Deck 6: Planning the Audit; Linking Audit Procedures to Risk

Question 1

The auditors' tests of controls are designed to substantiate the fairness of specific financial statement accounts.

Answer 1

False

Question 2

Which of the following matters is generally included in an auditor's engagement letter?

A) Limitations of the engagement.
B) Factors to be considered in establishing preliminary judgments about materiality.
C) Management's liability for all illegal acts committed by its employees.
D) The auditor's responsibility to obtain negative assurance relating to non-compliance with laws and regulations.

Answer 2

A

Question 3

Confirming a bank account establishes existence but not rights to the cash balance.

Answer 3

False

Question 4

Vouching the acquisition of assets is an audit procedure that is often performed to establish the valuation of the assets.

Question 5

To best test existence, an auditor would sample from the:

A) General ledger to source documents.
B) General ledger to the financial statements.
C) Source documents to the general ledger.
D) Source documents to journals.

Question 6

Which of the following factors would most likely cause a CPA to decide not to accept a new audit engagement?

A) Lack of understanding of the potential client's internal auditors' computer-assisted audit techniques.
B) Management's disregard for internal control.
C) The existence of related party transactions.
D) Management's attempt to meet earnings per share growth rate goals.

Question 7

While assessing the risks of material misstatement, auditors identify risks, relate risk to what could go wrong, consider the magnitude of risks, and:

A) Assess the risk of misstatements due to illegal acts.
B) Consider the complexity of the transactions involved.
C) Consider the likelihood that the risks could result in material misstatements.
D) Determine materiality levels.

Question 8

An audit plan includes a detailed listing of the audit procedures to be performed in the verification of items in the financial statements.

Question 9

Which of the following factors most likely would cause a CPA to not accept a new audit engagement?

A) The prospective client has fired its prior auditor.
B) The CPA lacks a thorough understanding of the prospective client's operations and industry.
C) The CPA is unable to review the predecessor auditor's working papers due to a major fire that destroyed both hard and soft copy documentation.
D) The prospective client is unwilling to make financial records available to the CPA.

Question 10

The auditors' understanding established with a client should be established through a(an):

A) Oral communication with the client.
B) Written communication with the client.
C) Written or oral communication with the client.
D) Completely detailed audit plan.

Question 11

Analytical procedures are seldom used during the risk assessment stage of an audit engagement because they are substantive procedures.

Question 12

Which of the following would be least likely to be considered an audit planning procedure?

A) Use an engagement letter.
B) Develop the overall audit strategy.
C) Perform the risk assessment.
D) Develop the audit plan.

Question 13

Which of the following is correct concerning requirements about auditor communications about fraud?

A) Fraud that involves senior management should be reported directly to the audit committee regardless of the amount involved.
B) All fraud with a material effect on the financial statements should be reported directly by the auditor to the Securities and Exchange Commission.
C) Fraud with a material effect on the financial statements should ordinarily be disclosed by the auditor through use of an "emphasis of a matter" paragraph added to the audit report.
D) The auditor has no responsibility to disclose fraud outside the entity under any circumstances.

Question 14

Preliminary arrangements with clients should be set forth in the management letter.

Question 15

Which of the following factors most likely would heighten an auditor's concern about the risk of fraudulent financial reporting?

A) Large amounts of liquid assets that are easily convertible into cash.
B) Low growth and profitability as compared to other entity's in the same industry.
C) Financial management's participation in the initial selection of accounting principles.
D) An overly complex organizational structure involving unusual lines of authority.

Question 16

At least a portion of the auditors' consideration of internal control usually is performed at an interim date rather than at the balance sheet date.

Question 17

The substantive approach to an audit is appropriate for many small businesses.

Question 18

Audit committees should be made up of the most qualified directors regardless of whether they are part of management of the company.

Question 19

Which of the following would heighten an auditor's concern about the risk of fraudulent financial reporting?

A) Inability to generate positive cash flows from operations, while reporting large increases in earnings.
B) Management's lack of interest in increasing the dividend paid on common stock.
C) Large amounts of liquid assets that are easily convertible into cash.
D) Inability to borrow necessary capital without obtaining waivers on debt covenants.

Question 20

The completeness of recording of assets is generally verified by tracing from the source documents to the recorded entry.

Question 21

Which of the following conditions identified during the audit increases the risk of employee fraud?

A) Large amounts of cash in the bank.
B) Existence of a mandatory vacation policy for employees performing key functions.
C) Inventory items of small size, but high value.
D) Presence of reconciling items on a client prepared year-end proof of cash.

Question 22

The risk of a material misstatement occurring in an account, assuming an absence of internal control, is referred to as:

A) Account risk.
B) Control risk.
C) Detection risk.
D) Inherent risk.

Question 23

Which of the following statements is accurate about "fraud risk factors" considered when conducting an audit?

A) Factors whose presence indicates that fraud exists.
B) Factors whose presence often have been observed in circumstances where frauds have occurred.
C) Factors whose presence will require modification to planned audit procedures.
D) Factors obtained during the audit which lead to required communications with the audit committee.

Question 24

Which of the following is least likely to be considered a financial statement audit risk factor?

A) Management operating and financing decisions are dominated by top management.
B) A new client with no prior audit history.
C) Rate of change in the entity's industry is rapid.
D) Profitability of the entity relative to its industry is inconsistent.

Question 25

A successor auditor is required to attempt communication with the predecessor auditor prior to:

A) Performing test of controls.
B) Testing beginning balances for the current year.
C) Making a proposal for the audit engagement.
D) Accepting the engagement.

Question 26

Which of the following is least likely to be required on an audit?

A) Evaluate the business rationale for significant, unusual transactions.
B) Make a legal determination of whether fraud has occurred.
C) Review accounting estimates for biases.
D) Test appropriateness of journal entries and adjustments.

Question 27

Which of the following is most likely to be considered a risk factor relating to fraudulent financial reporting?

A) Low turnover of senior management.
B) Extreme degree of competition within the industry.
C) Capital structure including various operating subsidiaries.
D) Sales goals in excess of any of the preceding three years.

Question 28

Which of the following circumstances would an auditor most likely consider a risk factor relating to misstatements arising from fraudulent financial reporting?

A) Several members of management have recently purchased additional shares of the entity's stock.
B) Several members of the board of directors have recently sold shares of the entity's stock.
C) The entity distributes financial forecasts to financial analysts that predict conservative operating results.
D) Management is interested in maintaining the entity's earnings trend by using aggressive accounting practices.

Question 29

A predecessor auditor will ordinarily initiate communication with the successor auditor: $\begin{array}{|l|l|}\hline\\\hline \text { A. } &~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ \\\hline \text { B. } & \\\hline \text { C. } \\\hline \text { D. } & \\\hline\end{array}$

A) Option A
B) Option B
C) Option C
D) Option D

Question 30

In using the information on the statement of cash flows while obtaining an understanding of a profitable, growing company, which of the following would ordinarily be least surprising to an auditor?

A) Decreases in accounts payable.
B) Decreases in accounts receivable.
C) Negative cash flows from investing.
D) Negative operating cash flows.

Question 31

Which of the following procedures is not performed as a part of planning an audit engagement?

A) Reviewing the working papers of the prior year.
B) Developing an overall audit strategy.
C) Confirmation of all major accounts.
D) Designing an audit plan.

Question 32

Which of the following is an example of fraudulent financial reporting?

A) Company management falsifies inventory count tags thereby overstating ending inventory and understating cost of goods sold.
B) An employee diverts customer payments to his personal use, concealing his actions by debiting an expense account, thus overstating expenses.
C) An employee steals inventory and the "shrinkage" is recorded in cost of goods sold.
D) An employee "borrows" tools from the company and neglects to return them; the cost is reported as a miscellaneous operating expense.

Question 33

Which measure of materiality (or both) considers quantitative considerations? $$\begin{array} { | l | c | c | } \hline & \text { Planning } & \text { Evaluation } \\\hline \text { A. } & \text { Yes } & \text { Yes } \\\hline \text { B. } & \text { Yes } & \text { No } \\\hline \text { C. } & \text { No } & \text { Yes } \\\hline \text { D. } & \text { No } & \text { No } \\\hline\end{array}$$

A) Option A
B) Option B
C) Option C
D) Option D

Question 34

Which of the following is (are) considered a further audit procedure(s) that may be designed after assessing the risks of material misstatement? $\begin{array}{|c|c|c|} \hline& \text { Substantive Tests of Details } & \text { Substantive Analytical Procedures } \\\hline \text { A. } & \text { Yes } & \text { Yes } \\\hline \text { B. } & \text { Yes } & \text { No } \\\hline \text { C. } & \text { No } & \text { Yes } \\\hline \text { D. } & \text { No } & \text { No } \\\hline\end{array}$

A) Option A
B) Option B
C) Option C
D) Option D

Question 35

If the business environment is experiencing a recession, the auditor most likely would focus increased attention on which of the following accounts?

A) Purchase returns and allowances.
B) Allowance for doubtful accounts.
C) Common stock.
D) Noncontrolling interest of a subsidiary purchased during the year.

Question 36

Which of the following is not one of the assertions made by management about an account balance?

A) Relevance.
B) Existence.
C) Valuation.
D) Rights and obligations.

Question 37

Audits of financial statements are designed to obtain reasonable assurance of detecting material misstatements due to: $$\begin{array} { | c | c | c | } \hline & \text { Errors } & \text { Misappropriation of Assets } \\\hline \text { A. } & \text { Yes } & \text { Yes } \\\hline \text { B. } & \text { Yes } & \text { No } \\\hline \text { C. } & \text { No } & \text { Yes } \\\hline \text { D. } & \text { No } & \text { No } \\\hline\end{array}$$

A) Option A
B) Option B
C) Option C
D) Option D

Question 38

Which of the following is not an example of a likely adjustment in the auditors' overall audit approach when significant risk is found to exist?

A) Apply increased professional skepticism about material transactions.
B) Increase the assessed level of detection risk.
C) Assign personnel with particular skill to areas of high risk.
D) Obtain increased evidence about the appropriateness of management's selection of accounting principles.

Question 39

Which of the following factors most likely would lead a CPA to conclude that a potential audit engagement should not be accepted?

A) There are significant related party transactions that management claims occurred in the ordinary course of business.
B) Internal control activities requiring the segregation of duties are subject to management override.
C) Management continues to employ an inefficient system of information technology to record financial transactions.
D) It is unlikely that sufficient evidence is available to support an opinion on the financial statements.

Question 40

When a company has changed auditors, according to the Professional Standards:

A) The successor auditor has the responsibility to initiate contact with the predecessor auditor to ask about the client before the engagement is accepted; the predecessor has no responsibility to initiate this contact, even when aware of matters bearing on the integrity of management.
B) The predecessor must always respond fully to all inquiries made by the successor auditor.
C) The successor must discuss with the predecessor matters bearing on the engagement prior to accepting the engagement.
D) The successor may choose not to attempt any communication with the predecessor auditor.

Question 41

Tracing from source documents forward to ledgers is most likely to address which assertion related to posted entries?

A) Completeness.
B) Existence.
C) Rights.
D) Valuation.

Question 42

Preliminary arrangements agreed to by the auditors and the client should be reduced to writing by the auditors. The best place to set forth these arrangements is in:

A) A memorandum to be placed in the permanent section of the auditing working papers.
B) An engagement letter.
C) A client representation letter.
D) A confirmation letter attached to the constructive services letter.

Question 43

Which of the following topics is not normally included in an engagement letter?

A) The auditors' preliminary assessment of internal control.
B) The auditors' estimate of the fee for the engagement.
C) Limitations on the scope of the engagement.
D) A description of responsibility for the detection of fraud.

Question 44

Determining that receivables are presented at net realizable value is most directly related to which management assertion?

A) Existence.
B) Rights.
C) Valuation.
D) Presentation and disclosure.

Question 45

The risk that the auditors' procedures will lead them to conclude that a material misstatement does not exist in an account balance when in fact such a misstatement does exist is referred to as:

A) Account risk.
B) Control risk.
C) Detection risk.
D) Inherent risk.

Question 46

Auditors must assess fraud risk on every audit and respond to the risks that are identified. Which of the following is not a procedure required to further address the fraud risk of management override of internal control?

A) Reviewing accounting estimates for biases.
B) Examining physical controls over assets.
C) Evaluating the business rationale for significant unusual transactions.
D) Examining journal entries and other adjustments for evidence of fraud.

Question 47

Which of the following is not an assertion that is made in the financial statements by management concerning each major account balance?

A) Completeness.
B) Rights and obligations.
C) Legality.
D) Valuation.

Question 48

The auditors must consider materiality in planning an audit engagement. Materiality for planning purposes is:

A) The auditors' preliminary estimate of the largest amount of misstatement that would be material to any one of the client's financial statements.
B) The auditors' preliminary estimate of the smallest amount of misstatement that would be material to any one of the client's financial statements.
C) The auditors' preliminary estimate of the amount of misstatement that would be material to the client's balance sheet.
D) An amount that cannot be quantitatively stated since it depends on the nature of the item.

Question 49

Tests for unrecorded assets typically involve tracing from:

A) Source documents to recorded journal entries.
B) Source documents to observations.
C) Recorded journal entries to documents.
D) Recorded journal entries to observations.

Question 50

To test for unsupported entries in the journals, the direction of audit testing should be to the:

A) Ledger entries.
B) Journal entries.
C) Original source documents.
D) Financial statements.

Question 51

Which of the following is not a required source of information for the auditors' assessment of fraud risk?

A) Discussion among audit team members.
B) Fraud risk factors.
C) Results of tests of controls.
D) Inquiry of management and others.

Question 52

The auditors will not ordinarily initiate discussion with the audit committee concerning the:

A) Extent to which the work of internal auditors will influence the scope of the examination.
B) Extent to which change in the company's organization will influence the scope of the examination.
C) Details of potential problems which the auditors believe might cause a qualified opinion.
D) Details of the procedures which the auditors intend to apply.

Question 53

Which statement is correct relating to a potential successor auditor's responsibility for communicating with the predecessor auditors in connection with a prospective new audit client?

A) The successor auditors have no responsibility to contact the predecessor auditors.
B) The successor auditors should obtain permission from the prospective client to contact the predecessor auditors.
C) The successor auditors should contact the predecessors regardless of whether the prospective client authorizes contact.
D) The successor auditors need not contact the predecessors if the successors are aware of all available relevant facts.

Question 54

Which of the following statements is correct regarding the auditor's determination of materiality?

A) The planning level of materiality should normally be the larger of the amount considered for the balance sheet versus the income statement.
B) The auditors' planning level of materiality may be disaggregated into smaller "tolerable misstatements" for the various accounts.
C) Auditors may use various rules of thumb to arrive at an evaluation level of materiality, but not for determining the planning level of materiality.
D) The amount used for the planning should equal that used for evaluation.

Question 55

The auditors are planning an audit engagement for a new client in a business that is unfamiliar to the auditors. Which of the following would be the most useful source of information for the auditors during the preliminary planning stage when they are trying to obtain a general understanding of audit problems that might be encountered?

A) Client manuals of accounts and charts of accounts.
B) AICPA Industry Audit Guides.
C) Prior-year working papers of the predecessor auditors.
D) Latest annual and interim financial statements issued by the client.

Question 56

Which of the following is not used by auditors to establish the completeness of recorded assets?

A) Assessing control risk.
B) Tracing from source documents to entries in the accounting records.
C) Performing analytical procedures.
D) Vouching transactions.

Question 57

Which of the following is not a general objective for the audit of asset accounts?

A) Establishing existence of assets.
B) Establishing proper valuation of assets.
C) Establishing proper liabilities relating to assets.
D) Establishing the completeness of assets.

Question 58

Which of the following is least likely to render a quantitatively small misstatement material?

A) Affects the registrant's compliance with regulatory requirements.
B) Masks a change in earnings or other trends.
C) Arises from an item not capable of precise measurement.
D) The transaction involves a related party.

Question 59

Which of the following is most likely to be an overall response to fraud risks identified in an audit?

A) Only use certified public accountants on the engagement.
B) Place increased emphasis on the audit of objective transactions rather than subjective transactions.
C) Supervise members of the audit team less closely and rely more upon judgment.
D) Use less predictable audit procedures.

Question 60

A form filed with the SEC when a company changes auditors is a:

A) Form 8-K.
B) Form 10-K.
C) Form S-1.
D) Form B-1.

Question 61

An auditor selects a sample from the file of shipping documents to determine whether invoices were prepared. This test is performed to satisfy the audit objective of:

A) Accuracy.
B) Completeness.
C) Control.
D) Existence.

Question 62

With respect to the auditor's planning of a year-end audit, which of the following statements is always true?

A) An engagement should not be accepted after the fiscal year-end.
B) An inventory count must be observed at the balance sheet date.
C) The client's audit committee should not be told of any specific audit procedures which will be performed.
D) It is an acceptable practice to carry out parts of the examination at interim dates.

Question 63

PCAOB standards suggest which of the following when interpreting the federal securities laws relating to materiality?

A) A material amount would significantly alter the "total mix" of information made available to an investor.
B) Materiality cannot be used as a basis for interpreting federal securities laws.
C) A material amount is that at which an individual's decision would be changed.
D) Materiality is composed of quantitative and not qualitative aspects.

Question 64

As a part of the planning process, auditors develop an audit strategy, an audit plan, and a time budget.
a. Describe an audit strategy and explain its purpose.
b. Describe an audit plan and explain its purpose.
c. Describe a time budget and explain its purpose.

Question 65

Many auditors take an approach to assessing the risk of material misstatement by beginning with an assessment of business risks.
a. Define business risks.
b. Why have auditors found it effective to take the approach of assessing business risks?
c. Identify a business risk and explain how it might affect the auditor's audit procedures.

Question 66

Which of the following is least likely to be included in an auditor's inquiry of management while obtaining information to identify the risks of material misstatement due to fraud?

A) Are all financial reporting operations at one location?
B) Does it have knowledge of fraud or suspect fraud?
C) Does it have programs to mitigate fraud risks?
D) Has it reported to the audit committee the nature of the company's internal control?

Question 67

An auditor who accepts an audit engagement and does not possess the industry expertise of the business entity, should:

A) Engage financial experts familiar with the nature of the business entity.
B) Obtain a knowledge of matters that relate to the nature of the entity's business.
C) Refer a substantial portion of the audit to another CPA who will act as the principal auditor.
D) First inform management that an unqualified opinion cannot be issued.

Question 68

An abnormal fluctuation in gross profit that might suggest the need for extended audit procedures for sales and inventories would most likely be identified in the risk assessment phase of the audit by the use of:

A) Tests of transactions and balances.
B) An assessment of internal control.
C) An audit time budget.
D) Analytical procedures.

Question 69

Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding the predecessor's:

A) Awareness of the consistency in the application of generally accepted accounting principles between accounting periods.
B) Evaluation of all matters of continuing accounting significance.
C) Opinion of any subsequent events occurring since the predecessor's audit report was issued.
D) Understanding as to the reasons for the change of auditors.

Question 70

When planning an audit, an auditor should:

A) Consider whether the extent of substantive procedures may be reduced based on the results of the internal control questionnaire.
B) Make preliminary judgments about materiality levels for audit purposes.
C) Conclude whether changes in compliance with prescribed control procedures justifies reliance on them.
D) Prepare a preliminary draft of the management representation letter.

Question 71

Which of the following is correct concerning the PCAOB's concept of a significant account?

A) It is the same as a relevant assertion.
B) The auditor need only consider significant accounts when controls do not operate effectively.
C) In deciding whether an account is a significant account one does not consider the effect of internal control.
D) It is an account for which qualitative materiality considerations are particularly important.

Question 72

On September 3, 20X1, Larkin, CPA, was engaged to audit the financial statements of Precious Metals Co. (PM), for the year ended October 31, 20X1. PM purchases precious metals at wholesale prices and resells them to craft clubs at retail. PM is a new client whose common stock was first offered to the public five years ago. PM received an unqualified opinion on its financial statements in each of the prior three years, but changes auditors after each engagement. In accepting the engagement, Larkin completed all of the appropriate client acceptance procedures.
Larkin instructed Johnson, an assistant on the engagement, to draft a planning checklist that would assist Larkin in preparing the audit staff for the fieldwork that is scheduled to begin on October 17, 20X1. On October 5, 20X1, Johnson prepared the planning checklist below (engagement letter points have been omitted). Indicate the inappropriate points that are included on Johnson's planning checklist.

Question 73

Which of the following situations would most likely require special audit planning by the auditors?

A) Some items of factory and office equipment do not bear identification numbers.
B) Depreciation methods used on the client's tax return differ from those used on the books.
C) Assets costing less than $500 are expensed even though the expected life exceeds one year.
D) Inventory is comprised of precious stones.

Question 74

Engagement letters are used by most auditors in performing professional services.
a. Describe the purpose of an engagement letter.
b. List four items that are normally included in an engagement letter.

Question 75

The auditor faces a risk that the audit will not detect material misstatements in the financial statements. In regard to minimizing this risk, the auditor primarily relies on:

A) Substantive procedures.
B) Tests of controls.
C) Internal control.
D) Statistical analysis.

Question 76

Individuals who commit fraud are ordinarily able to rationalize the act and also have an: $$\begin{array} { | l | c | c | } \hline & \text { Incentive } & \text { Opportunity } \\\hline \text { A. } & \text { Yes } & \text { Yes } \\\hline \text { B. } & \text { Yes } & \text { No } \\\hline \text { C. } & \text { No } & \text { Yes } \\\hline \text { D. } & \text { No } & \text { No } \\\hline\end{array}$$

A) Option A
B) Option B
C) Option C
D) Option D

Question 77

Auditors perform various tasks in planning an audit engagement. Provide an overall description of how each task is performed and its purpose.
a. Obtain an understanding of the client's business.
b. Assess audit risk and materiality for the engagement.
c. Assess fraud risk.
d. Assess the risk of material misstatement of assertions about financial statement accounts and classes of transactions.

Question 78

Hawkins requested permission to communicate with the predecessor auditor and review certain portions of the predecessor auditor's working papers. The prospective client's refusal to permit this will bear directly on Hawkins' decision concerning the:

A) Adequacy of the preplanned audit plan.
B) Ability to establish consistency in application of accounting principles between years.
C) Apparent scope limitation.
D) Integrity of management.