Question 1

An audit firm's business risk is affected by:

Accepted Answer

The business risk of an audit firm is affected by all of the factors listed in the options. The client's business risk is relevant because if the client is operating in a risky industry, the audit firm may face a greater threat of litigation or damage to its reputation. The firm's ability to make profits from the work it performs is also relevant because it affects the firm's financial stability, which in turn affects its ability to invest in quality control and other risk management measures. Finally, the integrity of the client's management is important because if management engages in unethical or illegal activities, the audit firm may face legal or reputational risks as a result.

Question 2

A company's recent restatement of previously issued financial statements is a favorable indicator that the company's internal controls are effective in the timely detection of errors and misstatements.

Accepted Answer

A restatement of previously issued financial statements often indicates that there were errors or misstatements in the original financial statements, suggesting a potential weakness in the company's internal controls rather than their effectiveness in timely detection.

Question 3

A management representation letter is an important item of audit evidence that auditors must obtain at the beginning of the engagement to establish an understanding of the terms of the engagement.

Accepted Answer

A management representation letter is obtained at the conclusion of an audit, not at the beginning. It is used to confirm oral representations made by management and to document the continuing appropriateness of such representations. The understanding of the terms of the engagement is typically established through an engagement letter, not a management representation letter.

Question 4

If a company's audit committee is not actively involved in the financial reporting function, this is viewed by auditors as a weakness in internal control.

Accepted Answer

The audit committee is responsible for overseeing the financial reporting function and ensuring the accuracy and completeness of financial statements. If they are not actively involved, it can indicate a weakness in internal control and may be viewed as a deficiency by auditors.

Question 5

An incoming auditor should protect its independence by avoiding communications with the predecessor auditor.

Accepted Answer

An incoming auditor should communicate with the predecessor auditor to obtain relevant information about the client and the audit. This includes matters related to accounting policies, significant transactions, and internal control deficiencies. However, the incoming auditor should also take steps to protect its independence and objectivity, such as evaluating the integrity of the previous auditor's work and considering whether any potential conflicts of interest exist.

Question 6

The risk of client misconduct is concerned with management's reputation and integrity.

Accepted Answer

Client misconduct can reflect poorly on the management and damage their reputation and integrity. Therefore, it is important for management to take preventive measures to avoid such risks.

Question 7

A request for proposal (RFP) is required for each client acceptance or continuance decision.

Accepted Answer

A request for proposal (RFP) is not required for each client acceptance or continuance decision. It is only required in situations where the auditor is seeking new clients or engagements. The RFP process allows the auditor to gather information about the potential client's needs and expectations, evaluate their suitability as a client for the firm, and make an informed decision about whether or not to accept the engagement. Conversely, when deciding whether to continue an existing engagement or client relationship, the auditor typically relies on a variety of other factors, such as ongoing risk assessments, discussions with management, and evaluation of prior audit performance.

Question 8

Information about changes in a company's ownership, management, and/or audit firm is provided within Form 8K.

Accepted Answer

Form 8K is a report that companies must file with the Securities and Exchange Commission (SEC) to disclose major events that could affect their business, such as changes in ownership or management. This information is typically included in Item 5 of the Form 8K.

Question 9

Facts that warn an auditor that fraud may be occurring can also inform the auditor's judgments on client acceptance and continuance.

Accepted Answer

Facts that indicate potential fraud may be a red flag to the auditor during client acceptance and continuance evaluations. This can include considerations of the client's integrity, ethical climate, and the risk of fraud in the industry or economic environment. The auditor may decide to decline or discontinue the engagement if the risk of fraud is high or if management is not committed to addressing potential fraud risks.

Question 10

Companies often change audit firms prior to an initial public offering (IPO).

Accepted Answer

This is true. Companies may choose to change audit firms prior to an IPO in order to ensure a fresh and independent review of their financial statements, as well as to potentially reduce the risk of any conflicts of interest with their previous auditor. Additionally, some underwriters or investors may prefer to work with certain audit firms or require a change in order to mitigate risk or achieve greater transparency.

Question 11

Which of the following is used by auditors as a source of guidance on client acceptance and continuance decisions?

Accepted Answer

All of the options - COSO frameworks, auditing standards, and the audit firm's quality control standards - are used by auditors as sources of guidance for client acceptance and continuance decisions. These frameworks and standards provide guidelines for assessing risks associated with potential clients and evaluating the effectiveness of a client's internal controls. The audit firm's quality control standards also help ensure that the firm is able to provide high-quality and objective audit services.

Question 12

In an audit engagement letter, a clause addressing document retention states that the auditors will retain the client company's accounting records until the audit fees have been collected.

Accepted Answer

A clause addressing document retention in an audit engagement letter should state that the auditors will retain the client company's accounting records for a certain number of years for legal and regulatory compliance purposes, not until the audit fees have been collected.

Question 13

Which of the following is not a reason why auditors perform an investigation of potential clients as part of their client acceptance and continuance procedures?

Accepted Answer

Auditors do not perform investigations of potential clients to assist them in recovering from financial decline. Instead, auditors want to ensure that they are able to perform effective audits and earn a profit, avoid litigation risk, and accept clients who possess a high level of integrity.

Question 14

An auditor's quality control (QC) standards provide important benchmarks against which an auditor can assess the quality of a potential client.

Accepted Answer

Auditor's quality control standards are designed to ensure that the audit firm consistently adheres to professional standards and regulatory requirements, and maintains high levels of audit quality. They do not specifically provide benchmarks for assessing the quality of potential clients.

Question 15

An audit firm should immediately decline to propose on a public company's audit if the company's CFO was recently a partner in the audit firm.

Accepted Answer

According to the SEC rules and regulations, an audit firm should not propose on a public company's audit if the company's CFO was a partner in the audit firm during the one-year period preceding the audit. This is to ensure independence and avoid any potential conflicts of interest.

Question 16

An auditor's professional competence is directly related to the audit fees it is able to negotiate as part of the client acceptance or continuance activities.

Accepted Answer

An auditor's professional competence is determined by their knowledge, skills, and abilities, not by the fees they negotiate. Audit fees may reflect the complexity of the audit but are not a direct measure of an auditor's competence.

Question 17

The Sarbanes-Oxley Act requires that all public companies have an audit committee comprised of at least three independent financial experts and at least one other person.

Accepted Answer

The Sarbanes-Oxley Act requires that all members of the audit committee be independent, but it does not specify that they must be financial experts, nor does it mandate a minimum number of financial experts. It does require the audit committee to have at least one member who is a financial expert or to disclose why there is no such expert on the committee.

Question 18

Audit firms should always avoid a potential client company that conducts significant related party transactions in the ordinary course of business.

Accepted Answer

While significant related party transactions may increase the risks of financial misstatements or conflicts of interests, it does not necessarily mean that audit firms should always avoid the potential client company. Audit firms must evaluate the nature and extent of related party transactions, as well as the adequacy of disclosure and internal controls, before accepting or continuing the audit engagement.

Question 19

Which of the following best describes the role of an audit firm's quality control standards to provide guidance addressing client acceptance and continuance?

Accepted Answer

Quality control standards should provide policies and procedures for audit firms to follow when determining whether to accept or continue performing an audit engagement. This helps ensure that the audit firm is taking appropriate steps to manage risk and maintain quality in their services. Choices A, B, and D do not specifically address client acceptance and continuance.

Question 20

An auditor's professional competence depends upon each of the following except:

Accepted Answer

While a reputation for issuing unqualified audit opinions may be desirable, it is not necessary for an auditor's professional competence. Professional competence is dependent on the auditor's knowledge, availability of necessary resources, and requisite training and proficiency.

Quiz 5: Client Acceptance and Continuance and Preliminary Engagement Procedures