Question 1

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

Accepted Answer

Choice "D" is correct. If the auditor becomes aware of management's interest in maintaining the entity's earnings trend by using aggressive accounting practices, this would be indicative of an attitude conducive to fraud. Choice "A" is incorrect. Management purchase of company stock does not necessarily indicate an increased risk of fraud. Choice "B" is incorrect. Sale by board members of company stock does not necessarily indicate an increased risk of fraud. Choice "C" is incorrect. Prediction of conservative operating results is not a fraud risk factor; commitment to aggressive or unrealistic predictions would more likely be indicative of fraud risk.

Question 2

Which of the following procedures would a CPA most likely perform in the planning stage of a financial statement audit?

Accepted Answer

Choice "D" is correct. The planning process should include application of analytical procedures, such as comparison of the financial statements with budgeted or anticipated results. Choice "A" is incorrect. Management representations are typically obtained at the end of the audit, not during the planning stage. Choice "B" is incorrect. Assuming all of those charged with governance are not also involved with managing the entity, the auditor is required to communicate with those charged with governance concerning adjustments arising from the current year's audit, not adjustments from the previous year. Choice "C" is incorrect. Inquiries are typically made of the client's attorney during the fieldwork stage of the audit, not during the planning stage.

Question 3

Which of the following statements about internal control is correct?

Accepted Answer

Choice "D" is correct. The concept of reasonable assurance recognizes that the cost of an entity's internal control should not exceed the benefits that are expected to be derived. The cost-benefit relationship is a primary criterion that should be considered in designing internal control. Choice "A" is incorrect. Even a properly maintained system of internal control is unable to reasonably ensure that collusion among employees cannot occur. Choice "B" is incorrect. Establishing and maintaining internal control is the responsibility of management - - not the internal auditor. Choice "C" is incorrect. An exceptionally strong internal control that has been tested and can be relied upon by the auditor will allow the auditor to reduce (but not eliminate) substantive tests on significant account balances.

Question 4

Which of the following statements is correct regarding the auditor's consideration of the possibility of illegal acts by clients?

Accepted Answer

Choice "C" is correct. If specific information concerning a possible illegal act comes to the auditor's attention, the auditor should apply additional audit procedures to determine whether an illegal act has in fact occurred. Choice "A" is incorrect. The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance that the financial statements are free of material misstatement. This is a different level of assurance than stating that "no illegal acts" have been committed by clients, since it is possible for an immaterial illegal act (for example a theft of a few dollars from the petty cash fund) to occur and not be identified by the auditor. Choice "B" is incorrect. The auditor's training, experience, and understanding of the client may not be sufficient to provide a basis for the determination as to whether illegal acts (especially indirect effect illegal acts) have occurred. Choice "D" is incorrect. If an illegal act has occurred, but the act has been properly accounted for and/or disclosed, there would be no need to express a qualified opinion or an adverse opinion.

Question 5

The overall attitude and awareness of those charged with governance (i.e., an entity's board of directors) concerning the importance of internal control usually is reflected in its:

Accepted Answer

Choice "C" is correct. The control environment reflects the overall attitude, awareness and actions of those charged with governance (i.e., the board of directors, management, owners, and others) concerning the importance of control and its emphasis in the entity. Choice "A" is incorrect. Computer-based controls are a control activity. The overall attitude and awareness of those charged with governance is not a control activity. Choice "B" is incorrect. A system of segregation of duties is a control activity. The overall attitude and awareness of those charged with governance is not a control activity. Choice "D" is incorrect. Safeguards over access to assets is a control activity. The overall attitude and awareness of those charged with governance is not a control activity.

Question 6

In planning the audit, the auditor obtains a sufficient understanding of the existing internal control. Which one of the following is not among the auditor's primary objectives for obtaining such knowledge?

Accepted Answer

Choice "C" is correct. Making constructive suggestions to the client is not a primary objective for obtaining an understanding of internal control, although it may be a desirable by-product of an audit engagement. Choices "A", "B", and "D" are incorrect, as the following are primary internal control planning objectives of an auditor in a financial statement audit: A. Identify types of potential material misstatements. B. Consider factors that affect the risk of material misstatements. D. Design effective substantive tests.

Question 7

Which of the following procedures most likely would provide an auditor with evidence about whether an entity's internal control activities are suitably designed to prevent or detect material misstatements?

Accepted Answer

Choice "D" is correct. Observation and inspection may be used to evaluate the design of controls. Observation of entity personnel applying control activities is a procedure that would likely provide evidence about the design of the activities. Choice "A" is incorrect. Reperforming control activities provides the auditor with evidence about the operating effectiveness of specific control activities, not the design effectiveness. Choice "B" is incorrect. Analytical procedures would not provide the auditor with evidence about the design of specific control activities. Choice "C" is incorrect. Vouching a sample of transactions directly related to control activities would not provide the auditor with evidence about the design of specific control activities.

Question 8

Which of the following procedures would an auditor most likely perform during an audit engagement's overall review stage in formulating an opinion on an entity's financial statements?

Accepted Answer

Choice "D" is correct. During every stage of the audit, the auditor should consider the assessment of the risk of material misstatement. During the overall review stage, the auditor should consider whether the results of any of the audit procedures affect the assessment of the risk of material misstatement due to fraud. Choice "A" is incorrect. The entity's attorney does not provide assurance regarding financial statement disclosure. Choice "B" is incorrect. Verifying clerical accuracy of client schedules would be performed during the audit, not during the overall review stage. Choice "C" is incorrect. Evaluating whether control weaknesses have been corrected is not typically performed during the overall review stage.

Question 9

Management's emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when:

Accepted Answer

Choice "B" is correct. Management's emphasis on meeting projected profit goals would significantly influence an entity's control environment when a significant portion of management compensation is represented by stock options, because management would then have a personal interest that might be at odds with accurate financial reporting. Choice "A" is incorrect. An effective internal audit function would tend to moderate management's emphasis on meeting projected profit goals, and would therefore tend to dampen the effect on the control environment. Choice "C" is incorrect. External policies established by outside parties would tend to moderate management's emphasis on meeting projected profit goals, and would therefore tend to dampen the effect on the control environment. Choice "D" is incorrect. Active participation of those charged with governance would tend to moderate management's emphasis on meeting projected profit goals, and would therefore tend to dampen the effect on the control environment.

Question 10

An auditor's risk assessment is based on the assumption that controls are operating effectively. Which of the following was not a step in making this assessment?

Accepted Answer

Choice "C" is correct. Tests of details of transactions are used to detect material misstatements in the financial statements after the auditor has assessed risk, not as part of making this assessment. Choice "A" is incorrect. Tests of controls are required to support the auditor's assumption that controls are operating effectively. Choice "B" is incorrect. Obtaining an understanding of each of the five components of internal control is required before making an assessment of control risk. The entity's accounting system (part of the information and communication component) and control environment are part of the five components. Choice "D" is incorrect. Considering whether control activities can have a pervasive effect on financial statement assertions is part of the auditor's risk assessment process.

Question 11

In an audit of financial statements in accordance with generally accepted auditing standards, an auditor is required to:

Accepted Answer

Choice "A" is correct. The auditor is required to document key elements of the understanding of the entity and its environment, including each of the components of internal control. Choice "B" is incorrect. Auditors are not required to search for significant deficiencies in the operation of internal control. They are merely required to report such conditions discovered during the audit to those charged with governance. Choice "C" is incorrect. Auditors are not required to perform tests of controls unless they plan to place reliance on a particular control. Since auditors are not required to rely on the client's controls, tests of controls are generally not required. Choice "D" is incorrect. The auditor generally is not required to determine whether the client's controls operated effectively to prevent or detect material errors. Such determination would only be required for controls on which the auditor plans to rely.

Question 12

An auditor has identified a risk of material misstatement due to fraud related to the inventory function. Which is least likely to be an appropriate response?

Accepted Answer

Choice "B" is correct. An auditor should respond to fraud risk by designing appropriate audit procedures. Requesting that management more closely monitor the inventory function does not improve the auditor's likelihood of detecting fraud. Choice "A" is incorrect. Observing inventory counts on an unannounced basis improves the likelihood that the auditor will detect fraud, since perpetrators may be caught unaware and may be less able to hide their fraudulent activities. Choice "C" is incorrect. Assigning more experienced personnel to the engagement is an appropriate response to identified risk, since more experienced personnel may be less likely to overlook a condition indicative of fraud. Choice "D" is incorrect. Requesting that inventory be counted on a date close to the end of the reporting period is an appropriate response to identified risk, since it minimizes the risk of manipulation of balances prior to the end of the reporting period.

Question 13

Which of the following is a management control method that most likely could improve management's ability to supervise company activities effectively?

Accepted Answer

Choice "C" is correct. The use of budgets and forecasts to identify variances improves managers' ability to supervise company activities. Variances from budgets serve as signals to managers that a potential problem exists. Choice "A" is incorrect. Compliance with internal controls mandated by a regulatory body may be necessary, but would not necessarily enhance the ability of a manager to supervise company activities. Choice "B" is incorrect. Limiting access to assets serves as a deterrent to employee theft, but does not really improve managers' ability to supervise company activities. Choice "D" is incorrect. Supporting employees with adequate resources is important, but it does not necessarily increase the supervisory capability of a manager.

Question 14

Which of the following components (elements) of an entity's internal control includes the development of personnel manuals documenting employee promotion and training policies?

Accepted Answer

Choice "B" is correct. The control environment element of an entity's internal control relates to the tone of the organization, which includes human resource policies and practices. Choice "A" is incorrect. Monitoring activities assess the quality of internal control performance over time. Choice "C" is incorrect. The information and communication system relates to the identification, capture, and exchange of information. Choice "D" is incorrect. A quality control system is not a component of an entity's internal control.

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 "D" is correct. Vouching recorded transactions to supporting documentation provides support for the occurrence assertion. The lack of supporting documentation calls into question the occurrence of the transactions under examination. Choice "A" is incorrect. Little emphasis on meeting earnings projections would be considered a positive factor in preventing material misstatements from occurring. Choice "B" is incorrect. As the representatives of shareholder interests, an active board of directors is considered a positive control. Choice "C" is incorrect. The existence of significant deficiencies in internal control may represent a conscious decision by management to accept that degree of risk because of cost or other considerations. Therefore, although failure to correct such deficiencies is considered a fraud risk factor, the auditor is more likely to be concerned about transactions that are not supported by proper documentation.

Question 16

Which statement is true with respect to discussion among engagement personnel regarding the risk of material misstatement due to fraud?

Accepted Answer

Choice "D" is correct. Audit documentation is required to include a description of the discussion among engagement personnel regarding the risk of material misstatement due to fraud. Choice "A" is incorrect. Discussion among engagement personnel regarding the risk of material misstatement due to fraud is required. Choice "B" is incorrect. The discussion should include all key members of the audit team, but if an audit involves more than one location, there could be multiple discussions with team members in different locations. Choice "C" is incorrect. Communication among audit team members about the risks of material misstatement due to fraud should continue throughout the audit.

Question 17

Management philosophy and operating style most likely would have a significant influence on an entity's control environment when:

Accepted Answer

Choice "B" is correct. Management philosophy and operating style encompass a broad range of characteristics. Such characteristics may include the following: management's approach to taking and monitoring business risks, management's attitudes and actions toward financial reporting, and management's attitudes toward information processing and accounting functions and personnel. These characteristics are more likely to have a significant influence on the control environment when management is dominated by one individual, since there will be few alternative viewpoints presented. Choice "A" is incorrect. The internal audit function is part of the monitoring component of internal control, not part of the control environment. If the internal auditor reports directly to management, this would reduce their objectivity and perhaps make the monitoring function less effective, but it would have minimal impact on the control environment. Choice "C" is incorrect. Accurate management job descriptions would not change the influence that management philosophy and operating style have on the entity's control environment. Choice "D" is incorrect. The involvement of those charged with governance in the reporting process would tend to moderate or offset the influence that management philosophy and operating style have on the entity's control environment.

Question 18

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 19

An auditor concludes that a client has committed an illegal act that has not been properly accounted for or disclosed. The auditor should withdraw from the engagement if the:

Accepted Answer

Choice "D" is correct. The auditor should withdraw from the engagement if the client refuses to accept the auditor's modified report. Choice "A" is incorrect. If the auditor is precluded from obtaining sufficient evidence, the auditor should consider disclaiming an opinion. Choice "B" is incorrect. The auditor must consider the effects of a direct material illegality on the financial statements and on other aspects of the audit, but need not withdraw from the engagement. Choice "C" is incorrect. If the auditor cannot estimate the effect of the illegal act on the financial statements, the auditor should consider disclaiming an opinion.

Question 20

During the annual audit of Ajax Corp., a publicly held company, Jones, CPA, a continuing auditor, determined that illegal political contributions had been made during each of the past seven years, including the year under audit. Jones notified the board of directors about the illegal contributions, but they refused to take any action because the amounts involved were immaterial to the financial statements. Jones should reconsider the intended degree of reliance to be placed on the:

Accepted Answer

Choice "C" is correct. The auditor should consider the implications of an illegal act in relation to other aspects of the audit, particularly the reliability of representations of management. Choice "A" is incorrect. The integrity of the client's attorney would not necessarily be affected by illegal acts performed by the client. Choice "B" is incorrect. The prior year audit plan would not be affected by the discovery of illegal acts in past years. Choice "D" is incorrect. The auditor should consider the quantitative and qualitative materiality of the illegal act. However, this does not change the preliminary judgment about materiality levels.

Exam 1: CPA Auditing and Attestation Exam