data.

A primary objective of procedures performed to obtain an understanding of internal control is to provide an auditor with

Knowledge necessary to assess the risk of misstatement.

Which of the following actions should the auditor take in response to discovering a deviation from the prescribed control procedure?

Make inquiries to understand the potential consequence of the deviation.

Management's attitude toward aggressive financial reporting and its emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when

Management is dominated by one individual who is also a shareholder.

Which of the following refers to a deficiency where there is more than a remote possibility that a material misstatement could occur in the financial statements due to a breakdown in the system of internal control?

Material weakness

When performing a test of a control with respect to control over cash receipts, an auditor may use a systematic sampling technique with a start at any randomly selected item. The biggest disadvantage of this type of sampling is that the items in the population

May occur in a systematic pattern, thus destroying the sample randomness.

Which of the following audit techniques most likely would provide an auditor with the most assurance about the effectiveness of the operation of an internal control procedure?

Observation of client personnel.

Which of the following procedures would an auditor most likely perform to test controls relating to management's assertion about the completeness of cash receipts for cash sales at a retail outlet?

Observe the consistency of the employees' use of cash registers and tapes.

Which of the following is NOT a part of tests of control?

Performance

Immediately upon receipt of cash, a responsible employee should

Prepare a remittance listing.

Which of the following tends to be most predictable for purposes of analytical procedures applied as substantive tests?

Relationships involving income statement accounts

A letter issued regarding significant deficiencies relating to an entity's internal control observed during an audit of financial statements should include a

Restriction on the distribution of the report.

The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the

Risk that material misstatements exist in the financial statements.

When an auditor identifies internal control deficiencies, what levels of internal control deficiencies must be reported to those charged with governance of the entity?

Significant deficiencies and material weaknesses in internal control.

A senior auditor conducted a dual-purpose test on a client's invoice to determine whether the invoice was approved and to ascertain the amount and other terms of the invoice. Which of the following lists two tests that the auditor performed?

Tests of controls and tests of details

An auditor may decide to increase the risk of incorrect rejection when

The cost and effort of selecting additional sample items are low.

When considering the internal control structure, an auditor should be aware of the concept of reasonable assurance, which recognizes that

The cost of an entity's internal control structure should not exceed the benefits expected to be derived.

Which of the following is an example of data that needs to be cleaned before it can be analyzed?

The data has dates in two different formats (MM/DD/YY and DD/MM/YY).

Which of the following factors is most likely to affect the extent of the documentation of the auditor's understanding of a client's system of internal controls?

The degree to which information technology is used in the accounting function.

When planning a classical variables sample, the risk of incorrect acceptance and the risk of incorrect rejection are related to what general factor that influences sample size?

The desired level of assurance from the sample.

An auditor of a nonissuer should design tests of details to ensure that sufficient audit evidence supports which of the following?

The planned level of assurance at the relevant assertion level.

Which of the following is an important consideration when deciding the nature of tests to use in a financial statement audit?

The procedures to be applied on a particular engagement are a matter of the auditor's professional judgment.

Which of the following represents an example of an IT application control?

The software application compares all sales invoices with underlying shipping information on the bills of lading and packing slips with sales invoices. If differences are revealed, a report is generated for review and follow-up by the billing supervisor.

Which of the following is a good example of an IT application control over the occurrence of revenue transactions?

The software application compares information on a sales invoice with information from the bill of lading to ensure that sales invoices are only prepared for actual shipments. Any exceptions are not processed and are set aside for manual follow-up.

Determining fair value of a transaction or financial statement item for inclusion in the financial statements is a type of accounting estimate.

True

If the assessed risk of material misstatement for an assertion is high, auditors need to gather more persuasive audit evidence.

True

When the entity's control environment has been assessed as effective, limited roll-forward procedures such as substantive analytical procedures are necessary.

True

Which of the following sample planning factors would influence the sample size for a substantive test of details for a specific account? Expected amount of misstatements: Yes/No Measure of tolerable misstatement: Yes/No

Yes, Yes

When performing tests of controls, the auditor is making _______.

a "yes or no" decision with respect to effectiveness

Internal control is defined as:

a process, effected by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of the objectives related to operations, reporting, and compliance.

An audit strategy can take _______.

a reliance on controls approach, a substantive approach, or a combination of both

Financial statements include _______.

a variety of items that cannot be measured precisely and must be estimated by client management

AU-C 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures states the objective of the auditor is to obtain sufficient appropriate evidence that _______.

accounting estimates are reasonable, and disclosures are adequate

Probability Proportionate to Size (PPS) sampling is _______.

an approach that uses attribute sampling theory to express a conclusion in dollar amounts

An accounting estimate is _______.

an approximation of a monetary amount when a precise means of measurement is not available

Audit sampling is when _______.

an auditor selects less than 100% of a population

Analytical procedures _______.

are evaluations of financial information through analysis of plausible relationships among both financial and non-financial data

Advances in the technological landscape _______.

are providing opportunities to rethink how an audit is performed

Analytical procedures:

are required during the planning and substantive testing phases of the audit.

Audit data analytics can be used _______.

at virtually any phase of the audit

Audit data analytics should _______.

be customized to the individual client and industry

An audit testing strategy that can be used to allow evidence obtained in prior audit periods to support a conclusion about IT application controls in the current audit period is known as _______.

benchmarking

The auditor begins selecting controls to test by _______.

by understanding the entity and the business and determining the risk of material fraud or error at the financial statement level

Documenting internal controls:

can be handled with a combination of narratives and flowcharts or logic diagrams.

One of the steps in the five step AICPA process to follow when planning, performing, and evaluating results from audit data analytics (ADA) is _______.

consider the relevance and reliability of the data used

A management letter:

contains recommendations for improving significant deficiencies and material weaknesses in internal control discovered during the course of the audit.

For clients with multiple locations, the auditors_______.

could vary which locations are tested each year and the type of audit procedures that are performed at the different locations

The software application compares all sales invoices with underlying shipping information on the bills of lading and packing slips with sales invoices. If differences are revealed, a report is generated for review and follow-up by the billing supervisor. This is an example of a(n):

detective control.

A key aspect of preparing the data for ADA is:

determining if the data is complete.

The choice of statistical or non-statistical sampling _______.

does not affect the selection of procedures, or the competence of evidence obtained about individual sample items

When the auditor is performing audit data analytics (ADA) as a substantive test of details of a population of transactions or balances, the auditor will have _______.

evaluated inherent risk

When an auditor asks management how it makes sure the reconciliation is prepared correctly and on a timely basis, this is an example of _______.

inquiry

Accounting estimates, by their nature _______.

involve subjective decision making on the part of management

A representative audit sample _______.

is likely to provide a reasonable basis for drawing a conclusion about an entire population

The choice of using audit sampling vs. audit data analytics (ADA) _______.

is often a matter of what is most effective and efficient in determining whether an assertion is presented fairly, in all material respects

An entity's risk assessment process:

is the entity's process for identifying and responding to business risks and the results of those risks.

Nonsampling risk:

is the risk that an auditor arrives at an inappropriate conclusion for a reason unrelated to sampling issues.

Sampling risk:

is the risk that the sample chosen by the auditor is not representative of the population of transactions.

The nature of an audit procedure refers to:

its purpose and its type.

The use of audit sampling _______.

may be a function of the efficiency and effectiveness of the audit procedure

The auditor's conclusion based on the sample _______.

may be different than the conclusion drawn if the auditor had audited the entire population

The purpose of the management letter is to ________.

meet the auditor's responsibility for communicating internal control matters in writing on a timely basis with those charged with governance

As with all audit procedures, auditors must _______.

must carefully plan the nature, timing, and extent of audit data analytics (ADA) to be used for each client

The ultimate purpose of a substantive test is to _______.

obtain reasonable assurance that an assertion is presented fairly in all material respects

The objectives of internal control include:

operations objectives, reporting objectives, and compliance objectives.

The auditor is most likely going to perform audit data analytics (ADA) as a substantive test when the auditor has _______.

performed tests of controls and concluded that the entity has strong controls

An auditor normally obtains an understanding of transaction-level controls by:

performing a system walkthrough.

The auditor testing the effectiveness of manual follow-up to see whether items put on an exception report were appropriately cleared is an example of _______.

reperformance

When an audit procedure is tested on an entire group of transactions, _______.

sampling is not required

The control environment:

sets the tone of an entity with respect to internal control and influences the control consciousness of its people.

If the auditor is able to collect evidence that IT general controls are strong, then the auditor can conclude that:

software applications are more likely to operate consistently over time.

An auditor is testing accounts receivable for a client that has 1,000 customers with customer balances that range from $150 to $185,000. The auditor subdivided the receivables into three groups: group 1 has all customers with receivable balances between $185,000 and $100,000, group 2 has all customers with receivable balances between $100,000 and $25,000, and group 3 has all customers with receivable balances less than $25,000. The auditor then randomly selects customers out of each group. This is known as:

stratified sampling.

In order to determine the extent of testing of controls, _______.

the auditor can use either statistically based sampling techniques or nonstatistical techniques

If the auditor determines that an effective compensating control does not exist, or tests of controls show that the compensating control is not functioning as designed, _______.

the auditor revises the overall audit risk assessment for the related account and assertion, and the planned audit strategy

When performing an integrated audit (to issue an opinion on the financial statements and an opinion on internal controls over financial reporting), _______.

the auditor uses a top-down approach to determine which controls to select

If the test results do not confirm the preliminary evaluation of controls, _______.

the auditor will consider whether there is a compensating control that might detect and correct a misstatement missed by the original control being tested

If the control environment is assessed to be weak, _______.

the auditors should address this by changing the audit plan to include more audit procedures and expanding the scope of the audit to include more of the client's locations

The population consists of _______.

the class of transactions or the account balance to be tested

The internal control component that addresses how an organization holds an individual accountable for his or her internal control responsibilities in pursuit of objectives is related to:

the control environment.

The more complex the client's operations and its internal controls, _______.

the more experienced the auditor who performs the work needs to be

Designing substantive procedures responds to:

the risk of material misstatement at the assertion level.

Estimation uncertainty is defined as _______.

the susceptibility of an accounting estimate and related disclosures due to an inherent lack of precision in its measurement

The critical difference between statistical and nonstatistical sampling is:

the use of the laws of probability in statistical sampling to determine sample size and develop a confidence interval around the results of the sample.

With respect to audit sampling, _______.

there is a direct relationship between assurance and sample size

After auditors have completed testing controls and drawn a conclusion about control risk, _______.

they make decisions about the nature, timing, and extent of substantive testing

The choice of using audit sampling versus audit data analytics (ADA) is often a matter of _______.

what is most effective and efficient in determining whether an assertion is presented fairly, in all material respects

The auditor is more likely to use audit sampling _______.

when internal controls are weak

With respect to timing, tests of controls _______.

will usually be carried out at an interim date, often about three months prior to year-end

The _______ clearly lays out the purpose of the test of the control, the nature and extent of the work performed at an interim date, the results of the audit tests, and the auditor's conclusion about control risk.

working paper