Question 1

Which of the following auditing procedures most likely would assist an auditor in identifying related party transactions?

Accepted Answer

Choice "C" is correct. Unusual nonrecurring transactions near year-end are characteristic of related party transactions. Since related party transactions are not at arm's-length, management may use such transactions to bolster sales or assets. Choice "A" is incorrect. Retesting ineffective controls would not assist the auditor in identifying related party transactions. Choice "B" is incorrect. Confirmation of accounts receivable would not assist the auditor in identifying related party transactions. Choice "D" is incorrect. Finding unrecorded contingent liabilities would not assist the auditor in identifying related party transactions.

Question 2

Which of the following would an auditor least likely consider with respect to fair values?

Accepted Answer

Choice "B" is correct. The auditor would consider subsequent events and transactions occurring before the completion of the audit, not after. The auditor is not responsible for predicting the future, and would not be expected to evaluate the effect of conditions arising subsequent to the audit, that, if known at the time of the audit, might have affected fair value measurements and disclosures. Choice "A" is incorrect. The auditor is responsible for understanding relevant controls. Segregation of duties between those committing the entity to certain transactions and those responsible for undertaking the valuations related to those transactions is a relevant control. Choice "C" is incorrect. The auditor is responsible for understanding the entity's process for determining fair value measurements and disclosures. Considering the role of information technology in determining fair value measurements and disclosures is part of understanding this process. Choice "D" is incorrect. The auditor should evaluate whether the valuation model is appropriate given the entity's circumstances. As part of this evaluation, the auditor should consider whether the valuation method is appropriate in relation to the business, industry, and environment in which the entity operates.

Question 3

Determining that proper amounts of depreciation are expensed provides assurance about management's assertion of:

Accepted Answer

Choice "A" is correct. Determining that proper amounts of depreciation are expensed provides assurance with regard to valuation and allocation related to the asset, and accuracy in terms of financial statement presentation. Choices "B", "C", and "D" are incorrect. Verifying depreciation computations does not provide evidence with respect to completeness, rights and obligations, existence, or occurrence.

Question 4

Which of the following procedures would an auditor ordinarily perform first in evaluating the reasonableness of management's accounting estimates?

Accepted Answer

Choice "C" is correct. In evaluating the reasonableness of an estimate, the auditor must first obtain an understanding of how management developed its estimate. Choices "A", "B", and "D" are incorrect. After obtaining an understanding of how management developed its estimate, the auditor would perform one or a combination of the following procedures: 1. Review subsequent events and transactions (occurring prior to completion of fieldwork) that corroborate the value of the estimate (choice "A"). 2. Develop an independent estimate of the item for comparative purposes (choice "B"). 3. Review and test the procedures used by management to develop the estimate (choice "Dd").

Question 5

In confirming a client's accounts receivable in prior years, an auditor found that there were many differences between the recorded account balances and the confirmation replies. These differences, which were not misstatements, required substantial time to resolve. In defining the sampling unit for the current year's audit, the auditor most likely would choose:

Accepted Answer

Choice "B" is correct. The auditor should consider the nature of the information requested when determining the sampling unit for the current year audit. Certain respondents' accounting systems may facilitate the confirmation of single transactions rather than of entire balances. Choice "A" is incorrect. The auditor would not limit the population to overdue balances, since current balances can also be misstated. Choices "C" and "D" are incorrect. Defining the sampling unit based on account size would not address the problem that caused differences during the prior year.

Question 6

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

Accepted Answer

Choice "A" is correct. Confirmation of accounts receivable confirm the existence of the receivable. A lower than expected response rate could be indicative of fictitious customer accounts. Choice "B" is incorrect. In a computerized accounting environment, audit trails generally exist for only a short time. Choice "C" is incorrect. The management representation letter should be signed and dated on the date of the auditor's report. Choice "D" is incorrect. Consultation with other accountants would not cause an auditor to believe material misstatements have occurred.

Question 7

The auditor's inventory observation test counts are traced to the client's inventory listing to test for which of the following financial statement assertions?

Accepted Answer

Choice "A" is correct. The auditor should test the physical inventory report by tracing test counts taken by the auditor to the report, thereby verifying its completeness. Choice "B" is incorrect. Tracing from test counts to the client's inventory listing does not test rights and obligations. Rights and obligations might be tested by examining paid vendors' invoices, inspecting consignment agreements and contracts, or by confirming inventory held at outside locations. Choice "C" is incorrect. Tracing from test counts to the client's inventory listing does not test allocation and valuation. Allocation and valuation might be tested by examining paid vendors' invoices, evaluating direct labor rates, recalculating overhead rates, or examining an analysis of inventory turnover. Choice "D" is incorrect. Tracing from test counts to the client's inventory listing does not test understandability and classification. Understandability and classification might be tested by confirming inventories pledged under loan agreements, examining drafts of the financial statements for appropriate balance sheet classification, etc.

Question 8

In auditing payroll, an auditor most likely would:

Accepted Answer

Choice "D" is correct. The analytical procedure comparing payroll to standards or budgets is the substantive procedure most likely used for payroll. Choice "A" is incorrect. Unclaimed payroll checks should be returned to an independent individual for follow up. Choice "B" is incorrect. Individual employee deductions may be difficult to trace directly to journal entries, as companies often make a single journal entry for the sum of individual employee deductions. Comparing payroll costs to standards or budgets is a more commonly used substantive audit procedure. Choice "C" is incorrect. Observing payroll distribution is an effective procedure to detect payments to fictitious employees, but with the advent of electronic payroll distribution, it is not as likely to be performed as comparing payroll costs to standards or budgets.

Question 9

In auditing a manufacturing entity, which of the following procedures would an auditor least likely perform to determine whether slow-moving, defective, and obsolete items included in inventory are properly identified?

Accepted Answer

Choice "A" is correct. Testing the computation of standard overhead rates relates to the accumulation of costs during the manufacturing process, and not to whether the inventory is slow-moving, defective, or obsolete after manufacture. Choice "B" is incorrect. During a tour of the manufacturing plant or production facility, the auditor should be alert for items that appear to be old, obsolete, or defective. Choice "C" is incorrect. Comparisons of inventory balances with anticipated sales volume might indicate higher inventory levels than would be expected, perhaps due to slow-moving, defective, or obsolete inventory items. Choice "D" is incorrect. Review of inventory experience and trends may indicate slow-moving, defective, or obsolete inventory items. For example, the auditor may notice a particular item that is building up in inventory, or a trend toward reduced sales of that item.

Question 10

The confirmation of customers' accounts receivable rarely provides reliable evidence about the completeness assertion because:

Accepted Answer

Choice "C" is correct. The completeness assertion states that all transactions that should be recorded are recorded. Accounts receivable confirmations rarely provide evidence about completeness since the recipients of the confirmations have a vested interest in not reporting understatements (i.e., transactions that have not been recorded). Choice "A" is incorrect. While some customers may sign and return a confirmation without proper consideration, this is not the reason why confirmations do not provide evidence about the completeness assertion relative to other assertions. Choice "B" is incorrect. If customers respond whenever they disagree with information printed on the confirmation, they would report both understatements and overstatements, in which case confirmations would provide evidence about completeness. However, this is not what the auditor usually sees -- respondents are less likely to report understatement errors. Choice "D" is incorrect. The balance of the account is not a relevant factor in determining whether the completeness assertion is tested by sending confirmations. If there are many accounts with low balances, the auditor may decide to send negative confirmations.

Question 11

Which of the following internal controls most likely would prevent direct labor hours from being charged to manufacturing overhead?

Accepted Answer

Choice "C" is correct. The use of time tickets to record actual labor worked on production orders is the best way to prevent direct labor from being charged to manufacturing overhead. Choice "A" is incorrect. The work-in-process inventory contains not only labor, but also materials and overhead. Choice "B" is incorrect. Daily journal entries are made to record the use of labor and materials. Reconciliation of the amount of daily labor to approved production orders would not prevent direct labor from being charged to manufacturing overhead. Choice "D" is incorrect. The work-in-process inventory contains not only labor, but also materials and overhead.

Question 12

In establishing the existence and ownership of long-term investments in the form of publicly-traded stock, an auditor most likely would inspect the securities or:

Accepted Answer

Choice "B" is correct. Confirmations should be requested from the custodian for securities that are in the possession of third parties. Choice "A" is incorrect. The investee company may not have timely information regarding the ownership of its stock, nor would an investee typically want to correspond with all of its shareholders in this manner. Choice "C" is incorrect. Analytical procedures might be used to test the reasonableness of dividend income, but this would not provide evidence about the existence and ownership of the investments. Choice "D" is incorrect. Inspecting the cash receipts journal for amounts that could represent the sale of securities might provide evidence regarding sales (and gains or losses on sales), but would not provide evidence about the existence and ownership of the investments.

Question 13

Which of the following procedures represents a weakness in internal controls for payroll?

Accepted Answer

Choice "A" is correct. Unclaimed payroll checks should be returned to an independent party for follow up. Returning such checks (assets) to the payroll department (recordkeeping) represents an inadequate segregation of duties. Choice "B" is incorrect. It is acceptable for the accounting department to set up the transfer of funds into the payroll account, since the accounting department does not have access to the actual funds. Choice "C" is incorrect. The treasurer's supervision is crucial in this choice, serving to separate the recordkeeping function (payroll department) from the custodial function (the treasurer). Choice "D" is incorrect. It is an appropriate segregation of duties for the payroll department to prepare the checks, while the chief financial officer signs them. This separates the recordkeeping function from the custodial function.

Question 14

An analysis of which of the following accounts would best aid in verifying that all fixed assets have been capitalized?

Accepted Answer

Choice "D" is correct. An analysis of the repairs and maintenance account would best aid the auditor in verifying that all fixed assets have been capitalized. This account is generally analyzed to test for completeness of asset additions (i.e., the auditor is looking for items recorded as repairs or maintenance that would more properly have been capitalized as betterment of an asset). Choice "A" is incorrect. An analysis of cash would not identify fixed assets that were not properly capitalized, since cash would be paid for the purchase regardless of whether the item were expensed or capitalized. Choice "B" is incorrect. An analysis of depreciation expense would not identify fixed assets that were not properly capitalized, since no depreciation would be included for items not already classified as assets. Choice "C" is incorrect. An analysis of property tax expense would not identify fixed assets that were not properly capitalized, since no property tax would be included for items not already classified as assets.

Question 15

When auditing related party transactions, an auditor places primary emphasis on:

Accepted Answer

Choice "D" is correct. The auditor should view related party transactions within the framework of existing pronouncements, placing primary emphasis on the adequacy of disclosure. Choice "A" is incorrect. Since related party transactions are (by definition) not considered to be at arm's length, the auditor generally does not ascertain the rights and obligations of the related parties. Choice "B" is incorrect. The auditor generally does not confirm the existence of the related parties. Choice "C" is incorrect. Since related party transactions are (by definition) not considered to be at arm's length, the auditor generally does not verify the valuation of the related party transactions.

Question 16

An auditor's principal objective in analyzing repairs and maintenance expense accounts is to:

Accepted Answer

Choice "C" is correct. The auditor reviews repair and maintenance expense accounts to test for completeness of asset additions (i.e., the auditor is looking for items recorded as repairs or maintenance that would more properly have been capitalized as betterment of an asset). Choice "A" is incorrect. Analyzing the repairs and maintenance account does not provide evidence about obsolete assets. The auditor might review asset records for old assets, or observe assets that are not being used, in an effort to determine whether obsolete plant and equipment assets were written off before year-end. Choice "B" is incorrect. Analyzing the repairs and maintenance account does not provide evidence about the existence of assets. The auditor might select recorded plant and equipment assets, and then physically locate and observe them, in order to verify existence. Choice "D" is incorrect. Analyzing the repairs and maintenance account does not provide evidence about assets that cannot be repaired. The auditor might review asset records for old assets, or observe assets that are not being used, in an effort to determine whether assets that cannot be repaired have been properly written off.

Question 17

The primary reason an auditor requests letters of inquiry be sent to a client's attorneys is to provide the auditor with:

Accepted Answer

Choice "B" is correct. A letter of audit inquiry to the client's lawyer is the auditor's primary means of obtaining corroboration of the information furnished by management concerning litigation, claims, and assessments. Choice "A" is incorrect. While the attorney is requested to provide the auditor with the likelihood of an unfavorable outcome, the primary source of this information is management. Choice "C" is incorrect. The attorney's opinion of historical experiences may provide some information to the auditor, but it is not the primary goal of audit inquiry letters. Choice "D" is incorrect. While the attorney is asked to comment on management's description and evaluation of litigation, claims, and assessments that existed at the balance sheet date, the primary source of this information is management.

Question 18

A client maintains perpetual inventory records in both quantities and dollars. If the assessed level of control risk is high, an auditor would probably:

Accepted Answer

Choice "B" is correct. The assessment of control risk affects the nature, timing, and extent of substantive audit procedures. If the assessed level of control risk is high, the auditor would generally request that the client schedule the inventory at the end of the year. Choice "A" is incorrect. If the assessed level of control risk is high, an auditor would probably increase the extent of substantive testing, not the extent of tests of controls. Choice "C" is incorrect. Client performance of physical counts is an effective internal control, but requesting multiple inventory counts through the year is not an appropriate reaction to the auditor's assessment of control risk as high. The assessment of control risk affects the nature, timing, and extent of substantive audit procedures. Choice "D" is incorrect. The assessment of control risk affects the nature, timing, and extent of substantive audit procedures. Given the high assessment of control risk, the auditor would prefer more effective substantive procedures; analytical procedures are generally less effective.

Question 19

When control risk is assessed as low for assertions related to payroll, substantive tests of payroll balances most likely would be limited to applying analytical procedures and:

Accepted Answer

Choice "D" is correct. If the control risk is assessed as low, less substantive testing is necessary. In such an instance, substantive testing would normally be limited to analytical procedures and recalculating yearend accruals. Choice "A" is incorrect. Observing distribution of paychecks is a test of controls, not a substantive test. Choice "B" is incorrect. Footing and crossfooting the payroll register is an important substantive test, but it is limited in its effectiveness. Even if control risk is assessed as low, more effective substantive procedures should be performed. Choice "C" is incorrect. Inspection of payroll tax returns is an extensive substantive test that would be performed if the control risk were assessed as high.

Question 20

Which of the following strategies most likely could improve the response rate of the confirmations of accounts receivable?

Accepted Answer

Choice "B" is correct. The auditor should consider the types of information respondents will be readily able to confirm. For instance, some accounting systems facilitate the confirmation of single transactions rather than entire balances. In such cases, the auditor might consider including a client-prepared statement of account showing details of the customer's account balance being confirmed. By making it easier for customers to determine which items are included in the balance being confirmed, the auditor also makes it more likely that those customers will respond. Choice "A" is incorrect. Restricting the selection of accounts to be confirmed to those customers with large balances doesn't improve response rates, as customers with large balances are not necessarily more likely to respond than customers with small balances. Choice "C" is incorrect. Explaining to customers that discrepancies will be investigated by an independent third party would not necessarily encourage them to respond, as they might be reluctant to set off this investigation. Choice "D" is incorrect. Responses received by fax should be verified by calling the senders and requesting that the original confirmations be mailed back. Asking customers to respond by fax might actually reduce the response rate for receiving the original confirmation, since customers may decide that since they already sent the fax, they don't need to send the original back as well.

Exam 1: CPA Auditing and Attestation Exam