Question 1

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

Accepted Answer

Choice "A" is correct. An auditor's concern about the risk of fraudulent financial reporting would be heightened if the entity were unable to generate cash flows from operations, but still reported substantial earnings growth, since these two occurrences are somewhat inconsistent. Choice "B" is incorrect. Management's excessive interest in increasing the stock price and earnings trend is a fraud risk factor; lack of such interest would not cause concern. Choice "C" is incorrect. Large amounts of liquid assets that are easily convertible into cash would heighten an auditor's concern about misappropriation of assets, not about fraudulent financial reporting. Choice "D" is incorrect. The need to grant debt covenants when borrowing capital is an ordinary occurrence that would not heighten the auditor's concern.

Question 2

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

Accepted Answer

Choice "D" is correct. The auditor identifies factors indicative of potential fraud ("fraud risk factors") as part of assessing the risk of material misstatement. An overly complex organization structure involving unusual lines of authority provides an opportunity for fraudulent financial reporting that would heighten the auditor's concern. Choice "A" is incorrect. Large amounts of liquid assets that are easily convertible into cash would heighten an auditor's concern about misappropriation of assets, not about fraudulent financial reporting. Choice "B" is incorrect. Low growth and profitability might heighten an auditor's concern if it became severe or if management faced excessive pressure to meet financial expectations, but would not necessarily in and of itself heighten an auditor's concern. Choice "C" is incorrect. Nonfinancial management's participation in the selection of accounting principles might heighten the auditor's concern; financial management is expected to participate in such activities.

Question 3

Which of the following statements is correct concerning an auditor's responsibility to report fraud?

Accepted Answer

Choice "D" is correct. The disclosure of fraudulent activities to parties other than the client's senior management and those charged with governance is not ordinarily part of the auditor's responsibility. Choice "A" is incorrect. Only fraud that causes a material misstatement of the financial statements or fraud involving senior management should be reported to those charged with governance. Choice "B" is incorrect. The disclosure of fraudulent activities to parties other than the client's senior management and those charged with governance is not ordinarily part of the auditor's responsibility. Although there are certain exceptions to this rule, disclosure to stockholders is not one of them. Choice "C" is incorrect. Fraudulent activities involving senior management of which the auditor becomes aware should be reported directly to those charged with governance, not to the SEC. (Only in certain limited circumstances would fraud be disclosed to the SEC via required regulatory reports.)

Question 4

Which of the following characteristics most likely would heighten an auditor's concern about the risk of material misstatement arising from fraudulent financial reporting?

Accepted Answer

Choice "C" is correct. Frequent disputes between management and the auditor is a fraud risk factor that would heighten an auditor's concern about the risk of material misstatement arising from fraudulent financial reporting. Choice "A" is incorrect. Management's excessive interest in maintaining or increasing the stock price and earnings trend is a fraud risk factor, but management's lack of interest in maintaining an earnings trend would not constitute a fraud risk factor. Choice "B" is incorrect. Since depreciation does not adjust an asset to market value, the sale of computer hardware at a loss before being fully depreciated is not unusual and would not heighten an auditor's concern. Choice "D" is incorrect. Bank reconciliations with outstanding checks are not unusual and would not heighten the auditor's concern about the risk of material misstatement. Outstanding checks can also be verified with the bank at a later date, when the checks clear.

Question 5

Which of the following characteristics most likely would heighten an auditor's concern about the risk of intentional manipulation of financial statements?

Accepted Answer

Choice "C" is correct. Excessive pressure on management to meet financial targets is a fraud risk factor that would heighten an auditor's concern about the risk of intentional manipulation of financial statements. Choice "A" is incorrect. Low turnover would reduce the auditor's concern about intentional manipulation of the financial statements. Choice "B" is incorrect. Insider purchases of company stock would not be a factor that would cause any particular concerns about intentional manipulation of financial statements. Choice "D" is incorrect. A slow rate of change in the entity's industry would reduce the auditor's concern about the risk of intentional manipulation of the financial statements.

Question 6

Which of the following is not an inquiry the auditor should make to identify the risks of material misstatement due to fraud?

Accepted Answer

Choice "B" is correct. The auditor should inquire whether management (not operating personnel) has communicated to those charged with governance (not management) regarding internal control and how it functions to prevent, deter, or detect material misstatement due to fraud. Choice "A" is incorrect. The auditor should inquire how management communicates to employees its views on acceptable business practices. Choice "C" is incorrect. The auditor should inquire whether there are any particular business segments for which a risk of fraud may be more likely to exist. Choice "D" is incorrect. The auditor should inquire whether management is aware of any allegations of fraud.

Question 7

The primary objective of procedures performed to obtain an understanding of the entity and its environment is to provide an auditor with:

Accepted Answer

Choice "A" is correct. The auditor should obtain an understanding of the entity and its environment sufficient to assess the risk of material misstatement and to design and perform further audit procedures. Choice "B" is incorrect. Assessing inherent risk is not the primary objective of obtaining an understanding of the entity and its environment. Choice "C" is incorrect. Obtaining an understanding of the entity and its environment is not a sufficient basis for issuing an audit opinion. Choice "D" is incorrect. Procedures performed to gain an understanding of the entity and its environment would not ordinarily test the consistency of the application of management's policies. If the auditor intends to rely on a control, its consistency in application would then be tested.

Question 8

Which statement is true regarding the three fraud risk factors (incentives/pressures, opportunity, and rationalization/attitude)?

Accepted Answer

Choice "B" is correct. During planning, the audit team is required to discuss the potential for material misstatement due to fraud, and the fraud risk factors should be included in that discussion. Choice "A" is incorrect. The auditor should determine whether and to what extent fraud risk factors are present during the planning stage of the audit, not during the final overall review stage. Choice "C" is incorrect. The existence of all three fraud risk factors does not necessarily imply that fraud has occurred, although it is indicative of a greater risk of fraud. Choice "D" is incorrect. Lack of observation of all three fraud risk factors does not necessarily imply that fraud has not occurred, as one factor may be significant enough on its own to result in fraud.

Question 9

Which of the following procedures would least likely result in the discovery of possible illegal acts?

Accepted Answer

Choice "D" is correct. Reviewing an internal control questionnaire provides information about control policies and procedures, but does not provide information about actual transactions or events that have occurred. Therefore, it is not likely to uncover any illegal acts. Choices "A" and "B" are incorrect. The auditor generally does not include procedures specifically to detect illegal acts, but may discover such acts through other procedures, such as reading the board minutes or making inquiries of management or of legal counsel. Choice "C" is incorrect. Performing tests of details of transactions may provide information indicative of illegal acts, such as information regarding unauthorized or improperly recorded transactions; payments of unusual fines or penalties; payments that are unusually large or excessive, especially those made in cash; unexplained payments; or payments for unspecified services.

Question 10

Jones, CPA, is auditing the financial statements of XYZ Retailing, Inc. What assurance does Jones provide that direct effect illegal acts that are material to XYZ's financial statements, and illegal acts that have a material, but indirect effect on the financial statements will be detected?

Accepted Answer

Choice "A" is correct. The auditor should design the audit to provide reasonable assurance that direct effect illegal acts are detected. Because of the nature of illegalities having an indirect effect on the financial statements, the auditor provides no assurance that such acts will be detected. Choices "B", "C", and "D" are incorrect, based on the above explanation.

Question 11

Which of the following statements reflects an auditor's responsibility for detecting errors and fraud?

Accepted Answer

Choice "D" is correct. The auditor should assess the risk that errors and fraud may cause the financial statements to contain a material misstatement. Based on that assessment, the auditor should design the audit to provide reasonable assurance of detecting material errors and fraud. Choice "A" is incorrect. An auditor is responsible for designing the audit to provide reasonable assurance of detecting material misstatement. This responsibility is the same regardless of the cause of the misstatement. The presence of employee collusion or management override does not change the auditor's responsibility, although it might explain why a properly planned and executed audit did not result in the discovery of material fraud. Choice "B" is incorrect. The audit should be designed to detect material errors and fraud, regardless of the cause. Choice "C" is incorrect. The auditor is not "responsible for detecting errors and fraud," but is responsible for designing the audit to provide reasonable assurance of detecting material misstatement, whether due to errors or fraud. Note that the auditor's responsibility relates to the design and execution of the audit, and that even an audit performed in accordance with GAAS may miss a material misstatement.

Question 12

Which of the following journal entries would the auditor least likely examine in an effort to address the risk of management override of controls?

Accepted Answer

Choice "A" is correct. Inappropriate or unauthorized journal entries are often used to override controls and manipulate the financial reporting process. Periodic, recurring accounting estimates are least likely to be subject to management override since they are expected and occur regularly. Choice "B" is incorrect. Inappropriate or unauthorized journal entries are often used to override controls and manipulate the financial reporting process. A journal entry made by a person who generally does not have that responsibility might be indicative of such management override. Choice "C" is incorrect. Inappropriate or unauthorized journal entries are often used to override controls and manipulate the financial reporting process. A journal entry recorded after closing without an appropriate explanation or description might be indicative of such management override. Choice "D" is incorrect. Inappropriate or unauthorized journal entries are often used to override controls and manipulate the financial reporting process. A journal entry made to a seldom-used account might be indicative of such management override.

Question 13

An auditor is required to establish an understanding with a client regarding the services to be performed for each engagement. This understanding generally includes:

Accepted Answer

Choice "C" is correct. An understanding between the auditor and the client generally includes the auditor's responsibilities. One of the auditor's responsibilities is to ensure that those charged with governance (e.g., the audit committee) are aware of any significant deficiencies in internal control that come to the auditor's attention. Choice "A" is incorrect. An understanding between the auditor and the client generally would not include the auditor's responsibility for determining preliminary judgments about materiality and audit risk factors, as an understanding generally is not obtained with respect to audit procedures or specific audit assessments. Choice "B" is incorrect. Management is not responsible for identifying mitigating factors when the auditor has doubt about the entity's ability to continue as a going concern. The auditor, however, would look for and evaluate mitigating factors to determine if such factors alleviate doubt about the entity's ability to continue as a going concern. Choice "D" is incorrect. Management is not responsible for providing the auditor with an assessment of the risk of material misstatement due to fraud. The auditor, however, is responsible for making such an assessment.

Question 14

Which of the following is least likely to aid the auditor in evaluating the risk of improper revenue recognition due to fraud?

Accepted Answer

Choice "A" is correct. Items other than revenue may affect sales commissions (e.g., changes to the commission structure), and therefore analyzing sales commissions is least likely to aid the auditor in evaluating the risk of improper revenue recognition due to fraud. Choice "B" is incorrect. An excess of sales volume over production capacity may be indicative of the recording of fictitious sales. Choice "C" is incorrect. Analysis of sales and returns by month might indicate situations where unauthorized shipments are sent in an effort to overstate revenue. (Larger than average sales in one month would be followed by larger than average returns in the next month.) Choice "D" is incorrect. Analytical procedures using disaggregated revenue data may indicate unusual relationships that are indicative of fraud.

Question 15

The audit plan usually cannot be finalized until the:

Accepted Answer

Choice "A" is correct. The auditor should obtain a sufficient understanding of the entity and its environment, including its internal control, to plan the audit of the entity's financial statements. Choice "B" is incorrect. The representation letter is not obtained until the end of the audit. Choice "C" is incorrect. Informing those charged with governance of significant deficiencies in internal control generally occurs during or at the completion of the audit. It is not required before completion of the audit plan. Choice "D" is incorrect. The search for unrecorded liabilities typically takes places after year-end, while the audit plan is prepared during planning. Information obtained from the search is not needed to finalize the audit plan

Question 16

An auditor who discovers that client employees have committed an illegal act that has a material effect on the client's financial statements most likely would withdraw from the engagement if:

Accepted Answer

Choice "B" is correct. The auditor may conclude that withdrawal is necessary if the client does not take the remedial action that the auditor considers necessary in the circumstances, even when the illegal act is not material to the financial statements. Choice "A" is incorrect. Whether or not the illegal act is a violation of GAAP does not determine the need to withdraw from the engagement. Choice "C" is incorrect. An illegal act committed in the prior year would not necessarily cause an auditor to withdraw from a current engagement. Choice "D" is incorrect. Assessment of control risk at a high level would cause an auditor to modify the nature, timing, or extent of audit procedures, but would not cause withdrawal from an engagement.

Question 17

Which of the following characteristics most likely would heighten an auditor's concern about the risk of material misstatements in an entity's financial statements?

Accepted Answer

Choice "A" is correct. In assessing the risk related to material misstatements in an entity's financial statements, the auditor would consider situations that threaten financial stability or profitability, since such situations might provide an incentive to fraudulently misstate the financial statements. Included as one of these characteristics is declining customer demand. Choice "B" is incorrect. Even though the bonding of employees who handle cash is recommended, it is not a significant characteristic in assessing the risk related to material misstatement in an entity's financial statements. Choice "C" is incorrect. Bank reconciliations with in-transit deposits are not unusual and would not heighten the auditor's concern about the risk of material misstatement. In-transit deposits can be verified with the bank at a later date. Choice "D" is incorrect. Since depreciation does not adjust an asset to market value, the sale of equipment at a loss before being fully depreciated is not unusual and would not heighten an auditor's concern.

Question 18

If an auditor's risk assessment is based on the effective operation of controls, the auditor will likely:

Accepted Answer

Choice "C" is correct. Assessing risk based on the effective operation of controls involves (1) identifying specific internal controls relevant to specific assertions that are likely to prevent or detect material misstatements in those assertions, and (2) performing tests of such controls to evaluate their effectiveness. Choice "A" is incorrect. Analytical procedures are used for planning purposes, as substantive tests, or as a final overall review. They are not used to support a risk assessment based on the effective operation of controls. Choice "B" is incorrect. Tests of details of transactions and account balances to identify potential errors and fraud are substantive tests. They are not used to support a risk assessment based on the effective operation of controls. Choice "D" is incorrect. The auditor may not assess risk based on the effective operation of controls unless tests of controls are performed. However, if the audit effort required to perform tests of controls exceeds the potential reduction in substantive testing, tests of controls will not be performed because doing so would reduce audit efficiency.

Question 19

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:

Accepted Answer

Choice "B" is correct. When management is dominated by one individual who is also a shareholder, there may be an opportunity for management to override control procedures. Choice "A" is incorrect. Influence of external parties serves an oversight role that strengthens the control environment and minimizes the effect of management's attitude. Choice "C" is incorrect. Existence of internal auditors with direct access to the board of directors strengthens the control environment and lessens the effect of management's attitude. Choice "D" is incorrect. Active participation of those charged with governance serves an oversight role that strengthens the control environment and lessens the effect of management's attitude.

Question 20

Which of the following circumstances most likely would cause an auditor to suspect that there are material misstatements in an entity's financial statements?

Accepted Answer

Choice "B" is correct. Missing or unavailable documents or electronic evidence may be indicative of an intentional material misstatement in the entity's financial statements (fraud). Choice "A" is incorrect. Senior financial management should participate in the selection of accounting principles and the determination of significant estimates. This would not be indicative of material misstatements in the entity's financial statements. Choice "C" is incorrect. The auditor would need to audit related party transactions to ensure that there is proper financial statement disclosure, but the existence of such transactions would not be indicative of material misstatements in the entity's financial statements. Choice "D" is incorrect. The fact that senior management wants to upgrade the entity's information technology capabilities would not be indicative of material misstatements in the entity's financial statements.

Exam 1: CPA Auditing and Attestation Exam

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

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

Which of the following statements is correct concerning an auditor's responsibility to report fraud?

Which of the following characteristics most likely would heighten an auditor's concern about the risk of material misstatement arising from fraudulent financial reporting?

Which of the following characteristics most likely would heighten an auditor's concern about the risk of intentional manipulation of financial statements?

Which of the following is not an inquiry the auditor should make to identify the risks of material misstatement due to fraud?

The primary objective of procedures performed to obtain an understanding of the entity and its environment is to provide an auditor with:

Which statement is true regarding the three fraud risk factors (incentives/pressures, opportunity, and rationalization/attitude) ?

Which of the following procedures would least likely result in the discovery of possible illegal acts?

Jones, CPA, is auditing the financial statements of XYZ Retailing, Inc. What assurance does Jones provide that direct effect illegal acts that are material to XYZ's financial statements, and illegal acts that have a material, but indirect effect on the financial statements will be detected?

Which of the following statements reflects an auditor's responsibility for detecting errors and fraud?

Which of the following journal entries would the auditor least likely examine in an effort to address the risk of management override of controls?

An auditor is required to establish an understanding with a client regarding the services to be performed for each engagement. This understanding generally includes:

Which of the following is least likely to aid the auditor in evaluating the risk of improper revenue recognition due to fraud?

The audit plan usually cannot be finalized until the:

An auditor who discovers that client employees have committed an illegal act that has a material effect on the client's financial statements most likely would withdraw from the engagement if:

Which of the following characteristics most likely would heighten an auditor's concern about the risk of material misstatements in an entity's financial statements?

If an auditor's risk assessment is based on the effective operation of controls, the auditor will likely:

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:

Which of the following circumstances most likely would cause an auditor to suspect that there are material misstatements in an entity's financial statements?