Question 1

An auditor of a manufacturer would most likely question whether that client has committed illegal acts if the client has:

Accepted Answer

Choice "A" is correct. Being forced to discontinue operations in a foreign country would cause the auditor of the manufacturer to question whether that client has committed an illegal act. Choice "B" is incorrect. Making political contributions to local politicians is not illegal. (Bribes are illegal.) Choice "C" is incorrect. Failure to correct material weaknesses in internal accounting control may represent a conscious decision by management to accept that degree of risk because of cost or other considerations. Choice "D" is incorrect. Disclosure of subsequent events is not indicative of an illegal act.

Question 2

An auditor should obtain knowledge of a client's information and communication system in order to understand each of the following, except:

Accepted Answer

Choice "D" is correct. Control activities (not the information and communication system) are the policies and procedures that help ensure that management directives are carried out. Choices "A", "B", and "C" are incorrect. The auditor obtains an understanding of an entity's information and communication system to understand how transactions are initiated, processed, and reported, the financial reporting process, and the means used by an entity to communicate financial reporting roles and responsibilities.

Question 3

Which of the following is not a control environment factor?

Accepted Answer

Choice "D" is correct. Policies and procedures involving segregation of duties are control activities, not control environment factors. Choice "A" is incorrect. Participation of those charged with governance is a control environment factor. Choice "B" is incorrect. Hiring and advancement policies are part of human resource policies and practices, which are control environment factors. Choice "C" is incorrect. Management's approach toward business risks is part of its philosophy and operating style, which is a control environment factor.

Question 4

Which of the following is not true with respect to the control activities of an entity?

Accepted Answer

Choice "B" is correct. Control activities are the policies and procedures that help ensure that management directives are carried out. These policies and procedures may relate to any of the three objectives (financial reporting, operations, and compliance), not strictly to the financial reporting objective. Choice "A" is incorrect. Control activities are defined as the policies and procedures that help ensure that management directives are carried out. Choice "C" is incorrect. As an auditor obtains an understanding about the other components of internal control, he or she is also likely to obtain some knowledge about control activities. Choice "D" is incorrect. Ordinarily, audit planning does not require an understanding of control activities related to each account balance, transaction class, and disclosure component.

Question 5

Which of the following items does not pertain to the control environment?

Accepted Answer

Choice "C" is correct. The accounting records pertain to the information and communication system, not to the control environment. Choices "A", "B", and "D" are incorrect, as management's philosophy and operating style, participation of those charged with governance, and personnel policies and practices are all part of the control environment.

Question 6

The most likely explanation why the auditor's examination cannot reasonably be expected to bring all illegal acts by the client to the auditor's attention is that:

Accepted Answer

Choice "B" is correct. The audit should be designed to identify material misstatements due to illegal acts, but illegal acts that relate to operating aspects rather than accounting aspects may not directly affect the financial statements, and therefore they may be less likely to be discovered by the auditor. Choice "A" is incorrect. The audit should be designed to identify material misstatements due to illegal acts, even if they are caused by management override of (its own) internal control. Choice "C" is incorrect. The audit should be designed to identify material misstatements due to illegal acts, even when minimal substantive testing is performed by the auditor due to a very strong system of internal control. Choice "D" is incorrect. The audit should be designed to identify material misstatements due to illegal acts, even when those illegal acts were perpetrated by the only person with access to both assets and the accounting records.

Question 7

The understanding with a client of an auditor's contractual obligation ordinarily is set forth in the:

Accepted Answer

Choice "C" is correct. An engagement letter, which is a presumptively mandatory requirement, sets forth the scope and nature of an auditor's contractual obligation to a client. Choice "A" is incorrect. A management letter (also known as a letter of recommendations, or a constructive services letter) is usually delivered by the auditor at the end of the audit. It identifies areas of weakness and provides recommended solutions. Choices "B" and "D" are incorrect. The scope and introductory paragraphs of the auditor's report do provide some information regarding the work performed by the auditor, but they do not express the auditor's understanding with the client as completely as does an engagement letter.

Question 8

In testing controls over cash disbursements, an auditor most likely would determine that the person who signs checks also:

Accepted Answer

Choice "D" is correct. Once signed, the check should be mailed to the payee by the check signer or an employee operating under the supervision of the check signer to prevent defalcations of checks. Generally, this occurs in the treasurer's department. Choice "A" is incorrect. The check signer would not normally review bank reconciliations. Choice "B" is incorrect. Accounts payable personnel should not have custody of signed checks since this would constitute a lack of segregation of duties between recording and custody. Choice "C" is incorrect. The check signer should have access to supporting documentation so that it can be reviewed before the check is signed.

Question 9

Which of the following characteristics most likely would be indicative of check kiting?

Accepted Answer

Choice "C" is correct. Kiting occurs when a check drawn on one bank is deposited in another bank and no record is made of the disbursement in the balance of the first bank. Frequent kiting may result in a high level of deposits coupled with a low average balance. Choice "A" is incorrect. High turnover of employees who have access to cash may be normal in certain industries, or it may be indicative of poor hiring policies, but it would not be indicative of check kiting. Choice "B" is incorrect. More checks may arrive on Mondays simply because Monday's mail includes the mail from over the weekend. This characteristic is not particularly indicative of check kiting. Choice "D" is incorrect. Frequent ATM checking account withdrawals indicate a frequent need for cash, but this situation is not particularly indicative of check kiting.

Question 10

The auditor should obtain sufficient knowledge of the client's information and communication system relevant to financial reporting to understand all of the following, except

Accepted Answer

Choice "D" is correct. Ordinarily, audit planning does not require an understanding of the control activities related to each account balance, transaction class, and disclosure component in the FS or to every assertion relevant to them. Choice "A" is incorrect. The auditor is required to understand significant classes of transactions and how they are processed. Choice "B" is incorrect. The auditor is required to understand the financial reporting process. Choice "C" is incorrect. The auditor is required to understand the methods used by the entity to communicate matters relevant to financial reporting.

Question 11

Which of the following procedures would an auditor most likely perform in searching for unrecorded liabilities?

Accepted Answer

Choice "C" is correct. The auditor is able to detect liabilities not recorded at year-end by comparing cash payments made after the balance sheet date to the related receiving reports and vendor invoices; any payments made on transactions dated before year-end reflect a liability that should have been recorded. Choice "A" is incorrect. Vouching a sample of recorded accounts payable entries to unmatched receiving reports does not test the completeness of the listing. Unrecorded liabilities would not be included in recorded accounts payable entries. Choice "B" is incorrect. Purchase orders issued after year-end should not be included in the year-end balance of accounts payable. This would be an example of an overstated liability, rather than an unrecorded one. Choice "D" is incorrect. Examination of cash disbursements entries made just prior to the balance sheet date relates to liabilities that have been paid, which would not be considered to be outstanding liabilities at year-end.

Question 12

Payroll Data Co. (PDC) processes payroll transactions for a retailer. Cook, CPA, is engaged to express an opinion on a description of PDC's internal controls placed in operation as of a specific date. These controls are relevant to the retailer's internal control, so Cook's report may be useful in providing the retailer's independent auditor with information necessary to plan a financial statement audit. Cook's report should:

Accepted Answer

Choice "A" is correct. There are two types of reports on the processing of transactions by service organizations: "reports on controls placed in operation" and "reports on controls placed in operation and tests of operating effectiveness." The former does not include tests of operating effectiveness and, therefore, are not intended to provide the user auditor with a basis for reducing the assessment of control risk. Accordingly, such reports should include a disclaimer of opinion regarding the operating effectiveness of the controls. Choice "B" is incorrect. The report should contain an indication that the controls were suitably designed to achieve specified control objectives, but it does not provide any assurance regarding the achievement of the user organization's (in this case, the retailer's) objectives. Choice "C" is incorrect. The service auditor (Cook) is not required to identify the service organization's (i.e., PDC's) controls relevant to specific financial statement assertions because this is not a financial statement audit. Choice "D" is incorrect. The service auditor (Cook) is not required to disclose the assessed level of control risk for the service organization (PDC).

Question 13

If specific information comes to an auditor's attention that implies the existence of possible illegal acts that could have a material, but indirect effect on the financial statements, the auditor should next:

Accepted Answer

Choice "A" is correct. If specific information comes to an auditor's attention that implies the existence of possible illegal acts that could have a material, but indirect effect on the financial statements, the auditor should next apply audit procedures specifically directed to ascertaining whether an illegal act has occurred. The auditor should obtain an understanding of the situation, inquire of management (at a level above those involved), consult legal counsel, and consider applying additional audit procedures if necessary. Choice "B" is incorrect. The auditor would consult with the client's legal counsel after obtaining an understanding of the situation and inquiring of management. Choice "C" is incorrect. The auditor would inquire of management at a level above those involved after obtaining an understanding of the situation. Choice "D" is incorrect. The auditor would only communicate with those charged with governance regarding detected illegal acts, not possible illegal acts.

Question 14

Ordinarily, the predecessor auditor permits the successor auditor to review the predecessor's audit documentation relating to:

Accepted Answer

Choice "A" is correct. Ordinarily, the predecessor auditor permits the successor auditor to review the predecessor's audit documentation relating to matters of continuing accounting and auditing significance, including both contingencies and balance sheet accounts. Contingencies have continuing significance as they may continue to affect the current year financial statements (either by remaining as contingencies or by being resolved); balance sheet accounts from the prior year-end have continuing significance since they are the opening balances for the current year. Choices "B", "C", and "D" are incorrect, per above explanation.

Question 15

Which of the following circumstances most likely would cause an auditor to consider whether material misstatements exist in an entity's financial statements?

Accepted Answer

Choice "A" is correct. Supporting records that should be readily available but are frequently not produced when requested would cause an auditor to consider whether material misstatements exist. Choice "B" is incorrect. Failure to correct significant deficiencies in internal control may represent a conscious decision by management to accept that degree of risk because of cost or other considerations. Although this is a fraud risk factor, the auditor is more likely to be concerned about missing audit evidence. Choice "C" is incorrect. Clerical errors listed on a monthly computer-generated exception report would be a control over data processing that would tend to minimize the risk of material misstatement. Choice "D" is incorrect. Differences being discovered during the client's annual physical inventory count is a common occurrence at most companies and would not necessarily indicate that a material misstatement exists.

Question 16

A successor auditor should request the new client to authorize the predecessor auditor to allow a review of the predecessor's:

Accepted Answer

Choice "C" is correct. It is not appropriate for the successor auditor to request a review of the predecessor auditor's engagement letter. This is a business matter between the client and the predecessor auditor that has no impact on the successor's audit. Conversely, review of the predecessor auditor's audit documentation is appropriate and customary to facilitate the successor's audit. Choices "A", "B", and "D" are incorrect, based on the above explanation.

Question 17

When an auditor becomes aware of a possible illegal act by a client, the auditor should obtain an understanding of the nature of the act to:

Accepted Answer

Choice "A" is correct. When an auditor becomes aware of a possible client illegal act, the auditor should next obtain an understanding of the nature of the act in order to evaluate the effect on the financial statements. Choices "B", "C", and "D" are incorrect. After evaluating the effect of the illegal act on the financial statements, the auditor may also determine the reliability of management's representations, consider whether other similar acts may have occurred, or recommend remedial actions to those charged with governance.

Question 18

Which of the following circumstances would most likely cause an auditor to suspect that material misstatements arising from fraud exist in a client's financial statements?

Accepted Answer

Choice "B" is correct. Material fraud ("intentional" misstatements or omissions) may result from large amounts of fictitious accounts receivable. Receiving significantly fewer confirmation responses than expected implies some accounts receivable may be fictitious. Choice "A" is incorrect. Selling property and equipment at a loss from book value is not unusual and would not necessarily be indicative of fraud. Choice "C" is incorrect. Bank reconciliations typically include in-transit items (e.g., deposits in transit and outstanding checks), and this would not necessarily be indicative of fraud. Choice "D" is incorrect. Clerical errors listed on an exception report would be a control over data processing that would tend to minimize the risk of material misstatement.

Question 19

Computer Services Company (CSC) processes payroll transactions for schools. Drake, CPA, is engaged to report on CSC's internal controls placed in operation as of a specific date. These internal controls are relevant to the schools' internal control, so Drake's report will be useful in providing the schools' independent auditors with information necessary to plan their audits. Drake's report expressing an opinion on CSC's internal controls placed in operation as of a specific date should contain a(an):

Accepted Answer

Choice "A" is correct. A report on internal controls for a service organization should include a description of the scope and nature of Drake's procedures. Choice "B" is incorrect. No statement is made in the report that all design deficiencies have been disclosed. Choice "C" is incorrect. The service auditor's opinion is not intended to provide evidence of operating effectiveness. Choice "D" is incorrect. No paragraph indicating the basis for the assessment of control risk is included in Drake's report.

Question 20

Before applying substantive tests to the details of asset accounts at an interim date, an auditor should assess:

Accepted Answer

Choice "C" is correct. Before performing substantive tests at an interim date, the auditor must assess the difficulty in controlling the incremental audit risk from the interim date (on which the substantive procedures are performed) to the year-end date (on which an opinion is rendered). Choice "A" is incorrect. The auditor would not have to assess control risk at a low level in order to perform substantive tests at interim. It may simply be more efficient to perform a substantive audit. As long as the balances tested at interim are reasonably predictable with respect to amount, relative significance and composition, the account may be tested at interim. Choice "B" is incorrect. Generally, inherent risk should be low in order to test substantively at interim. Choice "D" is incorrect. If the materiality level for those accounts to be tested is insignificant, then the auditor probably would not perform any substantive testing, since it is unlikely that a material error exists in an insignificant balance.

Exam 1: CPA Auditing and Attestation Exam