Principles of Auditing Chapter 3

Once the audit strategy has been established, the auditor develops a more detailed ____________ _______________

audit plan

For public companies, a relative percentage for establishing overall materiality is typically __. o 3% to 5% of income before taxes o 5% to 10% of total revenue o 3% to 5% of total assets o 5 to 10% of total equity

o 3% to 5% of income before taxes

Select all that apply When should the evaluation of client continuance take place? o At or near the completion of the audit. o At the beginning of the audit. o When a significant event occurs.

o At or near the completion of the audit. o When a significant event occurs.

When should the audit committee meet with external auditors to discuss the auditor's responsibilities and significant accounting policies? o Before the engagement starts o During the engagement o At the end of the engagement

o Before the engagement starts

Which of the following is not a factor that auditors should consider when evaluating the reliability of the internal audit function? o Competence o Systematic and disciplined approach o Composition o Objectivity

o Composition

A significant aspect of most audit engagements is the use of a(n) ______ specialist. o tax o valuation o IT o environmental o legal

o IT

Select all that apply Which of the following statements are correct? o Tests of controls check the operating effectiveness of controls. o Dual-purpose tests can improve audit efficiency. o Substantive tests of transactions check the operating effectiveness of controls. o Substantive tests of transactions are concerned with monetary misstatements. o Tests of controls are concerned with monetary misstatements. o An audit procedure should either be a test of controls or a substantive test of transactions.

o Tests of controls check the operating effectiveness of controls. o Dual-purpose tests can improve audit efficiency. o Substantive tests of transactions are concerned with monetary misstatements.

To detect material misstatements in a class of transactions, account balance and disclosure component of the financial statements, the auditor designs ____________ _____________

substantive procedures

The amount of overall materiality used to plan and perform audit procedures at the account or disclosure level is called __________ _______________.

tolerable misstatement

True or false: The extent of effort that goes into evaluating a new client is normally much less than the decision to continue with an existing client.

False

True or false: The audit team a public accounting firm uses for an engagement does not tend to vary from client to client.

False Pubic account firms need to ensure that engagements are completed by auditors having the proper degree of technical training and proficiency given the circumstances of the entity.

True or false: A public accounting firm should investigate a prospective client prior to accepting the engagement.

True

An individual or organization possessing expertise in a field other than accounting or auditing whose work is used to assist the auditor in obtaining sufficient, appropriate evidence is defined by auditing standards as a(n) ____________ ____________.

auditor specialist

Based on an understanding of the entity and environment, the auditor identifies those ___________ risks that may result in material misstatements.

business

Serving as a contract, the ___________ _____________outlines responsibilities and prevents misunderstandings between the auditor and client.

engagement letter

The arrangements reached between the auditor and the entity are formalized in a(n) _________ _____________.

engagement letter

Auditor's responsibility for detecting illegal acts having a direct and material effect on the financial statements is the same as that for ____________ and _________________.

errors; fraud

Information about an auditor's financial or business relationships with the firm's clients is documented by having all personnel complete an annual __________ _______________.

independence questionnaire

The maximum amount by which the auditor believes the financial statements could be misstated and still not affect the decision of users is overall __________

materiality

Which of the follow is not an inquiry that a successor auditor should make to a predecessor auditor? o The predecessor auditor's fee charged for audit work. o Communications to those charged with governance regarding fraud and noncompliance with laws or regulations by the entity. o Information that might bear on the integrity of management. o Disagreements with management about accounting policies, auditing procedures or other similarly significant matters. o Communications to management and those charged with governance regarding significant deficiencies and material weaknesses in internal control.

o The predecessor auditor's fee charged for audit work.

Materiality is assessed in terms of potential effect of a misstatement on decisions made by ______. o any potential lender or creditor o all stockholders of the corporation o a reasonable user of financial statements o employees and suppliers

o a reasonable user of financial statements

Auditors consider materiality from a reasonable user perspective and communicate to users that "the financial statements present fairly in ______ material respects. o no o some o most o all

o all

Many public accounting firms adopt a policy of not completing the current audit until ______ fees have been paid. o most of the current year's o most of the prior year's o all of the prior year's o all of the current year's

o all of the prior year's

When determining whether to use the work of the entity's internal auditors, the external auditor must obtain ______. o working papers from the internal auditors o certifications held by the internal auditors o an understanding of the internal audit function o resumes of the internal auditors

o an understanding of the internal audit function

Select all that apply A public accounting firm may disassociate itself from an auditing client due to ______. o auditing issues o accounting issues o corporate social responsibility issues o manufacturing issues o disputes over fees

o auditing issues o accounting issues o disputes over fees

The first phase of the audit process that relates to audit planning is ______. o planning the audit o client acceptance and continuance o preliminary engagement activities

o client acceptance and continuance

Select all that apply An auditor's independence would be considered impaired if the ______. o cousin of the auditor is a maintenance worker for the entity o client owes money to the auditor that has the characteristics of a loan o spouse of the auditor is an accounting supervisor for the entity o auditor received a casual lunch paid for by the client being audited

o client owes money to the auditor that has the characteristics of a loan o spouse of the auditor is an accounting supervisor for the entity

Auditors should consider laws and regulations that are generally recognized as having ______ effects on the determination of financial statement amounts. o direct and immaterial o indirect and immaterial o direct and material o indirect and material

o direct and material

Overall responsibility for an audit engagement rests with the ______. o internal auditors o audit committee o engagement partner o senior auditor

o engagement partner

Select all that apply During the documenting stage, the auditor ______. o ensures that the identified risks have been addressed o records how the entity is managing its risks o compiles his or her knowledge about the entity's business objectives and strategies o decides upon the nature, timing and extend of audit tests

o ensures that the identified risks have been addressed o records how the entity is managing its risks o compiles his or her knowledge about the entity's business objectives and strategies

Select all that apply Generally, the three preliminary engagement activities are ______. o documenting prior audit opinions that have been issued to the client o establishing an understanding with the entity o charging clients for preliminary audit work completed o determining the audit engagement team requirements o ensuring the audit team and firm are in compliance with ethical and independence requirements

o establishing an understanding with the entity o determining the audit engagement team requirements o ensuring the audit team and firm are in compliance with ethical and independence requirements

Select all that apply Engagement team members performing supervisory activities should ______. o inform engagement team members of their responsibilities o direct audit team members to bring any significant accounting or auditing issues to the audit committee o review the work of engagement team members

o inform engagement team members of their responsibilities o review the work of engagement team members

Select all that apply The terms of the audit engagement should include ______. o management's responsibilities o limitations of the engagement o auditor's responsibilities o the role of the board of directors o the objectives of the engagement

o management's responsibilities o limitations of the engagement o auditor's responsibilities o the objectives of the engagement

Select all that apply Under Section 301 of the Sarbanes-Oxley Act, the audit committee of a public company ______. o must have the authority to engage independent counsel to carry out duties as necessary o is directly responsible for the hiring, paying and oversight of the public accounting firm employed by the company o must consist of members who are part of the company's upper management o must preapprove all audit and nonaudit services provided by the auditors

o must have the authority to engage independent counsel to carry out duties as necessary o is directly responsible for the hiring, paying and oversight of the public accounting firm employed by the company o must preapprove all audit and nonaudit services provided by the auditors

Select all that apply In documenting the overall audit strategy and audit plan, auditors should document the ______. o nature of audit tests o timing of audit tests o outcomes of prior audit tests o extent of audit tests o prior audit fees

o nature of audit tests o timing of audit tests o extent of audit tests

Select all that apply Risk assessment procedures include ______. o observation and inspection o inquiries of management and others o establishing materiality o preliminary analytical procedures o completing industry benchmarking comparisons

o observation and inspection o inquiries of management and others o preliminary analytical procedures

Select all that apply Examples of tests of controls include ______. o observation of the application of specific controls o copying prior year auditing working papers o reperformance of the application of the control o inquiries of management, supervisory and staff personnel o inspecting documents, reports and electronic files

o observation of the application of specific controls o reperformance of the application of the control o inquiries of management, supervisory and staff personnel o inspecting documents, reports and electronic files

Auditor risk assessment procedures are used to ______. o obtain an understanding of the entity and its environment o set audit fees o determine the type of opinion to issue o determine whether or not to accept a client

o obtain an understanding of the entity and its environment

Auditors can reduce audit risk to an acceptably low level by ______. o using the internal audit function as part of the audit team o increase the amount charged for performing the audit o obtaining an understanding of the entity and its environment. o consulting with top-level management

o obtaining an understanding of the entity and its environment.

Public accounting firms should ______. o only evaluate continuing their relationship with current clients when conflicts arise o periodically evaluate whether to continue their relationship with current clients o not continue their relationship with current clients when conflicts arise

o periodically evaluate whether to continue their relationship with current clients

Select all that apply Factors that should be considered in the determination of staffing requirements for an audit include ______. o personnel availability o engagement size o timing of the work o engagement complexity o level of certainty

o personnel availability o engagement size o timing of the work o engagement complexity

Auditors should attempt to identify all related parties during the ______ phase of the audit. o testing o planning o client acceptance o evaluation

o planning

When a client has multiple locations, the auditor determines which locations or business units to audit and the extent of audit procedures to be performed during the ______ process. o fee setting o client acceptance o planning o implementation

o planning

Ensuring that members of the audit team meet independence requirements generally take place as part of ______. o audit strategy and planning o client acceptance and continuance o preliminary engagement activities o evaluating audit findings

o preliminary engagement activities

The auditor's consideration of materiality on an audit is a matter of ______. o industry related benchmarking o financial statement analysis o fees charged for the audit o professional judgment

o professional judgment

The consideration of materiality is a matter of ______. o cost effectiveness o professional judgment o engagement efficiency o audit fees charged

o professional judgment

Select all that apply If the auditor determines that the work of the internal audit function (IAF) can be used for purposes of the audit, the auditor must evaluate the ______. o quality control approach of the IAF o level of competence of the IAF o application by the IAF of a systematic and disciplined approach o extent to which the IAF's status and policies support the financial objectives of the client

o quality control approach of the IAF o level of competence of the IAF o application by the IAF of a systematic and disciplined approach

Auditors should establish an understanding with the entity about the terms of the engagement to ______. o document the understanding in the working papers o increase the billable hours charged to the client o reduce the risk of misinterpretation between the two parties o discuss the type of audit opinion expected

o reduce the risk of misinterpretation between the two parties

Materiality is a(n) __ concept. o absolute o relative o statistical o analytical

o relative

Ideally, the head of of internal auditing (chief audit executive) should ______. o only report to the audit committee o report administratively to the audit committee and functionally to senior management o report functionally to the audit committee and administratively to senior management o only report to senior management (CEO and CFO)

o report functionally to the audit committee and administratively to senior management

When auditing a company with multiple locations, the amount of audit attention devoted to various locations depends upon the ______. o size of various locations o number of locations o risk of material misstatement o recommendations of the audit committee o revenue generated at each location

o risk of material misstatement

Select all that apply The nature and extent of planning activities that are necessary depend on the ______ the entity o size of o compensation to be received from o market value of o auditor's previous experience with o complexity of

o size of o auditor's previous experience with o complexity of

Select all that apply The categories of substantive procedures are ______. o inquiries of management o substantive analytical procedures o tests of financial statements o tests of details

o substantive analytical procedures o tests of details

Tests of controls are performed to ______. o comply with accounting standards o determine the type of audit opinion to issue o test the operating effectiveness of controls o increase the audit fees charged to the client

o test the operating effectiveness of controls

Operating effectiveness is checked using ______. o tests of controls only o both tests of controls and substantive tests o substantive tests only o neither tests of controls nor substantive tests

o tests of controls only

Select all that apply When an auditor is asked to accept a new client, ______. o the auditor must ask permission of the client before contacting the predecessor auditor o an investigation of the client should be conducted after the engagement has been accepted o an entity acceptance questionnaire, checklist or memo is generally prepared to document the investigation

o the auditor must ask permission of the client before contacting the predecessor auditor o an entity acceptance questionnaire, checklist or memo is generally prepared to document the investigation

Select all that apply In establishing an understanding about the terms of the engagement with potential clients, ______ should be discussed. o using the work of internal auditors o the engagement letter o the type of opinion the audit firm expects to issue o the role of the client's audit committee

o using the work of internal auditors o the engagement letter o the role of the client's audit committee

Auditors should attempt to identify all ________ __________ because transactions with them may not be at "arm's length."

related parties