Question 1

A retail entity uses electronic data interchange (EDI) in executing and recording most of its purchase transactions. The entity's auditor recognizes that the documentation of the transactions will be retained for only a short period of time. To compensate for this limitation, the auditor most likely would:

Accepted Answer

Choice "B" is correct. When an entity transmits, processes, maintains, or accesses significant information electronically, some accounting data and source documents may be available only in electronic form, or only at a certain point in time. The auditor would generally perform tests of controls several times during the year to compensate for this limitation. Choice "A" is incorrect. Increasing the sample size related to cutoff testing will not provide evidence about transactions occurring throughout the period under audit, since cutoff testing relates to year-end. Choice "C" is incorrect. Auditing 100% of the year-end inventory does not provide evidence about transactions occurring throughout the period under audit. Choice "D" is incorrect. Failure to retain documentation for longer periods of time would not imply that control risk is reduced. If anything, this might lead to an increase in control risk, making it less likely that phony transactions would be detected after the fact.

Question 2

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

Accepted Answer

Choice "D" is correct. A successor auditor is required to attempt communication with the predecessor auditor prior to accepting a new engagement. Choice "A" is incorrect. A successor auditor is required to attempt communication with the predecessor auditor prior to accepting a new engagement. This certainly implies that such attempt will be made before any audit tests are performed; however, the requirement is stated in reference to the date of acceptance. Choice "B" is incorrect. A successor auditor is required to attempt communication with the predecessor auditor prior to accepting a new engagement. This certainly implies that such attempt will be made before any audit tests are performed; however, the requirement is stated in reference to the date of acceptance. Choice "C" is incorrect. A successor auditor is not required to attempt communication with the predecessor auditor prior to making a proposal for the audit engagement (remember that more than one auditor may be bidding for the engagement -- and it wouldn't be reasonable to expect the predecessor auditor to respond to all bidders). However, once a successor has been selected, that auditor must attempt communication with the predecessor auditor before actually accepting the engagement.

Question 3

When issuing an unqualified opinion, the auditor who evaluates the audit findings should be satisfied that the:

Accepted Answer

Choice "B" is correct. An unqualified opinion states that the financial statements are presented fairly, in all material respects. Accordingly, if the auditor believes that total misstatement (including both known and likely misstatements) is immaterial, an unqualified opinion is appropriate. Choice "A" is incorrect. Documenting misstatements in the management representation letter is not required, nor would it eliminate the need to modify the opinion if the known misstatements were material. Choice "C" is incorrect. Even if the client adjusts the financial statements to correct known misstatements, the auditor still must feel comfortable that any remaining unidentified misstatements would not be material to the financial statements before rendering an unqualified opinion. Choice "D" is incorrect. An auditor is not concerned with misstatements already corrected by the client. It is the auditor's estimate of uncorrected--and perhaps unknown--errors that affects the type of opinion rendered.

Question 4

An auditor's engagement letter most likely would include a statement that:

Accepted Answer

Choice "D" is correct. An auditor's engagement letter typically includes discussion of limitations of the engagement, such as the fact that the auditor will obtain only reasonable assurance, and therefore a material misstatement may remain undetected. Choice "A" is incorrect. An auditor's engagement letter typically covers the objectives of the engagement, management's responsibilities, the auditor's responsibilities, limitations of the engagement, and other matters involving the conduct of the audit. Potential significant deficiencies discovered during the prior year's audit would not typically be included in the engagement letter. Choice "B" is incorrect. While the auditor's engagement letter might include a discussion of the overall audit strategy, it typically would not include specific audit procedures. Choice "C" is incorrect. While the auditor's engagement letter might include a discussion of the auditor's responsibilities, this is usually discussed in fairly general terms. An engagement letter would not describe the auditor's responsibility with respect to specific issues (such as going concern issues).

Question 5

Prior to commencing fieldwork, an auditor usually discusses the general audit strategy with the client's management. Which of the following matters do the auditor and management agree upon at this time?

Accepted Answer

Choice "D" is correct. Prior to commencing fieldwork, an auditor would establish an understanding with the client as to the services to be performed and the overall audit strategy. This understanding may include arrangements involving the conduct of the engagement, such as timing, client assistance, and the availability of documents. Choice "A" is incorrect. The auditor does not evaluate the appropriateness of the entity's plans for dealing with adverse economic conditions prior to commencing fieldwork. The auditor might consider this as part of evaluating the client's ability to continue as a going concern, but this would not occur prior to commencing fieldwork. Choice "B" is incorrect. Determination of existing fraud risk factors is generally made during the fieldwork stage of the audit, as information and evidence is obtained. Also, fraud risk factors are assessed by the auditor, and would not necessarily be agreed upon with management. Choice "C" is incorrect. Identification and evaluation of control weaknesses generally occurs during the fieldwork stage of the audit, as information and evidence is obtained, not prior to the commencement of fieldwork.

Question 6

Which of the following factors most likely would influence an auditor's determination of the auditability of an entity's financial statements?

Accepted Answer

Choice "C" is correct. An auditor cannot audit inadequate accounting records (i.e., records that do not exist or are so poor that they cannot be relied upon). Choices "A" and "B" are incorrect. The following factors would be considered when accepting an audit engagement and might require extensions of audit work, but are not factors that would prevent the financial statements from being audited: A. The complexity of the accounting system. B. The existence of related party transactions. Choice "D" is incorrect. The operating effectiveness of control activities does not affect the auditability of financial statements, and it is not considered when accepting an audit engagement.

Question 7

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

Accepted Answer

Choice "D" is correct. If it is unlikely that sufficient appropriate audit evidence will be available to support an opinion on the financial statements, it would be pointless to conduct an audit. Choice "A" is incorrect. The existence of significant related party transactions would not prevent the auditor from accepting an audit engagement, regardless of the whether or not such transactions occurred in the ordinary course of business. The auditor would simply need to evaluate management's methods for identifying and disclosing related party transactions, and ultimately evaluate financial statement disclosure, as part of the audit. Choice "B" is incorrect. Internal control activities are often subject to management override, but this is no reason to reject a potential audit engagement. Rather, this risk should be assessed, and audit procedures should be designed only after taking into account the assessed level of risk. Choice "C" is incorrect. An inefficient system of information technology for recording financial transactions may not be optimal for the company, but as long as it is an effective system (i.e., as long as it provides reliable financial reporting), it will not affect the auditor's decision regarding acceptance of a new audit engagement.

Question 8

An auditor plans to apply substantive tests to the details of asset and liability accounts as of an interim date rather than as of the balance sheet date. The auditor should be aware that this practice:

Accepted Answer

Choice "D" is correct. Applying substantive tests to the details of asset and liability accounts as of an interim date increases risk, as it is possible that errors will occur between the date of interim testing and the balance sheet date. For this reason, the auditor generally selects for interim examination only accounts that are reasonably predictable with respect to amount, relative significance, and composition, and must also identify procedures sufficient to extend interim conclusions to year-end. Choice "A" is incorrect. The use of statistical sampling methods is not affected by the timing of audit procedures. Choice "B" is incorrect. Applying substantive tests to the details of asset and liability accounts as of an interim date increases risk, but it does not require all such tests to be reperformed. Instead, the auditor should perform procedures designed to extend the interim conclusions to year-end. Such procedures should be less in scope than the initial procedures performed at interim; otherwise, it would make more sense to have simply applied the more extensive tests at year-end in the first place. Choice "C" is incorrect. Generally, accounts selected for interim examination should be reasonably predictable with respect to amount, relative significance, and composition. Rapidly changing economic conditions might affect the valuation, significance, or composition of certain assets or liabilities, and therefore would make testing at interim less likely.

Question 9

Which of the following statements is correct concerning materiality in a financial statement audit?

Accepted Answer

Choice "D" is correct. Because the financial statements are interrelated, materiality levels are generally considered in terms of the smallest level of misstatement that could be material to any one of the financial statements. Choice "A" is incorrect. Analytical procedures are performed during an audit's review stage to evaluate the overall financial statement presentation and to assess the conclusions reached. They generally would not result in a change in materiality levels. Choice "B" is incorrect. If the materiality amount used in evaluating audit findings increases from the amount used in planning, the auditor should consider whether the audit plan needs to be modified. Typically, an increase in materiality levels would result in a decrease in audit risk, which would result in less substantive testing, not more. Choice "C" is incorrect. Qualitative considerations may lead to situations in which misstatements that do not exceed materiality limits are still likely to influence the economic decisions of users. In such cases, an otherwise immaterial misstatement is deemed to be material.

Question 10

A successor auditor should make specific and reasonable inquiries of the predecessor auditor regarding the predecessor's:

Accepted Answer

Choice "A" is correct. The successor auditor is required to make inquiries of the predecessor auditor before accepting an engagement. These inquiries should include the predecessor's understanding as to the reasons for the change in auditors. Choice "B" is incorrect. The successor auditor would not typically inquire regarding audit methodology used during the prior audit. Choices "C" and "D" are incorrect. The successor auditor is responsible for making his or her own judgments regarding the audit, and would not typically inquire regarding the predecessor auditor's judgments with respect to subsequent events or the internal audit function.

Question 11

Which of the following procedures would an auditor most likely include in the planning phase of a financial statement audit?

Accepted Answer

Choice "A" is correct. In all audits, the auditor should obtain a sufficient understanding of each of the five components of internal control in order to properly plan the audit. The entity's risk assessment process is one of the five components of internal control. Choice "B" is incorrect. Identification and testing of specific control activities generally occurs during the performance of the audit. Choice "C" is incorrect. Evaluating the reasonableness of accounting estimates generally occurs during the performance of the audit. Choice "D" is incorrect. Cutoff testing of sales and purchases generally occurs during the performance of the audit.

Question 12

The acceptable level of detection risk is inversely related to the:

Accepted Answer

Choice "A" is correct. The acceptable level of detection risk is inversely related to the assurance provided by substantive tests. For example, if the acceptable level of detection risk decreases, more assurance is required from substantive tests. Choice "B" is incorrect. The acceptable level of detection risk is determined independently of the risk of misapplying auditing procedures (non-sampling risk). Choice "C" is incorrect. The acceptable level of detection risk is determined independently of the preliminary judgment about materiality levels (tolerable error). Choice "D" is incorrect. The acceptable level of detection risk is directly related to the risk of failing to discover material misstatements (audit risk).

Question 13

In assessing the competence of a client's internal auditor, an independent auditor most likely would consider the:

Accepted Answer

Choice "A" is correct. In assessing the competence of a client's internal auditor, an independent auditor would consider the internal auditor's compliance with professional auditing standards. Such compliance could be evaluated by reviewing the audit plan and auditing procedures used by the internal auditor, as well as by assessing the quality of audit documentation provided. Choice "B" is incorrect. The internal auditor's access to management salary data has no bearing on his or her competency. Choice "C" is incorrect. The external auditor's assessment of control risk might be based in part on the existence and effectiveness of an internal audit group, but such assessment would not provide information regarding the competency of the internal auditor. Choice "D" is incorrect. Ratio analysis might be used to identify unusual transactions or events, but it would not provide information regarding the competency of the internal auditor.

Question 14

When an auditor increases the assessed level of control risk because certain control activities were determined to be ineffective, the auditor would most likely increase the:

Accepted Answer

Choice "C" is correct. As the assessed level of control risk increases, the acceptable level of detection risk for financial statement assertions decreases. To attain a decreased level of detection risk, greater assurance is needed from substantive tests. Increasing the extent of tests will provide greater assurance. Choice "A" is incorrect. Tests of controls are used to assess the level of control risk. Once such assessment is made, there is no need to perform further tests of controls. Choice "B" is incorrect. As the assessed level of control risk increases, the acceptable level of detection risk decreases. In this way, the auditor can keep total audit risk to an acceptable level. Choice "D" is incorrect. Inherent risk is based on the nature of the assertion and cannot be changed.

Question 15

Which of the following auditor concerns most likely could be so serious that the auditor concludes that a financial statement audit cannot be conducted?

Accepted Answer

Choice "B" is correct. An auditor's faith in the integrity of management is of the utmost importance in performing a financial statement audit. When an auditor is concerned that the integrity of management is suspect, the situation is serious enough to prevent the auditor from performing the audit. Choice "A" is incorrect. A lack of a written code of conduct is not unusual in a small company and certainly would not prevent an audit from being performed. Choice "C" is incorrect. Procedures requiring segregation of duties are almost always subject to management override, even in the best internal control system. Choice "D" is incorrect. An auditor would simply modify the appropriate audit procedures when management fails to modify prescribed controls for changes in conditions.

Question 16

An auditor reviews a client's accounting policies and procedures when considering which of the following planning matters?

Accepted Answer

Choice "D" is correct. An auditor would review the client's accounting policies and procedures as part of obtaining an understanding of the client's operations and business. This understanding is important because it affects the design of internal control, which in turn impacts planned auditing procedures. Choice "A" is incorrect. Although the auditor might consider the client's accounting policies and procedures when designing a sampling plan, this is not the primary reason for the auditor's review of the client's policies and procedures. Choice "B" is incorrect. The client's accounting policies and procedures would not affect preliminary judgments about materiality, which are generally based on either annualized interim financial statements or annual financial statements from a prior period. Choice "C" is incorrect. The client's accounting policies and procedures would not affect the nature of reports to be rendered. The nature of reports to be rendered would be based on the type of engagement and the specific results of that engagement.

Question 17

As the acceptable level of detection risk increases, an auditor may change the:

Accepted Answer

Choice "C" is correct. As the acceptable level of detection risk increases, the assurance (effectiveness) that must be provided from substantive tests can decrease. Thus the auditor may change the timing of substantive tests from year-end to an interim date. Choice "A" is incorrect. The assessed level of control risk is used to determine the acceptable level of detection risk, not vice versa. Choice "B" is incorrect. The acceptable level of detection risk affects the nature, timing and extent of substantive audit procedures, not control tests. Choice "D" is incorrect. As the acceptable level of detection risk increases, the level of assurance required from substantive tests decreases, and therefore the substantive procedures need not be as effective.

Question 18

Which of the following is an analytical procedure that an auditor most likely would perform when planning an audit?

Accepted Answer

Choice "D" is correct. During planning, analytical procedures consist of a review of data aggregated at a high level, with an objective of enhancing the auditor's understanding of the client. Comparing the current-year account balances for conformity with predictable patterns would fulfill this purpose. Choice "A" is incorrect. Confirmation of bank balances is a substantive audit procedure (not an analytical procedure) that would be performed during the fieldwork stage of the audit. Choice "B" is incorrect. Scanning accounts receivable for amounts over credit limits is a detailed procedure related to one specific account, and it would be performed during the fieldwork stage of the audit. Choice "C" is incorrect. Recalculating inventory extensions of physical inventory counts is a detailed procedure related to one specific account, and it would be performed during the fieldwork stage of the audit.

Question 19

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

Accepted Answer

Choice "B" is correct. During an economic downturn, it is more likely that customers will default on payments owed. The auditor should therefore focus increased attention on the allowance for doubtful accounts, to ensure that it has been adjusted to appropriately reflect this increased risk. Choice "A" is incorrect. A recession is not likely to affect purchase returns and allowances, though it might result in a decline in purchases. Choice "C" is incorrect. A recession is not likely to directly affect the common stock account. Choice "D" is incorrect. A recession is not likely to directly affect a pre-existing, noncontrolling interest in a subsidiary.

Question 20

The existence of audit risk is recognized by the statement in the auditor's standard report that the auditor:

Accepted Answer

Choice "A" is correct. The existence of audit risk is recognized by the statement in the auditor's standard report that the auditor obtains "reasonable assurance" (as opposed to absolute assurance) about whether the financial statements are free of material misstatement. The existence of audit risk (the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on materially misstated financial statements) is implied in this statement. Choice "B" is incorrect. Assessing the accounting principles used and evaluating the overall financial statement presentation relate to determining that the statements have been prepared in conformity with GAAP, not to recognizing the existence of audit risk. Choice "C" is incorrect. Realizing that some matters are more important than others illustrates the concept of materiality; however, this is not a statement included in the auditor's standard report. Choice "D" is incorrect. Indicating that the financial statements are the responsibility of management while the auditor's responsibility is to express an opinion on those financial statements delineates responsibility rather than illustrating the concept of audit risk.

Exam 1: CPA Auditing and Attestation Exam