TEST BANK for Auditing: A Practical Approach with Data Analytics 2nd Edition by Laura Davis Wiley, R by StudyGuide

4) Private companies, or non-issuers, are not required by the U.S. government to have an annual financial statement audit. Answer: TRUE Explanation: Private companies, or non-issuers, are not required by the U.S. government to have an annual financial statement audit, but often other interested users, such as a bank or lender, may request that a private company provide audited financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting 5) One of the reasons there is a demand for financial statement audits is that users of financial statements often lack accounting and legal knowledge to fully understand complex accounting and disclosure choices. Answer: TRUE Explanation: Financial statements are complex, the amounts are often affected by significant estimates, and the disclosures often require significant knowledge and experience to evaluate. Most financial statement users do not have the accounting and legal knowledge to assess the reasonableness of complex accounting and disclosure choices being made by the company. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: PC: Communication 6) In financial accounting, the balance sheet is a statement of financial position. Answer: TRUE Explanation: In financial accounting, the financial statements include the balance sheet (statement of financial position), income statement (statement of comprehensive income), statement of cash flows, statement of changes in equity and accompanying notes. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: PC: Communication

7) Business valuation falls within the purview of non-assurance services. Answer: TRUE Explanation: Many of these accounting firms provide non-assurance (or non-audit) services as well as assurance services. These non-assurance services include management consulting, business valuation, mergers and acquisitions, insolvency, tax and accounting services. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Measurement Analysis and Interpretation 8) Securities Exchange Act of 1934 regulates the ongoing trading of securities after the initial public offering and requires the annual audit of a public company's financial statements. Answer: TRUE Explanation: The Securities Exchange Act of 1934 regulates the ongoing trading of securities after the initial public offering and requires the annual audit of a public company's financial statements. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective 9) The Securities Act of 1933 enhances annual financial disclosures for public companies and placed more emphasis on corporate responsibility. Answer: FALSE Explanation: The Securities Act of 1933 regulates the disclosure of financial information in a company's initial public offering of stock and requires that the financial information be audited. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective 10) Neither client characteristics nor actions of the auditor affect the audit risk. Answer: FALSE Explanation: Audit risk is affected by client characteristics as well as actions of the auditor. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Reporting 3

11) Materiality is a relative concept, and it differs from company to company and from year to year for a given company. Answer: TRUE Explanation: Materiality is a relative concept, and it differs from company to company and from year to year for a given company. Auditors design an audit to provide reasonable assurance that the financial statements are free of material misstatement. However, auditors do not design an audit to look for immaterial misstatements because they would not influence a financial statement user. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Reporting 12) When auditors determine that the financial statements of a public company are presented fairly in accordance with the applicable financial reporting framework, they issue a type of report that PCAOB standards call "the standard clean report." Answer: FALSE Explanation: If auditors have determined the financial statements are presented fairly in accordance with the applicable financial reporting framework, they issue the standard unqualified report. The PCAOB standards use the term "unqualified" report. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Reporting 13) In an unqualified audit report on the financial statements of a public company, the concluding statement of the Basis for Opinion paragraph mentions reasonable basis for the audit firm's opinion. Answer: TRUE Explanation: The basis for opinion paragraph explains, in brief terms, the process of conducting an audit. It mentions the concept of reasonable assurance about whether the financial statements are free of material misstatement. It includes an explicit statement that PCAOB audit standards were followed because the audit pertains to a public company. The scope paragraph also includes a brief discussion of the professional judgments made during the audit. Finally, it concludes with a statement that the audit firm believes that its audit provides a reasonable basis for its opinion. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Reporting

14) In an audit report on the effectiveness of ICFR for a public company, the basis for opinion paragraph states the different responsibilities of management and auditors. Answer: FALSE Explanation: In an audit report on the effectiveness of ICFR for a public company, the basis for opinion paragraph states the different responsibilities of management and auditors. Like the audit report on the financial statements, this paragraph references registration with the PCAOB and independence requirements of the SEC and other federal securities laws. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective 15) In an audit report on the effectiveness of ICFR for a public company, the Opinion on Internal Control over Financial Reporting paragraph mentions that auditors are only required to obtain reasonable assurance about whether the company maintained, in all material respects, effective ICFR. Answer: TRUE Explanation: In an audit report on the effectiveness of ICFR for a public company, the Opinion on Internal Control over Financial Reporting paragraph explains that auditors conducted their audit in accordance with the standards of the PCAOB. In brief terms, it explains the process of conducting an audit of the effectiveness of ICFR. It mentions that auditors are only required to obtain reasonable assurance about whether the company maintained, in all material respects, effective ICFR. It concludes with a statement that the audit firm believes its audit provides a reasonable basis for its opinion. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective 16) A financial statement user's expectations are only impacted by legislation. Answer: FALSE Explanation: A financial statement user's expectations are often impacted by audit standards, ethical standards, regulations, legislation, and firm policy and procedures. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Measurement Analysis and Interpretation

17) The audit expectation gap is caused by user expectations such as: The auditor will catch all instances of fraud. Answer: TRUE Explanation: The audit expectation gap is caused by unrealistic user expectations such as: the auditor is providing complete assurance; the auditor is guaranteeing the future viability of the entity; an unmodified audit opinion is an indicator of complete accuracy of the financial statements; the auditor will definitely find any and all fraud; and that the auditor has checked all transactions. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting 18) Identify a service that falls under audit services. A) examination of historical financial statements B) compilation of historical financial statements C) inspection of website security D) review of financial forecast Answer: A Explanation: Examination of historical financial statements comes under audit services. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation 19) Examination of internal controls is a service that comes under ________ services, which fall under ________ services. A) audit; assurance B) assurance; attestation C) acceptable; assurance D) attestation; audit Answer: A Explanation: Attestation services (under the umbrella of assurance services) include review of historical financial statements, review of financial forecast, and examination of internal control. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation

20) Compared to an audit of historical financial statements, a review engagement is ________. A) less extensive and also less expensive B) more extensive and also more expensive C) less extensive but more expensive D) more extensive but less expensive Answer: A Explanation: In a review engagement, the practitioner expresses limited assurance that no material modifications need to be made to the financial statements. So, a review of historical financial statements is a less extensive, and therefore, less expensive service that can be very useful for smaller private companies. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation 21) Who are the only licensed accounting professionals in the United States? A) Certified Public Accountants (CPA) B) Chartered Accounts (CA) C) Financial Accountants (FA) D) Chief financial and operating officer (CFOO) Answer: A Explanation: Certified Public Accountants (CPA) are the only licensed accounting professionals in the United States. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation 22) As attestation services encompass more than just the inspection of historical financial statements, the term ________ is used rather than ________. A) practitioner; auditor B) auditor; practitioner C) intended user; auditor D) intended user; practitioner Answer: A Explanation: In attestation services, the term practitioner is used rather than auditor because attestation services encompass more than just the audit of historical financial statements. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting 7

23) What services are defined as independent professional services that improve the quality of information, or its context, for decision makers? A) assurance services B) attestation services C) absolute assurance D) audit services Answer: A Explanation: Assurance services are defined as independent professional services that improve the quality of information, or its context, for decision makers. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting 24) The most common assurance service is the ________. A) audit of a company's historical financial statements B) compilation of financial statements C) review of a company's financial controls D) review of a company's historical financial statements Answer: A Explanation: The audit of a company's historical financial statements is the most common assurance service. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting 25) A review of historical financial statements is an example of ________. A) attestation service B) absolute assurance C) financial forecast D) applicable financial reporting framework Answer: A Explanation: An example of an attestation service is a review of historical financial statements. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: AC: Reporting

26) Assurance, attestation, and auditing are similar because all three represent a common process of ________. A) taking information prepared by someone else and comparing that information to an established set of criteria. B) compiling and reviewing historical financial statements and providing non-financial information. C) compiling historical financial statements and providing non-financial information and web security. D) reviewing financial forecast, examining internal controls, and providing website security. Answer: A Explanation: The terms assurance, attestation, and auditing are sometimes used interchangeably, but they actually represent different types of services. They are similar because they all represent a common process of an independent accounting firm taking information prepared by someone else and comparing that information to an established set of criteria. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: AC: Reporting 27) Which of the following is true of assurance services? A) Both attestation and auditing services fall under the term of assurance services. B) The term information refers to subject matter that is an entire system, not standalone data. C) The services are performed by someone who was involved with the creation of the information. D) The intended user is an independent Certified Public Accountant qualified to perform the auditing service. Answer: A Explanation: Both attestation and auditing services fall under the term of assurance services. The term independent implies that the service is performed by someone who was not involved with the creation of the information and who is objective in the evaluation of the information. The term information refers to subject matter that can be standalone data or entire systems. The auditor refers to an independent Certified Public Accountant, or CPA, who is qualified to perform the auditing service. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: AC: Reporting

28) When CPAs are hired to report on the integrity of financial forecasts and reports on financial reporting processes, it is called an ________. A) attestation service B) absolute assurance C) applicable financial reporting framework D) audit service Answer: A Explanation: Companies produce financial information that goes beyond historical financial statements. Examples include financial forecasts and reports on financial reporting processes. When CPAs are hired to report on the integrity of this type of financial information, it is called an attestation service. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: AC: Reporting 29) In assurance services, the term "information" refers to subject matter that is ________. A) historical or prospective B) created by independent or in-house services C) financial and outside the purview of the non-financial D) internal to a company only Answer: A Explanation: In the assurance services, the term information refers to subject matter that can be financial or non-financial, historical or prospective, or standalone data or entire systems, internal or external to a company. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting

30) Which terms does the textbook claim are used interchangeably, but actually represent different types of services? A) assurance, attestation, and auditing B) accounting, auditing, and assurance C) accounting, attestation, and auditing D) assurance, attestation, and accounting Answer: A Explanation: Assurance, attestation and auditing are used interchangeably but represent different services. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting 31) Which of the following is included as a focus of assurance services? A) Compilation of historical financial statements B) Examination of internal controls C) Review of historical financial statements D) Review of financial forecast Answer: C Explanation: A review is a type of assurance service. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 32) A key similarity between assurance, attestation, and auditing services is ________. A) the comparison of information prepared by someone else against an established set of criteria B) the comparison of actual output to projected output C) the comparison of financial accounting data to managerial accounting data D) the comparison of financial audit data to tax audit data Answer: A Explanation: Assurance, attestation, and auditing services involve the comparison of information prepared by someone else against an established set of criteria. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting

33) The purpose of audit services is to provide ________. A) financial statement users with an opinion as to the fair presentation of the financial reporting B) management with an opinion as to the fairness of the company's managerial accounting procedures C) investment advice to the company D) limited assurance that no material modifications need to be made to the financial statements Answer: A Explanation: The purpose of an audit is to provide financial statement users with an opinion as to the fair presentation of the financial reporting. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 34) Which are the most specific services provided by the auditor? A) Compilation services B) Audit services C) Attestation services D) Assurance services Answer: B Explanation: Audit services are the most specific. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 35) Which is the most inclusive or broadest service provided by the auditor? A) Audit services B) Attestation services C) Assurance services D) A review of historical financial statements Answer: C Explanation: Assurance services are the broadest service. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting

36) The only professional who can audit a set of historical financial statements for a public or private company in the United States is ________. A) a Certified Public Accountant (CPA) B) a Certified Fraud Examiner (CFE) C) the IRS D) a loan officer Answer: A Explanation: A CPA is the only professional in the United States who can audit a set of historical financial statements for a public or private company. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting 37) The set of standards used in preparing the historical financial statements, such as GAAP or IFRS, is referred to as ________. A) the applicable financial reporting framework B) Generally Accepted Auditing Standards (GAAS) C) material modifications D) a review of historical financial statements Answer: A Explanation: The set of standards used in preparing the historical financial statements is referred to as the applicable financial reporting framework. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting 38) Any group that will be using the financial statements to make decisions, such as investors and creditors, is known as ________. A) intended users B) groups of standing C) decision-makers D) practitioners Answer: A Explanation: Intended users are any group that will be using the financial statements to make decisions. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting 13

39) Which of the following is not one of the three E's needed to become a licensed CPA? A) Education B) Examination C) Experience D) Efficiency Answer: D Explanation: The three E's are education, examination, and experience. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting 40) The only licensed accounting professionals in the United States are ________. A) Certified Public Accountants B) Chartered Accountants C) Certified Internal Auditors D) Certified Fraud Examiners Answer: A Explanation: CPAs are the only licensed accounting professionals in the United States. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 41) Assurance services are defined as ________. A) independent professional services that improve the quality of information, or its context, for decision makers B) individual provisional services to improve internal controls for financial statement users C) individual prospective financial statement quality D) independent information improvement Answer: A Explanation: Assurance services are independent professional services that improve the quality of information, or its context, for decision makers. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting

42) Which type of entity generally finds a review of historical financial statements to be the most useful? A) Large public corporations B) Small public corporations C) Large private corporations D) Small private corporations Answer: D Explanation: Small private corporations typically find reviews to be the most useful. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 43) Which of the following is a characteristic of an audit of historical financial statements? A) It provides limited assurance that no material modifications need to be made to the financial statements. B) It expresses an opinion on the fair presentation of the financial statements. C) It is the same as an examination of internal controls. D) It is broader than a review engagement. Answer: B Explanation: An audit expresses an opinion on the fair presentation of the financial statements. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 44) Which of the following is not one of the four sections tested on the CPA exam? A) Auditing and Attestation B) Business Environment and Concepts C) Regulation D) Internal Controls Answer: D Explanation: Internal controls are not one of the four parts of the CPA exam. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting

45) What is the final step in becoming a licensed CPA? A) Taking the CPA exam B) Meeting the educational requirements C) Work experience D) Pass an examination on the Rules of Professional Conduct Answer: C Explanation: The final step is getting the required work experience. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 46) Independent professional attestation services improve the quality of information. Quality is best described as an improvement in informational ________. A) relevance and reliability. B) financial and nonfinancial qualities C) historical and prospective qualities D) internal and external qualities Answer: A Explanation: Relevance and reliability improve the quality of information. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 47) The term practitioner would be least likely to be used when referring to the performance of ________. A) Audit services B) Attestation services C) Assurance services D) Bookkeeping services Answer: A Explanation: The term practitioner would least likely be used when referring to an audit because it is so specific that professionals who perform audits are called auditors. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting

48) A review of historical financial statements as compared to an audit of historical financial statements ________. A) is more extensive in terms of the work product required B) is typically less expensive C) provides greater assurance D) provides an opinion Answer: B Explanation: A review is typically less expensive than an audit because much less time and effort are involved. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 49) The term independent with respect to assurance services implies that the service is ________. A) performed by someone who was not involved with the creation of the information. B) performed by someone who was involved with the creation of the information and, therefore, fully understands it. C) performed by a company employee. D) is subjective. Answer: A Explanation: Independence implies that the service is performed by someone who was not involved with the creation of the information. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting

50) Examination of non-financial information falls under ________ services and outside of ________ services. A) Assurance; Audit B) Attestation; Assurance C) Audit; Assurance D) Attestation; Audit Answer: A Explanation: Assurance services include compilation of historical statements, website security, IT operations, and non-financial information. Attestation services (under the umbrella of assurance services) include review of historical financial statements, review of financial forecast, and examination of internal control. Historical financial statements come under audit services. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation 51) Among the various processes relating to auditing and assurance standards, the largest umbrella represents ________ services. A) Assurance B) Attestation C) Audit D) Review Answer: A Explanation: Among the various processes relating to auditing and assurance standards, the largest umbrella represents assurance services: independent professional services that improve the quality of information, or its context, for decision makers. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation

52) Argon, a new hire in Sky and Co. audit firm, was attending a training on the different service offerings being provided by the firm to its clients. Being a new professional in the audit industry, Argon was surprised to know that aside from Audit services, the firm also provides other Assurance and Attestation services which are terms Argon was not knowledgeable previously. Which among the following statements is correct when discussing the relationship between Assurance, Attestation, and Audit services? A) Independent CPAs can only perform Audit services, while Assurance and Attestation services are for non-independent CPAs only. B) The difference between the three services lies on the subject matter being audited or reviewed since only Audit services involve financial information while the others do not. C) Among the three services, Audit is the most specific and it involves the audit of financial statements and internal controls over financial reporting. D) Assurance, Attestation, and Audit services vary in terms of the type of client involved wherein Audit services can only be provided to public companies while the others are for private companies as well. Answer: C Explanation: Audit services are the most specific and narrow of the three services. Two primary types of audit services are an audit of financial statements and an audit of internal controls over financial reporting (ICFR). Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

53) Lotus was assigned to perform a review on the financial statements of Arsenia Company. Upon receiving the assignment, Lotus was delighted as the CEO of Arsenia is a close family member. However, Lotus was unsure whether or not Lotus is allowed to perform this engagement because of a possible threat to independence. Should Lotus be allowed to review the financial statements of Arsenia Company? A) No. Independence is required when performing a review engagement since this is under Assurance services. B) Yes. Even if Lotus is not independent with Arsenia Company, Lotus will be allowed since only a review will be performed and not an audit. C) No. Lotus will only be allowed despite the threat to independence if an audit will be performed instead of a review. D) Yes. Lotus will be allowed since there is only a threat to independence which can still be proven otherwise. Answer: A Explanation: Independence is not required to provide non-assurance services. These nonassurance services include management consulting, business valuation, mergers and acquisitions, tax, and accounting. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

54) Cloud, the auditor assigned to perform financial statement audit for Tin Company, was having a meeting with the client's representatives. Cloud was explaining to them the nature of the financial statement audit and the high-level audit procedures designed to discover misstatements. However, the client's representatives expressed their expectation for Cloud to detect all errors and misstatements in their financial statements as they want to present 100% accurate information as much as possible to their shareholders. Which among the following is the best response to this expectation? A) Detecting all misstatements and errors in the financial statements is the main objective of the audit so the client's expectation is valid. B) Audit procedures selected in an audit are designed only to discover material misstatements due to time and cost constraints. C) The extensiveness of the audit procedures planned in detecting misstatements will depend on the level of fee arranged between the auditor and the client. D) The audit procedures to be performed in the engagement should not be based on any expectation of detecting any misstatements in order to avoid bias. Answer: B Explanation: When planning an audit, auditors select audit procedures that are designed to discover material misstatements. Because of time and cost constraints, it would be impractical for an audit to focus on finding all misstatements. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 55) Within a U.S. context, the applicable financial reporting framework is typically ________. A) Generally Accepted Accounting Principles (GAAP) B) International Standard on Quality Control (ISQC) C) Auditing and Assurance Standards Board (AASB) D) International Financial Reporting Standards (IFRS) Answer: A Explanation: Within a U.S. context, the applicable financial reporting framework is typically generally accepted accounting principles (GAAP). Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation

56) Which two audits does an integrated audit combine? A) A financial statement audit and an audit of the effectiveness of ICFR B) A financial statement audit and a compliance audit C) A compliance audit and an audit of the effectiveness of ICFR D) A performance audit and an environmental audit Answer: A Explanation: An integrated audit is an audit that combines the financial statement audit with an audit of the effectiveness of ICFR. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation 57) The audit related to which of the following is specifically meant to express an opinion on the effectiveness of the company's system of internal controls over financial reporting? A) ICFR B) GAAP C) FASB D) AICPA Answer: A Explanation: Public companies in the U.S. are also required to have an audit of internal controls over financial reporting (ICFR). The objective in an audit of ICFR is to express an opinion on the effectiveness of the company's system of internal controls over financial reporting (AS 2201.03) following section 404(b) of the Sarbanes Oxley Act of 2002. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation

58) Which audit involves gathering evidence to determine whether the person or entity under review has followed the rules, policies, procedures, laws and regulations with which they must conform? A) A compliance audit B) A performance audit C) An integrated audit D) An internal audit Answer: A Explanation: A compliance audit involves gathering evidence to determine whether the person or entity under review has followed the rules, policies, procedures, laws and regulations with which they must conform. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation 59) What is a compliance audit? A) An audit to determine whether the entity has conformed with regulations, rules or processes B) An assessment of the economy, efficiency and effectiveness of an organization's operations C) An evaluation and improvement of risk management, internal control procedures and elements of the governance process D) An assessment of the company's financial statements Answer: A Explanation: A compliance audit is an audit to determine whether the entity has conformed to regulations, rules, or processes. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation 60) What is the applicable financial reporting framework in the U.S. known as? A) GAAP B) GAAS C) IFRS D) The Internal Revenue Code Answer: A Explanation: GAAP is the applicable financial reporting framework in the U.S. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting 23

61) Public companies, or issuers, in the U.S. are ________. A) required by the federal government to have quarterly financial statement audits B) required by the federal government to have annual financial statement audits C) required by the federal government to have semi-annual financial statement audits D) not required by the federal government to have financial statement audits Answer: B Explanation: Public companies in the U.S. are required to have annual financial statement audits. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting 62) Private companies, or non-issuers, in the U.S. are ________. A) required by the federal government to have quarterly financial statement audits B) required by the federal government to have annual financial statement audits C) required by the federal government to have semi-annual financial statement audits D) not required by the federal government to have financial statement audits Answer: D Explanation: Private companies in the U.S. are not required by the federal government to have financial statement audits. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting 63) Which of the following statements is true? A) Often interested users, like banks, ask private companies or non-users to provide audited financial statements. B) Public users are required to have three audits a year. C) Public users are required to have an audit of internal financial forecast reports (IFFRs). D) For efficiency purposes, the three required audits for public companies are performed at the same time. Answer: A Explanation: Often interested users, like banks, ask private companies or non-users to provide audited financial statements. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 24

64) ICFR stands for ________. A) internal controls over financial reporting B) internal controls for reporting C) international controls over financial reporting D) internal controls over forecast reports Answer: A Explanation: ICFR stands for internal control over financial reporting. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting 65) The limitations of an audit are NOT caused by ________. A) the nature of financial reporting B) the nature of audit procedures C) the need for the audit to be conducted within a reasonable period of time at a reasonable cost D) a guarantee that the financial statements are free from error Answer: D Explanation: Limitations of an audit are caused by the nature of financial reporting, the nature of audit procedures, and the need for an audit to be conducted within a reasonable period of time. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 66) The nature of audit procedures refers to the ________. A) reliance on evidence provided by the client and its management B) use of judgment when preparing financial statements due to the subjectivity required when arriving at accounting estimates C) materiality of misstatement D) pressures auditors face to complete their audit within a certain time frame at a reasonable cost Answer: A Explanation: The nature of audit procedures refers to the reliance on evidence provided by the client and its management. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting

67) A financial statement audit is conducted to ________. A) enhance the reliability and credibility of the information included in the financial statements B) guarantee that the financial statements are free from error or fraud C) determine whether financial documents were altered by those committing a fraud D) focus on finding all misstatements in the financial records Answer: A Explanation: A financial statement audit is conducted to enhance the reliability and credibility of the information included in the financial statements. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 68) An integrated audit refers to two audits performed at the same time, or ________. A) an audit on the effectiveness of internal controls and an audit of the financial statements for external purposes B) an internal audit and an external audit with the same identical objectives C) an audit for intentional material misstatements and an audit for errors D) an audit based on time constraints and an audit based on cost constraints Answer: A Explanation: An integrated audit refers to an audit on the effectiveness of internal controls and an audit of the financial statements for external purposes. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 69) The nature of audit procedures can refer to the concept of ________. A) consistency B) timeliness C) effectiveness D) materiality Answer: D Explanation: The nature of audit procedures can refer to the concept of materiality. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting

70) Pressures of time and money may affect the audit due to all of the following EXCEPT ________. A) clients want to issue their financial statements by a certain date B) clients refusing to pay additional fees for additional audit effort and time C) pressures within the CPA firm to complete all audits on a timely basis to avoid incurring costs that may not be recovered D) pressures by shareholders to find all misstatements in the financial reports Answer: D Explanation: Pressures by shareholders to find all misstatements in the financial reports do not affect the pressures of time and money in and audit. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 71) What type of audit involves gathering evidence to determine whether the person or entity under review has followed the rules? A) A compliance audit B) An operational audit C) A financial statement audit D) An integrated audit Answer: A Explanation: A compliance audit involves gathering evidence to determine whether a person or entity under review has followed the rules. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting

72) What type of audit is concerned with the economy, efficiency and effectiveness of an organization's activities? A) A compliance audit B) An operational audit C) A financial statement audit D) An integrated audit Answer: B Explanation: An operational audit is concerned with the economy, efficiency and effectiveness of an organization's activities. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 73) What type of audit provides an opinion by the auditor about whether the financial statements are presented fairly in accordance with an applicable financial reporting framework? A) A compliance audit B) An operational audit C) A financial statement audit D) An audit on the effectiveness of ICFR Answer: C Explanation: A financial statement audit provides an opinion about whether the financial statements are presented fairly in accordance with an applicable financial reporting framework. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Reporting 74) What type of audit is conducted to provide assurance about various aspects of an organization's activities rather than the reliability of financial statements? a(an) A) Compliance audit B) Operational audit C) Financial statement audit D) Internal audit Answer: D Explanation: An internal audit is conduced to provide assurance about various aspects of an organization's activities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting 28

75) Those charged with governance are the ________. A) CEO, CFO, and COO B) board of directors and management of an entity C) stockholders D) auditors Answer: B Explanation: The board of directors and management of an entity are those charged with governance. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective 76) In the United States, what entities are required by the federal government to have an annual financial statement audit? A) Public companies or issuers B) Private companies or issuers C) Public companies or non-issuers D) Private companies or non-issuers Answer: A Explanation: Public companies, or issuers, in the U.S. are required by the federal government to have an annual financial statement audit. Private companies, or non-issuers, are not required by the U.S. government to have an annual financial statement audit, but often other interested users request that a private company provide audited financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation

77) Who among the following users of the financial statement of a company may be particularly interested in evaluating whether the company is paying a fair amount of taxes given its reported earnings, and to gain a better understanding of the company's activities? A) Government B) General pubic C) Employees D) Investors Answer: A Explanation: Governments may read financial statements to determine whether the company is complying with regulations, to evaluate if the company is paying a fair amount of taxes given its reported earnings, and to gain a better understanding of the company's activities. A company in receipt of government grants often must provide a copy of its audited financial statements when applying for a grant and when reporting on how grant funds have been spent. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Measurement Analysis and Interpretation 78) Since users of financial statements make financial decisions that have real consequences, it is very important that users can depend on the information contained in the financial statements. What term captures this problem? A) Reliability B) Competing incentives C) Complexity D) Remoteness Answer: A Explanation: Financial statement users are concerned with the reliability of the information contained in the financial statements. Since they use that information to make decisions that have real consequences, it is very important that users can rely on the information contained in the financial statements. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Measurement Analysis and Interpretation

79) Most financial accounting and disclosure choices being made by the company are complicated and often require significant technical knowledge and experience in order to understand. What term captures this problem? A) Complexity B) Remoteness C) Competing incentives D) Reliability Answer: A Explanation: Financial statements are complex, the amounts are often affected by significant estimates, and the disclosures often require significant knowledge and experience to evaluate. Most financial statement users do not have the accounting and legal knowledge to assess the reasonableness of complex accounting and disclosure choices being made by the company. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation 80) Among the reasons why users demand an audit of financial statements, what is the problem of competing incentives? A) The company has a reason to disclose information in a way that presents it in favorable light. B) Financial statement users lack accounting and legal knowledge to understand accounting and disclosure choices. C) Financial statement users to not have access to the company under review and thus face difficulty in determining whether the statements are fair. D) Financial statement users need reliable information in order to make decisions that have real consequences. Answer: A Explanation: Company managers have an incentive to disclose the information contained in the financial statements in a way that presents their performance in the best possible light. Users may find it difficult or impossible to identify when management is presenting biased information. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: PC: Communication

81) Windy is preparing to enter into a University but has not decided yet what course to take. Windy's parents, who are both certified public accountants (CPA), provided a suggestion for Windy to study towards becoming an auditor. However, Windy is not knowledgeable about the work of an auditor and what drives the demand for audit services in the real business world. Which among the following is a valid explanation about the demand for audit and assurance services? A) Audit services are in demand among private companies since auditors help in the preparation of their financial statements in an efficient manner. B) More and more companies engage the work of audit firms because of the ease in obtaining the signature of certified public accountants as a sign that their financial statements are credible. C) Audit services are in demand because the main output of an audit is to provide guidance to companies on how they should run their businesses. D) Considering that financial statements can be complex, auditors can help the different users of the financial statements to assess the reasonableness of the information presented therein. Answer: D Explanation: Most financial statement users do not have the accounting and legal knowledge to assess the reasonableness of complex accounting and disclosure choices being made by the company so auditors can help in this assessment. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 82) Bloom is one of the junior auditors tasked to perform a financial statement audit for Radon Company. Bloom was having a meeting with the members of the audit team to refresh their understanding on their responsibilities as auditors. Bloom was somehow confused as Bloom's previous work before joining the audit firm was a preparer of financial statements. Which of the following is a responsibility of an auditor and not of a preparer? A) To make sure that the financial statements present information in accordance with the applicable financial reporting framework B) To design, implement, and maintain internal controls relevant to the fair presentation of financial statements C) Make estimates for some financial statement items and select the appropriate accounting policies for the presentation of the financial statements D) Seek evidence to corroborate or confirm information provided in the financial statements Answer: D Explanation: Auditors maintain a questioning mind and thoroughly investigate all evidence presented by their client. Auditors must seek independent evidence to corroborate, or confirm, information provided by their client. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 32

83) Which of the following falls within the purview of financial accounting? A) Changes in equity B) Management consulting C) Business valuation D) Mergers and acquisitions Answer: A Explanation: Financial accounting looks into statements that include the balance sheet (statement of financial position), income statement (statement of comprehensive income), statement of cash flows, statement of changes in equity and accompanying notes. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Measurement Analysis and Interpretation 84) Which of the following comes under the purview of the Public Company Accounting Oversight Board? A) Auditing Standards (AS) B) Statements on Auditing Standards (SAS) C) Statements on Standards for Attestation Engagement (SSAE) D) Statements on Quality Control Standards (SQCS) Answer: A Explanation: Standards issued by the PCAOB are called Auditing Standards (AS), which provide minimum requirements and guidance for auditing services. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective

85) Which of the following is a private professional membership organization of CPAs representing the accounting profession? A) AICPA B) PCAOB C) ASB D) IAASB Answer: A Explanation: The AICPA is a private professional membership organization of CPAs representing the accounting profession. There are over 430,000 members in 137 countries (www.aicpa.org). Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective 86) Which act created the Public Company Accounting Oversight Board, which oversees the audits of public companies? A) The SOX Act of 2002 B) The Securities Act of 1933 C) The Securities Exchange Act of 1934 D) The Companies Act 2006 Answer: A Explanation: The SOX Act of 2002 created the Public Company Accounting Oversight Board, or PCAOB, which oversees the audits of public companies. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective 87) The responsibility for creating and grading the Uniform CPA Exam lies with the ________. A) AICPA B) COSO C) FASB D) IAASB Answer: A Explanation: The AICPA is responsible for creating and grading the Uniform CPA Exam. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective 34

88) Which of the following is true of the PCAOB? A) It can impose punishment on accounting firms that do not adhere to standards. B) Prior to its creation, the audit profession was highly unregulated. C) In 2015, it reorganized its auditing standards using several numbering systems. D) When it was created, it rejected nearly all the then standards of the audit profession. Answer: A Explanation: The PCAOB has disciplinary authority over registered firms and can impose punishment on accounting firms that do not adhere to standards. Punishments can include revoking a firm's registration, monetary fines, and banning an individual from auditing public companies. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective 89) Arwen is an accounting student who is currently studying the different regulators and organizations which are involved in the audit profession. This was the first time Arwen encountered most of these organizations and was having a difficulty in understanding the differences that each role plays. Which among the following statements mostly relates to COSO? A) Maintains the authoritative standards of financial reporting recognized by other regulators and organizations for the audit profession B) Focuses on providing guidance to management and expertise in the areas of internal control, enterprise risk management, and fraud deterrence C) Represents the accounting profession before rule-making bodies and is responsible for grading the Uniform CPA Exam D) Oversees the audits of public companies to protect the interests of users of the financial statements such as investors Answer: B Explanation: COSO is an independent private-sector group that focuses on providing guidance to management and expertise in the areas of internal control, enterprise risk management, and fraud deterrence. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

90) If the auditors do not have access to all the information relevant to the audit, this is known as a(an) ________. A) material misstatement B) limitation in scope C) estimate D) sampling technique Answer: B Explanation: A limitation in scope occurs when the auditors do not have access to all the information relevant to the audit. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Reporting 91) Eagle, the assigned auditor for Shelob Company, was having a discussion with the client's representative. This was the first time that Shelob will have its financial statements audited by an external party. During the discussion, Shelob wanted to know what is the best-case scenario regarding the opinion which Eagle can issue as a result of the financial statement audit. What is the best explanation on what a reasonable assurance is? A) Reasonable assurance is a high level of assurance that there are no material misstatements though not absolute. B) Reasonable assurance means that the financial statements are 100% accurate. C) Reasonable assurance is a high level of assurance that material misstatements are probable though not detected. D) Reasonable assurance is subjective and will depend on the agreement between the auditor and client in terms of its interpretation. Answer: A Explanation: Reasonable assurance is a high, but not absolute, level of assurance. In other words, the auditor does not "guarantee" or "certify" that the financial statements are 100% accurate because that is considered absolute assurance, which is not possible with content that is subjective. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

92) Win, who is the audit engagement partner for the audit of Pippin Company, was having an argument with the client's representative. The discussion transpired due to a misunderstanding regarding the term reasonable assurance as the client interpreted it as providing a guarantee that financial statements are free from all errors and misstatements. The client is asking Win the reasons why only reasonable assurance can be attained. What should Win provide as the most appropriate explanation? A) The audit team cannot provide absolute assurance as this will be a risk on the audit firm's reputation if later on a material misstatement is discovered. B) Absolute assurance is currently not attainable based on the fee agreed for this engagement though amenable upon further discussion of the fee. C) Absolute assurance cannot be attained as the audit is time bound and they are not in a position to audit 100% of Pippin's accounts and transactions. D) The audit team cannot provide an absolute assurance because the auditors are expected to commit mistakes when conducting the audit. Answer: C Explanation: An audit could not be completed in a reasonable amount of time if auditors had to provide absolute assurance. For some accounts and transactions, auditors use sampling techniques when gathering audit evidence and therefore do not examine 100% of a company's transactions for the period under audit. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 93) Which statement is correct as to financial statement audit reports for public versus private companies? A) There is a standard report for the audit of public company financial statements and a standard report for the audit of private company financial statements. B) There is a standard report for the audit of public company financial statements but none for auditing private company financial statements. C) There is a standard report for the audit of private company financial statements but none for auditing public company financial statements. D) There is no distinction between standard reports for the audit of financial statements, regardless of whether the company is private or public. Answer: A Explanation: There is a standard report for the audit of public company financial statements and a standard report for the audit of private company financial statements. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Reporting

94) In an unqualified audit report on the financial statements of a public company, what does the first statement of the opinion paragraph state? A) An audit was conducted, which financial statements were audited, and the dates of the financial statements. B) PCAOB audit standards were followed since it is a public company. C) The audit firm believes that its audit provides a reasonable basis for its opinion. D) Management is responsible for the fair presentation of the financial statements. Answer: A Explanation: In the opinion paragraph, the first sentence explains that an audit was conducted and identifies the financial statements and the dates of the financial statements. The second sentence states the auditor's opinion. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Reporting 95) With regard to financial statements, the auditor is required to obtain reasonable assurance, which is a level of assurance that is ________. A) high, but not absolute B) guaranteed, but not absolute C) 100%, but not objective D) objective, and not subjective Answer: A Explanation: The auditor is only required to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. Reasonable assurance is a high, but not absolute, level of assurance (AU-C 200.06). In other words, the auditor does not "guarantee" or "certify" that the financial statements are 100% accurate because that is considered absolute assurance which is not possible with content that is subjective. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Ethics AICPA: AC: Reporting

96) When auditors determine that the financial statements of a private firm are presented fairly in accordance with the applicable financial reporting framework, they issue the standard ________ report, which is often referred to as a "________" report. A) unmodified; clean B) qualified; clean C) modified; rough D) unqualified; rough Answer: A Explanation: If auditors have determined the financial statements are presented fairly in accordance with the applicable financial reporting framework, they issue the standard unmodified report. The unmodified report is often referred to as a "clean" report. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Reporting 97) In an audit report on the effectiveness of ICFR for a public company, what does the Opinion on Internal Control over Financial Reporting paragraph explain? A) The auditors conducted their audit in accordance with the standards of the PCAOB. B) An internal control system does not eliminate all risk associated with the preparation of financial statements. C) A material misstatement of the financial statements will not be prevented or detected on a timely basis. D) Circumstances may change in the future and render controls ineffective if the controls are not modified appropriately. Answer: A Explanation: In an audit report on the effectiveness of ICFR for a public company, the Opinion on Internal Control over Financial Reporting paragraph explains that auditors conducted their audit in accordance with the standards of the PCAOB. In brief terms, it explains the process of conducting an audit of the effectiveness of ICFR. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective

98) In an audit report on the effectiveness of ICFR for a public company, which paragraph cautions not to use the current year opinion to assume that future internal controls will be effective? A) Definition and inherent limitations paragraph B) Scope paragraph C) Opinion paragraph D) Paragraph referencing the financial statement audit Answer: A Explanation: The final sentence of the definition and inherent limitations paragraph cautions not to use the current year opinion to assume that future internal controls will be effective. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective 99) In an audit report on the effectiveness of ICFR for a public company, what does the definition and inherent limitations paragraph provide? A) Definition of ICFR that is taken directly from PCAOB AS 2201 B) Indication that the firm is registered with the PCAOB C) Different responsibilities of management and auditors D) Process of conducting an audit of the effectiveness of ICFR Answer: A Explanation: In an audit report on the effectiveness of ICFR for a public company, the definition and inherent limitations paragraph provides a definition of ICFR that is taken directly from PCAOB AS 2201. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective

100) In an audit report on the effectiveness of ICFR for a public company, to what does the basis of opinion paragraph make a reference? A) Registration with the PCAOB and independence requirements of the SEC and other federal securities laws B) The financial statement audit report and the type of opinion that was given on the financial statements. C) The COSO Internal Control-Integrated Framework as the criteria used as the basis for determining if ICFR are effective. D) A definition of ICFR that is taken directly from PCAOB AS 2201. Answer: A Explanation: In an audit report on the effectiveness of ICFR for a public company, the basis for opinion paragraph states the different responsibilities of management and auditors. Like the audit report on the financial statements, this paragraph references registration with the PCAOB and independence requirements of the SEC and other federal securities laws. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective 101) Which of the following is the discovery of material weakness? A) Conclusion that the company did not maintain effective ICFR over the period under audit. B) Risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. C) Identification of accounts and related assertions most at risk of material misstatement. D) High, but not absolute, level of assurance in a judgment about matters that are subjective. Answer: A Explanation: If auditors conclude the company did not maintain effective ICFR over the period under audit, it would mean the auditors discovered a material weakness in the client's ICFR. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective

102) If auditors conclude the company did not maintain effective ICFR over the period under audit, it would mean the auditors discovered a/an ________ in the client's ICFR. A) material weakness B) audit risk C) reasonable assurance D) professional skepticism Answer: A Explanation: If auditors conclude the company did not maintain effective ICFR over the period under audit, it would mean the auditors discovered a material weakness in the client's ICFR. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective 103) Bright was assigned as the auditor of Elendil Company, a public company engaged in the production of environment-friendly cars made out of wooden materials and is considered as an Accelerated Filer as per SEC. Bright explained to the client's representatives that aside from the financial statement audit, the audit team is also required to produce an audit report on the internal controls over financial reporting of Elendil. However, this was questioned by Elendil's representative as they do not understand the reason behind. Which of the following statements provide the reason why audit of ICFR is necessary? A) The audit team needs to conduct the audit of ICFR as an effective ICFR will mean that they need not conduct a financial statement audit for efficiency purposes. B) Audit of ICFR is required because an effective ICFR provides reasonable assurance on the reliability of financial reporting for external purposes. C) Conducting an audit of ICFR is required because every public company is prone to have poor internal controls in detecting fraud. D) The audit team needs to conduct an audit of ICFR so they can provide Elendil with suggestions on how they can improve their internal controls over financial reporting. Answer: B Explanation: The reason for requiring an audit of internal controls is because effective ICFR provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

104) Starry, the assigned audit engagement partner for Forlong Company, was preparing for an important meeting with the client's representative. This meeting is aimed to address the overall expectation gap between the financial statement users and the auditors. Which of the following should not be considered as an expectation gap for the audit? A) The auditor will audit all of the accounts and transactions of Forlong Company to provide an absolute assurance. B) The auditor, as a result of a successful audit, guarantees the future viability of Forlong Company. C) The procedures to be performed by the audit team will definitely find any and all fraud inside Forlong Company. D) The audit team has the necessary skills and knowledge to properly conduct the audit in accordance with the auditing standards. Answer: D Explanation: It is correct for the financial statement users to expect auditors to have the necessary skills and knowledge to properly conduct the audit in accordance with the auditing standards. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 105) The audit expectation gap is narrowed by realistic user expectations such as that the auditor ________. A) tests a sample of transactions B) is providing complete assurance C) is guaranteeing the future viability of the entity D) will definitely find any and all fraud Answer: A Explanation: One of the many realistic expectations that we must have of auditors is that the auditor does not check all transactions but only a sample of transactions. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting

106) The audit expectation gap occurs when there is a difference between the expectations of the ________. A) auditors and financial statement users B) auditors and review C) company under review and financial statement users D) generally accepted accounting principles and auditors Answer: A Explanation: The audit expectation gap occurs when there is a difference between the expectations of auditors and financial statement users. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting 107) Which of the following beliefs will narrow the audit expectation gap? A) There is no guarantee the auditor will find all material fraud, should fraud have occurred. B) The auditor is providing complete assurance. C) The auditor is guaranteeing the future viability of the entity. D) An unmodified audit opinion is an indicator of complete accuracy of the financial statements. Answer: A Explanation: The audit expectation gap will narrow with the awareness that the auditor will assess the risk of fraud and conduct tests to try to uncover any fraud, but there is no guarantee the auditor will find all material fraud, should one have occurred. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting 108) Economic conditions impact ________. A) financial statement user's expectations B) auditor performance C) both financial statement user's expectations and auditor performance D) neither financial statement user's expectations not auditor performance Answer: A Explanation: The economic conditions impact financial statement user's expectations. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting

109) Legislation impacts ________. A) auditor performance B) financial statement user's expectations C) both financial statement user's expectations and auditor performance D) neither financial statement user's expectations not auditor performance Answer: A Explanation: Legislation impacts auditor performance. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective 110) Education of financial statement users as to the responsibilities of preparers and auditors of financial statements will ________. A) reduce the audit expectation gap B) ensure the auditor will find all material fraud C) guarantee the future viability of the entity D) increase audit firm reputation and independence Answer: A Explanation: Education of financial statement users as to the responsibilities of preparers and auditors of financial statements will reduce the audit expectation gap. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting 111) In the context of auditing and assurance standards, ________ are the most specific and narrow. Answer: audit services Explanation: The relationship of assurance, attestation, and auditing services resembles overlapping umbrellas. Audit services are the most specific and narrow of the three services. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting

112) As attestation services encompass more than just the inspection of historical financial statements, the term ________ is used rather than ________. Answer: practitioner; auditor Explanation: In attestation services, the term practitioner is used rather than auditor because attestation services encompass more than just the audit of historical financial statements. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation 113) Website security and IT operations are services that come under ________ services but fall outside ________ services. Answer: assurance; attestation Explanation: Assurance services include compilation of historical statements, website security, IT operations, and non-financial information. Attestation services (under the umbrella of assurance services) include review of historical financial statements, review of financial forecast, and examination of internal control. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation 114) According to Financial Accounting Standards Board (FASB), information that is omitted or misstated could influence decisions that users make on the basis of the financial information of a specific reporting entity; in such a case, information is ________. Answer: material Explanation: The Financial Accounting Standards Board (FASB) defines materiality as follows: Information is material if omitting it or misstating it could influence decisions that users make on the basis of the financial information of a specific reporting entity. (SFAC No. 8, para QC11) Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation

115) The Internal Revenue Service (IRS) may conduct an audit of an individual or a company to determine if tax laws have been followed and the correct amount of tax paid. Thus an income tax audit is the best example of a/an ________. Answer: compliance audit Explanation: One of the best examples of a compliance audit is an income tax audit. The Internal Revenue Service (IRS) may conduct an audit of an individual or a company to determine if tax laws have been followed and the correct amount of tax paid. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation 116) ________ are users of financial statements who are particularly interested in the capacity of the company to pay a dividend. Answer: Investors Explanation: Investors generally read financial statements to determine whether they should invest in the company. They are interested in the return on their investment and are concerned that the entity will remain a going concern (continue operating) into the foreseeable future. Investors may also be interested in the capacity of the company to pay a dividend. Prospective investors read financial statements to determine whether they should buy shares in the entity. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Measurement Analysis and Interpretation 117) ________ are users of financial statements who are particularly interested in determining whether the company is sufficiently credit worthy. Answer: Lenders Explanation: Lenders may read financial statements to determine whether an entity is sufficiently credit worthy to make a loan to the entity and whether it can pay the interest and principal as they come due. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Measurement Analysis and Interpretation

118) ________ relates to the application of relevant training, knowledge, and experience that auditors use while making informed audit decisions in conducting an audit. Answer: Professional judgment Explanation: Professional judgment relates to the application of relevant training, knowledge, and experience that auditors use while making informed audit decisions in conducting an audit. Auditors must use their judgment throughout the entire audit. For example, auditors must use judgment when determining if an information source is reliable. They must also use judgment when deciding if enough audit evidence has been gathered to support the audit opinion. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Measurement Analysis and Interpretation 119) ________ relates to auditors remaining independent of the entity, its management and its staff when completing the audit work and thoroughly investigating all evidence presented by their client. Answer: Professional skepticism Explanation: Professional skepticism means the auditors remain independent of the entity, its management and its staff when completing the audit work. In a practical sense, it means the auditors maintain a questioning mind and thoroughly investigate all evidence presented by their client. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Measurement Analysis and Interpretation 120) The accounting firm CBIZ/Mayer Hoffman McCann PC is one of the ________ firms. Answer: mid-tier Explanation: Below the Big 4, the next tier of accounting firms is known as the mid-tier. The firms that comprise the mid-tier have a significant presence nationally and most have international affiliations. The mid-tier firms in the U.S. include, among others, Grant Thornton LLP, BDO USA LLP, RSM LLP, CBIZ/Mayer Hoffman McCann PC, and Crowe Global LLC. These firms service medium-sized and smaller clients. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: Customer Perspective

121) The paragraph of an unmodified audit report on the financial statements of a private firm explains that an audit was conducted and identifies the financial statements and the date of the financial statements is the ________ paragraph. Answer: opinion Explanation: The opinion paragraph of an unmodified audit report on the financial statements explains that an audit was conducted and identifies the financial statements and the date of the financial statements. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Reporting 122) In an unmodified audit report on the financial statements of a private firm, the ________ paragraph states that the auditor believes that the financial statements are fairly presented, in all material respects, in accordance with the applicable financial reporting framework. Answer: opinion Explanation: In an unmodified audit report on the financial statements of a private firm, the opinion paragraph clearly states the auditor's opinion that the financial statements are fairly presented, in all material respects, in accordance with the applicable financial reporting framework. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Reporting 123) In the title of an audit report on the effectiveness of ICFR for a public company, the term ________ emphasizes that the auditors are external to the company and therefore can provide an objective opinion. Answer: independent Explanation: In the title of an audit report on the effectiveness of ICFR for a public company, the term "independent" emphasizes that the auditors are external to the company and therefore can provide an objective opinion. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective

124) In an audit report on the effectiveness of ICFR for a public company, report ________ indicates that the firm is registered with the PCAOB. Answer: title Explanation: In the title of an audit report on the effectiveness of ICFR for a public company, the term "registered" is required to indicate that the firm is registered with the PCAOB. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective 125) One of the factors that impacts auditor performance is ________. Answer: audit standards, ethical standards, regulations, legislation, or firm policy and procedures Explanation: Auditor performance is impacted by audit standards, ethical standards, regulations, legislation, and firm policy and procedures. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Measurement Analysis and Interpretation 126) ________ is an assurance service but not an attestation service. Select all that apply. A) Review of historical financial statements B) Compilation of non-financial information C) Examination of internal control D) Review of a financial forecast Answer: B Explanation: Assurance services include compilation of non-financial information, historical statements, website security, and IT operations. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation

127) When describing assurance, attestation, and audit services, which of the following can be considered a common characteristic among these services? Select all that apply. A) An independent accounting firm obtains information prepared by someone else and compares it with a set of criteria. B) An independent accounting firm provides a written report discussing the results of the service performed. C) An independent accounting firm provides a service that adds credibility to the information making it useful for decision making. D) An independent accounting firm provides financial statement users with an opinion on whether financial statements are presented fairly in accordance with an applicable framework. Answer: A, B, C Explanation: Providing an opinion as to whether financial statements are presented fairly in accordance with an applicable financial reporting framework only pertains to audit services in particular. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

128) In determining which types of services an independent accounting firm provides, which of the following falls under attestation services? Select all that apply. A) Audit of historical financial statements B) Examination of financial forecasts C) System organization and control reports D) Risk advisory services E) Website security services F) Agreed-upon procedures Answer: A, B, C, F Explanation: Risk advisory, website security, and data integrity services fall are classified as assurance services but not attestation. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 129) In determining which types of services an independent accounting firm provides, which of the following falls under audit services? Select all that apply. A) Audit of historical financial statements B) Examination of financial forecasts C) Audit of internal controls over financial reporting D) Review of historical financial statements Answer: A, C Explanation: Examination of financial forecasts and review of historical financial statements are classified as attestation but not audit services. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

130) When understanding the differences between review and audit services, which of the following relates to a review rather than an audit? Select all that apply. A) The practitioner does not provide an opinion on whether the financial statements are presented fairly. B) The practitioner obtains reasonable assurance about whether the financial statements as a whole are free of material misstatement. C) It is a less expensive service that can be very useful for smaller private companies. D) The practitioner expresses limited assurance that no material modifications need to be made to the financial statements. Answer: A, C, D Explanation: Obtaining reasonable assurance is applicable to audit services rather than review. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 131) When discussing the fact that an audit is not a guarantee that the financial statements are free from error or fraud, which of the following can be stated as a limitation of an audit? Select all that apply. A) The nature of financial reporting B) The nature of audit procedures C) The need for the audit to be conducted within a reasonable period of time D) The need for the audit to be conducted at a reasonable cost Answer: A, B, C, D Explanation: The limitations of an audit are caused by (1) the nature of financial reporting, (2) the nature of audit procedures, and (3) the need for the audit to be conducted within a reasonable period of time at a reasonable cost (AU-C 200.A49). Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

132) In understanding the demand for audit and assurance services, which of the following can be considered as a financial statement user? Select all that apply. A) Investors B) Suppliers C) Customers D) Lenders E) Employees F) Governments G) General public Answer: A, B, C, D, E, F, G Explanation: Financial statement users include current and potential investors, suppliers, customers, lenders, employees, governments, and the general public. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 133) Which of the following is/are acceptable reasons why financial statement users demand an audit service? Select all that apply. A) Users do not have access to the company under review. B) Financial statements are complex and often require significant knowledge and experience to evaluate. C) Users want to obtain absolute assurance that financial statements are free from error. D) Users may find it difficult or impossible to identify when management is presenting biased information. E) Users are concerned with the reliability of the information contained in the financial statements. Answer: A, B, D, E Explanation: Financial statement users demand an audit of financial statements because of remoteness, complexity, competing incentives, and reliability. Obtaining absolute assurance is not achievable in an audit. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

134) In differentiating the role of a preparer versus an auditor, which of the following more closely relates to a preparer? Select all that apply. A) Ensures information in the financial statements complies with the applicable financial reporting framework B) Maintains a questioning mind and thoroughly investigates evidence presented C) Designs, implements, and maintains internal control over financial reporting D) Provides access to all records, documentation, and personnel relevant to the financial statement preparation Answer: A, C, D Explanation: Maintaining a questioning mind to investigate thoroughly evidence presented is a task of an auditor. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 135) Which of the following is/are regulators and other organizations that impact the audit process and the profession? Select all that apply. A) Securities and Exchange Commission (SEC) B) Public Company Accounting Oversight Board (PCAOB) C) American Institute of Certified Public Accountants (AICPA) D) Financial Accounting Standards Board (FASB) E) Committee on Sponsoring Organizations of Treadway Commission (COSO) F) National Association of State Boards of Accountancy (NASBA) Answer: A, B, C, D, E, F Explanation: The regulators and other organizations that impact the audit process and the profession include the SEC, PCAOB, AICPA, FASB, COSO, and NASBA. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

136) In identifying the audit expectation gaps, which of the following pertains to reality of an audit service? Select all that apply. A) The auditor has checked all transactions. B) An auditor provides reasonable assurance. C) An auditor guarantees the future viability of the entity. D) The auditor will definitely find any and all fraud. Answer: B Explanation: An auditor only provides reasonable assurance, does not guarantee future viability of the entity, does not guarantee that the auditor will find all material fraud, and tests a sample of transactions. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 137) Briefly describe the similarities between assurance, attestation, and audit services. Answer: The terms assurance, attestation, and auditing are sometimes used interchangeably, but they actually represent different types of services. They are similar in that they all represent a common process of an independent accounting firm taking information prepared by someone else and comparing that information to an established set of criteria. At the end of the service, the independent accounting firm provides a written report about the results of the service performed. This process is important because it adds credibility, or integrity, to the information, which makes it more useful for decision making. Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Analytic AICPA: AC: Measurement Analysis and Interpretation 138) In an attestation engagement, what is a CPA engaged to provide? Answer: Attestation services are performed when an independent practitioner, or CPA, is engaged to issue a report on subject matter that is the responsibility of another party. Diff: 1 LO: 1 Bloom: Application Min: 1 AACSB: Analytic AICPA: AC: Reporting

139) What is the primary goal of the CPA in performing the attest function? Answer: The CPA's primary goal is to determine whether the client's assertions are fairly stated. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Measurement Analysis and Interpretation 140) Briefly describe the focus of each of the following professional engagements: 1 - Auditing Engagement 2 - Attestation Engagement 3 - Assurance Engagement Answer: 1 - Auditing Engagement - financial statements 2 - Attestation Engagement - financial information about the entity 3 - Assurance Engagement - any information as requested by the entity Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research 141) Wella is a newly-promoted partner in an auditing firm and is currently conducting a training for new-hires. One of the participants wanted to know why a financial statement audit is important and how it adds value to its intended users. What should be Wella's response? Answer: The purpose of an audit of financial statements is to provide financial statement users with an opinion by the auditor on whether the financial statements are presented fairly in accordance with an applicable financial reporting framework. These audit services enhance the degree of confidence that intended users can place in the financial statements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research

142) In a financial audit report issued by the audit team, Claudia, the audit team manager, noticed that the terms 'practitioner' and 'auditor' were used interchangeably by the team. What should be the explanation of Claudia why these terms should not be used interchangeably? Answer: The term 'practitioner' is used for attestation services because these encompass more than just the audit of historical financial statements and internal controls which is more appropriate for the term 'auditor'. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research 143) What is independence and when discussing the difference between assurance, attestation, and audit services, which among these is independence required? Answer: The term independence is common to audit, attestation, and assurance services. Independence implies that the service is performed by someone who was not involved with the creation of the information and who is objective in the evaluation of the information. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research

144) Junior, a newly-hired staff of a professional services firm, was having a hard time in choosing which among the services currently being offered by the firm should Junior choose as a specialization. For Junior to have a better decision, how would you describe the differences between financial statement audit, compliance audit, operational audit, and internal audit? Answer: • A financial statement audit is to provide financial statement users with an opinion by the auditor on whether the financial statements are presently fairly in accordance with an applicable financial reporting framework, which enhances the degree of confidence that intended users can place in the financial statements. • A compliance audit involves gathering evidence to determine whether the person or entity under review has followed the rules, policies, procedures, laws, and regulations with which they must conform. • Operational (performance) audits are concerned with the economy, efficiency, and effectiveness of an organization's activities. • Internal audits are conducted to provide assurance about various aspects of an organization's activities. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research 145) During a discussion with a potential new client, one of the partners in an audit firm was explaining to the client the process of a financial statement audit. However, as the client was only considered a relatively small business, the client asked if there is a less extensive service than an audit which the partner can offer. What is the best way that the partner can explain what a review is and how it differs from an audit? Answer: In a review, the auditor does not provide an opinion on whether the interim financial statements are presented fairly. Instead, the auditor would only state if there were any material modifications that should be made for the interim financial statements to be in conformity with the applicable financial reporting framework. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research

146) Explain why the nature of financial reporting is considered a limitation of an audit. Answer: The nature of audit procedures refers to the reliance on evidence provided by the client and its management. It can be difficult for an auditor to determine whether a fraud has occurred because documents altered by those committing the fraud generally hide evidence. Also, auditors often use sampling techniques when gathering audit evidence. If a sample is not representative of all items available for testing, an auditor may arrive at an incorrect conclusion. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research 147) Explain why the need for a timely audit is considered a limitation of an audit. Answer: The timeliness and cost of a financial statement audit refer to the pressure auditors face to complete their audit within a certain time frame at a reasonable cost. While it is important that auditors do not omit procedures in an effort to meet time and cost constraints, they may be under some pressure to do so. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research 148) You were assigned by your manager to conduct an operational audit for a new client. However, this is your first time to conduct this engagement and is not familiar with the relevant terms used in this service. How would you explain the differences between economy, efficiency, and effectiveness? Answer: • Economy refers to the cost of inputs, including wages and materials. • Efficiency refers to the relationship between inputs and outputs, or the use of the minimum number of inputs to achieve a given output. • Effectiveness refers to the achievement of certain goals or the production of a certain level of outputs. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research

149) You are an accounting professor in a university and is currently teaching accounting to college students. In one of your lessons, a student asked who are the users of financial statements. As a response to your student, who will you mention as users of financial statements and how do they use these? Answer: Financial statement users include current and potential investors, suppliers, customers, lenders, employees, governments, and the general public. • Investors generally read financial statements to determine whether they should invest in the company. • Suppliers may read financial statements to determine whether the company can pay for goods or services supplied. • In many business-to-business transactions, customers may read financial statements to determine whether a company they rely on is likely to remain a going concern and meet their needs. • Lenders may read financial statements to determine whether an entity is sufficiently creditworthy to qualify for a loan and whether it can pay the interest and principal as they come due. • Employees may read financial statements to determine whether the entity can pay their wages or salaries and other benefits (for example, pensions). • Governments may read financial statements to determine whether the company is complying with regulations, to evaluate if the company is paying a fair amount of taxes given its reported earnings, and to gain a better understanding of the company's activities. • The general public may read financial statements to determine whether they should associate with the company (for example, as a future employee, customer, or supplier), and to gain a better understanding of the company, what it does, and its plans for the future. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research 150) Sky is a manager in an audit firm and is currently assigned a booth in a job fair to promote their firm to job seekers. A number of job seekers asked Sky what audit and assurances services are and if these are services that companies need nowadays. How should Sky explain what drives the demand for audit and assurance services? Answer: There are a number of reasons why some or all of these users would demand an audit of financial statements. These include remoteness of financial statement users, complexity of financial statements, competing incentives which may lead to biased presentation, and reliability of information. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research

151) Hodor is currently seeking his first job in the accounting and auditing field and came across two interesting jobs in Hodor's dream company. One of the roles is a preparer and another is an auditor but Hodor is having a hard time distinguishing between the two. What is the best explanation to Hodor regarding the differences between a preparer and auditor role? Answer: Preparer responsibility include the following: • Ensuring the information included in the financial statements is presented fairly and complies with the applicable financial reporting framework, which in the United States is most often GAAP. • Designing, implementing, and maintaining internal control relevant to the preparation and fair presentation of the financial statements. • Providing the auditors with access to all records, documentation, and personnel relevant to the preparation and fair presentation of the financial statements, and any additional information the auditors may consider relevant to complete the audit. Auditor responsibility include the following: • Conducting the audit in accordance with the appropriate auditing standards. • Planning and performing the audit with professional skepticism. • Planning and performing the audit with professional judgment. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research 152) Pricefirecoopers (PFC) is a newly created professional services firm and is in the process of hiring individuals to work for them. The Human Resources department is building up the job description of an auditor but does not know what to indicate. What skills would you recommend to the Human Resources department as ideal for the role of an auditor? Answer: • Auditors must have extensive knowledge of accounting and auditing standards. • Auditors must have good analytical and critical-thinking skills. • Auditors must possess technology skills, especially in the area of data analytics. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research

153) Identify the different regulators and organizations that affect the audit profession and briefly describe their function. Answer: • Securities and Exchange Commission (SEC) — primary task is to enforce and interpret securities laws • Public Company Accounting Oversight Board (PCAOB) — its mission is to oversee the audits of public companies to protect the interests of investors • American Institute of Certified Public Accountants (AICPA) — represents the profession before rule-making bodies, acts as an advocate for the profession before legislative bodies, provides educational materials to its members, and sets ethical standards for the profession. Auditing standards for non-issuers. • Financial Accounting Standards Board (FASB) — mission is to establish financial accounting and reporting standards for nongovernmental entities with the goal of providing information that is useful for decision making • Committee on Sponsoring Organizations of the Treadway Commission (COSO) — focuses on providing guidance to management and expertise in the areas of internal control, enterprise risk management, and fraud deterrence • National Association of State Boards of Accountancy (NASBA) and State Boards of Accountancy — mission is to enhance the effectiveness and advance the common interests of its members, which are the state boards of accountancy Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research 154) Explain the term 'reasonable assurance' as it relates to a financial statement audit. Answer: Reasonable assurance is a high, but not absolute, level of assurance. In other words, the auditor does not "guarantee" or "certify" that the financial statements are 100% accurate because that is considered absolute assurance, which is not possible with content that is subjective. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research

155) Your client, McCoy Manufacturing, wants an audit so that the management can tell their bank that their financial statements have been certified to be 100% accurate. Explain why you, the auditor, are unable to provide absolute assurance on the accuracy of the financial statements. Answer: The responsibility of the auditor is to provide an opinion on whether the financial statements are presented fairly in accordance with the applicable financial reporting framework. An opinion is defined as a judgment about matters that are subjective. The preparation of financial statements is considered somewhat subjective because management must make some estimates and choose between different accounting methods. Therefore, the auditor is only required to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. Reasonable assurance is a high, but not absolute, level of assurance (AU-C 200.06). In other words, the auditor does not "guarantee" or "certify" that the financial statements are 100% accurate because that is considered absolute assurance which is not possible with content that is subjective. Diff: 3 LO: 6 Bloom: Synthesis Min: 3 AACSB: Reflective Thinking AICPA: BC: Governance Perspective 156) You are a college instructor assigned to teach the subject of auditing. During your discussion regarding audit risk, one of the students asked if an audit risk can be completely eliminated when performing a financial statement audit. What is the best response to this question? Answer: Audit risk can be reduced but not eliminated because of certain limitations of an audit such as the use of sampling and professional judgment. Auditors can only provide reasonable but not absolute assurance. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research

157) Julia, the audit manager, was approached by the audit team for guidance regarding the appropriate opinion they should issue regarding a particular client. The team had concluded that the financial statements are not presented fairly in accordance with the applicable financial reporting framework but is not sure what type of modified opinion they should issue. How should Julia describe the three types of modified opinion to the team for them to know which one is appropriate? Answer: The three types of modified opinion are the following: • Qualified — financial statements are presented fairly, except for the uncorrected departures or the auditor's inability to gather evidence for a material item • Adverse — financial statements are not presented fairly and should not be relied upon • Disclaimer of opinion — auditor was not able to gather sufficient appropriate evidence or is not independent and cannot express an opinion Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research 158) Below is a sample of the first section of a standard audit report for Gawronski's Hockey Manufacturing Company, a private company. There are two errors in this report. Describe the errors. Auditor's Report To the creditors of Gawronski's Hockey Manufacturing Company: Report on the Financial Statements We have audited the accompanying financial statements of Gawronski's Hockey Manufacturing Company, which comprises the balance sheets as of December 31, 2022 and 2021, and the related statements of income, changes in equity and cash flows for the years then ended, and the related notes to the financial statements. Answer: [1] Title — the term independent is missing in the title of the report [2] Address — The report is addressed to the creditors of the company rather than the owners or shareholders of the company and to the board of directors, if applicable. Diff: 3 LO: 6 Bloom: Evaluation Min: 3 AACSB: Analytic AICPA: AC: Reporting

159) Below is a sample of the auditor's responsibility section of a standard audit report for Gawronski's Hockey Manufacturing Company, a private company. There are two errors in this report. Describe the errors. Auditor's Responsibility Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted accounting principles. Those standards require that we plan and perform the audit to obtain absolute assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Answer: Both errors are in the first paragraph Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain absolute assurance about whether the financial statements are free from material misstatement. 1) The appropriate audit standards would be those issued by the ASB since the company is a private company. 2) Audits provide reasonable assurance, not absolute. Diff: 3 LO: 6 Bloom: Evaluation Min: 3 AACSB: Analytic AICPA: AC: Reporting

160) Below is a sample of the auditor's opinion section of a standard audit report for Gawronski's Hockey Manufacturing Company, a private company. There are two errors in this report. Describe the errors. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Gawronski's Hockey Manufacturing Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for the years then ended in accordance with auditing standards generally accepted in the United States of America. Keith Christy, Partner Adrian, Michigan February 15, 2023 Answer: Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Gawronski's Hockey Manufacturing Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Christy and Quinlan, LLP February 15, 2023 1) The financial statements are in accordance with GAAP, not GAAS 2) The firm name is used in the signature, not the individual partner's name Diff: 3 LO: 6 Bloom: Evaluation Min: 3 AACSB: Analytic AICPA: AC: Reporting

161) The standard "clean" audit reports for audits of public companies have several differences to reports for audits of private companies. Describe at least three of those differences noted in the audit reports for public companies. Answer: Some differences that may be noted include: Title -The term registered is included to emphasize the firm is registered with the PCAOB. Paragraph order — The opinion paragraph comes at the beginning of the report, along with other differences in the order of paragraphs Paragraph referencing the audit of internal control — This paragraph is unique to the public company audit report. Public companies are required to have an audit of ICFR and auditors issue a separate opinion for that audit, which is discussed in the next section. Basis for opinion paragraph —The private company report goes into more detail regarding the responsibilities of management and auditors. One key difference is this paragraph references registration with the PCAOB and independence requirements of the SEC and other federal securities laws. Scope paragraph — It includes an explicit statement that PCAOB audit standards were followed since it is a public company. Auditor tenure — The final component of the report is a sentence that states the year in which the firm began serving consecutively as the company's auditor. Diff: 3 LO: 6 Bloom: Evaluation Min: 3 AACSB: Analytic AICPA: AC: Reporting 162) Describe the auditor's responsibility regarding the detection of fraud. Answer: The auditor should design audit procedures that will provide reasonable assurance that the financial statements are free from material misstatement due to errors and/or fraud. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: AC: Risk Assessment, Analysis and Management

163) You are auditing Gray Enterprises, a public company. During the audit, a material weakness was discovered during the audit of internal controls over financial reporting. Discuss how the auditors should handle this situation in the audit report and reference the appropriate PCAOB auditing standard. Answer: If one or more material weaknesses are discovered during the audit, then auditors issue an adverse opinion on the effectiveness of ICFR that explicitly states the company did not maintain effective ICFR during the period under audit. PCAOB AS 2201 dictates how auditors would modify the audit report to express an adverse opinion. Diff: 3 LO: 7 Bloom: Evaluation Min: 3 AACSB: Analytic AICPA: AC: Reporting 164) When does an auditor issue an adverse opinion when performing an audit on internal controls over financial reporting? Answer: If one or more material weaknesses are discovered during the audit, then auditors issue an adverse opinion on the effectiveness of ICFR that explicitly states the company did not maintain effective ICFR during the period under audit. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research 165) Explain the concept of a company's internal control over financial reporting. Answer: A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research

166) Explain what is a performance gap and how can it be reduced. Answer: Performance gap is the difference between auditor performance and auditing standards and regulations. This can be reduced by: • Auditors performing their duties appropriately, complying with auditing standards, and meeting the minimum standards of performance that should be expected of all auditors. • Inspections of audits to ensure that auditing standards have been correctly applied. • Assurance providers reporting accurately the level of assurance being provided. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research 167) Explain what is an expectation gap and how can it be reduced. Answer: Expectation gap is the difference between a financial statement user's expectations and auditing standards and regulations. This can be reduced by: • Auditing standards being reviewed and updated on a regular basis to enhance the work being done by auditors. • Education of financial statement users as to the responsibilities of preparers and auditors of financial statements. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Research 168) Smith Corp. orally engaged TRA CPAs, to audit its financial statements. The management of Smith Corp. informed TRA CPAs that it suspected that the accounts receivable was materially overstated. Although the financial statements audited by TRA CPAs did, in fact, include a materially overstated accounts receivable balance, TRA issued an unqualified opinion. Smith Corp then relied on the financial statements in deciding to obtain a loan from Town Bank to expand its operations and Town Bank relied on the financial statements in making the loan to Smith Corp. As a result of the overstated accounts receivable balance, Smith Corp. has defaulted on the loan and has incurred a substantial loss. If Smith Corp sues TRA CPAs for negligence in failing to discover the overstatement, what is TRA CPA's best defense? Answer: TRA CPAs best defense is that the audit was performed by Dex in accordance with generally accepted auditing standards. Diff: 3 LO: 7 Bloom: Evaluation Min: 3 AACSB: Ethics AICPA: AC: Measurement Analysis and Interpretation

169) You are a staff auditor at Broman, LLP. You have been assigned to an audit engagement with a new intern. The intern mentions the client stated, "he was glad the auditors were there to guarantee the future success of the business so that his lousy banker would get off his back". You explain that the audit firm does not guarantee anything. Explain the audit expectation gap to the intern and provide several ways that the audit expectation gap can be reduced. Answer: The audit expectation gap occurs when there is a difference between the expectations of auditors and financial statement users. The gap occurs when user beliefs do not align with what an auditor has actually done. In particular, the gap is caused by unrealistic user expectations such as: o the auditor is providing complete assurance o the auditor is guaranteeing the future viability of the entity o an unmodified audit opinion is an indicator of complete accuracy of the financial statements o the auditor will definitely find any and all fraud o the auditor has checked all transactions. The reality is that: o an auditor provides reasonable assurance o the audit does not guarantee the future viability of the entity o an unmodified opinion indicates the auditor believes there are no material misstatements in the financial statements o the auditor will assess the risk of fraud and conduct tests to try to uncover any fraud, but there is no guarantee the auditor will find all material fraud, should one have occurred o the auditor tests a sample of transactions. The audit expectation gap can be reduced by: o auditors performing their duties appropriately, complying with auditing standards and meeting the minimum standards of performance that should be expected of all auditors o inspections of audits to ensure that auditing standards have been applied correctly o auditing standards being reviewed and updated on a regular basis to enhance the work being done by auditors o education of financial statement users as to the responsibilities of preparers and auditors of financial statements o assurance providers reporting accurately the level of assurance being provided Diff: 3 LO: 8 Bloom: Synthesis Min: 3 AACSB: Analytic AICPA: AC: Reporting

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Auditing, 2e (Johnson) Chapter 2 Professionalism and Professional Responsibilities 1) The cornerstone of the public accounting profession is evidenced by the work done in the public interest by CPAs. Answer: TRUE Explanation: The cornerstone of the public accounting profession is recognized in the public interest in the work done by CPAs Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 2) Both licensed tax preparers and CPA professionals have the right to sign tax returns. Answer: TRUE Explanation: The right to sign tax returns as a tax preparer is granted to both licensed tax preparers and licensed CPA Professionals. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: Governance Perspective; AC: Reporting; PC: None 3) A professional concerned for the public interest (CPI) is defined by their professional line of work or occupation. Answer: FALSE Explanation: In the context of an EC Professional, the profession is usually defined by the line of work or occupation. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: Governance Perspective; AC: Reporting; PC: None

4) The rules of AICPA Code of Professional Conduct are applicable to members in public practice only. Answer: FALSE Explanation: The rules of AICPA Code of Professional Conduct are applicable to members in public practice, those in business, and others. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: Governance Perspective; AC: Reporting; PC: None 5) The rules of conduct of the AICPA Code of Professional Conduct establish minimum standards of ethical conduct in the performance of professional services. Answer: FALSE Explanation: The rules of conduct of the AICPA Code of Professional Conduct establish minimum standards of acceptable conduct in the performance of professional services. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: Governance Perspective; AC: Reporting; PC: None 6) CPAs must obtain their license from State Boards of Accountancy. Answer: TRUE Explanation: CPAs must obtain their license from State Boards of Accountancy, irrespective of whether they are members of the AICPA or not. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: Governance Perspective; AC: Reporting; PC: None 7) An adverse interest threat is a threat that a CPA will not act with objectivity because the CPA's interests are opposed to the client's interests. Answer: TRUE Explanation: An adverse interest threat is a threat that a CPA will not act with objectivity because the CPA's interests are opposed to the client's interests. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: Governance Perspective; AC: Reporting; PC: None 2

8) Of the three basic types of safeguards, the first is the safeguards implemented by a client. Answer: FALSE Explanation: In three basic types of safeguards, the first is safeguards created by the profession (e.g., the safeguards suggested in the rules of the code of conduct, legislation, or regulation). Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: Governance Perspective; AC: Reporting; PC: None 9) CPAs should evaluate identified threats individually only. Answer: FALSE Explanation: CPAs should evaluate identified threats both individually and in aggregate. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 10) According to the integrity and objectivity rule, a member need not be free of conflict of interest. Answer: FALSE Explanation: According to the integrity and objectivity rule, a member should be free of conflict of interest. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 11) The rule on integrity and objectivity applies to all services performed by CPAs. Answer: TRUE Explanation: The rule on integrity and objectivity applies to all services performed by CPAs, including tax, audit, bookkeeping, and consulting services. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None

12) Independence in appearance is avoiding potential conflicts of interest that can be observed by others. Answer: TRUE Explanation: Independence in appearance is avoiding potential conflicts of interest that can be observed by others. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 13) Partners and managers with consultation, oversight, or review responsibilities related to the engagement are covered members. Answer: TRUE Explanation: Partners and managers with consultation, oversight, or review responsibilities related to the engagement are covered members. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting; PC: None 14) A covered member can be a trustee of a trust or an executor of an estate who invests in an attest client. Answer: FALSE Explanation: A covered member cannot be a trustee of a trust or an executor of an estate who invests in an attest client. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 15) The general standards of the AICPA Code of Professional Conduct can help study and understand the ethical behavior of CPAs. Answer: TRUE Explanation: The general standards of the AICPA Code of Professional Conduct can help study and understand the ethical behavior of CPAs. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 4

16) The general standards of the AICPA Code of Professional Conduct apply only to CPAs performing attest engagements. Answer: FALSE Explanation: The general standards of the AICPA Code of Professional Conduct apply to all CPAs performing public accounting services. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 17) If a CPA is unable to gain sufficient competence, a CPA should suggest the engagement of a competent person to perform the needed professional service. Answer: TRUE Explanation: If a CPA is unable to gain sufficient competence, a CPA should suggest the engagement of a competent person to perform the needed professional service. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 18) It is important for a client who is considering purchasing accounting software to know that their CPA is being paid a commission if the business purchases the software. Answer: TRUE Explanation: It is important for a client considering purchasing accounting software to know that the CPA is being paid a commission if the business purchases the software. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Technology AICPA: BC: Global and Industry Perspectives; AC: Reporting; PC: None 19) Rule 1.500 of the AICPA pertains to confidential information. Answer: FALSE Explanation: Rule 1.700 of the AICPA pertains to confidential information. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 5

20) The auditor generally uses the due care defense in breach of contract suits involving negligence. Answer: TRUE Explanation: The auditor generally uses the due care defense in breach of contract suits involving negligence. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 21) In the case of an embezzlement, the bonding company can bring suits against the CPA for failing to discover the fraud. Answer: TRUE Explanation: When an embezzlement occurs, the bonding company reimburses the insured (the client) for its losses. Then, under the right of subrogation to the insured's contractual claim, the bonding company can bring suits against the CPA for failing to discover the fraud. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 22) A due care defense is a primary defense against tort actions just as it constitutes a contributory negligence defense. Answer: TRUE Explanation: A due care defense is a primary defense against tort actions,as it is for contributory negligence. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None

23) In legal defense, the defendant must establish that the plaintiff's loss resulted in whole or in part from causes other than the false or misleading statements. Answer: TRUE Explanation: In defense, the defendant must establish that the plaintiff's loss resulted in whole or in part from causes other than the false or misleading statements. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 24) The defendant in a Section 18 suit must prove that he or she had knowledge of the false or misleading statement. Answer: FALSE Explanation: The defendant (the auditor) in a Section 18 suit must prove that he or she had no knowledge of the false or misleading statement. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 25) Only smaller class action lawsuits, which involve less than 50 people, can still be filed in a state court. Answer: TRUE Explanation: Only smaller class action lawsuits, which involve less than 50 people, can still be filed in a state court. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None

26) In defining a profession or professional, one common characteristic is ________. A) concern for the public interest B) self-promotion C) effective marketing skills D) effective communication skills Answer: A Explanation: A profession can be defined by a concern for the public interest. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 27) CPAs and the accounting profession in general are often defined by a responsibility and concern for the public interest. In order for accountants and CPAs to effectively uphold this concern for the public interest, which of the following must be adhered to? A) The CPA must apply effective, impartial judgment at all times, but ultimately submit to management's wishes during an audit. B) CPAs should approach any audit objectively and impartially and be cognizant that their primary beneficiary is ultimately the public and the public interest. C) Complete optional continuing professional education courses if the CPA so chooses, to learn about new developments in the field. D) CPAs must pass a rigorous professional exam, complete an experience requirement, and agree to immediately withdraw from any audit when there is a disagreement between the auditor and management. Answer: B Explanation: CPAs should approach any audit objectively and impartially and be cognizant that their primary beneficiary is ultimately the public and the public interest. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

28) Johnson CPA Firm has been assisting a client with tax preparation work. The client is a small business who hired Johnson CPA Firm because they did not have the necessary expertise inhouse to file the appropriate and correct tax forms. As the engagement draws to a close, the client requests that Johnson CPA Firm sign the tax report on their behalf. Johnson's most appropriate response in this situation is ________. A) to advise the client that under State Board of Accountancy rules, they are not allowed to sign the tax forms, and that the client should sign instead B) to explain to the client that while Johnson can sign the forms, the legal liability for any errors or fraud remains with the client C) to advise the client that Johnson, as a CPA firm, is authorized to sign the tax forms as a tax preparer D) to request the client to take the tax forms to another CPA for review and signing, as it would be a conflict of interest for Johnson to sign off on their own work Answer: C Explanation: to request the client take the tax forms to another CPA for review and signing, as it would be a conflict of interest for Johnson to sign off on their own work. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 29) External auditors must be extremely careful when interacting with management during an audit, and should maintain independence in appearance and fact at all times, to the greatest extent possible. Which of the following choices best describes the relationship between the external auditors and client management? A) External auditors should collaborate closely with client management and withdraw immediately if there are any disagreements. B) External auditors need to be seen as being independent of management, and ensure they are ultimately serving the public interest. C) Management and the external auditors should preemptively agree on what changes the auditor will make, to ensure management cooperate accordingly. D) External auditors need to be independent of management in order to guarantee reasonable assurance of no material misstatements in the financial statements. Answer: B Explanation: External auditors need to be seen as being independent of management, and ensure they are ultimately serving the public interest. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

30) Which group licenses CPAs? A) The FASB B) The SEC C) The AICPA D) The State Boards of Accountancy Answer: D Explanation: The State Boards of Accountancy license CPAs. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: Governance Perspective; AC: Reporting; PC: None 31) What must CPAs complete to achieve licensure? A) An application, required education, and pass the CPA Exam. B) Required education, pass the CPA Exam, and requisite experience requirement. C) An application, fingerprints, and pass the CPA Exam. D) A background check, drug test, and pass the CPA Exam. Answer: B Explanation: CPAs must have the required education, pass the exam, and possess the requisite experience. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: Governance Perspective; AC: Reporting; PC: None 32) There was public concern about professional auditing in the late 1990s and the 21st century when about ________ of all public companies had to restate their earnings. A) 8 percent B) 2 percent C) 15 percent D) 30 percent Answer: A Explanation: During the late 1990s and the first few years of the 21st century, auditors failed to find many material misstatements on a timely basis, and many times management had to restate earnings due to material misstatements. There was public concern about the quality of professional auditing services when about 8% of all public companies had to restate their earnings in the late 1990s and early 21st Century. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 10

33) According to Chapter 2 regarding professionalism and professional responsibilities, CPI stands for ________. A) commitment to professional integrity B) concern for public interest C) continuing professional interest D) classified professional intelligence Answer: B Explanation: CPI stands for concern for public interest. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 34) Interpretations provide additional guidance regarding the scope and applicability of the ________. A) rules of conduct B) standards C) conceptual framework D) principles Answer: A Explanation: Interpretations provide additional guidance regarding the scope and applicability of the rules of conduct. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: Global and Industry Perspectives; AC: Reporting; PC: None

35) One of the defining characteristics of a profession, including the accounting profession, is a code of professional ethics, and a commitment by members to abide by and adhere to this code. Which of the following statements is most accurate pertaining to a code of professional ethics? A) As the code is not enforceable, members should ideally attempt to abide by the code of ethics at all times and document any departures from it. B) A professional code of ethics which members are strictly required to adhere to enhances investors and the public's confidence in CPAs and the accounting profession. C) A code of professional ethics must be practicable but should not be idealistic. D) CPAs who abide by the code of professional ethics generally do not affect the reputation of the accounting profession in general. Answer: B Explanation: A professional code of ethics which members are strictly required to adhere to enhances investors and the public's confidence in CPAs and the accounting profession. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 36) Many State Boards of Accountancy work with the AICPA on a multitude of professional issues as well as having incorporated the AICPA Code of Professional Conduct into state rules which make them applicable to all CPAs in those states. Which of the following statements best describes the AICPA Code of Professional Conduct? A) Rules of conduct are designed to establish optional guidelines for performance of professional services, and interpretations provide additional guidance with respect to applicability and scope of the rules of conduct. B) Principles outline the basic tenets of ethical conduct and provide a framework, and rules of conduct establish minimum standards of acceptable conduct. C) Principles express basic tenets of ethical conduct and provide a framework, and interpretations provide optional guidance which do not require justifications of departures. D) The AICPA bylaws require members adhere to all principles of the AICPA Code of Professional Conduct. Answer: B Explanation: Principles outline the basic tenets of ethical conduct and provide a framework, and rules of conduct establish minimum standards of acceptable conduct. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

37) CPAs and the accounting profession adhere to what is known as the AICPA Code of Professional Conduct. In addition to other guidance for members and CPAs, the code consists of principles, rules of conduct, and interpretations. Which of the following statements is true regarding the AICPA Code of Professional Conduct? A) The code of professional conduct is optional; however, CPAs are encouraged to adhere to this code by both the AICPA and State Boards of Accountancy. B) Code interpretations have helped to establish minimum standards, requiring a justification by an CPA that departs from these standards. C) Code of professional conduct principles are generally considered to be more important than interpretations, and rules of conduct represent the only mandatory part of the code. D) A CPA that departs from a rule of conduct and/or an interpretation must be prepared to justify such a departure. Answer: D Explanation: A CPA that departs from a rule of conduct and/or an interpretation must be prepared to justify such a departure. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 38) Which of the following components of the AICPA are enforceable? A) Rules of conduct B) Principles C) Interpretations D) None of the choices is correct Answer: A Explanation: The rules of conduct of the AICPA are enforceable, but not the principles or interpretations. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None

39) The structure of the AICPA ________ includes four major sections: preface, rules for members in public practice, rules for members in business, and rules for other members. A) Code of Professional Conduct B) Conceptual Framework C) Independence Rules D) Rules of Conduct Answer: A Explanation: The AICPA Code of Professional Conduct is organized in four major sections: 1) a preface; 2) rules for members in public practice; 3) rules for members in business; and 4) rules for other members. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None 40) Which of the following provides guidance to all members of the AICPA with respect to performance of their professional responsibilities? A) Code of Professional Conduct B) Rules of Conduct C) Principles D) Interpretations Answer: A Explanation: The AICPA Code of Professional Conduct, which includes principles, rules, and interpretations, provides guidance to all members of the AICPA with respect to performance of their professional responsibilities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: None

41) Which component of the AICPA's Code of Professional Conduct expresses the basic tenets of ethical conduct and provides the framework for the rules that govern the performance of a member's professional responsibilities? A) Principles B) Rules of Conduct C) Interpretations D) General standards Answer: A Explanation: The principles express the basic tenets of ethical conduct and provide the framework for the rules. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 42) Which component of the AICPA's Code of Professional Conduct establishes minimum standards of acceptable conduct in the performance of professional services? A) Principles B) Rules of Conduct C) Interpretations D) General standards Answer: B Explanation: The Rules of Conduct establish minimum standards of acceptable conduct. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 43) Which component of the AICPA's Code of Professional Conduct provides additional guidance regarding the scope and applicability of the rules of conduct? A) Principles B) Rules of Conduct C) Interpretations D) General standards Answer: C Explanation: The interpretations provide additional guidance. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 15

44) The AICPA Code of Professional Conduct can be found online and is organized in four sections. Which section is first? A) Part I on ethical rules. B) Preface applicable to all members. C) Introduction to the History of the Code of Conduct. D) Foreword about AICPA membership. Answer: B Explanation: The preface is the first section of The Code. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 45) In the online version of the AICPA Code of Professional Conduct, what are used to make it easy to find related topics? A) Summaries B) A series of hyperlinks C) Outlines D) Interpretations Answer: B Explanation: Hyperlinks are used in the online version of The Code to make it easy to find related topics. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 46) Which section of the AICPA Code of Professional Conduct includes ethical rules for members in business? A) Part I B) Part II C) Part III D) Some other section Answer: B Explanation: Part II includes ethical rules for members in business. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

47) Which section of the AICPA Code of Professional Conduct includes ethical rules for other members, like non-CPA members of the AICPA? A) Part I B) Part II C) Part III D) Some other section Answer: C Explanation: Part III of The Code includes ethical rules for other members. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 48) Which section of the AICPA Code of Professional Conduct includes ethical rules for members in public practice? A) Part I B) Part II C) Part III D) Some other section Answer: A Explanation: Part I includes ethical rules for members in public practice. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 49) Which component of the AICPA's Code of Professional Conduct is enforceable wherein members must be prepared to justify departures? A) Principles B) Rules of Conduct C) Commitments D) Standards Answer: B Explanation: The rules are enforceable wherein members must be prepared to justify departures. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

50) Which component of the AICPA's Code of Professional Conduct requires that a member who departs from it shall have the burden of justifying the departure in a disciplinary hearing? A) Principles B) Standards C) Commitments D) Interpretations Answer: D Explanation: A member who departs from the interpretations shall have the burden of justifying the departure. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 51) The AICPA is an accounting organization representing the profession and membership is ________. A) non-voluntary B) voluntary C) free D) required Answer: B Explanation: Membership in the AICPA is voluntary. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 52) State Boards of Accountancy typically ________. A) work separately from the AICPA on many professional issues B) work together with the AICPA on many professional issues C) have separate codes of conduct from the AICPA D) leave the task of licensure to the AICPA Answer: B Explanation: State boards typically work together with the AICPA on many professional issues. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

53) When you pass the CPA exam and then seek licensure, you would apply to ________. A) AICPA B) your university C) NASBA D) your State Board of Accountancy Answer: D Explanation: You would apply to the State Board of Accountancy. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 54) What is a key element that best separates recognized professions from other occupations? A) Large application fees B) A commitment to ethical behavior C) Certifications D) Specific schooling requirements Answer: B Explanation: A commitment to ethical behavior separates recognized professions from other occupations. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 55) Although codes of ethics may be designed in part to encourage ideal behavior, they must also be ________. A) practical and enforceable B) idealistic and above the law C) easy to remember and basic D) balanced and confidential Answer: A Explanation: Codes of ethics must also be practical and enforceable. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

56) If a CFO of a company is dealing with an ethical situation, which section of the AICPA's Code of Professional Ethics might he/she refer? A) Part I B) Part II C) Part III D) Some other section Answer: B Explanation: He/she should refer to Part II as a member in business. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 57) If a public practice CPA firm is concerned about the ethical nature of the firm's advertising, which section of the AICPA's Code of Professional Ethics would provide guidance? A) Part I B) Part II C) Part III D) Some other section Answer: A Explanation: Part I would provide guidance to members in public practice. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 58) To be meaningful, a code of ethics must strike a balance between being ________. A) above the law but below the ideal B) below the law but above the ideal C) above the law but below practical D) below the law but above practical Answer: A Explanation: A code of ethics should be above the law but below the ideal. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

59) In which section of the AICPA Code of Professional Conduct could you find the definitions to concepts mentioned in the Code? A) Part I B) Part II C) Part III D) Preface applicable to all members Answer: D Explanation: Definitions are located in the preface. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 60) Which of the following is the threat that, due to a long or close relationship with a client, a CPA will become too sympathetic to the client's interests or too accepting of the client's work or product? A) Familiarity threat B) Adverse interest threat C) Advocacy threat D) Self-review threat Answer: A Explanation: A familiarity threat is the threat that, due to a long or close relationship with a client, a CPA will become too sympathetic to the client's interests or too accepting of the client's work or product. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 61) An advocacy threat is the threat that a CPA will ________. A) promote a client's interests B) take on the role of client management C) become too sympathetic to a client's interests D) not act with objectivity Answer: A Explanation: An advocacy threat is the threat that a CPA will promote a client's interests. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 21

62) If a CPA, during the course of an audit, needs to refer to the AICPA Code of Professional Conduct in an attempt to answer a question or resolve a dispute, the CPA should be cognizant of which of the following? A) The AICPA Code of Professional Conduct is extremely extensive and will be able to provide guidance on any situation or scenario the CPA needs assistance with. B) While the AICPA Code of Professional Conduct is extensive, it may not address every situation or scenario. In this instance, the CPA should refer to the conceptual framework. C) A reasonable and informed third party should be able to conclude, having been made aware of relevant information, that there is no threat to the CPAs compliance with the rules. D) While the AICPA Code of Professional Conduct is extensive, it may not address every situation or scenario. In this instance, the CPA should refer exclusively to the rules of conduct set forth in the code. Answer: B Explanation: While the AICPA Code of Professional Conduct is extensive, it may not address every situation or scenario. In this instance, the CPA should refer to the conceptual framework. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 63) Sunnyside External Auditors is working on the audit of Transparent Windows Co. The audit client is a relatively small firm who had historically been using a different external auditor. The client has recently apprised the auditor of ongoing litigation, and requested that the external auditor provide expert witness services to assist the client in their dense. In this situation, which of the following should the auditor be aware of? A) A familiarity threat exists, because the new external auditor has immediately been asked to assist the client in the capacity of an expert witness. B) A management participation threat exists, as the external auditor in providing expert witness services will be assuming managerial functions. C) An advocacy threat exists, because in providing expert witness services, the CPAs objectivity may be questionable. D) An adverse interest threat exists because the CPA is now performing expert witness services and may be cross-examined by the plaintiff and be compelled to provide evidence against the client. Answer: C Explanation: An advocacy threat exists, because in providing expert witness services, the CPAs objectivity may be questionable. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

64) Blue-Sky External Auditors are working on the audit of Timber Company, a large company that specializes in wood and lumber products. During the course of the audit, it has been determined that a former audit manager of Blue-Sky is now employed with Timber Company. Based on this scenario, which of the following types of threats may exist? A) An advocacy threat may exist because the interests of the former employee who now works for Timber Company may be misaligned with the interests of the external auditor. B) A management participation threat may exist because the former employee occupies a role in the client's management. C) An adverse interest threat likely exists because the former employee of the audit firm will now be placed in a position which will cause a conflict of interest. D) A familiarity threat may exist because the former employee may have greater knowledge of the policies and practices of the external auditor. Answer: D Explanation: A familiarity threat may exist because the former employee may have greater knowledge of the policies and practices of the external auditor. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 65) Glowbright External Auditors are currently reviewing their audit clients to determine where audit staff, resources and monies should be best allocated. During the course of the review, it has been determined that two clients, both large companies, represent approximately sixty percent of Glowbright's revenue. In this situation, Glowbright should be aware of what type of possible threat? A) A self-review threat is likely to exist because the auditor is unlikely to remain objective during the course of the audit because the client represents a substantial portion of the auditor's revenues. B) An undue influence threat may exist because the auditor is more likely to subordinate his or her judgment to employees of a major audit client. C) A self-interest threat may exist because the client represents a relatively significant portion of the auditors' revenues. D) A self-interest threat may exist because the auditor is more likely to issue a clean audit opinion to a major audit client. Answer: C Explanation: A self-interest threat may exist because the client represents a relatively significant portion of the auditors' revenues. Diff: 3 LO: 3 Bloom: Evaluation Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

66) During the audit of Oak Company, a firm that specializes in kitchen cabinetry and other types of furniture, senior management of Oak Company has approached the external auditor and requested assistance with bookkeeping services. Oak does not have the expertise in-house, and is thus requesting assistance from the auditor. What type of threat may exist in this situation? A) A self-review threat may exist because if the external auditor accepts the assignment to complete bookkeeping services, this will put the auditing firm in a position of having to review its own work. B) A self-interest threat is likely to exist because the auditor will now benefit from increased revenues from the client due to the ancillary work taken on. C) A management participation threat may exist because in taking on and completing extra services for the client, the auditor is more likely to be involved in managerial decisions and assume a managerial role. D) An advocacy threat could exist because the external auditor will now benefit financially from an interest with the client. Answer: A Explanation: A self-review threat may exist because if the external auditor accepts the assignment to complete bookkeeping services, this will put the auditing firm in a position of having to review its own work. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

67) During the audit of Frame Company, a medium size firm that specializes in framing services, the external auditor has determined that one of the client's key officers has a conflict of interest. This conflict of interest has been brought to the attention of the firm's board of directors who have proceeded to reassign the employee accordingly. What type of safeguard does this represent, and why? A) This type of safeguard represents a safeguard created by the profession, because the code specifically prohibits conflicts of interest within the client's management. B) This type of safeguard represents a safeguard implemented by the client, because the client's senior management took action to reassign the key employee to a different role, removing the conflict of interest. C) This represents a safeguard employed by the accounting firm, because the auditor preemptively notified management of the conflict of interest. D) None of the choices is correct. Answer: B Explanation: This type of safeguard represents a safeguard implemented by the client, because the client's senior management took action to reassign the key employee to a different role, removing the conflict of interest. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 68) A/an ________ threat exists if a CPA performs bookkeeping services for a private company client and that work needs to be evaluated by the same firm in the course of an attest engagement. A) self-review B) undue influence C) adverse interest D) advocacy Answer: A Explanation: A self-review threat exists if a CPA performs bookkeeping services for a private company client and that work needs to be evaluated by the same firm in the course of an attest engagement. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

69) If a CPA is unable to implement effective safeguards, what should the CPA do? A) Decline the engagement. B) Proceed with the professional service. C) Document the identified threats. D) Evaluate the significance of the threat. Answer: A Explanation: If a CPA is unable to implement effective safeguards, the CPA should decline or terminate the engagement. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 70) Rules of Professional Conduct and related interpretations are specifically written for ________. A) FASB members B) Accountants in public practice C) Accountants in private practice D) SEC personnel Answer: B Explanation: The rules of professional conduct and related interpretations are specifically written for those in public practice. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

71) In the absence of a rule or an interpretation, a CPA could use which of the following to apply to the accounting for a certain situation? A) The SEC rulings B) The Conceptual Framework C) An auditing textbook D) The IRS Code Answer: B Explanation: The rules in the AICPA Code of Professional Conduct and related interpretations seek to address many situations for members in public practice. However, the rules and interpretations cannot address every possible relationship or circumstance that might arise. Thus, in the absence of a rule or an interpretation, a CPA should use the Conceptual Framework to evaluate what to do. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 72) A threat that is due to a long or close relationship is a(n) ________. A) familiarity threat B) management participation threat C) self-interest threat D) self-review threat Answer: A Explanation: A familiarity threat is due to a long or close relationship. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

73) A threat that a CPA will take on the role of client decision making or assume associated responsibilities is a(n) ________. A) familiarity threat B) management participation threat C) self-interest threat D) self-review threat Answer: B Explanation: A management participation threat is the threat that a CPA will take on the role of client decisions or assume associated responsibilities. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 74) A threat that a CPA will promote a client's interests or position to the point that his or her objectivity is compromised is a(n) ________. A) familiarity threat B) advocacy threat C) self-interest threat D) self-review threat Answer: B Explanation: The advocacy threat is the threat that a CPA will promote a client's interests to the point that his or her objectivity is compromised. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 75) A threat that a CPA will not act with objectivity because the CPA's interests are opposed to the client's interests is a(n) ________. A) familiarity threat B) advocacy threat C) self-interest threat D) adverse Interest Threat Answer: D Explanation: The adverse interest threat is the threat that a CPA will not act with objectivity because the CPA's interests are opposed to the client's interests. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 28

76) A threat that a CPA could benefit, financially or otherwise, from an interest in, or relationship with, a client or persons associated with the client is a(n) ________. A) familiarity threat B) management participation threat C) self-interest threat D) self-review threat Answer: C Explanation: The self-interest threat is the threat that a CPA could benefit from an interest in or relationship with a client or persons associated with the client. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 77) A threat that a CPA will not appropriately evaluate the results of a previous judgment made by, or service performed by, an individual in the CPA's firm is a(n) ________. A) familiarity threat B) advocacy threat C) self-interest threat D) self-review threat Answer: D Explanation: The self-review threat is the threat that a CPA will not appropriately evaluate the results of a previous judgment made by, or service performed by, and individual in the CPA's firm. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

78) A threat that a CPA will allow a third party to coerce his/her judgment about a client is known as a(n) ________. A) familiarity threat B) advocacy threat C) self-interest threat D) undue influence threat Answer: D Explanation: The undue influence threat is the threat that a CPA will allow a third party to coerce his/her judgment about a client. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 79) The first step in the process to assist the CPA in making an ethical judgment is ________. A) identify threats to compliance with rules B) evaluate the significance of the threat C) identify and apply safeguards D) evaluate the effectiveness of the safeguards Answer: A Explanation: The first step is to identify threats. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 80) The last step in the process to assist the CPA in making an ethical judgment is ________. A) document the threats and safeguards B) evaluate the significance of the threat C) identify and apply safeguards D) evaluate the effectiveness of the safeguards Answer: A Explanation: The last step is to document the threats and safeguards. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

81) The second step in the process to assist the CPA in making an ethical judgment is ________. A) identify threats to compliance with rules B) evaluate the significance of the threat C) identify and apply safeguards D) evaluate the effectiveness of the safeguards Answer: B Explanation: The second step is to evaluate the significance of the threat. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 82) The third step in the process to assist the CPA in making an ethical judgment is ________. A) identify threats to compliance with rules B) evaluate the significance of the threat C) identify and apply safeguards D) evaluate the effectiveness of the safeguards Answer: C Explanation: The third step is to identify and apply safeguards. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 83) The fourth step in the process to assist the CPA in making an ethical judgment is ________. A) identify threats to compliance with rules B) evaluate the significance of the threat C) identify and apply safeguards D) evaluate the effectiveness of the safeguards Answer: D Explanation: The fourth step is to evaluate the effectiveness of the safeguards Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

84) A CPA should judge his or her ethical conduct from the perspective of a ________. A) reasonable and informed third party B) circuit court judge C) high school graduate D) IRS agent Answer: A Explanation: A CPA should judge his or her ethical conduct from the perspective of a reasonable and informed third party. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 85) What are the three types of safeguards against threats to a CPA's compliance with the ethical rules of the profession? A) Independence, legal liability, and accounting standards B) Self-control, internal compass, and future goals C) Safeguard of regulation, client implemented controls, and CPA firm policies D) Safeguard of standards, Acts of Congress, certification Answer: C Explanation: The three types of safeguards are regulation, client implemented controls, and CPA firm policies. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

86) Which of the following statements is true? A) It is possible for a CPA firm to rely solely on safeguards implemented by the client to eliminate or reduce significant threats to an acceptable level. B) There are five basic safeguards to assist CPAs with threats to compliance with the accounting profession's ethical rules. C) If a CPA concludes that threats are at an acceptable level after applying the identified safeguards, then the CPA may proceed with the professional service. D) To evaluate the significance of a threat, CPAs should evaluate identified threats in aggregate. Answer: C Explanation: If a CPA concludes that threats are at an acceptable level after applying the identified safeguards, then the CPA may proceed with the professional service. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 87) If the CPA is unable to implement effective safeguard to a threat of compliance with the accounting profession's ethical rules, he/she should ________. A) proceed with the professional service B) decline or terminate the engagement C) limit the engagement to all non-audit areas D) limit the engagement to only Federal taxation Answer: B Explanation: If a CPA is unable to implement effective safeguards, he/she should decline or terminate the engagement. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

88) At step 5, when a CPA confronts threats to ethical decision-making and the safeguards applied to reduce the threat, what is the suggested best practice? A) Document the identified threats, document the safeguards applied, and document the CPA's evaluation of the effectiveness of the safeguards. B) Immediately decline the engagement, terminate the contract, and contact the AICPA. C) Contact the FBI, tape all conversations with the client, then offer the engagement to a competitor. D) Increase the fee charged to absorb any risk, immediately conclude that the threats are at an acceptable level and proceed with an internal control audit. Answer: A Explanation: The CPA should document the identified threats, document the safeguards applied, and document the CPA's evaluation of the effectiveness of the safeguards. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 89) A CPA works at a firm and also maintains a private practice as an expert witness for intellectual property cases. While at an audit client's office, he overhears a telephone conversation about a patent dispute and offers his services. When he takes the expert witness job, this position creates what type of threat to his professional ethics? A) Familiarity threat B) Advocacy threat C) Self-interest threat D) Self-review threat Answer: B Explanation: This is an example of an advocacy threat. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

90) According to the integrity and objectivity rule, in the performance of any professional service, a member shall not knowingly ________. A) misrepresent facts B) decentralize work to subordinates C) omit a material fact D) None of the choices is correct. Answer: A Explanation: According to the integrity and objectivity rule, in the performance of any professional service, a member shall not knowingly misrepresent facts or subordinate judgment. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 91) How does a small firm resolve the conflict of interest issue in a divorce case? A) Provide tax services to only one of the two parties. B) Using separate engagement teams in providing tax services to both parties. C) Resign from the engagement. D) They do not need to resolve the conflict of interest in the case of a divorce. Answer: A Explanation: A small firm remains free of conflict of interest in a divorce case by providing tax services to one of the two parties. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 92) Which of the following issues arises when taxes are not properly distributed to the parties involved in a divorce case? A) Conflict of interest B) Misrepresentation of fact C) Legal liability D) Gross negligence Answer: A Explanation: A conflict of interest arises when tax is not properly distributed to the parties involved in a divorce case. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 35

93) The Integrity and Objectivity Rule, AICPA Codification section 1.100.001 advises that in the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others. Which of the following statements best describes which services performed by a CPA this rule would apply to? A) All taxation and bookkeeping services performed by the CPA would be covered under this rule. B) All bookkeeping and consulting services performed by the CPA would be covered under this rule. C) This rule covers consulting services offered by the CPA. D) All of the choices are correct. Answer: D Explanation: All of these answer choices are correct. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 94) Candlestick CPA firm is currently representing a husband and wife in a divorce settlement case. Candlestick is a relatively large CPA firm. Top management of Candlestick are meeting to discuss whether or not a conflict of interest may exist in this case because they are representing both parties in the divorce settlement. Which of the statements below is true regarding Candlestick's best option in this case? A) Under the AICPA Rules of Professional Conduct, Candlestick is prohibited from representing both parties, as this represents a conflict of interest for the firm. B) To avoid liability in this case, Candlestick is required under the AICPA Code of Professional Conduct to apprise each party in writing of the representation of the other party. C) Candlestick must determine if its size will objectively allow two separate engagement teams to represent each client in the divorce case. D) Candlestick is required to immediately refer one of the two parties in the divorce case to another CPA firm. Answer: C Explanation: Candlestick must determine if its size will objectively allow two separate engagement teams to represent each client in the divorce case. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

95) Sunnyside External Auditors is currently completing the audit of CVL Enterprises; a firm that sells a variety of plastic products around the continental US. During the most recent meeting with the client's senior management, a difference of opinion was noted with respect to an understatement of depreciation expense listed on the income statement which the auditor feels overstates the client's net income. Which of the choices below represent the auditor's best approach to dealing with this difference of opinion? A) If the overstatement of net income is material in amount but is confined to the income statement, the auditor should conclude the threat is at an acceptable level. B) If the overstatement of net income is immaterial in amount, the auditor may proceed and document the threat at an acceptable level. C) If the understatement of depreciation expense results in a material change to net income, the auditor should notify the SEC and withdraw from the engagement. D) If the overstatement of net income is not corrected immediately, the auditor should notify management in writing of their intention to withdraw from the engagement. Answer: B Explanation: If the overstatement of net income is immaterial in amount, the auditor may proceed and document the threat at an acceptable level. Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 96) What should a CPA do if he/she concludes a difference of opinion with an audit supervisor regarding an on-going audit engagement may result in a material misrepresentation of fact or a violation of professional standards? A) Quit the job. B) Discuss his or her concerns with the supervisor. C) Obtain more training. D) Search for a certification that focuses on material misrepresentations. Answer: B Explanation: The CPA should discuss his or her concerns with the supervisor. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

97) The rule on integrity and objectivity applies to ________. A) all services performed by CPAs B) some services performed by CPAs C) only audit, services performed by CPAs D) only non-audit services performed by CPAs Answer: A Explanation: The rule on integrity and objectivity applies to all services performed by CPAs. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 98) What are the two common issues that arise and are related to integrity and objectivity? A) Conflicts of interest and subordination of judgment. B) Ethical judgment and subjectivity. C) Independence and compliance D) Efficiency and effectiveness. Answer: A Explanation: Conflicts of interest and subordination of judgment are the two common issues that arise related to integrity and objectivity. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 99) The subordination of judgment threat is at an acceptable level when ________. A) the CPA concludes the position taken by the firm does not result in a material misrepresentation of fact or a violation of applicable standards, laws, or regulations B) the CPA does not have a difference of opinion related to the application of accounting principles, auditing standards, or other relevant professional standards C) the CPA safeguards the position by also providing tax services D) the CPA agrees to maintain confidentiality about the matter Answer: A Explanation: The subordination of judgment threat is at an acceptable level when the CPA concludes the position taken by the firm does not result in a material misrepresentation of fact or a violation of applicable standards, laws, or regulations. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 38

100) When might self-interest, familiarity, and undue influence most likely threaten a CPA's compliance with integrity and objectivity? A) When a CPA and his or her supervisor, or another person within the CPA firm, have a difference of opinion related to the application of accounting principles B) When a CPA mistakenly applies the wrong auditing standard C) When a CPA pads his or her expense account D) When a CPA takes concerns about an engagement to another partner Answer: A Explanation: When a CPA and his or her supervisor, or another person within the CPA firm, have a difference of opinion related to the application of accounting principles. self-interest, familiarity, and undue influence most likely threaten a CPAs compliance with integrity and objectivity. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 101) A conflict of interest occurs when a CPA ________. A) performs both tax and bookkeeping services for the same client B) performs a professional service related to a particular matter involving two or more clients whose interests, with respect to that matter, are in conflict C) represents a client in a divorce tax matter D) represents a client in any legal dispute Answer: B Explanation: Conflict of interest occurs when a CPA performs a professional service related to a particular matter involving two or more clients whose interests, with respect to that matter, are in conflict. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

102) What safeguards do most CPA firms have against conflicts of interest and subordination of judgment? A) Specific policies to prevent the firm from violating professional standards and to protect the CPA. B) Monetary settlements for severance pay to the CPA involved. C) Whistleblower rules and regulations. D) Human resource counseling and tip hotlines. Answer: B Explanation: Most firms have specific policies to prevent the firm from violating professional standards and to protect the CPA. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 103) If after discussing a potential subordination of judgment threat with a supervisor, a CPA does not feel that the matter is resolved, what should he or she do? A) Discuss his or her concerns with the appropriate higher level(s) of management within the CPA's firm. B) Contact the AICPA about the problem. C) Immediately ask HR to reassign him or her. D) Start looking for a new position at another firm. Answer: A Explanation: The CPA should discuss his or her concerns with the appropriate higher level(s) of management within the CPA's firm. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

104) In a small CPA firm, if the firm provides tax services to both parties who subsequently begin divorce proceedings, it is customary to do what? A) Resign providing tax services to one of the two parties in a divorce to remain free of any conflict of interest. B) Use separate engagement teams in providing tax services to the husband and to the wife, who are provided clear policies and procedures on maintaining confidentiality. C) Engage in a background check on both parties. D) Provide only consulting services to both parties. Answer: A Explanation: The firm should resign from providing tax services to one of the two parties in a divorce to remain free of any conflict of interest. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 105) A committee of the board of directors responsible for oversight of internal controls, financial reporting and disclosure in the financial statements, regulatory compliance, and the company's independent auditors is/are called (a/an) ________. A) audit committee B) covered members C) executors D) dependents Answer: A Explanation: A committee of the board of directors responsible for oversight of internal controls, financial reporting and disclosure in the financial statements, regulatory compliance, and the company's independent auditors is called an audit committee. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

106) Interpretation 1.295 indicates that before performing nonattest services, the CPA should establish and document in writing an understanding with the client regarding ________. A) any limitations of the engagement, only B) the objectives of the engagement and the services to be performed, only C) the services to be performed, only D) the objectives of the engagement, the services to be performed, and any limitations of the engagement Answer: D Explanation: Interpretation 1.295 indicates that before performing nonattest services, the CPA should establish and document in writing an understanding with the client regarding the objectives of the engagement,the services to be performed, and any limitations of the engagement. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 107) As a general rule, professional employees in a CPA firm who are not covered members and their immediate family members cannot ________. A) be a trustee, director, or officer of an attest client or of the client's pension or profit-sharing trust B) have a direct investment of more than 1% in an attest client C) hold a non-key position with an attest client D) have an indirect investment of more than 5% in an attest client Answer: A Explanation: As a general rule, professional employees in a CPA firm who are not covered members and their immediate family members cannot have a direct investment of more than 5% in an attest client,hold a key position with an attest client, and be a trustee, director, or officer of an attest client or of the client's pension or profit-sharing trust. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

108) A ________ is someone who prepares or supervises others involved in preparing the financial statements or material accounting records or someone who is involved in accounting decision making. A) key person B) covered member C) trustee D) immediate family member Answer: A Explanation: A key person is someone who prepares or supervises others involved in preparing the financial statements or material accounting records or someone who is involved in accounting decision making. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 109) AICPA Codification section 1.200.001 addresses auditor independence and advises that a member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council. Which of the choices below best collectively represent the reasons the auditor must maintain independence? A) Auditor independence helps maintain the CPAs professional and independent image, and indemnifies the auditor against external litigation. B) Auditor independence is measured by independence in appearance which dictates that the auditor act with integrity and objectivity at all times throughout an engagement. C) Auditor independence in fact and appearance helps solidify the CPAs professional reputation in the eyes of the public, and also aligns with a CPAs duty to uphold the public interest. D) If an auditor is perceived as not being independent in fact and appearance, the likelihood of litigation against the client and auditor will generally decrease. Answer: C Explanation: Auditor independence in fact and appearance helps solidify the CPAs professional reputation in the eyes of the public, and also aligns with a CPAs duty to uphold the public interest. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

110) While conducting the external audit of GreenLeaf Enterprises, the audit manager of Jackson external auditors responsible for the day-to-day operations and staff assigned to the audit has been meeting with the CFO of GreenLeaf Enterprises each Friday for a working lunch at a local restaurant. The meeting is designed to provide an informal atmosphere whereby the audit manager can keep the CFO abreast of the audit and any important matters needing the CFOs attention. A potential issue with independence exists here because ________. A) it may be perceived that the audit manager and CFO meeting weekly for lunch compromises independence in fact B) it may be perceived that the audit manager and CFO meeting in this manner compromises independence in appearance C) it may be assumed by both the client and audit staff that the audit manager is using the lunch to discuss important accounting issues offline D) it may be perceived that the weekly meetings have been arranged by the CFO to ensure that there are no surprises with respect to the rendering of the audit opinion upon conclusion of the audit Answer: B Explanation: it may be perceived that the audit manager and CFO meeting in this manner compromises independence in appearance. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

111) During the audit of Brown Company, the lead partner assigned to the audit engagement has learned from the client's board of directors that the company will soon begin paying a healthy dividend on outstanding stock. Brown Company plans to issue a press release in the following month to apprise the market of this. The lead partner assigned to this audit contacts a close friend and advises him of this, instructing him to buy up some of the company stock as he believes the value will increase. With respect to independence, this action would best be described as ________. A) no threat to independence in appearance, because the partner is using a close friend to buy the stock and thus appear beyond reproach B) no threat to independence in fact, because the lead partner has avoided a conflict of interest by having a friend purchase the stock C) a threat to independence in fact, because the audit partner assigned to the engagement is neglecting the public trust for personal gain D) a threat to independence in appearance because if it is determined that the audit partner took this action, his or her reputation would be damaged Answer: C Explanation: a threat to independence in fact, because the audit partner assigned to the engagement is neglecting the public trust for personal gain. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 112) With the advent of accounting and CPA firms that have many professionals spread out diffusely all over the globe, many issues arise with respect to independence. An example of an issue that may arise is related to ________. A) an increase in the demand for non-auditing services, which may allow CPA firms extra sources of revenue B) whether family members of a CPA or covered member may inadvertently cause threats to independence C) whether any covered members may have a direct or indirect investment in the client under audit D) All of the choices are correct. Answer: D Explanation: All of these answer choices are correct. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

113) During the course of the external audit, Moon Auditing Firm has discovered that one of their senior audit managers has a mortgage outstanding from the audit client, TMI Bank. Moon Auditing Firm has policies and protocols in place surrounding conflicts of interest in this area. Which of the choices below would represent Moon's best course of action given these circumstances? A) If the senior audit manager is a covered member, he or she should immediately be reassigned to a different audit client. B) Moon should obtain permission to investigate the details of the outstanding mortgage, to determine when the mortgage loan was taken out, and should ask the employee to refinance immediately. C) An exception exists for covered members holding mortgage balances with attest clients. D) This represents confidential information and is beyond the scope and purview of audit confidentiality. Answer: C Explanation: An exception exists for covered members holding mortgage balances with attest clients. Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 114) During the external audit of Sun Enterprises, Inc. a senior audit staff associate approaches you, as the audit manager with responsibility for day-to-day operations of the engagement and advises that she has been approached by the audit client with respect to filling a current vacancy for head of the Internal Audit Department. In response to this, and following a conversation with the partner with overall responsibility for the audit, the decision is made to remove the audit senior from the audit and reassign her to a different client. Which of the following best describes the reasoning that underpins this decision? A) This employment offer represents a threat to the audit in the sense that the audit associate may now be more lenient to the client and overlook areas of audit concern. B) The auditors' objectivity and independence are immediately considered impaired, and thus the associate should be immediately removed from the engagement. C) To avoid situations where a CPAs integrity or objectivity may be compromised, which would impair the auditors credibility and independence. D) When an audit firm employee is offered unemployment with a potential client, the audit firm may be able to take advantage of access to information that they otherwise would not have had. Answer: C Explanation: To avoid situations where a CPAs integrity or objectivity may be in a position of being compromised, which would impair the auditors credibility and independence. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 46

115) During the external audit of Starbright Company, the external auditor has noted that the company has an extremely high turnover of employees. During a recent meeting, Starbright management has advised that the treasurer has recently left to take another position with a different company, and has asked the senior audit manager assigned to the audit to sign checks in an emergency capacity until a suitable replacement has been found. Which of the choices below best describe the problem with this situation? A) The audit manager may take advantage of this situation to write other checks for personal gain, and there may be no internal controls to detect this. B) The CPA authorizing disbursements of client funds, even in an emergency capacity may represent a threat to independence as the auditor is exercising authority on behalf of a client. C) The audit manager has been placed in a situation whereby a conflict of interest exists, and should withdraw from the engagement immediately. D) By writing checks on behalf of the client, the external auditor assumes responsibility for any bounced checks. Answer: B Explanation: The CPA authorizing disbursements of client funds, even in an emergency capacity may represent a threat to independence as the auditor is exercising authority on behalf of a client. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

116) During a recent meeting with the top management of Axle Co. advice has been requested on certain stock transactions that the client has entered into. The client is seeking the CPA firm's advice and input on whether to sell certain stocks that management feel may drop in value in the near future, and indicates they may ask the CPA firm to conduct the transactions. Does this represent a threat to independence, and why? A) This does not represent a threat to independence, as the client is merely asking for the CPA firm's unofficial input. B) This does not represent a threat to independence, as even if advice is given, the client is still wholly responsible for any gains or losses incurred. C) This may represent a threat to independence, as if the CPA firm gives bad advice, the client may sue the CPA firm. D) This may represent a threat to independence, as the CPA firm may ultimately end up making investment decisions on behalf of the client. Answer: D Explanation: This may represent a threat to independence, as the CPA firm may ultimately end up making investment decisions on behalf of the client. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 117) SEC rules prohibit an audit firm from providing which of the following non-attest services to an audit client? A) Actuarial services, only B) Internal audit outsourcing and bookkeeping services, only C) Bookkeeping and actuarial services, only D) Internal audit outsourcing, bookkeeping, and actuarial services Answer: D Explanation: SEC rules prohibit an audit firm from providing the following non-attest services to an audit client: 1)Internal audit outsourcing services; 2)Bookkeeping services; and 3)Actuarial services. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

118) Attest services do not include ________. A) audits B) reviews under SSARs C) examinations, reviews and agreed-upon procedures under SSAE D) compilation reports of financial statements Answer: D Explanation: Attest services do not include compilations. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 119) "Independent in fact" is best defined as ________. A) addressing potential conflicts of interest that can be observed or factually determined by others B) acting with integrity and objectivity C) acting in a way that is observable under the Rules of Conduct D) acting with independence and integrity Answer: B Explanation: Independence in fact is best defined as acting with integrity and objectivity. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 120) Being independent in appearance is best defined as ________. A) addressing potential conflicts of interest that can be observed or factually determined by others B) acting with integrity and objectivity C) acting with independence and integrity D) disclosing some of the common threats that he or she faces to acting independently Answer: A Explanation: Independence in appearance is best defined as addressing potential conflicts of interest that can be observed or factually determined by others. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

121) Section 1.200 of the AICPA Code of Professional Conduct specifies a number of circumstances that can impair ________. A) the appearance of independence to guide CPAs in observable aspects of ethical conduct B) the appearance of integrity regarding ethical conduct C) safeguards that prevent a lack of independence D) how to evaluate threats as an independent third-party Answer: A Explanation: Section 1.200 specifies a number of circumstances that can impair the appearance of independence. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 122) A covered member, under the independence rules in the AICPA Code of Professional Conduct, is best defined as a person in a position to ________. A) potentially influence attest decisions or the outcome of an attest engagement B) potentially influence decisions or outcomes in non-audit services C) take on or influence a third-party position D) perform tax services that is both independent in fact and appearance Answer: A Explanation: A covered member is a person in a position to potentially influence attest decisions or the outcome of an attest engagement. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

123) Which of the following statements is true? A) A covered member can own one share of an attest client because it is immaterial. B) A covered member cannot own a mutual fund which contains attest client shares, as long as the investment in the mutual fund is not material to the covered member. C) A covered member can be an executor of an estate, which invests in an attest client, as long as the investment is not material. D) A CPA firm as an entity is prohibited from the same activities as a covered member of the firm. Answer: D Explanation: A CPA firm as an entity is prohibited from the same activities as a covered member of the firm. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 124) Which of the following activities is not a prohibited activity that impairs independence? A) A direct investment in the attest client B) A joint, closely held investment with an attest client that is material to the covered member C) A material indirect investment in the attest client D) Having a home mortgage from a bank who is an attest client Answer: D Explanation: Having a home mortgage from a bank who is an attest client is allowed. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

125) When can a spouse that works for an attestation client still participate in an employee benefit plan that includes employee stock ownership plans or employee stock option plans? A) There are no restrictions. B) When the benefits are offered equitably to all similar employees C) When the benefits are offered equitably to a majority of similar employees D) As long as the CPA firm approves every stock-related plan Answer: B Explanation: A spouse can work for the attest client and still participate in an employee benefit plan that includes employee stock ownership plans or employee stock option plans as long as benefits are offered equitably to all similar employees. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 126) Which of the following standards refers to undertaking professional services that can be completed with the appropriate level of professional skill? A) Professional Competence B) Due Professional Care C) Sufficient Relevant Data D) Planning and Supervision Answer: A Explanation: Professional Competence refers to undertaking professional services that can be completed with professional competence. (skill) Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

127) According to the due professional care standard, CPAs should exercise professional care expected of ________ in the performance of professional services. A) other CPAs B) covered members C) CPAs involved in consulting services D) a reasonable person Answer: A Explanation: According to the due professional care standard, CPAs should exercise professional care expected of other CPAs in the performance of professional services. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 128) During an initial client meeting with Broadside Enterprises, the external auditors, RayBright CPAs are discussing the client's needs. Broadside management has expressed a desire for RayBright to perform auditing and attestation services, as well as some ancillary accounting services. As RayBright seeks to determine which services it can effectively perform, which General Standard would be most applicable to this decision? A) The Sufficient Relevant Data standard, as RayBright will need to make sure it has access to all required data in order to make the decision. B) The Professional Competence standard, as RayBright should only undertake services it can perform with professional competence. C) The Planning and Supervision standard, as RayBright needs to understand the scope of services it can perform in order to assign the appropriate audit staff. D) The Due Professional Care standard, as the level of professional care will depend on the level of services performed. Answer: B Explanation: The Professional Competence standard, as RayBright should only undertake services it can perform with professional competence. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

129) During an initial client meeting with Broadside Enterprises, the external auditors, RayBright CPAs are discussing the client's needs. Broadside management has agreed to hire the auditor and provided RayBright with details of what work needs to be done. Broadside operates in a niche industry which requires specialized knowledge. As RayBright seeks to determine the most effective way to perform the audit of Broadside, which General Standard would be most applicable to this decision? A) The Planning and Supervision standard, as RayBright will want to ensure staff with the appropriate expertise are assigned to this audit. B) The Sufficient Relevant Data standard, as RayBright will need to make sure it has access to all required data in order to make the decision. C) The Due Professional Care standard, as the level of professional care will depend on the level of services performed. D) The Professional Competence standard, as RayBright should only undertake services it can perform with professional competence. Answer: A Explanation: The Planning and Supervision standard, as RayBright will want to ensure staff with the appropriate expertise are assigned to this audit. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 130) Which of the following general standards refers to adequately preparing for the engagement and providing the appropriate management oversight to the performance of professional services? A) Planning and Supervision B) Sufficient Relevant Data C) Due Care D) Audit Planning Answer: A Explanation: Planning and Supervision is the general standard that expects CPAs to adequately plan and supervise the performance of professional services. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

131) The general standards in the AICPA Code of Professional Conduct do NOT include ________. A) professional competence B) due professional care C) planning for materiality D) sufficient relevant data Answer: C Explanation: The general standards to not include planning for materiality. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 132) The definition for professional competence is ________. A) undertake only those professional services that the member or the member's firm can reasonably expect to be completed with professional competence B) exercise due professional care in the performance of professional services C) adequately plan and supervise the performance of professional services D) obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed Answer: A Explanation: Professional competence is: undertake only those professional services that the member or the member's firm can reasonably expect to be completed with professional competence. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

133) Which of the following standards is used for preparing financial statements with other accounting principles? A) GAAP B) GAAS C) Rule 1.320 on Accounting Principles D) Principles of the Code of Professional Conduct Answer: A Explanation: Generally Accepted Accounting Principles (GAAP) is used for preparing financial statements with other accounting principles. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 134) CPAs in public practice are required to adhere to strict rules pertaining to client confidentiality. In general, client permission must be obtained before the CPA releases any confidential information. Which of the scenarios below best represents a viable exception to the client confidentiality rules? A) An audit client of the CPA contacts the auditor to object about information that will be disclosed in the financial statements which the client feels is confidential. B) The CPA discloses confidential client information as a result of a subpoena received from a legal authority. C) The CPA discloses all confidential client information as part of a peer review instituted by a State Board of Accountancy. D) There are no exceptions to the client confidentiality rule. Answer: B Explanation: The CPA discloses confidential client information as a result of a subpoena received from a legal authority. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

135) Which of the following should auditors know in regard to potential lawsuits against them? A) People who can sue them B) Allegations made in lawsuits C) Defenses they can use in court D) All the options are correct. Answer: D Explanation: Auditors should know people who can sue them, the allegations made in lawsuits, and defenses they can use in court. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 136) The rule on fees and other types of remuneration address how many circumstances that are extremely important? A) 1 B) 2 C) 3 D) 4 Answer: B Explanation: The rule of fees and other types of remuneration address two circumstances that are extremely important. These are Rule 1.510 on Contingent Fees and Rule 1.520 on Commissions and Referral Fees. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

137) An important issue, and one of major concern to an external auditor and CPA firm is legal liability. The CPA firm may have to contend with litigation and must be prepared to respond accordingly. Which of the following most accurately describes an auditor's potential liability under common law? A) Under common law, an auditor may be liable to clients under either common law or tort law, but the auditor is not liable to third parties. B) Under common law, an auditor may be liable to other beneficiaries, which represent a foreseen class of third parties. C) Common law makes the auditor liable under either contract or tort law, and may also make the auditor liable to foreseen and foreseeable third parties. D) Under common law doctrines and precedents, the auditor does not assume any liability for audit and attest engagements. The liability is solely the clients. Answer: C Explanation: Common law makes the auditor liable under either contract or tort law, and may also make the auditor liable to foreseen and foreseeable third parties. Diff: 3 LO: 8 Bloom: Evaluation Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 138) HappyDaze external auditors is currently being sued under contract law for rendering a clean audit opinion on financial statements which it was later determined contained material misstatements. The lawsuit alleges breach of contract on the part of the external auditor. Which of the following choices would most likely represent a successful argument for the plaintiff in bringing this suit? A) HappyDaze, during the course of the audit, did not adhere to Generally Accepted Auditing Standards, and therefore are liable accordingly. B) Due to delays by the client in providing information that the auditor had requested in a timely manner, the audit report was delivered later than the initially agreed-upon date. C) Although HappyDaze issued an audit report in compliance with Generally Accepted Auditing Standards, the plaintiff believes that the auditor was still negligent. D) None of the choices is correct. Answer: A Explanation: HappyDaze, during the course of the audit, did not adhere to Generally Accepted Auditing Standards, and therefore are liable accordingly. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

139) During an initial client meeting with Brightspace Paint Company, senior management have advised the new external auditor, Accuracy Auditing Inc. that a current lawsuit is pending against the predecessor auditor. The lawsuit, a fraud case, was brought by Brightspace's bonding company. In this case, the bonding company would represent ________. A) a primary beneficiary, because the bonding company as part of the bonding agreement was required to reimburse the client due to fraud B) a primary beneficiary, because the bonding company represents a foreseen class of third parties C) a subrogee, because the bonding company has acquired the rights of another entity by means of substitution D) None of the choices is correct. Answer: C Explanation: a subrogee, because the bonding company has acquired the rights of another entity by means of substitution. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 140) Teflon Auditors are currently the subject of litigation by a third party who asserts that the auditor was negligent during a recent audit. As a result of the alleged negligence, the third party was injured and is seeking recompense against the auditor. Specifically, the third party is alleging a failure of due care on the part of the auditor. The argument most likely to prevail in court in successfully litigating this case is for ________. A) the third party to allege fraud, as a failure of due care may be construed by a court as misrepresentation or nondisclosure of a material fact B) the third party to allege ordinary negligence on the grounds that the auditor failed to exercise the care a reasonable person would have exercised under similar circumstances C) the third party to allege gross negligence, as a lack of due care may be construed by a court to represent a failure to use even slight care in the circumstances D) None of the choices is correct. Answer: B Explanation: the third party to allege ordinary negligence on the grounds that the auditor failed to exercise the care a reasonable person would have exercised under similar circumstances. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

141) Lucky External Auditors are currently in discussions with the management of SunnySide Enterprises with respect to possibly performing an attest engagement for this client. The client has disclosed that the audit report is primarily needed for their bank, which they have recently applied for a substantial loan with to fund future growth and expansion. Based on the information provided in this scenario, which of the following statements most accurately describes the external auditors' potential liability to the client's bank? A) The client's bank would represent a primary beneficiary under common law, on the basis that the client disclosed the name of the bank and the reason for the audit. B) The client's bank would represent another beneficiary, as under common law, creditors fall into the class of other beneficiaries. C) The client's bank would represent a primary beneficiary under common law on the basis that the bank can only bring suit against the auditor if the client chooses to also. D) As a third party, the external auditor is not liable to the bank, and the bank is unable to bring suit against the auditor as the result of an audit. Answer: A Explanation: The client's bank would represent a primary beneficiary under common law, on the basis that the client disclosed the name of the bank and the reason for the audit. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 142) Breezy Inc. is bringing suit against Hazy Firm external auditors on the grounds of negligence on the part of the auditor. Specifically, Breezy asserts that due to the auditor's negligence, Breezy has been injured financially and is seeking restitution. In order to successfully litigate such a case, Breezy will have to be able to do which of the following? A) Breezy will have to prove that they owed a duty of care to the auditors, and that this duty of care was breached. B) Breezy will have to show that the auditor's negligence was the proximate cause of their damage, and that the auditor breached a duty of care. C) Breezy will have to show that they suffered actual damages as a result of the auditor's negligence, and that Breezy did not breach their duty of care. D) All of the choices are correct. Answer: B Explanation: Breezy will have to show that the auditor's negligence was the proximate cause of their damage, and that the auditor breached a duty of care. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

143) Breezy Inc. is bringing suit against Hazy Firm external auditors on the grounds of negligence on the part of the auditor. Specifically, Breezy asserts that due to the auditor's negligence, Breezy has been injured financially and is seeking restitution. What would the external auditor's best defense to this lawsuit be? A) That the auditor was not negligent and owed a duty of care to Breezy Inc. B) That because Breezy did not suffer any actual losses as a result of the auditor's actions, no duty of care was owed by the auditor. C) That Breezy had no losses as a result of the audit, or that the losses were caused by different events. D) All of the choices are correct. Answer: C Explanation: That Breezy had no losses as a result of the audit, or that the losses were caused by different events. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 144) Hensley Auditing Firm has been contacted by Wythe Company to discuss an attest engagement centering around an initial public offering of stock the client is contemplating. If the client proceeds with the stock issuance and the client and auditor are subsequently sued by parties who purchased securities as a result of the initial offering, the lawsuit is most likely to be on which grounds? A) The suit is likely to be filed under the Securities Act of 1933, alleging a material misleading financial statement. B) The suit will be filed under the SEC Act of 1934, alleging reliance on false or misleading financial statements. C) The suit will likely be filed under the Securities Act of 1933, with the plaintiff attempting to link the financial loss to the misleading financial statements. D) The suit will likely be filed under the Sarbanes-Oxley Act, with the plaintiff alleging reliance on the financial statements, and a material loss suffered as a result. Answer: A Explanation: The suit is likely to be filed under the Securities Act of 1933, alleging a material misleading financial statement. Diff: 2 LO: 9 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

145) Hensley Auditing Firm has been contacted by Wythe Company to discuss an attest engagement centering around an initial public offering of stock the client is contemplating. If the client proceeds with the stock issuance and the client and auditor are subsequently sued by parties who purchased securities as a result of the initial offering, which of the following would represent the auditor's best defense in court? A) The auditor owed no duty of care to the plaintiff, due to no privity of contract existing in these circumstances. B) That the auditor followed published and appropriate auditing standards, and had reason to believe the accuracy of the registration statement. C) That the auditor relied on disclosures made by the client, and is thus not liable for misrepresentations made by this party. D) That the losses suffered by the third party were a result of actions and misrepresentations by the client, not the auditor. Answer: B Explanation: That the auditor followed published and appropriate auditing standards, and had reason to believe the accuracy of the registration statement. Diff: 2 LO: 9 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 146) Green Company is undergoing the annual audit by Red Firm Inc. who are external auditors. Red Firm Inc. has audited Green Company for the last five years. During a meeting with top management, it is disclosed to the auditor that Green Company and now the auditor is being sued by a mutual fund that invested in a large number of shares of Green Company's common stock. The mutual fund is bringing suit on the grounds that material misstatements in the financial statements existed. For the mutual fund to prevail in such a case, what would have to be proven in court? A) That the mutual fund purchased the securities and as a result of reliance on the misleading financial statements suffered damages. B) Even if no damages were incurred by the mutual fund, the fact that it purchased securities that it otherwise may not have done represent grounds for a successful suit. C) Under the Sarbanes-Oxley Act, the plaintiff can bring suit on the grounds of fraud and negligence by the auditor. D) Under the Securities Act of 1934, the mutual fund is unable to sue the auditor directly. Instead, the individual investors would have to bring suit separately. Answer: A Explanation: That the mutual fund purchased the securities and as a result of reliance on the misleading financial statements suffered damages. Diff: 3 LO: 9 Bloom: Evaluation Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 62

147) Green Company is undergoing the annual audit from Red Firm Inc. external auditors. Red Firm Inc. has audited Green Company for the last five years. During a meeting with top management, it is disclosed to the auditor that Green Company and now the auditor is being sued by a mutual fund that invested in a large number of shares of Green Company's common stock. The mutual fund is bringing suit on the grounds that material misstatements in the financial statements existed. Which of the following choices represent the auditor's most likely successful defense to this suit? A) The auditor must be able to demonstrate reliance on information provided and statements made by the client, in order to be dismissed from the lawsuit. B) The auditor acted in good faith, and was not aware of any misleading or false statements made by the client. C) Although the auditor had knowledge of the misleading statements, the firm still acted in good faith and is thus not liable under the Securities Act of 1934. D) All of the choices are correct. Answer: B Explanation: The auditor acted in good faith, and was not aware of any misleading or false statements made by the client. Diff: 2 LO: 9 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

148) During the audit of Summer Company, a large publicly-traded firm, Winter external auditors were approached by the audit client with respect to performing additional services on behalf of the client. The additional services requested by Summer Company include performing some routine internal audit functions and actuarial calculations to assist in pension provision estimates. Which of the following statements is correct regarding Winter's response to this request? A) The external auditors are able to perform these extra services, but in so doing will increase the overall cost of the audit. B) Under the Securities Act of 1933, the external auditors are prohibited from performing actuarial services, but can assist with the internal audit work. C) Under the Sarbanes-Oxley Act, the auditor is prohibited from performing either function as part of an attest engagement. D) Under the Sarbanes-Oxley Act, the auditor is free to perform actuarial services for the client, but internal audit outsourcing is prohibited due to an inherent conflict of interest. Answer: C Explanation: Under the Sarbanes-Oxley Act, the auditor is prohibited from performing either function as part of an attest engagement. Diff: 2 LO: 9 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 149) Axe Co., a large retailer specializing in fashion merchandise and apparel is receiving its yearly audit from StarShine external auditors. StarShine has been auditing Axe Co. for a number of years and is very familiar with the client. StarShine has been assisting Axe Co. with a recent secondary stock offering and providing technical advice to the client. Under this scenario, StarShine could be liable under which of the following? A) Under the Securities Act of 1933, StarShine may be liable for gross negligence if they fail to provide absolute assurance on financial statements issued around the time of the secondary offering. B) Under the Sarbanes-Oxley Act, StarShine may be liable for providing a prohibited investment advisory service during an attest function. C) Under the Securities Act of 1934, StarShine are not liable for any investment advice given, only for direct lawsuits pertaining to the attest function. D) None of the choices is correct. Answer: B Explanation: Under the Sarbanes-Oxley Act, StarShine may be liable for providing a prohibited investment advisory service during an attest function. Diff: 2 LO: 9 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 64

150) During a recent discussion with the top management of GreenTree Company, a large publicly-traded entity, the external auditors, Wood's CPA firm has been apprised that the management of GreenTree may have knowingly allowed misstatements in the firm's most recent financial statements to be published. GreenTree's management are inquiring of the auditor as to management's potential liability in such a situation. The best response to this question by the external auditor would be which of the following? A) Once the financial statements have been audited and are published to the public at large, the liability rests solely with the auditor. B) It is unlikely that any party bringing such a suit would prevail in court, as all auditor discussions with management are confidential and are not disclosable as evidence in court. C) Under the Sarbanes-Oxley Act, management are liable for any misstatements they knowingly allowed to be published and promulgated to the public. D) Under the Proportionate Liability doctrine, top management will be personally liable for any damages awarded by a court on a proportionate basis. Answer: C Explanation: Under the Sarbanes-Oxley Act, management are liable for any misstatements they knowingly allowed to be published and promulgated to the public. Diff: 2 LO: 9 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 151) What is the other name of the Securities Act of 1933? A) The Truth in Securities Act B) The Antifraud Provisions Act C) The Foreign Corrupt Practices Act D) The Private Securities Litigation Reform Act Answer: A Explanation: The Securities Act of 1933 is known as the Truth in Securities Act and was enacted following the stock market crash and Great Depression of 1929 on May 27, 1933. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

152) ________ subjects auditors to penalties of fines or imprisonment or both. A) Criminal liability B) Proportionate liability C) Diligence defense D) Bookkeeping Answer: A Explanation: Criminal liability subjects auditors to penalties of fines or imprisonment or both. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 153) Under Section 18(a) of the Securities Act of 1934, the plaintiff ________. A) may be any person buying or selling the securities B) does not have to prove the existence of a materially false or misleading statement C) does not have to prove reliance on such a statement and damage resulting from such reliance D) had no knowledge of the false or misleading statement Answer: A Explanation: Under Section 18(a) of the Securities Act of 1934, the plaintiff may be any person buying or selling the securities and must prove the existence of a materially false or misleading statement and reliance on such a statement and damage resulting from such reliance. Only the defendant has to prove that he/she had no knowledge of the false or misleading statement. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

154) What is a due diligence defense? A) An audit firm must show that it made a reasonable investigation, that the firm followed auditing standards, and accordingly had reasonable grounds to believe, and did believe, that the statements certified were true at the date of the statements and as of the time the registration statement became effective. B) Not having to prove reliance on the false or misleading statement or that the loss suffered was the proximate result of the statement if purchase was made before the issuance of an income statement covering a period of at least 12 months following the effective date of the registration statement. C) Basing a claim on an alleged materially false or misleading financial statement contained in the registration statement. D) Concluding that subsequent events review was in conformity with generally accepted auditing standards. Answer: A Explanation: In a due diligence defense, an audit firm must show that it made a reasonable investigation, that the firm followed auditing standards, and accordingly had a reasonable grounds to believe, and did believe, that the statements certified were true at the date of the statements and as of the time the registration statement became effective. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 155) The ________ government grants a CPA license to those who pass the CPA exam and earn prescribed work experience. Answer: state Explanation: The state government grants a CPA license to those who pass the CPA exam and earn prescribed work experience. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

156) A/an ________ is valued by the high level of skill rather than the concern for the public interest. Answer: EC Professional Explanation: The profession of an EC Professional is defined by the high level of skill, while that of a CPI Professional is recognized by the concern for the public interest. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 157) ________ are accountancy bodies involved in the licensing of CPAs. Answer: State Boards of Accountancy Explanation: State Boards of Accountancy are accountancy bodies involved in the licensing of CPAs Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 158) ________ are often referred to as "pros" because of their skill and level of expertise. Answer: Professional athletes Explanation: Professional athletes are often referred to as "pros" because of their skill and level of expertise. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 159) Auditors try to achieve independence in appearance in order to ________. Answer: maintain public confidence in the profession Explanation: Auditors try to achieve independence in appearance in order to Maintain public confidence in the profession. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

160) ________ govern the performance of a member's professional responsibilities. Answer: Principles Explanation: Principles govern the performance of a member's professional responsibilities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 161) ________ may be designed in part to encourage ideal behavior, they must also be both practical and enforceable. Answer: Codes of ethics Explanation: Codes of ethics may be designed in part to encourage ideal behavior, they must also be both practical and enforceable. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 162) A/an ________ threat is the threat that a CPA will take on the role of client management or otherwise assume management responsibilities. Answer: management participation Explanation: A management participation threat is the threat that a CPA will take on the role of client management or otherwise assume management responsibilities. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 163) If a CPA concludes that the threat is not at an acceptable level, the CPA should ________. Answer: identify and apply safeguards Explanation: If a CPA concludes that the threat is not at an acceptable level, the CPA should identify and apply safeguards. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior

164) If a CPA concludes that threats are at an acceptable level after applying the identified safeguards, then the CPA may proceed with the ________. Answer: professional service Explanation: If a CPA concludes that threats are at an acceptable level after applying the identified safeguards, then the CPA may proceed with the professional service. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 165) In a ________ CPA firm, appropriate safeguards might include the involvement of another firm. Answer: small Explanation: In a small CPA firm, appropriate safeguards might include the involvement of another firm. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 166) The two common issues related to integrity and objectivity are ________ and ________. Answer: conflicts of interest; subordination of judgment Explanation: The two common issues related to integrity and objectivity are conflicts of interest and subordination of judgment. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 167) A ________ firm may safeguard conflict of interest using separate engagement teams in providing tax services to both parties in a divorce. Answer: large Explanation: A large firm may safeguard conflict of interest using separate engagement teams in providing tax services to both parties in a divorce. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 70

168) The subordination of judgment threat is at an acceptable level if the CPA concludes that the position taken by the firm does not result in a ________. Answer: material misrepresentation of fact Explanation: The subordination of judgment threat is at an acceptable level if the CPA concludes that the position taken by the firm does not result in a material misrepresentation of fact. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 169) If the investment in the mutual fund is material to the covered member, and the mutual fund owns any shares in an attest client, ________ is impaired. Answer: independence Explanation: If the investment in the mutual fund is material to the covered member, and the mutual fund owns any shares in an attest client,independence is impaired. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 170) A ________ is in a position to potentially influence attest decisions or the outcome of an attest engagement. Answer: covered member Explanation: A covered member is a person in a position to potentially influence attest decisions or the outcome of an attest engagement. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 171) An important issue for many spouses is their ability to participate in ________. Answer: stock compensation plans Explanation: An important issue for many spouses is their ability to participate in stock compensation plans. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 71

172) According to the general standards of the AICPA Code, a member shall comply with the standards of professional services and any interpretations thereof by bodies designated by ________. Answer: council Explanation: According to the general standards of the AICPA Code, a member shall comply with the standards of professional services and any interpretations thereof by bodies designated by council. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 173) If a tax practitioner does not have experience performing audits or reviews,he/she should refer the engagement to a ________. Answer: qualified CPA Explanation: If a tax practitioner does not have experience performing audits or reviews, he/she should refer the engagement to another qualified CPA. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 174) The general standards of the AICPA Code of Professional Conduct apply only to ________ in public practice. Answer: CPA firms Explanation: The general standards of the AICPA Code of Professional Conduct apply only to CPA firms that perform professional services for clients. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

175) A CPA should obtain ________ to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed. Answer: sufficient relevant data Explanation: A CPA should obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 176) The ________ rule does not preclude a CPA from initiating a complaint with the professional ethics division of the AICPA. Answer: confidential client information Explanation: The confidential client information rule does not preclude a CPA from initiating a complaint with the professional ethics division of the AICPA. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 177) An individual or collective group who is not in privity with the parties to a contract is called a ________. Answer: third party Explanation: An individual or collective group who is not in privity with the parties to a contract is called a third party. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 178) The auditor's ________ is vital in refuting charges for breach of contract and breach of duty in a tort action. Answer: documentation Explanation: The auditor's documentation is vital in refuting charges for breach of contract and breach of duty in a tort action. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 73

179) Anyone identified to the auditor by name prior to the audit who is a recipient of the auditor's report is called a ________. Answer: primary beneficiary Explanation: Anyone identified to the auditor by name prior to the audit who is a recipient of the auditor's report is called a primary beneficiary. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 180) ________ refer(s) to unnamed third parties, such as creditors, stockholders, and potential investors, who use the auditor's report. Answer: Other beneficiaries Explanation: Other beneficiaries refer to unnamed third parties, such as creditors, stockholders, and potential investors, who use the auditor's report. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 181) Auditors have liability under ________ for addressing client requirements. Answer: common law Explanation: Auditors have liability under common law for addressing the client requirements. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 182) Auditors have liability under ________ for addressing the requirements of third-party users of financial statements. Answer: statutory law Explanation: Auditors have liability under statutory law for addressing the requirements of third-party users of financial statements. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 74

183) ________ arises when defendants who are not found to have "knowingly committed a violation" of the securities law are liable based on the defendant's percentage of responsibility. Answer: Proportionate liability Explanation: Proportionate liability arises when defendants who are not found to have "knowingly committed a violation" of the securities law are liable based on the defendant's percentage of responsibility. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 184) The ________ was the act passed in 2002 after the public was dissatisfied with the quality of audits of public companies. Answer: Sarbanes-Oxley Act Explanation: The public was not satisfied with the quality of audits of public companies. The result was the Sarbanes-Oxley Act of 2002 and the creation of the PCAOB to provide oversight of the auditors of public companies. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Professional Behavior 185) ________ is established by the state and federal legislative bodies and specifically addresses the auditor's liability under certain circumstances. Answer: Statutory law Explanation: The statutory law is established by the state and federal legislative bodies and specifically addresses the auditor's liability under certain circumstances. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

186) A ________ is the defense wherein an audit firm shows that it had made a reasonable investigation, had followed auditing standards, and accordingly had reasonable grounds to believe that the statements certified were true at the date of the statements and true of the time the registration statement became effective. Answer: due diligence defense Explanation: A due diligence defense is the defense wherein an audit firm shows that it had made a reasonable investigation, had followed auditing standards, and accordingly had reasonable grounds to believe that the statements certified were true at the date of the statements and true of the time the registration statement became effective. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 187) In order to become a Certified Public Accountant (CPA) one must pass a professional examination and also fulfill the requisite experience requirements. Once a CPA has obtained his or her license, a CPA A) may sign an audit or attest report, but is typically not allowed to sign a tax return as a tax preparer. B) must abide by all professional standards and the AICPA code of conduct. C) must keep their professional education current by obtaining the minimum required number of professional education courses each year. D) is authorized to sign an audit report or an attest report, and may also sign a tax return as a tax preparer. Answer: B, C, D Explanation: A CPA should abide by all professional standards, keep their professional education current, and may sign audit/attest reports as well as tax returns as a tax preparer. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

188) The AICPA Code of Professional Conduct has been incorporated by many states into state rules, and thus applies to CPAs who are practicing in those states. Which of the following statements are correct with respect to the AICPA Code of Professional Conduct? A) The code consists of principles, rules and interpretations and other guidance for AICPA members. B) Interpretations offer additional guidance regarding the scope and applicability of the rules of conduct, however practicing CPAs are free to depart from these interpretations without justification. C) Rules of conduct establish minimum standards to help the CPA determine acceptable conduct in the performance of professional services. D) The code is organized into three major sections, beginning with Members in Business. Answer: A, C Explanation: The code consists of principles, rules and interpretations and other guidance for AICPA members. Rules of conduct establish minimum standards to help the CPA determine acceptable conduct in the performance of professional services. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

189) Juniper auditors are beginning the audit of Star Enterprises, a small business and new audit client for Juniper. It has been determined that one of Star Enterprises' key officers is the spouse of an audit manager that has been assigned to this client. In addition, Juniper has indicated that help will be needed in other areas such as providing bookkeeping services. Which of the choices below correctly represent the threats to independence that may exist in this situation? A) An advocacy threat may exist because the manager may not act objectively due to a potential conflict of interest. B) A familiarity threat may exist in that the manager may become too close to the audit client. C) A management participation threat may exist due to the client asking the auditor to perform extra services which may cause the CPA to make management decisions. D) An adverse interest threat may exist due to Juniper informing star that they are currently pursuing litigation against the predecessor auditor. Answer: B, C Explanation: A familiarity threat may exist in that the manager may become too close to the audit client. A management participation threat may exist due to the client asking the auditor to perform extra services which may cause the CPA to make management decisions. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

190) Starglow is a small CPA firm that specializes in auditing services to small and some medium size clients. Starglow is currently attempting to determine the best course of action to handle a conflict of interest case where Starglow is representing both the husband and wife in a divorce settlement case. Which of the options below would represent Starglows' correct choice of action? A) Upon realizing that they are representing both parties, Starglow should immediately advise both parties in writing of their intention to withdraw from the engagement. B) Starglow should determine if it can feasibly represent both clients and still maintain independence and objectivity, and if so, proceed with assisting and representing both clients. C) As Starglow is a smaller CPA firm, it may be required to withdraw representation to one of the parties in the divorce settlement case, in order to avoid a conflict of interest. D) Starglow needs to simply advise both parties in writing of their representation of the other party, which will indemnify them against any future attempts at litigation by either party. Answer: B, C Explanation: Starglow should determine if it can feasibly represent both clients and still maintain independence and objectivity, and if so, proceed with assisting and representing both clients. As Starglow is a smaller CPA firm, it may be required to withdraw representation to one of the parties in the divorce settlement case, in order to avoid a conflict of interest. LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 191) Identify two possible threats that occur when a CPA and his or her supervisor have a difference of opinion related to the application of accounting principles, auditing standards, or other relevant professional standards? A) Self-interest B) Advocacy C) Familiarity D) Self-review Answer: A, C Explanation: Self-interest, familiarity, and undue influence threats may exist when a CPA and his or her supervisor have a difference of opinion related to the application of accounting principles, auditing standards, or other relevant professional standards. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

192) When considering threats to auditor independence, an issue of extreme importance is that of covered members. Covered members represent persons in positions to potentially influence attest decisions and/or the outcome of an audit engagement. Select any of the following scenarios that may represent an impairment of independence to a covered member. A) A member of the audit engagement team assigned to a client has determined that he or she has a material indirect interest in the client under audit. B) A different partner working in the same office as the partner assigned to the audit client, who has a loan outstanding with the audit client. C) A nephew of an audit manager assigned to the audit client who owns shares of stock in the client. D) A member of a compensation committee who has an indirect, immaterial interest in the audit client. Answer: A, B Explanation: A member of the audit engagement team assigned to a client has determined that he or she has a material indirect interest in the client under audit. A different partner working in the same office as the partner assigned to the audit client, and who has a loan outstanding with the audit client. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 193) Greengrass auditors is determining whether to accept a new audit client, Breezy Inc. As part of its client acceptance procedure, Greengrass is attempting to evaluate whether the firm has the necessary expertise and competence to effectively audit Breezy, Inc. Some of the key considerations for Greengrass would include ________. A) ensuring that the audit, if accepted, can be undertaken and completed with professional competence B) obtaining enough information on the client to allow a subjective determination of whether professional services can be effectively performed C) ensure that if the audit client is accepted and the audit proceeds, adequate planning and supervision is possible with respect to the performance of professional services D) All of the choices are correct. Answer: D Explanation: All of these answer choices are correct. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

194) With respect to CPAs in public practice, Rule 1.320 on accounting principles advises that CPAs should not knowingly express an affirmative audit opinion or state that he or she is not aware of any material modifications made to the financial statements if the opposite exists. Select all answer choices below which accurately describe the theories that underpin this rule. A) A presumption that adherence to authoritative accounting principles promulgated by professional bodies would result in accurate financial statements. B) The option for the CPA to depart from the accounting principle, if he or she deems it appropriate, in order to achieve fair and accurate financial statement presentation. C) The belief that forcing CPAs to always abide by these principles will introduce an element of standardization and uniformity in financial statements and audit reports. D) To provide legal protection and indemnity to the auditor in case they are subject to litigation. Answer: A, B Explanation: A presumption that adherence to authoritative accounting principles promulgated by professional bodies would result in accurate financial statements. The option for the CPA to depart from the accounting principle, if he or she deems it appropriate, in order to achieve fair and accurate financial statement presentation. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 195) Britannia External Auditors recently published an audit report which has become the focus of litigation. The plaintiff has alleged breach of contract on the part of the external auditor. Which of the following choices would represent viable options for the plaintiff to attempt to prove Britannia did indeed breach a contract? A) In the course of the audit, Britannia violated a confidentiality agreement with the client. B) Britannia had agreed to deliver the audit report in full on a predetermined specified date, and due to audit staff turnover, was not able to deliver on its promise. C) It has been alleged that Britannia may have issued a standard audit report which did not follow generally accepted auditing standards. D) All of the choices are correct. Answer: D Explanation: All of these answer choices are correct. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

196) Bluetooth External Auditors is currently engaged in the audit of Farmside Enterprises. During the audit, it has been determined that Farmside has conducted an initial offering of common stock in order to raise needed capital for expansion. Senior management of Farmside is attempting to understand their liability in this case. Select all responses below which accurately describe Bluetooth's best response. A) Initial stock offerings are regulated by the Securities Act of 1933. Under the provisions of this act, the auditor may also be liable for losses resulting from ordinary negligence. B) Initial stock offerings are regulated by the SEC act of 1934. Under the provisions of this act, the auditor may also be liable for losses resulting from gross negligence. C) The plaintiffs may be any person who acquired securities that were described in the firm's registration statement, regardless of whether or not they are a client of the auditor. D) Plaintiffs who purchased securities as part of initial offering need to prove reliance on the false or misleading statements in order to prevail in court. Answer: A, C Explanation: Initial stock offerings are regulated by the Securities Act of 1933. Under the provisions of this act, the auditor may also be liable for losses resulting from ordinary negligence. The plaintiffs may be any person who acquired securities that were described in the firm's registration statement, regardless of whether or not they are a client of the auditor. Diff: 2 LO: 9 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

197) Match each of the threats below with the appropriate description. A. Undue influence threat B. Self-interest threat C. Management participation threat D. Adverse interest threat ____ The threat that a CPA will take on the role of client leadership or assume such responsibilities. ____ The threat that a CPA could benefit from an interest in, or relationship with, a client or persons associated with a client. ____ The threat that a CPA will subordinate his or her judgment to an individual associated with the client or a relevant third party. ____ The threat that a CPA will not act with objectivity because the CPA's interests are opposed to client interests. Answer: Undue influence threat– the threat that a CPA will subordinate his or her judgment to an individual associated with the client or a relevant third party. Self-interest threat–the threat that a CPA could benefit from an interest in, or relationship with, a client or persons associated with a client. Management participation threat–the threat that a CPA will take on the role of client leadership or assume such responsibilities. Adverse interest threat–the threat that a CPA will not act with objectivity because the CPA's interests are opposed to client interests. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

198) Match the following entities with the appropriate categories. A. covered member B. executor of an estate C. nondependent children D. dependent member ____ key management position ____ member of the engagement team ____ immediate family member ____ close relative Answer: A covered member may be a member of the engagement team. An executor of an estate holds a key management position. Nondependent children of a covered member are their close relatives. Dependent members of a covered member are their immediate family members. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 199) Why do auditors try to achieve independence in appearance? Answer: Auditors try to achieve independence in appearance in order to maintain public confidence in the profession. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Technology and Tools; PC: Decision Making

200) Stephen has recently obtained his CPA license and is getting ready to start a new job as CFO of a publicly-traded company. Stephen meets his friend Allen for coffee at a local coffee shop. Allen is curious about Stephen's new CPA license, and asks Stephen to explain what his obligations are under the new license and how important the license really is. Which of the following options best describes Stephen's response? A) The CPA license is important because one must pass a rigorous professional exam and complete a work experience requirement before obtaining the license. After the license is obtained, a CPA is considered an expert and must prioritize his or her concern for the public interest. B) The CPA license represents a prestigious certification for an individual to achieve in his or her career. Upon obtaining the license, firms are usually willing to higher wages and salaries, because stock prices and investor confidence in that company will always increase. C) The CPA license is important because in addition to having to pass a rigorous professional exam and complete a work experience requirement, the CPA is responsible for ensuring that the goals and interests of the company and the public always align. D) Becoming a CPA represents an embodiment of the public trust in that individual to always do the right thing in tough circumstances, and the public's expectation that the CPA will prioritize their obligation to their employer over accurate and fair presentation of the firm's financial statements. Answer: A Explanation: The CPA license is important because one must pass a rigorous professional exam and complete a work experience requirement before obtaining the license. After the license is obtained, a CPA is considered an expert and must prioritize his or her concern for the public interest. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 201) Can a CPA who has never audited a commercial bank, audit the bank? Answer: The CPA may accept the engagement to audit the commercial bank after attaining a suitable level of understanding of the transactions and accounting practices unique to commercial banking. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Technology and Tools; PC: Decision Making

202) Jim, a recent college graduate, has recently obtained his CPA license. Jim has been contacted by the dean of a local college's school of business and asked to participate in a forum about the CPA license and what his responsibilities are as a CPA. During the forum, a student inquires as to whether Jim is required to abide by a code of conduct. Jim should respond with which of the following answers? A) The accounting profession has a code known as the AICPA Code of Professional Conduct. The code is split into principles, rules of conduct, and departures. A CPA must always follow these rules of conduct, and be prepared to justify any departures. B) The AICPA Code of Professional Conduct represent the rules that guide CPAs. This code is split into principles which provide basic tenets; rules of conduct which help establish minimum standards, and interpretations which can offer additional guidance. A CPA is required to be a member of the AICPA and expected to abide by the code of conduct in order to keep his or her license. C) The AICPA Code of Professional Conduct is designed to help CPAs in practice handle ethical conflicts and sets forth rules of conduct which should be followed. While membership of the AICPA is voluntary, it is fair to say that the majority, if not all CPAs should strive to abide by the code of conduct. D) The AICPA Code of Professional Conduct is voluntary, and thus the rules are practicable and certainly helpful to practicing CPAs, but not enforceable. The code is purposefully split into interpretations, principles, and a strict code of ethics. Answer: C Explanation: The AICPA Code of Professional Conduct is designed to help CPAs in practice handle ethical conflicts and sets forth rules of conduct which should be followed. While membership of the AICPA is voluntary, it is fair to say that the majority, if not all CPAs should strive to abide by the code of conduct. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

203) Martha and Betty are both senior managers for a prominent local auditing firm. During the audit of a client that they are both working on, Martha and Betty are discussing the accounting conceptual framework and are deliberating on how the framework can be used to 'fill in the gaps' of the AICPA Code of Professional Conduct. Martha has been a CPA for many years, whereas Betty only recently obtained her licensure. Betty asks Martha to explain her understanding of the conceptual framework and how best to utilize this framework when faced with a particular challenging circumstance. Which of the following would be Martha's most appropriate response? A) The framework represents a comprehensive body of accounting rules and principles which CPAs can refer to for guidance and assistance in areas of accounting and ethics. If a suitable course of action cannot be determined using the conceptual framework, the CPA should instead refer to the AICPA Code of Professional Conduct. B) The framework represents an authoritative body of knowledge in the accounting profession, and is designed to help CPAs and other members of the accounting profession by providing guidance in a variety of areas. The framework is a great place for a CPA to look if suitable guidance cannot be found in the AICPA Code of Professional Conduct. C) The framework is a useful tool for CPAs in practice, but its usage is optional. While many CPAs refer to the framework for guidance, others simply depart from its rules and provide justifications for doing so which creates an inconsistency in the profession. D) The conceptual framework represents a useful tool for CPAs in practice, but many of the rules are so ambiguous CPAs rarely agree on their interpretation and application, thus the code is rarely used. Answer: B Explanation: The framework represents an authoritative body of knowledge in the accounting profession, and is designed to help CPAs and other members of the accounting profession by providing guidance in a variety of areas. The framework is a great place for a CPA to look if suitable guidance cannot be found in the AICPA Code of Professional Conduct. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

204) Honey & Co. external auditors have recently accepted an attest engagement with a new client, Flower Enterprises. During the initial client meeting, top management of Flower Enterprises apprised the auditor that several key members of management had recently departed and were yet to be replaced, and as a result, management of Flower Enterprises would be leaning on the auditors for informal advice and guidance until these positions could be replaced with the appropriate expertise. One of the key departures was the head of Internal Audit. Upon learning this information, the external auditors convene a private meeting to discuss possible threats to independence. The outcomes of this meeting are likely to include ________. A) an adverse interest threat may exist because it will be harder for the CPA to act objectively, and a familiarity threat may also exist because the external auditors will now have to make management decisions B) a management participation threat is likely to exist due to the departure of several top managers, and a self-review threat is also likely to exist because with less key management in place, the CPA is more likely to have to review their own work as well as the work of the internal audit function C) a self-review threat may exist because the CPA is likely to have to assume functions ordinarily performed by the client, and a management participation threat may exist because the CPA firm is essentially being asked to fill in for various empty management positions D) an undue influence threat may exist due to the remaining members of the client's management asserting their positions and power, and an adverse interest threat may also exist because the CPA firm is likely to be less objective now that audit fees can be increased Answer: C Explanation: A self-review threat may exist because the CPA is likely to have to assume functions ordinarily performed by the client, and a management participation threat may exist because the CPA firm is essentially being asked to fill in for various empty management positions. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 205) What is the conceptual difference between attestation standards and generally accepted auditing standards? Answer: Attestation standards provide a framework for the attest function beyond historical financial statements. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Technology and Tools; PC: Decision Making

206) Tabletop External Auditors are currently completing the audit of Star Enterprises, Inc. a manufacturer of specialized astronomy and stargazing equipment with sales throughout the continental United States. In a recent meeting with Star Enterprises' top management, a difference of opinion was noted on the depreciation method Star Enterprises has been using for its factory equipment; currently the straight line method. Tabletop auditors convened a private meeting to include just the audit managers assigned to the audit to discuss this issue further. During this meeting, it came to light that three of the audit managers believe straight line depreciation is the most appropriate method and the other three audit managers believe double declining balance is more appropriate. The lead partner assigned to the engagement has been called in to settle the difference of opinion. Which of the choices below most accurately reflect the lead partner's decision process in arriving at the suitable method? A) The lead partner assigned to the engagement is likely to attempt to determine if the straight line method of depreciation is causing a material misstatement in the financial statements, and if so, request it be changed to the double declining balance method to avoid future misstatements. B) The lead partner assigned to the engagement is likely to advise all senior managers that choice of depreciation method is ultimately the clients to make, and thus the audit staff should simply audit the depreciation expenses to make sure they are correct. C) If both depreciation methods are not likely to cause a potentially material misstatement in the financial statements, the lead partner will likely advise the audit managers to defer the decision to client management. D) Per the AICPA Code of Professional Conduct, the lead partner is likely to take the concerns directly to the client's board of directors and request the issue be voted on and decided at the next board meeting. Answer: A Explanation: The lead partner assigned to the engagement is likely to attempt to determine if the straight line method of depreciation is causing a material misstatement in the financial statements, and if so, request it be changed to the double declining balance method to avoid future misstatements. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

207) Sam and Dave are both audit partners in a medium-size CPA firm. Sam has recently joined the firm from another organization, and is being mentored by Dave, a much more experienced auditor and long-time CPA. One day, Sam and Dave are discussing the concept of covered members, which piques Sam's curiosity. Sam advises that while he understands the lists of who is and who isn't a covered member, he is not sure why only certain people are included and others are not. In answering this question and providing a broader conceptual understanding of what it means to be a covered member, Dave should advise which of the following? A) It is important to understand that as a covered member, the CPA is now liable for any and all misstatements contained in the client's financial statements, whether or not they are discovered. B) Restrictions related to covered members can be thought of as a safeguard to help people in certain positions of potential influence avoid conflicts of interest. This helps to maintain both independence in fact and independence in appearance. C) Covered members can be thought of those people who, during a particular attest engagement, may be placed in a position where they have conflicting interests. When this happens, the covered member may continue working on the engagement but should disclose any potential conflict of interest immediately to avoid litigation. D) As a covered member is considered to generally be anyone who can influence the outcome of an attest engagement or the decisions made during the engagement, a covered member or members of their family are strictly prohibited from holding any direct or indirect interest in an attest client. Answer: B Explanation: Restrictions related to covered members can be thought of as a safeguard to help people in certain positions of potential influence avoid conflicts of interest. This helps to maintain both independence in fact and independence in appearance. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

208) During the initial phases of the external audit of Dark Co., Light CPAs' audit managers and partners assigned to the engagement are discussing any potential conflicts of interest that may be present and need to be addressed. One of the audit managers advises that his wife has recently taken a job with Dark Co. and will be responsible for the client's data entry as well as being the petty cash custodian. Based on this information, what would be the most appropriate classification of both the audit manager and his wife? A) The partners will likely conclude that the audit manager assigned to the audit is a covered member because of his involvement in the audit and ability to influence its outcome, and will likely also conclude that the audit manager's spouse is a covered member due to her involvement with the client's cash. B) The partners are likely to agree that the audit manager assigned to this audit is a covered member by virtue of the fact that he can influence the outcome of the engagement, and that his wife is likely not considered a key member because of the immateriality of the petty cash fund. C) The partners are likely to conclude that the audit manager's spouse holds a key position with the client and thus the audit manager should be reassigned to a separate attest engagement forthwith. D) It is probable that the audit partners will conclude that the audit managers' spouse does not hold a key position with the client due to the immateriality of the petty cash fund, and that the audit manager is not a covered person as the partners will ultimately make all important decisions. Answer: B Explanation: The partners are likely to agree that the audit manager assigned to this audit is a covered member by virtue of the fact that he can influence the outcome of the engagement, and that his wife is likely not considered a key member because of the immateriality of the petty cash fund. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

209) Ramsey external auditors are currently completing an attest engagement for Proctor Industries. Proctor is a medium size firm that specializes in Bluetooth technology equipment such as headphones and speakers. During one of the initial meetings with the client, it has come to light that a former audit partner that worked for Ramsey up until eight months ago is now employed by Proctor in the role of head of Internal Audit. The engagement team partners assigned responsibility for the audit are discussing how best to proceed. The most likely course of action for Ramsey to pursue is ________. A) to advise Proctor of this conflict of interest and signify their intention to withdraw from the engagement pursuant to rules contained in the AICPA Code of Professional Conduct to avoid any issues that may arise B) to immediately modify all procedures related to the audit to counter the familiarity the exemployee has with the auditing firm and its procedures. If it is not possible or appropriate to make such modifications, the auditor should withdraw from the engagement C) to determine the level of familiarity the former employee had or may have of the audit procedures to be employed and determine if any revisions need to be made. Ramsey should also ensure that the same level of professional skepticism is applied to this individual as others working for the client D) to utilize the former employee as an unofficial source of information on the firm to help discover any areas of heightened risk within the firm Answer: C Explanation: to determine the level of familiarity the former employee had or may have of the audit procedures to be employed and determine if any revisions need to be made. Ramsey should also ensure that the same level of professional skepticism is applied to this individual as others working for the client. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

210) Apple external auditors has been busy auditing the financial statements of Orange Inc. a supplier of fresh orange and apple juice across the Midwestern United States. It has been observed by the auditors throughout the course of the engagement that Orange Inc. appears drastically understaffed in the accounting department. As a result of this, and in order to ensure the audit is completed on budget and on time, several of the junior staff members assigned to the audit have been helping out with basic accounting tasks such as inputting of journal entries and preparation of sales orders and bills of lading. During a recent discussion between the two partners assigned to the engagement, this issue has come up and is being discussed. The discussion between the two partners is likely to center around which of the following? A) Whether or not Apple auditors can charge Orange Inc. more money as a result of the extra work the auditing firm staff are now having to perform, and if so, how best to include these extra fees as part of the cost of the audit. B) Whether or not a potential impairment to independence may exist because of the auditing staff's involvement with the client's accounting function, and how this could be construed by the public at large. C) That the audit staff's involvement in the client's accounting function does not represent a threat to independence because the audit staff are only performing menial and mostly immaterial accounting tasks. D) Whether the partners should consider meeting with the client's top management to discuss further opportunities for the auditor's staff to assist the client in meeting deadlines and performing all functions necessary to ensure the audit is completed in a timely manner. Answer: B Explanation: Whether or not a potential impairment to independence may exist because of the auditing staff's involvement with the client's accounting function, and how this could be construed by the public at large. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

211) Alan Johnson, an experienced CPA and auditor has recently retired from a long career in financial accounting. Upon retiring, Alan was approached by the board of directors of Trustman Company, a large distributor of medical device products and publicly-traded entity, and asked to join its audit committee. Alan accepts the offer. During the first meeting of the audit committee, a question is raised by another committee member as to the current external auditor's independence. It has been brought to the audit committee's attention that the external auditor is having to perform certain bookkeeping and actuarial functions on behalf of the client due to a lack of expertise on the client's staff. Which of the following would be Alan's best response when asked for his opinion on the matter? A) Alan should respond that it is appropriate for the auditor to perform these services so long as the calculations and work is checked by a member of Trustman Company thereafter. B) Alan should advise that while it is appropriate for the auditor to assist the client with these functions in the interim, an urgent effort should be made to fill these expertise gaps. C) Alan should express concern with the external auditor performing these functions, explaining that in so doing, the auditor is being put in a position of having to audit its own work. D) Alan should express concern with the external auditor performing these functions, as the public and regulatory agencies are more likely to view the auditor as being an advocate for the firm. Answer: C Explanation: Alan should express concern with the external auditor performing these functions, explaining that in so doing, the auditor is being put in a position of having to audit its own work. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

212) You have been hired to audit JarCakes, Inc., a small privately held local bakery that specializes in jarred cupcakes. As the bakery is small, they have requested that you do several other tasks for them. The bakery owner, Jared Sampson, is frequently out of town at conventions. As such, Jared has requested that you sign checks for him in emergency situations when he is out of town and payments must be made. In addition, when he is away, he has requested that the payroll clerk provide you with approved timecards to use in generating payroll checks. Jared's wife, Rita, is the accountant for JarCakes. She frequently attends conventions with her husband. Accordingly, Jared has also asked if it would be possible for you to post journal entries in the accounting. Rita would send you all information for any journal entries that are required, including the appropriate account classification. Additionally, Jared would like a new accounting information system installed. He considers you the expert, so he would like you to take full ownership of that project. As JarCakes is small and he has no IT staff, Jared would also like you to supervise his personnel in the daily operation of the new accounting information system. Finally, as Jared's expertise is in baking, and not in business, he would like you to serve in an investment advisory role for him, by recommending the allocation of funds that he should invest in various asset classes. Prepare a response to Jared, outlining which of his requests are allowed non-attest services and which of his requests are not allowed under the Independence rules. Answer: A CPA may not accept responsibility to authorize payment of client funds, or accept responsibility to sign or cosign client checks, even if only in emergency situations. When assisting a small business client with payroll using payroll time records provided and approved by the client, the CPA can generate unsigned checks or process the client's payroll. In an accounting service engagement for a nonpublic client, a CPA may record transactions for which management has determined or approved the appropriate account classification or post coded transactions to a client's general ledger. In an IT engagement, a CPA may design, install, or integrate a client's information system, provided the client makes all management decisions. However, a CPA may not supervise client personnel in the daily operation of a client's information system. In an investment advisory engagement with an attest and tax client, a CPA can recommend the allocation of funds that a client should invest in various asset classes, depending upon the client's desired rate of return, risk tolerance, and so on. Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

213) Darla Barker, CPA owns a small tax practice located in Ann Arbor, MI. Darla's family friend, Stephen Grey, owns a small security firm in Livonia, MI. Stephen's banker has decided that Stephen's company needs to submit audited financial statements in order to maintain Stephen's line of credit with the bank. Stephen emails Darla asking if she would be interested in performing the audit of his company. Stephen is on a tight deadline from the bank and would like the audited statements within 6 weeks. Darla's tax practice has never performed an audit for any client previously. Draft an email response from Darla to Stephen, referencing the appropriate section of the AICPA Code of Professional Conduct. Answer: Students will submit different content here but the key points of their email responses should be to (1) thank Stephen for considering our firm, (2) respectively and politely decline the engagement, (3) explain why the engagement must be declined — we simply do not have the experience and knowledge necessary to complete the engagement within the required time frame, and (4) suggest another CPA who may be able to help Stephen. The email response should reference the general standards: "A member shall comply with the following standards and with any interpretations thereof by bodies designated by Council: 1. Professional Competence. Undertake only those professional services that the member or the member's firm can reasonably expect to be completed with professional competence. 2. Due Professional Care. Exercise due professional care in the performance of professional services. 3. Planning and Supervision. Adequately plan and supervise the performance of professional services. 4. Sufficient Relevant Data. Obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed." Diff: 3 LO: 6 Bloom: Synthesis Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Technology and Tools; PC: Decision Making 214) STAR, CPA is auditing a not-for profit. Provide an example of due professional care with for this audit. Answer: Several responses would be acceptable. For example, consultation with an independent appraiser regarding the valuation of fine art for a not-for-profit museum would evidence proper due care. Diff: 2 LO: 6 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

215) Beaver Auditing Inc. has been approached by the management of Igloo Enterprises, a regional maker of ice creams and other iced treats in the southeastern United States. Igloo Enterprises is searching for a new external auditor to complete its yearly financial statement audit. Beaver Auditing Inc. has recently lost a number of key and experienced staff to a competitor due to a better salary and benefits package and has been struggling to replace the lost expertise. The partners of Beaver Auditing Inc. are meeting to discuss whether or not they should accept this audit engagement. Which of the choices below would best represent concerns that Beaver's partners may have in accepting this audit? A) Beaver's partners may be concerned with the heightened risk that the audit client is new, and that as a result, there is an increased chance of the auditors missing a material misstatement in the financial statements. B) Beaver's partners are likely to be concerned that the firm may struggle to complete the engagement with professional competence due to expertise lacking in certain areas and may also be concerned as to whether this lack of expertise will cause a lack of due care. C) The partners may be concerned that due to a staffing shortage, the external auditors will be less likely to be able to collect sufficient relevant data, which in turn means decreased inherent risk and an increased likelihood of future litigation. D) The partners may be concerned about being able to complete the audit in the agreed-upon timeframe, which may result in the auditor's reliance on the internal audit function to complete the areas where expertise is lacking. Answer: B Explanation: Beaver's partners are likely to be concerned that the firm may struggle to complete the engagement with professional competence due to expertise lacking in certain areas and may also be concerned as to whether this lack of expertise will cause a lack of due care. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

216) Elaine and Denise, both partners in a CPA firm are discussing the accounting principles rule and how this rule is applicable to their business and the auditing profession in general. Elaine states that her understanding of the rule is to protect auditing companies from placing themselves in a position of increased litigation whereas Denise explains that her interpretation of the rule is that it is designed to help ensure that CPAs and auditing firms adhere to the principle and do not depart from it unless a clear justification can be made. Which of the two partners are correct and why? A) Elaine is correct because a CPA firm is more likely to experience issues with litigation if they do not strictly follow the rules as set forth. B) Denise is correct because the spirit of the rule is to help ensure that CPAs and auditing firms do not make false or misleading statements which could cause harm to the general public. C) Both Elaine and Denise are correct because when the rule is adhered to, it may help auditing firms to avoid litigation, as well as ensuring no false or misleading statements about the financial statements are made. D) None of the choices is correct. Answer: C Explanation: Both Elaine and Denise are correct because when the rule is adhered to, it may help auditing firms to avoid litigation, as well as ensuring no false or misleading statements about the financial statements are made. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None

217) HPI Auditing Firm has just received a subpoena in connection with auditing work performed in the previous year for one of its former attest clients, Slippery Inc. The subpoena has requested the furnishing of client information which is considered to be confidential by the external auditor. HPI has consulted their in-house legal expert to advise the best course of action in relation to this subpoena. Which of the following choices would represent the most likely and appropriate response from the auditor's in-house legal counsel? A) The subpoena should be considered null and void on the grounds that HPU Auditing Firm no longer provides auditing and attestation services to this client. B) The subpoena is enforceable so long as it is issued by a valid legal authority, and the requested client information should be furnished accordingly. C) The subpoena is enforceable so long as it is issued by a valid legal authority, but the former attest client should be notified and permission received before the release of any client information. D) The auditing firm's in-house legal counsel should respond to the legal authority issuing the subpoena within ten business days to advise that the auditor-attest client relationship is privileged, and thus no information can legally be shared. Answer: B Explanation: The subpoena is enforceable so long as it is issued by a valid legal authority, and the requested client information should be furnished accordingly. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Ethics AICPA: BC: None; AC: Reporting; PC: None 218) Patrick Bronson is the owner of a local CPA firm. His client, J.R.'s Convenience Store, is a small local business that records its transactions on a cash basis. Each year, Patrick's firm prepares financial statements for J.R.'s on a cash basis. Is this a violation of the accounting principles rule? How should the CPA treat the preparation of cash basis financial statements? Answer: No. It is appropriate and compliant that many small businesses use the cash basis. Financial statements prepared using a cash basis would be considered financial reporting frameworks other than generally accepted accounting principles (GAAP). In this situation, the client's financial statements, and the CPA's report thereon, should not purport that the financial statements are in accordance with GAAP, and the financial statements and the CPA's report should clarify the financial reporting framework used. Diff: 3 LO: 7 Bloom: Synthesis Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

219) You are starting up a small CPA firm in your town. Your friend, Bruce, is an advisor at the local investment services firm. Bruce tells you this could be a great opportunity for both of you. Bruce suggests that you each pay each other a $100 referral fee for each client that you successfully refer to the other. Compose an answer to Bruce, in accordance with the AICPA Code of Professional Conduct. Answer: Students will submit different content here but the key points of their answer to Bruce should be to (1) decline the offer and (2) explain that such an arrangement is not allowed per the AICPA Code of Professional Conduct. In general, entering into a referral fee associated with an attest client impairs independence due to the advocacy threat associated with these types of fees. It is appropriate for CPAs to accept a referral fee, with respect to non-attest clients. However, these fee arrangements are prohibited for attest clients as they impair independence. Diff: 3 LO: 7 Bloom: Synthesis Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 220) Miller, CPAs is performing an audit of the financial statements of Big Craft Brewery. Pete Henderson, the CEO of Big Craft Brewery has requested that Miller CPAs omit the financial statement disclosures for segment reporting, as that is confidential information that could harm his competitive advantage, if made public. Draft an email from Miller CPAs to Pete Henderson in response to his request. Answer: Students will submit different content here but the key elements in their email to Pete should be that omitting a required disclosure would be unacceptable. Then, explain that the rule on confidential client information should not be construed as relieving a CPA of his or her professional obligation to comply with accounting principles. Hence, a client cannot claim that information should not be disclosed in financial statements due to client confidentiality if the information is required by GAAP. Diff: 3 LO: 7 Bloom: Synthesis Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

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221) Compare and contrast auditor liability under contract law vs. tort law. Answer: An auditor may be liable to a client for breach of contract when the audit firm: o Issues a standard audit report when he or she has not made an audit in accordance with generally accepted auditing standards (GAAS). o Does not deliver the audit report by the agreed-upon date. o Violates the client's confidential relationship. A CPA may also be liable to a client under tort law. A tort is a wrongful act that injures another person's property, body, or reputation. A tort action may be based on any one of the following causes: o Ordinary negligence - Failure to exercise the degree of care a person of ordinary prudence (a reasonable person) would exercise under the same circumstances. o Gross negligence - Failure to use even slight care in the circumstances. o Fraud - Intentional deception, such as misrepresentation, concealment, or nondisclosure of a material fact, that results in injury to another. In some cases a distinction has been made between fraud and constructive fraud. Constructive fraud may be inferred from gross negligence or reckless disregard for the truth. Diff: 3 LO: 8 Bloom: Synthesis Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 222) Briefly compare the differences between ordinary negligence, gross negligence, and fraud. Answer: o Ordinary negligence - Failure to exercise the degree of care a person of ordinary prudence (a reasonable person) would exercise under the same circumstances. o Gross negligence - Failure to use even slight care in the circumstances. o Fraud - Intentional deception, such as misrepresentation, concealment, or nondisclosure of a material fact, that results in injury to another. In some cases a distinction has been made between fraud and constructive fraud. Constructive fraud may be inferred from gross negligence or reckless disregard for the truth. Diff: 3 LO: 8 Bloom: Evaluation Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

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223) Evaluate the following statement: Maria Boynton is the plaintiff in a case against Sutherby & Alton, CPAs, arguing that she suffered a loss by relying on the financial statements of Big Box, Inc., which were audited by Sutherby & Alton, CPAs. Under the Securities Act of 1933, Marcia must prove that the auditors were negligent or fraudulent in certifying the financial statements involved. Answer: According to the Securities Act of 1933, the plaintiff (e.g., investors): o May be any person acquiring securities described in the registration statement, whether or not he or she is a client of the auditor. o Must base the claim on an alleged materially false or misleading financial statement contained in the registration statement. o Does not have to prove reliance on the false or misleading statement or that the loss suffered was the proximate result of the statement if purchase was made before the issuance of an income statement covering a period of at least 12 months following the effective date of the registration statement. o Does not have to prove that the auditors were negligent or fraudulent in certifying the financial statements involved. Diff: 3 LO: 9 Bloom: Evaluation Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 224) The Sarbanes-Oxley Act of 2002 made it unlawful to perform audit services for a public company and also perform the certain nonattest services for audit clients. List three of the prohibited services and come up with an example of why it may be inappropriate for an auditor to perform both an audit and that particular service. Answer: Specific student answers will vary but should address the ethical implications and threats to independence, conflicts of interest, etc. SOX makes it "unlawful" to perform audit services for a public company and also perform the following nonattest services for audit clients: o Bookkeeping or other services related to the accounting records or financial statements of the audit client o Financial information systems design and implementation o Appraisal or valuation services, fairness opinions, or contribution-in-kind reports o Actuarial services o Internal audit outsourcing services o Management functions or human resources o Broker or dealer, investment adviser, or investment banking services o Legal services and expert services unrelated to the audit o Any other service that the PCAOB determines, by regulation, is impermissible Diff: 3 LO: 9 Bloom: Evaluation Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making 102

225) Tim O'Neal, CEO of a public company, explains to you, his auditor, that he does not believe he is responsible for the fair presentation of his company's financial statements. After all, isn't that what he hired you for? Draft a response to Mr. O'Neal. Answer: Specific student answers will vary but should address that management is responsible for the fair presentation of the financial statements and that the auditor is responsible for following GAAS and issuing an opinion on the fair presentation of the financial statements. Section 302 of SOX requires a public company's CEO and CFO to prepare a statement to accompany the audit report to certify the "appropriateness of the financial statements and disclosures contained in the periodic report, and that those financial statements and disclosures fairly present, in all material respects, the operations and financial condition of the issuer." It also creates a liability for the CEO and CFO who knowingly and intentionally make false certifications. Diff: 3 LO: 9 Bloom: Synthesis Min: 1 AACSB: Ethics AICPA: BC: Governance Perspective; AC: Reporting; PC: Decision Making

Auditing, 2e (Johnson) Chapter 3 Risk Assessment Part I: Audit Risk and Audit Strategy 1) Which of the following is/are the primary means of communication for gathering information while assessing management integrity? A) communication with the previous auditor, only B) communication with client personnel and with the client's industry peers, only C) communication with the client's industry peers, only D) communication with the client personnel, the client's industry peers and the previous auditor Answer: D Explanation: Assessing management integrity information is gathered primarily through communication. Communication with the client personnel, the client's industry peers, the previous auditor and the third parties such as client bankers and lawyers are some of the key communications. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 2) As per the appendix to AU-C 210, Terms of Engagement, a typical engagement letter for a private company client begins with a paragraph on the ________. A) objective and scope of the audit B) responsibilities of the auditor C) responsibilities of management D) fee arrangements and billings Answer: A Explanation: According to the appendix to AU-C 210, Terms of Engagement, a typical engagement letter for a private company client begins with a paragraph on the objective and scope of the audit. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

3) The requirement that the auditor have access to all information needed to perform the audit is stated in ________. A) the engagement letter B) substantive procedures C) an audit strategy D) AU-C 300 Planning an Audit Answer: A Explanation: The requirement that the auditor have access to all information required to perform the audit is stated in the engagement letter. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 4) An engagement letter is prepared by the ________ and acknowledged and signed by the ________ before the audit begins. A) auditor; client B) client; client C) auditor; state government D) federal government; client Answer: A Explanation: An engagement letter is prepared by an auditor and acknowledged by a client before the audit begins. It is a form of contract between an auditor and the client. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 5) What is the first stage of any audit? A) Client acceptance or a continuance decision B) Risk assessment C) Reporting D) Risk response Answer: A Explanation: The first stage is a client acceptance or continuation decision. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

6) The factor that influences client acceptance and retention decisions with respect to whether the accounting firm has the expertise to perform the services requested by the client is known as: A) competence issues. B) independence issues. C) integrity of management. D) special circumstances and unusual risk. Answer: A Explanation: Competence relates to whether the accounting firm has the expertise to perform the services requested by the client. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 7) Which of the following is a positive factor influencing client acceptance and retention decisions with respect to the integrity of management? A) Management places a premium on representational faithfulness of accounting information. B) Concerns exist about the integrity of management in business and accounting decisions. C) Management is preoccupied with meeting specific accounting numbers. D) Management integrity in business and accounting decisions seem to be situational and only remedied when noted by the auditors. Answer: A Explanation: Management placing a premium on representational faithfulness would be a positive factor. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

8) Which of the following is a positive factor influencing client acceptance and retention with respect to special circumstances and unusual risks? A) There are minimal regulatory reporting requirements. B) There are significant regulatory reporting requirements with close monitoring by regulators. C) The client voices significant concerns about the scope of audit work. D) The client is experiencing profitability issues, weak cash flows, and is close to violation of debt covenants. Answer: A Explanation: Minimal regulatory reporting requirements would be considered a positive factor. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 9) Which of the following would be least likely to help you assess the integrity of management? A) Interviews with human resources about its long-term disability provider. B) Interviews about the reputation of the client, its management, directors, and key stakeholders with the previous auditor. C) Interviews with management about its attitude to risk exposure. D) Interviews with the prior auditor about the client's reasons for switching audit firms, if the company was previously audited. Answer: A Explanation: Interviews with HR about the long-term disability provider would be least effective in assessing the integrity of management. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

10) Which of the following would be considered as internal information gathered primarily about the integrity of client management? A) Communication with client personnel B) Communication with the client's bankers and lawyers C) Communication with the client's industry peers D) A review of articles in industry trade journals Answer: A Explanation: Communication with client personnel would be helpful information regarding the integrity of management. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 11) An engagement letter is prepared by an auditor and acknowledged by a client ________. A) before the audit begins B) after the audit is completed C) before the client's year-end D) after the interim report is issued Answer: A Explanation: Engagement letters are prepared before the audit begins. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 12) An engagement letter is like a(an) ________. A) contract B) audit report C) job application D) note payable Answer: A Explanation: An engagement letter is similar to a contract. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

13) When is it necessary to send a new engagement letter to a continuing client? A) Only when the terms of the engagement have changed. B) Every year. C) On a quarterly basis. D) Along with the CPA's bill for the first year of services. Answer: A Explanation: It is only necessary to send a new engagement letter to a continuing client when the terms of the engagement have changed. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 14) The engagement letter does NOT include ________. A) the requirement that the auditor have access to all social security numbers of client employees in order to perform background checks B) an explanation of the scope of the audit C) the timing of the completion of various aspects of the audit D) an overview of the client's responsibility for the preparation of the financial statements Answer: A Explanation: The engagement letter does not include the requirement that the auditor have access to all social security numbers of client employees. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

15) What happens if an independence threat appears to be insurmountable? A) An audit firm should decline the offer to be the auditor of a prospective client or resign from the audit of an existing client. B) The audit firm should contact the State Board of Accountancy so they can make a press release to discourage other accountants from taking the engagement. C) The audit firm should make certain that safeguards are put in place to limit or remove those threats. D) The audit firm should take the engagement and continue to make certain that safeguards are put in place to limit or remove those threats. Answer: A Explanation: If an independence threat appears to be insurmountable, the firm should decline an offer to be the auditor or resign. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 16) The main purpose of an engagement letter is to ________. A) avoid any misunderstandings between the auditor and the client B) advertise the additional services that the CPA firm provides C) present the conclusion of the audit D) request any and all information that the CPA firm might need to complete the audit Answer: A Explanation: The main purpose of an engagement letter is to avoid any misunderstandings. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

17) If management is preoccupied with meeting specific accounting numbers, this is a negative factor that should influence client acceptance and retention and is associated with ________. A) the integrity of management B) competence issues within the audit firm C) independence issues within the audit firm D) special circumstances and unusual risks Answer: A Explanation: When management is overly concerned with "the numbers," there could be pressure to misstate the financial statements — an integrity of management issue. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 18) Which of the following is not a phase of the audit? A) The risk continuance phase B) The risk assessment phase C) The risk response phase D) The reporting phase Answer: A Explanation: There is no risk continuance phase of the audit. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 19) Which of the following was one of the largest accounting firms in the world during the 1990's and early 2000's? A) Arthur Andersen B) Laventhol & Horwath C) Arthur Young & Co D) Supreme, Inc. Answer: A Explanation: Arthur Andersen was one of the largest accounting firms in the world. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

20) Auditors gather information through communication with individuals internal and external to the prospective client. Which of the following would be internal to the client? A) Communication with client personnel B) Communication with third parties C) Communication with the client's industry peers D) Communication with the previous auditor Answer: A Explanation: Communication with client personnel is considered internal. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 21) The new auditor should communicate with the previous auditor in order to ________. A) gain an understanding about the reasons for the change of auditors B) get all the passwords and logins to the client software C) get the previous auditor's work papers D) serve them with an official change of auditor notice Answer: A Explanation: The new auditor should communicate with the previous auditor to gain an understanding about the reasons for the change of auditors. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 22) If a company refuses permission to contact its previous audit firm, what should the new auditor do? A) Consider the implications of that refusal when deciding whether to accept the engagement. B) Contact potential third parties to gain information about the client firm. C) Review newspaper and magazine articles about the client. D) Do a background check on the CEO of the company. Answer: A Explanation: The new auditor should consider the implications of that refusal when deciding whether to accept the engagement. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

23) Which of the following is a negative factor influencing client acceptance and retention with respect to competence issues? A) The audit firm does not have the affiliation with specialists to meet client needs. B) The client has a weak accounting system with few internal controls. C) The audit firm has conflict of interest issues that cannot be resolved prior to client acceptance. D) There are significant regulatory reporting requirements with close monitoring by regulators. Answer: A Explanation: If the audit firm does not have the affiliation with specialists to meet client needs, that would be considered a negative factor. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 24) Henley and Sarah, the owners and partners of StayBright CPA Firm, are planning to meet with a potential new client. At this juncture, little is known about the client except that they recently split with the predecessor auditor citing differences of opinion on 'important accounting policies.' Based on this information, what is Henley and Sarah's best course of action? A) Advise the client that based on the information they have received about the reason for termination of the predecessor auditor, inherent risk is too high, and they will not be able to accept the audit. B) Meet with the client and ask questions pertaining to the reasons for termination of the predecessor auditor, maintaining an appropriate level of professional skepticism throughout. C) Proceed with the client meeting and ask questions about the split with the previous auditor. Advise management that written assurances will have to be provided, assuring that in the instance of a dispute, the auditors' recommendation will always be followed. D) Explain to the client that generally accepted auditing standards require client's management to justify any departures from generally accepted accounting principles, and that the auditor is not liable for any such departures. Answer: B Explanation: Meet with the client and ask questions pertaining to the reasons for termination of the predecessor auditor, maintaining an appropriate level of professional skepticism throughout. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

25) Auditing firms consider a variety and multitude of factors when deciding whether or not to accept both a new audit client and retain an existing one. Which of the following choices would represent a situation where an auditor might choose to not accept a client? A) The firm has a clearly defined and properly adhered to hierarchy and reporting structure. B) The client's firm has a history of financial statement restatements. C) The client shows a record of strong profitability and operating cash flows, and has done so for many years. D) The client appears to have a robust and effective accounting system, with a newly installed system of internal controls. Answer: B Explanation: The client's firm has a history of financial statement restatements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 26) The partners of Mayfair CPAs are meeting to discuss the upcoming audit of an ongoing, major audit client. The client has recently replaced some key executive positions, as due to an economic downturn, demand has slackened and profitability issues are becoming a concern. Based on this information, what would be the audit firms' best course of action? A) Advise the client that because of the increased inherent risk associated with high management turnover and weak demand, the audit firm will no longer be able to perform attestation services. B) Perform the audit as normal, and request written assurances from both top management and the internal audit function relating to areas of higher audit risk. C) Consider performing the audit, but consider focusing audit time and resources on areas such as revenue that may now have a higher risk of material misstatement. D) Advise the client that Mayfair CPAs will assist the client in locating a new auditor, and proceed with disclaim an audit opinion. Answer: C Explanation: Consider performing the audit, but consider focusing audit time and resources on areas such as revenue that may now have a higher risk of material misstatement. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

27) Juniper Auditing Firm is discussing one of their largest audit clients, Canopus Inc., a retailer of emergency lifesaving equipment throughout the United States. The client has recently advised Juniper Auditing Firm that due to its location, it will be problematic this year for the auditors to access and audit the inventory accounts. Based on this information, what is Juniper Auditing Firm's most appropriate course of action? A) Juniper should immediately withdraw from the audit and proceed with issuance of a disclaimer of opinion. B) Juniper should consider employing the services of an audit firm close to the geographical location of the inventory. C) Juniper should request information from the internal audit function pertaining to the inventory accounts, and use this information to perform alternate audit procedures. D) As the client has high inventory turnover relative to the industry, this does not present a problem. Answer: B Explanation: Juniper should consider employing the services of an audit firm close to the geographical location of the inventory. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 28) As part of the ongoing audit of Winter Enterprises, the external auditor, Ghassan CPAs are reviewing the client's balance sheet. An audit manager has noticed a contingent liability on the balance sheet, with an associated note explaining the client believes they may be the subject of litigation in the near future. What would be the auditor's best course of action at this juncture? A) Request permission from the client's management to contact the client's legal counsel and discuss the details of this potential litigation. B) Request written assurances from top management, indemnifying the external auditors from any lawsuits filed against the client. C) Directly contact the client's legal counsel and attempt to obtain further details of the potential litigation. This should be done independently of the client and without the client's knowledge so management cannot alter any documentation or attempt to influence the external legal counsel. D) Immediately advise the client in writing of the auditor's intention to withdraw from the audit, citing the risk of litigation and the auditor's potential joint and several liability as the reason. Answer: A Explanation: Request permission from the client's management to contact the client's legal counsel and discuss the details of this potential litigation. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

29) Johnson and Co. CPAs is considering accepting a new audit client, DeBole Inc., a national distributor of whiskey and other spirituous products. The CPA firm is interested in contacting the predecessor audit before accepting the new client. Which of the following best represents questions the new auditor may have? A) How much prior audit fees were charged to the client, and how many billable hours were allotted to each area of the audit? B) Significant communications between the prior auditor and management pertaining to those charged with governance. C) The prior auditors understanding of the reasons why management has decided to switch to a different auditor. D) Any conflicts of interest between the major shareholders and bondholders of the client. Answer: C Explanation: The prior auditors understanding of the reasons why management has decided to switch to a different auditor. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 30) During a meeting between the senior audit partners of Baker CPA Firm and senior management of Fitzgerald LLC, a question has arisen about a new lease accounting standard which requires capitalization of the majority of former operating leases. Management does not appear to have capitalized leases in adherence to this new standard. What should the auditors' response to this be? A) If management is not adhering to accounting principles and rules set forth by professional bodies, the auditor should not accept the engagement. B) The auditor should advise management that they are likely to make recommendations to ensure the client adheres to generally accepted accounting principles. Failure to abide by these recommendations could result in the auditor issuing a qualified or adverse opinion. C) Management will need to provide written documentation to the auditor, justifying their departure from the new standard in order to receive a clean audit opinion. D) The auditor should work closely with the internal audit function to ensure that moving forward, the client adheres to all rules set forth by professional bodies. Answer: B Explanation: The auditor should advise management that they are likely to make recommendations to ensure the client adheres to generally accepted accounting principles. Failure to abide by these recommendations could result in the auditor issuing a qualified or adverse opinion. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 13

31) Johnsonville CPAs are currently working on the audit of Townsend, Inc., a retailer of fine bedding and other linen products. The audit managers assigned to the audit are attempting to determine where potential risks of material misstatement may be for the client. Which of the following statements would be true at this juncture? A) Johnsonville CPAs are most likely at the client acceptance stage of the audit, and are determining if Townsend represents a client they wish to accept. B) Johnsonville CPAs are most likely at the risk assessment phase of the audit, and are attempting to determine where risk areas may be in order to form the audit plan. C) Johnsonville CPAs are at the audit risk phase of the audit, and are looking to determine if the client possesses any external risk factors that could factor into the audit. D) Johnsonville CPAs are at the risk response phase of the audit, and are likely to perform risk and materiality assessments in order to determine where risks of misstatement may occur. Answer: B Explanation: Johnsonville CPAs are most likely at the risk assessment phase of the audit, and are attempting to determine where risk areas may be in order to form the audit plan. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 32) Tate CPA firm is completing an attestation engagement for Marjorie Enterprises, a distributor of pies and other pastry products throughout the United States, Canada, and Mexico. One of Tate's partners assigned to the engagement is concerned about how exchange rate fluctuations may affect balance sheet valuations for some accounts such as accounts receivable and payable. A suggested course of action for Tate would be which of the following? A) Based on this information, Tate should decrease the risk of material misstatement, and increase audit risk accordingly. B) Tate should consider employing the services of a valuation specialist to accurately audit exchange rate fluctuations recorded in the client's financial statements. C) Tate should consider focusing audit time on tests of controls to ensure that exchange rate fluctuations are appropriately recorded in the client's financial statements. D) Tate should advise the client's management that to be on the safe side, the auditors will issue a disclaimer of opinion on receivables and payables to avoid any future litigation. Answer: C Explanation: Tate should consider focusing audit time on tests of controls to ensure that exchange rate fluctuations are appropriately recorded in the client's financial statements. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

33) Brooks CPA firm are wrapping up the audit of Seagram Enterprises, a distributor of lawn care and fertilizer products throughout the United States and Canada. With the audit largely completed, the audit partner with responsibility for the engagement is attempting to determine the appropriate audit opinion. Which of the following choices best represents the partner's course of action at this point? A) The audit partner should review all evidence gathered, including any notable and qualifying areas, and proceed with issuance of an opinion. B) The audit partner should proceed with tests of the client's system of internal control to ensure that the preliminary audit opinion is correct. C) The audit partner should form an audit opinion, and then convene a meeting with client management and the internal audit function to discuss the suitability of this opinion. D) The audit partner should attempt to determine overall materiality for the audit, and then issue an audit opinion accordingly. Answer: A Explanation: The audit partner should review all evidence gathered, including any notable and qualifying areas, and proceed with issuance of an opinion. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 34) During the audit of Bloom Company, the external auditors, Simon CPA firm are performing tests of controls on the client's system of internal control. Which of the following statements best describes why the auditors are testing internal controls? A) The auditors routinely check a client's system of internal control as part of the audit, and typically allot equal amounts of time and resources to auditing each control. B) The auditors usually audit a client's internal controls after the risk assessment phase has been completed, and they have a better sense of which controls may need to be audited. C) The auditors usually perform substantive testing, including tests of details on a client's internal controls in order to decrease audit risk. D) Generally accepted auditing standards require CPA firms performing attest engagements to check all of a public or private client's internal controls Answer: B Explanation: The auditors usually audit a client's internal controls after the risk assessment phase has been completed, and they have a better sense of which controls may need to be audited. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

35) If an external auditor has tested a client's system of internal control and found it to not be effective or reliable, which of the following statements pertaining to the auditors' subsequent course of action is true? A) The audit firm should disclaim an opinion on the client's system of internal controls, and focus instead only on the client's financial statements. B) The auditor is more likely to adopt a reliance on control strategies, and subsequently will spend less time performing substantive tests. C) The auditor is likely to perform increased substantive testing to account for the identified internal control deficiencies. D) Apprise the internal audit function in writing of the noted internal control deficiencies, and advise that they must be corrected by conclusion of the audit or a qualified opinion will be issued. Answer: C Explanation: The auditor is likely to perform increased substantive testing to account for the identified internal control deficiencies. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 36) During the audit of Newsome Enterprises, Inc., a distributor of carburetors and other engine parts, it has been noted by the auditing firm, Betelgeuse CPAs, that a number of expense accounts still remain open and with balances after the client's closing procedures have been finalized. Based on this finding, which of the following statements is true? A) There may be expenses that pertain to the following period; in which case it is appropriate to leave the expense accounts open. B) This finding points to a potential deficiency in the client's system of internal control, and should be investigated further. C) This finding indicates that the client's system of internal control is deficient, and the auditor will need to redesign the internal controls and implement them to correct this deficiency. D) The auditor should request the client sign a written document releasing the order of any and all liability pertaining to issues that arise in the future pertaining to the client's closing procedures. Answer: B Explanation: This finding points to a potential deficiency in the client's system of internal control, and should be investigated further. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

37) Which of the following involves gaining an understanding of the client, identifying risk factors, developing an audit strategy, and setting planning materiality? A) Risk assessment phase B) Risk response phase C) Substantive procedures D) Tests of controls Answer: A Explanation: The risk assessment phase involves gaining an understanding of the client, identifying risk factors, developing an audit strategy and setting planning materiality. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 38) Which of the following is performed during the risk assessment phase? A) Risk and materiality assessment B) Detailed tests of controls C) Substantive testing of transactions and accounts D) Drawing conclusions based upon the evidence gathered Answer: A Explanation: Risk assessment phase involves performing a risk and materiality assessment. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 39) Which of the following processes is associated with the reporting phase? A) Conclusions are drawn when testing the client's controls. B) Decisions are made about extent and timing of detailed testing of account balances. C) Risk assessment procedures are performed to ensure appropriate attention is paid to transactions. D) Factors are identified that may impact the risk of a material misstatement. Answer: A Explanation: In the reporting phase, conclusions are drawn when testing the client's controls. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

40) What term refers to the determination of the amount of time to spend testing the client's internal controls and conducting detailed testing of transactions and account balances? A) Audit strategy B) Risk response C) Reporting D) Risk assessment Answer: A Explanation: Audit strategy involves determination of the amount of time to spend testing the client's internal controls and conducting detailed testing of transactions and account balances. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 41) The risk response phase involves the ________. A) performance of detailed tests of controls and substantive testing B) evaluation of the results of the detailed testing C) performing of a risk and materiality assessment D) development of an audit strategy Answer: A Explanation: The risk response phase involves the performance of detailed tests of controls and substantive testing. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 42) Which overview defines an audit strategy? A) The determination of the amount of time to spend testing the client's internal controls and conducting detailed testing of transactions and account balances. B) Gaining an understanding of the client, including identifying risk factors. C) Performing tests of controls and detailed substantive testing of transactions and accounts. D) Evaluation of results of the detailed testing in light of the auditor's understanding of the client and forming an opinion on the fair presentation of the client's financial statements. Answer: A Explanation: Audit strategy is the determination of the amount of time to spend testing the client's internal controls and conducting detailed testing of transactions and account balances. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 18

43) The risk assessment process is a(an) ________. A) iterative process B) one-time process C) concluding process D) infrequent process Answer: A Explanation: The risk assessment process is an iterative process. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 44) The final phase of the audit involves ________. A) drawing conclusions based upon the evidence gathered and arriving at an opinion about the fair presentation of the financial statements B) detailed testing of internal controls, transactions, account balances, and disclosures the auditors have determined to be at high risk of material misstatement C) planning the audit by assessing risk to reduce audit risk to an acceptably low level D) gaining an understanding of the client and identifying factors that may impact the risk of a material misstatement occurring in the financial statements Answer: A Explanation: The final phase of the audit involves drawing conclusions based upon the evidence gathered and arriving at an opinion. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

45) An evaluation of the results of the detailed testing in light of the auditor's understanding of the client and forming an opinion on the fair presentation of the client's financial statements is associated with what phase of the audit? A) The reporting phase B) The response phase C) The risk assessment phase D) The risk of material misstatement phase Answer: A Explanation: This is associated with the reporting phase. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 46) Identification of risk factors is typically associated with what phase of the audit? A) The risk assessment phase B) The risk response phase C) The reporting phase D) The audit strategy phase Answer: A Explanation: Identification of risk factors is typically associated with the risk assessment phase. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 47) Which phase helps improve the efficiency and effectiveness of the audit? A) The risk assessment phase B) The risk response phase C) The reporting phase D) The audit strategy phase Answer: A Explanation: The risk assessment phase helps to improve the efficiency and effectiveness of the audit. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

48) Audit risk is best defined as the ________. A) risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated B) application of risk assessment procedures C) element that helps form risk assessment D) risk of noncompliance with laws and regulations Answer: A Explanation: Audit risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 49) Auditors make preliminary risk assessments while ________. A) planning the audit B) drawing conclusions about client controls, transactions, and account balances C) planning to rely on the client's system of internal controls D) testing the account balances and transactions Answer: A Explanation: Auditors make preliminary risk assessments while planning the audit. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 50) The auditor's opinion is expressed in the ________. A) audit report B) financial statement footnotes C) retained earnings statement D) risk response phase documentation Answer: A Explanation: The auditor's opinion is expressed in the audit report. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

51) Developing an audit strategy is typically accomplished in the ________. A) risk assessment phase B) risk response phase C) reporting phase D) audit strategy phase Answer: A Explanation: The audit strategy is typically developed in the risk assessment phase. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 52) Performance of detailed tests of controls and substantive testing is typically accomplished in the ________ phase of the audit. A) risk response B) audit strategy C) reporting D) risk assessment Answer: A Explanation: Performance of tests of controls and substantive testing is typically accomplished in the risk response phase. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 53) Auditors make decisions about the extent and timing of detailed testing of account balances and transactions during the ________phase of the audit. A) risk response B) audit strategy C) reporting D) risk assessment Answer: A Explanation: These decisions occur in the risk response phase. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

54) When considering clients like Boeing, inventory will most likely be the largest current asset and prepaid expenses will be one of the smallest. As a result, the auditors should plan to ________. A) devote more audit time to the inventory account than the prepaid expenses account B) devote more audit time to prepaid expenses to the inventory account C) use more complex audit tests for inventory and more simple audit tests for prepaid expenses D) observe more material misstatements in prepaid expenses due to timing differences as compared to the inventory account Answer: A Explanation: As a result, auditors should plan to devote more audit time to the inventory account than the prepaid expenses account. Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 55) What must happen before planning the audit and implementing the phase of risk assessment? A) The client acceptance or continuation decision has to be made B) The risk response phase has to be completed C) The reporting phase must be undertaken D) The audit strategy must be planned Answer: A Explanation: The client acceptance or continuation decision has to be made before planning the audit and implementing the risk assessment phase. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

56) What is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated? A) Audit risk B) Risk response C) Risk assessment D) Risk reporting Answer: A Explanation: Audit risk is the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 57) AU-C 300 Planning an Audit and AS 2101 Audit Planning primarily requires auditors to ________. A) plan the audit by assessing risk to reduce audit risk to an acceptably low level B) perform tests of the system of internal control, or tests of account balances, transactions, or disclosures C) make decisions about the extent and timing of detailed testing of account balances and transactions D) rely on the client's system of internal controls Answer: A Explanation: These standards primarily require auditors to plan the audit by assessing risk to reduce audit risk to an acceptably low level. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

58) In general, what does detailed testing of account balances provide? A) The evidence needed by auditors to determine if the financial statements are fairly presented in accordance with GAAP B) Information about revising preliminary conclusions drawn during the risk assessment phase C) The exact amount of time spent gathering audit evidence D) A listing of the audit tests performed during all phases Answer: A Explanation: Detailed testing of account balances provides the evidence needed by auditors to determine if the financial statements are fairly presented. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 59) What is the last phase of the audit? A) The reporting phase B) The risk response phase C) The audit strategy phase D) The risk assessment phase Answer: A Explanation: The last phase is the reporting phase. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 60) What is the second phase of the audit? A) The risk response phase B) The reporting phase C) The audit strategy phase D) The risk assessment phase Answer: A Explanation: The second phase is the risk response phase. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

61) When the financial statements are materially misstated for a particular client, which of the following will constitute an audit risk? A) An auditor expressing an incorrect audit opinion B) The discontinuance of an internal process from a previous year C) Creditors and investors expressing a favorable opinion D) Some stakeholders not relying on the auditing firm Answer: A Explanation: Audit risk is the risk of an auditor expressing an inappropriate audit opinion when the financial statements are materially misstated. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 62) Information is considered quantitatively material if it exceeds the magnitude of an auditor's ________ materiality assessment. A) planning B) performance C) qualitative D) quantitative Answer: A Explanation: Information is considered quantitatively material if it exceeds the magnitude of an auditor's planning materiality assessment. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 63) Misstatements that impact a user's decision-making process for a reason other than its magnitude constitute ________ materiality. A) qualitative B) quantitative C) performance D) All of these answer choices are correct Answer: A Explanation: Qualitative materiality is information or misstatements that impact a user's decision-making process for a reason other than its magnitude. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 26

64) Which of the following is an amount set by the auditor that is used to make decisions about the extent of audit procedures for a particular class of transaction, account balance, or disclosure? A) Performance materiality B) Planning materiality C) Overall materiality D) Qualitative materiality Answer: A Explanation: Performance materiality is an amount set by the auditor that is less than planning materiality and is used to make decisions about the extent of audit procedures for a particular class of transaction, account balance, or disclosure. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 65) From a definitional perspective, information is considered material if it ________. A) impacts the decision-making process of users of the financial statements B) is diverse in nature C) only includes qualitative evidence D) includes income statement benchmarks Answer: A Explanation: Information is considered material if it impacts the decision-making process of users of the financial statements. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 66) Information is considered quantitatively material if it ________. A) exceeds the dollar magnitude of an auditor's planning materiality assessment B) affects a user's decision-making process for a reason other than its dollar magnitude C) indicates the audit client is in danger of breaching a debt covenant D) indicates there is a change in client operations that affects the level of risk faced by the client Answer: A Explanation: Information is considered quantitatively material if it exceeds the dollar magnitude of an auditor's planning materiality assessment. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 27

67) Information is considered qualitatively material if it ________. A) affects a user's decision-making process for a reason other than its magnitude B) exceeds the dollar magnitude of an auditor's planning materiality assessment C) can be presented as a percentage of net income D) includes liquidity ratios of interest to bond holders Answer: A Explanation: Information is considered qualitatively material if it affects a user's decisionmaking process for a reason other than its dollar magnitude. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 68) Which of the following statements is true? A) The auditing standards require specific percentages be applied as benchmarks in setting planning materiality. B) For both private and publicly traded companies, the primary users of financial statements are the stockholders. C) Auditors rely heavily on their professional judgment in setting planning materiality D) Audit firms do not vary in the method they use to set planning materiality in the risk assessment phase. Answer: C Explanation: The auditing standards encourage the use of benchmarks but allow auditors to use their professional judgement to determine which benchmarks to use. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

69) If new information comes to light that would cause the auditor to establish a different level of planning materiality, then the auditor ________. A) should examine the information and make adjustments to materiality as needed B) issue a qualified opinion as part of the audit report C) follow the auditing standards that recommend an appropriate percentage of total assets as a benchmark for planning materiality for all companies D) have management of the company select the appropriate benchmark for planning materiality Answer: A Explanation: If new information comes to light that would cause the auditors to establish a different level of planning materiality, then they should examine the information and make adjustments to materiality as needed. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 70) In an analysis by Eilifsen and Messier (2015), of the eight largest U. S. public accounting firms in the study, ________ firms revealed that they use "income before income taxes" as the primary benchmark for determining planning materiality. A) seven B) six C) five D) four Answer: A Explanation: Seven firms revealed that they use "income before income taxes" as the primary benchmark for determining planning materiality. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

71) In addition to income before income taxes, another common benchmark(s) for determining planning materiality for private company audits is(are) ________. A) total assets and total revenues B) net income C) income tax rate D) net liabilities Answer: A Explanation: Other acceptable benchmarks are total assets and total revenues. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 72) Total equity may be more reliable of a benchmark for determining planning materiality when a company is experiencing a ________. A) loss or very poor operating results B) high number of operating lease contracts C) large amount of property, plant, and equipment purchases D) significant volume of sales. Answer: A Explanation: Total equity may be more reliable when the company is experiencing a loss of very poor operating results. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 73) A majority of companies in the Eilifsen and Messier (2015) study used ________ percent of income before taxes to determine planning materiality. A) 5 B) 10 C) 15 D) 2 Answer: A Explanation: A majority of companies used 5% of income before taxes. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

74) A(an)________ is an amount set by the auditor that is less than planning materiality and is used to make decisions about the extent of audit procedures for a particular class of transaction, account balance, or disclosure. A) performance materiality B) quantitative materiality C) qualitative materiality D) auditing standard Answer: A Explanation: Performance materiality is an amount set by the auditor that is less than planning materiality and is used to make decisions about the extent of audit procedures for a particular class of transaction, account balance, or disclosure. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 75) The use of performance materiality should reduce the ________ and/or undetected misstatements in the financial statements is greater than materiality for the financial statements as a whole. A) probability that the sum of immaterial B) sum of the probabilities of material C) difference between the material D) the product of probabilities for material Answer: A Explanation: The use of performance materiality should reduce the probability that the sum of immaterial and/or undetected misstatements in the financial statements is greater than materiality for the financial statements as a whole. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

76) The determination of performance materiality is ________and involves the exercise of professional judgment. A) not a simple mechanical calculation B) a simple mechanical calculation C) a simple manual calculation D) a mechanical calculation that includes solving for derivatives Answer: A Explanation: The determination of performance materiality is not a simple mechanical calculation. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 77) After determining materiality, which of the following is NOT a step for the auditor to follow? A) Determine who is most likely to commit fraud B) Determine the type and extent of risk assessment procedures to be performed C) Identify and assess the risk of material misstatements occurring at the financial statement level and the account balance level D) Begin development of an audit strategy Answer: A Explanation: The auditor does not determine who has the greatest potential to commit fraud after determining materiality. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

78) If auditors determine a higher planning materiality level, they will plan to gather ________ extensive audit evidence. A) less B) more C) a greater proportion of D) complex Answer: A Explanation: Higher materiality thresholds will result in auditors gathering less extensive audit evidence. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 79) Holding everything else constant, as the auditor's evaluation of materiality_______, the auditor is looking to obtain a more precise conclusion about the financial statements. The ________ precision of the audit will cause the auditor to perform more extensive audit procedures. A) decreases, increased B) increases, decreased C) increases, increased D) decreases, decreased Answer: A Explanation: Holding everything else constant, as the auditor's evaluation of materiality decreases, the auditor is looking to obtain a more precise conclusion about the financial statements. The increased precision of the audit will cause the auditor to perform more extensive audit procedures. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

80) The use of performance materiality should: A) reduce the probability that the sum of immaterial and/or undetected misstatements in the financial statements is greater than materiality for the financial statements as a whole. B) increase the probability that the sum of immaterial and/or undetected misstatements in the financial statements is greater than materiality for the financial statements as a whole. C) reduce the probability that the sum of immaterial and/or undetected misstatements in the financial statements is less than materiality for the financial statements as a whole. D) increase the probability that the sum of immaterial and/or undetected misstatements in the financial statements is less than materiality for the financial statements as a whole. Answer: A Explanation: The use of performance materiality should reduce the probability that the sum of immaterial and/or undetected misstatements in the financial statements is greater than materiality for the financial statements as a whole. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 81) Martin Inc. is being audited by the firm MNE and Associates. MNE's auditors decide that $100 million is the planning materiality and $50 million is the appropriate performance materiality at the account level. If all of Martin's account balances are below $50 million, the auditors will: A) still perform some audit procedures on the account because the immaterial misstatements can be material in aggregate. B) perform detailed audit procedures on the accounts because the sum of Martin's accounts is greater than $50 million. C) end audit procedures, both detailed and on controls, because performance materiality has reduced the probability that the sum of immaterial and/or undetected misstatements in the financial statements is less than materiality for the financial statements as a whole. D) check the auditing standard guidelines for the determination of performance materiality. Answer: A Explanation: The auditors will perform test work on immaterial accounts because immaterial misstatements can become material in aggregate. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

82) MNE and Associates is auditing Blanchard Company. MNE has decided to use a materiality threshold of 5% of earnings before income tax as a benchmark. If income (earnings) before income tax was $33 million, what would be the amount of planning materiality? A) $1.65 million B) $31.43 million C) $660,000 D) $34.65 million Answer: A Explanation: $33 × 0.05 = $1.65. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 83) In the Eilifsen and Messier (2015) study, the firms that used benchmarks of total assets and total revenues, used what percent of these figures to determine their planning materiality? A) 0.25% to 2.0% B) 2.0% to 2.5% C) 0.25% to 5.0% D) 5.0% to 7.5% Answer: A Explanation: 0.25% to 2.0% of total assets and total revenues were used. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

84) MNE and Associates used the benchmark of 5% of income (earnings) before income tax and came up with $9.5 million as their planning materiality for Garden, Inc. MNE also determined that planning materiality using a benchmark of 1% total assets resulted in $23 million. How should MNE decide which planning materiality amount to use? A) Ultimately, the auditors must use their professional judgment to decide on the planning materiality amount, along with qualitative factors in the final assessment. B) The auditors would use the largest amount in order to detect larger material misstatements. C) The auditors would use the smaller amount in order to keep with the principle of conservatism. D) The auditors would average the two amounts because the use of two benchmarks provides greater precision. Answer: A Explanation: Ultimately, the auditors must use their professional judgment to decide on the planning materiality amount, along with qualitative factors in the final assessment. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 85) Which of the following denotes information or misstatements that exceed the magnitude of an auditor's preliminary materiality assessment? A) Quantitative materiality B) Qualitative materiality C) Professional materiality D) Professional judgement Answer: A Explanation: Quantitative materiality is information or misstatements that exceed the magnitude of an auditor's preliminary materiality assessment, which is a percentage of an appropriate benchmark Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

86) What is performance materiality? A) Amount or amounts set by the auditors at less than the materiality level for particular classes of transactions, account balances, or disclosures B) Information or misstatements that impact a user's decision-making process for a reason other than its magnitude C) Information or misstatements that exceed the magnitude of an auditor's preliminary materiality assessment, which is a percentage of an appropriate benchmark D) None of these options are correct. Answer: A Explanation: Performance materiality is amount or amounts set by the auditors at less than the materiality level for particular classes of transactions, account balances, or disclosures Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 87) Materiality is an extremely important concept in the world of auditing and attestation services. Auditors consider this carefully when planning and executing an audit. Which of the following choices best describes and explains the concept of materiality as it pertains to auditing? A) Materiality relates to the concept of whether something is considered important or not to the auditor, and refers to quantitative amounts contained in the financial statements. B) Materiality is a legal term defined by the courts and interpreted by judges and juries during trials. C) Materiality relates to whether knowledge of a certain item would influence a reasonable person's decision on something, and could be quantitative or qualitative. D) Materiality relates to whether a reasonable person would be influenced by knowledge of the item, and refers to qualitative information provided, such as notes to the financial statements. Answer: C Explanation: Materiality relates to whether knowledge of a certain item would influence someone's decision on something, and could be quantitative or qualitative Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

88) Two audit partners are discussing planning materiality for one of their larger clients, Seaford Enterprises, a regional provider of public transportation services in the southwestern United States. In the context of an attestation engagement, planning materiality refers to which of the following? A) The overall level of materiality that the auditor objectively selects once an understanding of the client has been developed and any areas of increased audit risk identified. B) The level of materiality required to be assigned to each individual balance sheet and income statement account. C) The level of materiality that is agreed upon jointly between the auditor and the client's senior management at the beginning of the audit engagement. D) The level of materiality that the auditor decides upon before initiating the engagement, and having consulted with the predecessor auditor. Answer: A Explanation: The overall level of materiality that the auditor objectively selects once an understanding of the client has been developed and any areas of increased audit risk identified. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 89) An audit partner assigned to the engagement of Jaycee Enterprises has just learned from the client's legal counsel that the client is likely to be getting sued in the near future related to product defects. The auditor is planning to convene a meeting with the client's legal counsel to discuss this matter further and to determine if a contingent liability will need to be recorded in the financial statements. Which of the following statements is true pertaining to this potential litigation? A) The auditor will need to record a contingent liability if an estimated dollar amount can be provided by the client's legal counsel, even if the probability of the litigation is unknown. B) Upon learning of the likely litigation, the auditor should consider immediately withdrawing from the engagement to preserve the firms' reputation. C) If upon meeting with the client's legal counsel, the auditor feels the litigation is probable and a dollar estimate can be reasonably estimated, the contingent liability should be recorded in the financial statements. D) The auditor should meet with the client's legal counsel and gather all necessary information, and then defer the decision as to whether to include any information on this in the financial statements to management. Answer: C Explanation: If upon meeting with the client's legal counsel, the auditor feels the litigation is probable and a dollar estimate can be reasonably estimated, the contingent liability should be recorded. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 38

90) While reviewing the financial statements of a potential new audit client, Ken, the senior audit partner and owner of Leonard's CPA Firm has noted that the client has a contingent liability recorded on the balance sheet for a relatively insignificant dollar amount. Ken proceeds to check the accompanying note to the financial statements which advises the amount is to retain the services of a specialist law firm who believe this may become a class action lawsuit. Based on this information, it could be said that A) as no litigation has been filed at present, there is no need to record a liability of any kind or accompanying note in the financial statements. B) although the amount may be quantitatively immaterial at present, the qualitative indicator of a potential class action lawsuit is enough to warrant its recording in the financial statements. C) the client's best course of action is to immediately notify the Securities and Exchange Commission of the possible litigation. D) even a quantitatively immaterial amount should still be recorded in the client's financial statements, regardless of whether or not a qualitative element exists. Answer: B Explanation: although the amount may be quantitatively immaterial at present, the qualitative indicator of a potential class action lawsuit is enough to warrant its recording in the financial statements. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

91) As part of the audit of DarkSky LLC, the external auditors, PeeDee CPAs are examining the inventory accounts of the client and have noted potentially material misstatements in multiple inventory accounts. The current asset inventory represents a relatively large amount of the client's total assets, and inventory turnover has been steadily decreasing. Which of the following statements is true regarding the inventory misstatements? A) As the client's inventory represents a relatively large proportion of their total assets, this is likely to be considered material and would represent an area where an audit adjustment may be required. B) As inventory turnover is steadily decreasing, it is likely that the client will purchase less inventory moving forward, so materiality should not be a concern. C) Any potential misstatements whether material or not in the client's inventory accounts should be of concern to the auditor due the heightened audit risk. D) In order to decrease audit risk, the auditor should obtain written assurances from management to release the auditor of liability should any future litigation ensure involving this area. Answer: A Explanation: As the client's inventory represents a relatively large proportion of their total assets, this is likely to be considered material and would represent an area where an audit adjustment may be required. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 92) Two audit managers assigned to an engagement are discussing the concept of materiality with a new staff associate. The staff associate in question has raised some queries about performance materiality, and is trying to glean a better understanding of this area. Which of the following statements would be most appropriate to advise the staff associate? A) Performance materiality relates to individual accounts and assertions, and should always be greater than planning materiality for the same account or assertion. B) Planning materiality is used by the external auditors to help determine the nature, timing, and extent of audit procedures to be conducted. C) Performance materiality will be less than planning materiality, and should be lower than materiality for individual accounts and transactions. D) Performance materiality and the overall materiality assessed by the auditor is a subjective determination undertaken by the auditor before the audit starts. Answer: C Explanation: Performance materiality will be less than planning materiality, and should be lower than materiality for individual accounts and transactions. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 40

93) Carrie, an external auditor working on the attest engagement for Jackson Enterprises is discussing the audit of accounts receivable and the associated allowance accounts with some of the staff in the internal audit function. The staff have advised her that they have already completed the audit of these accounts, and can provide Carrie with appropriate documentation accordingly. Which of the following would represent an appropriate exercise of professional skepticism by Carrie? A) As the internal audit function is considered to be effective and strong by the external auditors, no further action by Carrie is required. B) Carrie should consider accepting the evidence and documentation from the internal audit function, but should also consider applying checks and audit procedures to corroborate the conclusions reached. C) Carrie should advise the internal audit function that because the allowance accounts contains subjective measurements, it is required to be audited by the external auditors. D) Carrie should accepting the evidence and documentation supplied by the internal audit function, but should recheck this area and perform a separate audit on the assumption that the internal auditors may be covering up error or fraud. Answer: B Explanation: Carrie should consider accepting the evidence and documentation from the internal audit function, but should also consider applying checks and audit procedures to corroborate the conclusions reached. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

94) During the audit of Griffin LLC, the external auditors, Weisz CPAs are examining accounts receivable. While working on this area of the audit, one of the external auditor's audit managers has noticed that the predecessor auditor and the client calculated different balances for receivables and the associated allowance during last year's audit. As a result of this finding, which of the following statements most appropriately describes the auditors' employment of professional skepticism? A) As the discrepancy pertains to the prior year's audit, and relates to a period when the auditor was not engaged, the auditor should disregard this discrepancy. B) The auditor should attempt to investigate the discrepancy further, to determine the reasons for the discrepancy and if such divergences in opinion between management and the auditor may affect the current year's audit. C) The auditor should separately contact the predecessor auditor and confidentially request further details of the discrepancy. D) The auditor should immediately consider withdrawing from the current engagement in order to preserve the firm's reputation. Answer: B Explanation: The auditor should attempt to investigate the discrepancy further, to determine the reasons for the discrepancy and if such divergences in opinion between management and the auditor may affect the current year's audit. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

95) While performing the external audit on the revenue accounts of Outdoors, Inc., a supplier of kayaks and other recreational sailing equipment, the external auditors, Francisco CPAs, have noted a significantly larger balance in the sales returns and allowances account compared to last year. Which of the following choices would represent an appropriate exercise of professional skepticism based on this finding? A) The auditor is likely to assume that the audit client has made larger allowances in order to remain competitive in the industry. B) The auditor is likely to initiate an investigation as to why this is the case, and assign this task to the internal audit function who are more familiar with the client's operations. C) The auditor should investigate the large increase in this account, as the returns could be associated with agreements beforehand to return goods sold. D) The auditor should request that management investigate this accordingly, and provide a formal report to the external auditors for inclusion in the current year's audit file. Answer: C Explanation: The auditor should investigate the large increase in this account, as the returns could be associated with agreements beforehand to return goods sold. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 96) John and Caroline, two audit staff associates assigned to the audit of King Enterprises are discussing audit risk. As newly-hired employees, both John and Caroline are keen to understand more about this area and how it pertains to their jobs with the firm. Which of the following statements most accurately describes audit risk? A) Audit risk can be best thought of as the risk that any misstatement contained in the financial statements is detected and corrected by the auditors. B) Audit risk is a subset of the risk of material misstatement, and is set jointly by the auditors and top management. C) Audit risk is most appropriately thought of as the risk that the auditor renders a clean opinion on financial statements which are materially misstated. D) Audit risk is best thought of as the risk that the external auditors do not manage to eliminate inherent risk as part of the audit. Answer: C Explanation: Audit risk is most appropriately thought of as the risk that the auditor renders a clean opinion on financial statements which are materially misstated. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

97) Understanding assertions is a key part of understanding the systematic approach undertaken by most external auditors. Which of the following statements is more accurate pertaining to assertions in auditing? A) Assertions are representations made orally by management pertaining to the financial statements, and for which they can be held liable. B) Assertions are considered to be made by management and apply to the financial statements. Assertions may be both explicit and implicit. C) Assertions are determined by the auditor at the beginning of the audit engagement as part of the risk assessment phase, and then are subsequently audited by the auditor. D) Assertions are made by management and checked by the external auditor. Assertions only apply to quantitative amounts contained in the financial statements. Answer: B Explanation: Assertions are considered to be made by management and apply to the financial statements. Assertions may be both explicit and implicit. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 98) Lucky Auditing Firm is completing the external audit of Starmount LLC, an international provider of telecommunications and videoconferencing equipment. Lucky Auditing Firm has observed over the last few years of the audit how quickly the client's industry appears to change. With this in mind, which of the following statements is most accurate? A) Once the current year's audit is over, the external auditing firm should consider not accepting any future engagements due to the increased audit risk associated with rapidly changing industries. B) Rapid technological developments in the client's industry are likely to increase inherent risk, which may also increase audit risk and impact detection risk. C) Any rapidly changing industry represents an increased likelihood of fraud. It is prudent for the auditor to avoid such industries. D) It is likely that due to the rapidly changing industry, the subjectivity of accounting estimates has increased, decreasing audit risk and increasing the risk of material misstatement. Answer: B Explanation: Rapid technological developments in the client's industry are likely to increase inherent risk, which may also increase audit risk. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

99) The audit manager assigned to the audit engagement of Haavisto LLC is attempting to explain the concept of detection risk to a newly hired staff associate. Which of the following statements most accurately describes the concept of detection risk? A) Detection risk is closely related to the risk of material misstatement, and is generally set at the same level initially for all industries. B) Detection risk refers to the risk that the auditor fails to detect any misstatements in the client's financial statements because the auditor employed incorrect audit procedures. C) Detection risk relates to the concept that the auditor may inadvertently miss a material misstatement in the client's accounts because of inappropriate testing procedures. D) Detection risk is inversely related to audit risk, and is typically determined by the audit partner at the conclusion of the engagement. Answer: C Explanation: Detection risk relates to the concept that the auditor may inadvertently miss a material misstatement in the client's accounts because of inappropriate testing procedures. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 100) Fanfare CPA Firm is currently completing the audit engagement for ShoeFit Enterprises LLC, a national provider of a wide range of shoes which are distributed through stores all over the country. Which of the following would best represent an area of higher inherent risk for the auditors? A) The decentralized structure of the client's operations, which may make auditing the inventory accounts more challenging. B) Due to its location in the stores, inventory may be more easily stolen by employees and visitors to the store. C) It may be more challenging to audit the client's specific revenue accounts due to the large range of merchandise they sell. D) As consumer tastes and preferences in this area change rapidly, the inventory being stocked in the stores may fast become obsolete. Answer: B Explanation: Due to its location in the stores, inventory may be more easily stolen by employees and visitors to the store. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

101) When would auditors increase the amount of detailed audit procedures used to test the yearend account balances and transactions from throughout the year? A) When the detection risk is low B) When the inherent risk is low C) When the control risk is low D) When the inherent risk in high Answer: A Explanation: A low detection risk means the auditors increase the amount of detailed audit procedures used to test the year-end account balances and transactions from throughout the year. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 102) What is audit risk? A) the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated B) the risk that an auditor expresses an objectionable audit opinion when the financial statements are materially misstated C) the risk that an auditor expresses an adverse opinion when the financial statements are materially misstated D) the risk that an auditor expresses an incompatible audit opinion when the financial statements are materially misstated Answer: A Explanation: the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

103) At the assertion level, the risk of material misstatement refers to risks that affect classes of ________. A) account balances, only B) transactions and disclosures, only C) disclosures, only D) transactions, account balances, and disclosures Answer: D Explanation: At the assertion level, the risk of material misstatement refers to risks that affect classes of transactions, account balances and disclosures. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 104) The auditor can set detection risk as high if ________. A) inherent risk and control risk are both low B) inherent risk and control risk are both high C) inherent risk is low and control risk is high D) inherent risk is high and control risk is low Answer: A Explanation: If inherent risk and control risk are low, the auditor can set detection risk as high. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 105) Which term means that (or is defined as): auditors should maintain a questioning mind and thoroughly investigate all evidence presented by the client? A) Professional skepticism B) Audit risk C) Audit responsibility D) Audit Assertion Answer: A Explanation: Professional skepticism means that auditors should maintain a questioning mind and thoroughly investigate all evidence presented by the client. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

106) AU-C 200.A22, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance With Generally Accepted Auditing Standards states auditors should be skeptical if certain situations arise. Which situation is NOT included in those that AU-C 200.A22 presents? A) A situation indicates that there is the need for fewer audit procedures. B) Audit evidence recently gathered is contradictory to other evidence previously gathered. C) New information brings into question the reliability of client documents or responses to auditor inquiries. D) Conditions are observed that indicate evidence of possible fraud. Answer: A Explanation: AU-C 200.A22 does not include situations that indicate the need for fewer audit procedures. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 107) In order to maintain professional skepticism, an auditor must also maintain ________. A) independence from management B) support of management's questionable assumptions C) situational reliability D) support of questionable financial disclosures Answer: A Explanation: An auditor must also maintain independence from management. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

108) Throughout all phases of the audit, auditors should keep questions in mind when gathering audit evidence. Which is of the following is an example? A) Do we need to perform more audit procedures? B) If management offers to take us to eat lunch during the audit, should we assume this is breakdown in controls? C) Should we assume that client management is dishonest until proven otherwise? D) Should we assume that any information from management and those charged with governance is correct? Answer: A Explanation: Auditors should consider whether they need to perform more audit procedures. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 109) What is audit risk? A) The risk that an auditor expresses an inappropriate audit opinion when financial statements are materially misstated B) The risk that is explicit or implied and made by management regarding the recognition, measurement, presentation and disclosure of items included in the financial statements and notes C) The risk that a client's internal controls will not prevent or detect a material misstatement on a timely basis D) The assessed risk of material misstatement that, in the auditor's judgment, requires special audit consideration Answer: A Explanation: Audit risk is the risk that an auditor expresses an inappropriate audit opinion when financial statements are materially misstated. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

110) What is the first stage in audit risk assessment? A) Identification of accounts and related assertions most at risk of material misstatement, referred to as inherent risk B) Performance of audit procedures to identify transactions and accounts where the risk of material misstatement is lowest C) Test the existence assertion of recorded inventory D) Determination of the effectiveness of the client's system of internal controls Answer: A Explanation: The first stage involves the identification of accounts and related assertions most at risk of material misstatement, referred to as inherent risk. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 111) When classifying risks as being significant, consideration is given to whether the risk involves all the following except involvement of ________. A) very simple transactions B) fraud C) significant third parties D) significant subjectivity in measurement Answer: A Explanation: Consideration is not given to the involvement of very simple transactions. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 112) The second stage in audit risk assessment is to ________. A) gain an understanding of the client's system of internal controls B) prevent fraud C) use subjective measurement in financial statements D) focus on the significant transactions outside of the client's normal course of business Answer: A Explanation: The second stage is to gain an understanding of the client's system of internal controls. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 50

113) What is control risk? A) The risk that a client's internal controls will not prevent or detect a material misstatement on a timely basis. B) The assessed risk of material misstatement that, in the auditor's judgment, requires special audit consideration C) An audit risk assessment that involves the identification of accounts and related assertions most at risk of material misstatement D) A risk that management's assertion, or claim, that recorded inventory exists Answer: A Explanation: Control risk is the risk that a client's internal controls will not prevent or detect a material misstatement on a timely basis. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 114) Which of the following statements is true? A) Inherent risk is the susceptibility of an assertion to material misstatement before consideration of any related controls. B) Inherent risk assessment is affected by internal factors but not external factors. C) It is possible to eliminate audit risk. D) During the risk assessment phase, auditors will perform audit procedures to identify transactions and accounts where the risk of material misstatement is lowest. Answer: A Explanation: Inherent risk is the susceptibility of an assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

115) Higher inherent risk factors are found where ________. A) transactions or account balances are derived from significant estimates B) transactions or account balances are easily confirmed with reliable sources C) the client's industry is thriving D) the client's location has minimal risk of being affected by a natural disaster Answer: A Explanation: Higher inherent risk traits are found where transactions or account balances are derived from significant estimates. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 116) Lower inherent risk factors are found where ________. A) technological developments are a minimal factor in the valuation of the client's assets B) the client's industry is experiencing a period of decline C) the client has insufficient working capital and is at risk of violating loan contracts D) the client's location is at risk of facing natural disasters, such as hurricanes and flooding Answer Answer: A Explanation: Lower inherent risk traits are found where technological developments are a minimal factor in the valuation of a client's assets. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 117) What are the benefits of considering management assertions in the audit process? A) Assertions help guide the procedures conducted by auditors. B) Assertions guarantee that fraud will be found. C) It is possible to eliminate audit risk when assertions are used. D) Assertions eliminate the risk that inventory will be stolen. Answer: A Explanation: Assertions help guide the procedures conducted by auditors. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

118) The assessed level of inherent and control risk for each assertion will ________. A) guide auditors in developing their audit strategy to gather appropriate audit evidence B) guarantee the effectiveness of the client's system of internal controls C) eliminate the risk of material misstatement for each account D) eliminate the need for professional skepticism Answer: A Explanation: The assessed level of inherent risk and control risk for each assertion will guide auditors in developing their audit strategy to gather appropriate audit evidence. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 119) AU-C 200.A22, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance With Generally Accepted Auditing Standards states auditors should be skeptical if which of the following situations arises during the audit? A) Situations that indicate the need for additional audit procedures beyond what is required by generally accepted auditing standards B) An environment of information stability and little change of client documents C) Conditions where gaining evidence of possible fraud is impossible D) Audit evidence recently gathered agrees with other evidence previously gathered Answer: A Explanation: Auditors should be skeptical of situations that indicate the need for additional audit procedures beyond what is required by generally accepted auditing standards. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 120) What should auditors aim for when working with audit risk? A) Reducing audit risk to an acceptably low level B) Eliminating audit risk C) Increasing audit risk to an acceptably high level D) Stabilizing audit risk from year to year in order to eliminate audit procedures Answer: A Explanation: Auditors should aim to reduce audit risk to an acceptably low level. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 53

121) The audit risk model can also be used for quantitative analysis in which all risks are stated as a percentage ranging from ________. A) 1% to 1% B) 1% to 100% C) 1% to 10% D) 1% to 5% Answer: B Explanation: The audit risk model can also be used for quantitative analysis in which all risks are stated as a percentage ranging from 1% to 100%. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 122) A significant risk is an identified and assessed risk of material misstatement that, in the auditor's judgment, requires special audit consideration. Which of the following would be classified as a significant risk? A) A risk related to a significant economic or accounting development. B) A risk related to transactions for a simple operating lease, like you sign when you rent an apartment. C) A risk that does not involve a related party transaction. D) A risk related to a transaction that involves a recording error, but was not intentional, like a fraud. Answer: A Explanation: A risk related to a significant economic or accounting development would most likely be classified as a significant risk. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

123) The audit risk model is presented as ________. A) AR = f (IR * CR * DR) B) AR = f (IR + CR + DR) C) AR = f (IR + CR — DR) D) AR = f (IR * CR) / DR Answer: A Explanation: The audit risk model is presented as: AR = f(IR * CR * DR). Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 124) During which phase or phases of the audit do auditors adopt the attitude of professional skepticism? A) risk response phase B) reporting phase C) risk assessment phase D) all phases of the audit Answer: D Explanation: Auditors have a responsibility to plan and perform an audit with professional skepticism. Professional skepticism is an attitude adopted by auditors when conducting all phases of the audit. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 125) In the context of an auditor's attitude, what basic assumption does maintaining professional skepticism entail? A) The client management is not always honest. B) The client management is not always dishonest. C) The client management is always dishonest. D) The client management is always honest. Answer: A Explanation: Maintaining professional skepticism does not mean auditors should assume client management is being dishonest. Auditors should not assume management is dishonest, but at the same time, auditors should not assume management is always honest or correct. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 55

126) In an audit situation, which of the following risks can be reduced to zero? A) Detection risk and inherent risk, but not control risk B) Inherent risk, control risk, and detection risk C) Control risk and detection risk, but not inherent risk D) Neither detection risk, inherent risk, nor control risk. Answer: D Explanation: It is impossible to reduce any of these risks to zero. Risk will always exist in an audit, whether it is from economic or industry factors (inherent risk), a failure of an internal control (control risk), or a failure of an audit procedure (detection risk). Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 127) In an audit strategy, the first step is to identify ________ risks during the ________ phase. A) inherent; risk assessment B) detection; risk response C) significant; reporting D) control; risk response Answer: A Explanation: In an audit strategy, the first step is to identify inherent risks at the account or assertion level during the risk assessment phase when auditors are gaining an understanding of the client and the environment in which it operates. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 128) What audit procedures are designed to detect material misstatements at the assertion level? A) Substantive procedures B) Tests of control C) Fraudulent financial reporting D) Misappropriation of assets Answer: A Explanation: Substantive procedures (substantive testing or tests of details) are audit procedures designed to detect material misstatements at the assertion level. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 56

129) If RMM is low, auditors are much more likely to perform substantive procedures for balance sheet accounts ________. A) one or two months prior to year-end B) one or two months after year-end C) at year-end D) None of these answer choices are correct. Answer: A Explanation: If RMM is low, auditors may perform substantive procedures for balance sheet accounts one or two months prior to year-end, rather than at year-end. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 130) In a general timeline of when audit activities occur for the audit of a client that uses a calendar year-end, the period referred to as "interim" is typically during the latter part of the ________. A) third quarter and into the fourth quarter B) second quarter and into the third quarter C) first quarter and into the second quarter D) first quarter through fourth quarter Answer Answer: A Explanation: In a general timeline of when audit activities occur for the audit of a client that uses a calendar year-end, the period referred to as "interim" is typically during the latter part of the third quarter and into the fourth quarter. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

131) For a privately held client, auditors may decide to perform some tests of controls or not perform any tests of controls, if inherent risk is assessed as ________. A) moderate or low B) high or moderate C) unusually high D) None of these options are correct. Answer: A Explanation: If inherent risk is assessed as moderate or low, auditors may decide to perform some tests of controls or not perform any tests of controls. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 132) Which of the following heavily influences the process of determining an audit strategy for an account or assertion? A) The risk of material misstatement B) Materiality C) Professional skepticism D) All of these options are correct. Answer: D Explanation: Essentially, the process of determining an audit strategy for an account or assertion is heavily influenced by materiality, professional skepticism, and the risk of material misstatement. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 133) An audit strategy is developed at the ________ level. A) account or assertion B) disclosure or materiality C) financial statement D) materiality or assertion Answer: A Explanation: An audit strategy is developed at the account or assertion level, such as for accounts receivable, inventory, and other line items on the financial statements. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 58

134) If results from the tests of controls show the internal controls are effective at preventing and/or detecting material misstatements, auditors will conclude that control risk is ________ and overall risk of material misstatement (RMM) is ________. A) low; low B) high; high C) high; low D) low; high Answer: A Explanation: If results from the tests of controls show the internal control is effective at preventing and/or detecting material misstatements, auditors will conclude that control risk is low and overall risk of material misstatement (RMM) is low. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 135) What two factors lead to the development of an overall strategy? A) The auditor's determination of materiality and audit risk B) The auditor's determination of inherent risk and control risk C) The auditor's determination of the risk of material misstatement and professional skepticism D) The auditor's determination of performance materiality and fraud risk Answer: A Explanation: Materiality and audit risk are the two factors that lead to the development of an overall strategy. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

136) In accounting, "year-end" is typically the period ________. A) when the client's accounting year has substantially finished, and the account balances reflect the totals for the entire year under audit B) that is 4-6 weeks after the auditors leave the client's location C) during the latter part of the third quarter and into the fourth quarter D) when most of the audit planning and risk assessment occur Answer: A Explanation: Year-end is typically the period when the client's accounting year has substantially finished, and the account balances reflect the totals for the year under audit. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 137) What are tests of controls? A) Audit procedures designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level. B) Audit procedures designed for the determining the amount of time spent testing the client's internal controls and conducting detailed testing of transactions and account balances. C) Audit controls for developing an audit plan that details the nature, extent, and timing of audit procedures to be performed. D) Audit timelines of when audit activities occur for the audit of a client that uses a calendar year-end. Answer: A Explanation: Tests of controls are audit procedures designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

138) If inherent risk is determined to be high for an account or assertion, the next step is to ________. A) determine if an internal control is in place to mitigate the risk of a material misstatement B) determine if professional skepticism is being used C) determine whether management is aware of the risk D) perform less extensive detailed substantive tests Answer: A Explanation: The next step is to determine if an internal control is in place to mitigate the risk of a material misstatement. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 139) The risk of material misstatement is a function of ________. A) inherent risk and control risk B) control risk and deterrent risk C) inherent risk and deterrent risk D) detection risk and deterrent risk Answer: A Explanation: RMM is a function of inherent risk and control risk. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 140) An audit plan details the nature, extent, and timing of audit procedures to be performed. The "nature" of audit procedures is best defined as ________. A) what type of procedure will be used B) the reliability and relevance of evidence obtained in the audit C) when the procedure will be performed D) how much testing will be done Answer: A Explanation: The nature is best defined as what type of procedure will be used. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

141) An audit plan details the nature, extent, and timing of audit procedures to be performed. The "extent" of audit procedures is best defined as ________. A) how much testing will be done B) what type of procedure will be used C) the reliability and relevance of evidence obtained in the audit D) when the procedure will be performed Answer: A Explanation: The extent is best defined as how much testing will be done. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 142) An audit plan details the nature, extent, and timing of audit procedures to be performed. The "timing" of audit procedures is best defined as ________. A) when the procedure will be performed B) how much testing will be done C) what type of procedure will be used D) the reliability and relevance of evidence obtained in the audit Answer: A Explanation: Timing is best defined as when the procedure will be performed. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 143) The determination of when audit procedures will be performed is primarily dependent upon ________. A) the effectiveness of the client's controls B) the effectiveness of the client's human resources manager C) the audit fee D) the effectiveness of client's cloud functionality Answer: A Explanation: The determination of when audit procedures will be performed is primarily dependent upon the effectiveness of the client's controls. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

144) Substantive procedures are also known as ________. A) tests of details B) tests of controls C) tests of complex transactions D) risk assessment Answer: A Explanation: Substantive procedures are known as tests of details. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 145) Tests of controls are also known as ________. A) internal controls testing B) substantive control testing C) tests of details D) material misstatement testing Answer: A Explanation: Tests of controls are also known as controls testing. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 146) Substantive procedures are designed to ________. A) detect material misstatements at the assertion level B) evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level C) determine the quantity of audit procedures to be performed D) determine when the audit procedures will be performed Answer: A Explanation: Substantive procedures are designed to detect material misstatements at the assertion level. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

147) The process used when developing an audit strategy at the account or assertion level begins with identifying inherent risks at the account or assertion level. The second step is to ________. A) determine whether an internal control can mitigate the risk factor B) increase the extent of detailed substantive procedures performed at year-end C) perform less extensive detailed substantive procedures at interim D) determine whether insurance can be purchased to eliminate internal controls Answer: A Explanation: The second step is to determine whether an internal control can mitigate the risk factor. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 148) In the substantive approach, if there is no internal control in place and inherent risk is high, the auditors ________. A) assess RMM as high since both inherent and control risk are high B) assess inherent and detective risk as high C) assess control and detective risk as high D) issue a qualified opinion Answer: A Explanation: The auditors assess RMM as high since both inherent risk and control risk are high. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 149) In the substantive approach, if there is an internal control in place, the auditors may ________. A) test the effectiveness of the internal control B) issue a qualified opinion C) assess all procedures in the audit as having high audit risk D) withdraw from the audit Answer: A Explanation: The auditors may test the effectiveness of the internal controls. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 64

150) Auditors can control detection risk by ________. A) planning to perform more or less detailed audit procedures B) planning to perform more or less audit procedures on controls C) designing internal controls for the client D) designing the software processes that the client uses to process accounting information Answer: A Explanation: Auditors can control detection risk by planning to perform more or less detailed audit procedures. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 151) How are components of the audit risk model rearranged to solve for detection risk? A) DR = AR ÷ RMM B) DR = AR + RMM C) DR = AR - RMM D) DR = AR x RMM Answer: A Explanation: DR = AR / RMM. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 152) Suppose auditors assess inherent risk and control risk as low, 25% and 8% respectively. If auditors want to keep audit risk relatively low at 5%, then what is detection risk? A) 2.50 or 250% B) .02 or 2% C) .05 or 5% D) 2.00 or 200% Answer: A Explanation: .05 = (.25 x .08 x DR); DR = .05 / (.25 x .08), DR = 2.5 or 250%. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

153) A detection risk of 1.5 or 150% means ________. A) there would be a 150% risk that the auditors' procedures will not be effective in detecting a material misstatement B) auditors will need to undertake 1.5 times the audit procedures planned in the initial stages of the audit C) there would be a 150% risk that the auditors' procedures will be effective in detecting a material misstatement D) auditors will perform extensive detailed testing of related account balances and use larger sample sizes because a 1.5 detection risk is a low detection risk Answer: A Explanation: A detection risk of 1.5 or 150% means that there would be a 150% risk that the auditor's procedures will not be effective in detecting a material misstatement. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 154) Auditors want a low audit risk of 5% and a low detection risk of 5%. In order to achieve this, what will inherent risk and control risk have to be? A) 100% for both B) 1% for inherent risk and 100% for control risk C) 1% for both D) The risks cannot be determined because there is not enough information. Answer: A Explanation: AR = IR x CR x DR, so 5% = IR x CR x 5%. Inherent risk and control risk would both have to be 100%. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

155) Part of planning an appropriate and effective audit strategy is for the auditor to determine the nature, timing and extent of audit procedures to be performed. Which of the following choices is correct regarding the nature, timing and extent of audit procedures? A) With respect to timing, accounts and assertions that are considered to be higher inherent risk are generally audited at the beginning of the engagement. B) With respect to the extent of audit procedures, the quantity is typically increased for accounts and assertions considered to be of lower inherent risk. C) With respect to the timing of audit procedures, accounts and assertions that are considered to be higher risk are generally audited closer to the balance sheet date. D) All of these statements are correct. Answer: C Explanation: With respect to the timing of audit procedures, accounts and assertions that are considered to be higher risk are generally audited closer to the balance sheet date. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 156) Two audit staff associates, Paul and Brenda are discussing the relationship between internal control and substantive testing performed by the auditor on an engagement. Paul advises Brenda that he is not quite sure of how this relationship works, and how these two areas are connected. Brenda's best response to this question would be which of the following? A) There really is no quantifiable relationship between these two areas. They just represent different parts of the audit. B) When a client's internal controls are assessed as stronger and more effective by the auditor, less substantive testing may be performed in order to reach an opinion, and vice-versa. C) When a client has a strong system of internal controls, the auditor will typically increase substantive testing in order to corroborate any conclusions drawn on internal control. D) The relationship between the two is such that the auditor performs substantive testing, including tests of details, on the clients system of internal control in order to assess the effectiveness of controls. Answer: B Explanation: When a client's internal controls are assessed as stronger and more effective by the auditor, less substantive testing may be performed in order to reach an opinion, and vice-versa. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

157) During the audit of Sunrise Enterprises, LLC, a provider of plastic utensils and other items to restaurants throughout the southeastern United States, the auditors have determined that the client's inventory represents an area of higher inherent risk. As a result, which of the following choices would most likely represent a prudent course of action by the auditor? A) The auditor may decide to audit the inventory accounts closer to the balance sheet date, and extend the extent of procedures performed on these accounts. B) The auditor is likely to perform procedures on these accounts closer to the beginning of the audit, to allow more time to fix any problems uncovered. C) The auditor is likely to adopt a reliance on controls strategy, and perform less substantive procedures accordingly. D) The auditor is most likely to simply disclaim an opinion on the client's inventory and any related accounts, as this area represents higher audit risk. Answer: A Explanation: The auditor may decide to audit the inventory account closer to the balance sheet date, and extend the extent of procedures performed on these accounts. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 158) Michael and Sonya, two audit managers are discussing year-end versus interim procedures with a new audit staff associate, Kai. Kai is trying to understand why some accounts are tested in interim periods and others at year end. Michael and Sonya's best response to this question would be which of the following? A) Accounts and assertions that are assessed by the auditor as likely to contain an increased risk of material misstatement are usually audited during interim periods. B) Auditors may choose to audit accounts and assertions potentially containing a higher risk of material misstatement closer to year end, as account balances typically reflect year end totals. C) Accounts and assertions that the auditor assesses as likely to represent decreased audit risk are usually audited at year end, to allow time during the audit to focus on higher risk areas. D) Generally accepted auditing standards require the auditor to meet with senior management at the beginning of the audit and discuss when each account will be tested, and the nature and extent of testing for each. Answer: B Explanation: Auditors may choose to assess accounts and assertions potentially containing a higher risk of material misstatement closer to year end, as account balances typically reflect year end totals. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

159) Janice and Derek, two audit staff associates assigned to the audit of Peabody Enterprises are discussing the relationship between the risk of material misstatement and the overall audit strategy. Which of the following statements made by Derek is correct? A) There really isn't any particular relationship between the risk of material misstatement and audit strategy. They're just different parts of the audit. B) When the risk of material misstatement is assessed as high by the auditor, then the audit team is more likely to rely on the client's controls and perform less substantive testing. C) If the auditor assesses the risk of material misstatement as high, then the auditor is likely to rely less on the client's system of internal controls, and is likely to perform increased substantive testing. D) If the auditor determines that the risk of material misstatement is low, then the auditor is likely to adopt a reliance on controls strategy, and perform additional substantive testing. Answer: C Explanation: If the auditor assesses the risk of material misstatement as high, then the auditor is likely to rely less on the client's system of internal controls, and is likely to perform increased substantive testing. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 160) During the audit of Glazier LLC, a distributor of glass products throughout the continental United States, it has been determined by the auditor, Locktight CPAs, that the client's system of internal control is not as robust as had been initially thought. As a result of this finding, which of the following strategies is most likely? A) The auditor will advise the internal control function to begin remedying defective internal controls, and will return to the audit once these controls have been corrected. B) The auditor will assess risk of material misstatement as high and adopt a reliance approach, whereby the auditor will perform increased substantive testing, including tests of details. C) The auditor is likely to assess the risk of material misstatement as high, and rely less on the client's controls. As a result, the auditor will increase substantive testing to compensate for this. D) The auditor will assess the client's controls as defective, increase the risk of material misstatement and substantive tests, and decrease audit risk. Answer: C Explanation: The auditor is likely to assess the risk of material misstatement as high, and rely less on the client's controls. As a result, the auditor will increase substantive testing to compensate for this. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

161) During the audit of Rogers Enterprises, Inc., a regional supplier of perfumes to luxury department stores, a discrepancy has been noted by an audit staff associate working on the inventory accounts. In particular, there is a significant discrepancy between the inventory listed in the client's general ledger and the physical inventory count, which revealed significantly less inventory. Which of the following choices represents the most appropriate next step by the auditor to this finding? A) The auditor should disclaim an opinion on the client's inventory accounts, in order to protect the reputation and standing of the audit firm. B) The auditor should consider the possibility of fraud or error and investigate accordingly, attempting to uncover the reasons for the discrepancy. C) The auditor should work on the premise that the discrepancy is an error, and propose correcting entries to adjust the inventory accounts accordingly. D) The auditor should presume that fraud is occurring, and interview all staff members working in this department to uncover the perpetrator. Answer: B Explanation: The auditor should consider the possibility of fraud and investigate accordingly, attempting to uncover the reasons for the discrepancy. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 162) While completing the audit of Dayside LLC, the external auditors, Daybreak CPA Firm have noticed that for revenue entries up to three months old, no inventory has been shipped out accordingly. Based on this, what is the auditors' most likely conclusion and course of action? A) The auditor should presume that the revenue entries are fictitious and propose adjusting entries to remove these from the books. B) The auditor should presume this represents a fraud risk, and attempt to verify the sales transactions as well as why inventory has not been shipped out. C) The auditors should assume that the client is committing fraud, and examine inventory turnover ratios throughout the year to corroborate this. D) The auditor is likely to conclude that an increased risk of fraud is now present, and will attempt to obtain written assurances from management that the entries are not fictitious. Answer: B Explanation: The auditor should presume this represents a fraud risk, and attempt to verify the sales transactions as well as why inventory has not been shipped out. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

163) During the audit of one of their largest clients, the auditing firm, White CPAs, is discussing any industry changes with the client's top management during the initial phase of the audit. The client's Chief Financial Officer notes that the industry appears to be becoming more competitive than it used to be, with several new entrants into the market. Based on this information, what is most likely to be the auditors' response? A) Document the conversation and alert the audit staff working on the engagement to look out for any signs of fraud related to misappropriation of assets. B) Explain to the client that based on this information, the auditor will need to conduct more tests of internal controls and more substantive procedures, increasing the cost of the audit. C) Document the conversation, and consider increasing inherent risk and risk of material misstatement related to the audit, particularly to revenue accounts. D) Make note of the meeting, and plan to adopt a reliance on controls strategy. Answer: C Explanation: Document the conversation, and consider increasing inherent risk and risk of material misstatement related to the audit, particularly to revenue accounts. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 164) John and Kayla, two audit staff associates are discussing potential telltale signs to watch out for during an audit, which may indicate an increased fraud risk. Which of the following would represent an increased fraud risk? A) The clients that their firm takes on have robust and effective whistleblowing systems, and the anonymity of the informant is protected throughout. B) One of their clients has recently installed a new system of internal control which the client's staff are currently familiarizing themselves with and are not yet fully proficient in. C) The clients their firm works with have historically had low turnover and strong employee retention in key positions. D) The firm they work for has a company policy which dictates that no clients with related parties or related party transactions will be taken on. Answer: B Explanation: One of their clients has recently installed a new system of internal control which the client's staff are currently familiarizing themselves with and becoming proficient in. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

165) Tom and Laura are discussing the importance of corporate culture and associated fraud risks. Laura is attempting to understand more about this area, and has asked Tom to explain this in more detail. Which of the following statements by Tom is correct? A) There really isn't any particular relationship between fraud risk and corporate culture, despite what you may read. It's never been proven. B) When the corporate culture of a firm, especially top management tend to be more aggressive, fraud risk always increases too. C) When corporate culture and the tone at the top transmits honesty and integrity, this tends to permeate through the organization, helping to reduce fraud risk. D) When a firm's senior management is focused on profit maximization for its shareholders, this will increase fraud risk. Answer: C Explanation: When corporate culture and the tone at the top transmits honesty and integrity, this tends to permeate through the organization, helping to reduce fraud risk. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 166) While meeting with the senior management of Dove Enterprises, Inc., a national retailer of shower gel and other toiletries products throughout the United States, the external auditors have been advised that a member of the audit committee is also a major vendor of the client. Based on this information, what is the auditors' most likely course of action? A) The auditor should consider immediately withdrawing from the engagement, citing independence concerns. B) The auditor should interview the director in question, and obtain written assurances that there is no fraud occurring, for documentation purposes and inclusion in the audit file. C) The auditor should exercise an appropriate level of professional skepticism and plan to conduct increased procedures in this area. D) The auditors should advise management that this represents a serious conflict of interest, and request they adopt a company policy prohibiting this. Answer: C Explanation: The auditor should exercise an appropriate level of professional skepticism and plan to conduct increased procedures in this area. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

167) Timing differences such as bringing forward the recognition of revenues and delaying the recognition of expenses is an example of ________. A) fraudulent financial reporting B) performance materiality C) planning materiality D) balance sheet benchmarks Answer: A Explanation: Timing differences such as bringing forward the recognition of revenues and delaying the recognition of expenses is a case of fraudulent financial reporting. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 168) In the context of identifying fraud, which of the following describes theft of inventory by employees or others? A) Misappropriation of assets B) Fraudulent financial reporting C) A loss that is not the result of fraud D) Cooking the books Answer: A Explanation: In the context of identifying fraud, theft of inventory by employees or others is an instance of misappropriation of assets. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 169) The general type of fraud that involves some form of theft is typically known as ________. A) misappropriation of assets B) improper asset valuation C) fictitious sales D) unrecorded liabilities Answer: A Explanation: Theft is known as misappropriation of assets. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

170) The general type of fraud that involves intentionally misstating items or omitting important facts from the financial statements is typically known as ________. A) fraudulent financial reporting B) writing checks to fictitious vendors C) using company cars for personal use D) theft of inventory by employees Answer: A Explanation: Intentionally misstating items or omitting important facts from the financial statements is typically known as fraudulent financial reporting. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 171) An example of fraudulent financial reporting is ________. A) timing differences such as bringing forward the recognition of revenues and delaying the recognition of expenses B) writing checks to fictitious vendors C) using company cars for personal use D) theft of inventory by employees Answer: A Explanation: Timing differences in revenue or expense recognition may be an example of fraudulent financial reporting. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 172) An example of misappropriation of assets is ________. A) employees remaining on the payroll after ceasing employment B) improper asset valuation C) fictitious sales D) unrecorded liabilities Answer: A Explanation: Employees remaining on the payroll after ceasing employment may be an example of misappropriation of assets. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 74

173) Where does the responsibility for preventing and detecting fraud rest? A) With client management and those charged with governance B) With the auditors C) Solely with the CEO D) Solely with the CFO Answer: A Explanation: The responsibility lies with client management and those charged with governance. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 174) Prevention of fraud refers to ________. A) the use of controls and procedures aimed at avoiding a fraud B) the use of controls and procedures aimed at uncovering a fraud should one occur C) auditors who assess fraud risk factors D) incentives to commit fraud Answer: A Explanation: Prevention of fraud refers to the use of controls and procedures aimed at avoiding a fraud. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 175) Detection of fraud refers to ________. A) the use of controls and procedures aimed at uncovering a fraud should one occur B) the use of controls and procedures aimed at avoiding a fraud C) auditors who assess fraud risk factors D) incentives to commit fraud Answer: A Explanation: Detection of fraud refers to the use of controls and procedures aimed at uncovering a fraud should one occur. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

176) Which of the following is not a fraud risk factor? A) The firm's fiscal year end being during the busy season. B) An incentive or pressure to commit fraud C) An opportunity to commit fraud D) Rationalization to justify fraudulent actions Answer: A Explanation: Fraud risk factors do not include the amount of ethics training provided by the company. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 177) Which of the following is an impediment to the application of professional skepticism? A) Workload of the auditors B) Lack of confidence in management C) A trend to keep audit costs high D) A sole focus on the audit engagement and no other services Answer: A Explanation: The workload of auditors is an impediment to the application of professional skepticism. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 178) Which of the following is an example of an incentive or pressure that increases the risk of fraud? A) The client operates in a highly competitive industry B) The number of job offers that the company makes per year C) The due date of employee contracts D) The client maintains stable financial ratios relative to the industry. Answer: A Explanation: The client operating in a highly competitive industry is an example of an incentive or pressure that increases the risk of fraud. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

179) Which of the following is most likely an example of an opportunity that increases the risk that a fraud may have been perpetrated? A) A high volume of transactions close to year-end B) A high turnover of clerical staff C) A high reliance on simple accounting transactions D) A high amount of depreciation expense Answer: A Explanation: A high volume of transactions close to year-end is an example of an opportunity. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 180) Which of the following examples most likely is an attitude or rationalization used to justify a fraud? A) An excessive focus on maximization of profits and/or stock price B) An excessive focus on unionization C) An excessive focus on vacation time D) An excessive focus on application of ethical standards Answer: A Explanation: An excessive focus on maximization of profits and/or stock price is an example of an attitude or rationalization. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 181) What are the primary procedures auditors use in the fraud risk assessment process? A) Brainstorming B) Accuracy checking C) Documentation D) Flowcharting Answer: A Explanation: Brainstorming is a primary procedure that auditors use in the fraud risk assessment process. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

182) What type of direct inquiry does an auditor make of the audit committee regarding the potential for fraud? A) The auditor inquires about the audit committee's role in preventing and detecting fraud. B) The auditor inquires about the audit committee's role to communicate with vendors. C) The auditor inquires about the audit committee's role in the auditor brainstorming session. D) The auditor inquires about the audit committee's role in determining performance materiality for the audit. Answer: A Explanation: The auditor inquires about the audit committee's role in preventing and detecting fraud. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 183) The auditor brainstorming session serves as an opportunity for ________. A) more senior members of the audit team to share important information about the client with new members of the audit team B) the audit team to share stories about other clients C) the audit team to relax and not worry about documentation D) partners to impress staff members within the accounting firm Answer: A Explanation: The brainstorming session serves as an opportunity for more senior members of the audit team to share important information about the client with new members of the audit team. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

184) The application of human bias toward client preferences can impede professional skepticism. Which of the following is an example of human bias at work in the audit? A) Evaluating audit evidence consistent with client preferences B) No overt emphasis on selling additional services to the client C) No overt emphasis on keeping audit costs low D) Gathering complex evidence that is the most reliable and relevant Answer: A Explanation: An example of human bias would be evaluating audit evidence consistent with client preferences. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 185) The PCAOB periodically issues Staff Audit Practice Alerts, and these ________. A) are meant to provide guidance in the application of the standards B) have the full weight of any audit standard C) are FASB standards D) are IRS regulations Answer: A Explanation: The Staff Audit Practice Alerts are meant to provide guidance in the application of the standards. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

186) The purpose of Alert No. 10 from the PCAOB is to ________. A) remind auditors of the requirement to appropriately apply professional skepticism throughout the audit, as well as various judgments about certain situations B) present the new auditing standard C) present a listing of which registered accounting firms failed to exercise professional skepticism D) present a detailed report listing the client companies that need more scrutinizing by audit firms regarding fraud red flags Answer: A Explanation: The purpose of Alert No. 10 from the PCAOB is to remind auditors of the requirement to appropriately apply professional skepticism throughout the audit, as well as various judgments about certain situations. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 187) A pressure on auditors to maintain good client relationships to ensure future audit engagements leads to a change in thinking that could ________. A) weaken professional skepticism B) strengthen tests of controls C) reduce significant risk D) increase quantitative materiality Answer: A Explanation: A pressure on auditors to maintain good client relationships to ensure future audit engagements leads to human bias that could weaken professional skepticism. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

188) Timing differences such as bringing forward the recognition of revenues before they are earned and delaying the recognition of expenses that have already occurred are examples of ________. A) fraudulent financial reporting B) misappropriation of assets C) performance materiality D) professional skepticism Answer: A Explanation: Timing differences such as bringing forward the recognition of revenues and delaying the recognition of expenses are examples of fraudulent financial reporting. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 189) Which of the following is NOT an element of a firms' quality control system that can help ensure the appropriate application of professional skepticism? A) Geographical location. B) Firm culture C) Professional competence and assigning personnel to engagement teams D) Documentation Answer: A Explanation: Heavy workload is not an element of a quality control system. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 190) Which of the following is a red flag of fraud? A) High turnover of key employees B) High inventory turnover rate C) High current ratios D) High quick ratios Answer: A Explanation: High turnover of key employees is a red flag of fraud. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

191) Which of the following are special circumstances or unusual risk factors that influence client acceptance and retention decisions? A) Profitability issues B) Firm has an affiliation with a specialist C) Firm does not have the expertise needed to provide services requested by client D) Conflict of interest issues Answer: A, C, D Explanation: A special circumstance or unusual risk factor that influences client acceptance and retention is profitability issues of the firm. Conflict of interest issues in the firm, firm does not have expertise needed to provide the full scope of services requested by the client and firm does not have affiliation with specialists to meet client needs are among the special circumstance or unusual risk factor that influences client acceptance and retention. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 192) Which of the following are true in the light of AU-C 210 Terms of Engagement and AS 2610 Initial audits — Communications between Predecessor and Successor Auditors? A) The auditor must obtain permission from the prospective client before communicating with the previous auditor. B) A prospective client may decline to grant an auditor the permission to communicate with the previous auditor. C) The refusal of a prospective client to grant access to previous auditors has no bearing an auditor's decision to accept the engagement. D) The law mandates that a prospective permit an auditor to communicate with a previous auditor of the client. Answer: A, B Explanation: AU-C 210 Terms of Engagement and AS 2610 Initial audits — Communications Between Predecessor and Successor Auditors require that the auditor obtain permission from the prospective client before communicating with the predecessor, or previous, auditor. If that permission is not granted, the auditor should consider the implications of that refusal when deciding whether to accept the engagement (AU-C 210.11). Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

193) Jackson CPAs is considering taking on the audit of a new client, Wyoming Industries, Inc. Wyoming Industries is a large, decentralized provider of rubber products to a variety of industries and is a very successful firm with a strong internal audit function. As the partners discuss this client acceptance decision, which of the following factors would likely be discussed? A) The experience and competence of management, and their focus on accurate representation of the firm's financial position through the financial statements. B) What method of inventory costing Wyoming Industries' competitors are currently using, and the likelihood that the auditors will recommend this be changed. C) The structural and management reporting hierarchy of the client, including lines of responsibility and reporting. D) Whether the auditors can rely on the strong internal audit function to audit higher risk areas of the client's business. Answer: A, C Explanation: The experience and competence of management, and their focus on accurate representation of the firm's financial position through the financial statements. The structural and management reporting hierarchy of the client, including lines of responsibility and reporting. Whether the auditors can rely on the strong internal audit function to audit higher risk areas of the client's business. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

194) Davie Industries is a group that owns and operates car dealerships across the western United States. At the request of a major lending institution, Davie Industries is seeking an auditor to perform an attest engagement to assist in obtaining external financing in order to fund further expansion. After an initial meeting with this potential client, the auditors, Mendoza CPAs, are discussing the acceptance decision. Which of the following choices would represent reasons why Mendoza might decline the engagement? A) The internal audit function of Davie Industries is relatively experienced and reports to the Chief Audit Officer. B) Management of Davie Industries pushes aggressive growth and sales targets, and this culture permeates the organization. C) Management inquired of the CPA firm during the initial meeting about the possibility of switching depreciation methods to increase net income to help in obtaining the loan. D) The turnover of employees in key positions appears to be relatively low, with the average tenure of key employees being around fifteen years. Answer: B, C Explanation: Management of Davie Industries pushes aggressive growth and sales targets, and this culture permeates the organization. Management inquired of the CPA firm during the initial meeting about the possibility of switching depreciation methods to increase net income to help in obtaining the loan. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

195) Praya CPA firm has recently accepted a new client, Blue Industries, Inc., a distributor of specialty medical devices and other equipment throughout the United States and Canada. As Praya CPAs begin to move through the initial risk assessment phases of the audit, which of the following represent risks that Praya will incorporate into the audit strategy? A) Praya will consider and attempt to determine the client's risk of material misstatement, and plan audit procedures around this. B) Per generally accepted auditing standards, Praya will prioritize and focus on detection risk during the risk assessment phase. C) At this stage of the audit, Praya's main focus will be on requesting client management calculate and determine an appropriate level of audit risk. D) Praya will likely examine any risk factors that may be unique to the client or the client's industry at this stage of the audit. Answer: A, D Explanation: Praya will consider and attempt to determine the client's risk of material misstatement, and plan audit procedures around this. Praya will likely examine any risk factors that may be unique to the client or the client's industry at this stage of the audit. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 196) Thames CPA Firm is currently completing the audit of River Enterprises, a wholesaler of fishing boats and other maritime excursion vehicles. The partners of Thames CPA Firm are attempting to determine the strength and pervasiveness of the client's system of internal control. At what stage of the audit is Thames CPA Firm likely to test internal controls? A) Testing of a client's system of internal control is typically performed by the auditor during the risk assessment phase of the audit, in order to help set detection risk. B) The auditor is most likely to examine and audit a client's system of internal controls during the risk response phase, to determine the reliability of internal controls. C) During the risk assessment phase of the audit, the auditor is most likely to perform detailed testing of internal controls to assess whether or not they can be relied upon. D) The auditor typically audits a client's system of internal control during the risk response phase of the audit, to determine if the client may be too risky and whether the auditor should withdraw. Answer: B, C Explanation: The auditor is most likely to examine and audit a client's system of internal controls during the risk response phase, to determine the reliability of internal controls. During the risk assessment phase of the audit, the auditor is most likely to perform detailed testing of internal controls to assess whether or not they can be relied upon. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 85

197) Which of the following are covered during the risk response phase of an audit? A) The performance of detailed tests of controls B) Substantive or detailed testing of transactions and accounts C) Forming an opinion on the fair presentation of the client's financial statements D) Identifying factors that may impact the risk of a material misstatement occurring Answer: A, B Explanation: The risk response phase involves the performance of detailed tests of controls and substantive, or detailed, testing of transactions and accounts. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 198) Typically, which of the following are income statement benchmarks? A) Profit before tax B) Total revenue C) Cost of goods sold D) Operating expenses Answer: A, B Explanation: Income statement benchmarks are typically profit before tax or total revenue. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 199) Which of the following could exhibit materiality? A) Information that is misstated B) Information that is omitted but should be disclosed C) Information that is disclosed but should be omitted D) Information that is accurately stated but redundant Answer: A, B Explanation: Materiality includes information that is misstated and information that is omitted but should be disclosed. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

200) Star Industries, Inc. is currently under the initial stages of an audit by GlowBright CPA firm. As part of the external audit, the two partners assigned to the audit client are attempting to determine what may constitute materiality for this client. Which of the following choices may constitute a material item for the auditors to consider when planning the next stages of the audit? A) Senior management of Star Industries, Inc. experiences low turnover, and has a good relationship with the client's board of directors. B) The predecessor auditor of Star Industries, Inc. withdrew from the attest engagement of this client, citing differences in opinion on significant accounting methods. C) The partners of GlowBright CPA Firm have noticed that a contingent liability for a relatively small dollar amount has been recorded on the client's most recent balance sheet. D) The client's internal audit function is staffed by employees who are required to have a fouryear degree in accounting or finance, and are encouraged to obtain the CIA (Certified Internal Auditor) licensure. Answer: B, C Explanation: The predecessor auditor of Star Industries, Inc. withdrew from the attest engagement of this client, citing differences in opinion on significant accounting methods. The partners of GlowBright CPA Firm have noticed that a contingent liability for a relatively small dollar amount has been recorded on the client's most recent balance sheet. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

201) The audit partners of Faberge External Auditors, LLC have convened a meeting with the audit managers and staff associates that will be assigned to the audit of Glo-Bus Enterprises, a leading national provider of gaming console and other peripheral electronic equipment. The audit partners wish to ensure that staff assigned to the engagement exercise appropriate levels of professional skepticism. Which of the following represent situations where professional skepticism should be exercised? A) The client's senior management has adopted aggressive sales and company growth targets in an attempt to position themselves as the industry leader. B) The client's internal audit function appears to be efficient, proficient, and independent of senior management. C) In meetings with the client's senior management, it has been noted by the audit partners that conflicting responses have been received regarding the preferred choice of depreciation method. D) It has been reported in local media outlets that a major customer of the client may pursue litigation to address a grievance pertaining to product warranties. Answer: A, C, D Explanation: The client's senior management has adopted aggressive sales and company growth targets in an attempt to position themselves as the industry leader. In meetings with the client's senior management, it has been noted by the audit partners that conflicting responses have been received regarding the preferred choice of depreciation method. It has been reported in local media outlets that a major customer of the client may pursue litigation to address a grievance pertaining to product warranties. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

202) Bryan, a recent college graduate and new hire to Pillar CPA Firm, is being trained and mentored by Michelle, an experienced auditor and long-time CPA. Bryan has inquired of Michelle as to what exactly is meant by a client's risk of material misstatement. Which of the following choices would represent appropriate responses to this question by Michelle? A) A client's risk of material misstatement is determined objectively by the auditor, having consulted with both the client's management and internal audit function. B) Risk of material misstatement pertains only to the auditor, and can be best thought of as the risk that an auditor renders an inaccurate audit opinion on a client's financial statements. C) Risk of material misstatement is typically considered to be the risk that a client's financial statements are in some way materially misstated. D) A client's risk of material misstatement can be at both the financial statement level and the assertion level. The auditor is likely to consider both as part of assessing client risk. Answer: C, D Explanation: Risk of material misstatement is typically considered to be the risk that a client's financial statements are in some way materially misstated. A client's risk of material misstatement can be at both the financial statement level and the assertion level. The auditor is likely to consider both as part of assessing client risk. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

203) In auditing, which of the following attitudes are part of professional skepticism? A) Being alert to conditions that may indicate possible misstatement due to fraud B) A critical assessment of audit evidence C) An assumption that client management is being dishonest D) Allowing for a degree of misstatement attributable to human error Answer: A, B Explanation: Professional skepticism is an attitude that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to fraud or error, and a critical assessment of audit evidence. Does maintaining professional skepticism mean auditors should assume client management is being dishonest? The answer is no. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 204) If RMM is lower for the current year's audit than the prior year's audit, which of the following would be true of the audit strategy? A) The nature, extent, and timing of substantive procedures would be adjusted. B) The strategy will be to rely more on the client's internal controls. C) The strategy would be to rely more on the auditor's substantive procedures. D) Auditors may decide to use larger sample sizes. Answer: A, B Explanation: If RMM is low, the audit strategy will be to rely more on the client's internal controls and less on the auditor's substantive procedures. The nature, extent, and timing of substantive procedures would be adjusted since the client's internal control is strong. For example, auditors may decide to use smaller sample sizes since RMM is low. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

205) The senior audit partners of Dagsboro CPAs are meeting with the audit team to discuss the audit of Ocean City Enterprises, a retailer of beach clothing and other apparel, which is in the initial phases. One of the audit staff associates has raised the question as to what type of audit strategy would be best for this client. Which of the following responses from the audit partners would be most appropriate? A) As every client and every industry is different, the team assigned to the engagement should determine on an individual basis whether they rely on tests of controls or substantive procedures. B) The audit is likely to involve both testing of controls to determine the effectiveness of the client's system of internal control, and substantive procedures designed to detect material misstatements. C) The audit managers assigned to the engagement are likely to consider incorporating the timing of procedures into the audit strategy. D) The audit strategy is most likely to involve testing of controls only for client's deemed to represent lower inherent risk, and both testing of controls and substantive procedures for clients deemed to represent higher inherent risk. Answer: B, C Explanation: The audit is likely to involve both testing of controls to determine the effectiveness of the client's system of internal control, and substantive procedures designed to detect material misstatements. The audit managers assigned to the engagement are likely to consider incorporating the timing of procedures into the audit strategy. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

206) As part of the audit of GreySky Enterprises, Inc., the team assigned to the engagement is attempting to determine if it may be possible to adopt a reliance on controls approach, as this query has been raised by a staff associate working on the engagement. Which of the following responses to this question from the partner leading the engagement would be most appropriate? A) The audit team assigned to the engagement should carefully consider the client's overall system of internal control, and the strength and reliability of this system. B) For any given risks that the audit team has identified, does the client's system of internal control possess one or more controls that can mitigate the identified risk? C) Have the controls identified by the auditing team been tested by the internal auditors to ensure that they are working correctly and as planned? D) The client's top management should be requested in writing to provide written assurances pertaining to the efficacy, suitability, and reliability of the system of internal controls. Answer: A, B, C Explanation: The audit team assigned to the engagement should carefully consider the client's overall system of internal control, and the strength and reliability of this system. For any given risks that the audit team has identified, does the client's system of internal control possess one or more controls that can mitigate the identified risk? Have the controls identified by the auditing team been tested by the internal auditors to ensure that they are working correctly and as planned? The audit team assigned to the engagement should carefully consider the client's overall system of internal control, and the strength and reliability of this system. For any given risks that the audit team has identified, does the client's system of internal control possess one or more controls that can mitigate the identified risk? Have the controls identified by the auditing team been tested by the internal auditors to ensure that they are working correctly and as planned? Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

207) The audit partners of DGH CPA firm are meeting with a major client's internal audit function to discuss fraud risk assessment procedures instituted by the client. The audit partners are particularly interested in learning of any areas of increased audit risk, and why these risks may exist. Which of the following choices represent areas of increased risk that the external auditors may choose to focus on? A) Due to aggressive sales and growth targets by management, the internal auditors have questioned some revenue recognition policies instituted by management in the past. B) The Chief Financial Officer of the client has inquired numerous times of the internal audit function as to whether the firm can switch from LIFO to FIFO inventory costing, but failed to provide a legitimate reason why. C) Management and the internal audit function installed a new enterprise planning system two years prior, which improved the accuracy of the client's records and decreased errors. Answer: A, B Explanation: Due to aggressive sales and growth targets by management, the internal auditors have questioned some revenue recognition policies instituted by management in the past. The Chief Financial Officer of the client has inquired numerous times of the internal audit function as to whether the firm can switch from LIFO to FIFO inventory costing, but failed to provide a legitimate reason why. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 208) Which of the following are possible indicators of fraud in a company? A) A high turnover of key employees B) Overly dominant management C) Poor compensation practices D) A simplified business structure Answer: A, B, C Explanation: Examples of red flags indicative of fraud include a high turnover of key employees; overly dominant management; poor compensation practices; a complex business structure. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

209) Which of the following are examples of fraudulent financial reporting? A) Improper asset valuations B) Unrecorded liabilities C) Recording fictitious sales D) Writing checks to fictitious vendors Answer: A, B, C Explanation: Improper asset valuations, unrecorded liabilities, and recording fictitious sales are some examples of fraudulent financial reporting. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 210) Which of the following are examples of fraud risk factors? A) Incentives and pressures to commit a fraud, B) Opportunities to perpetrate a fraud C) Attitudes and rationalizations used to justify committing fraud D) Auditors working without the client's previous year records Answer: A, B, C Explanation: When assessing the risk of fraud, auditors consider the fraud risk factors that may be present, such as incentives and pressures to commit a fraud, opportunities to perpetrate a fraud, and attitudes and rationalizations used to justify committing fraud (AU-C 240 Appendix 1). Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

211) Which of the following are examples of opportunities that increase the risk that a fraud may have been perpetrated? A) Accounts that rely on estimates and judgment B) A high volume of transactions close to year-end C) Significant adjusting entries and reversals after year-end D) A low turnover of staff with accounting responsibilities Answer: A, B, C Explanation: Examples of opportunities that increase the risk that a fraud may have been perpetrated include: accounts that rely on estimates and judgment; a high volume of transactions close to year-end; significant adjusting entries and reversals after year-end; and a high turnover of staff with accounting or internal control responsibilities. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 212) Which of the following are examples of attitudes and rationalizations used to justify a fraud? A) Employees placing low priority on the entity's value or ethical standards B) A poor attitude regarding compliance with accounting regulations C) Rationalization that other companies make the same inappropriate accounting choices D) A lack of focus on profit making and/or the maximization of stock price Answer: A, B, C Explanation: Examples of attitudes and rationalizations used to justify a fraud include: (1) management and employees do not place a high priority on the entity's value or ethical standards; (2) an excessive focus on maximization of profits and/or stock price; (3) a poor attitude regarding compliance with accounting regulations; (4) rationalization that other companies make the same inappropriate accounting choices. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

213) _______ involves determination of the amount of time to spend testing the client's internal controls and conducting detailed testing of transactions and account balances. A) Audit strategy B) Tests of controls C) Integrated audit D) Compliance audit Answer: A Explanation: Audit strategy - An audit strategy involves determination of the amount of time to spend testing the client's internal controls and conducting detailed testing of transactions and account balances. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 214) _______ risk represents the susceptibility of an assertion to a misstatement that could be material before consideration of any related controls. A) Inherent B) Control C) Detection D) Significant Answer: A Explanation: Inherent - An inherent risk is the susceptibility of an assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

215) _______ component or components of audit risk can be controlled by the auditor. A) Detection risk B) Inherent risk C) Control risk D) All of these answer choices are correct Answer: A Explanation: Detection Risk - Detection risk is the only component of audit risk that can be controlled by the auditor. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 216) _______ risk influences decisions about sample size. A) Detection B) Control C) Inherent D) RMM Answer: A Explanation: Detection - Detection risk influences decisions about sample size. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 217) During the risk assessment phase of the audit, auditors assess the risk of a material misstatement due to ________. A) fraud B) control risk C) the timing of audit procedures D) the extent of audit procedures Answer: A Explanation: Fraud - During the risk assessment phase of the audit, auditors assess the risk of a material misstatement due to fraud. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

218) Steve, an audit partner at a medium-sized CPA firm has been assigned the task of mentoring Barbara, a newly promoted audit senior. One day at lunch, Steve and Barbara are discussing the topic of taking on new clients and retaining existing ones. Barbara is having a hard time understanding why once an auditor has accepted a client, the decision would be revaluated at future points. Steve's best response to Barbara's question is A) to respond that from a financial standpoint, the auditor owes a duty to itself to reevaluate its ongoing client relationships, as it may be able to adjust the cost and pricing of the audit in response to client changes. This strategy helps the auditor maximize profitability. B) to explain that because a major part of what the auditor provides is credibility, it is both prudent and appropriate for the auditor to carefully reevaluate clients and the risk they may represent to the auditors reputation. C) to advise Barbara that in order to effectively mitigate risk, the audit firm regularly reviews its ongoing client relationships, and attempts to only transact business with clients for which the risk of material misstatement is higher. D) to explain that because the auditor is reliant on its own reputation to both obtain future clients and maintain existing ones, the auditor must carefully assess the clients risk profile to make sure audit risk can be eliminated. Answer: B Explanation: to explain that because a major part of what the auditor provides is credibility, it is both prudent and appropriate for the auditor to carefully reevaluate clients and the risk they may represent to the auditors reputation. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

219) During an auditing class at Mayfair State University, a student has asked the professor to explain and elaborate on the importance of auditor objectivity and impartiality relative to the client. The student is confused as to what effect issuing a clean audit opinion on a client with materially misstated financial statements would have on the auditor. The professor's best and most appropriate response to this question would be which of the following? A) If an auditor issues an unqualified opinion on the financial statements of a client which later turn out to be materially misstated, the auditors reputation for performing effective and credible audits may be impaired, which may cause a loss of business for the auditor. B) if an auditor inadvertently issues an unqualified opinion on a client's financial statements and it is later determined that material misstatements are contained within those financial statements, the auditor is fully liable for all monetary losses by all stakeholders who choose to pursue litigation. C) If the auditor is apprised by either the client or any third party at any point proceeding conclusion of the audit that material misstatements have been proven to exist in the financial statements, the auditor is liable to the client for all audit fees charged, and liable to third parties for any monetary losses suffered. D) So long as the auditor took all reasonable precautions and has documented evidence of audit procedures that would be considered reasonable and prudent at the time, the auditor cannot be sued under either common or statutory law. Answer: A Explanation: If an auditor issues an unqualified opinion on the financial statements of a client which later turn out to be materially misstated, the auditors reputation for performing effective and credible audits may be impaired, which may cause a loss of business for the auditor. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

220) Centrum External Auditors, LLC are considering accepting a new client; StarLock Industries, Inc. StarLock Industries is a publicly-traded national distributor of beds and bedding products throughout the continental United States. As part of the client acceptance decision, Centrum's partners are discussing what happened to StarLock's previous auditor. The client's top management has advised that they terminated the previous auditor after disagreements and differences of opinion on 'key accounting measures'. At this juncture, Centrum's most prudent and appropriate course of action would be A) to advise top management of StarLock Industries that they will be unable to accept this audit engagement. Any client that has terminated a relationship with an auditor due to a disagreement is likely to represent increased inherent risk. B) to request top management's written position to contact the previous auditor and discuss the circumstances surrounding the disagreement with them. Once Centrum gains a better understanding of the situation, it will likely assist in the client acceptance/rejection decision. C) to proceed with client acceptance. StarLock Industries operates in a fairly specialized industry, and it is most likely that the previous auditor's lack of understanding caused the disagreement on accounting measures. D) to advise StarLock Industries' top management that per generally accepted auditing standards, all accounting measures requiring any degree of judgment are to be determined by the auditor, not management. Answer: B Explanation: to request top management's written position to contact the previous auditor and discuss the circumstances surrounding the disagreement with them. Once Centrum gains a better understanding of the situation, it will likely assist in the client acceptance/rejection decision. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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221) A new hire to Ainsley CPA firm, Shanna, is being mentored by Dave, an experienced auditor and CPA. Shanna is about to begin her first audit with Dave as her mentor. Dave has spent some time going over what Shanna is likely to see and experience during the first few days of the audit. Shanna asks Dave to explain the idea of an engagement letter, and if this letter is really needed. Dave's most suitable response to this inquiry would be to advise A) that the engagement letter that a client reviews and signs prior to the initial audit is more of a formality. The auditor has historically used the engagement letter to clearly lay out the conditions and expectations of the audit, and to ensure that the auditor cannot be sued. B) that as a matter of policy, and in adherence to generally accepted auditing standards, an updated engagement letter is required to be signed by the client before any engagement begins. The purpose of this is to make sure the client fully understands what the audit would entail and what exactly will be audited in advance. C) that the engagement letter helps to make sure that the client and the audit are 'on the same page' with respect to important audit details such as the scope and timing of the work, and to help the auditor should the client or any third parties attempt litigation. D) that in the electronic era, most auditing firms no longer have their client's sign engagement letters. This is because the amount of documentation generated electronically negates the need for a formal engagement letter. Answer: C Explanation: that the engagement letter helps to make sure that the client and the audit are 'on the same page' with respect to important audit details such as the scope and timing of the work, and to help the auditor should the client or any third parties attempt litigation. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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222) During the initial stages of the audit of Becker Company, a medium-sized distributor of plastic pipes across the southeastern United States, an audit intern, Sarah, is being supervised by Mike, an experienced auditor and long-time CPA. Sarah has noticed that the audit team appear to be spending a large amount of time gathering information about the client, such as any unique accounting situations the client may be in, the industry in which the client operates, etc. Sarah consults Mike as to why the audit team is spending a seemingly large amount of time on something she perceives as relatively trivial. Which of the following choices represent Mike's most appropriate response to this question? A) Because the auditors have agreed on the audit procedures with client management beforehand, the auditors are obliged to spend at least a predetermined amount of time examining the particulars of the client. This client represents an ongoing audit client, so the auditors have determined risk of material misstatement to be low. B) During the initial, risk response phase of the audit, it is well worth the investiture of the auditor's time and effort to ensure that they learn as much as possible about the client. Even ongoing clients experience changes in their situations which the auditor will want to be aware of. Understanding the client better helps the auditor to identify locations of possible risks and misstatements. C) From a budgetary and client billing standpoint, every external audit is broken down into the exact number of billable hours to be charged to each part of the audit. If the auditors do not record the allotted number of billable hours for this part of the audit, they are likely to have to refund money to the client. D) Because audits represent risk to the auditor, it is well worth the investiture of time and effort to try to learn as much as possible about the client before accepting or rejecting the client. As it only takes one or two bad clients to ruin the auditors' reputation, it is worth the time and effort spent. Answer: B Explanation: During the initial, risk response phase of the audit, it is well worth the investiture of the auditor's time and effort to ensure that they learn as much as possible about the client. Even ongoing clients experience changes in their situations which the auditor will want to be aware of. Understanding the client better helps the auditor to identify locations of possible risks and misstatements. Diff: 3 LO: 2 Bloom: Evaluation Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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223) Marlene is a new audit staff associate who has been assigned to the audit of Bentley Enterprises, Inc. The CPA firm that Marlene works for has audited Bentley Enterprises for the last five years, and is familiar with the client's industry and significant areas of risk. Marlene's supervisor Ben, an audit manager assigned to Bentley Enterprises, is attempting to explain the concept of a client's system of internal control to Marlene, and why testing of controls are important. Ben can explain this best to Marlene by saying A) a. that a client's system of internal control can be best thought of as the policies, procedures etc. that the client enacts to try to ensure the business runs as it should, and to help the company achieve its mission. Even with a robust system of internal controls in place, the auditor will still test controls as part of the audit to ensure they are operating effectively. B) that testing of a client's system of internal control is important to ensure that appropriate controls are operating as they have been designed to do. If the auditor determines that the client's system of internal control is not operating as designed, the auditor is likely to decrease inherent risk related to the audit and increase overall detection risk. C) that if the audit client represents an ongoing client, with a historical record of a strong system of internal control, the auditor is likely to focus more audit time and attention on testing internal controls, and less time to substantive testing, such as tests of details. D) that the auditor always spends a certain pre-determined amount of time on the audit of internal controls. The amount of time spent is agreed upon jointly by the auditors, client management, and the internal audit function. Answer: A Explanation: that a client's system of internal control can be best thought of as the policies, procedures etc. that the client enacts to try to ensure the business runs as it should, and to help the company achieve its mission. Even with a robust system of internal controls in place, the auditor will still test controls as part of the audit to ensure they are operating effectively. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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224) Cooper, a recent college graduate and new hire of Anderson CPAs is discussing the overall procedures of an audit with his supervisor, Caitlin. Anderson advises that when he took auditing classes in college he always seemed to get 'lost in the weeds' and asks Caitlin to provide him with a general overview of the audit procedures utilized. Caitlin's best response to this question would be which of the following? A) Every audit for every client at Anderson CPAs is completely different, as we perform attest engagements for a variety of clients in a wide array of industries. As a result, there is no standardization or similar procedures carried out between audits. B) Most audits start with testing a client's system of internal controls. Once this has been done, the auditor can determine where to focus audit time and resources in order to lower audit risk to an acceptable level. C) The auditor precedes any audit with gaining an understanding of the client and beginning to develop an audit strategy. Once a strategy is formed, the auditor will typically proceed with testing the client's system of internal controls and performing substantive tests in order to form an opinion on the financial statements. D) Once the auditor has gained an understanding of the client, the auditor will typically perform substantive testing in order to determine which of the client's internal controls are performing as designed, and where areas of increased audit risk may be. Once tests of controls have been performed, the auditor is ready to issue an audit opinion. Answer: C Explanation: The auditor precedes any audit with gaining an understanding of the client and beginning to develop an audit strategy. Once a strategy is formed, the auditor will typically proceed with testing the client's system of internal controls and performing substantive tests in order to form an opinion on the financial statements. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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225) Mike and Elizabeth, two audit staff associates are working on the audit of PeaGram LLC, a nationwide distributor of frozen foods. Mike and Elizabeth are discussing the concept of materiality, and how this concept is related to the auditing profession. The two staff associates have differing opinions on what materiality is, and why it is important. Which of the following answers best describes materiality and why is it important? A) Materiality is an important concept in auditing, and relates to determining a threshold of when something is considered to be important by a reasonable person. Every auditing firm has a predetermined and set level of materiality which is exercised on every engagement to ensure consistency. B) Materiality can be best thought of as information that might influence decisions that people make pertaining to matters at hand. There is not a predefined quantitative or qualitative threshold for materiality; rather it is determined more on a case-by-case basis. C) Materiality is determined by the courts, and so auditors are typically less concerned about this concept. So long as the auditor adheres to court determined materiality thresholds, then it is unlikely that any suit brought against them will prevail. D) Materiality is an important concept, and one that the auditing profession takes seriously. During the attest engagement of a public company, generally accepted auditing standards require the auditor to meet with the client's audit committee and senior management and set the appropriate level of materiality. Answer: B Explanation: Materiality can be best thought of as information that might influence decisions that people make pertaining to matters at hand. There is not a predefined quantitative or qualitative threshold for materiality; rather it is determined more on a case-by-case basis. Diff: 3 LO: 3 Bloom: Evaluation Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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226) Susan, an audit staff associate assigned to the audit of Juno LLC has approached you, her supervisor to assist with a query she has. Susan advises that she has learned that Juno LLC is planning to record a contingent liability in this year's financial statements because they are expecting to be litigated against in connection to a product defect and subsequent recall. Susan is wondering if this is material to the audit. Your best response to this question would be to advise which of the following? A) Any litigation against the client is always material, regardless of whether the dollar amount is known and whether the lawsuit is likely to prevail in court. As such, Susan should recommend to the client that this is material and must be disclosed. B) Until an exact dollar amount and likelihood of the plaintiff's prevailing in court are known, any such threatened litigation should not be considered to be material, and should not be disclosed in either the financial statements or the notes to the financial statements. C) As this is likely to involve a significant outlay of cash by the client should the lawsuit prevail, along with potential damage to the client's reputation regardless of the outcome of the lawsuit, this should be considered material and disclosed by the client accordingly. D) The decision as to whether this is material or not is solely at the discretion of client management, as they will be liable for any damages awarded, not the auditor. As a result, the auditor should simply document the potential litigation and nothing more. Answer: C Explanation: As this is likely to involve a significant outlay of cash by the client should the lawsuit prevail, along with potential damage to the client's reputation regardless of the outcome of the lawsuit, this should be considered material and disclosed by the client accordingly. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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227) Steve and Tony, two audit managers working on the audit of JCL Enterprises are discussing materiality. Steve and Tony are relatively inexperienced audit managers and this is the first time they have been responsible for the day-to-day operations of a client's audit. One of the staff associates approaches them and advises that she has been asked a question by one the client's internal auditors pertaining to materiality and is unsure how to answer. The question pertained to how the auditors would know when something should be considered material and investigated further and/or disclosed accordingly. Steve and Tony's most appropriate response to this question would be to advise which of the following? A) Audit materiality, per generally accepted auditing standards, is determined with reference to a strict percentage, and based on the client's total assets. In most cases, 3% of total assets is considered to be the threshold for materiality. B) The question of when something is likely to be considered material by the auditors pertains less to the dollar amount and more toward whether knowledge of the item would cause a reasonably informed person to perhaps act or decide differently based on this information. C) The internal auditor appears to be referring to overall planning materiality. The audit staff associate should advise the internal auditor that this level of materiality is set jointly between the external auditor and the client's board of directors. D) When attempting to set a threshold or benchmark for materiality, the auditors will typically select accounts from the statement of cash flows, as this represents the best and most accurate measure of the actual cash the company is receiving and disbursing each period. Answer: B Explanation: The question of when something is likely to be considered material by the auditors pertains less to the dollar amount and more toward whether knowledge of the item would cause a reasonably informed person to perhaps act or decide differently based on this information. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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228) An important component of any external audit is that of professional skepticism, and the auditor retaining an open and questioning mind throughout the audit. Which of the following scenarios best and most accurately represents the concept of professional skepticism and its appropriate exercise by the auditor? A) Steve, an experienced audit partner is currently completing the audit of a major audit client. Steve has been the lead partner assigned to this engagement for the last three years. Steve and the Chief Financial Officer, Mary, have struck up a friendship over the last two years and Mary routinely provides Steve with copies of requested documents and records. B) Alison, the audit partner assigned to the engagement of SeaBreeze Enterprises is meeting with the client's accounts receivable function to discuss gross and net receivables. The head of the Accounts Receivable function has advised that all calculations and allowances have been doublechecked, however Alison advises she will assign an audit staff associate to check all calculations. C) Brent, a senior audit manager working on the attest engagement for a publicly-traded client routinely goes to lunch with senior members of the client's management. Brent has recently advised some his staff to accept copies of documents provided to them by the client, and that there is no need to check the authenticity of the documents, as the client's staff are trustworthy. D) Mary, an audit partner assigned to the attest engagement of one of their biggest clients, is concerned about the client finding a replacement auditor. In order to keep the client's management happy, Mary advises that moving forward, they will allow the internal auditors to audit the accounts receivable and related allowance accounts, and will rely on the work of this function. Answer: B Explanation: Alison, the audit partner assigned to the engagement of SeaBreeze Enterprises is meeting with the client's accounts receivable function to discuss gross and net receivables. The head of the Accounts Receivable function has advised that all calculations and allowances have been double-checked, however Alison advises she will assign an audit staff associate to check all calculations. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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229) During the audit of GreenGrass LLC, the external auditors, FairShot CPAs, have recently sent positive confirmations to the client's bank, requesting details of both balances on deposit and loans outstanding. Once these confirmations are returned by the bank, the balances do not agree with the client's records. Specifically, the cash in deposit accounts is significantly lower and the loan balances significantly higher than the client had indicated. The best example of the exercise of professional skepticism in this situation would be which of the following? A) The auditor should assume that the reason for the balance discrepancies in the deposit and loan accounts is due to the time lag. As a result, no further investigation is required or warranted. B) Due to the significant differences in balances in both the deposit and loan accounts, the auditor is obliged to investigate further. The most appropriate course of action would be for the auditor to request the internal audit function investigate these discrepancies and formally report the findings to the external auditors. C) The best course of action for the external auditors to take upon learning of the significant discrepancies in the deposit and loan accounts would be to employ a team of external auditors to investigate the discrepancies, and request the client's permission to contact the bank for further inquiries, if needed. D) Generally accepted auditing standards do not allow for any discrepancies in deposit and loan balances, thus the auditor's most prudent course of action is to either issue a qualified opinion on this area of the audit, or disclaim an opinion completely. Answer: C Explanation: The best course of action for the external auditors to take upon learning of the significant discrepancies in the deposit and loan accounts would be to employ a team of external auditors to investigate the discrepancies, and request the client's permission to contact the bank for further inquiries, if needed. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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230) During the audit of the revenue accounts for BlackWater Inc., a provider of specialty scuba gear and other underwater apparatus, it has been noted by the auditing firm, Johnson CPAs, that the client's revenue accounts are significantly higher than last year. It has also been noted that the client's inventory turnover ratio has decreased somewhat significantly since last year. Based on these facts and circumstances, the most appropriate exercise of professional skepticism would be A) for the auditor to assume that because the client's sales have significantly increased, the client has likely also significantly increased their inventory purchases which would account for the decreased inventory turnover. B) confirm with management that because revenue and sales are now higher, the corresponding increase in cost of goods sold has caused the decrease in the inventory turnover. C) to investigate the reasons for the increase in sales and decrease in inventory turnover ratio, to attempt to understand and reconcile why these contradictory indicators exist. Both areas should be investigated by teams employed by the external auditors. D) to advise the client's top management that an increase in revenue and demand coupled with a simultaneous decrease in inventory turnover appears contradictory, and request management investigate and formally report back the findings to the external auditor for inclusion in the audit report. Answer: C Explanation: to investigate the reasons for the increase in sales and decrease in inventory turnover ratio, to attempt to understand and reconcile why these contradictory indicators exist. Both areas should be investigated by teams employed by the external auditors. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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231) During the initial phases of the audit of Cannon Enterprises Inc., a retailer of novelty gift cards and other boutique gifts, the head of the internal audit function has advised the two audit partners assigned to the engagement that Cannon Enterprises really installed a new computer system designed to improve processing, reporting and collection of accounts receivable and payable. The head of Internal Audit further advises that since its installation, the system appears to be working well and the staff in this area have received adequate and thorough training on it. Based on this information, which of the following statements is most accurate pertaining to the risk of material misstatement as it relates to this area? A) As the implementation of this new system was successful, and the staff assigned to this area have been well trained, there should be no increase or decrease to the corresponding level of risk of material misstatement. B) Because a new system has been installed, even with adequate staff training, an increased risk of material misstatement now exists at the financial statement level because errors in processing and recording transactions related to these areas may affect multiple accounts. C) Although the head of Internal Audit has advised that staff have been adequately trained on the new systems, it is still possible that an increased risk of material misstatement may exist at the account and transaction level, as errors in these areas would affect specific accounts. D) Based on the external auditors learning of the implementation of the new system, they should err on the side of caution and issue a qualified opinion for this year's audit until the system has had more time to prove itself. Answer: B Explanation: Because a new system has been installed, even with adequate staff training, an increased risk of material misstatement now exists at the financial statement level because errors in processing and recording transactions related to these areas may affect multiple accounts. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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232) Bob and Casey, two audit staff associates are discussing audit procedures for the upcoming audit of Yacht LLC, a purveyor of luxury sailing boats to clients in the United States and Europe. In particular, Bob and Casey are discussing the nature, timing and extent of audit procedures that they will likely be involved in undertaking. Which of the following statements best describes an example of an audit procedure that may be conducted?? A) A specific audit procedure may be conducted closer to the end of the audit, especially for accounts and transactions that the auditor has determined represent decreased audit risk. B) With respect to the extent of a particular audit procedure, the auditors may decide to increase sample size if detection risk has been assessed as low, and conversely decrease sample size if detection risk has been assessed as high. C) The auditors are likely to perform substantive procedures, including substantive tests of details on the client's internal controls. These procedures are to designed to ensure that clientdesigned internal controls are operating effectively. D) The auditor is likely to request the internal audit function test all internal controls employed by the client. Once this is complete, the internal audit function should provide a formal written report to the external auditors, for inclusion in the permanent audit file. Answer: B Explanation: With respect to the extent of a particular audit procedure, the auditors may decide to increase sample size if detection risk has been assessed as low, and conversely decrease sample size if detection risk has been assessed as high. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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233) Bob and Carrie, two senior audit managers working for Jones CPA Firm are currently completing the audit of NexGen Enterprises, Inc., a distributor of textbooks and educational materials across the United States, Canada, and Mexico, and an ongoing audit client. In prior audits, Jones CPA firm have noted that the client's system of internal control has been effective and strong. In addition, it has been further noted that the client operates and maintains a strong and independent internal audit function staffed by competent and experienced professionals. Based on this information, which of the following audit strategies are likely to be the most appropriate? A) Jones CPA Firm is likely to adopt a reliance on controls strategy, whereby the external auditor will increase inherent risk and sample sizes related to internal controls. This strategy will ensure that nothing has changed since the last audit. B) Based on this information, it is likely that Jones CPA Firm will adopt a reliance on controls strategy, as based on information and evidence gathered in prior audits, the client's system of internal controls is robust and effective. Part of this strategy will be to focus more on internal controls and less on substantive testing. C) Based on this information, Jones CPA Firm is likely to adopt a reliance on controls strategy, as prior audits have gathered and documented evidence that the client's system of internal control is strong. Part of this strategy will be to increase substantive tests of details to corroborate the auditor's opinions on internal control. D) It is most likely that Jones CPA Firm will focus audit time, attention, and resources on performing substantive tests of account balances, transactions, and tests of details. As the client's system of internal control is known to be strong, there is no need to focus audit attention here. Answer: B Explanation: Based on this information, it is likely that Jones CPA Firm will adopt a reliance on controls strategy, as based on information and evidence gathered in prior audits, the client's system of internal controls is robust and effective. Part of this strategy will be to focus more on internal controls and less on substantive testing. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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234) Suzy and Harry, audit managers assigned to the audit of Old Dominion Enterprises, are discussing how the nature, timing, and extent of audit procedures may be different when the risk of material misstatement has been assessed to be high versus low for an account balance. Which of the following statements most accurately describes the differences in the nature, timing, and extent of audit procedures for accounts with high versus low risk of material misstatement? A) When the risk of material misstatement is assessed as high by the auditors, the auditor is less likely to rely on the client's controls. The auditor is also more likely to perform more substantive procedures before forming an opinion on the financial statements. B) When the risk of material misstatement is assessed as low by the auditors, the auditor is more likely to adopt a reliance strategy with respect to the client's internal controls. The auditor is likely to also increase substantive tests of details before issuing an audit opinion. C) Generally accepted auditing standards require that when an auditor assesses the risk of material misstatement as high, the auditor perform additional substantive testing procedures on the client's system of internal control, including substantive tests of details. D) When the risk of material misstatement is assessed as low by the auditors, a greater reliance is typically placed on the client's system of internal controls. Because greater reliance is placed in this area, there is no need or requirement for the auditor to adjust the nature, extent or timing of audit procedures. Answer: A Explanation: When the risk of material misstatement is assessed as high by the auditors, the auditor is less likely to rely on the client's controls. The auditor is also more likely to perform more substantive procedures. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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235) During the audit of Sunset Enterprises, LLC, a manufacturer of sunblock and other UV protection equipment, an audit staff associate has notified the audit manager assigned to the engagement of a discrepancy in one of the client's revenue accounts. It appears that the client has booked multiple revenue entries during the last week of their fiscal year for which the staff associate is unable to find any supporting documentation. The audit manager's best response to this query by the staff associate would be A) to immediately notify the client's management of the discrepancy, giving them a specified amount of time to produce the paperwork necessary in order to support the recorded revenue entries. B) to advise the staff associate that it is normal and customary at the end of the client's fiscal year for documentation supporting the revenue transactions to not be generated until the following fiscal year. As a result of this, the audit staff associate should make a note to follow up on this during next year's audit. C) to work on the premise that this may simply be an error or oversight on the part of the client. Further audit procedures should be conducted by the staff associate in order to corroborate the transactions. D) to assume that due to the timing of the entries to the revenue account, the transactions are fictitious and should be treated as fraudulent. The next step would be for the audit manager to notify the audit partner with overall responsibility for the engagement of this development. Answer: C Explanation: to work on the premise that this may simply be an error or oversight on the part of the client. Further audit procedures should be conducted by the staff associate in order to corroborate the transactions. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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236) During a meeting between the senior management of Delco Company and their external auditors, Jamboree CPAs, the issue has been raised by one of the audit partners as to the high level of turnover in some of the client's executive positions. It has also been noted by another audit partner that Delco's business structure, which has recently been overhauled and restructured is more complex than before, with more reporting lines than before. Which of the following statements best describes why the external auditors may be concerned about these issues? A) The external auditor may be concerned that with a high level of turnover for people in key positions, it may be more challenging for the auditor to obtain the necessary documentation and assurances that are required as part of the audit. This makes the issuance of a qualified or even a disclaimer of opinion more likely. B) The external auditors may be concerned that high management turnover is indicative of problems within the firm that the auditor may be unaware of. In addition, the added complexity introduced by the new reporting hierarchy may provide increased opportunities for error or fraud. C) The external auditors are likely to be concerned about the high levels of management turnover, as it is likely that fraud is occurring which is precipitating this high turnover level. The auditor is also likely to presume that the reporting hierarchy restructure has been purposefully introduced to cover the tracks of those who may be committing fraud. D) It is likely that with management turnover being at a high level, the auditors will likely be asked to take on the role of management in some capacity. This will create a conflict of interest and resultant loss of independence for the auditors, who are thus more likely to simply issue a disclaimer of opinion on the client's financial statements. Answer: B Explanation: The external auditors may be concerned that high management turnover is indicative of problems within the firm that the auditor may be unaware of. In addition, the added complexity introduced by the new reporting hierarchy may provide increased opportunities for error or fraud. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

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237) During the audit of Easy Company, a national distributor of paper products, Longleaf CPAs are performing audit procedures related to accounts payable. Specifically, the audit manager with day-to-day responsibility for the audit has requested two audit staff associates perform a procedure whereby the file containing the client's vendor addresses is matched against the file containing the client's employee addresses. Once the check is complete, three matches are noted, all pertaining to long-time employees of the client in fairly senior positions. What would be the most appropriate response to this finding? A) The auditor should assume, based on the longevity and seniority of these employees, that this is just an error. Consequently, it should simply be noted and documented in the file. B) The auditor should contact the employees individually and separately and interview them pertaining to why these addresses match. Upon conclusion of the interview, the employees should be requested to provide written assurances that the address matches are simply errors in the system, and that the employees are not also vendors of the client. C) The auditors should contact the respective employees' supervisors, and alert them of the finding. The auditor should also separately institute inquiries to determine if the employees are also receiving payments from the client, and if so, if these payments are legitimate. D) The auditors should refer this finding to the client's internal audit function, as this function is more familiar with both the client and the staff working for the client. If there is any fraud, it is thus more likely that the internal auditors will locate it. Answer: C Explanation: The auditors should contact the respective employees' supervisors, and alert them of the finding. The auditor should also separately institute inquiries to determine if the employees are also receiving payments from the client, and if so, if these payments are legitimate. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

Auditing, 2e (Johnson) Chapter 4 Risk Assessment Part II: Understanding the Client 1) When the auditor is engaged at the risk assessment stage of the audit, analytical procedures are rarely used because these would represent substantive procedures. Answer: FALSE Explanation: Analytical procedures are typically used extensively throughout the risk assessment stage in an attempt to draw attention to areas of potentially higher inherent risk. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 2) Audit committee composition should consist of the most competent and independent directors, irrespective of whether they are employed by the client company. Answer: FALSE Explanation: Audit committees should be partially comprised of non-management directors to help ensure the audit firm is able to remain independent. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 3) The audit partner will meet with members of the board once the audit is concluded and not before its conclusion. Answer: FALSE Explanation: The audit partner will meet with members of the board, when necessary, throughout the audit. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

4) An audit committee is a sub-committee of the board of directors. Answer: TRUE Explanation: An audit committee is a sub-committee of the board of directors. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 5) Which factor would likely increase an auditor's concern pertaining to risk of fraudulent financial reporting? A) Excessive amount of liquid assets that could easily be converted to cash B) Low profitability/growth with respect to competitors in the same industry C) Management participation in selection of accounting methods and principles D) An extremely confusing and overly complex institutional structure, with blurred lines of authority Answer: D Explanation: A confusing organizational hierarchy would increase inherent risk, and thus a greater risk of fraudulent financial reporting would be present. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 6) In the context of fraudulent financial reporting, which would most likely represent a risk factor? A) Low employee turnover at senior management levels B) High degree of competition in the particular industry C) The structure of the company includes subsidiary companies D) Revenue expectations from management have increased slightly from the prior year Answer: B Explanation: A high degree of competition within the industry could signal the potential for fraud, in that management/employees might commit financial statement fraud to match or exceed the financial performance of their competitors. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

7) In a period of recession in a particular industry, the auditor would typically spend more time on which of the following accounts? A) Purchase discounts B) Allowance for doubtful accounts C) Preferred stock D) Equity method investment account with a noncontrolling interest in a subsidiary Answer: B Explanation: In a period of recession, there is increased probability that accounts receivable will prove uncollectable and may be written off. A close examination of an aging report may be useful. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 8) When the auditors are considering the risk of material misstatement, they will attempt to identify major risks, determine how these risks could relate to fraud or error, consider the importance of the risks, and ________. A) notify management of these risks B) attempt to immediately resolve any identified risks C) determine the probability that the identified risks might result in material misstatements D) determine who is responsible for each identified risk Answer: C Explanation: An auditor is engaged to identify material misstatements. Minor (immaterial) misstatements will undoubtedly be uncovered in the course of the audit, but that have no bearing on the audit itself. An audit is not conducted to purposefully look for fraudulent activity. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

9) If an auditor is considering accepting a client in an industry that is unfamiliar to the auditor, the auditor should ________. A) not accept the engagement B) attempt to learn all matters that would materially pertain to the entity's business C) issue a disclaimer of opinion D) rely on the opinion of specialists the auditor hires Answer: B Explanation: In this situation, the auditor should attempt to learn more about the client's industry and all factors that might be material to the audit. The auditor would not simply rely on specialists in this instance. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 10) Generally speaking, client firms engaged in international trade would be considered to have ________. A) lower inherent risk B) higher inherent risk C) lower control risk D) less complicated operations Answer: B Explanation: Generally speaking, any foreign trade will increase inherent risk due to the introduction of complicating factors such as foreign exchange rates, foreign political climates etc. The financial statements should be converted to the local currency before being audited. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

11) Strawberry, an external auditor, was assigned to audit the financial statements of Winter Company who is engaged in the production of iced popsicles. As part of the audit, Strawberry wanted to understand the processes within the company and decided to start by conducting an observation. However, Winter Company wants to obtain a justification first as to why Strawberry will be allowed to observe how things are being done inside the company. What should be the response of Strawberry? A) I will be looking into observing the step-by-step process of making iced popsicles and will provide you with process improvement ideas to improve efficiency. This will add value to the audit and will benefit you. B) Having an understanding of the relevant processes within your company is necessary to identify and understand events, transactions, and practices that may have an impact on your financial statements. Observation is one way to achieve this. C) The observation that I will do is aimed at documenting material weaknesses in your production and internal control systems. By doing so, you will be provided with proposals on how to address these weaknesses. D) Observations are used to determine if there may be material misstatements in your financial statements. This is the goal of an external audit. Answer: B Explanation: Gaining an understanding of the client is for auditors to identify and understand event, transactions, and practices that may have an impact on the financial statements. A great way to learn more about a client is to observe its operations. To learn more about a client's products, take a tour of the client's production line to see how the products are made. To learn more about how payroll transactions are processed, observe the process happening in the payroll department. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

12) The Big Blue House is a company engaged in the manufacture of paint removers. While studying the client's industry, Luna, the assigned external auditor for Big Blue House, comes across a legitimate article which discussed the decision of the Environmental Protection Agency to ban methylene chloride. Luna also learned during an observation that this chemical is being used by the Big Blue House for its paint removers. What is the responsibility of Luna regarding this non-compliance? A) Luna has no responsibility regarding this non-compliance. External auditors are not expected to be experts in non-accounting laws and regulations. B) Luna can ignore this non-compliance. The focus of the external audit is on the financial statements only. C) Luna has the responsibility to report this to the Environmental Protection Agency immediately. Luna does not need to get the consent of Big Blue House. D) Luna is responsible for detecting material misstatements related to this non-compliance. This non-compliance might have a direct and material effect on the financial statements. Answer: D Explanation: For illegal acts that have a direct and material effect on the financial statements, the auditors have the same responsibility for detecting those acts as they do for detecting material misstatements caused by error or fraud. If auditors discover or suspect that an illegal act has occurred, they should use professional skepticism and gain an understanding of the nature of the act, gather information to determine the possible effects on the financial statements, and document all of their work. Auditors should consider the implications of noncompliance on other areas of the audit, such as audit risk, materiality, and reliability of management representations. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 13) The concept of inherent risk is most closely tied to the idea of ________. A) global risk B) audit risk C) underlying business risks D) currency risk Answer: C Explanation: The concept of inherent risk is closely tied to underlying business risks, which vary by industry and client. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

14) Common factors that influence inherent risk are________. A) importers and exporters B) major suppliers C) discounts D) All of the choices are correct. Answer: D Explanation: All of the answer choices are factors that influence inherent risk. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 15) For illegal acts that have a material but indirect effect on the financial statements, the auditor's responsibility ________ performing specified audit procedures that may identify noncompliance. A) is limited to B) goes beyond C) does not include D) None of the choices is correct. Answer: A Explanation: For illegal acts that have a material but indirect effect on the financial statements, the auditor's responsibility is limited to performing specified audit procedures that may identify noncompliance. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

16) When the economy is poor, a fall in profits can easily be explained to shareholders when most companies in the industry are also experiencing a decline in earnings. Therefore, when the economy is poor, there is a tendency within an entity to ________. A) maximize write-offs B) maximize profits C) minimize revenues D) minimize profits Answer: A Explanation: When the economy is poor, there is a tendency to maximize write-offs because a fall in profits can easily be explained to shareholders when most companies in the industry are also experiencing a decline in earnings. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 17) Which of the following is true of the influence of significant accounts and classes of transactions on inherent risk? A) When determination of account balance is objective, the inherent risk is low. B) When the transactions are routine and relatively homogenous, the inherent risk is high. C) When an account has a high volume of transactions, the inherent risk is low. D) When the determination of an account balance is subjective, the inherent risk is low. Answer: A Explanation: When determination of account balance is objective, the inherent risk is low. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

18) Which of the following factors indicate higher inherent risks? A) Industry subject to changing trends B) Demand is not seasonal C) Industry has low chance of technological obsolescence D) Steady profitability Answer: A Explanation: In the context of demand, the factors that could lead to higher inherent risk assessments are as follows: (1) Seasonal demand for products which leads to sporadic revenue flow; (2) Industry subject to changing trends; and (3) Industry subject to technological obsolescence. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 19) Truffles, the engagement partner of a team assigned to audit Butternut Company, was discussing with the team the procedures they will perform to gain an understanding of the client. In their discussion regarding the issue of segregation of duties, one of the newly hired auditors asked Truffles what audit procedure will most likely illuminate this issue. What do you think is the most appropriate response of Truffles? A) Inquiring or asking questions may be the most appropriate response as you get to sit down with the actual persons performing the processes. Their words should be enough evidence for us to consider. B) I would say analytical procedures should be performed to highlight this. By understanding unusual fluctuations in the accounts being considered, we might be able to pinpoint if there is proper segregation of duties or not. C) Performing inspection of documents may be best to identify segregation of duties. Inspecting the signatures in the documents would be easy and we can directly determine if these were approved by the proper authority. D) Observation during the usual performance of the process provides the best evidence of segregation of duties. This will involve seeing the actual persons performing the process without relying only on documents or inquiries. Answer: D Explanation: A great way to learn more about a client is to observe its operations. By actually seeing in person how the process is being performed, the auditor can identify if there is proper segregation of duties rather than just relying on documents and inquiries. This is a best practice during an internal controls assessment. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

20) Yellow is a junior auditor assigned to audit Rainbow Company who is engaged in providing internet service to its customers. During the planning meeting of the external audit team, they were discussing their strategy in terms of understanding their client. Not having any previous audit experience, Yellow asked the audit manager as to what level of knowledge and understanding they need to acquire in the engagement. What should be the response of the audit manager to Yellow? A) We should focus our efforts on obtaining knowledge at the client-level. In this way, we will not be wasting time and effort in understanding the industry in which it operates which is unnecessary. B) Understanding the entity and its environment entails obtaining knowledge at the client-level, industry-level and general business environment level since all these levels influence inherent risk. C) It is enough that we understand at the client-level only so long as we identify both entity-level risks and transaction-level risks. These two can compensate for our lack of understanding at the industry-level. D) Gaining an understanding of the entity and its environment varies from one engagement to another. The level of understanding required from the external auditors will depend on what the client requires. Answer: B Explanation: In addition to gaining an understanding of the entity, auditors must be knowledgeable about the industry in which the entity operates and the general business environment because these factors also influence inherent risk. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

21) While doing an inquiry for Gold Company, Neon, the external auditor assigned, noted that the company's payroll staff assigned to distribute checks to the employees also has access to create and approve new employee records in the system. Upon doing a preliminary investigation, Neon discovered fictitious employee records approved by the payroll staff which might mean that there is a misappropriation of cash. Which of the following is the appropriate next step for Neon to perform? A) Set up a meeting with the payroll staff and confront them about the issue of misappropriation. This will be efficient for the audit and will speed up the process of investigation. B) Conduct further investigation to understand the nature of the act and gather information to determine possible effects on the financial statements. C) Discuss the situation with legal authorities outside the organization. This may be effective in apprising firm management of possible legal ramifications. D) Withdraw from the audit engagement immediately. This will avoid potential damage to the reputation of the audit firm. Answer: B Explanation: If auditors discover or suspect that an illegal act has occurred, they should use professional skepticism and gain an understanding of the nature of the act, gather information to determine the possible effects on the financial statements, and document all of their work. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

22) During the audit of Teddy Company, the external auditor, Spring, has noted from the planning session with the audit team that it is important to properly identify entity-level and transaction-level risks. However, as this is Spring's first audit engagement, Spring is having a difficult time making a distinction between the two, so he consulted with the audit manager for examples. Which of the following is the best response from the audit manager? A) An entity-level risk is that which affects multiple accounts and assertions. An example is when a company is under pressure to maintain a certain return on assets ratio. B) An entity-level risk is that which affects multiple accounts and assertions. An example is when a company has a target level of sales so the risk of misstatement might involve both the sales and receivables accounts. C) A transaction-level risk is that which affects limited accounts and assertions. An example is when a company has a target level of sales so the risk of misstatement might involve both the sales and receivables account. D) Entity-level and transaction-level risks differ in terms of the amount of the misstatement. Risks of large misstatements will be considered as entity-level risks while small amounts will be transaction-level risks. Answer: A Explanation: Entity-level risks are the client risks that affect multiple financial statement accounts, assertions, and transaction classes while transaction-level risks are client risks that affect only one transaction class, account, or assertion. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

23) Delgardo Fashion Company is being audited by Ice and Co. external auditors. Delgardo's management has disclosed to the external auditors that the fashion industry can be fickle and has stressed how quickly consumers' tastes change. At this stage of the audit, the external auditors are attempting to gain a better understanding of the client and the industry in which the client operates. Which of the following approaches would be the most appropriate audit strategy to gain an understanding of the client and the industry? A) The external auditors should plan to spend more time on inquiry and observation, with less focus on analytical procedures. B) The external auditors should discuss with the client's management the opportunity to delegate analytical procedures such as the calculation of key ratios to the internal auditing function, allowing the external auditors to focus on observational techniques and tests of internal control. C) The external auditor should plan to conduct inquiry and observational procedures to gain a further understanding of the client's operations and industry in tandem with analytical procedures to examine key ratios such as inventory and accounts receivable turnover. D) The external auditor should consider adopting a strategy whereby inspection procedures become the primary focus and comprise the bulk of the audit, enabling the auditor to review key management disclosures. Answer: C Explanation: The external auditor would want to conduct inquiry and observational procedures in order to gain a further understanding of the client, in addition to conducting analytical procedures such as calculating inventory and receivables turnover ratios due to rapidly shifting consumer tastes. Diff: 2 LO: 1, 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

24) Ernst & Old external auditing company is attempting to gain an understanding of a new audit client, Margram Enterprises. The external auditors have thus far ascertained that Margram Enterprises operates in a very competitive industry, and that the firm's management has recently changed the compensation structure for its sales staff to a more performance-based system, which includes bonuses for meeting aggressive sales goals. Which of the following represents the most appropriate approach the external auditor should take to gain an understanding of this client? A) Seek permission from the client to immediately contact the predecessor auditor, and adopt a reliance strategy based on the predecessor auditor's responses. B) Discuss the new compensation structure with senior management, and request the internal audit function to conduct procedures to confirm the accuracy and existence of all sales transactions and related receivables entered into the system since inception of the new compensation scheme. C) Plan inquiry procedures of management to obtain a thorough understanding of the new compensation structure, including inspection of the minutes of board of directors' meetings for relevant approvals, and conduct analytical procedures to examine changes in inventory and receivables turnover ratios. D) Focus audit time and resources on analytical procedures such as inventory and accounts receivable turnover only, as this will provide stronger evidence than inquiry and inspection procedures. Answer: C Explanation: Gaining an understanding involves considering issues at an entity level, industry level, and broader economic level using inquiry, documentation and analytical procedures. Diff: 2 LO: 1, 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

25) During an audit, Trek Auditing Company is seeking to understand the closing process of their new client, Cannon Enterprises. Senior management has recently disclosed that Cannon Enterprises' previous auditor resigned, citing disagreement with firm management centering on the propriety of closing process procedures. As a result of this disclosure, Trek Auditing Company is most likely to ________. A) advise senior management of their intention to withdraw from the audit engagement, due to an unacceptably high level of inherent risk surrounding the closing process B) delegate authority and responsibility of the audit of the closing process and related internal controls to the internal audit function, to lessen the external auditor's risk and liability C) examine adjusting and closing entries to ensure that asset and liability accounts are zeroed out in preparation for the next period, and balances transferred to retained earnings D) plan and perform procedures to ensure that transactions are recorded in the correct period, and that internal controls pertaining to the closing process are functioning appropriately Answer: D Explanation: The biggest risk associated with the closing procedures is that transactions or events are recorded in the wrong accounting period. Therefore is it important for Trek auditing company the auditors to test the internal controls over closing procedures. Diff: 2 LO: 1, 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

26) Vanilla, an external auditor with five years of experience in the automotive industry, was assigned to audit the financial statements of Merry Market, a large supermarket which caters to a lot of customers. Vanilla is in the process of understanding how Merry Market measures performance to know how it affects the auditor's risk assessment. During an inquiry, the accounting manager of Merry Market suggested to Vanilla to use the same understanding of Key Performance Indicators (KPIs) from previous experience in the automotive industry so as not to waste too much time in gathering new information about Merry Market's KPIs. How should Vanilla respond to this? A) That is a good idea! Since you are also engaged in selling products in the same way as the automotive industry, the way you measure performance should be relatively the same. B) I do not think this suggestion makes sense as the automotive industry is highly different from how things run in a supermarket. However, if your concern is the time it takes to get this information, we can skip this audit procedure as we prioritize the suggestions of our clients. C) Applying the same understanding of KPIs from what I have seen in the automotive industry to Merry Market is not advisable. Not all clients use the same KPIs and, therefore, the risk assessment will be different depending on the circumstances surrounding a specific client or industry. D) We can use the same understanding of KPIs so long as you agree to adjust your KPI measurements to that of the automotive industry moving forward. In this way, we won't need to understand your current ways of measuring KPIs and we can skip this step. Answer: C Explanation: It is very important for auditors to understand which KPIs a client is most concerned about so the audit can be planned around relevant accounts. It is inappropriate to assume all clients use the same KPIs. It is also inappropriate to assume a client will use the same KPIs every year. Just as businesses change their focus, KPIs change to help businesses achieve new goals. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

27) During an annual external audit of a recurring client, Hope, the auditor assigned, was asked by the engagement partner to obtain an understanding of the client's Key Performance Indicators (KPI). In the meeting with the client's representatives, Hope was questioned whether it is still necessary to obtain this understanding as they have been their client for three years now. It has been noted during the initial part of the audit that there were major changes in the organizational structure and that the majority of the executives were replaced by new employees. What should be Hope's response to the client? A) As the company has undergone major changes in its organizational structure, it is likely that new goals have been set. With this, KPIs from the previous years may not be applicable anymore. B) It is necessary to obtain this understanding as this step is mandatory for the audit. Whatever the circumstances may be, auditors will assume zero understanding even if this is a recurring audit. C) We are well aware of the changes in the majority of the executives so we assume that there might be changes as well in the focus of the business. However, if you provide assurance that the business focus has not changed that is sufficient. D) We can just use our previous year's understanding of your KPIs as this will also be beneficial for us. This will save us a lot of time and we can perform the audit more efficiently. Answer: A Explanation: It is very important for auditors to understand which KPIs a client is most concerned about so the audit can be planned around relevant accounts. It is inappropriate to assume a client will use the same KPIs every year. Just as businesses change their focus, KPIs change to help businesses achieve new goals. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 28) Which of the following refers to measurements, agreed to beforehand, that can be quantified and reflect the success factors of an organization? A) Key performance indicators B) Acid-test ratio C) Current ratio D) Price-earnings ratio Answer: A Explanation: Key performance indicators (KPIs) are measurements, agreed to beforehand, that can be quantified and reflect the success factors of an organization. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

29) Of the following scenarios, which would most likely result in an audit firm not accepting an engagement? A) Some internal controls related to credit granting procedures are not operating effectively. B) IT systems and architecture are antiquated and not capable of current processing and recording requirements. C) Significant related party transactions, of which the auditor has been advised, are a routine part of business. D) The client has advised that the auditor will be unable to confirm certain inventories with no valid reason given. Answer: D Explanation: If a valid, justifiable reason cannot be given as to why certain information will be withheld from the auditor, the auditor should not accept the engagement unless the same level of assurance can be obtained by the application of alternative audit procedures. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 30) If the management of an entity is close to breaching a debt covenant that requires maintaining a prespecified current ratio, management may have an incentive to ________. A) either overstate current assets or understate current liabilities B) understate either current assets or current liabilities C) overstate either current assets or current liabilities D) either understate current assets or overstate current liabilities Answer: A Explanation: If the management of an entity is close to breaching a debt covenant that requires maintaining a certain current ratio, management may have an incentive to either overstate current assets or understate current liabilities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

31) When scrutinizing a statement of cash flows in an attempt to gain a better understanding of the client, which would be most surprising to an auditor? A) An increase in accounts receivable B) A decrease in payables C) Negative investing cash flows D) Negative operating cash flows Answer: D Explanation: Negative operating cash flows indicates a problem area for the client. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 32) With respect to Key Performance Indicators, auditors should ________. A) disregard them as they are likely to be unrelated to the audit B) ask management to provide a detailed explanation of which KPIs are of the most important to them so that related audit procedures can be planned C) assign the task of investigation to the internal audit function D) assign new KPIs to the client as a result of the audit process Answer: B Explanation: It is very important for auditors to understand which KPIs a client is most concerned about in that year so the audit can be planned around relevant accounts. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 33) The price-earnings (PE) ratio could best be defined as ________. A) the value of the stock on the open market B) being closely related to the dividend discount model C) how much a stockholder is willing to pay per dollar of earnings D) what dividend percentage payout the stock pays Answer: C Explanation: The price-earnings (PE) ratio indicates the price a stockholder is willing to pay per dollar of earnings. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

34) A company's ability to meet its needs for cash in the short term is called ________. A) liquidity B) profitability C) materiality D) due professional care Answer: A Explanation: Liquidity is the ability of a company to meet its needs for cash in the short term. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 35) Market price per share divided by earnings per share equals ________. A) the price-earnings ratio B) the current ratio C) the acid test ratio D) the debt to equity ratio Answer: A Explanation: The price-earnings ratio shows how much a stockholder is willing to pay per dollar of earnings. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management 36) Which of the following reflects the earnings return on each issued share? A) Earnings per share B) Cash earnings per share C) Price-earnings ratio D) Current ratio Answer: A Explanation: Earnings per share reflects the earnings return on each issued share. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

37) Which of the following equals cash earnings per share (CEPS)? A) Operating cash flow divided by outstanding shares B) Profit divided by weighted average common stock shares issued C) Market price per share divided by earnings per share D) Market price per share divided by operating cash flow Answer: A Explanation: Operating cash flow divided by outstanding shares equals cash earnings per share. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management 38) Which of the following equals earnings per share (EPS)? A) Profit divided by weighted average common stock shares issued B) Market price per share divided by earnings per share C) Operating cash flow divided by outstanding shares D) Cost of sales divided by average inventory Answer: A Explanation: Profit divided by weighted average common stock shares issued equals earnings per share (EPS). Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 39) Sustainable cash flows from operations are those that are adjusted for influences which are ________. A) one-time B) unexpected C) seasonal D) annual Answer: A Explanation: Sustainable cash flows from operations are cash flows from operations adjusted for one-time influences. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

40) The cash flows provided, or used, by ________ activities indicate a company's ability to generate cash. A) operating B) investing C) financing D) All of the choices are correct. Answer: A Explanation: The cash flows provided, or used, by operating activities indicate a company's ability to generate cash. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 41) To be meaningful, the cash flow from operations amount should be adjusted for any one-time influences on cash flow from operations to determine ________ cash flow from operations. A) sustainable B) unexpected C) seasonal D) one-time Answer: A Explanation: To be meaningful, the cash flow from operations amount should be adjusted for any one-time influences on cash flow from operations to determine sustainable cash flow from operations. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

42) The ability of cash flows from operations to cover current debt and dividends is equal to ________. A) sustainable cash flow from operations/ (current portion of financing debt + dividends) B) (sustainable cash flow from operations/ current portion of financing debt) - dividends C) (current portion of financing debt + dividends)/ sustainable cash flow from operations D) current portion of financing debt + (dividends/ sustainable cash flow from operations) Answer: A Explanation: The ability of cash flows from operations to cover current debt and dividends = Sustainable cash flow from operations/ (Current portion of financing debt + Dividends). Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 43) Which of the following choices would indicate an appropriate change in the auditor's approach to the audit when an increased level of risk is present in a certain area? A) Assignment of personnel with specialized skills for the area of increased risk B) Assigning less audit staff to the engagement C) Withdrawing from the audit D) Obtain management assurances in writing pertaining to the increased area of risk Answer: A Explanation: If an increased risk is detected in a certain area, the auditor may well decide to assign staff with particular expertise to that portion of the engagement. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

44) During the performance of analytical procedures on Lollipop Company's financial ratios, Blueberry, the auditor assigned, noticed that the inventory turnover days was significantly higher than the industry average. Because of this variance, Blueberry decided to inquire with the finance manager of Lollipop regarding possible explanations. Which justification provided by the finance manager should Blueberry mostly rely on in assessing risk of material misstatement of inventories? A) As compared to other players in the same industry, Lollipop is smaller in size. That is why we have longer inventory turnover days. B) Lollipop Company uses a different accounting method than the majority of our competitors. That is why our inventory amount reported is lower and is thus giving us a higher inventory turnover in days. C) We have a lot of obsolete inventories as we have introduced new products recently. However, we already have a plan to dispose of these obsolete inventories D) Lollipop Company was the defendant in a lawsuit for the year being audited. This led to poor sales performance and low inventory turnover. Answer: C Explanation: Obsolete inventories which have book values exceeding net realizable value is enough reason to rely on the variance in the inventory days highlighted through the analytical procedures. The inventory turnover in days varies widely from one industry to another. If a client operates in a high-technology industry or the fashion industry, where customer preferences change quickly, an increase in the inventory turnover in days may indicate the client is not keeping up with change and products are not being sold as quickly. When this ratio increases by more than expected, auditors will plan to spend more audit time gathering evidence about the valuation of inventory. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

45) As part of the risk assessment procedures being conducted for the audit of Marshmallow Company, the external auditor, Mango, performed analytical procedures to understand the trend of selected financial ratios of the company. However, the newly-promoted finance manager of Marshmallow stated that he does not see the value in doing this. To explain the value of analytical procedures to the finance manager, what should be the response of Mango? A) The trend analysis being performed on selected financial ratios will allow me to conclude whether there are material misstatements in the financial statements. This will speed up the audit process to your advantage. B) These analytical procedures are designed for us to provide recommendations to you as to how you can improve your financial ratios. By improving your financial ratios, your shareholders will be pleased. C) Part of the external audit is to report on the financial performance of our clients which includes the analysis of the financial ratios. Financial performance assessment will be included in the audit report. D) By conducting analytical procedures, we will be able to highlight any unusual fluctuations in the account balances as per our expectations. This will help us to identify which areas might have risk of material misstatements. Answer: D Explanation: Analytical procedures aid in highlighting unusual fluctuations in accounts, identifying risk, enhancing understanding of a client and its industry, identifying the accounts at risk of material misstatement, and minimizing audit risk. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 46) An indicator that the auditor might need to adopt extended audit procedures would be best evidenced by ________. A) an unusual fluctuation in gross profit margin last year B) net sales increasing approximately 3% per year C) a new competitor entering the client's industry D) the client's current ratio decreasing slightly Answer: A Explanation: Any unusual/unexplained fluctuation in an account balance should give rise to the auditor adopting further audit procedures in an attempt to uncover and isolate the cause of the fluctuation. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

47) During the audit of Honey Company, the external auditors, Nectar and Co., are examining and attempting to understand the liquidity and solvency of their client. Honey Company operates in an industry where receivables, often from overseas, typically take longer to be collected. The external auditors have also determined that a long-term loan will mature in the next year as well as a significant long-term lease being up for renewal in the next three months. In order to accurately assess Honey Company's liquidity and solvency, the external auditors should ________. A) examine key liquidity and solvency ratios using data available for the most recent fiscal year, in addition to conducting analytical procedures to confirm historical lease payments and the associated lease expense B) conduct analytical procedures to determine trends in liquidity, solvency, and receivables turnover ratios, and also inquire of management regarding details of lease renewal costs C) attempt to send confirmations to overseas clients to ascertain collectability ratios and potential bad debt expense, as evidence of high collectability patterns will ensure liquidity and solvency D) advise the client to immediately refinance the long-term loan in order to improve liquidity ratios, and delegate analytical procedures to the internal audit function Answer: B Explanation: Auditors use trends over time to determine if liquidity and solvency is improving or declining, as well as considering upcoming changes in obligations. If there are no historical trends to compare to due to a firm being new, then industry trends may be utilized. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

48) Faith Company, the audit client of Coco, obtained a large long-term loan from the bank. Part of the agreement with the bank is for Faith to remain liquid and demonstrate its ability to pay current debts when they fall due for the duration of the loan. Coco, who is new to the world of external audit, was asked by the audit manager to identify which ratios might identify risks of misstatement because of this agreement with the bank. Which of the following should Coco highlight to the audit manager? A) We should look at the earnings per share ratio which is calculated by dividing net income by the weighted average number of common shares. B) With this agreement, I think it is worth looking into the quick ratio which is calculated by dividing the amount of current assets less inventory and prepaids by the amount of current liabilities. C) I would suggest looking into the debt to assets ratio which is computed by dividing the amount of total debt by the total assets. D) I think the ratio which might indicate a higher risk of misstatement would be the interest coverage ratio which is calculated by dividing the earnings before interest and tax with the amount of interest expense. Answer: B Explanation: Quick ratio measures the ability to meet short-term obligations with liquid assets such as cash, short-term investments, and receivables. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

49) Sunny was assigned as one of the external auditors of Melon Corporation. While in the process of obtaining an understanding of Melon, Sunny performed analytical procedures to identify unusual fluctuations when compared to expectations. For the year being audited, Sunny was made aware that Melon had invested in a significant number of new machines by taking out a ten-year bank loan. It was expected that the new machines will generate profit for the company starting next year. Which of the following assessments by Sunny indicates an unusual fluctuation considering the investment made by Melon for the year being audited? A) Return on assets ratio by Melon Corporation increased as compared to the previous year. This is unusual as income is only expected to increase in the following year. B) Operating profit margin was constant as compared with the previous year. This should not be the case as operating profit is expected to increase. C) Times interest earned decreased as compared with the previous year. This is the opposite of what is expected as interest expense should increase as a result of the loan. D) Debt to equity ratio of Melon Corporation decreased as compared with the previous year. This is expected as net income will decrease as a result of higher interest expense. Answer: A Explanation: Return on Asset (ROA) ratio is Net Income divided by Average Total Asset. ROA Indicates the ability to generate income from average investment in total assets. With the investment made by Melon, the amount of assets is expected to increase and therefore will decrease the return on assets ratio. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

50) Happy, the external auditor assigned to audit Winter Corporation, plans to perform analytical procedures to assess risk. One of the instructions by the audit manager was to perform regression analysis when applicable. Being new to this concept, Happy asked the audit manager for an example of regression analysis. What example should the audit manager provide? A) Regression analysis can be done by grouping data into various dimensions. After sorting data into these dimensions, you can analyze the consistency of relationships between data as compared to your expectation. B) To perform regression analysis, you can select a specific account and analyze its trend. Taking sales as an example, you can predict future amounts based on past performance. C) One example of regression analysis is looking at sales and selling expenses. Any movement in sales would most likely have a direct correlation with selling expenses. D) Regression analysis involves the comparison of an entity's financial ratios with the industry ratios. Significant differences might indicate risks of misstatement in the company being audited. Answer: C Explanation: Regression analysis provides a statistical measure of the associations among data. It establishes whether movements in the independent variables result in a change in the dependent variable.This analysis considers the relationship between a dependent variable, such as sales, and various independent variables, such as selling costs, purchases, and advertising expenses. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

51) The external audit team assigned to audit Four Seasons Company is having a meeting to discuss its plan for the audit engagement. During its brainstorming session, the team has come up with various types of analytical procedures to be performed. Teddy, one of the junior auditors, was having difficulty understanding common-size analysis. Which of the following explanations by the audit manager is correct? A) Common-size analysis takes into account the trend of account balances over time. It allows auditors to assess the movement of accounts over time and match with the auditor's understanding. B) Common-size analysis involves comparing account balances to a specific line item. An example is determining the proportion of all line items in the balance sheet relative to the amount of total assets. C) Common-size analysis involves calculating different ratios such as profitability, liquidity, and solvency. These will then be compared to the auditor's expectation based on an understanding of the client. D) Common-size analysis involves the comparison of specific line items in the financial statements with another entity of the same size and industry. Any variation might indicate risks of misstatement in the company being audited. Answer: B Explanation: Common-size analysis (or vertical analysis) is a comparison of account balances to a single line item. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

52) One of the audit teams of Summer audit firm was having a discussion regarding the different financial ratios which they can calculate when obtaining an understanding of its client. However, from a wide selection of ratios, the team is having difficulty in determining which falls into each of these categories — profitability, liquidity, solvency, and activity. Which of the following statements by the team members is correct about the financial ratios? A) The current ratio measures the ability of the company to pay its long-term debts as they come due. Thus, the current ratio falls under solvency ratios. B) The return on assets ratio indicates the ability of the company to convert its assets into cash. This ratio falls under activity ratios. C) The receivables turnover ratio measures how long it takes to collect cash from customers. This falls under profitability ratios. D) The quick or acid-test ratio measures the ability of the company to meet its short-term obligations with its liquid assets. Thus, the quick ratio falls under liquidity ratios. Answer: D Explanation: Quick ratio measures the firm's ability to meet short-term obligations with liquid assets such as cash, short-term investments, and receivables. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management 53) Analytical procedures are conducted during the risk assessment phase of the audit to ________. A) highlight normal fluctuations in accounts B) aid in the elimination of risk C) identify accounts at risk of material misstatement D) complete the audit work Answer: C Explanation: Auditors routinely use analytical procedures to assist in identification of accounts that may be at risk of material misstatement. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

54) An auditor is always particularly concerned with a metric that measures how long it takes the client firm to purchase inventory, sell the inventory, and collect the associated receivable. This metric is commonly referred to as ________. A) the gross operating cycle B) the financing cycle C) the investing cycle D) the inventory cycle Answer: A Explanation: The operating cycle is an estimate of the number of days it takes for a company to purchase inventory, sell it, and collect the receivable. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 55) An auditor is concerned about short-term interest payment obligations due to a recent major bond issue of the client. A ratio the auditor should consider determining is ________. A) debt-equity ratio B) quick (acid test) ratio C) times interest earned ratio D) short term payment ratio Answer: C Explanation: Times interest earned measures the ability of earnings to cover interest payments. A low ratio indicates a client may have difficulty meeting its interest payments to lenders. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 56) If an auditor is attempting to assess the long-term viability of the client firm as a going concern, the auditor should attempt to calculate ________. A) solvency ratios B) liquidity ratios C) price-earnings multiples D) weighted average cost of capital Answer: A Explanation: Solvency ratios are used to access the long-term viability of a company. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 32

57) An auditor has determined that a client's 'days in receivables' ratio has slowly increased over the last three years. Which of the following could be a possible reason for this? A) The client has hired a collection agency which is extremely efficient at collecting. B) The receivables have been secured as collateral for a recent capital asset purchase. C) The accounts receivable department has implemented a new IT system, making collections much quicker and more efficient. D) The accounts receivable turnover ratio has decreased due to poor internal controls related to credit granting procedures. Answer: D Explanation: As accounts receivable turnover decreases, the corollary ratio, days in receivables increases. These operate in the inverse. Poor internal controls related to credit granting procedures could lead to difficulty in collecting outstanding accounts receivable. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 58) If an auditor was interested in determining a client firm's ability to generate income from its investments, the best ratio to calculate would be ________. A) the times interest earned ratio B) the debt to assets ratio C) the return on assets ratio D) the return on equity ratio Answer: C Explanation: The return on assets ratio indicates the ability of a company to generate income from its average investment in total assets. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

59) A comparison of account balances over time constitutes ________. A) a trend analysis B) a common-size analysis C) a ratio analysis D) a time series analysis Answer: A Explanation: Trend analysis is a comparison of account balances over time. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 60) A comparison of account balances to a single line item, such as total assets, is termed ________. A) common-size analysis B) trend analysis C) substantive procedures D) a compliance audit Answer: A Explanation: Common-size analysis is a comparison of account balances to a single line item. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 61) Which of the following indicates the ability of a company to generate income from its average investment in total assets? A) Return on assets B) Return on stockholders' equity C) Gross profit margin D) Profit margin Answer: A Explanation: The return on assets (ROA) ratio indicates the ability of a company to generate income from its average investment in total assets. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

62) Which of the following are evaluations of financial information by studying plausible relationships among both financial and non-financial data? A) Analytical procedures B) Closing procedures C) Trend analyses D) Common-size analyses Answer: A Explanation: AU-C 315 and AS 2110 define analytical procedures as an evaluation of financial information by studying plausible relationships among both financial and non-financial data. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 63) Which of the following common profitability ratios indicates the ability of a company to generate income from the funds invested by its common stockholders? A) Return on stockholders' equity B) Return on assets C) Profit margin D) Gross profit margin Answer: A Explanation: The return on stockholder's equity ratio indicates the ability of a company to generate income from the funds invested by its common stockholders. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management 64) Which term refers to an affiliate, principal owner, manager, or other party that is not independent of the entity? A) Related party B) Primary beneficiary C) Third party D) Other beneficiaries Answer: A Explanation: The term related party refers to an affiliate, principal owner, manager, or other party that is not independent of the entity. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 35

65) Generally speaking, the existence of related party transactions ________. A) increases inherent risk and should be investigated further B) decreases inherent risk and should be investigated further C) is illegal and should be reported to the Securities and Exchange Commission D) is not worthy of further investigation Answer: A Explanation: The existence of related party transactions does not necessarily signal illegality, but does increase inherent risk, and should be investigated by the auditor. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 66) During the risk assessment phase, the audit team should gain an understanding of the client's procedures for ________. A) identifying related parties and authorizing transactions with related parties B) authorizing transactions with related parties and disclosing the relationships and transactions in the financial statements C) authorizing transactions with related parties D) All of these answer choices are correct. Answer: B Explanation: The audit team should gain an understanding of the client's procedures for identifying related parties, authorizing transactions with related parties, and disclosing the relationships and transactions in the financial statements. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

67) Which of the following is among the procedures used by auditors to identify related parties? A) Review financial statements of competitors B) Trace inventory quantities from the floor to the ledger C) Gain an understanding of the industry D) Review correspondence from the client's advisors, such as attorneys or consultants Answer: D Explanation: Some of the procedures used by auditors to identify related parties are: review life insurance policies purchased by the client; review shareholder registers to identify the principal shareholders; review correspondence from the client's advisors, such as attorneys or consultants. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 68) Reading contracts or other agreements related to ________ transactions is one of the ways in which auditors identify related parties. A) significant unusual B) usual insignificant C) insignificant but unusual D) usual but significant Answer: A Explanation: Reading contracts or other agreements related to significant unusual transactions is one of the ways in which auditors identify related parties. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

69) During an audit of Bloom Company, the senior management has disclosed to the external auditor, Flowers Auditing Firm, the existence of related party transactions. The husband of a senior executive is a majority shareholder in the firm. In addition, a minority shareholder in the firm is the majority owner of a subsidiary wholly owned by Bloom Company. Discussions among audit team members with respect to related party transactions would most likely focus on ________. A) analytical procedures to examine client records pertaining to related party transactions, such as the minutes of board of directors' meetings B) the substance of the transactions, ensuring they are accounted for at arms-length and the existence of proper authorization and disclosure of related party relationships C) maintaining an approach and attitude of professional skepticism throughout, and obtaining written assurances from senior management pertaining to fraud risk from related parties D) confirmation that payments received from and made to related parties are timely and accurate, and that related parties are only disclosed in the financial statements if material transactions relating to them occur Answer: B Explanation: In addition to identifying the related parties, the audit team needs to consider proper authorization and disclosure of these transactions. The audit team should gain an understanding of the client's procedures for identifying related parties, authorizing transactions with related parties, and disclosing the relationships and transactions in the financial statements. The client should have internal controls in place to ensure that related parties are identified and disclosed. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 70) Should the client have internal controls in place to ensure related parties are being identified? A) Yes, and the client is required to disclose them. B) No, not necessarily. C) Yes, but the client is under no obligation to disclose them. D) None of the answer choices are correct. Answer: A Explanation: The client should have internal controls in place to ensure related parties are being identified and disclosed. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

71) Auditors of private companies that do not have an audit committee or even a board of directors should communicate with ________. A) those charged with governance B) executive directors C) non-executive directors D) None of the answer choices are correct. Answer: A Explanation: Some private companies may not have an audit committee or even a board of directors. In that case, auditors should communicate with those charged with governance. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 72) Which of the following elements would normally be included in an auditor's engagement letter? A) Potential limitations of the audit engagement B) Responsibility of management for any and all illegal acts perpetrated by its employees C) Initial judgments pertaining to materiality D) Whether or not the auditor will attempt to obtain negative assurance with respect to management's compliance with laws and regulations Answer: A Explanation: An auditor will stress the limitations of the audit engagement in an engagement letter to ensure expectation consistency between management and the auditor, and to also try to limit liability. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

73) Initial agreements and understandings between the client and auditors should be documented and set forth in a/an ________. A) legal letter B) confirmation letter C) engagement letter D) informal memorandum Answer: C Explanation: The engagement letter should be prepared by the auditor and signed by the client's management, and should document their initial understanding of audit procedures, areas of risk, notable management disclosures etc. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 74) Corporate governance may be best thought of as ________. A) the people, systems, and processes within companies used to ensure that companies are wellmanaged B) the level of control exerted by senior management C) a subsidiary entity that is controlled by a parent company D) corporate donations to political parties and non-profit entities Answer: A Explanation: Corporate governance could be best thought of as the people, systems, and processes within a company that help to ensure it is well managed. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 75) Non-executive directors should ideally be ________. A) objective and knowledgeable about the industry B) employed by the client firm C) from an unrelated industry, to ensure maximum objectiveness D) expected to have the same level of knowledge about the company as executive directors Answer: A Explanation: Non-executive directors should be objective and knowledgeable about the industry. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 40

76) The audit committee is responsible for the ________ of the auditors. A) oversight and appointment B) appointment and compensation C) oversight and compensation D) All of the choices are correct. Answer: D Explanation: The audit committee is responsible for the appointment, compensation, and oversight of the auditors. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 77) Which of the following best describes the board of directors of a company? A) They represent the shareholders of the company. B) They ensure that the company is being run to benefit the employees. C) The board of directors consist of full-time employees of the company. D) The board of directors does not include the chief executive officer. Answer: A Explanation: The board of directors is a group that represents the shareholders and is responsible for ensuring the company is being run to benefit the shareholders. The board of directors is appointed by the firm's stockholders if the company is a public company. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 78) A member of a company board is ________. A) either an executive or non-executive director B) always an executive director C) always a non-executive director D) None of these answer choices are correct. Answer: A Explanation: A board is comprised of a mixture of executive and non-executive directors. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

79) What is the typical method by which an auditor outlines the details of the engagement, and communicates this to the client's management? A) An audit plan B) Audit working papers C) Engagement letter D) Risk assessment Answer: C Explanation: The engagement letter is used by the auditor to confirm a mutual understanding of the engagement, details of the engagement etc. The engagement letter is required to be signed by both parties. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 80) Which of the following acts directs that the audit committee members should be independent members of the board of directors, not executive directors or otherwise affiliated with the issuer? A) The Sarbanes Oxley Act of 2002 B) The Securities Act of 1933 C) The Securities Exchange Act of 1934 D) The Foreign Corrupt Practices Act of 1977 Answer: A Explanation: The Sarbanes Oxley Act of 2002 directs that the audit committee members should be independent members of the board of directors, not executive directors or otherwise affiliated with the issuer. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

81) The ultimate responsibility for the financial reporting process rests with the ________, but the efficiency of achieving this goal is improved by the ________. A) full board; audit committee B) audit committee; executive directors C) non-executive directors; audit committee D) executive directors; full board Answer: A Explanation: While ultimate responsibility for the financial reporting process rests with the full board, an audit committee can improve the efficiency of achieving this goal. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 82) The term that specifically refers to the use of computers to process, record, and store financial reporting data and other information is ________. A) information technology B) analytical procedures C) audit data analytics D) trend analysis Answer: A Explanation: Information technology is the use of computers to process, record, and store financial reporting data and other information. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 83) Assuming a lack of internal control in a client's system, the risk of material misstatement is known as? A) Audit risk B) Detection risk C) Inherent risk D) Client risk Answer: C Explanation: Inherent risk is defined as the risks that simply exist, irrespective of internal controls. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 43

84) The use of Information Technology in accounting processes includes ________. A) customer acquisition B) transaction initiation C) employee performance reviews D) interviewing accounting personnel Answer: B Explanation: Information Technology (IT) is a part of most company's accounting processes, which include transaction initiation, recording, processing, correction as needed, transfer to the general ledger, and compilation of the financial statements. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 85) In addition to the annual financial statements, clients often prepare ________ interim financial statements. A) semi-monthly B) biweekly C) quarterly D) monthly Answer: C Explanation: In addition to the annual financial statements, clients prepare monthly, quarterly, and/or half-yearly financial statements for internal and/or external purposes. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

86) If an auditor suspects management is overriding controls related to the closing process, the auditor should ________. A) extend audit procedures to carefully check adjusting and closing entries that are prepared at the end of the period B) extend audit procedures to check all balance sheet accounts C) obtain management's written representation in lieu of further audit procedures D) make these audit procedures the focus of the audit engagement Answer: A Explanation: The auditor should carefully check adjusting and closing entries to ensure that ending balances are correct and not over or understated. The auditor should also look for evidence of management override of related controls. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 87) Which of the following are processes used by a client when finalizing the accounts for an accounting period? A) Closing procedures B) Analytical procedures C) Audit strategies D) Assurance services Answer: A Explanation: Closing procedures are processes used by a client when finalizing the accounts for an accounting period. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

88) Inherent risk related to closing procedures would generally be increased when ________. A) a client is found to have strong closing procedures, and sound internal control practices relating to closing B) no errors and omissions are located when auditing the closing process C) staff assigned to deal with closing procedures are relatively inexperienced D) the closing process is relatively straightforward Answer: C Explanation: Inexperienced staff are more prone to mistakes leading to errors in the closing process, and potentially resulting in account misstatements. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 89) A common risk relating to closing entries is that ________. A) permanent accounts are often closed by mistake B) temporary accounts are often closed by mistake C) management may override controls relating to adjusting and closing entries D) temporary accounts, if closed, will carry a balance over to the subsequent accounting period Answer: C Explanation: Auditors, when auditing the closing process, should design audit procedures to check for management override of controls relating to adjusting and closing entries. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 90) Clients that prepare financial statements ________ are more likely to have well-established closing procedures than clients that prepare financial statements ________. A) monthly; annually B) annually; monthly C) half-yearly; monthly D) annually; half-yearly Answer: A Explanation: Clients that prepare financial statements monthly are more likely to have wellestablished closing procedures than clients that prepare financial statements only annually. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 46

91) _______ is a comparison of account balances over time. Answer: Trend analysis Explanation: Trend analysis is used by auditors to compare account balances over an extended period of time. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 92) _______ ratios generally reflect a company's ability to generate earnings with its assets. Answer: Profitability Explanation: Profitability ratios reflect a company's ability to generate earnings and ultimately the cash flow required to pay debts, meet other obligations and fund future expansion. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 93) The number of days, on average, it takes a company to sell its inventory is called inventory ________ in days. Answer: turnover Explanation: Inventory turnover in days measures how many days, on average, it takes a company to sell its inventory. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 94) In order to analyze data that occur regularly within the client (e.g., sales and purchases), ________ analysis can be used. Answer: time series Explanation: Time series analysis can be used to analyze data that occur regularly within the client, for example, sales and purchases. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 47

95) Processes used by a client when finalizing the accounts for an accounting period are called ________. Answer: closing procedures Explanation: Closing procedures are processes used by a client when finalizing the accounts for an accounting period. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 96) Which of the following is/are business risk/s a fast-food restaurant could face? Select all that apply. A) Employee turnover B) Strong competition C) Quickly changing customer preferences D) Capital structure that is basic Answer: A, B, C Explanation: Some of the business risks of a fast-food restaurant are high employee turnover, strong competition, and quickly changing customer preferences. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 97) Which of the following industry-level and business environment factors present/s higher inherent risks? Select all that apply. A) A new industry with little or no government support B) Heavily regulated industry with special taxes and unique regulations C) Demand is not seasonal which provides steady revenue flow D) Industry minimally affected by trends Answer: A, B Explanation: If the client is in an industry that is new with little or no government support or in a heavily regulated industry with special taxes and unique regulations, then the auditor would expect higher inherent risks. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

98) Among the wide array of audit procedures being performed by auditors, which of the following is/are mainly related to gaining an understanding of the client? Select all that apply. A) Sending positive and negative accounts receivable confirmations to client customers B) Setting up meetings with client personnel to ask questions about operations processes C) Conducting a walkthrough around the client's facilities to observe how products are made D) Testing whether bank statement reconciliations are properly prepared, reviewed, and approved E) Reading minutes of meetings to look for key issues and strategic initiatives being discussed Answer: B, C, E Explanation: Procedures performed to gain an understanding of the client are Inquiry, Analytical Procedures, Observation, and Inspection. Substantive Testing and Test of Controls are not for this purpose. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 99) Which of the following is/are correct regarding an indirect effect of noncompliance with laws and regulations to the audit? Select all that apply. A) It does not have an explicit impact on amounts and disclosures in the financial statements. B) It could require the creation of a contingent liability or an additional disclosure. C) It has an explicit impact on amounts and disclosures in the financial statements. D) It does not require the creation of a contingent liability or an additional disclosure. Answer: A, B Explanation: An indirect effect is an audit situation in which noncompliance with laws and regulations does not have a direct impact on amounts and disclosures in the financial statements, but it could require the creation of a contingent liability or an additional disclosure. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

100) Which of the following could represent increased inherent risk? Select all that apply. A) A client offers warranties on its products B) A client has a larger number of locations and operations are decentralized C) A client's transactions are complex and unique D) A client takes advantage of discounts offered by suppliers Answer: A, B, C Explanation: Some of the factors that reduce inherent risk are: (1) Client offers warranties on its products; (2) Client has larger number of locations and operations are decentralized; (3) Client's transactions are complex and unique. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 101) Which of the following KPIs is/are common to most clients? Select all that apply. A) Return on assets B) Return on stockholder's equity C) Inventory turnover D) Risk-weighted assets Answer: A, B Explanation: Some KPIs are common to many clients, such as return on assets and return on stockholder's equity. Other KPIs will vary from industry to industry and client to client. For example, a client in the airline industry is concerned about revenue per passenger mile, a client in the retail industry is concerned about inventory turnover, and a client in the finance industry is concerned about its risk-weighted assets and interest margins. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

102) Which of the following is/are promise/s often made by companies that agree to debt covenants with lenders when taking on loans? Select all that apply. A) Maintain specified profitability, liquidity, or other financial ratios B) Seek the lender's permission before taking on new borrowings C) Seek the lender's permission before acquiring other companies D) Maintain high technological standards in its production processes Answer: A, B, C Explanation: Companies often agree to debt covenants with lenders when taking on loans. That is, they promise to maintain specified profitability, liquidity, or other financial ratios or to seek the lender's permission before taking on new borrowings or acquiring other companies. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 103) Which of the following does the net operating cycle measure in terms of the length of time it takes the company to perform? Select all that apply. A) Purchase and sell inventory B) Collect the receivable C) Pay back creditors D) Restock inventory Answer: A, B, C Explanation: Net operating cycle measures how many days, on average, it takes a company to purchase and sell inventory, collect the receivable, and pay back creditors. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

104) Due to the advancement in technology such as electronic spreadsheets and data software, performing analytical procedures is far from what it was in the previous years. Which of the following is/are the advantage/s of using these advancements in technology as a tool in performing analytical procedures? Select all that apply. A) Ensures complete accuracy of data input used in the analysis B) Improvement in turnaround time of obtaining data from the client's accounting system C) Reduction in human error when inputting data for analysis D) Improvement in the time it takes to generate analysis on the data inputted Answer: B, C, D Explanation: Use of technology does not ensure complete accuracy of data as this can still be manipulated. These tools make it easier and quicker to extract data and generate analysis. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 105) Which of the following is/are considered a related party of a company? Select all that apply. A) An affiliate B) The principal owner C) The manager D) The government Answer: A, B, C Explanation: A related party is an affiliate, principal owner, manager, or other party that is not independent of the entity. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

106) Which of the following describe/s the executive directors on the board? Select all that apply. A) Part of the company's management team B) Employed by the company C) Not employees of the company D) Auditors of the company Answer: A, B Explanation: Executive directors are also part of the company's management team, and they are employed by the company. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 107) The Sarbanes Oxley Act of 2002 has specific requirements in terms of the composition and duties of the audit committee. Which of the following is/are correct in relation to SOX? Select all that apply. A) Audit committee members must be independent members of the board of directors, not executive directors or otherwise affiliated with the issuer. B) Audit committee members can accept consulting or advisory fees from the issuer, beyond the normal director compensation. C) At least one audit committee member must be a financial expert as evidenced through education or work experience. D) The audit committee is responsible for the appointment and compensation of the auditors but not for its oversight. E) Auditors report directly to the audit committee, and the audit committee is responsible for resolving any disagreements between management and the auditors over financial reporting. F) The audit committee establishes procedures for receiving complaints regarding accounting or internal control matters of the company. Answer: A, C, E, F Explanation: Audit committee members cannot accept consulting fees from the issuer, beyond the normal director compensation. The audit committee also has responsibility for the oversight of the auditors. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

108) Which of the following is/are risk/s associated with Information Technology? Select all that apply. A) Unauthorized access to software B) Errors in programs C) Loss of data D) Multiple backups Answer: A, B, C Explanation: Risks associated with IT include unauthorized access to computers, software, and data; errors in programs; lack of backup; and loss of data. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 109) It is important for auditors to identify significant risks, as well as any controls that mitigate those risks, during which phase/s? Select all that apply. A) Risk assessment phase B) Control risk assessment phase C) Reporting phase D) Conclusion phase Answer: A, B Explanation: At the risk assessment phase, and as part of assessing control risk, it is important for auditors to identify significant risks, as well as any controls that mitigate those risks. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

110) Assessing the digital mindset of the client is an important step to be conducted by auditors when understanding the inherent risks surrounding the client. Which of the following questions is/are related to assessing the client's digital mindset? Select all that apply. A) Does the client have a virtual workforce who is working remotely? B) Does the client invest in the proper laptops/computers for the tasks being performed by its employees? C) Does the client have a policy in place to protect the data collected within the company? D) Does the client have the same level of technology as its competitors? E) Does the client have a data warehouse which is adequately secured? Answer: A, B, C, D, E Explanation: Digital mindset refers to the client's attitudes and behaviors toward technology. All of these questions relate to understanding the digital mindset of the client. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 111) If auditors believe the client is under pressure to report strong results, which of the following risks exist/s with regard to the current year's income? Select all that apply. A) Inclusion of revenues earned after year-end B) Exclusion of expenses incurred before year-end C) Exclusion of revenues earned after year-end D) Inclusion of expenses incurred before year-end Answer: A, B Explanation: If auditors believe the client is under pressure to report strong results, there is risk that revenues earned after year-end may be included in the current year's income and expenses incurred before year-end may be excluded. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

112) If auditors believe their client is under pressure to smooth its income and not report any unexpected increases, which of the following risks is/are likely to occur with regard to current income? Select all that apply. A) Exclusion of revenues earned just before year-end B) Inclusion of expenses incurred after year-end C) Inclusion of revenues earned just before year-end D) Exclusion of expenses incurred after year-end Answer: A, B Explanation: If auditors believe their client is under pressure to smooth its income and not report any unexpected increases, there is risk that revenues earned just before year-end will be excluded from current income and expenses incurred after year-end will be included. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 113) During risk assessment, auditors gain an understanding of the client's closing procedures as this can affect the financial results being reported by the client. Which of the following procedures can be performed by the auditor to gain this understanding on the closing process and assess its adequacy? Select all that apply. A) Consider pressures on the client to overstate profit being reported B) Analyze the figures affected by the closing process in terms of reasonableness C) Check accuracy of accrual calculations used in the closing process D) Trace transactions around year-end to documents to determine appropriate dates Answer: A, B, C, D Explanation: In understanding and assessing the closing process of the client, the auditor needs to be aware of any pressure to the reported figures, accuracy of the accruals made, and whether transactions have been recorded in the proper accounting period. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

114) How well current assets cover current liabilities is indicated by the ________ ratio. A) current B) acid-test C) price-earnings D) debt to equity Answer: A Explanation: The current ratio indicates how well current assets cover current liabilities. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 115) Sustainable cash flow from operations minus capital expenditures is equal to ________. A) sustainable free cash flow B) gross operating cycle C) net operating cycle D) None of the choices is correct. Answer: A Explanation: Sustainable cash flow from operations — capital expenditures = sustainable free cash flow. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 116) For public companies, Section 301 of the Sarbanes-Oxley Act has specific requirements for the composition and duties of the ________. A) audit committee B) executive directors C) non-executive directors D) All of the choices are correct. Answer: A Explanation: For public companies, Section 301 of the Sarbanes-Oxley Act has specific requirements for the composition and duties of the audit committee. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

117) Auditors check the accuracy of accrual and deferral calculations around _______-end and look at earnings trends to assess whether the reported income is in line with similar prior year periods. A) year B) month C) quarter D) week Answer: A Explanation: Auditors check the accuracy of accrual and deferral calculations around year-end and look at earnings trends to assess whether the reported income is in line with similar prior year periods (months or quarters). Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 118) Match each of the ratios with its definition. A. gross profit margin B. profit margin C. return on assets D. return on stockholders' equity ____ net income/net sales ____ net income/average equity ____ net income/average assets ____ gross profit/net sales Answer: Gross profit margin = Gross profit/net sales; Profit margin = Net income/net sales; Return on assets = Net income/average assets; Return on stockholders' equity = Net income/average equity. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

119) Can an auditor place complete reliance on internal control to the exclusion of other audit procedures? Answer: An auditor cannot place complete reliance on internal control to the exclusion of other audit procedures. They are co-dependent and must both be present. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: PC: Decision Making 120) If a client experienced all of the following events during the fiscal year, what effect would the auditor expect to see on the inventory turnover ratio? A. Items shipped on consignment during the last month of the year were recorded as sales. B. A significant number of credit memos for returned merchandise that were issued during the last month of the year were not recorded. C. Year-end purchases of inventory were understated by incorrectly excluding items received before the year end. Answer: The auditor would expect to see the inventory turnover increase substantially from the prior year. Diff: 3 LO: 2 Bloom: Application Min: 3 AACSB: Reflective Thinking AICPA: PC: Decision Making

121) Analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. They range from simple comparisons to the use of complex models involving many relationships and elements of data. They involve comparisons of recorded amounts, or ratios developed from recorded amounts, to expectations developed by auditors. Describe the broad purposes of analytical procedures and identify the sources of information from which an auditor develops expectations. Answer: Analytical procedures are used for these broad purposes: 1. To assist the auditor in planning the nature, timing, and extent of other audit procedures 2. As a substantive test to obtain evidential matter about particular assertions related to account balances or classes of transactions 3. As an overall review of the financial information in the final review stage of the audit An auditor's expectations are developed from the following sources of information: 1. Financial information for comparable prior periods considering known changes. 2. Anticipated results for example, budgets, forecasts, and extrapolations. 3. Relationships among elements of financial information within the period. 4. Information regarding the industry in which the client operates. 5. Relationships of financial information with relevant nonfinancial information. Diff: 2 LO: 3 Bloom: Synthesis Min: 1 AACSB: Analytic AICPA: PC: Research 122) If the current year accounts receivable is larger than last year but the allowance for doubtful accounts is the same, what account needs to be audited carefully and why? Answer: If the current year accounts receivable is larger than last year but the allowance for doubtful accounts is the same, the collectability of accounts receivable is of concern. The allowance for doubtful accounts or bad debt expense may be understated. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

123) If current year fixed assets are larger and current depreciation expense is the same as last year, what account should be reviewed by the auditor and why? Answer: If current year fixed assets are larger and current depreciation expense is the same as last year, depreciation expense and accumulated depreciation may be understated. It may also be possible that fixed assets are overstated. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 124) Which of the following engagement planning procedures would most likely assist the auditor in identifying related party transactions before the balance sheet date? - Interviewing internal auditors about their reporting responsibilities - Reviewing accounting records for recurring transactions occurring near year-end - Inspecting communications with the client's legal counsel regarding recorded contingent liabilities - Scanning the minutes for significant transactions with members of the board of directors Answer: Scanning the minutes for significant transactions with members of the board of directors will alert the auditor to potential related party transactions. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 125) Explain why it is important for the board of directors to have a mixture of executive and non-executive members. Answer: It is important that the board of directors has a mixture of executive and non-executive members. The executive members have a deeper understanding of the company and its workings. The non-executive members may be better representatives of shareholders as they are not company employees and can be more impartial in their strategic decision-making. Ideally, nonexecutive directors should be somewhat independent of the company and be objective and knowledgeable about the industry and financial reporting. The presence of non-executive board members helps to reduce the risk of material misstatement because they provide oversight of toplevel management decisions, such as the amount of dividends declared, plans for significant asset purchases, purchases and sales of major investments, and major agreements with other companies. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective 61

126) You are auditing Toy Time, a private company located in Nashville, TN. Toy Time does not have a board of directors, nor an audit committee. Explain with whom the auditors should communicate. Research and reference the appropriate AU-C standard that identifies this. Answer: Some private companies may not have an audit committee or even a board of directors. In that case, auditors should communicate with those charged with governance. Those charged with governance are persons with responsibility for overseeing the strategic direction of the entity and the obligations related to the accountability of the entity, including the financial reporting process. Those charged with governance may include management personnel, such as executive members of a governance board or an owner-manager (AU-C 260.06). Diff: 3 LO: 5 Bloom: Synthesis Min: 3 AACSB: Communication AICPA: PC: Research 127) For public companies, Section 301 of the Sarbanes-Oxley Act has specific requirements for the composition and duties of the audit committee. Describe three of those requirements. Answer: SOX Sec. 301 requirements and duties for audit committees of public companies: o Audit committee members must be independent members of the board of directors, not executive directors or otherwise affiliated with the issuer. o Audit committee members cannot accept consulting or advisory fees from the issuer, beyond the normal director compensation. o The audit committee is responsible for the appointment, compensation, and oversight of the auditors. o Auditors report directly to the audit committee, and the audit committee is responsible for resolving any disagreements between management and auditors over financial reporting. o The audit committee establishes procedures for receiving complaints regarding accounting or internal control matters of the company, including receipt of anonymous complaints from employees. o The audit committee has authority to engage legal counsel if necessary. Diff: 3 LO: 5 Bloom: Synthesis Min: 3 AACSB: Analytic AICPA: BC: Governance Perspective

128) During an audit of Chien Products, you note that all new accounting employees are set up with a temporary password of "abc123". You also noted that employees are not required to change their passwords when they first set up their accounts, nor is there a requirement to change passwords regularly. Write a paragraph describing the implications of these IT risks. Answer: Student answers will vary but should generally discuss unauthorized access to data. Unauthorized access to data can occur when there is insufficient security or poor password protection procedures. Unauthorized access can result in data being lost or distorted. Unauthorized access to computer programs can result in either fraud or misstatements in the financial statements. Access can be limited in several ways, including by security protocols (such as locked doors), frequent changes of passwords, and review of program changes by appropriate IT management. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 129) Your new client, Pool Chem, Inc., is looking to purchase a new accounting software system. Your client asks for your advice on the advantages and disadvantages of purchasing an "off the shelf" program vs. an internally developed program. Prepare a response to your client. Answer: New programs can be purchased "off the shelf" from a software provider or developed internally by a client's staff. When a client purchases a general-purpose program off the shelf, there is a risk it will require modification to suit the client's operations, which can lead to errors. An advantage of purchasing general-purpose programs from reputable companies is they will have been tested before being made available for sale. In contrast, when a client's staff develops a program, the program is more likely to have the features required but there is a risk of errors if the program is written by inexperienced staff or it is not adequately tested before being put into operation. Human error is an inherent risk in this situation. Diff: 3 LO: 6 Bloom: Evaluation Min: 3 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

130) DanSpring Collections is a collections business located in Des Moines, IA. DanSpring frequently makes changes to the invoicing software programming to update customer pricing and discounts. Explain the steps that DanSpring can take to avoid errors in making these programming changes. Answer: Programs may need to be changed due to changes in sales prices, updating of discounts being offered to customers and so on. It is important that these changes be made by authorized personnel on a timely basis to avoid errors, and that there are appropriate controls over such changes. It is important that new programs and changes to programs are tested extensively before being put into operation. Diff: 2 LO: 6 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 131) During your audit of Cookie Factory, Inc. for the year ended December 31, 2020, you discover that Cookie Factory incorrectly booked a December 31, 2020 credit sale in January 2021. Explain how this error will impact the Income Statement and Balance Sheets for the years ending December 31, 2020 and 2021. Answer: The year ended December 31, 2020 income will be understated. The December 31, 2020 accounts receivable on the balance sheet will be understated. The year ended December 31, 2020 income will be understated. The year ended December 31, 2021 income will be overstated stated. The December 31, 2021 balance sheet would be unaffected, as the accounts receivable would have been properly recorded and most likely paid by that time. Diff: 3 LO: 7 Bloom: Evaluation Min: 3 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

Auditing, 2e (Johnson) Chapter 5 Audit Evidence 1) It is management's responsibility to ensure that financial statements are fairly and truthfully presented. Answer: TRUE Explanation: It is management's responsibility to ensure financial statements are fairly and truthfully presented. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 2) Examples of assertions include: accuracy, cutoff and valuation and allocation. Answer: TRUE Explanation: Accuracy, cutoff, and valuation and allocation are all assertions which auditors test. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 3) Sufficient audit evidence relates to the quantity of audit evidence gathered. Answer: TRUE Explanation: Sufficient audit evidence relates to the quantity of the audit evidence gathered. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 4) Reliability relates to the source of the evidence and the nature of the evidence. Answer: TRUE Explanation: Reliability relates to the source of the evidence and nature of the evidence. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

5) Audit risk affects the quantity and quality of evidence gathered by an auditor during the risk response phase. Answer: TRUE Explanation: Audit risk affects the quantity and quality of evidence gathered by an auditor during the risk response phase. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 6) Inspection of documents can only be used as a test of controls. Answer: FALSE Explanation: Inspection of documents can be used as a risk assessment procedure, test of controls, or a substantive procedure. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 7) Inquiry involves asking verbal questions only. Answer: FALSE Explanation: Inquiry involves asking questions verbally or in written form of knowledgeable individuals internal or external to the client. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 8) A specialist is an individual or an organization with expertise in a field other than accounting or auditing. Answer: TRUE Explanation: A specialist is an individual or an organization with expertise in a field other than accounting or auditing. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

9) The permanent file includes client information and documentation that applies to the most recent year's audit. Answer: FALSE Explanation: The permanent file includes client information and documentation that applies to multiple audits. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 10) The current file includes extracts from the minutes of meetings, such as the board of directors' meetings, which pertain to the current audit. Answer: TRUE Explanation: The current file includes extracts from the minutes of meetings, such as the board of directors' meetings, which pertain to the current audit. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 11) Which assertion is common to both (i) classes of transactions and events for the period under audit and (ii) account balances at the period-end? A) Classification B) Completeness C) Rights and obligation D) Valuation and allocation Answer: B Explanation: The assertion of completeness is common to both (i) classes of transactions and events for the period under audit and (ii) account balances at the period-end. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

12) What do you call a statement or representation, explicit or implied, made by management regarding the recognition, measurement, presentation, and disclosure of items included in the financial statements and notes? A) Assertion B) Inspection C) Tracing D) Vouching Answer: A Explanation: An assertion is a statement or representation, explicit or implied, made by management regarding the recognition, measurement, presentation, and disclosure of items included in the financial statements and notes. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 13) When reporting inventory on the financial statements, management claims that the items exist, are owned by the entity, represent a complete list of the inventory owned, and are valued appropriately. These are examples of ________. A) assertions B) accounting records C) negative confirmation D) positive confirmation Answer: A Explanation: Examples of assertions when reporting inventory include the assertions that the items exist, are owned by the entity, represent a complete list of the inventory owned, and are valued appropriately. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

14) Auditors who are searching for evidence that assets, liabilities, and equity items have been recorded at appropriate amounts and allocated to the correct general ledger accounts consider ________. A) existence B) classification C) valuation and allocation D) rights and obligations Answer: C Explanation: When considering valuation and allocation, auditors search for evidence that assets, liabilities, and equity items have been recorded at appropriate amounts and allocated to the correct general ledger accounts. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 15) Auditors gathering evidence to verify that recorded assets are owned by the entity and recorded liabilities represent commitments of the entity consider ________. A) rights and obligations B) completeness C) occurrence D) valuation and allocation Answer: A Explanation: When considering rights and obligations, auditors gather evidence to verify that recorded assets are owned by the entity and recorded liabilities represent commitments of the entity. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

16) What term signifies assertions that have a reasonable possibility of containing a material misstatement that would cause the financial statements to be materially misstated? A) Relevant assertions B) Rights and obligations C) Valuation and allocation D) Accuracy and valuation Answer: A Explanation: Relevant assertions are assertions that have a reasonable possibility of containing a material misstatement that would cause the financial statements to be materially misstated. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 17) In the context of assertions about classes of transactions and events for the period under audit, auditors considering occurrence gather evidence to verify that ________. A) a recorded transaction or event, such as a revenue or an expense item, actually took place and relates to the entity B) all transactions have been recorded and the financial statements are not understated or overstated because transactions have been omitted C) transactions and events have been recorded at appropriate amounts D) transactions and events have been recorded in the proper accounts Answer: A Explanation: When considering occurrence, auditors gather evidence to verify that a recorded transaction or event, such as a revenue or an expense item, actually took place and relates to the entity. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

18) Auditors do the following when considering rights and obligations? A) Gather evidence to verify that recorded assets are owned by the entity and recorded liabilities represent commitments of the entity. B) Search for evidence to verify that asset, liability, and equity items on the balance sheet actually exist. C) Search for assets, liabilities, and equity items to ensure they have been recorded. D) Search for evidence that assets, liabilities, and equity items have been recorded at appropriate amounts. Answer: A Explanation: When considering rights and obligations, auditors gather evidence to verify that recorded assets are owned by the entity and recorded liabilities represent commitments of the entity. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 19) Which of the following is a detailed listing of the audit procedures to be used when testing controls and when conducting substantive audit procedures? A) Audit data analytics B) Accounting records C) Analytical procedures D) Audit program Answer: D Explanation: An audit program is a listing of details of the audit procedures to be used when testing controls and when conducting detailed substantive audit procedures Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; PC: Decision Making

20) Auditors perform the following when considering existence? A) Search for evidence to verify that asset, liability, and equity items on the balance sheet actually exist. B) Gather evidence to verify recorded assets are owned by the entity and recorded liabilities represent commitments of the entity. C) Search for assets, liabilities, and equity items to ensure they have been recorded. D) Search for evidence that assets, liabilities, and equity items have been recorded at appropriate amounts. Answer: A Explanation: When considering existence, auditors search for evidence to verify that asset, liability, and equity items on the balance sheet actually exist. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; PC: Decision Making 21) Auditors gathering evidence that transactions and events have been recorded at appropriate amounts consider ________. A) accuracy B) occurrence C) completeness D) classification Answer: A Explanation: When considering accuracy, auditors gather evidence that transactions and events have been recorded at appropriate amounts. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

22) When considering classification, auditors gather evidence that transactions and events have been recorded ________. A) in the proper accounts B) in the correct accounting period C) at appropriate amounts D) alongside equity interests Answer: A Explanation: When considering classification, auditors gather evidence that transactions and events have been recorded in the proper accounts. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 23) Management assertions are best defined as ________. A) sometimes being present in the financial statements, and sometimes not B) optional items for the auditor to check C) representations by management, explicit and implicit, contained within the financial statements D) management communications with an attorney Answer: C Explanation: An assertion is a statement or representation, explicit or implied, made by management regarding the recognition, measurement, presentation and disclosure of items included in the financial statements and notes. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 24) With regard to management assertions, it is true to say that ________. A) all assertions apply to all accounts and balances B) only some assertions apply to accounts and their balances C) none of the assertions apply to accounts and their balances D) management should be consulted to determine which assertions apply to which accounts Answer: B Explanation: Some, but not all, management assertions apply only to accounts and their balances. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 9

25) The responsibility of ensuring sufficient appropriate audit evidence is gathered to arrive at an opinion is ________. A) the responsibility of the auditor B) the responsibility of management C) a joint responsibility between management and the auditor D) a function of internal control Answer: A Explanation: The responsibility of ensuring sufficient appropriate audit evidence is gathered to arrive at an opinion is the responsibility of the auditor, not management. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 26) The completeness assertion relates to ________. A) all transactions and events that should have been recorded have been recorded B) all payroll accounting records are complete and valued correctly C) all entries are recorded in the correct period D) all accounts are valued at their correct amounts Answer: A Explanation: The completeness assertion relates to all transactions and events that should have been recorded have been recorded. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 27) The management assertion of classification deals with ________. A) ensuring vacancies are posted to appropriated classified ads B) transactions and events have been recorded in the proper accounts C) classifying between the appropriate financial statements D) current versus non-current only Answer: B Explanation: The management assertion of classification deals with transactions and events being recorded in the proper accounts. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 10

28) The accuracy and valuation assertion relates to ________. A) financial and other information is disclosed fairly and in appropriate amounts B) ensuring records of ownership of assets is accurate C) the auditor's charges for fees and services provided D) all disclosures having been properly made Answer: A Explanation: The accuracy and valuation assertions assert that financial and other information is disclosed fairly and in appropriate amounts. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 29) The cutoff assertion deals with ________. A) ensuring accounts are appropriately valued B) ensuring amounts are recorded in the correct accounts C) transactions and events have been recorded in the correct accounting period D) ensuring that assets, liabilities and equity interests exist Answer: C Explanation: The cutoff assertion asserts that transactions and events have been recorded in the correct accounting period. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 30) When testing for the ________ assertion, auditors gather evidence that all transactions have been recorded and the financial statements are not understated or overstated. A) completeness B) cutoff C) valuation and allocation D) disclosure Answer: A Explanation: When testing for the completeness assertion, auditors gather evidence that all transactions have been recorded and the financial statements are not understated or overstated. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

31) When testing for the ________ assertion, auditors gather evidence that transactions and events have been recorded at appropriate amounts. A) cutoff B) accuracy C) existence D) completeness Answer: B Explanation: When considering accuracy, auditors gather evidence that transactions and events have been recorded at appropriate amounts. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 32) When testing for the ________ assertion, auditors search for evidence that transactions have been recorded in the correct accounting period. A) rights and obligations B) valuation and accuracy C) cutoff D) existence Answer: C Explanation: When considering cut-off, auditors search for evidence that transactions have been recorded in the correct accounting period. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 33) When testing for the ________ assertion, auditors gather evidence that transactions and events have been recorded in the proper accounts. A) classification B) existence C) rights and obligations D) presentation and disclosure Answer: A Explanation: When considering classification, auditors gather evidence that transactions and events have been recorded in the proper accounts. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 12

34) When testing for the ________ assertion, auditors search for evidence to verify that asset, liability and equity items on the balance sheet actually exist. A) presentation and disclosure B) existence C) occurrence D) valuation and accuracy Answer: B Explanation: When considering existence, auditors search for evidence to verify that asset, liability and equity items on the balance sheet actually exist. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 35) When testing for the ________ assertion, auditors gather evidence to verify recorded assets are owned by the entity and recorded liabilities represent commitments of the entity. A) existence B) valuation and accuracy C) rights and obligations D) occurrence Answer: C Explanation: When considering rights and obligations, auditors gather evidence to verify recorded assets are owned by the entity and recorded liabilities represent commitments of the entity. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

36) When testing for the ________ assertion, auditors search for assets, liabilities and equity items to ensure they have been recorded. A) cutoff B) valuation and accuracy C) completeness D) presentation and disclosure Answer: C Explanation: When considering completeness, auditors search for assets, liabilities and equity items to ensure they have been recorded. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 37) When testing for the ________ assertion, auditors search for evidence that assets, liabilities and equity items have been recorded at appropriate amounts and allocated to the correct general ledger accounts. A) presentation and disclosure B) valuation and allocation C) existence D) occurrence Answer: B Explanation: When considering valuation and allocation, auditors search for evidence that assets, liabilities and equity items have been recorded at appropriate amounts and allocated to the correct general ledger accounts. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

38) Considering the risk of overstatement of receivables due to premature revenue recognition that inflates revenues and receivables, which assertion for the accounts receivable balance is most relevant? A) Accuracy B) Existence C) Completeness D) Rights and obligations Answer: B Explanation: The existence assertion for the accounts receivable balance is typically a relevant assertion because of the risk of overstatement of receivables due to premature revenue recognition, which inflates revenues and receivables. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 39) Auditors inspecting a sample of accounts payable balances listed on the ledger and verifying that they are actual payables owed by the client gather evidence in support of the ________ assertion. A) accuracy B) occurrence C) completeness D) existence Answer: D Explanation: Suppose auditors inspect a sample of accounts payable balances from the ledger and verify that they are true payables owed by the client. Have the auditors gathered evidence about completeness? No, they have not. They have gathered evidence in support of the existence assertion that payables that have been recorded actually do exist. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

40) The procedure of auditors examining a client's unpaid invoices file and determining if payables have been properly created for any unpaid invoices would provide evidence in support of the ________ assertion. A) accuracy B) occurrence C) completeness D) cut-off Answer: C Explanation: The procedure of auditors examining a client's unpaid invoices file and determining if payables have been properly created for any unpaid invoices would provide relevant, or appropriate, evidence in support of the completeness assertion. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 41) When testing for the ________ assertion, auditors ensure that all items included in the financial statements are appropriately aggregated and disaggregated and clearly described, and related disclosures are relevant and understandable. A) classification and understandability B) cutoff C) presentation and disclosure D) occurrence Answer: C Explanation: Auditors ensure that all items included in the financial statements are appropriately aggregated and disaggregated and clearly described, and related disclosures are relevant and understandable Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

42) A fundamental premise of any external audit is checking assertions and searching for evidence to either corroborate or refute these assertions. Which of the following statements best describes the idea of an assertion and who holds responsibility for the assertions made? A) Assertions are made by the auditing firm after a careful preliminary review of the industry in which the client operates and any specific operating characteristics that may be unique to the client. B) Assertions are made by the client's management, and are implicit within the financial statements. Management holds ultimate responsibility for the accuracy of these assertions. C) Assertions are statements made by management regarding the presentation and disclosure of notes contained in the financial statements and measurement of account balances contained in the notes to the financial statements. D) Management and the external auditors hold joint responsibility for the assertions contained in the financial statements because management prepares the financial statements which are then checked by the auditors. Answer: B Explanation: Assertions are made by the client's management, and are implicit within the financial statements. Management holds ultimate responsibility for the accuracy of these assertions. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

43) During the audit of a client's inventory account by the external auditors, which of the following assertions pertaining to inventory are likely to be evaluated by the external auditor, and for what reason? A) The cutoff assertion is likely to be audited to ensure that inventory has been recorded as purchased and sold within the correct period, and the valuation assertion is likely to be audited to ensure that inventory is recorded in the appropriate accounts. B) The auditor will most likely audit the valuation assertion to ensure that inventory is appropriately valued, along with the occurrence assertion to ensure that stated levels of inventory exist. C) The existence assertion is likely to be audited to ensure that inventory levels stated in the client's account exist, and the valuation assertion to ensure that inventory is appropriately valued. D) The auditor will generally delegate the audit of inventory accounts to the internal audit function, as this function is more familiar with the client's operations. Answer: C Explanation: The existence assertion is likely to be audited to ensure that inventory levels stated in the client's account exist, and the valuation assertion to ensure that inventory is appropriately valued. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

44) Two audit managers are discussing the upcoming audit of one of their major client's revenue accounts. The client in question has strong demand and credit sales, and is one of the industry's most prominent competitors. The assertions that are most likely to be evaluated as part of this audit include ________. A) the occurrence assertion for revenue to ensure that stated revenue transactions actually occurred, and the existence assertion for accounts receivable to ensure stated receivables actually exist B) the existence assertion for revenue to ensure that stated revenue transactions actually exist, and the occurrence assertion for accounts receivable to ensure stated receivables actually occurred C) the cutoff assertion for revenue to ensure that revenue has been recorded in the correct period, and the valuation assertion to ensure that the client has rights to the receivable generated D) the rights and obligations assertion to ensure that the client has rights to any receivables, and the accuracy assertion to ensure the revenue is recorded in the proper account Answer: A Explanation: The occurrence assertion for revenue to ensure that stated revenue transactions actually occurred, and the existence assertion for accounts receivable to ensure stated receivables actually exist. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 45) Assertions play a key role in the external audit of any firm. Assertions represent an efficient and systematic method of auditing a client's accounts and disclosures. At what point in the audit are assertions most likely to be used by the auditor? A) Assertions are typically used by the auditor during the preliminary phases of the audit, as they only relate to risk assessment procedures conducted by the auditor. B) Assertions may be used by the auditor at various stages during the audit, and may relate to risk assessment procedures and helping the auditor determine appropriate types of evidence to collect. C) Assertions are usually determined during the preliminary stages of the audit, with the internal audit function typically assuming responsibility for assertions relating to areas of higher risk. D) Assertions are typically utilized by the auditor during the final stages of the audit, when the auditor is checking assertions related to presentation and disclosure. Answer: B Explanation: Assertions may be used by the auditor at various stages during the audit, and may relate to risk assessment procedures and helping the auditor determine appropriate types of evidence to collect. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 19

46) Martha and Sallie are working on the audit of Bloom Company and are discussing assertions. Martha, a seasoned auditor, has been given the task of training Sallie. Sallie is attempting to understand more about audit procedures and has asked Martha to explain how to determine when an assertion should be evaluated for a particular account. Martha's most appropriate response to this question would be to ________. A) advise that every assertion is applicable to every account, and the main concern for the auditor is determining appropriate procedures to check each assertion B) explain that the auditor simply needs to either consult the prior year's audit file or contact the predecessor auditor in the case of a new client to determine which assertions were checked in prior years, and plan to audit these C) advise that different assertions will apply to different accounts, and they will not all apply to each account. It is a matter of auditor judgment to determine which assertions may apply to the accounts D) explain that they, as external auditors, will work closely with the internal audit function who will provide lists of which assertions need to be checked for each of the client's accounts Answer: C Explanation: Different assertions will apply to different accounts, and they will not all apply to each account. It is a matter of auditor judgment to determine which assertions may apply to the accounts. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

47) Verne external auditors are currently completing the audit of Davis, Inc., a manufacturer of specialty furniture which sells in retail stores across the country. A question has been raised by an audit manager with respect to the client's extensive use of leasing. The assertion that would most likely be related to this would be the ________. A) valuation assertion, as the auditor will need to check to ensure that the asset and liability accounts associated with the lease are properly valued B) rights and obligations assertion, because the auditor will be concerned with ensuring all leases are recorded and noted as such, and not as the client's own assets C) presentation and disclosure assertion, because the auditor will want to make sure that all leases are not listed on the client's balance sheet or in the notes to the financial statements D) occurrence assertion, as the auditor will be looking to check to make sure that all historical leases actually occurred Answer: B Explanation: The rights and obligations assertion, because the auditor will be concerned with ensuring all leases are recorded and noted as such, and not as the client's own assets. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 48) During the audit of Somerset Enterprises, a distributor of mechanical parts across the United States and Canada, a question has been raised by an audit staff associate with respect to the balances listed by management for the accounts receivable and associated allowance accounts. The assertion that would most directly relate to this issue would be ________. A) the rights and obligations assertion, as the auditor will be looking to check to ensure the client has rights to any net receivables B) the presentation and disclosure assertion, as the auditor's primary focus for these accounts will be ensuring they are correctly displayed C) the valuation assertion, as the auditor will be focused on ensuring that the gross and net amounts of receivables, along with the associated allowance, are fairly and accurately valued D) none of these answer choices are correct Answer: C Explanation: The valuation assertion, as the auditor will be focused on ensuring that the gross and net amounts of receivables, along with the associated allowance, are fairly and accurately valued. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

49) Which of the following statements best describes the relationship between auditing relevant assertions, the risk of misstatement, and the overall audit program used by the auditor? A) The overall audit program is used to determine which assertions the external auditor should focus on, at which point the auditor will determine the appropriate level of acceptable misstatement B) Once the auditor has completed auditing various assertions for the client's accounts, the risk of material misstatement is determined and the overall audit program put in place. C) Auditors typically assess the risk of material misstatement at the relevant assertion level, and use these assessments of risk to form the overall audit program. D) There is no relationship between the auditing assertions, the risk of misstatement, and the overall audit program utilized by the auditor. Answer: C Explanation: Auditors typically assess the risk of material misstatement at the relevant assertion level, and use these assessments of risk to form the overall audit program. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 50) An important part of any audit is the gathering of sufficient and appropriate audit evidence by the auditing team assigned to the engagement. Which of the following choices most accurately describes the types of audit evidence that an auditor might collect in order to support his or her opinion on the financial statements? A) The auditor is likely to collect a wide breadth of information to either corroborate or refute the financial statement assertions made by management. The question of how much evidence and the types of evidence to collect are generally a matter of auditor judgment. B) The auditor is likely to collect many different types of information to support various management assertions. The assertions pertaining to areas of higher inherent risk are likely to be audited by the internal audit function due to their increased familiarity with the client. C) During the preliminary stages of the audit, the auditor will determine which assertions should be audited as part of the risk assessment phase. Once this is complete, the auditor will apprise management of which assertions will be audited and the audit plan for each. D) For areas of the audit representing higher inherent risk, the auditor is likely to solicit oral evidence to corroborate or refute assertions in the financial statements. This is often done by requesting verbal assurances from senior management to include in the final audit report. Answer: A Explanation: The auditor is likely to collect a wide breadth of information to either corroborate or refute the financial statement assertions made by management. The question of how much evidence and the types of evidence to collect are generally a matter of auditor judgment. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 22

51) John and Dianne are working on the audit of Beam Enterprises Inc, a retailer of candy and other sweet treats. John and Dianne have been assigned the task of auditing the accounts receivable accounts. Which of the following best represents the type of evidence John and Dianne might collect? A) John and Dianne will likely collect bank confirmations to corroborate the existence assertion of accounts receivable. B) John and Dianne will likely examine a sample of accounts receivable, and attempt to trace these entries back to the revenue transactions that initiated them, gathering evidence such as confirmations and sales invoices. C) It is likely that John and Dianne will request copies of the sales invoices supporting these transactions from top management, to provide assurance these transactions exist and really occurred. D) None of these answer choices are correct. Answer: B Explanation: John and Dianne will likely examine a sample of accounts receivable, and attempt to trace these entries back to the revenue transactions that initiated them, gathering evidence such as confirmations and sales invoices. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

52) Steve and Sarah have been assigned to the audit of accounts payable for one of their auditing firm's larger clients. Before the audit starts, Steve and Sarah are sitting at lunch one day discussing how this part of the audit might be handled. Steve mentions that they will have to be careful to make sure they collect the right kinds of evidence to support the assertions they check as part of accounts payable. Which of the following best represents the assertions that might be evaluated and the evidence gathered to support these assertions? A) Steve and Sarah are likely to examine the population of accounts payable balances, sending confirmations to all vendors and other holders, asking them to confirm balances owed by the client to support the rights and obligations assertion. B) Steve and Sarah are likely to support the existence assertion of accounts payable by confirming balances with parties to whom the client owes balances and documenting accordingly. C) Steve and Sarah are likely to audit the completeness assertion of accounts payable by checking to see if there is any evidence of missing invoices and/or invoices that have not been entered into the records. D) Steve and Sarah are most likely to audit the cutoff assertion by sending confirmations to accounts receivable holders, requesting they confirm balances owed accordingly. Answer: C Explanation: Steve and Sarah are likely to audit the completeness assertion of accounts payable by checking to see if there is any evidence of missing invoices and/or invoices that have not been entered into the records. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

53) During the audit of Margram Enterprises Inc., a wholesaler of farming and agricultural equipment throughout the Northeastern United States and Canada, a question has been raised by one of the audit managers working on the audit as to the information being provided to the auditor by management. Margram Enterprises is a long-time audit client, and management turnover is generally low. Which of the following choices best represents the auditors approach to evidence in this case? A) As Margram Enterprises represents a long-time and trusted audit client, the external auditor should accept documentary evidence submitted by management and assume its authenticity and legitimacy. B) In every case, the external auditor should check the accuracy, authenticity and legitimacy of documentary evidence submitted by management, and should request verification by the client's internal auditors. C) The auditor should treat documentary evidence submitted by the client's management with the appropriate level of professional skepticism, confirming the accuracy, authenticity, and legitimacy of the evidence where appropriate. D) The auditor should request written assurances from top management of the client, preemptively confirming that any and all audit evidence submitted to the auditor will be bona fide and accurate. Answer: C Explanation: The auditor should treat documentary evidence submitted by the client's management with the appropriate level of professional skepticism, confirming the accuracy, authenticity, and legitimacy of the evidence where appropriate. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

54) Johnny and Rebecca are discussing the different types of evidence they plan to collect as part of the audit of a major client; a large, decentralized firm with operations all over the continental United States. There has been some disagreement between Johnny and Rebecca as to which types of audit evidence might be considered the most reliable, so they have approached you, their supervisor, to settle the dispute. Which of the following responses would be the most appropriate in this scenario? A) All audit evidence, regardless of how it was gathered and from whom it was gathered is legitimate and compelling, and represents sufficient, appropriate audit evidence. B) The legitimacy and reliability of the audit evidence will be determined by how and from whom it was gathered. For example, evidence obtained externally is usually more reliable than evidence obtained internally. C) Evidence obtained from senior management and the internal audit function is generally considered the most reliable, as these parties have the most knowledge of the client. D) Generally accepted auditing standards provide strict guidelines on what types and the quantity of evidence that must be collected for each assertion. Answer: B Explanation: The legitimacy and reliability of the audit evidence will be determined by how and from whom it was gathered. For example, evidence obtained externally is usually more reliable than evidence obtained internally. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

55) SafeBet External Auditors are currently working on the audit of Barrel Co., a distributor of fine whiskey and other spirituous products. Because Barrel Co. is a publicly-traded firm, the auditors are also planning the audit of the client's system of internal control. Which of the following best describes the relationship between the system of internal control and audit evidence generated by the client? A) There is no relationship between the client's system of internal control and the quality of audit evidence generated. B) A client with a weak system of internal control is less likely to generate reliable audit documentation and evidence, which the auditors are required to rely on. C) A client with a strong and effective system of internal control is more likely to generate reliable audit documentation and evidence which the auditor can rely on. D) Generally accepted auditing standards require that as part of an integrated audit of the client's financial statements and system of internal control, the auditor rely on documentary evidence generated by the client. Answer: C Explanation: A client with a strong and effective system of internal control is more likely to generate reliable audit documentation and evidence which the auditor can rely on. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

56) During the audit of Hornet Inc., a large nationwide distributor of pest control products, there has been considerable discussion with the client's top management as to how the evidence required to issue an appropriate audit opinion will be obtained. Management has offered various suggestions with respect to how the information can be passed to the external auditors. Which of the following suggestions would be the most problematic for the auditor? A) Management has offered to contact their bank and request copies of loan agreements, interest rates etc. to corroborate outstanding loan balances. Once the information has been sent to the client by the bank, it will be forwarded directly to the auditors. B) Management has agreed to allow the auditor access to the inventory accounts in the general ledger, as well as physical access to inventory contained at its locations. C) Management have agreed to pass all information pertaining to outstanding accounts receivables to the auditor, who will contact all clients with balances owed and confirm their existence. D) Management has advised that all information will first be gathered by the internal audit function to cut down on the cost of the external audit, and will then be passed to the auditors. Answer: D Explanation: Management has advised that all information will first be gathered by the internal audit function to cut down on the cost of the external audit, and will then be passed to the auditors. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

57) Stella and Tony, two relatively inexperienced audit staff associates are discussing audit evidence in a meeting. Stella and Tony are part of a team auditing a large audit client. The audit manager running the meeting has advised the team that as part of gathering audit evidence, they should take reasonable steps to ensure the evidence is persuasive. Which of the following statements would most accurately describe the concept of persuasive audit evidence? A) Evidence obtained through internal channels such as the client's management and the internal audit function are generally considered more persuasive. B) Audit evidence is generally considered more persuasive if it is obtained independently by the external auditors, and then passed to management to review its authenticity and accuracy. C) There is generally an inverse relationship between the quality and quantity of audit evidence gathered, with more persuasive evidence being gathered if the risk of material misstatement is high. D) It is a matter of auditor judgment to determine when the quality and quantity of audit evidence is appropriate and sufficient. The auditor usually gathers less evidence when risk of material misstatement is higher. Answer: C Explanation: There is generally an inverse relationship between the quality and quantity of audit evidence gathered, with more persuasive evidence being gathered if the risk of material misstatement is high. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 58) The sufficiency of audit evidence refers to the ________. A) quantity of audit evidence gathered B) quality of audit evidence gathered C) logical connection with the assertion being tested D) source, form, or nature of the audit evidence Answer: A Explanation: The sufficiency of audit evidence refers to the quantity of audit evidence gathered. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

59) The information that auditors use when arriving at their opinion on the fair presentation of the client's financial statements is called ________. A) audit evidence B) relevant assertion C) receivable confirmation D) working papers Answer: A Explanation: Audit evidence is the information auditors use when arriving at their opinion on the fair presentation of the client's financial statements (AU-C 500 Audit Evidence and AS1105 Audit Evidence). Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 60) The appropriateness of audit evidence refers to the ________. A) quality of audit evidence gathered B) quantity of audit evidence gathered C) logical connection with the assertion being tested D) source, form, or nature of the audit evidence Answer: A Explanation: The appropriateness of audit evidence refers to the quality of audit evidence gathered. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 61) In audit evidence, which of the following refers to the logical connection with the assertion being tested? A) Reliability B) Sufficiency C) Relevance D) Appropriateness Answer: C Explanation: In audit evidence, relevance refers to the logical connection with the assertion being tested. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 30

62) When would auditors want to decrease the risk that their audit procedures will not detect a material misstatement? A) When detection risk is high B) When detection risk is low C) When inherent risk is low D) When control risk is low Answer: B Explanation: When detection risk is low, auditors want to decrease the risk that their audit procedures will not detect a material misstatement. Diff: 1 LO: 2 Bloom: Analysis Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 63) The quality of audit evidence is determined by its ________ in providing support for the conclusions on which the auditor's opinion is based. A) relevance and reliability B) accuracy and valuation C) classification and understandability D) occurrence and rights and obligations Answer: A Explanation: According to AU-C 500.A5 and AS 1105.06, the quality of audit evidence is determined by its relevance and reliability in providing support for the conclusions on which the auditor's opinion is based. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management; PC: Decision Making

64) The amount of evidence that an auditor must collect is a function of ________. A) the risk of material misstatement in a relevant assertion for an account balance or class of transactions B) prior years' audit risk C) a detailed assessment of the clients' system of internal control D) the ability of the client to provide all documentation requested by the auditor Answer: A Explanation: The amount of evidence that an auditor determines must be collected is a function of the risk of material misstatement in a relevant assertion for an account balance or class of transactions. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 65) Audit evidence will typically consist of ________. A) all observations made by the auditor B) all records prepared by the auditor, not including records received from external entities C) information that supports and corroborates management's assertions and any information that contradicts the assertions D) information that supports the auditor's initial assessment of audit risk Answer: C Explanation: Audit evidence consists of information that supports and corroborates management's assertions and any information that contradicts the assertions. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 66) The specific procedures auditors will use to gather evidence are detailed in the ________. A) financial statements B) representation letter C) audit program D) flowchart Answer: C Explanation: The specific procedures auditors will use to gather evidence are detailed in the audit program. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 32

67) Relevance of audit evidence refers to ________. A) its importance to the audit B) its relevance to outside investors and creditors C) its relationship to the assertion being tested D) its relevance to the balance sheet Answer: C Explanation: Relevance of audit evidence refers to its relationship to the assertion being tested. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 68) Reliability of audit evidence refers to ________. A) the source of the evidence and form or nature of the evidence B) the accuracy and reliability of the balances C) only the specific source of the information D) only the nature of the evidence only Answer: A Explanation: Reliability of audit evidence refers to the source of the evidence and form or nature of the evidence. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 69) Auditors communicating directly with a client's bank regarding the existence of the client's cash account balances at year-end would be an example of an ________. A) audit issue B) independent source C) internal source D) illegal communication Answer: B Explanation: Auditors communicating directly with a client's bank regarding the existence of the client's cash account balances at year-end would be an example of an independent source. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

70) When there is a low risk of material misstatement with an assertion and the client's system of internal controls is considered effective at reducing risk, ________. A) detection risk is set at low B) detection risk is set at high C) inherent risk is set to medium D) control risk is ignored Answer: B Explanation: When there is a low risk of material misstatement with an assertion and the client's system of internal controls is considered effective at reducing risk, detection risk is set as high. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 71) Auditors are willing to accept a higher risk that their audit procedures may not detect a material misstatement ________. A) when detection risk is high B) when control risk is high C) when detection risk is low D) when control risk is low Answer: A Explanation: If detection risk is high, that means auditors are willing to accept a higher risk that their audit procedures may not detect a material misstatement. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

72) Auditors would plan for audit procedures that may result in lower quality evidence and possibly a decreased quantity of evidence for that assertion ________. A) when detection risk is high B) when audit risk is low C) when management risk is low D) when control risk is high Answer: A Explanation: When detection risk is high, auditors would plan for audit procedures that may result in lower quality evidence and possibly a decreased quantity of evidence for that assertion. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 73) Auditors inspecting purchase orders for proper authorization by a manager before a purchase is made would be an example of ________. A) a test of controls B) client communication C) substantive procedures D) analytical procedures Answer: A Explanation: Auditors inspecting purchase orders for proper authorization by a manager before a purchase is made would be an example of a test of controls. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 74) An auditors' evaluation of financial information by studying plausible relationships among both financial and non-financial data ________. A) is known as recalculation B) is known as reperformance C) is referred to as substantive testing D) is referred to as analytical procedures Answer: D Explanation: Analytical procedures are an evaluation of financial information by studying plausible relationships among both financial and non-financial data. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 35

75) The primary assertion that is tested when using receivable confirmations is ________. A) existence B) occurrence C) accuracy D) completeness Answer: A Explanation: The primary assertion that is tested when using receivable confirmations is existence. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 76) The auditing procedure of observation ________. A) only provides evidence of a process at the time auditors observe it being carried out B) is less reliable than auditing associated ledger accounts C) should be performed only once during the audit for each account D) should be conducted by the internal audit function to save time Answer: A Explanation: The auditing procedure of observation only provides evidence of a process at the time auditors observe it being carried out. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 77) What procedures are designed to detect material misstatements at the assertion level (namely, tests of details and substantive analytical procedures)? A) Tests of controls B) Substantive procedures C) Analytical procedures D) Risk assessment procedures Answer: B Explanation: Substantive procedures are methods designed to detect material misstatements at the assertion level. Two categories of substantive procedures are tests of details (of account balances, transactions, and disclosures) and substantive analytical procedures. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 36

78) Which of the following provides evidence for the occurrence assertion? A) Tracing B) Visualization C) Vouching D) Tests of controls Answer: C Explanation: Vouching provides evidence for the occurrence assertion. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 79) Selecting source documents and working forward to follow the transaction through to recording in the journal and ledger is called ________. A) tracing B) vouching C) inquiring D) observing Answer: A Explanation: Tracing is a type of inspection in which auditors select source documents and work forward to follow the transaction through to recording in the journal and ledger. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

80) Positive confirmations ask recipients to reply ________. A) in all circumstances. If a response cannot be obtained, auditors must obtain alternative evidence to determine if the balance exists. B) only if they disagree with the information provided. If a recipient does not respond, it is assumed that he/she agrees with the information provided C) in all circumstances. If a recipient does not respond, it is assumed that he/she agrees with the information provided D) only if they disagree with the information provided. If a response cannot be obtained, auditors assume that the receivable does not exist Answer: A Explanation: Positive confirmations ask recipients to reply in all circumstances. If a response cannot be obtained, auditors assume that the receivable does not exist. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 81) Receivable confirmations provide very little evidence regarding the ________ assertion. A) accuracy B) rights and obligation C) occurrence D) completeness Answer: D Explanation: The primary assertion being tested when using receivable confirmations is existence. The confirmations provide audit evidence that the customers exist. They also provide some evidence on ownership (rights and obligations assertion), as customers confirm that they owe money to the client. Customers are only asked to confirm they owe the amount outstanding at year-end (or at an interim date). They do not confirm their intention to pay the amount due. Therefore, confirmations provide very little evidence regarding the valuation and allocation assertion. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

82) Positive confirmation is correspondence sent directly by an auditor to a third party, who must respond ________. A) in all circumstances B) only if it disagrees with the information provided C) only if it agrees with the information provided D) in circumstances where the client disagrees with the auditor Answer: A Explanation: Positive confirmation is correspondence sent directly by an auditor to a third party, who is asked to respond to the auditor on the matter(s) included in the letter in all circumstances (that is, whether they agree or disagree with the information included in the auditor's letter). Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 83) Auditors spend a considerable amount of total audit time on the process of obtaining and evaluating audit evidence in support of management assertions, which is sourced primarily from the client's ________. A) working papers B) accounting records C) internal auditors D) audit data analytics Answer: B Explanation: Auditors spend a considerable amount of total audit time on the process of obtaining and evaluating audit evidence in support of management assertions. The primary source of the evidence is the client's accounting records. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

84) Which of the following helps discover and analyze patterns, identify anomalies, and extract other useful information in data underlying the subject matter of an audit? A) Tests of Control B) ADA (Audit Data Analytics) C) XBRL (Extensible Business Reporting Language) D) GAAP (Generally Accepted Accounting Principles) Answer: B Explanation: Audit data analytics (ADA) uses software to discover and analyze patterns, identify anomalies, and extract other useful information in data underlying the subject matter of an audit through analysis, modeling, and visualization for the purpose of planning or performing an audit. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 85) Among methods used by auditors in gathering evidence, what are tests of control? A) Methods used to determine the operating effectiveness of the client's controls in preventing, or detecting and correcting, material misstatements at the assertion level. B) Methods designed to detect material misstatements at the assertion level. C) Methods used to gain an understanding of a client and its industry for the purpose of identifying risk of material misstatement. D) Methods used in the evaluation of financial information by studying plausible relationships among both financial and non-financial data. Answer: A Explanation: Tests of controls are methods used to determine the operating effectiveness of the client's controls in preventing, or detecting and correcting, material misstatements at the assertion level. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making

86) If an auditor has determined that inherent risk for accounts receivable is high and wishes to verify the balance as accurate, the best corroborating evidence would be ________. A) a phone call to the client B) a negative confirmation sent to the entity in question C) a positive confirmation sent to the entity in question D) inspection of supporting documents relating to the receivables transactions Answer: C Explanation: If an auditor has determined that inherent risk for accounts receivable is high and wishes to verify the balance as accurate, the best corroborating evidence would be a positive confirmation sent to the entity in question. Positive confirmations ask recipients to reply in all circumstances. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 87) When an auditor selects transactions from the sales journal or ledger and then examines the underlying source documents, such as a shipping document and an invoice to the customer, this is known as ________. A) tracing B) vouching C) examination D) inspection of records Answer: B Explanation: When an auditor selects transactions from the sales journal or ledger and then examines the underlying source documents, such as a shipping document and an invoice to the customer, this is known as vouching. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

88) When auditors start with the underlying source documents and work forward to follow the transaction through to recording in the journal and ledger, this is referred to as ________. A) audit procedures B) substantive procedures C) tracing D) vouching Answer: C Explanation: When auditors start with the underlying source documents and work forward to follow the transaction through to recording in the journal and ledger, this is referred to as tracing. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 89) A common audit procedure that involves watching a process or procedure being carried out by client personnel or another party is known as ________. A) inspection B) observation C) recalculation D) reperformance Answer: B Explanation: Observation is an audit procedure that involves watching a process or procedure being carried out by client personnel or another party. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 90) When an auditor asks questions verbally or in written form of knowledgeable individuals internal to the client, this is referred to as ________. A) confirmation B) attestation C) affirmation D) inquiry Answer: D Explanation: Inquiry involves asking questions verbally or in written form of knowledgeable individuals internal or external to the client. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 42

91) An auditor's request for information about the amount of cash held in the bank and details of any loans is referred to as a ________. A) bank confirmation B) financial confirmation C) negative confirmation D) audit confirmation Answer: A Explanation: A bank confirmation is a request for information about the amount of cash held in the bank, details of any loans with the bank (e.g., interest rates and terms), and details of any pledges of assets made to guarantee loans. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management 92) The primary assertion being tested when using receivable confirmations is ________. A) completeness B) valuation and accuracy C) existence D) rights and obligations Answer: C Explanation: The primary assertion being tested when using receivable confirmations is existence. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management

93) A type of analytical procedure in which auditors use their professional judgment to review accounting data to identify unusual or significant items that may be an indication of a material misstatement ________. A) is referred to as scanning B) is known as substantive testing C) is known as an audit review D) is no longer allowed under Sarbanes-Oxley Answer: A Explanation: Scanning is a type of analytical procedure in which auditors use their professional judgment to review accounting data to identify unusual or significant items that may be an indication of a material misstatement. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 94) Performing numerical accuracy tests for foreign currency translation, payroll taxes, interest on loans outstanding, and depreciation calculations ________. A) is the role of the internal audit function B) is the responsibility of management C) is referred to as recalculation D) is unnecessary if the client is assessed as having low control risk Answer: C Explanation: Recalculation is the audit procedure of checking the mathematical accuracy of documents or records. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Ethics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

95) Using Audit Data Analytics (ADA) software typically makes the audit ________. A) more comprehensive but less efficient B) less comprehensive and less efficient C) less comprehensive but more efficient D) more comprehensive and more efficient Answer: D Explanation: Using ADA software makes the audit (1) more comprehensive because each item in a client's file can be examined and subjected to a variety of tests and (2) more efficient because the computer can handle large volumes of data, thereby reducing time-consuming clerical tasks. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 96) An important component of any external audit is the gathering of sufficient and appropriate audit evidence by the audit team assigned to the engagement. During which phase of the audit does the audit team typically collect audit evidence? A) During the preliminary, risk assessment phase of the audit, so the auditor can use this documentation and evidence gathered during the audit. B) The audit team will typically collect the majority of the evidence for the audit during the test of the client's system of internal control. C) Auditors generally will gather appropriate and sufficient audit evidence at all stages of the audit, including the risk assessment phase, testing of controls, and when performing substantive procedures. D) Auditors are required to follow strict rules promulgated by the Public Company Accounting Oversight Board which govern when certain types of audit evidence are to be collected, and the quantity thereof. Answer: C Explanation: Auditors generally will gather appropriate and sufficient audit evidence at all stages of the audit, including the risk assessment phase, testing of controls, and when performing substantive procedures. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

97) As part of the external audit of Candle Co., a regional distributor of candles and other wax products, you have been assigned to audit the client's liability accounts. You are aware that since the last audit, the client conducted a bond issue. Which of the following best represents the types of evidence that you would collect to audit assertions pertaining to this area? A) It is likely that you would conduct an inspection procedure to inspect documents related to the bond issue, as well as analytical procedures to calculate interest expense related to the bonds. B) You would likely perform a substantive procedure to check the accuracy of interest paid in relation to the bonds, as well as inspecting documents pertaining to the original bond issue. C) Evidence would likely be gathered to confirm that internal controls in this area are effective, as well as performing a vouching procedure to vouch cash paid out initially to bondholders with bond certificates. D) It is likely that you would perform a substantive procedure to match bond coupon payments in the general ledger to the appropriate accounts, and inspect documents and certificates pertaining to the original bond issue. Answer: A Explanation: It is likely that you would conduct an inspection procedure to inspect documents related to the bond issue, as well as analytical procedures to calculate interest expense related to the bonds. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

98) Two audit staff associates have been assigned the task of auditing the client's revenue accounts. At the beginning of the engagement, the two staff associates are discussing how best to perform this audit, and what procedures this would most likely involve. Which of the following most accurately describes the procedures that the staff associates will use to audit these accounts? A) The staff associates will follow the directions of the client's management and the internal audit function in determining and executing procures to audit the revenue accounts. B) The staff associates are likely to start with the underlying source documents pertaining to selected entries in the revenue account, and then work forwards to match these entries with either cash received or accounts receivable balances. C) The staff associates are likely to start with the underlying source documents pertaining to entries in the revenue account, and attempt to match these with their corresponding accounts payable. D) One staff associate is likely to attempt to confirm selected revenue entries with the customers who initiated these transactions, while the other staff associate will look to confirm that all associated payables are being paid in a timely manner, taking advantage of any early payment discounts. Answer: B Explanation: The staff associates are likely to start with the underlying source documents pertaining to selected entries in the revenue account, and then work forwards to match these entries with either cash received or accounts receivable balances. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

99) As part of the audit of TableTop LLC, a manufacturer of high-end specialized furniture, the partners of the external auditors, CPI Auditing Inc. are meeting to discuss which audit procedures may be more appropriate in this case. The auditors are interested in learning more about the quantities of materials that go into the products sold by TableTop LLC. A method the auditor could use to achieve this would be to ________. A) perform an inquiry procedure, inquiring of management as to the types and quantities of material that go into each product and documenting the responses received B) perform an observation procedure, which may involve either the auditor or a specialist observing the materials used and the processes conducted in order to manufacture the products C) send confirmations to the client's vendors who supply raw materials to the client, asking them to confirm this information D) attempt to reperform the processes and procedures used by the client's manufacturing staff, to corroborate the quantities used in the client's products Answer: B Explanation: Perform an observation procedure, which may involve either the auditor or a specialist observing the materials used and the processes conducted in order to manufacture the products. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

100) DayGlow Inc. is a manufacturer of specialized motors for racing cars and trucks, and operates in both the American and Canadian markets. As part of the audit of DayGlow Inc., the partners of the external auditors, StraightLace LLC are meeting to discuss some areas of potentially higher inherent risk. One area that has been mentioned is the client's international operations; more specifically receivables from Canadian firms. Which of the following best represents an audit procedure that might be used to audit this area? A) A reperformance procedure, whereby the auditor reperforms the process of shipping to a fictitious Canadian client and receiving funds at a later date in settlement of a receivable. B) A receivable confirmation procedure, whereby the auditor sends confirmations to a sample of Canadian clients, requesting they confirm the balances owed to them by the client. C) A recalculation procedure to ensure that the sales and receivables amounts are recorded correctly, and have been adjusted as necessary due to foreign currency fluctuations. D) An analytical procedure, whereby the auditors will examine trends in sales and associated receivables from US clients to ensure that currency translation fluctuations have been appropriately recorded. Answer: C Explanation: A recalculation procedure to ensure that the sales and receivables amounts are recorded correctly, and have been adjusted as necessary due to foreign currency fluctuations. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 101) Kate, a junior employee at a small auditing firm, has been assigned by her supervisor to review and audit the cash account. As Kate is new and has not worked on this audit client before, which of the following procedures would you recommend to Kate to help gain an overview of the account and any anomalous transactions that may need further attention? A) A scanning procedure, whereby Kate should scan the cash journal for signs of any unusual or anomalous entries which may need investigating. B) A recalculation procedure, whereby Kate should attempt to reconcile the ending balance of the cash account, accounting for all debit and credit entries made during the period. C) A reperformance procedure, as this will give Kate the opportunity to follow selected transactions through from beginning to end, and decrease the risk of material misstatement in this account. D) A reconciliation procedure, whereby Kate sends negative confirmations to the client's bank and asks for cash balances to be confirmed. Answer: A Explanation: A scanning procedure, whereby Kate should scan the cash journal for signs of any unusual or anomalous entries which may need investigating. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 49

102) During the audit of Ransom Enterprises, a large manufacturer of personal computing devices, the auditor, StrongBow CPAs is concerned that it will take them an inordinate amount of time to effectively audit some accounts due to the sheer volume of transactions in these accounts. A viable suggestion to handle this problem could be ________. A) to consider employing audit data analytics (ADA) as an automated tool to search for issues and areas that may require further investigation B) to advise the client that their internal audit function will be required to handle all accounts with large balances and voluminous transactions C) to advise the client that the CPA firm will be taking on extra temporary staff to handle this problem, and that the hours worked by these temporary staff will be billed to the client as part of the regular audit D) to advise the client that the CPA firm is not willing to audit these accounts due to increased risk, and will either issue a disclaimer of opinion on these accounts or withdraw from the audit completely Answer: A Explanation: To consider employing audit data analytics (ADA) as an automated tool to search for issues and areas that may require further investigation. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 103) While planning the audit of one of their largest clients, the audit partners of Globe CPAs are discussing whether to introduce audit data analytics into this client's audit for the first time. A couple of the partners are more reticent because of their lack of knowledge and inexperience with audit data analytics; however some of the other partners are keen to instigate this new technology. Which of the following choices represent arguments the partners could make in favor of audit data analytics? A) The audit can be considered to be more extensive and comprehensive because audit data analytics allows for audits of a population, not just a sample. B) Audit data analytics can often be done remotely, freeing up auditor time to focus on other, more value-added tasks. C) Auditors can focus less on the procedural aspects of the audit, and instead focus more of their time and energy on objectively interpreting and evaluating the results of the audit data analytics procedures. D) All of these answer choices are correct. Answer: D Explanation: All of these answer choices are correct. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 50

104) SunnyDay CPAs are beginning the audit of Wyoming Enterprises, Inc., a large and diversified provider of financial and investment advising services across the Midwestern United States. It has been noted by the external auditors that Wyoming Enterprises maintains a defined benefit plan for its employees. The partners of SunnyDay CPAs are attempting to determine if they have the necessary expertise to audit accounts related to retirement obligations. If the partners determine that they do not have the necessary in-house expertise, they will most likely ________. A) advise the client's senior management that they will disclaim an opinion on those accounts, whereas all other accounts subject to audit will receive an unmodified opinion B) consider hiring the services of a specialist who is proficient in the necessary calculations and techniques to render an opinion on the propriety of the balances C) consider withdrawing from the engagement and finding a suitable, qualified replacement auditor, per generally accepted auditing standards D) consider hiring the services of a specialist as recommended by client management who is proficient in this area and is qualified to perform all necessary calculations and conduct all necessary procedures Answer: B Explanation: Consider hiring the services of a specialist who is proficient in the necessary calculations and techniques to render an opinion on the propriety of the balances. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 105) Two audit partners in charge of the external audit of Virginia Enterprises have decided to retain the services of a specialist in order to effectively complete the audit of the client's inventory accounts. The client maintains specialized inventory which the auditor is unsure how to appropriately value. Examples of evidence that the specialist may generate could include ________. A) detailed calculations showing how the inventory has been objectively and accurately appraised, along with any supporting schedules for the calculations B) sources the specialist used, showing their impartiality and objectivity in providing underlying data to support calculations made C) confirmation that the specialist is independent of client management, and that management has in no way attempted to influence or bias the auditors procedures or judgment D) All of these answer choices are correct. Answer: D Explanation: All of these answer choices are correct. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 51

106) The audit partners of Flower Enterprises are attempting to locate and retain the services of a specialist to assist in the audit of a major client's property, plant, and equipment accounts. The client maintains an array of specialized equipment which is beyond the scope of the auditor's expertise in auditing effectively. Which of the following choices best represents key considerations of the audit partners in selecting a specialist? A) Is the specialist independent of management, and does the specialist possess the necessary technical skills, credentials and objectivity to perform effectively? B) Will the specialist be able to access the necessary information provided to him or her by management, in order to effectively complete their work? C) Will the specialist be required to bill the client directly for their work? Or can the services of the specialist be included as part of the audit fees? D) If the specialist does not possess the requisite skills and experience, will they commit to gaining the necessary skills and experience in a reasonable timeframe? Answer: A Explanation: Is the specialist independent of management, and does the specialist possess the necessary technical skills, credentials and objectivity to perform effectively. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 107) Jericho CPAs are currently completing the audit of Towson Enterprises, Inc., a national distributor of vehicle and other mechanical parts. Due to some unexpected circumstances, Jericho CPAs are without a number of their audit staff associates. The audit partners have convened a meeting to discuss whether it would be appropriate to rely on the work of the client's internal audit function during the absence of these staff associates. Which of the following would best represent key considerations in making this decision? A) Whether or not the work of the internal audit function can still be constituted as billable hours on behalf of the external auditor. B) The proficiency and competence of the internal audit function, and whether or not it is capable of operating independently of management and without bias. C) The competence of the internal audit function, and how quickly management can review the conclusions drawn by this function before forwarding the findings to the external auditor. D) None of these answer choices are correct. Answer: B Explanation: The proficiency and competence of the internal audit function, and whether or not it is capable of operating independently of management and without bias. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 52

108) The audit managers assigned to the audit of Star Enterprises are considering the strength and experience of the internal audit function. Upon investigation, the external auditors have determined that the head of the internal audit function is a close friend of the Chief Financial Officer. Based on this finding, which of the following statements is true? A) The external auditors should plan to adopt a reliance strategy and fully rely on the work of the internal audit function and their familiarity with the client, especially in areas of higher inherent risk. B) The external auditors should exercise appropriate levels of professional skepticism; carefully and objectively reviewing any work performed by the internal auditors. C) Generally accepted auditing standards prohibit an external auditor's reliance on the internal audit function if there is potential for a conflict of interest to exist. D) The external auditors should assign areas of lower inherent risk to the internal audit function, which will balance any conflicts of interest that may occur. Answer: B Explanation: The external auditors should exercise appropriate levels of professional skepticism; carefully and objectively reviewing any work performed by the internal auditors. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

109) RightSide CPAs are getting ready to start the audit of NewSome Enterprises. This will be the third year that RightSide CPAs have provided auditing and attestation services to this client. The client is a large, well diversified firm and has been in business for many years. It has come to the attention of the audit partners responsible for the engagement that the client has just undergone a significant restructuring. Which of the following choices best represents the auditor's response to this news? A) The auditor should immediately contact the client's management and notify them of their intention to withdraw from the engagement, due to increased inherent risk. B) The audit partners should contact both client management and the client's internal audit function, requesting details of the restructure and written assurances that inherent risk has not increased. C) The audit partners should attempt to understand significant details of the restructure, and whether the restructure may have caused impairments to objectivity and independence in areas such as internal audit. D) The client's restructure is of no concern to the external auditors, and does not pose any problems or threats that the auditors should consider in their next audit. Answer: C Explanation: The audit partners should attempt to understand significant details of the restructure, and whether the restructure may have caused impairments to objectivity and independence in areas such as internal audit. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

110) As part of Java CPAs client acceptance procedures, the audit partners of Java are attempting to determine the proficiency of a potential new client's internal audit function. As the client is rather large relative to Java's resources, the partners have determined that it is likely they will need to place at least some reliance on this function. Which of the following choices best describes the key considerations the partners of Java will need to make to assess the competency of the client's internal audit function? A) Are the staff members employed in the internal audit function appropriately qualified, and do they possess any advanced credentials? B) Is the size of the internal audit function proportionate to the size of the client, or is the function understaffed? C) What are the policies and procedures enacted by the client in order to ensure that appropriately qualified and knowledgeable individuals with the correct experience and skillsets are being hired? D) All of these answer choices are correct. Answer: D Explanation: All of these answer choices are correct. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 111) It is typical for medium to large size companies to maintain an internal audit function. Many external audit firms pay close attention to the competency and professionalism of this function. Which of the statements below best describes why an internal auditor may wish to consider studying for a professional designation in his or her field? A) Because if the internal auditor is able to obtain advanced licensures and professional designations, he or she will be able to earn more money. B) Because being a member of a professional body that holds its members to certain ethical standards and codes of conduct enhances the reputation and perceived professionalism of that individual. C) If the auditor is able to obtain advanced credentials and professional licensures in his or her field, the auditor is much more likely to be offered a partner-track position at a prestigious firm. D) All of these answer choices are correct. Answer: B Explanation: Being a member of a professional body that holds it members to certain ethical standards and codes of conduct enhances the reputation and perceived professionalism of that individual. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

112) According to Brazel's research, responses from financial statement auditors in the U.S. who were surveyed about their experiences with IT auditors indicated that they believe IT auditors' ________ levels vary in practice. A) competence B) capability C) objectivity D) participation Answer: C Explanation: Responses from financial statement auditors in the U.S. who were surveyed about their experiences with IT auditors indicated that they believe IT auditors' competence levels vary in practice. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 113) In the PCAOB standard, the term "other auditors" refers to ________. A) component auditors B) principal auditors C) the group engagement team D) the group engagement partner Answer: A Explanation: The guidance in the PCAOB standard is essentially the same as that in the ASB standard for private companies. The key difference is the PCAOB standard uses different terminology. The term "principal auditor" is used instead of "group engagement team" and "group engagement partner." The term "other auditors" is used instead of "component auditors." Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management; PC: Decision Making

114) Who among the following is generally the most experienced in an audit team? A) Partner B) Manager C) Senior/in-charge D) Staff/associates Answer: A Explanation: In an audit team, the partner is generally the most experienced with 10 or more years of experience. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting 115) In general, reliance on an IT specialist is appropriate when the financial statement auditor complies with the conditions of AU-C ________. A) 610 B) 620 C) 600 D) 500 Answer: B Explanation: In general, reliance on an IT specialist is appropriate when the financial statement auditor complies with the conditions of AU-C 620. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting

116) Which of the following is an individual or organization with expertise in a field other than accounting or auditing whose work in that field is used by the auditors to assist in obtaining sufficient appropriate evidence? A) Component auditor B) Internal auditor C) Specialist D) Group engagement partner Answer: C Explanation: A specialist is an individual or organization with expertise in a field other than accounting or auditing whose work in that field is used by the auditors to assist in obtaining sufficient appropriate evidence. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting 117) In cases wherein specialists are hired, the responsibility for arriving at an overall conclusion regarding fair presentation of a client's financial statements rests with the ________. A) auditors B) specialists C) clients D) government Answer: A Explanation: The responsibility for arriving at an overall conclusion regarding fair presentation of a client's financial statements rests with the auditors. When auditors decide to use a specialist, that responsibility is not reduced in any way. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting

118) What do auditors consider when determining the extent to which the internal auditors' work will affect the auditors' procedures? A) The materiality of the account balance or transaction, the risk of material misstatement of the assertions, and the amount of subjectivity involved in evaluating the evidence gathered. B) Only the materiality of the account balance or transaction and the risk of material misstatement of the assertions. C) Only the risk of material misstatement of the assertions related to the account balance, transaction, or disclosure and the amount of subjectivity involved in evaluating evidence gathered. D) Only the amount of subjectivity involved in evaluating the evidence gathered. Answer: A Explanation: When determining the extent to which the internal auditors' work will affect the auditors' procedures, auditors consider the materiality of the account balance or transaction, the risk of material misstatement of the assertions related to the account balance, transaction, or disclosure, and the amount of subjectivity involved in evaluating the evidence gathered (AU 2605.20). Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting 119) The extent of review of the component auditor's work depends on a number of factors. The group engagement partner will spend more time if the component auditor ________. A) has a good reputation B) is dealing with a component that is material C) has done audit work for the group engagement partner in the past D) is auditing statements that are at low risk of material misstatement Answer: B Explanation: The extent of review of the component auditor's work depends on a number of factors. The group engagement partner will spend more time when the component is material and/or at risk of material misstatement. The group engagement partner will spend less time if the component auditor has a good reputation and/or has done audit work for the group engagement partner in the past, and if the financial statements being audited by the component auditor are at low risk of material misstatement. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting

120) The PCAOB standard corresponding to an independent auditor's report when work of a component auditor is used is ________. A) AS 1205 Part of the Work Performed by Other Independent Auditors B) AS 2110 Identifying and Assessing the Risks of Material Misstatement C) AS 2605 Consideration of the Internal Audit Function D) AS 1210 Using the Work of a Specialist Answer: A Explanation: The PCAOB standard corresponding to an independent auditor's report when work of a component auditor is used is AS 1205 Part of the Work Performed by Other Independent Auditors. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting 121) With respect to relying on the work of the internal audit function, external auditors should ________. A) always be willing to accept work completed and documentation provided B) never be willing to accept work completed by the internal audit function C) impartially assess the objectivity, competence and processes of the internal audit function D) always assign junior members of the audit team to assist the internal audit function Answer: C Explanation: With respect to relying on the work of the internal audit function, external auditors should impartially assess the objectivity, competence and processes of the internal audit function. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: Governance Perspective; AC: Reporting

122) An individual or an organization with expertise in a field other than accounting or auditing whose work in that field is used by the auditors to assist in obtaining sufficient appropriate audit evidence ________. A) is commonly known as an outside consultant B) is typically referred to as a specialist C) is not to be relied upon by the auditor D) should report to management, not the auditor Answer: B Explanation: A specialist is an individual or an organization with expertise in a field other than accounting or auditing whose work in that field is used by the auditors to assist in obtaining sufficient appropriate audit evidence. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management 123) Employees of the client that perform assurance and consulting activities designed to evaluate and improve the effectiveness of the entity's governance, risk management, and internal control processes ________. A) should be expected to assist the auditor with the audit B) are known as internal auditors C) are referred to as specialists D) will provide evidence to the auditor which should always be considered reliable Answer: B Explanation: Internal auditors are employees of the client that perform assurance and consulting activities designed to evaluate and improve the effectiveness of the entity's governance, risk management, and internal control processes. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management

124) Examples of evidence indicating the competency of the internal audit function could be ________. A) professional certification in a relevant field B) high turnover of internal audit employees C) low salaries compared to the industry average D) little or no training provided to new employees Answer: A Explanation: Evidence of competency could be provided by technical training and proficiency that may be evidenced by education, years of experience, and professional certification in a relevant field. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management 125) Financial information of more than one entity, or component ________. A) are known as parent-subsidiary statements B) are not allowed under GAAP C) are referred to as group financial statements D) should be audited by the internal audit function instead Answer: C Explanation: Group financial statements include the financial information of more than one entity, or component, such as consolidated financial statements prepared by a parent company. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management

126) An entity or business activity that is required by the applicable financial reporting framework to prepare financial information that will be included in group financial statements ________. A) is known as a component B) is referred to as a subsidiary C) should send separate financial information directly to the auditor D) should be audited by the internal audit function Answer: A Explanation: A component is an entity or business activity that is required by the applicable financial reporting framework to prepare financial information that will be included in group financial statements. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management 127) As part of any external audit, auditors gather a variety of evidence to support their findings and conclusions. The evidence collected and documented are stored as part of the auditor's working papers. Which of the following statements most accurately defines the working papers? A) The working papers are used to store information gathered as part of the audit. Before the audit is complete, the working papers are submitted to management for approval. B) The working papers typically contain both the permanent and current year's files. The permanent file is maintained by the internal audit function as it pertains to multiple years, and the external auditor maintains custody of the current year's audit file. C) The working papers typically consist of the permanent file and the current year's audit file. The current file is more likely to contain details of the board of directors and key long-term loan covenants. D) The working papers consist of the permanent file and the current file. The permanent file is likely to contain details such as significant accounting policies pertinent to the client, and the current file is more likely to contain risk assessments at the financial statement level. Answer: D Explanation: The working papers consist of the permanent file and the current file. The permanent file is likely to contain details such as significant accounting policies pertinent to the client, and the current file is more likely to contain risk assessments at the financial statement level. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

128) During the audit of the stockholder's equity accounts of Melon Enterprises, the external auditors, Jackson CPAs are trying to locate details of stock option plans for Melon Enterprises' key executives. One of the audit managers assigned to the engagement advises that he has seen these records recently, but doesn't remember where. He asks you to find and retrieve it. Where is the most likely location of this information? A) This information is most likely to be contained in the permanent file. The best course of action would be to contact management and request permission to view this file and make a copy of stock option plans. B) This information should be stored in the permanent audit file which the auditor retains possession of, along with other key information and records pertaining to the executives' stock options. C) Information pertaining to stock options for firm executives will be part of the minutes of the board of directors meetings, so this would be the first place to check. D) This information is typically retained by the client's legal counsel. Written permission should be obtained from management before requesting this information. Answer: B Explanation: This information should be stored in the permanent audit file which the auditor retains possession of, along with other key information and records pertaining to the executives' stock options. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

129) During a meeting with the senior management of GreenGrass Enterprises, LLC, a distributor of lawn care and fertilizer products across the country, a query has been raised by the external auditors pertaining to the client's use of double-declining balance method depreciation. The auditors are attempting to confirm their understanding as to why the client uses this method. The documentation and reasoning behind this choice of accounting method is most likely to be found ________. A) in the minutes of the board of directors meeting, as this choice of depreciation method has to be voted on by senior management at least once a year B) in the permanent audit file, which typically contains details of significant accounting methods used by the client C) in the current year's audit file, and typically located in the risk assessment section under substantive tests of details D) in the internal audit function, as this function, per generally accepted auditing standards, maintains responsibility for selection of appropriate accounting methods Answer: B Explanation: In the permanent audit file, which typically contains details of significant accounting methods used by the client. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 130) As the audit of Bambridge LLC nears its conclusion, the audit partners are reviewing samples of the audit evidence gathered and key conclusions drawn by the managers who supervised the audit. One of the partners raises a question about the client's system of internal control over cash receipts and disbursements. The partner has asked you to locate and furnish appropriate information gathered as part of the audit pertaining to this area. Where is this information most likely to be located? A) This information should be contained in the current year's audit file, because the client's system of internal control will have been reviewed as part of this audit. B) This information is most likely to be stored in the permanent audit file, because a clients' system of internal control is not typically subject to change and should remain the same over the years. C) This information is stored by the internal audit function per generally accepted auditing standards, as the responsibility for internal control rests with this function. D) None of these answer choices are correct. Answer: A Explanation: This information should be contained in the current year's audit file, because the client's system of internal control will have been reviewed as part of this audit. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 65

131) Two months after the audit of Bell Enterprises, you are approached by your supervisor, an audit partner at the firm you work for, and asked to electronically unlock the audit file pertaining to Bell Enterprises, as the partner wishes to make an adjustment. Upon receipt of such a request, your best course of action is to ________. A) advise the partner that once the file is electronically locked, it cannot be unlocked under any circumstances B) request details as to why the audit file needs to be unlocked, and document that this action was requested, and by whom C) advise the partner that you are willing to electronically unlock the document once you have received permission and confirmation from the client D) advise the partner to explain the details of why the document needs to be unlocked, and then you will take care of any changes accordingly Answer: B Explanation: Request details as to why the audit file needs to be unlocked, and document that this action was requested, and by whom. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 132) While completing the external audit of Carnegie LLC, you are reviewing the working papers gathered as part of the audit. You note that on some of the working papers pertaining to accounts receivable confirmations, the initials 'DM' appear to have completed and reviewed the work. The initials 'DM' only apply to one person working on the engagement. Upon observing this, your best course of action would be which of the following? A) Assume that this individual, a supervisor whom you know and trust, was just short-staffed and was taking initiative so as not to delay the audit. B) Contact the individual and ask for a written explanation as to why the records appear to indicate they have both completed and reviewed their own work. C) Contact the individuals' supervisor and apprise him or her of the situation, requesting that they investigate accordingly. D) Notify the client's top management and internal audit function, and request additional written assurances in this area. Answer: C Explanation: Contact the individuals' supervisor and apprise him or her of the situation, requesting that they investigate accordingly. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

133) As the audit of Somerset Enterprises draws to a close, the audit partners are meeting with the client's top management to discuss the findings and particulars of the audit. One of the audit partners assigned to the engagement has explained to management that the auditors are recommending some adjusting entries be made to the clients' net accounts receivables and associated allowance balances. Where would information pertaining to these proposed adjusting entries most likely be contained? A) This information should be stored with the accounts receivable department directly. The supervisor of this department should be able to furnish this. B) This information should be stored by the auditors, and is most likely contained in the current year's audit file. C) This information is usually stored by the auditors as part of the external audit, and is typically contained in the permanent audit file in the section pertaining to the client's key accounting policies. D) This information is most likely to be found in the current year's audit file, and thus should be requested from the internal audit function and reviewed accordingly. Answer: B Explanation: This information should be stored by the auditors, and is most likely contained in the current year's audit file. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

134) Two new audit staff associates, John and Tina are discussing the upcoming audit of Glass Enterprises, a large and decentralized distributor of blown glass products throughout the United States, Canada, and Mexico. John and Tina have been advised by their supervisor that as this is the first audit of this client, they will get to see a lot of audit documentation and where the various documentation is stored by the auditor. Which of the following statements best describes the types of information likely to be collected and retained by the auditor on this first audit? A) The types of information collected and retained by the auditor as part of the initial client audit should be identical to information gathered in future audits, as the auditor must ensure consistency among audits. B) It is probable that due to this being the initial client audit, less information will be gathered during this audit, and more information will be gathered over time, and in future audits. C) It is likely that more information will be gathered during the initial audit that will be placed in the permanent audit file; with less information likely being added to this file in future audits. D) It is likely that more information will be added to the current year's audit file during the initial audit; with less information being added to this file in future audits. Answer: C Explanation: It is likely that more information will be gathered during the initial audit that will be placed in the permanent audit file; with less information likely being added to this file in future audits. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 135) At the front of every audit file is the client's ________ supporting the financial statements. A) trial balance B) prior year audit file C) key performance indicators D) relevant assertions Answer: A Explanation: At the front of every audit file is a copy of the client's trial balance that supports the financial statements. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication, Data Analytics AICPA: AC: Reporting

136) AU-C 230 Audit Documentation and AS 1215 Audit Documentation require auditors to document each stage of the audit in their ________ to provide a record of work completed and evidence gathered in forming their audit opinion. A) bank confirmations B) audit data analytics C) group financial statements D) working papers Answer: D Explanation: AU-C 230 Audit Documentation and AS 1215 Audit Documentation require auditors to document each stage of the audit in their working papers to provide a record of work completed and evidence gathered in forming their audit opinion. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting 137) Which of the following includes client information and documentation that applies to multiple audits? A) Permanent file B) Lead schedules C) Bank confirmations D) Current file Answer: A Explanation: The permanent file includes client information and documentation that applies to multiple audits. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting

138) Which of the following are included in the permanent file and not in the current file? A) Debt covenants B) All testing and evidence gathered in preparation of the audit report C) Correspondence with other auditors and specialists D) Extracts from the minutes of meetings Answer: A Explanation: Debt covenants will be included in the permanent file. Auditors can check the details of these agreements to assess the client's compliance with covenants. If a client has longterm commitments with customers and suppliers, auditors will include the relevant documentation in the permanent file. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting 139) Which of the following is true of the permanent file? A) It includes details of key personnel and an organizational chart. B) In the first year of a continuing audit, it offers no information for future audits. C) The information included in it is checked and updated at the end of each annual audit. D) It makes no reference to the client's primary accounting policies and methodologies. Answer: A Explanation: In the first year of a continuing audit, auditors develop information that will be relevant to future audits. The information included in the permanent file is checked and updated at the start of each annual audit. Key personnel are detailed and an organizational chart is included in the permanent file. The permanent file details a client's primary accounting policies and methodologies. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting

140) Which of the following summarizes the detail included in a specific account on the financial statements? A) Vouching B) Assertion C) Lead schedule D) Bank confirmation Answer: C Explanation: A lead schedule summarizes the detail included in a specific account on the financial statements. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: AC: Reporting 141) An auditor has just prepared and sent a letter to management detailing weaknesses in internal control. A copy of this letter should be ________. A) sent to the client's attorney B) placed in the permanent file C) placed in the temporary file, and removed when the client corrects the deficiencies D) filed with the Securities and Exchange Commission Answer: B Explanation: An auditor has just prepared and sent a letter to management detailing weaknesses in internal control. A copy of this letter should be placed in the permanent file, for reference in future years. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 142) Current year working papers for an audit client should contain ________. A) a copy of the lead schedule B) a copy of the working papers C) copies of the lead schedule and working papers D) neither copies of the lead schedules nor working papers. Answer: C Explanation: Current years' working papers for an audit client should contain copies of the lead schedule and working papers. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 71

143) Ultimate responsibility for audit decisions, supervision of the team members, and the issuance of the final audit report rests with ________. A) management B) the audit partner C) the audit manager D) the audit committee Answer: B Explanation: The partner holds ultimate responsibility for audit decisions, supervision of the team members, and the issuance of the final audit report. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 144) A detailed record of work completed, and evidence gathered in forming the audit opinion ________. A) is contained in the working papers B) is referred to as the audit plan C) should be submitted by the auditor to management for approval D) is confidential and should not be shared with client personnel Answer: A Explanation: AU-C 230 Audit Documentation and AS 1215 Audit Documentation require auditors to document each stage of the audit in their working papers to provide a record of work completed and evidence gathered in forming their audit opinion. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

145) Auditors document details of tests undertaken ________. A) in the audit planning phase B) once the audit is completed C) during the risk response phase D) during risk assessment Answer: C Explanation: During the risk response phase, auditors develop an audit program, and document details of tests undertaken, copies of significant documents sighted, correspondence with the client's lawyers and bankers, confirmations received from customers and inquiries of management. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 146) Client information and documentation that applies to multiple audits should be ________. A) stored in the current file B) stored in the permanent file C) destroyed upon completion of the audit D) returned to the client upon completion of the audit Answer: B Explanation: The permanent file includes client information and documentation that applies to multiple audits. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 147) The permanent file should include ________. A) details of all members of the internal audit function B) details of the client's board of directors and its subcommittees C) details of all committees at the client's place of business D) all related party transactions Answer: B Explanation: The permanent file includes details of the client's board of directors and its subcommittees, such as the audit committee. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 73

148) A client's primary accounting methodologies and significant accounting policies ________. A) should be stored in the current file B) should be stored in the permanent file C) should be re-examined by the auditor once the audit report has been published D) is confidential, and should not be shared with the auditor Answer: B Explanation: The permanent file should detail a client's primary accounting policies and methodologies. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 149) Letters to management that detail weaknesses in internal controls identified by the auditors in previous years should be ________. A) included in the permanent file B) included in the current file C) destroyed if management corrects the weaknesses D) sent directly to the management's attorney for review Answer: A Explanation: Reports sent to the client during previous audits will be included in the permanent file. For example, letters to management that detail weaknesses in internal controls identified by the auditors in previous years are included in the permanent file. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 150) As audit work is performed and the auditor amasses client information and documentation that apply to the current year's audit, ________. A) this should be placed in the current file B) this should be retained in the permanent file C) copies of all information should be placed in both the current and permanent files D) it should be destroyed after seven days to protect client confidentiality Answer: A Explanation: The current file is developed as audit work is performed and includes client information and documentation that apply to the current year's audit. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 74

151) Extracts from the minutes of meetings that pertain to the current audit ________. A) should never be copied by the auditor B) should be added to the current file C) should immediately be copied and placed in the permanent file D) are confidential, and should not be shared with the auditor Answer: B Explanation: The current file includes extracts from the minutes of meetings, such as the board of directors' meetings, which pertain to the current audit. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 152) With respect to an auditor's working papers, a lead schedule ________. A) summarizes the detail included in a certain account B) details who will be responsible for what parts of the audit C) should be sent to the client before acceptance of the audit D) should be prepared by the partner in charge of the audit Answer: A Explanation: A lead schedule that summarizes the detail included in the financial statements for a particular account. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 153) Documentation contained in the working papers for a client ________. A) will be the same for each client within a particular industry B) will contain a few minor variations between different clients C) will vary by client D) should be shared with the client and appropriate changes made Answer: C Explanation: Documentation contained in the working papers for a client will vary by client. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

154) A document containing details of the period under audit, and the initials of preparers and reviewers is referred to as ________. A) an audit working paper B) an audit plan C) a management representation letter D) a positive confirmation Answer: A Explanation: A document containing details of the period under audit, and the initials of preparers and reviewers is referred to as an audit working paper. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 155) If an audit partner reviewing an engagement was attempting to locate details of long-term contracts and agreements, this information would be found in ________. A) the representation letter B) communications with the client's attorney C) the permanent file D) the current file Answer: C Explanation: The permanent file would contain details of long-term contracts and agreements. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 156) Once risks are identified, auditors assess the risk of material misstatement at the ________ level for these significant classes of transactions and account balances. A) relevant assertion B) account C) financial statement D) disclosure Answer: A Explanation: Once risks are identified, auditors assess the risk of material misstatement at the relevant assertion level for these significant classes of transactions and account balances. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 76

157) ________ is the information auditors use when arriving at their opinion on the fair presentation of the client's financial statements. A) Opinion evidence B) Audit evidence C) Privileged client information D) Internal audit evidence Answer: B Explanation: Audit evidence is the information auditors use when arriving at their opinion on the fair presentation of the client's financial statements. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 158) ________ refers to the quantity of audit evidence gathered. A) Appropriate B) Timely C) Sufficient D) Complete Answer: C Explanation: Sufficient refers to the quantity of audit evidence gathered. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 159) Evidence gathered from a knowledgeable source independent of the client is more ________ than evidence gathered solely from internal client sources. A) complete B) accurate C) reliable D) questionable Answer: C Explanation: Evidence gathered from a knowledgeable source independent of the client is more reliable than evidence gathered solely from internal client sources. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

160) ________ involves the examination of documents and physical assets. A) Observation B) Inspection C) Examination D) Recording Answer: B Explanation: Inspection involves the examination of documents and physical assets. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 161) Management assertions are extremely important to the profession of auditing. Auditors essentially test assertions implicit within the financial statements to effectively audit different areas of an entity. Which of the statements below are true pertaining to assertions? A) Assertions are made implicitly by management, and are contained within the financial statements of the entity being audited. B) Assertions are made explicitly by the auditor, and are tested by the auditor to ensure compliance with applicable rules and regulations. C) Assertions may relate to measurement of account balances, presentation and disclosure, and are routinely tested as part of the audit. D) During the risk assessment phase of the audit, auditors typically use management assertions as a guide to determining where higher risk areas of the audit may be. Answer: A, C Explanation: Assertions are made implicitly by management, and are contained within the financial statements of the entity being audited. Assertions may relate to measurement of account balances, presentation and disclosure, and are routinely tested as part of the audit. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

162) As part of the audit of Jameson Company, Guthrie External Auditors is determining where areas of higher inherent risk may be within the firm. Which of the following choices would be correct pertaining to assertions that Guthrie auditors may evaluate and the appropriate reasoning for checking these assertions? A) Guthrie may audit the rights and obligations assertions assertion to ensure that balances contained in the accounts are stated at their correct value. B) Guthrie may audit the existence assertion to ensure that physical assets such as property, plant and equipment actually exist. C) Guthrie may audit the cutoff assertion to ensure that transactions and events have been recorded in the proper accounts. D) Guthrie may audit the valuation and allocation assertion to ensure that assets, liabilities and equity items have been recorded at the appropriate amounts and any adjustments correctly recorded. Answer: B, D Explanation: Guthrie may audit the existence assertion to ensure that physical assets such as property, plant and equipment actually exist. Guthrie may audit the valuation and allocation assertion to ensure that assets, liabilities and equity items have been recorded at the appropriate amounts and any adjustments correctly recorded. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

163) As part of a routine external audit, auditors will gather a multitude and variety of audit evidence to corroborate and document their opinions and conclusions on the client's financial statements. Which of the statements below are correct with respect to audit evidence? A) Auditors must gather sufficient audit evidence, meaning that the more evidence the auditor is able to gather, the less likely a material misstatement will be missed. The quantity ultimately collected is a matter of professional judgment. B) A general rule of thumb for audit evidence is that as the risk of material misstatement increases, the amount of audit evidence the auditor will typically collect will decrease. C) Audit evidence may be considered as more appropriate when it is obtained from internal as opposed to external sources, and is less susceptible to management bias. D) Persuasive audit evidence pertains to the idea that the evidence the auditor has gathered is considered to be both appropriate and sufficient for the auditor to reasonably draw a conclusion. Answer: A, D Explanation: Auditors must gather sufficient audit evidence, meaning that the more evidence the auditor is able to gather, the less likely a material misstatement will be missed. The quantity ultimately collected is a matter of professional judgment. Persuasive audit evidence pertains to the idea that the evidence the auditor has gathered is considered to be both appropriate and sufficient for the auditor to reasonably draw a conclusion. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

164) Janice Co. external auditors are currently performing the audit of SunnySide Company, a retailer that specializes in antique furniture. The lead partner assigned to the engagement along with the senior audit managers are discussing the different types of audit evidence that should be collected in order to form an opinion on the financial statements. Which of the following statements made by the staff assigned to this audit are correct with respect to audit evidence? A) If we collect enough evidence to support each assertion we want to audit, there will be no problems in issuing a clean audit opinion for this client. B) We should use the internal audit staff to collect audit evidence pertaining to areas of higher risk, as they are more familiar with the company than we are. C) We should not think of the quantity of audit evidence as achieving a certain number or threshold of documents, but rather when the auditor feels as though enough support has been gathered to support a particular assertion. D) Areas where information is more susceptible to management bias may be less reliable; we should either collect more evidence in this area and/or attempt to obtain higher quality evidence. Answer: C, D Explanation: We should not think of the quantity of audit evidence as achieving a certain number or threshold of documents, but rather when the auditor feels as though enough support has been gathered to support that particular assertion. Areas where information is more susceptible to management bias may be less reliable, we should either collect more evidence in this area and/or attempt to obtain higher quality evidence. Diff: 3 LO: 2 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

165) As part of an external audit, auditors perform a variety of procedures in order to document their opinions and conclusions on the fair presentation of a client's financial statements. Which of the statements below are correct with respect to types of procedures that auditors may perform, and the reason for performing them? A) As part of an external audit, auditors will likely test a client's system of internal controls. Internal control refers to the controls a client has put in place to maintain effective and efficient operations. B) An auditor may perform a recalculation procedure. An example of this could be an auditor footing the totals in a client spreadsheet to ensure numerical accuracy. C) An auditor may send a confirmation to one of the client's banks. This procedure allows the auditor an opportunity to independently execute procedures or test controls that were designed by the client. D) An auditor may choose to perform a reperformance procedure which involves the auditor requesting balance information from a client's bank or verification of an amount owed to the client by a third party. Answer: A, B Explanation: As part of an external audit, auditors will likely test a client's system of internal controls. Internal control refers to the controls a client has put in place to maintain effective and efficient operations. An auditor may perform a recalculation procedure. An example of this could be an auditor footing the totals in a client spreadsheet to ensure numerical accuracy. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

166) The audit partners and senior audit managers of Frame Auditing Co. are meeting to discuss a client they have recently accepted, Murky Inc. Murky Inc. is a distributor of sheet metal throughout the continental United States, and the auditors have determined from an initial client meeting that inherent risk is likely to be higher in this audit. The meeting has been convened to discuss the types of audit procedures to be conducted in order to ensure an appropriate opinion is issued on the financial statements. Which of the following statements would represent prudent recommendations pertaining to audit procedures for this client? A) As the client is viewed by the auditor as representing higher inherent risk, Frame Auditing Co. is likely to send positive confirmations if employing a confirmation procedure. B) To verify and audit quantitative documents such as invoices and spreadsheets, Frame Auditing Co. will likely perform a reperformance procedure to check for quantitative accuracy in documents and records. C) Frame Auditing Company may choose to invest significant resources upfront in inquiry procedures in order to fully understand where the areas of higher inherent risk may be. D) Frame Auditing Company is likely to defer areas of higher risk to Murky Inc's internal audit function and adopt a reliance strategy. Answer: A, C Explanation: As the client is viewed by the auditor as representing higher inherent risk, Frame Auditing Co. is likely to send positive confirmations if employing a confirmation procedure. Frame Auditing Company may choose to invest significant resources upfront in inquiry procedures in order to fully understand where the areas of higher inherent risk may be. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

167) During the course of any external audit, the auditors must think carefully about whether they are able to rely on the work of others, and if so, to what extent. Which of the following statements is true with respect to auditors relying on the work of third parties? A) Auditors should routinely attempt to rely on the work and procedures of third parties during an audit, as doing so decreases the cost of the audit and helps make the auditor more competitive. B) Auditors may sometimes need to retain the services of a specialist to assist in certain areas of the audit. This may be true for audit clients in very specialized industries. C) Per Generally Accepted Auditing Standards, it is permissible for the external auditor to presume the competence, independence, and objectivity of staff employed in the internal auditing function. D) If the auditor will need to rely on a specialist for assistance with certain parts of the audit, the auditor should take all necessary steps to ensure the specialist is competent, capable and that his or her work is reliable. Answer: B, D Explanation: Auditors may sometimes need to retain the services of a specialist to assist in certain areas of the audit. This may be true for audit clients in very specialized industries. If the auditor will need to rely on a specialist for assistance with certain parts of the audit, the auditor should take all necessary steps to ensure the specialist is competent, capable and that his or her work is reliable. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

168) McKee external auditors are beginning the audit of Star Enterprises, a wholesaler and national distributor of copper piping and tubing across the United States and Canada. The audit partners assigned to the engagement along with top management of Star Enterprises are discussing the staffing of the audit and what reliance, if any, the external auditors will have on third parties. Which of the following statements are correct with respect to assignment of duties to third parties? A) Top management has requested that the auditor rely on the work performed by the internal audit function to the greatest extent possible in order to lower the cost of the audit. B) The partners of the auditing firm have advised that they will be hiring specialists to perform inventory valuation calculations, and that they will hire the specialist to do this work. C) Management have requested that the external auditors rely on the work of another external auditor from a separate accounting firm with respect to the audit of a subsidiary firm owned by Star Enterprises. Management has advised there is no need to check the credibility of this auditor as they have been a client of this auditor for many years. D) The manager of the internal audit function advises that his department will assist the external auditors in gathering of information, and will perform any work requested by the external auditors. Answer: B, D Explanation: The partners of the auditing firm have advised that they will be hiring specialists to perform inventory valuation calculations, and that they will hire the specialist to do this work. The manager of the internal audit function advises that his department will assist the external auditors in gathering of information, and will perform any work requested by the external auditors. Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

169) Auditing standards require auditors to maintain a record of procedures performed, evidence obtained, and the conclusions that were reached as part of the audit. Which of the following statements are true pertaining audit documentation gathered? A) Auditors generally maintain client information pertaining to multiple years and audits in a permanent file. B) Auditors maintain audit information and documentation gathered as part of a current year's audit in the current file, which may contain tests of controls and evidence gathered. C) Auditors typically maintain a copy of the engagement letter, potential fraud risks, and an assessment of materiality in the current audit file. D) Most audit working papers are likely to be contained electronically, with files backed up in a secure location. Answer: A, B, D Explanation: Auditors generally maintain client information pertaining to multiple years and audits in a permanent file. Auditors maintain audit information and documentation gathered as part of a current year's audit in the current file, which may contain tests of controls and evidence gathered. Most audit working papers are likely to be contained electronically, with files backed up in a secure location. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

170) DayGlow Auditing Firm is performing the external audit of Moon Enterprises, Inc. Moon Enterprises is a retailer of astronomical equipment including telescopes and star charts. The current audit represents the third year that DayGlow Auditing Firm has provided external auditing services to Moon Enterprises, Inc. One of the audit managers assigned to the audit is attempting to locate information needed for the current year's audit. Which of the following statements are accurate with respect to the location of the needed audit information? A) The audit manager is most likely to find documentation pertaining to details of the board of directors and minutes from board meetings in the current file. B) Documents pertaining to lease obligations are most likely to be obtained by consulting the current audit file. C) The audit manager is most likely to find information and documentation pertaining to the use of specialists in the current audit file. D) The audit manager is most likely to learn of any documented deficiencies in internal control by consulting the current file. Answer: C, D Explanation: The audit manager is most likely to find information and documentation pertaining to the use of specialists in the current audit file. The audit manager is most likely to learn of any documented deficiencies in internal control by consulting the current file. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

171) During the audit of Lake Enterprises Inc., a retailer of fine jewelry, a question has been raised by one of the audit seniors pertaining to auditing the valuation assertion of the inventory accounts associated with the client. The audit manager is approaching you, the audit partner with overall responsibility for the engagement, to request assistance with this area of the audit. As you have overall responsibility for the engagement and will ultimately sign the audit report on behalf of your firm, the best response would be ________. A) to advise the audit manager that due to the specialized nature of the inventory accounts and the large balances involved, this area of the audit would be better handled by the internal audit function B) to determine if due to the specialized nature of the inventory, an appropriate and prudent course of action might be to contact management and request the services of a valuation specialist C) to independently employ the services of a valuation specialist who is competent and qualified to accurately value the inventory in question and assist with the valuation assertion D) to independently employ the services of a valuation specialist who is familiar with the inventory and can appropriately appraise the inventory value, to assist in auditing the existence assertion Answer: C Explanation: To independently employ the services of a valuation specialist who is competent and qualified to accurately value the inventory in question and assist with the valuation assertion. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

172) Jones External Auditors are currently working on the audit of Star Enterprises, Inc. Star Enterprises is a large nationwide retailer of party supplies and sells largely on generous credit terms. During a monthly audit meeting among the audit partner assigned to the engagement and the audit managers, the question has arisen about the large balances in accounts receivable for this client. Which of the following would be the most prudent course of action in auditing the accounts receivable account? A) Jones auditors should pay close attention to auditing the cutoff assertion of accounts receivable to ensure that the net realizable value of accounts receivable and associated allowance is realistic. B) The most likely course of action would be for Jones to consult with the client's internal audit function and request they audit all outstanding accounts receivable balances due to their increased familiarity with the client's major customers. C) Jones auditors will be primarily concerned with auditing the existence assertion of accounts receivable and the occurrence assertion relating to the revenue generation that preceded it. D) For liability reasons, Jones is most likely to advise Star Enterprises' senior management that it is not possible to effectively audit accounts receivable, and will issue a qualified audit opinion accordingly. Answer: C Explanation: Jones auditors will be primarily concerned with auditing the existence assertion of accounts receivable and the occurrence assertion relating to the revenue generation that preceded it. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

173) While completing the external audit of Greenfield Inc., a distributor of luxury pools and hot-tubs in the southeastern United States, the external auditors, Coopers Auditing LLC, are determining the most appropriate course of action to effectively audit the inventory account for the client and check any associated assertions. Various suggestions have been put forth by the staff assigned to the audit with respect to how they feel this could be best handled. The most likely and prudent course of action for Coopers' staff would be ________. A) to focus the audit time and allotted hours on auditing the cutoff and disclosure assertions for the inventory accounts to ensure that balances are fairly and accurately presented. If so, the auditors will be in a position to issue a clean audit opinion on the financial statements B) to spend the audit hours assigned to this area of the audit focusing on the existence and valuation assertions, to ensure that the inventory exists and is appropriately valued. If this is not the case, the auditors can disclaim an opinion on the financial statements C) to request that the internal audit function handle this area of the audit, as staff working in the internal audit function are more likely to be familiar with whether or not the inventory is accurately and appropriately valued D) to request written assurances from top management which can be added to the current years' audit file, confirming that inventory classifications and account balances are correct. If such assurances can be obtained, the auditors will be able to decrease the cost of the audit Answer: B Explanation: To spend the audit hours assigned to this area of the audit focusing on the existence and valuation assertions, to ensure that the inventory exists and is appropriately valued. If this is not the case, the auditors can disclaim an opinion on the financial statements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

174) Tabletop External Auditors are in negotiations with a potential new audit client, FishTank Industries, Inc. FishTank Industries supplies specialty fish, aquariums and related supplies to markets throughout the United States. During an initial meeting, the senior audit staff who would be assigned to the engagement are discussing assertions and deciding which assertions might apply to this account, and why. The best example of assertions that might apply to FishTank Industries, Inc. are ________. A) assertions pertaining to account balances, to ensure that the balances themselves are presented in a fair and transparent manner, and assertions pertaining to events to ensure that ending balances are accurate and reflect all transactions that have occurred during the period B) assertions pertaining to transactions and classes of events for the audit period in question. Examples of such assertions could be occurrence and completeness pertaining to whether recorded transactions actually occurred and whether all transactions have been recorded C) assertions that relate to accuracy to ensure that transactions have been recorded at the appropriate amounts, and also that transactions that occurred in the period have been recorded in the proper accounts D) None of these answer choices are correct. Answer: B Explanation: Assertions pertaining to transactions and classes of events for the audit period in question. Examples of such assertions could be occurrence and completeness pertaining to whether recorded transactions actually occurred and whether all transactions have been recorded. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

175) During the audit of Jackson LLC, Brand External auditors are determining what audit evidence will need to be collected to support the assertions being tested as part of the audit and corroborate assertions made by management that are implicit within the financial statements. Which of the following statements most accurately describes the types, and importance of, audit evidence likely to be collected as part of the audit? A) Audit evidence, regardless of the form it may take, is considered equally important and of equal weight in gathering evidence and corroborating assertions made by management. All audit evidence should be examined, evaluated, and documented accordingly. B) Audit evidence may take different forms and may be weighted differently in terms of its weight in supporting management assertions and helping the auditor to form a basis for an opinion on the financial statements. Audit evidence gathered should be sufficient to support the auditors' opinion on the financial statements. C) Generally accepted auditing standards require the auditor to only accept paper documents to support certain assertions and provide reliable evidence corroborating management's assertions contained in the financial statements. Electronic documents are more likely to be tampered with and/or forged than original paper documents. D) Audit evidence provided directly by the client is generally considered more reliable than audit evidence gathered externally and independently by the auditor. This type of evidence is considered more reliable as third parties may not have accurate and up-to-date balances pertaining to the client. Answer: B Explanation: Audit evidence may take different forms and may be weighted differently in terms of its weight in supporting management assertions and helping the auditor to form a basis for an opinion on the financial statements. Audit evidence gathered should be sufficient to support the auditors' opinion on the financial statements. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

176) The partners of Spring Auditing Company are discussing a current, ongoing audit for one of their clients, Slippery Slope Mining Company. Slippery Slope specializes in swimwear and other beach and pool products and has been a client of Spring Auditing Company for a number of years. The partners are discussing how much audit evidence will need to be gathered to support assertions relating to accounts receivable, which represent a large percentage of total assets. Which of the following choices would best represent assertions related to accounts receivable, and how much evidence might need to be gathered in order to corroborate such assertions? A) The auditors are most likely to check the cutoff and presentation and disclosure assertions related to accounts receivable and will most likely audit all accounts due to the high relative dollar amount, gathering a large amount of audit evidence in the process. B) The auditors will likely focus their audit time and resources on auditing the valuation and allocation and existence assertions to ensure that the receivables selected actually exist and are appropriately valued in the financial statements. How much audit evidence to gather will be determined by auditor judgment. C) The auditors will likely spend the majority of audit time and resources focusing on the occurrence and cutoff assertions to ensure that no notes receivable have been incorrectly classified as accounts receivable, and to ensure that all preceding revenue transactions that generated the accounts receivable occurred. D) The auditors will follow generally accepted auditing standards pertaining to how much audit evidence should be gathered for each account being audited, and will likely focus audit time and resources on the presentation and disclosure and occurrence assertions. Answer: B Explanation: The auditors will likely focus their audit time and resources on auditing the valuation and allocation and existence assertions to ensure that the receivables selected actually exist and are appropriately valued in the financial statements. How much audit evidence to gather will be determined by auditor judgment. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

177) A fellow audit partner is considering the most appropriate audit procedures to conduct in order to effectively audit a client's accounts receivable balance, and has come to you for advice and guidance. In particular, the auditor is interested in designing audit procedures to audit the existence and valuation assertions of accounts receivable. Which of the following recommendations would you be most likely to provide to the audit partner to effectively audit these assertions? A) A confirmation procedure to audit the existence assertion whereby positive confirmations are sent out to all clients with balances, and a vouching procedure whereby all accounts receivable balances are matched to the revenue transactions that initiated them. B) A matching procedure whereby the auditor matches all client accounts receivables with all client accounts payables in order to audit the valuation assertion and check for existence. This procedure will also enable the auditor to gather documentation pertaining to the valuation assertion. C) A confirmation procedure whereby the auditor attempts to positively confirm a selected sample of accounts receivables to audit the existence assertion, coupled with a further procedure to check that the sampled receivables are stated at their appropriate net realizable value in order to gather sufficient audit evidence to corroborate the valuation assertion. D) The best course of action for the external auditor to take in this scenario is to request the internal audit function mail negative confirmations to holders of large account receivable balances, and attempt to obtain written assurances from top management to place in the audit file confirming all accounts receivable are appropriately valued at their net realizable value. Answer: C Explanation: A confirmation procedure whereby the auditor attempts to positively confirm a selected sample of accounts receivables to audit the existence assertion, coupled with a further procedure to check that the sampled receivables are stated at their appropriate net realizable value in order to gather sufficient audit evidence to corroborate the valuation assertion. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

178) The senior staff of RedRoof External auditors are discussing the upcoming audit of Freon Enterprises Inc., a distributor of gasoline and liquid petroleum products through the Northeastern United States. An issue of contention has arisen with respect to what type of audit evidence would be most reliable, as during the previous year's audit, an inexperienced audit junior inadvertently gathered information which ultimately provided to be unreliable in supporting some assertions related to accounts payable. In order to ensure that the information gathered in this year's audit is as reliable as possible, the auditors will ________. A) request that all information is gathered by the internal audit function, to whom authority for auditing selected accounts payable balances will be delegated. The internal auditors increased familiarity with the client and associated payables will strengthen the reliability of audit evidence B) select a sample of accounts payable and attempt to independently and externally verify and corroborate outstanding balances, as well as documenting procedures conducted to verify the effectiveness of the client's internal controls over accounts payable C) select a sample of outstanding accounts payable balances and attempt to trace these balances back to the revenue transactions that preceded them, as well as conducting procedures to confirm the effectiveness of the client's internal controls over accounts payable D) attempt to confirm the authenticity of all outstanding accounts payable balances by requesting written assurances from senior management that all outstanding accounts payable are listed in the liabilities section of the balance sheet, and confirm that the client has the appropriate controls in place to ensure no accounts payable have inadvertently not been included Answer: B Explanation: Select a sample of accounts payable and attempt to independently and externally verify and corroborate outstanding balances, as well as documenting procedures conducted to verify the effectiveness of the client's internal controls over accounts payable. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

179) If the current year accounts receivable are larger than last year but the allowance for doubtful accounts is the same, what account should be carefully audited and why? Answer: If the current year accounts receivable are larger than last year but the allowance for doubtful accounts is the same, the collectability of accounts receivable is of concern. The allowance for doubtful accounts may be understated, and/or the bad debt expense may be understated as well. Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 180) What are some challenges in establishing an internal control system in a small business? Answer: Internal control challenges in small business would include: A. Separation of functional responsibilities would be difficult because of the small number of employees. B. The owner manager has to assume a greater role to oversee and supervise authorization, recordkeeping, and custodial functions. C. The owner manager must be diligent, competent, and have a high degree of integrity Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 181) As per GAAS, auditors are required to obtain a sufficient understanding of an entity's internal control. Does this mean that auditors should always try to obtain enough evidence to assess control risk below the "maximum" level? Explain. Answer: Auditors do not always have to obtain enough evidence to assess control risk below the "maximum" level. There may be occasions when the audit team chooses to test everything substantively rather than relying on internal controls to reduce substantive testing. For example, for fixed assets, there are usually a small number of very material transactions. Testing controls would not be efficient if the audit team is going to examine every transaction anyway. Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

182) A group of senior audit managers is discussing the upcoming audit of a prominent audit client, specifically the procedures that will be used by the auditor to obtain the necessary and sufficient audit evidence required to form an opinion on the client's financial statements. The managers are discussing the various types of procedures that could be employed. Which of the following statements best and most accurately describes the types of procedures the auditor could perform? A) The auditors are likely to begin the audit with tests of controls which will assist the auditor in understanding more about the client and the industry in which the client operates etc. The auditor will also likely perform substantive procedures in order to verify a sample of the client's transactions and account balances. B) The auditor will likely begin the audit with substantive procedures which may involve tests of details and substantive analytical procedures. The results of these procedures will assist the auditor in determining which of the client's internal controls are operating effectively and which should be audited. C) The auditor is likely to begin the audit with risk assessment procedures to assist in gaining an understanding of the client and it's industry. These procedures are likely to be followed by tests of controls to determine how effective the client's system of internal control is and then substantive procedures to test for material misstatements at the assertion level. D) All of these answer choices represent types of procedures the auditor may choose to perform in auditing this client. Answer: C Explanation: The auditor is likely to begin the audit with risk assessment procedures to assist in gaining an understanding of the client and it's industry. These procedures are likely to be followed by tests of controls to determine how effective the client's system of internal control is and then substantive procedures to test for material misstatements at the assertion level. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

183) StraightRoad external auditors are currently working on the audit of DryWall LLC, a national provider of building equipment and supplies to wholesalers and distributors through the eastern United States. Drywall LLC is a large company with decentralized operations and locations in order to serve its clients who are typically regional building firms throughout the country. The individual responsible for Drywall's internal audit function has recently apprised StraightRoad auditors that a number of recent compliance and operational audits have uncovered problems with accuracy and record keeping. Based on these factors, StraightRoad is most likely to adopt ________. A) a reliance strategy on the internal audit function, basing the audit findings in this area on the work of the internal auditors, whom they will also request audit the client's system of internal control B) procedures whereby inspection of lease agreements, deeds, and titles are performed in order to gather evidence for assets the external auditor is unable to view physically, and procedures to test the client's system of internal control to assess its effectiveness and where applicable, provide recommendations to correct C) risk assessment procedures in order to fully understand the client and the industry in which the client operates due to its decentralized nature, along with substantive procedures to test the system of internal control the client has in place D) procedures to test the client's system of internal control to ensure its operating effectiveness and provide recommendations where necessary, along with vouching procedures where the auditor will select sample documents and work forward to corroborate the transactions generated by these documents Answer: B Explanation: Procedures whereby inspection of lease agreements, deeds, and titles are performed in order to gather evidence for assets the external auditor is unable to view physically, and procedures to test the client's system of internal control to assess its effectiveness and where applicable, provide recommendations to correct. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

184) Harry and Emily, two senior audit managers assigned to the same client are discussing vouching procedures. Harry, a newer and less experienced auditor is trying to understand exactly what vouching is, and what it entails. Emily has explained to Harry that for the client they are preparing to audit, vouching will be a common procedure. Emily explains to Harry that the best way for him to understand the procedure is by way of an example. Which of the following choices best describes the example of vouching Emily should use? A) Vouching can be used to audit the existence of an accounts receivable balance and the occurrence of the revenue transaction or transactions that preceded it. B) Vouching can be used to audit the occurrence of an accounts receivable balance and the existence of the purchase transaction that preceded it. C) Vouching is typically used to confirm balances in quantitative documents such as spreadsheets, and represents a way of ensuring the mathematical accuracy of such documents. D) Vouching can be used to corroborate the existence of an accounts payable balance with the revenue transaction or transactions that preceded it. Answer: A Explanation: Vouching can be used to audit the existence of an accounts receivable balance and the occurrence of the revenue transaction or transactions that preceded it. Diff: 3 LO: 3 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

185) Ainsley and Harriot, both recent college graduates and newly hired employees at a large auditing firm are discussing audit procedures used to obtain assurance from third parties associated with the client. Ainsley and Harriot's supervisor advises them that they are referring to confirmations, and that there are different types and that they are sent for different reasons. They ask the supervisor to elaborate on confirmations and situations where these confirmations might be used. The supervisor's best response to this inquiry would be ________. A) to advise that positive confirmations are typically used for clients considered to be of lower inherent risk, and that confirmations are considered most secure when the auditor is able to control the process from beginning to end B) to explain that negative confirmations are often used to confirm bank balances and amounts on deposit at other lending institutions, and positive confirmations are typically used to confirm accounts receivable and payable balances C) to explain that external confirmations are more likely to be used for a higher risk client, with positive confirmations more likely to be sent to customers whose balances the auditor thinks may be in dispute D) that the most common type of confirmation sent by the auditor is an accounts receivable confirmation, whereby the third party is asked to confirm amounts that the client owes the third party Answer: C Explanation: To explain that external confirmations are more likely to be used for a higher risk client, with positive confirmations more likely to be sent to customers whose balances the auditor thinks may be in dispute. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

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186) Latisha, a recent college graduate has just begun work with a large auditing firm and has been assigned a mentor; a much more experienced auditor with many years of experience. While they are sitting at lunch one day, Latisha notes that while the auditing firm is large and has many people with many different skillsets and talents working for it, she does not understand how they have the personnel to effectively audit their wide breadth of clients. In responding to this inquiry, her mentor's best response is ________. A) that the auditing firm carefully selects its audit and attestation clients to make sure that these clients only operate in industries in which the auditor is proficient in auditing. This approach helps to minimize problems and litigation B) that auditors often rely on the work of specialists to audit certain accounts and balances that they may not have the expertise to effectively audit. The auditor will typically control the appointment of the third party specialist C) that if the audit team assigned to the audit of a particular client can refer back to their knowledge and experiences from prior audits of the same client, then a specialist is required to corroborate any conclusions drawn by the audit team D) that generally accepted auditing standards require that auditors retain the services of specialists for any accounts and/or balances that they do not have the expertise to audit, and defer the appointment decision of the specialist to the client's management Answer: B Explanation: Auditors often rely on the work of specialists to audit certain accounts and balances that they may not have the expertise to effectively audit. The auditor will typically control the appointment of the third party specialist. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

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187) Jones External Auditors are currently working on the audit of McKay Lumber Company; a provider of logging and timber services in the northwestern region of the United States. The audit partners with overall responsibility for the engagement have assigned an audit team to audit the client's current assets. It has been determined by this team that collectively they do not have the necessary skills or expertise to effectively audit the client's inventory accounts. As a result of this finding, the partners in charge of the audit are likely to ________. A) convene to discuss this matter, and attempt to retain the services of a specialist with the necessary skills and experience to objectively provide the information needed to assist the auditors in auditing the assertions related to the inventory account B) convene to discuss this matter, and request that the client's management attempt to retain a specialist firm to assist with the audit of the inventory account, who can objectively and accurately determine if balances and valuations associated with the inventory account are accurate C) attempt to find a specialist who is completely independent of the client's management, who is able to confirm that inventory balances are accurate and can train the auditors staff in such procedures D) issue a qualified opinion if the inventory balances represent a small percentage of total assets, and a disclaimer of opinion of they represent a large percentage of total assets Answer: A Explanation: Convene to discuss this matter, and attempt to retain the services of a specialist with the necessary skills and experience to objectively provide the information needed to assist the auditors in auditing the assertions related to the inventory account. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

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188) Bruce, a recent hire to a medium sized auditing firm is currently about to begin his first audit, a large multinational firm with operations across the globe. Alan, Bruce's supervisor has explained to Bruce that the client has a proficient and well-staffed internal audit function. Bruce asks Alan to elaborate on the duties of this internal audit function, and also wants to know why a firm with an internal audit function needs the assistance of an outside auditing firm. Alan's best response to these inquiries is ________. A) to advise that the internal audit function are not licensed auditors, and that as a result, their audits do not provide the necessary level of assurance for the client when issuing stock, obtaining bank loans etc. B) to explain that the internal audit function assists the client with audits of operations, efficiency, and compliance, but are required by generally accepted auditing standards to have an independent third party examine and corroborate their work C) to advise that the internal audit function's value comes in helping the client stay efficient, compliant and in many cases, competitive, but that an external audit is still needed because the internal auditor may struggle to be objective and impartial D) to explain that the internal audit function assists the client with many internal audits and other functions, but the most important duty of the internal audit function is assessing the competence and objectivity of the external auditors Answer: C Explanation: To advise that the internal audit function's value comes in helping the client stay efficient, compliant and in many cases, competitive, but that an external audit is still needed because the internal auditor may struggle to be objective and impartial. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

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189) A few new employees of BlueSky Auditing Firm are at lunch, and are discussing the internal audit function of a client they are soon to begin auditing, in particular the strengths and weaknesses they perceive might make this function stronger or weaker relative to the client they work for. Which of the following best represents a strong internal audit function which would be considered objective and reliable by the external auditors? A) A medium sized client employs staff in an internal audit capacity. Currently, the head of the internal audit function reports directly to the Chief Financial Officer due to an organization restructure. B) A large audit client possesses an experienced internal audit function. The client firm has enacted policies to ensure as best as possible that no member of the internal audit function is placed in a situation where a conflict of interest may occur. C) A smaller auditing client maintains a small and limited internal audit function. Several members of the internal auditing function also operate in other roles within the company due to its small size. D) A medium size auditing client maintains a reasonably large and independent internal audit function. The board of the client are attempting to pass motions to allocate more funds to this function, which is currently considered to be underfunded. Answer: B Explanation: A large audit client possesses an experienced internal audit function. The client firm has enacted policies to ensure as best as possible that no member of the internal audit function is placed in a situation where a conflict of interest may occur. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 190) Compare and contrast the various roles of the members of an audit team. Answer: The senior and associates perform the detail testing under the supervision of the manager. The partner holds ultimate responsibility for audit decisions, supervision of the team members, and the issuance of the final audit report. Throughout the engagement as audit procedures are completed and documented, they are reviewed by an audit team member with seniority over the team member who did the work. Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: AC: Reporting

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191) Describe a situation in which an auditor may wish to use the work of a specialist. Answer: Student answers will vary. Some examples of when a specialist may be used include estimating oil and mineral reserves for inventory reporting and performing actuarial calculations for the determination of employee benefit plan liabilities. Specialists may also be used to evaluate the quality of inventory, such as taking samples of grain from a grain elevator to determine if the grain has any bacteria or other attributes that could affect its quality. Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: AC: Reporting 192) You are on the audit of Specialty Wines, Inc. and have determined a vintner is needed to assess the quality and value of wine stocks. Explain how you can assess the competence, capability, and objectivity of the specialist. Refer to the AU-C section that covers using the work of a specialist. Answer: Student answers will vary. In general, they should touch on the following: Competence refers to the expertise of the specialist. What are the qualifications of the specialist? Does he or she maintain a license or certification in a relevant field? How many years of experience does the specialist have in the relevant field? Capability refers to the ability of the specialist to perform the required work. For example, does the specialist have the time and resources needed to complete the work? Is the specialist located in the area or will significant travel be required? Objectivity refers to the possible effects that bias, conflicts of interest, or the influence of others may have on the professional judgement of the specialist (AU-C 620.A15). Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: AC: Reporting

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193) You are the audit manager on the audit of Tutoring Services, Inc. Tutoring Services, Inc. has an internal audit department. In your evaluation of the objectivity and competence of the internal audit department, you determine the following: The internal auditors report directly to the CFO. One of the six members of the internal audit department is a Certified Internal Auditor. Five of the six members of the internal audit department have less than two years of experience. The internal audit manager often helps out with the month end closing process, in order to maximize efficiency. Determine whether or not the audit department can be objective and competent. Provide details to support your determination. Answer: Factors that impact objectivity of internal auditors: • Report directly to the board of directors, audit committee, or owner-manager • No assignment of managerial or operational duties that are outside of the internal audit function • Policies prohibiting internal auditors from auditing areas where relatives are employed or areas where the internal auditor was previously assigned before moving to the internal audit function • Internal auditors are members of a professional body that obligates compliance with professional standards regarding objectivity Factors that impact competence of internal auditors: • Technical training and proficiency that may be evidenced by education, years of experience, and professional certification in a relevant field • Membership in relevant professional bodies that require compliance with professional standards and continuing professional education • Appropriate staffing relative to the size of the entity • Established policies for hiring, training, and assigning internal auditors • Quality of work documentation and reports The internal audit department is most likely not objective nor competent based on the descriptions above. Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management

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194) When auditing Elegant Jewelry Designs, Blumeray, CPA was not familiar with the quality and cut of the company's precious jewel inventory. To address this shortcoming, Blumeray hired Gannet, an expert in jewel valuation, to assist in the inventory valuation. Should Blumeray refer to Gannet's work in the audit report? Answer: The auditors' report should mention the use of the specialist only when the specialist's findings affect the auditors' conclusions. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Analytic AICPA: AC: Risk Assessment, Analysis and Management 195) You are the audit senior on the Pizza Now audit. You have been assigned to work with a new intern. The intern is unfamiliar with the format and composition of audit working papers. Prepare a memo for the intern that discusses the purpose of the working papers and identifies the items generally included in an audit working paper. Answer: Student answers will vary, but should cover the following: AU-C 230 Audit Documentation and AS 1215 Audit Documentation require auditors to document each stage of the audit in their working papers to provide a record of work completed and evidence gathered in forming their audit opinion. An audit working paper generally includes: o client name o period under audit o title describing the contents of the working paper o file reference indicating where the working paper fits in the audit file o initials identifying the preparer of the working paper together with the date the working paper was prepared o initials identifying the reviewer(s) of the working paper together with the date(s) the working paper was reviewed o cross-referencing between working papers indicating where further work and evidence is summarized elsewhere. Working papers are used to document the details of each audit. The two main files held for each client are the permanent file and the current file. Diff: 3 LO: 5 Bloom: Synthesis Min: 1 AACSB: Analytic AICPA: AC: Reporting

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196) Steven, an audit partner assigned to the attest engagement for Candle Enterprises is examining samples of the evidence that has been obtained by the audit staff that worked on the engagement. Before signing off on the audit and issuing a clean opinion, Steven is required by company policy to review samples of documents and other working papers to ensure accuracy etc. With respect to the current year's audit file that Steven is reviewing, it would be fair to say that ________. A) any member of the audit engagement team should be able to look through the file and at the evidence gathered and agree with the opinion formed and issued by the partner assigned to the engagement B) any member of any regulatory body or enforcement agency should be able to examine the audit evidence gathered and agree with the auditors opinion on all aspects of the audit C) any experienced and seasoned auditor not attached to or part of the audit should be able to examine the audit evidence gathered and understand the conclusions that were reached as part of the audit D) any other partner assigned to the same office as the audit partner completing the engagement must be able to review the work completed and agree that absolute assurance is appropriate in this case Answer: C Explanation: Any experienced and seasoned auditor not attached to or part of the audit should be able to examine the audit evidence gathered and understand the conclusions that were reached as part of the audit. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

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197) Sam and Dave, two new employees of an auditing firm are discussing the topic of audit evidence at lunch one day. Sam has expressed concerns to Dave that he is unsure as to when enough evidence will have been collected to appropriately document and support any part of the audit. Sam is concerned that he may inadvertently not collect enough evidence and may cause problems for himself and the firm if he doesn't. Sam asks Dave what his thoughts are on how much audit evidence it is appropriate to collect. Dave's best response to this question is to ________. A) advise that as new employees, the question of how much evidence to collect is not really something they should concern themselves with. Instead, their supervisors will determine this and will advise them accordingly B) explain that there is no answer to this question that will be correct in all cases. It is more likely that the amount of evidence to be collected will vary by client and will depend on the procedures conducted, how persuasive the evidence collected is, and how much judgment the auditor is using C) advise that generally accepted auditing standards lay down clear and strict rules on how much evidence must be gathered in each audit and for each account, so they will simply need to adhere to these standards D) explain that the audit partner with overall responsibility for the audit will have set rules and standards as to how much audit evidence should be collected for each account and assertion, and that this document will be contained in the permanent file, so they should consult that Answer: B Explanation: Explain that there is no answer to this question that will be correct in all cases. It is more likely that the amount of evidence to be collected will vary by client and will depend on the procedures conducted, how persuasive the evidence collected is, and how much judgment the auditor is using. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

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198) Two college students, Ricky and Maria are leaving their audit class for the day. As they walk across campus, they begin discussing the lecture the professor had given on the various documents collected by the auditor and the differences between the permanent file and current year's audit file. Ricky asks Maria to explain the differences in more detail, as he wasn't fully understanding why there was a need for these two different files. Maria's most appropriate response to this question would be ________. A) to explain that there isn't a great deal of difference between the permanent file and current year's audit file, and that some firms just use a permanent file to store all important documentation related to the audit B) to advise that the current year's audit file is typically used to store information that is less likely to change from year to year, such as copies of long-term contracts and agreements, and the minutes of board of directors meetings C) to explain that the permanent file is typically used to store items that are less likely to change from year to year, such as significant accounting policies and prior year's financial statements D) to advise that the key difference between the two files was that the current year's audit file is used, per generally accepted auditing standards, to store all key communications with management Answer: C Explanation: To explain that the permanent file is typically used to store items that are less likely to change from year to year, such as significant accounting policies and prior year's financial statements. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

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199) Jane and Sandra, two audit staff associates, have been assigned to the audit of QuickSilver, Inc., a distributor of sand and building materials throughout the southeastern United States. One morning, they are reviewing the current year's audit file and notice that some documents appear to be missing. They are unable to locate a copy of the engagement letter or the minutes of last year's board of directors meeting, which the partner has requested for review. Which of the following represents Jane and Sandra's most appropriate response to this? A) To contact the audit partner requesting the documents and explain that they are missing and that he or she should consult the permanent file as they must be in there. B) To contact senior management of the client and request copies of these documents, to add back into the audit file and furnish to the partner requesting them. C) To advise the partner requesting the documents that the minutes of the board of directors meetings should be located in the permanent file, and that they will institute a search for the missing engagement letter. D) Per generally accepted auditing standards, and as part of any external audit, missing documents must be reported to both the client's management and the PCAOB within seven business days. Answer: C Explanation: Advise the partner requesting the documents that the minutes of the board of directors meetings should be located in the permanent file, and that they will institute a search for the missing engagement letter. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

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200) Compare and contrast the permanent file and the current file. Provide at least three examples of the types of documentation found in each. Answer: Student answers will vary but should contain the following: The permanent file includes client information and documentation that applies to multiple audits. The current file is developed as audit work is performed and includes client information and documentation that apply to the current year's audit. The permanent file usually contains the client's head office address, other locations, and contact details (telephone, fax and email). Key personnel are detailed, and an organizational chart is included in the permanent file. A client's organizational chart includes details of key roles within the organization and the names of the people in those roles. The file may also include the details of the client's bank(s) and lawyer(s). The permanent file includes copies of long-term contracts and agreements. The permanent file includes details of the client's board of directors and its subcommittees, such as the audit committee. The file includes the minutes of significant meetings held by the client, such as its board of directors' meetings. It may include details of bonus and stock option plans for the client's senior staff. The permanent file details a client's primary accounting policies and methodologies. Prior financial statements and audit reports will be included in the permanent file. Details of prior analytical procedures are included and added to so auditors can observe changing trends. Flowcharts and narratives detailing a client's system of internal controls are included in the permanent file and amended as needed during the risk assessment phase of each audit. Reports sent to the client during previous audits will be included in the permanent file. The current file includes the details of all testing and evidence gathered in preparation of the audit report. The current file also includes correspondence between the auditors and their client, the client's bankers, and the client's lawyers that pertain to the current audit period. Correspondence with other auditors, specialists and relevant third parties are also included. The engagement letter is included in the current file, along with the management letter, detailing any weaknesses uncovered in the client's system of internal control. The current file includes extracts from the minutes of meetings, such as the board of directors' meetings, which pertain to the current audit. The file includes details of the audit planning process and the audit program. The current file also includes detailed descriptions of evidence gathered, testing conducted, and audit procedures performed. It will detail the analytical procedures, tests of controls and detailed substantive testing undertaken, as well as the conclusions drawn at the completion of testing. The current file includes testing of any subsequent events and a copy of the final audit opinion. Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: AC: Reporting © (2022) John Wiley & Sons, Inc. All rights reserved. Instructors who are authorized users of this course are permitted to download these materials and use them in connection with the course. Except as permitted herein or by law, no part of these materials should be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise. 112

Auditing, 2e (Johnson) Chapter 6 Gaining an Understanding of the Client's System of Internal Control 1) An integrated audit refers to the audit of the financial statements as well as the system of internal control. Answer: TRUE Explanation: An integrated audit refers to the audit of the financial statements as well as the system of internal control. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 2) The most commonly accepted global auditing framework for internal control is the integrated framework developed by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Answer: TRUE Explanation: The most commonly accepted global auditing framework for internal control is the integrated framework developed by the Committee of Sponsoring Organizations of the Treadway Commission. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 3) The control environment helps to set the foundation for effective internal control and provides discipline and structure. Answer: TRUE Explanation: The control environment helps to sets the foundation for effective internal control and provides discipline and structure. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

4) Entity-level controls are controls that affect a particular transaction or group of transactions. Answer: FALSE Explanation: Transaction-level controls are controls that affect a particular transaction or group of transactions. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 5) Management, with the oversight of the internal control department, selects and develops control activities to assure that the entity achieves its objectives. Answer: FALSE Explanation: Management, with the oversight of the board of directors, selects and develops control activities to assure that the entity achieves its objectives. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 6) A shipping document which serves as acknowledgement of receipt of goods for delivery by a freight carrier is referred to as a bill of lading. Answer: TRUE Explanation: A shipping document which serves as acknowledgement of receipt of goods for delivery by a freight carrier is referred to as a bill of lading. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 7) An IT system that produces a transaction trail that is available for audit for only a short period of time is an example of an IT system risk. Answer: TRUE Explanation: An IT system that produces a transaction trail that is available for audit for only a short period of time is an example of an IT system risk. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 2

8) Flowcharts are a form of documenting internal controls in smaller and less complex organizations. Answer: FALSE Explanation: Flowcharts are a form of documenting internal controls in larger and more complex organizations. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 9) A deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness is referred to as a significant deficiency. Answer: TRUE Explanation: A deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness is referred to as a significant deficiency. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 10) The management letter prepared by the auditor should only discuss internal control related issues discovered during the audit. Answer: FALSE Explanation: The management letter discusses internal control weaknesses and other matters discovered during the course of the audit. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

11) What does COSO define as a process effected by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of the objectives related to operations, reporting and compliance? A) Internal control B) Compliance C) Reporting D) Risk assessment Answer: A Explanation: Internal control is a process, affected by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of the objectives related to operations, reporting and compliance. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 12) One of the seventeen COSO principles of internal control states that "the organization holds individual accountable for their internal control responsibilities in the pursuit of objectives." To which component of internal control does this principle belong? A) Control Environment B) Risk Assessment C) Control Activities D) Information and Communication Answer: A Explanation: The principle that states that "the organization holds individual accountable for their internal control responsibilities in the pursuit of objectives" is part of the Control Environment component of internal control. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

13) The control environment ________. A) describes the auditor's system of internal control B) refers to both the financial statements of the client and the audit work being conducted C) sets the foundation for effective internal control, and provides discipline and structure D) speaks to the ability of the client to gain funding in capital markets Answer: C Explanation: The control environment also sets the foundation for effective internal control, provides discipline and structure. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 14) An integrated audit focuses on ________. A) integrating the internal and external audit functions B) auditing both internal control over financial reporting(ICFR) and the financial statements C) integrating component auditors D) comparing prior year results with the current year to look for abnormalities Answer: B Explanation: An integrated audit focuses on the audit of both internal control and the financial statements. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 15) Internal control ________. A) relates only to a client's IT systems B) relates to the efficiency of the internal audit function C) is a very broad concept and can encompass all of the elements of an organization D) is unrelated to the audit Answer: C Explanation: Internal control is a very broad concept and encompasses all of the elements of an organization – its resources, systems, processes, culture, structure and tasks. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

16) The COSO Framework identifies three objectives of internal control that allow organizations to focus on the differing purposes of internal control. One of these is ________. A) client acceptance and continuance B) compliance objectives which pertain to adherence to laws and regulations to which the entity is subject C) internal control analysis D) risk of material misstatement Answer: B Explanation: One of the three identified objectives of internal control as identified by the COSO framework is compliance objectives. These pertain to adherence to laws and regulations to which the entity is subject. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 17) An effective and robust system of internal control ________. A) will guarantee that the entity will meet its objectives B) will eliminate all risks related to entity objectives C) can only provide an entity with reasonable assurance in achieving its financial reporting objectives D) should be carefully examined to see if the benefits outweigh the costs of providing such a system Answer: C Explanation: Internal control, no matter how effective, can only provide an entity with reasonable assurance in achieving its financial reporting objectives. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

18) Common inherent limitations in internal control include ________. A) ineffective understanding of the purpose of a control B) controls within a software system are never overridden C) no evidence or history of collusion within the organization D) top management agree as to the type and extent of system to implement Answer: A Explanation: Common inherent limitations in internal control include an ineffective understanding of the purpose of a control. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 19) Compensating controls are described as ________. A) controls that deal with monetary compensation for employees and contractors B) controls that compensate for another control's potential ineffectiveness C) controls that are determined to be redundant after analysis D) controls that have been determined by the auditor to be effective Answer: B Explanation: If potential errors are not investigated and corrected, the programmed control that flags items for review losses its effectiveness. These limitations of internal controls are often mitigated by other controls (often referred to as compensating controls). Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 20) The external auditor's primary concern should be ________. A) adequately controlling the entities operations and its financial reporting B) adequately supervising the internal audit function C) with the reporting objective and the operations objectives related to safeguarding of assets D) ensuring management is immediately made aware of any errors regardless of size Answer: C Explanation: Management, including those charged with governance, is concerned about adequately controlling the entities operations, its financial reporting, and its adherence to laws and regulations. The external auditor, on the other hand, is primarily concerned with the reporting objective and the operations objectives related to safeguard of assets. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 7

21) As per the COSO Framework, the operations objectives of internal control include ________. A) the safeguarding of assets against loss B) the adherence to laws and regulations C) reliability and timeliness D) timeliness and transparency Answer: A Explanation: As per the COSO framework, the operations objectives of internal control pertain to the effectiveness and efficiency of the entity's operations, including operational and financial performance goals, and safeguarding of assets against loss. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 22) As per the COSO Framework, one of the reporting objectives of internal control pertains to ________. A) reliability and transparency B) efficiency of the entity's operations C) adherence to laws and regulations D) safeguarding of assets against loss Answer: A Explanation: As per the COSO Framework, reporting objectives pertain to internal and external financial and non-financial reporting and may encompass reliability, timeliness, transparency, or other terms as set forth by regulators, recognized standard setters, or the entity's policies. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

23) Which of the following principles is within the control environment component of the seventeen COSO principles of internal control? A) The organization demonstrates a commitment to attract, develop, and retain competent individuals in alignment with objectives. B) The organization specifies objectives with sufficient clarity to enable the identification and assessment of risks relating to objectives. C) The organization identifies risks to the achievement of its objectives across the entity and analyzes risk as a basis for determining how the risks should be managed. D) The organization considers the potential for fraud in assessing the risks to the achievement of objectives. Answer: A Explanation: One of the principles within the Control Environment component of the seventeen COSO principles of internal control states that the organization demonstrates a commitment to attract, develop, and retain competent individuals in alignment with objectives. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 24) Martin and Keona, two new hires to Ace CPA firm are discussing the concept of internal control. Neither of them is sure that they fully understand what internal control is. Which of the following statements could best be used to describe internal control? A) Internal control can best be thought of as a system implemented by management to ensure that there are no misstatements whatsoever in the financial statements. B) Internal control can best be conceptualized as a system to help ensure management and the firm's owners that the firm is meeting its operational and financial objectives in an effective and efficient manner. C) Internal control is a system of governance implemented by a firm's management and the internal audit function which is designed to ensure no error or fraud exists within the firm. D) All of these answer choices are correct. Answer: B Explanation: Internal control can best be conceptualized as a system to help ensure management and the firm's owners that the firm is meeting its operational and financial objectives in an effective and efficient manner. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

25) During an auditing class at Youngblood State University, the professor is discussing some of the advantages to a firm of having a robust and effective system of internal control. Which of the following statements best describes some of these advantages? A) Firms with more robust and effective systems of internal control are likely to avoid litigation and enjoy lower costs of capital than rival firms. B) Firms that have effective and efficient systems of internal control are less likely to need an internal audit function, which can save the company money and increase their bottom line. C) Firms that have robust and effective systems of internal control are typically less prone to material misstatements in the financial statements. D) Firms that spend a lot of money on their internal controls and can prove their efficacy are subject to decreased SEC regulation. Answer: C Explanation: Firms that have robust and effective systems of internal control are typically less prone to misstatements in the financial statements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 26) Jamika and Bruce are staff associates working on the audit of Jackson Enterprises, a national distributor of plastics. Jamika recently overhead one of the audit managers discussing control risk with the partner assigned to the engagement, and has asked Steve if he knows what this means. What is Steve's best response to this question? A) Control risk relates to the risk that the auditing firm, having performed all necessary audit procedures, renders an inaccurate opinion on the financial statements. B) Control risk relates to the risk that the client's system of internal control may not prevent or detect errors from occurring in the clients operations and financial statements. C) Control risk speaks to the threat of future litigation arising from prior financial statements audits by the auditing firm. D) None of these answer choices are correct. Answer: B Explanation: Control risk relates to the risk that the client's system of internal control may not prevent or detect errors from occurring in the clients operations and financial statements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

27) Marjorie, a staff associate, is discussing the audit of Newberry Enterprises with her boss Claire, the audit manager assigned to the engagement. Marjorie has heard Claire discussing the term 'control environment' in meetings with the client, but is not exactly sure what this means. Which of the following is the best response in describing control environment to Marjorie? A) Control environment speaks to how well the client controls important ratios such as days in receivables and days in inventory. B) Control environment is related to the firm's selection of specific activities and procedures that effectively mitigate risk. C) Control environment helps set the tone for the entity, and examines companywide issues such as management's attitude toward ethical values and employees acting with integrity. D) The organization's control environment is related to how well the organization eliminates fraud. Answer: C Explanation: Control environment deals with a more topological level, and examines companywide issues such as management's attitude toward ethical values and employees acting with integrity. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 28) Internal control is extremely important to any organization with respect to its optimal functioning and operational/financial performance. Which of the following statements most accurately encapsulates a firm's system of internal control? A) Internal control, when implemented properly, is designed by management and the internal audit function to provide absolute assurance of no misstatements in the financial statements. B) A firm's system of internal control is designed to provide reasonable assurance that the financial statements are free of material misstatements. C) A firm's system of internal control is designed to provide reasonable assurance that the financial statements are free of misstatements. D) A client's system of internal control is designed to assist the external auditor in performing less substantive procedures, reducing the cost of the audit. Answer: B Explanation: A firm's system of internal control is designed to provide reasonable assurance that the financial statements are free of material misstatements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

29) Ken, an audit manager assigned to the audit of Parkside LLC is discussing internal control with a new staff associate, Sandra. Sandra is keen to learn more about internal control and how effective it may or may not be. Which of the following responses from Ken would best help Sandra? A) So long as a client's system of internal control is designed properly and approved by the external auditors, then there is no concern of any misstatements in the financial statements. B) Even with a robust system of internal control, there is still the possibility of misstatements due to management collusion or ineffective controls. C) The audit of internal control is typically very expensive during the first year's integrated audit, but the cost is significantly less in future audits as the external auditor only performs minimal checks thereafter. D) Overall responsibility of a client's system of internal control falls upon the internal audit function. If the client does not have an internal audit function, responsibility falls upon the audit committee. Answer: B Explanation: Even with a robust system of internal control, there is still the possibility of misstatements due to management collusion or ineffective controls. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 30) Don, an audit partner at Haribo CPA firm is discussing the idea of a client's system of internal control with Annie, a new audit staff associate. Annie is curious as to why the external auditors place such a high emphasis on internal control. Which of the following represents Don's best response to this question? A) External auditing firms have carved out a niche for themselves in performing separate audits of internal control as well as the financial statements, and can accordingly increase the cost of the audit. B) An auditor needs to gain a sound understanding of a client's internal controls to help understand what substantive testing may be necessary. C) Part of the requirements of an integrated audit is that the auditor performs substantive tests on the client's internal control function. D) If the external auditors can determine early on in the audit that the client's transaction-level controls are effective, then the auditors can adopt a reliance strategy and increase substantive testing. Answer: B Explanation: An auditor needs to gain a sound understanding of a client's internal controls to help understand what substantive testing may be necessary. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 12

31) During the initial stages of the audit of Campbell Company, a distributor of sheet metal across the southeastern United States, the audit partner with overall responsibility for the engagement has noted that management has implemented strict codes of ethics for all employees. This attitude and approach from top management would represent which of the following? A) A transaction-level control, because this is likely to decrease the risk of material misstatement. B) An example of a strong control environment, which would allow the auditor to increase control risk. C) An entity-level control, because senior management's attitude and approach are likely to permeate the entire organization. D) An example of effective oversight by the board of directors, enabling the auditor to decrease the control environment. Answer: C Explanation: An entity-level control, because senior management's attitude and approach are likely to permeate the entire organization. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 32) During the audit of the privately held Wood Company, the external auditors, Green CPAs, have noted from reviewing minutes of the board of director's meetings that there are very few external directors on the client's audit committee. What might be an appropriate response to this by the auditors? A) The auditors should consider decreasing inherent risk, and increasing control risk to compensate for this. B) The auditors should consider the decreased independence of the audit committee when planning audit procedures, and adjust any planned procedures accordingly. C) The auditors are likely to decrease substantive testing, and increase reliance on the internal audit function. D) The auditors should consider withdrawing from the engagement, and protecting the reputation of the firm. Answer: B Explanation: The auditors should consider the decreased independence of the audit committee when planning audit procedures, and adjust any planned procedures accordingly. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

33) During the audit of Seagrave Enterprises, LLC, a retailer of fishing and other maritime sporting equipment throughout the east coast of the United States, the external auditors, Peabody CPAs, are examining the education, experience, and qualifications of employees in key positions. The auditors have determined that these employees are competent and well qualified for their respective positions. What actions might the auditor take in response to this finding? A) The auditor is likely to increase control risk, and focus substantive testing on areas such as cash receipts and disbursements. B) The auditors are likely to access the client's control environment as high, and decrease audit risk accordingly. C) The auditors are likely to decrease audit risk and the risk of material misstatement. D) The auditors are likely to decrease audit risk and increase the resultant risk of material misstatement. Answer: C Explanation: The auditors are likely to decrease audit risk and the risk of material misstatement. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 34) During the preliminary stages of the audit of Zotero Enterprises, a national provider of children's play equipment, the external auditors, Mankins CPA Firm, has noted that the client's hierarchy and reporting lines are blurred and confusing. As a result of this finding, how might the auditors adapt their audit procedures? A) The auditors are likely to place increased reliance on the internal auditors, as this function is more familiar with the client's operations. B) The auditors are likely to increase control risk, and also increase the risk of material misstatement. C) The auditors are likely to request additional written assurances from senior management, to guard against any future litigation related to the audit or the client's financial statements. D) The auditors are likely to conduct decreased substantive procedures, and increase analytical procedures and tests of details. Answer: B Explanation: The external auditors are likely to increase control risk, and also increase the risk of material misstatement. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

35) An example of an entity level control would be ________. A) an entity's risk assessment process B) a detective control pertaining to accounts receivable C) a preventive control relating to an IT function D) a physical lock on a storage facility Answer: A Explanation: An example of one of the COSO defined entity controls would be an entity's risk assessment process. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 36) In a top-down approach to understanding internal control over financial reporting and selecting the specific internal controls to test, the auditor focuses on _______-level controls. A) entity B) division C) operating unit D) function Answer: A Explanation: PCAOB Auditing Standard No. 5 describes a top-down approach to understanding internal control over financial reporting and selecting the specific internal controls to test. The auditor focuses on entity-level controls and works down to significant accounts and disclosures and their relevant assertions. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

37) Which of the following is comprised of the attitudes, awareness and actions of management and those charged with governance concerning the entity's internal control and its importance in the entity? A) Control environment B) Entity-level controls C) Monitoring activities D) Information and communication Answer: A Explanation: The control environment is comprised of the attitudes, awareness and actions of management and those charged with governance concerning the entity's internal control and its importance in the entity. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: Process and Resource Management Perspectives; AC: Risk Assessment, Analysis and Management; PC: None 38) Compared to other types of entity-level controls, the auditor finds ________ the easiest to test because their operation is readily verifiable. A) control activities B) control environment C) risk assessment D) information and communication Answer: A Explanation: Compared to other types of entity-level controls, the auditor finds control activities the easiest to test because their operation is readily verifiable. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

39) Which process involves assessing the design and operation of controls on a timely basis and taking necessary corrective actions? A) Monitoring B) Risk assessment C) Control activities D) Information and communication Answer: A Explanation: Monitoring is a process that assesses the quality of internal control performance over time. It involves assessing the design and operation of controls on a timely basis and taking necessary corrective actions. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 40) A top-down approach begins by ________. A) considering what can go wrong in the preparation of the financial statements B) considering which members of top management might be committing fraud C) assigning the highest ranking and most experienced members of an audit team to an audit D) sending questionnaires to top management to complete before interviewing any mid-level management employees Answer: A Explanation: A top-down approach begins by considering what can go wrong in the preparation of the financial statements. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 41) Establishing an appropriate level of professional skepticism is achieved by ________. A) gaining an understanding of the entity-level (or entity-wide) internal control components B) talking to the internal audit function C) discussions with the client's attorney D) a directive from the audit partner in charge Answer: A Explanation: Gaining an understanding of the entity-level (or entity-wide) internal control components helps in establishing the appropriate level of professional skepticism. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 17

42) Integrity and ethical behavior ________. A) are provided by the auditor to the client in training sessions B) are of no concern, for they are always present C) are the products of the organization's ethical and behavioral standards D) should start at the bottom and work their way up the organization Answer: C Explanation: Integrity and ethical behavior are the products of the organization's ethical and behavioral standards. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 43) An entity's risk assessment process ________. A) should be reevaluated every five years to respond to changing market conditions and threats B) should only solicit feedback from and be crafted by top management C) is its process for identifying and responding to risks that an organization will not achieve its objectives D) is the same as the auditor's consideration of risk Answer: C Explanation: An entity's risk assessment process is its process for identifying and responding to risks that an organization will not achieve its objectives. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

44) In an audit, the purpose of risk assessment is to ________. A) form an ultimate opinion on the financial statements based on management's directives B) assess the combined inherent, control and detection risks to evaluate the likelihood that material misstatements could occur in the financial statements C) audit the system of internal control only D) ultimately ensure that the internal audit function is performing properly Answer: B Explanation: In an audit, the purpose of risk assessment is to assess the combined inherent, control and detection risks to evaluate the likelihood that material misstatements could occur in the financial report. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 45) Policies and procedures enacted by the entity which help ensure that management's directives are carried out are generally referred to as ________. A) management activities B) control activities C) legislative activities D) company procedures Answer: B Explanation: Policies and procedures enacted by the entity which help ensure that management's directives are carried out are generally referred to as control activities. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

46) Physical controls are concerned with limiting ________. A) physical access to assets to those authorized to have access B) the informational output of the firm C) investors access to certain records of the firm which should be kept private D) access to accounting information to senior managers only Answer: A Explanation: Physical controls are concerned with limiting the following two types of access to assets and important records: (1) direct physical access and (2) indirect access through the preparation or processing of documents such as sales orders and disbursement vouchers that authorize the use or disposition of assets. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 47) Maddie and Howard, two audit managers assigned to the audit of Wick Enterprises are discussing internal control with a new staff associate, Kendra. Kendra is curious as to how firms attempt to mitigate risks to the greatest extent possible. Which of the following represents Maddie and Howard's best response to this question? A) Firms understand that risk is inherent in most industries, and that there is very little they can do to mitigate it. B) Firms typically implement control activities which are designed to help mitigate risk and ultimately ensure the firm's goals and objectives are achieved. C) Firms implement control activities which are designed to eliminate risk and ensure that there are no material misstatements in the financial statements. D) Auditors that are auditing firms that have implemented strong controls usually increase control risk to compensate for this. Answer: B Explanation: Firms typically implement control activities which are designed to help mitigate risk and ultimately ensure the firm's goals and objectives are achieved. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

48) Anne, an audit partner assigned to the audit of Fortitude Enterprises, LLC is attempting to explain the importance of segregation of duties to a new auditor. Which of the following would represent the best example of segregation of duties for this firm? A) An employee authorizes transactions pertaining to payment of accounts payable, and is responsible for updating the ledger to reflect transactions. B) A staff member maintains the physical inventory and also the records for inventory, but does not authorize inventory shipments. C) An employee is responsible for updating accounts receivable records to reflect charges and payments, but has no responsibility for authorizing transactions. D) A new employee handles all of the company's machinery acquisitions and retirements, as well as being responsible for updating the records to reflect these changes. Answer: C Explanation: An employee is responsible for updating accounts receivable records to reflect charges and payments, but has no responsibility for authorizing transactions. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

49) After an initial meeting with the client's senior management, an auditor assigned to the audit of Bookbinder LLC is attempting to understand the entity-level controls enacted by the organization. Which of the following would represent the most appropriate way for the auditor to achieve this understanding? A) The auditor should consider conducting a walkthrough of the client's entity-level controls to ensure they are operating effectively. B) The auditor should attempt to obtain written assurances from senior management that all entity-level controls are operating effectively. C) The auditor should consider reviewing company policies and procedures as well as minutes of board of director meetings. D) The auditor should request the internal audit function conduct an audit of entity-level controls, and report the findings back to the external auditor. Answer: C Explanation: The auditor should consider reviewing company policies and procedures as well as minutes of board of director meetings. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 50) Reports that summarize the detail of account balances such as an aged trial balance of accounts receivable are an example of which category of control activities? A) Performance reviews B) Information processing controls C) Physical controls D) Segregation of duties Answer: A Explanation: Reports that summarize the detail of account balances such as an aged trial balance of accounts are an example of the performance review category of control activities. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: Decision Making

51) If an employee who has access to the custody of assets steals a cash remittance and covers the theft by recording a bad-debt write off, there was likely a failure in the category of ________. A) segregation of duties B) performance reviews C) authorization control D) physical controls Answer: A Explanation: An example of segregation of duties: an individual who processes cash remittances from customers (has access to the custody of assets) should not also have authority to approve and record credits to customers' accounts for sales returns and allowances or write offs (authorize transactions). In such a case, the individual could steal a cash remittance and cover the theft by recording a sales return or allowance or bad-debt write off. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 52) Transaction-level controls are those controls that ________. A) controls that affect a particular transaction or group of transactions B) are used reactively to determine where problems have occurred C) deal with the financial statements in general D) management have suggested the auditor implement Answer: A Explanation: Transaction-level controls are those controls that controls that affect a particular transaction or group of transactions. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

53) Risks related to the prelisting of cash receipts and remittance advices relate to ________. A) cash sales may not be recorded B) errors may be made in journalizing cash receipts C) checks received may not agree with prelist of cash D) receipts may be posted to the wrong customer account Answer: C Explanation: Risks related to the prelisting of cash receipts and remittance advices relate to checks received may not agree with prelist of cash. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 54) A control ensuring that sales are recorded in the sales ledger is a/an ________-level control. A) transaction B) entity C) division D) function Answer: A Explanation: A control ensuring that sales are recorded in the sales ledger is a transaction-level control. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 55) When an auditor decides to follow a particular transaction from initiation through where it is recorded in the financial records, this is known as ________. A) reperformance B) walkthrough C) recalculation D) vouching Answer: B Explanation: A walkthrough involves following a transaction from initiating the transaction until it is recorded in the financial records. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

56) A report sent to each customer showing the beginning receivable balance, transactions during the month, and the ending receivable balance is best described as ________. A) a statement of cash receipts B) an aging of accounts receivable C) monthly statements of receivable balances D) a general ledger receivables report Answer: C Explanation: Monthly statements of receivable balances: A report sent to each customer showing the beginning receivable balance, transactions during the month, and the ending receivable balance. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 57) Documents and files relating to recording sales would be ________. A) bill of lading and sales database B) sales invoice and sales database C) sales invoice, sales cycle database, and monthly statements of receivables balances D) bill of lading and monthly receivables balances Answer: C Explanation: Documents and files relating to recording sales would be sales invoice, sales cycle database, and monthly statements of receivables balances. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 58) Key assertions pertaining to the audit of credit sales are ________. A) completeness and valuation B) accuracy and occurrence C) valuation and allocation D) rights and obligations Answer: B Explanation: Key assertions pertaining to the audit of credit sales are accuracy and occurrence. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

59) Key assertions pertaining to the delivery of goods are ________. A) accuracy, completeness, and occurrence B) completeness, occurrence, and cutoff C) accuracy, occurrence, and rights and obligations D) presentation and disclosure Answer: A Explanation: Key assertions pertaining to the delivery of goods are accuracy, completeness, and occurrence. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 60) The key assertion an auditor would be testing when examining a sales invoice to determine if it was billed to the correct customer would be ________. A) valuation and accuracy B) classification C) rights and obligations D) cutoff Answer: B Explanation: The key assertion an auditor would be testing when examining a sales invoice to determine if it was billed to the correct customer would be classification. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 61) Which of the following is a report sent to each customer showing the beginning receivable balance, transactions during the month, and the ending receivable balance? A) Monthly statement of receivable balances B) Sales invoice C) Sales cycle database D) Customer master file Answer: A Explanation: Monthly statements of receivable balances are a report sent to each customer showing the beginning receivable balance, transactions during the month, and the ending receivable balance. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making 26

62) Which of the following documents contains the customer shipping and billing information and the customer credit limit? A) Customer master file B) Packing slip C) Bill of landing D) Sales invoice Answer: A Explanation: A customer master file is an electronic file containing the customer shipping and billing information and the customer credit limit. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making 63) Documents and files related to initiating credit sales would be ________. A) customer master file and sales order B) sales order and sales invoice C) bill of lading and packing slip D) credit sales order Answer: A Explanation: Documents and files related to initiating credit sales would be customer master file and sales order. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

64) A bill of lading is a (an) ________. A) shipping document serving as acknowledgement of receipt of goods for delivery by a freight carrier B) client prepared document with the details of items included in a shipment C) electronic file that accumulates data on sales, cash receipts, and accounts receivables D) electronic file containing the customer shipping and billing information and the customer credit limit Answer: A Explanation: A bill of lading is a shipping document which serves as acknowledgement of receipt of goods for delivery by a freight carrier. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making 65) If you place a control that only a limited number of individuals can change the customer master file and all file changes are reviewed by appropriate levels of management, which of the following risks will you be addressing? A) Sales made to unauthorized customers B) Goods released from warehouse for unauthorized orders C) Some shipments going unbilled D) Sales invoices recorded in the incorrect amount Answer: A Explanation: If you place a control that only a limited number of individuals can change the customer master file and all file changes are reviewed by appropriate levels of management, you will be addressing the risk that sales may be made to unauthorized customers. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making

66) If you place a control that the computer checks run-to-run total of beginning receivables, plus sales transactions with the sum of ending receivables, which of the following risks will you be addressing? A) Invoices not journalized or posted to customer accounts B) Sales invoices recorded in the incorrect accounting period C) Products shipped without shipping documents being generated D) Sale made without credit approval Answer: A Explanation: If you place a control that the computer checks the run-to-run total of beginning receivables, plus sales transactions with the sum of ending receivables, you will be addressing the risk of invoices not being journalized or posted to customer accounts. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making 67) An audit manager is attempting to audit a sample of revenue transactions for a major client. The auditor is concerned with ensuring that the selected revenue transactions are not fictitious. Which of the following would be the most prudent method of achieving this? A) The auditor should select a sample of revenue transactions and then trace them to the corresponding accounts payable entries. B) The auditor should examine copies of sales orders and bills of lading, and attempt to trace to cash and accounts receivable entries, respectively. C) The auditor should begin by examining monthly accounts receivable statement balances and tracing to the customer master file to make sure the client's exist. D) None of these choices are correct. Answer: B Explanation: The auditor should examine copies of sales orders and bills of lading, and attempt to trace to cash and accounts receivable entries, respectively. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

68) Sally, an audit manager assigned to the audit of Nebraska LLC is going over the audit of inventory with a couple of the staff associates. Sally is explaining what to look for in this area with respect to risks, and which assertions they may be tied to. Which of the following is correct relating to risks to look out for, and the assertions they may be tied to? A) Inventory may be being shipped out without proper authorization, which would affect the cutoff assertion. B) Inventory may be being shipped out without the necessary supporting documentation, which would affect the accuracy assertion. C) Inventory sold on credit may not be being recorded in the accounting records, which would affect the presentation and disclosure assertion. D) Inventory may be being stockpiled, which may affect the accuracy and cutoff assertions. Answer: B Explanation: Inventory may be being shipped out with the necessary supporting documentation, which would affect the accuracy assertion. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 69) Madison and Johnnie, two audit staff associates, are eating lunch one day in the client's cafeteria. They overhear a couple of the employees talking about accounts receivable and the firms' credit sales in general. What might be some risks associated with this area, and what assertions might they be tied to? A) Unauthorized credit sales may be made to customers who do not have the requisite credit score or history with the company, which would affect the occurrence and valuation assertions. B) Customers that purchase goods on credit may be late settling their outstanding balances, which would affect the cutoff assertion. C) Fictitious credit sales may be recorded to overstate revenue and receivables, affecting the presentation and disclosure assertions. D) None of these answer choices are correct. Answer: A Explanation: Unauthorized credit sales may be made to customers who do not have the requisite credit score or history with the company, which would affect the occurrence and valuation assertions. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

70) John, the audit partner in charge of Cash CPA Firm is discussing the concept of risk with a new audit intern, Sarah. Sarah explains that she understands what risk is, but doesn't understand why auditors would need to concern themselves with it. Which of the following represents John's best reply? A) Risk is something that all auditors need to be concerned about. The only way that risk can be eliminated is through an effective audit. B) Part of what the auditors do toward the end of an audit is complete the risk assessment phase. This involves substantive testing and discussing risk with the client's major shareholders. C) Risk can really mean anything that stops the company achieving its operational and financial goals. Part of the auditor's job is to identify risks that may materially affect the client's financial statements. D) A major component of risk is the auditors risk of material misstatement, which is inversely related to control and detection risk. Answer: C Explanation: Risk can really mean anything that stops the company achieving its operational and financial goals. Part of the auditor's job is to identify risks. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 71) Nicky and Steve, audit managers working for Templeton CPAs, are discussing the pros and cons of a new IT system one of their major clients recently installed. Which of the following statements correctly lists a pro and con of IT systems? A) IT systems are likely to reduce the effectiveness of internal control, and cause auditors to increase detection risk. B) An effective IT system may help to ensure more consistency and accuracy in processing, but may also be more prone to outside attacks such as hacks and phishing attempts. C) An effective IT system produces less documentary evidence for the auditors to have to deal with, but also saves the firm money on paper printouts. D) An IT system will not process inaccurate data, which will alert the auditors to potential problems. Answer: B Explanation: An effective IT system may help to ensure more consistency and accuracy in processing, but may also be more prone to outside attacks such as hacks and phishing attempts. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

72) A major contributor to any firm's operational and financial success is an effective system of internal control. Controls are often split into IT general controls and IT application controls. Which of the following best describes the difference between these two types of controls? A) IT general controls focus on specific applications such as a sales order processing system or accounts payable. B) IT application controls are typically instituted by the entity's board of directors and are usually pervasive across the organization. C) IT application controls are typically designed to prevent problems in particular processes, whereas IT general controls usually represent a higher level of controls. D) IT general controls typically deal with specific transaction processing, whereas IT application controls deal more with specific parts of each process. Answer: C Explanation: IT application controls are typically designed to prevent problems in particular processes, whereas IT general controls usually represent a higher level of controls. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 73) The management of Caliber Company has recently installed a new operating system in an attempt to modernize their operations and be more competitive. The external auditors, Pillar CPAs, have just learned of this recent installation. With respect to the client's system of internal control, which of the following is correct? A) The auditors are likely to be interested in examining system software acquisition and change controls to ensure the system has been installed and is working properly. B) The auditors are likely to be concerned with access controls to ensure that the programs the client is running have correct access to the operating system. C) The auditors are likely to be concerned with data center and network operations controls, as they will want to ensure that the client's data is segregated completely from the client's employees. D) None of these answer choices are correct. Answer: A Explanation: The auditors are likely to be interested in examining system software acquisition and change controls to ensure the system has been installed and is working properly. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

74) Jackie and Steve, audit associates working on the audit of Peagram Enterprises, LLC, are discussing different types of controls a company might employ, particularly input, processing, and output controls. Which of the following statements pertaining to these controls is most accurate? A) Input, processing, and output controls are implemented and maintained by management, who provide written assurances to the external auditors regarding these controls. B) Input and output controls are examples of entity-level controls, whereas processing controls are an example of IT application controls. C) Input, processing, and output controls are designed to provide a firm with reasonable assurances that the input, processing, and output of data are being performed effectively, efficiently, and accurately. D) None of these answer choices are correct. Answer: C Explanation: Input, processing, and output controls are designed to provide a firm with reasonable assurances that the input, processing, and output of data are being performed effectively, efficiently, and accurately. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 75) Delacie, an audit manager assigned to the audit of Buckworth LLC, is discussing internal control with a new audit staff associate, Suzy. Suzy is curious to learn more about IT application controls. Which of the following statements by Delacie would be most helpful in helping Suzy understand these controls? A) IT application controls are determined and implemented jointly by the entity's board of directors and the audit committee. B) IT application controls help ensure that data entered into a system for processing is valid and accurate. C) IT application controls are used to help data accuracy, and are implemented by the external auditor as part of the audit. D) IT application controls are typically used in smaller firms, because they are very expensive to implement and maintain. Answer: B Explanation: IT application controls help ensure that data entered into a system for processing is valid and accurate. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

76) During the previous year's audit of Babin Enterprises, the external auditors recommended some changes to internal control as part of the integrated audit. This year, during the initial meeting between the audit partners and the client's senior management, the Chief Information Officer apprised the auditors that a new control has been introduced whereby an accounts receivable clerk compares the receivable balance to the sales order which initiated it. What type of control does this represent? A) This represents an entity-level control, as the decision to implement this control was made at the senior management level. B) This is an example of an IT transaction control, as the client's IT system is primarily responsible for the processing of sales and receivables. C) This represents an example of an IT-dependent manual control, as an employee is essentially checking to ensure the system has processed the data correctly. D) This is an example of an IT application control, which the client's internal audit function will assume responsibility for auditing and reviewing. Answer: C Explanation: This represents an example of an IT-dependent manual control, as an employee is essentially checking to ensure the system has processed the data correctly. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 77) IT dependent manual controls are controls that chiefly involve manual review of the ________ of computer- generated information. A) completeness and accuracy B) cutoff and classification C) rights and obligations D) valuation and allocation Answer: A Explanation: IT Dependent Manual Controls are controls that involve manual review of the completeness and accuracy of computer-generated information. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Technology AICPA: BC: None; AC: Technology and Tools; PC: Decision Making

78) Which of the following are designed to provide reasonable assurance that the recording, processing, and reporting of data by an IT system are properly performed for specific applications? A) Computer application controls B) Computer general controls C) IT dependent manual controls D) None of these options are correct. Answer: A Explanation: Computer application controls are designed to provide reasonable assurance that the recording, processing, and reporting of data by an IT system are properly performed for specific applications. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Technology AICPA: BC: None; AC: Technology and Tools; PC: Decision Making 79) IT general controls are ________-level controls. A) entity B) division C) transaction D) function Answer: A Explanation: An important set of controls are entity level controls called computer general controls. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Technology AICPA: BC: None; AC: Technology and Tools; PC: Decision Making

80) Which of the following types of control are designed to control program development, program changes, computer operations, and access to programs and data? A) IT general controls B) Computer application controls C) IT dependent manual controls D) None of these options are correct. Answer: A Explanation: IT general controls control program development, program changes, computer operations, and access to programs and data. They represent a higher level of controls designed to provide reasonable assurance that individual computer applications operate consistently and effectively. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Technology AICPA: BC: None; AC: Technology and Tools; PC: Decision Making 81) Applications controls will ________. A) differ for each transaction cycle B) remain the same for each transaction cycle C) be closely related to transaction processing controls D) always consist of input controls and processing controls Answer: A Explanation: The purpose of application controls is to use the power of information technology to control transactions in individual transaction cycles. Hence, applications controls will differ for each transaction cycle (e.g., sales vs. inventory controls). Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Technology and Tools; PC: Decision Making

82) A major benefit of an IT system is ________. A) elimination of mistakes B) elimination of the need for personnel C) greater consistency in processing than manual systems D) increased workload created by exception reports Answer: C Explanation: A major benefit of an IT system is greater consistency in processing than manual systems. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 83) An example of a risk created by an IT system is ________. A) increased efficiency in processing transactions B) less documentary evidence C) potential availability of real-time financial information D) the extra cost of staffing an IT support function Answer: B Explanation: An example of a risk created by an IT system is that there is often less documentary evidence of the performance of control procedures in computer systems. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 84) The concept of computer general controls, controlling computer systems, and programs is an example of a(an) ________. A) layering activity B) IT activity C) general control activity D) auditing process activity Answer: A Explanation: The concept of computer general controls controlling computer systems and programs is an example of a layering activity. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

85) When the computer system checks the validity of a customer number or whether a customer has reached their credit limit is an example of a(an) ________. A) internal audit control B) internal system control C) computer application control D) systems application control Answer: C Explanation: In many cases the data is subject to computer application controls, where the computer checks, for example, the validity of a customer number or whether a customer has reached its credit limit. These controls are computer application controls which are designed to provide reasonable assurance that the IT system records, processes and reports data properly for specific applications. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 86) Controlling program development, program changes, computer operations, and securing access to programs and data is the purpose of ________. A) independent controls B) manual controls C) IT general controls D) tech controls Answer: C Explanation: Controlling program development, program changes, computer operations, and securing access to programs and data is the purpose of general controls. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

87) IT general controls pertain to ________. A) only the IT environment B) only IT activities C) the IT environment and all IT activities D) individual IT applications Answer: C Explanation: IT general controls pertain to the IT environment and all IT activities as opposed to a single IT application. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 88) Input controls are designed to provide reasonable assurance that ________. A) data received for processing have been properly authorized and converted into machinesensible form B) data received for processing have been properly authorized only C) the computer processing has been performed as intended for the particular application D) reports generated by the accounting system are accurate and reliable Answer: A Explanation: Input controls are designed to provide reasonable assurance that data received for processing have been properly authorized and converted into machine-sensible form. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 89) When an output is reviewed for completeness and apparent reasonableness, it is known as ________. A) a reasonableness test B) visual scanning C) a comparison to source documents D) statistical accuracy checking Answer: B Explanation: When an output is reviewed for completeness and apparent reasonableness, this is known as visual scanning. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 39

90) An automated procedure to verify that only alphabetical, numerical, or other special characters appear as required in data fields is known as ________. A) missing data check B) valid character check C) valid code check D) sequence test check Answer: B Explanation: The purpose of a valid character check is to verify that only alphabetical, numerical, or other special characters appear as required in data fields. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 91) Access controls include a combination of ________ safeguards. A) physical, software, and procedural B) administrative and legal C) software and hardware D) transaction-level Answer: A Explanation: Access controls are designed to prevent unauthorized use of IT equipment, data files, and computer programs. The specific controls include a combination of physical, software, and procedural safeguards. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Technology AICPA: BC: None; AC: Technology and Tools; PC: Decision Making 92) What group or groups of application controls are widely recognized? A) Input, timing, and service controls B) Timing, service, and processing controls C) Processing, output, and service controls D) Input, processing, and output controls Answer: D Explanation: The following three groups of application controls are widely recognized: input controls, processing controls, and output controls. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Technology AICPA: BC: None; AC: Technology and Tools; PC: Decision Making 40

93) Which of the following application controls is a processing control? A) Before-and-after report B) Missing data check C) Visual scanning D) Reconciliation of totals Answer: A Explanation: The before-and-after report serves as a processing control. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Technology AICPA: BC: None; AC: Technology and Tools; PC: Decision Making 94) Which application control matches the classification (or transaction) code against the master list of codes permitted for the type of transaction to be processed? A) Valid code check B) Missing data check C) Limit check D) Valid character check Answer: A Explanation: Valid code check matches the classification (e.g., expense account number) or transaction code (e.g., cash receipts entry) against the master list of codes permitted for the type of transaction to be processed. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Technology AICPA: BC: None; AC: Technology and Tools; PC: Decision Making 95) Run-to-run totals compare ________. A) ending balances with beginning balances plus known transactions processed. B) contents of a master file before and after each update. C) data with an expected limit. D) actual results and estimated results. Answer: A Explanation: Run-to-run totals are a comparison of ending balances with beginning balances plus known transactions processed. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Technology AICPA: BC: None; AC: Technology and Tools; PC: Decision Making

96) A logic diagram is best described as ________. A) a complex system of flowcharts detailing the audit procedures conducted and key audit findings B) a narrative surmise of the key audit findings C) providing a visual perspective of the flow of the transaction and key controls D) being completed by the client and the auditor upon conclusion of the audit Answer: C Explanation: A logic diagram can best be thought of as a flowchart, but with a greater level of detail, hopefully to enhance the readers understanding of the process. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 97) The most common forms of documentation that auditor uses to signify their understanding of the system of internal control include ________. A) audit plan B) only flowcharts C) flowcharts, narratives, and logic diagrams D) logic diagrams only Answer: C Explanation: The most common forms of documentation that auditor use to signify their understanding of the system of internal control include narratives, flowcharts, and logic diagrams. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 98) The auditor's understanding of the client's system of internal control should be ________. A) discussed among audit team members only B) submitted to the client's internal audit function for agreement/approval C) well documented so it can be referred back to at any time D) in documentary form only and submitted to the client's attorneys for risk assessment Answer: C Explanation: The auditors understanding of the client's system of internal control should be well documented, so it can be referred back to at any time. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 42

99) An auditor's documentation of the client's system of internal controls ________. A) should always be written and updated regularly as the auditor gains further understanding B) is the client's responsibility, and should be provided to the auditor by the client C) should be jointly drafted by the auditor and the client D) should be retained in the permanent audit file and never shared with the client Answer: A Explanation: An auditor's documentation of the client's system of internal controls should always be written and updated regularly as the auditor gains further understanding. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 100) One disadvantage of flowcharts is they ________. A) are technically complex and thus misunderstood B) are too simplistic C) usually take longer to prepare than narratives or checklists D) are more expensive to prepare due to the number of audit hours involved Answer: C Explanation: Flowcharts are not often used as they usually take longer to prepare than narratives or checklists. Instead, logic diagrams are more common. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 101) Good use of a narrative method of understanding a client's system of internal control would be when the ________. A) client is large and complicated B) is relatively small and not overly complex C) requests the auditor do so D) inherent risk is deemed to be high Answer: B Explanation: Good use of a narrative method of understanding a client's system of internal control would be when the client is relatively small and not overly complex. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 43

102) What are the most common forms of documentation for client internal controls, particularly in smaller environments where accounting and internal control activities are simple? A) Narratives B) Logic diagrams C) Flow charts D) Preformatted questionnaires Answer: A Explanation: Narratives are the most common form of documentation, particularly in smaller environments where accounting and internal control activities are simple or where a particular flow of a transaction is relatively simple and straightforward. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making 103) Which of the following is a form of documenting internal controls that is typically a page divided into two sections? A) Combinations of narratives and flowcharts B) Checklists C) Preformatted questionnaires D) Narratives Answer: A Explanation: Combinations of narratives and flowcharts–this form of documenting internal controls is typically a page divided into two sections with the process flowchart on the left-hand side and the narrative describing each step in the flow on the right-hand side. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making

104) What kind of internal control documentation is particularly helpful in industries that the auditor may not personally be familiar with? A) Checklists and preformatted questionnaires B) Combinations of narratives and flowcharts C) Flowcharts and logic diagrams D) Narratives and logic diagrams Answer: A Explanation: An internal control checklist or questionnaire is a technique used to systematically identify the most common types of internal control procedures that should be present. This is particularly helpful in industries that the auditor may not personally be familiar with, or when less experienced auditors find it difficult to identify which are the critical controls. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making 105) Logic diagrams provide ________. A) a visual perspective of the flow of the transactions and key controls throughout the flow that is often simpler for the reader or reviewer to understand B) a description (in words) of each step of the flow of a transaction from start to finish (that is, from initiation to reporting in the financial report C) a process flowchart on the left-hand side and the narrative describing each step in the flow on the right-hand side D) extensive description of steps detailing all aspects of transaction in the internal control processes Answer: A Explanation: Logic diagrams provide a visual perspective of the flow of the transaction and key controls throughout the flow that is often simpler for the reader or reviewer to understand. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making

106) Kaylen and Jared, two audit associates, are coming to the end of their first audit of a major client's internal control, and are attempting to determine how best to document their understanding of this system. Which of the following statements is true with respect to documenting this understanding? A) As the client is a large firm with a complicated hierarchy and organizational structure, Kaylen and Jared should consider using a narrative to document their understanding. B) Kaylen and Jared may decide to document their understanding using a flowchart, as a graphical representation may better and more logically represent such a complex system. C) Jared has suggested using a checklist, as this will save time and greatly simplify the complex system of internal control. D) None of these answer choices are correct. Answer: B Explanation: Kaylen and Jared may decide to document their understanding using a flowchart, as a graphical representation may better and more logically represent such a complex system. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 107) Donald, a senior audit partner at Anderson CPA Firm is discussing how best to document internal control with a new audit associate, Kayla. Kayla has advised she is unsure of how best to capture a sound understanding of the client's system of internal control. Donald has recommended Kayla devise a flowchart to help with this. Which of the following represents benefits of using a flowchart? A) A flowchart is a graphical and logical way to break down complex information and processes into more easily understandable informational flows. B) A flowchart may be easier to explain to other audit and client staff, and may help them gain a quicker and more in-depth understanding. C) The flowchart is a recognized procedure used by many auditors to gain an understanding of internal control. D) All of these answer choices are correct. Answer: D Explanation: All of these answer choices are correct. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

108) Rajinder and Delia are discussing the various ways that an auditing firm can document a client's system of internal control. Rajinder explains to Delia that he likes the flowchart approach, to which Delia replies that she is a fan of the checklist method. Which of the following choices represent benefits to using the checklist approach to documenting internal control? A) A checklist may prove extremely useful when an auditor is auditing a client in an industry where he or she has relatively little experience. B) A checklist represents an efficient way to document extremely complex systems of internal control. C) A checklist is usually divided into different sections and narratives, with the narrative accompanying the checklist itself. D) None of these answer choices are correct. Answer: A Explanation: A checklist may prove extremely useful when an auditor is auditing a client in an industry where he or she has relatively little experience. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 109) Two audit staff associates, Latisha and Tonya, are discussing their understanding of how internal control works. Latisha and Tonya are both relatively new to the world of auditing, and are discussing the different types of internal control systems they have seen on their audits. Which of the following statements is correct regarding a client's system of internal controls? A) The general rule is that the more money a client spends on their system of internal control, the more likely it is to eliminate misstatements from the financial statements. B) The most effective systems of internal control are designed by the external auditors, as they have vast experience in auditing internal control, and are implemented by management. C) Although systems will vary between organizations, an effective and well-designed system should offer reasonable assurance that material misstatements in the financial statements have been prevented and/or detected. D) All of these answer choices are correct. Answer: C Explanation: Although systems will vary between organizations, an effective and well-designed system should offer reasonable assurance that material misstatements in the financial statements have been prevented and/or detected. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

110) Jamie, the audit manager assigned to the audit of Black Enterprises Inc. has determined, with the help of his team, that the client's system of internal control is robust and controls are operating effectively. As a result of this finding, which are Jamie and his team most likely to do? A) Jamie and his team are likely to increase substantive testing, including tests of details. B) Jamie and his team are likely to adopt a reliance strategy, and may perform less substantive testing as a result. C) Jamie and his team are likely to request that the internal audit function complete the audit of IT general and application controls, and furnish a formal written report to the auditor. D) Jamie and his team are now in a position to issue a qualified opinion on the client's system of internal control, and continue on with the rest of the audit. Answer: B Explanation: Jamie and his team are likely to adopt a reliance strategy, and may perform less substantive testing as a result. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 111) Adrian, an experienced auditor and audit partner assigned to the audit of Pan-American Enterprises is discussing internal control with an audit intern, Stephanie. Stephanie asks Adrian to explain what assertions are, and how they relate to the client's system of internal control. Which of the following represents Adrian's best response to this question? A) There really isn't any relationship between internal controls and client assertions. You are misunderstanding the two. B) Assertions are related to internal controls because the clients system of internal control is used extensively to test assertions. C) Internal control is related to assertions in the sense that a poor system of internal control could affect certain assertions such as classification, valuation, completeness etc. D) None of these answer choices are correct. Answer: C Explanation: Internal control is related to assertions in the sense that a poor system of internal control could affect certain assertions such as classification, valuation, completeness etc. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

112) Two senior audit managers, Deana and Alice, are discussing the system of internal control of one of their biggest clients with Rudy, a recent college graduate and audit trainee. Rudy is inquiring as to what exactly a deficiency in internal control is, and asks them to explain. Which of the following represents the most appropriate response to this question? A) A deficiency in internal control is present when the client's statements are materially misstated. If the auditor detects a deficiency, they will usually disclaim an opinion. B) A deficiency in internal control is typically present when the auditor has determined that the design and/or operation of a control is not preventing or detecting misstatements in a timely manner. C) If a deficiency in internal control appears to exist, the auditors will typically adopt a reliance strategy and decrease substantive testing. D) Deficiencies in internal control are considered separately and in isolation when the auditor forms an opinion on internal control. Answer: B Explanation: A deficiency in internal control is typically present when the auditor has determined that the design and/or operation of a control is not helping to prevent misstatements in a timely manner. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 113) Jarvis, a newly-hired employee of Pompeii CPA Firm, is discussing internal control deficiencies and material weaknesses with one of the more experienced auditors, Heather. Jarvis is keen to understand more about this area; especially material weaknesses. Which of the following statements by Heather would be most appropriate in response to this? A) There really isn't a specific, defined relationship between control deficiencies and material weaknesses. They tend to operate in isolation of each other. B) If an auditor detects a material weakness in the client's system of internal control, generally accepted auditing standards require the auditor to disclaim an opinion on the financial statements. C) A material weakness may represent a combination of deficiencies that causes the auditor to believe there is a reasonable chance of misstatement in the client's financial statements. D) None of these answer choices are correct. Answer: C Explanation: A material weakness may represent a combination of deficiencies that causes the auditor to believe there is a reasonable chance of misstatement in the client's financial statements. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 49

114) Charles and Eddie are discussing various clients' systems of internal control, in particular significant deficiencies in internal control. Which of the statements below is correct with respect to significant deficiencies in internal control? A) If an auditor determines that a significant deficiency in internal control exists, the auditor will typically withdraw from the engagement in order to preserve the reputation of the firm. B) An auditor is required to report a significant deficiency to those charged with governance, which may develop into a material weakness in the future if left uncorrected. C) Generally accepted auditing standards dictate that the client's internal control function is legally responsible for any significant deficiencies found by the external auditors. D) None of these answer choices are correct. Answer: B Explanation: An auditor is required to report a significant deficiency to those charged with governance, and may develop into a material weakness in the future if left uncorrected. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 115) Johnny and Susan, two new audit interns at Jackson CPA firm are discussing the idea of an integrated audit. Johnny is unsure as to what an integrated audit actually is, and Susan is attempting to explain. Which of the following responses by Susan is most likely to help Johnny? A) An integrated audit is where the external auditors and internal audit function pool resources and determine which areas of the client they will take responsibility for auditing. B) An integrated audit focuses on internal control, and integrates the audit of IT application controls with IT general controls. C) An integrated audit is performed by the external auditors, and integrates the audit of internal controls over financial reporting with the audit of the financial statements. D) None of these answer choices are correct. Answer: C Explanation: An integrated audit is performed by the external auditors, and integrates the audit of internal control with the audit of the financial statements. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

116) Which of the following is a deficiency in internal control such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented on a timely basis? A) Material weakness B) Deficiency in internal control C) Significant deficiency D) Immaterial weakness Answer: A Explanation: Material weaknesses is a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented, or detected and corrected, on a timely basis. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: Decision Making 117) An inherent limitation of internal control is that it ________. A) is only as good as those that designed it B) often fails to provide complete assurance of misstatements C) can only provide an entity with reasonable assurance in achieving its financial reporting objectives D) may be costly to implement, and seldom yields any tangible benefits Answer: C Explanation: Internal control, no matter how effective, can only provide an entity with reasonable assurance in achieving its financial reporting objectives. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

118) Upon consideration of a client's system of internal control, when an auditor identifies areas with weaknesses, ________. A) reduced substantive testing in this area will be appropriate to reach the desired level of assurance B) increased substantive testing in this area will be appropriate to reach the desired level of assurance C) the auditor should document the weaknesses and refer to them during next year's audit D) the auditor should disclaim an opinion on those areas Answer: B Explanation: Increased substantive testing in this area will be appropriate to reach the desired level of assurance. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 119) When the auditor identifies internal control strengths, ________. A) inherent risk is increased B) control risk is unaffected C) control risk is decreased D) there is no relationship between strength of internal control and inherent risk Answer: C Explanation: When the auditor identifies internal control strengths, control risk is decreased. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 120) When the auditor identifies internal control weaknesses, ________. A) control risk is increased B) control risk is decreased C) risk of material misstatement decreases D) inherent risk is decreased Answer: A Explanation: When the auditor identifies internal control weaknesses, control risk is increased. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

121) A deficiency in internal controls is described as ________. A) a combination of deficiencies in internal control which are as severe as material weaknesses B) a deficiency in the design or operation of a single control that does not allow management to prevent and correct misstatements on a timely basis C) a deficiency, or combination of deficiencies in internal control D) a deficiency that has created a reasonable possibility of a material misstatement Answer: B Explanation: A deficiency in internal controls is described as a deficiency in the design or operation of a single control that does not allow management to prevent and correct misstatements on a timely basis. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 122) An important outcome of understanding the client's system of internal control is the auditor's ability to ________. A) guarantee there are no misstatements in the financial statements B) make recommendations on costs savings related to internal control C) make observations, draw conclusions and offer recommendations regarding the strengths and weaknesses observed D) ensure an unqualified audit opinion in regard to the financial statements Answer: C Explanation: An important outcome of understanding the system of internal controls that a client puts in place is the ability to make observations, draw conclusions and offer recommendations regarding the strengths and weaknesses observed. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

123) A deficiency in an operation exists when ________. A) a properly designed control does not operate as designed or the person performing the control does not possess the necessary authority or competence to perform the control effectively B) properly designed control operates as designed and the person performing the control possesses the necessary authority or competence to perform the control effectively C) it has become clear to the auditor that performance of the operation creates significant risk that a material misstatement will not be detected by the client system D) an improperly designed control does not operate as designed or the person performing the control possesses the necessary authority or competence to perform the control effectively Answer: A Explanation: A deficiency in the operation exists when a properly designed control does not operate as designed or the person performing the control does not possess the necessary authority or competence to perform the control effectively. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 124) A deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented, or detected and corrected, on a timely basis is best described as ________. A) a material weakness B) a significant deficiency C) a material deficiency D) a deficiency Answer: A Explanation: A material weakness is defined as deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented, or detected and corrected, on a timely basis. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

125) An auditor's understanding of a client's system of internal control ________. A) is unrelated to the level of substantive procedures an auditor will conduct B) will help the auditor to determine areas of risk to direct audit attention and resources to C) is optional, and should only be conducted for larger clients D) is a helpful tool to determine the accuracy of account balances and transactions Answer: B Explanation: An auditor's understanding of a client's system of internal control will help the auditor to determine areas of risk to direct audit attention and resources to. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 126) Bruce and Paula, two audit partners assigned to the attestation engagement for DeBole Enterprises, LLC, are discussing the client's system of internal control. In particular, the discussion is centered on significant deficiencies and material weaknesses noted in the client's system. Which of the following statements regarding significant deficiencies and material weaknesses is correct? A) The auditor typically apprises senior management of significant deficiencies and material weaknesses in the initial engagement letter. B) The auditor usually notifies the internal audit function of any noted significant deficiencies, and refers material weaknesses to senior management for correction. C) The auditor is required by auditing standards to notify management of significant deficiencies and material weaknesses in a timely manner. D) The auditors typically notify senior management of significant deficiencies and material weaknesses in the audit report. Answer: C Explanation: The auditor is required by auditing standards to notify management of significant deficiencies and material weaknesses in a timely manner. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

127) As the audit of Lily Enterprises draws to a conclusion, the audit partners with responsibility for the engagement are meeting to discuss significant audit matters. One of the partners mentions the noted deficiencies in the client's system of internal control. The most appropriate way for the auditor to communicate such deficiencies is through which of the following? A) The auditor should communicate significant deficiencies in the client's system of internal control through the engagement letter, detailing recommendations to fix the issues noted. B) The auditor should communicate significant deficiencies in the client's system of internal control to those charged with governance through a formal management letter. C) The auditor should prepare a formal written document which is delivered to the head of the internal audit function. D) Generally accepted auditing standards require the auditor to notify the audit committee of all deficiencies within ten business days. Answer: B Explanation: The auditor should communicate significant deficiencies in the client's system of internal control to those charged with governance through a formal management letter. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 128) Bob and Cassie, two audit staff associates, are discussing the management letter which is soon to be issued by the partner with overall responsibility for the engagement with respect to the audit of Candle Enterprises, Inc. Bob and Cassie are discussing why the audit firm they work for would even issue such a communication. Which of the following best represents a purpose and benefit of the management letter? A) A management letter is sent to those charged with governance of the entity, and affords management an opportunity to receive an expert opinion on internal controls. B) A management letter is sent to the client's senior management by the auditor and details any and all mistakes and misstatements found as part of the audit. C) A management letter provides the auditors official opinion on the client's system of internal control, and requires management follow all recommendations made by the auditor. D) None of these answer choices are correct. Answer: A Explanation: A management letter is sent to those charged with governance of the entity, and affords management an opportunity to receive an expert opinion on internal controls. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

129) Dan and Lisa are discussing the management letter which is soon to be sent by their audit firm to a client that they are wrapping up the audit of. Dan and Lisa are curious to understand when a weakness would be considered sufficient to communicate with management, and ask you, the audit manager. Your most appropriate response to this question would be which of the following? A) Generally accepted auditing standards set forth very clear guidelines on when an auditor should communicate or not communicate a weakness. The best advice is just to follow these guidelines. B) The determination as to whether a weakness should be communicated to management is a more subjective one, and relies on the auditors' professional judgment. C) In order to avoid litigation to the greatest extent possible, external auditors routinely communicate all weaknesses regardless of magnitude or pervasiveness to management. D) None of these answer choices are correct. Answer: B Explanation: The determination as to whether a weakness should be communicated to management is a more subjective one, and relies on the auditors' professional judgment. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 130) Phil and Cristin, two audit managers assigned to the engagement of Wallace LLC are discussing the management letter with a new audit intern, Jessica. Jessica questions what the benefits are to the firm and the auditor in sending this letter. Which of the following best represents Phil and Cristin's response? A) The management letter allows the auditor an opportunity to formally communicate internal control deficiencies and weaknesses to those charged with governance. B) The management letter gives the client's senior management an opportunity to learn about weaknesses they may not have been aware of, and take actions to fix these weaknesses. C) Managements attitude and response toward the management letter provides the auditor with a sense of the importance that management places on internal control and remedying any deficiencies. D) All of these answer choices are correct. Answer: D Explanation: All of these answer choices are correct. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

131) The management letter should ________. A) be prepared by the audit team, be provided to the client, and discuss internal control weaknesses and other matters discovered during the audit B) only discuss internal control weaknesses C) be sent at the beginning of the engagement D) also be sent to the client's attorneys as a matter of course Answer: A Explanation: The management letter should be prepared by the audit team and be provided to the client. It should discuss internal control weaknesses and other matters discovered during the audit. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 132) By whose standards are internal control weaknesses commonly categorized into three groups? A) Both PCAOB and U.S. GAAS B) PCAOB only C) U.S. GAAS only D) Neither PCAOB nor U.S. GAAS Answer: A Explanation: Internal control weaknesses are commonly categorized into three groups by both PCAOB auditing standards and U.S. Generally Accepted Auditing Standards. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management; PC: Decision Making

133) A purpose of the management letter is to ________. A) communicate internal control matters in writing on a timely basis with those charged with governance B) identify, analyze, and manage the risks that affect an entity's ability to achieve its operational effectiveness C) ensure that every transaction is authorized by management personnel acting within the scope of their authority D) control program development, program changes, and computer operations and to secure access to programs and data Answer: A Explanation: The purpose of the management letter is to meet the auditor's responsibility for communicating internal control matters in writing on a timely basis with those charged with governance and to inform those charged with governance of the auditor's recommendations for improving its internal controls. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 134) PCAOB Audit Standard No. 2201 requires that ________. A) an auditor issues a qualified opinion on all accounts that were not tested in their entirety B) the audit partner should solely make the determination as to whether any material weaknesses have been identified as part of the audit C) all companies with a market capitalization of $75,000,000 or more file documentation with the Securities and Exchange Commission (SEC) detailing all deficiencies identified as part of the audit D) in an audit of ICFR, material weaknesses are reported to the public in the auditor report on ICFR Answer: D Explanation: PCAOB Audit Standard No. 2201 requires that in an audit of ICFR, material weaknesses are reported to the public in the auditor report on ICFR. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

135) Those charged with governance of an organization ________. A) should always be sure to look out for their own interests as well as those of the company B) cannot be legally held responsible for the actions of the company C) should rely on the auditors for guidance D) have an obligation to be concerned with the entity's financial reporting to shareholders and the investing public Answer: D Explanation: Those charged with governance of an organization have an obligation to be concerned with the entity's financial reporting to shareholders and the investing public. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 136) A management letter is sometimes also referred to as a ________. A) representation letter B) audit letter C) letter of recommendations D) confirmation Answer: C Explanation: A management letter is also sometimes referred to as a letter of recommendations. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 137) A management letter is ________. A) formally sent by the auditor to the client before acceptance of the engagement B) a deliverable prepared by the audit team and provided to those charged with governance C) sent from management to the auditor, detailing management's assessment of the auditor's performance during the audit D) sent to the auditor by management, giving permission to contact the predecessor auditor Answer: B Explanation: A management letter is a deliverable prepared by the audit team and provided to those charged with governance. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

138) The management letter discusses ________. A) all issues that management wishes to bring to the attention of the auditor B) all current and pending litigation against the client C) internal control weaknesses and other matters discovered during the course of the audit D) management's disagreements with the auditors regarding certain accounting principles Answer: C Explanation: The management letter discusses internal control weaknesses and other matters discovered during the course of the audit. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 139) The purpose of the management letter is to ________. A) meet the auditor's responsibility for communicating internal control matters in writing on a timely basis with those charged with governance B) inform management of the auditors pending desire to withdraw from the engagement C) meet the auditor's responsibility for communicating external control matters in writing on a timely basis with those charged with governance D) request management confirm the makeup and composition of its board of directors and any associated conflicts of interest Answer: A Explanation: The purpose of the management letter is to meet the auditor's responsibility for communicating internal control matters in writing on a timely basis with those charged with governance. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

140) One of the key functions of a management letter is to ________. A) provide management with some idea as to the audit opinion they will likely receive B) advise management of the auditor's requirements with respect to filing reports with the Securities and Exchange Commission (SEC) C) attempt to resolve differences of opinion on accounting estimated used by management in which the auditor disagrees D) inform those charged with governance of the auditor's recommendations for improving its internal controls Answer: D Explanation: One of the key functions of a management letter is to inform those charged with governance of the auditor's recommendations for improving its internal controls. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 141) ________ is a key component of the overall audit risk assessment and provides evidence that influences the resulting audit strategy developed by the auditor. A) Control risk B) Inherent risk C) Audit risk D) Client risk Answer: A Explanation: Control risk is a key component of the overall audit risk assessment and provides evidence that influences the resulting audit strategy developed by the auditor. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

142) The ________ also sets the foundation for effective internal control, and provides discipline and structure A) risk environment B) industry in which the client operates C) control environment D) audit partner in charge Answer: C Explanation: Control environment Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 143) The transaction flow in a typical sales process for a client that sells goods begins with processing the orders and ends with ________. Answer: recording sales and trade receivables Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making 144) ________ are controls that affect a particular transaction or group of transactions A) Entity level controls B) Transaction level controls C) Audit controls D) Client controls Answer: B Explanation: Transaction level controls are controls that affect a particular transaction or group of transactions. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

145) ________ are designed to provide assurance that changes to computer applications are introduced in a controlled and coordinated manner. A) Access controls B) Program change controls C) Manual controls D) Auditing controls Answer: B Explanation: Program change controls are designed to provide assurance that changes to computer applications are introduced in a controlled and coordinated manner. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 146) ________ controls are designed to provide reasonable assurance that IT records, processes and reports data properly for specific applications. A) manual B) independent C) computer application D) IT system Answer: C Explanation: Computer application controls are controls designed to provide reasonable assurance that IT records, processes and reports data properly for specific applications. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 147) ________ are internal controls that are performed by individuals but rely on computer generated information. A) Manual controls B) IT dependent manual controls C) IT controls D) Process controls Answer: B Explanation: IT dependent manual controls are internal controls that are performed by individuals but rely on computer generated information. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 64

148) A ________ involves the auditor describing (in words) each step of the flow of a transaction from start to finish A) flowchart B) narrative C) reperformance procedure D) logic diagram Answer: B Explanation: A narrative involves the auditor describing (in words) each step of the flow of a transaction from start to finish. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 149) A management letter is sometimes referred to as a ________. Answer: letter of recommendations Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

150) Which two of the following principles are within the monitoring component of the seventeen COSO principles of internal control? A) The organization selects, develops, and performs ongoing and/or separate evaluations to ascertain whether the components of internal control are present and functioning. B) The organization evaluates and communicates internal control deficiencies in a timely manner to those parties responsible for taking corrective action, including senior management and the board of directors, as appropriate. C) The organization internally communicates information, including objectives and responsibilities for internal control, necessary to support the functioning of internal control. D) The organization communicates with external parties regarding matters affecting the functioning of internal control. Answer: A, B Explanation: Among the seventeen COSO principles of internal control, the two principles within the Monitoring component are as follows: 1.The organization selects, develops, and performs ongoing and/or separate evaluations to ascertain whether the components of internal control are present and functioning. 2. The organization evaluates and communicates internal control deficiencies in a timely manner to those parties responsible for taking corrective action, including senior management and the board of directors, as appropriate. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management; PC: Decision Making 151) Which three of the following are included in common inherent limitation in internal control? A) Human error that results in a breakdown in internal control B) Ineffective understanding of the purpose of a control C) Collusion by two or more individuals to circumvent a control D) A control within a software that cannot be overridden or disabled Answer: A, B, C Explanation: Common inherent limitation in internal control include the following: 1.human error that results in a breakdown in internal control, 2. ineffective understanding of the purpose of a control, 3. collusion by two or more individuals to circumvent a control, 4. a control within a software program being overridden or disabled. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management; PC: Decision Making

152) Which three of the following are among the five components of internal control? A) The control environment B) Risk assessment C) Information and communication D) Reward and Punishment Answer: A, B, C Explanation: A second dimension of the COSO Framework identifies five integrated components of internal control: 1. The control environment, 2. risk assessment, 3. control activities, 4. information and communication, and 5. monitoring. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management; PC: Decision Making 153) Which two of the following require the auditor to obtain an understanding of an entity's internal control on all audit engagements? A) AS 2201 An Audit of Internal Control over Financial Reporting that is Integrated with an Audit of Financial Statements B) AU-C 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement C) AS 2815 The Meaning of "Present Fairly in Conformity with Generally Accepted Accounting Principles" D) AS 6110 Compliance Auditing Considerations in Audits of Recipients of Governmental Financial Assistance Answer: A, B Explanation: Both, AS 2201 An Audit of Internal Control over Financial Reporting that is Integrated with an Audit of Financial Statements and AU-C 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement require the auditor to obtain an understanding of an entity's internal control on all audit engagements. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Governance Perspective; AC: Risk Assessment, Analysis and Management; PC: Decision Making

154) Steve and Anna, two recent college graduates are meeting up for coffee as they have both been hired by the same accounting firm. One of the topics of conversation is the concept of internal control. Steve explains to Anna that he is not fully sure what internal control really means, and why it would be important to an audit. Select all choices that correctly define and explain internal control? A) Internal control helps a company achieve its stated goals and objectives, and should help the firm to run more efficiently. B) Internal control helps to provide reasonable assurance to firm stakeholders pertaining to the company achieving its goals and mission etc. C) Internal control is a process controlled by the client's external audit function, and under the control of the client's board of directors. D) In order for an external auditor to understand a client's system of internal control, they must first gain an understanding of the client's control risk. Answer: A, B Explanation: Internal control helps a company achieve its stated goals and objectives, and should help the firm to run more efficiently. Internal control helps to provide reasonable assurance to firm stakeholders pertaining to the company achieving its goals and mission etc. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 155) Diane and Alan are discussing the relationship between a client's system of internal control and control risk as assessed by the auditor. Which of the following statements is correct pertaining to this relationship? A) There is no relationship between control risk as assessed by the auditor and a client's system of internal control. B) When an auditor gains an understanding of a client's system of internal control and determines that it is not as effective as first thought, control risk is likely to be assessed higher. C) If an auditor assesses a client's control risk to be high, then the auditor is likely to conduct more substantive testing. D) If the auditor determines that a client's control risk is low, the auditor will conduct increased substantive testing. Answer: B, C Explanation: When an auditor gains an understanding of a client's system of internal control and determines that it is not as effective as first though, control risk is likely to be assessed higher. If the auditor determines that a client's control risk is low, the auditor will conduct increased substantive testing. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 68

156) Jackson CPA Firm is beginning the audit of Decker Enterprises, Inc., a distributor of lawn care equipment throughout the continental United States. The partner with overall responsibility for the audit has noted that management adheres to very high ethical standards, and expects the company employees to do the same. One of Decker's senior management has mentioned to the audit partner that she has noticed not all credit sales are appearing in accounts receivable. Select all statements that accurately describe this scenario. A) An example of a transaction level control is a strong tone at the top as demonstrated by the firm's senior management. B) A strong tone at the top as demonstrated by the client's senior management is an example of an entity-level control. C) The issue with accounts receivable and the client's tone at the top are both examples of entitylevel controls. D) The potential issue pertaining to accounts receivable represents an example of a transactionlevel control. Answer: B, D Explanation: A strong tone at the top as demonstrated by the client's senior management is an example of an entity-level control. The potential issue pertaining to accounts receivable represents an example of a transaction-level control. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 157) Jerry and Sandy, two audit senior managers assigned to the audit of Peabody LLC are discussing the concept of risk assessment with a new audit intern, Mark. Mark is trying to understand how risk assessment is related to a client's external audit. Select all of the choices that represent appropriate responses. A) There is only an indirect relationship at best between risk assessment and a client's external audit. B) Risk assessment is a critical component to an external audit because identified risks may increase the likelihood of misstatements in the financial statements. C) Risk assessment as it pertains to the external auditors pertains to financial risks only, as the auditor is engaged to detect material misstatements in the client's financial statements. D) The auditor performing an external audit is concerned with all risks at the risk assessment phase. Answer: B, D Explanation: Risk assessment is germane to an external audit because identified risks may increase the likelihood of misstatements in the financial statements. The auditor performing an external audit is concerned with all risks at the risk assessment phase. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 69

158) Which two of the following are external risk factors that an entity might consider? A) Technological development can affect the nature and timing of research and development or lead to changes in procurement. B) Changing customer needs or expectations can affect product development, production processes, customer service, pricing or warranties. C) The quality of personnel hired and methods of training and motivation can influence the level of control consciousness within the entity. D) The nature of the entity's activities, and employee accessibility to assets can contribute to misappropriation of resources. Answer: A, B Explanation: Two of external risk factors that an entity might consider are: 1. Technological development can affect the nature and timing of research and development or lead to changes in procurement. 2. Changing customer needs or expectations can affect product development, production processes, customer service, pricing or warranties. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 159) Which three of the following are true of monitoring? A) Much of the information used in monitoring is produced by the entity's information systems. B) Ongoing monitoring procedures are built into the normal recurring activities of the entity. C) One of the most common monitoring activities is the internal audit function. D) Monitoring excludes information obtained from communications with external parties. Answer: A, B, C Explanation: Much of the information used in monitoring is produced by the entity's information systems. Ongoing monitoring procedures are built into the normal recurring activities of the entity. One of the most common monitoring activities is the internal audit function. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Process and Resource Management Perspectives; AC: Risk Assessment, Analysis and Management; PC: Decision Making

160) In the context of internal controls, which three of the following are true of a smaller entity? (choose three options) A) It has limitations surrounding its ability to put effective internal controls in place. B) The small number of its employees limits its ability to segregate duties. C) The risk of management override can be reduced by establishing documented policies and procedures. D) It is easier for smaller entities to have a paper trail of documentation supporting an assessment of internal controls. Answer: A, B, C Explanation: In smaller entities there are often limitations surrounding the entity's ability to put effective internal controls in place. This is due to the limited number of employees, which in turn impacts the ability of the organization to segregate duties. Also, it is often not practical for smaller organizations to create an appropriate paper trail of documentation that allows an assessment of internal controls to be made. The risk of management override can be reduced by establishing documented policies and procedures. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: Process and Resource Management Perspectives; AC: Risk Assessment, Analysis and Management; PC: Decision Making 161) Which two of the following are true of a sales invoice? A) It states the particulars of a sale, including the amount owed, terms, and date of sale. B) It is used to bill customers, and it provides the basis for recording a sale in the sales journal. C) It is a client prepared document with the details of items included in a shipment. D) It serves as acknowledgement of receipt of goods for delivery by a freight carrier. Answer: A, B Explanation: A sales invoice is a client prepared document stating the particulars of a sale, including the amount owed, terms, and date of sale. It is used to bill customers, and it provides the basis for recording a sale in the sales journal. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making

162) While initiating sales, errors in which two of the following documents or files could mean the risk of sales being made to unauthorized customers? A) Customer master file B) Sales order C) Sales invoice D) Perpetual inventory Answer: A, B Explanation: While initiating sales, errors in the customer master file or sales order could mean the risk of sales being made to unauthorized customers. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication, Data Analytics AICPA: BC: None; AC: Reporting; PC: Decision Making 163) Which three of the following are possible risks during the specific transaction of delivering goods? A) Goods may be released from warehouse for unauthorized orders. B) Products are shipped without shipping documents being generated. C) Goods ordered may not be shipped. D) Some shipments may not be billed. Answer: A, B, C Explanation: During the specific transaction of delivering goods, the possible risks include the following: Goods may be released from warehouse for unauthorized orders; products are shipped without shipping documents being generated; and goods ordered may not be shipped. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Communication, Data Analytics AICPA: BC: None; AC: Reporting; PC: Decision Making

164) As part of an external audit, an auditor is examining selected revenue entries for credit sales, and ensuring the accounts receivable balances have been recorded appropriately. The auditor has compared the sales order, the shipping documents and associated receivables documents to ensure everything is correct. Select all statements that accurately describe this process. A) This type of audit procedure pertains to tests of entity-level controls, as management sets policies pertaining to what documentation is collected and what is recorded at each stage. B) This type of audit procedure is typically deferred to the internal auditors by the external auditor, making this a test of entity-level controls. C) These procedures describe tests of transaction-level controls, as the balances and supporting documents checked by the auditor relate to transactions the entity has initiated. D) The documents gathered as evidence by the auditor during this audit procedure would support the auditor's conclusion on transaction-level controls. Answer: C, D Explanation: These procedures describe tests of transaction-level controls, as the balances and supporting documents checked by the auditor relate to transactions the entity has initiated. The documents gathered as evidence by the auditor during this audit procedure would support the auditor's conclusion on transaction-level controls. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 165) While inputting a sales order for a new client, Tina receives a message from the sales order system notifying her that the shipping and billing addresses do not match, and that the shipping address does not come back as a valid address. Based on this information, which of the following statements pertaining to controls are correct? A) The messages Tina has received are examples of entity-level controls, and designed to stop goods being shipped to a nonexistent address. B) The messages Tina has received are examples of IT application controls, and are designed to help minimize errors and fraud in this area. C) Effective IT application controls help to minimize control risk associated with the client. D) The messages Tina has received are examples of IT general controls, and will ensure that no fraud or error can occur pertaining to revenue of receivables. Answer: B, C Explanation: The messages Tina has received are examples of IT application controls, and are designed to help minimize errors and fraud in this area. Effective IT application controls help to minimize control risk associated with the client. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 73

166) Juneberry Inc., a national provider of party supplies is discussing the recent acquisition and installation of a new customer relationship management system with its external auditor, Mayfair CPAs. The partner assigned to the engagement is curious as to whether the system has been installed and is operating properly. Based on this concern, which of the following statements are accurate? A) The controls pertaining to the successful installation and ongoing effectiveness of the new system are IT general controls. B) In order for a system to be installed and operate efficiently, the client must have robust and appropriate program change controls in place. C) Once the new system had been installed, attention should have been given by client management to access controls, to ensure that the right employees have the correct level of access. D) Client management and internal auditors should regularly test maintenance controls to ensure that data files and software programs are appropriately secure. Answer: A, B, C, D Explanation: The controls pertaining the successful installation and ongoing effectiveness of the new system are IT general controls. Once the new system had been installed, attention should have been given by client management to access controls, to ensure that the right employees have the correct level of access. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

167) John and Elaine, two audit managers assigned to the audit of Hodges Enterprises, Inc. are discussing how best to document the internal controls the client has in place. John and Elaine are attempting to appropriately document internal controls to assist with the audit. Which of the following choices represent appropriate methods to document internal control? A) John advises that he might record in written form the client's purchases-payables process from start to finish. B) Elaine advises John that she is a more 'visual' person, and plans to prepare a flowchart to help her understand the client's revenue and receivables cycle. C) John advises Elaine that in order to document his understanding of IT general controls, he will ask the IT department to formulate and complete a questionnaire. D) Elaine advises John that to help her understanding of the client's controls over cash receipts and disbursements; she will request management prepare a document fully detailing all procedures related to this area. Answer: A, B Explanation: John advises that he might record in written form the client's purchases-payables process from start to finish. Elaine advises John that she is a more 'visual' person, and plans to prepare a flowchart to help her understand the client's revenue and receivables cycle. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

168) Darren and Sandra, audit managers assigned to the audit of Haavisto LLC, are discussing internal control weaknesses with a new audit staff associate, Kenya. Kenya is attempting to learn more about this area and in particular, understand what happens if an auditor determines a client's system of internal controls are weak. Which of the following statements are true regarding internal controls? A) If the auditor determines that there are deficiencies in a client's system of internal control, then the auditor is likely to decrease substantive testing and adopt a reliance strategy. B) If internal control is assessed as effective by the auditor, then it is likely that the auditor will perform decreased substantive testing. C) If an audit client has weak internal controls, the auditor will assume that a material weakness exists and will perform audit procedures designed to eliminate this risk. D) If the auditor determines that one of the client's internal controls is not operating as designed, this may constitute a material weakness, and the auditor would subsequently increase substantive testing. Answer: B, D Explanation: If internal control is assessed as effective by the auditor, then it is likely that the auditor will perform decreased substantive testing. If the auditor determines that one of the client's internal controls is not operating as designed, this would constitute a material weakness, and the auditor would subsequently increase substantive testing. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 169) A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that ________ and ________. (choose two options) A) is less severe than a material weakness B) merits attention by those charged with governance C) is more severe than a material weakness D) does not merit attention by those charged with governance Answer: A, B Explanation: A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: Decision Making

170) Which of the following statements relating to identifying strengths and weaknesses in a system of internal controls are true? (choose two options) A) If the auditor identifies internal control weaknesses, the risk of material misstatements being undetected by management's processes and controls increases. B) The auditor typically performs additional substantive testing in the areas of internal control weakness in order to identify and quantify potential material misstatement. C) There is no link between weaknesses in internal controls (that is, observations that controls being tested did not operate as intended) and the level of substantive procedures required. D) When the auditor identifies internal control weaknesses, the auditor will consider a lower assessed level of control risk approach for assertions influenced by these weaknesses. Answer: A, B Explanation: When the auditor identifies internal control strengths, the auditor will consider a lower assessed level of control risk approach for assertions influenced by these strengths. If the auditor identifies internal control weaknesses, the risk of material misstatements being undetected by management's processes and controls increases. Further, the areas of weakness are where the auditor typically performs additional substantive testing to quantify potential material misstatement. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: Decision Making 171) As the audit of Short Enterprises reaches its conclusion, the external auditors are preparing the management letter. It has been noted that several weaknesses exist in the client's system of internal control. Based on this information, which of the following are correct? A) Generally accepted auditing standards require all weaknesses in internal control to be submitted to management in writing. B) The auditor typically communicates all identified material weaknesses in internal control to the audit committee and the internal audit function. C) The question as to which weaknesses in internal control management should be notified about is a matter of auditor judgment. D) Providing notification to management relating to internal control weaknesses allows the auditors an opportunity to access management's response with respect to correcting noted deficiencies. Answer: C, D Explanation: The question as to which weaknesses in internal control management should be notified about is a matter of auditor judgment. Providing notification to management relating to internal control weaknesses allows the auditors an opportunity to access management's response with respect to correcting noted deficiencies. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 77

172) Match each of the common documents and files that are found in the process of selling goods with its definition. A. Customer master file B. Sales order C. Bill of lading D. Packing slip ____ A client prepared prenumbered document that includes customer information, description and quantity of what was ordered, and terms of sale. ____ An electronic file containing the customer shipping and billing information and the customer credit limit. ____ A client prepared document with the details of items included in a shipment. ____ A shipping document that serves as acknowledgement of receipt of goods for delivery by a freight carrier. Answer: Common documents and files that are found in the process of selling goods include, among others, the following four: Customer master file: An electronic file containing the customer shipping and billing information and the customer credit limit. Sales order: A client prepared pre-numbered document that includes customer information, description and quantity of what was ordered, and terms of sale. Bill of Lading: A shipping document which serves as acknowledgement of receipt of goods for delivery by a freight carrier. Packing Slip: A client prepared document with the details of items included in a shipment. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making 173) Auditors are required to obtain a sufficient understanding of an entity's internal control. This understanding is required by the performance principle of GAAS. What are some of the goals (purposes) for conducting an evaluation of an entity's internal control? Answer: The audit team has two primary reasons for conducting an evaluation of an entity's internal control. First, the PCAOB requires an audit of the effectiveness of internal control and that the audit be an integrated part of the financial statement audit for publicly traded companies. The second reason for evaluating an entity's internal control is to comply with the performance principle of GAAS: To assess the risk of material misstatement to give the auditors a basis for planning the audit and determining the nature, timing, and extent of audit procedures for the substantive audit plan. The audit team assesses control risk. Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 78

174) List several elements of a company's control environment. Answer: Some of the elements of a control environment include: * management's philosophy and operating style. * company organization structure. * functioning of the board of directors, particularly its audit committee. * methods of assigning authority and responsibility. * management's monitoring methods, including internal auditing. * personnel policies and practices. * external influences. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Research; PC: Decision Making 175) Dana and Casey are discussing the idea of internal control after leaving their college auditing class. Dana tells Casey that internal control appears to be more tied to a firm being able to achieve its objectives, and doesn't really understand what it has to do with the external auditors. Casey agrees, adding that he doesn't see any reason why an auditor would be interested in whether or not a firm is achieving its objectives. Which of the following offers the best explanation to help Dana and Casey understand this better? A) Whether or not a firm achieves its objectives is not really a concern of the external auditors. Their job is simply to audit the financial statements and attempt to detect any material misstatements if they are present. B) The auditors concern themselves with internal control, which is tied to a firm achieving its operational and financial objectives etc. If a client's system of internal control is weak, then there is an increased likelihood of material misstatements in the financial statements. C) The external auditors typically provide an integrated audit which involves auditing both the clients' system of internal control as well as the financial statements. If the auditors are able to confirm that internal control is effective, then they can increase substantive testing. D) The auditors are secondarily concerned with whether or not a firm is achieving its stated goals and objectives, as a company that is not achieving its objectives represents increased audit risk and decrease control risk. Answer: B Explanation: The auditors concern themselves with internal control, which is tied to a firm achieving its operational and financial objectives etc. If a client's system of internal control is weak, then there is an increased likelihood of misstatements in the financial statements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

176) Jessie and Sam are discussing internal controls one day at lunch. They are currently working on their first audit together, which is in its preliminary stages. As a result, they are both keen to understand internal control more fully. Jessie has mentioned that some clients are likely to have stronger systems of internal control than others, and some firms will spend more money in this area than others. Sam agrees, and adds that no matter how robust of a system, and how much money is spent, there is no such thing as a perfect system of internal control. Which of the following statements pertaining to internal control is accurate? A) A well designed and robust system of internal control is designed to provide the company with complete assurance that stated objectives and goals are being met, and that no misstatements are contained in the financial statements. B) Internal control can only be effective if it is designed properly, and regularly reviewed. In order to ensure the system of internal control is as effective as possible, and to ensure its impartiality, the external auditors should assume overall responsibility for the system. C) A robust and effective system of internal control can help management by providing reasonable assurance that operational and financial goals are being met. An effective system also helps the auditors in reducing control and audit risk. D) Despite being effective and robust, even the best systems of internal control can be circumvented. When this happens, the external auditors will usually reduce reliance on controls and perform less substantive testing. Answer: C Explanation: A robust and effective system of internal control can help management by providing reasonable assurance that operational and financial goals are being met. An effective system also helps the auditors in reducing control and audit risk. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

177) Brian and Stella, two audit managers, are discussing the ongoing audit of PipeCo Enterprises, a national distributor of cut and blown glass products. Brian has mentioned to Stella that the management of PipeCo Enterprises seems rather aggressive with respect to setting sales goals and other targets. A senior manager with the firm has also confided in Stella that management often override controls put in place to prevent revenue entries being recorded in the incorrect period. Based on these facts, which of the following statements best reflects Brian and Stella's concerns at this juncture of the audit? A) Brian and Stella are external auditors, so this information is not something that should be of concern to them. They are likely to pass this information along to the internal audit function, and allow the internal auditors to respond appropriately. B) Brian and Stella are likely to be concerned that top management is taking this approach, and is also overriding internal controls put specifically in place to prevent certain issues. They are also more likely to form the opinion that transaction-level controls may be weak. C) Brian and Stella will be concerned about management overriding controls related to transactions being recorded in the correct period. They are likely to focus increased audit attention in this area, and will likely now adopt a reliance strategy with less substantive tests of details. D) Brian and Stella will most likely respond to these concerns by interviewing senior management and requesting written assurances related to transactions being recorded in the correct period. If management are willing to provide such assurances, this will help indemnify the auditor if any litigation arises. Answer: B Explanation: Brian and Stella are likely to be concerned that top management is taking this approach, and is also overriding internal controls put specifically in place to prevent certain issues. They are also more likely to form the opinion that transaction-level controls may be weak. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

178) During the audit of Hill Enterprises, Inc., a small wholesaler of mountain biking and other outdoor equipment in the southeastern United States, the external auditors, Jones CPAs, are discussing the importance of segregation of duties with the firm's management. Both the firm's CEO and CFO do not see the importance of this concept, and tell the auditors that it sounds like nothing more than a reason to have to hire extra staff. Which of the following would be the best explanation to describe and explain segregation of duties to these executives? A) Segregation of duties helps to ensure that no one employee is overworked, and as a result, inadvertently commits errors related to their job. Increased errors may spill over into the financial statements, which would increase audit risk for the auditors. B) Segregation of duties is important to both the firm and the external auditors. An appropriate division of duties helps to ensure that no one employee is put in a position where he or she has an opportunity commit fraud or make mistakes that impact multiple areas. C) If a firm's top management commit to an effective and appropriate segregation of duties, then the external auditors are usually able to complete the audit with less billable hours charged. This in turn reduces the cost of the audit which benefits management and the shareholders. D) Segregation of duties is important for both the external auditors and the firm because the auditors are required to adhere to strict rules and guidelines set forth in generally accepted auditing standards which dictate minimum standards a firm must abide by in this area. Answer: B Explanation: Segregation of duties is important to both the firm and the external auditors. An appropriate division of duties helps to ensure that no one employee is put in a position where he or she may commit fraud. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

179) What kind of error or fraud could happen if the inventory warehouse manager also had responsibility for making the physical inventory count and reconciling discrepancies to the perpetual inventory records? Answer: The inventory manager could commit an inadvertent error of miscounting and adjust the error into the accounts and inventory records, or steal inventory and adjust the inventory records permanently to cover up the theft. Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 180) Brian's wife, Susan, owns a printing business in town. Brian works in the accounts payable department of Martin's Shoes. Susan prints invoices for work supposedly done for Martin's Shoes, even though no actual work was performed for Martin's Shoes. Brian then brings the invoices to work and enters them into the accounts payable system to be approved for payment. Martin's Shoes pays these invoices and sends Susan's printing company a check. 1. Name two internal controls that might prevent or detect these fraudulent payments. 2. Name two audit procedures that might detect this fraud. Answer: 1. Internal controls would include: Voucher package that includes a receiving report. An approved vendor list and the requirement that the vendor be on the approved vendor list. The inclusion of an expense account for the charging of all material. Each department gets a report of all expenses each month for review. 2. Audit procedures would include: Review of voucher packages to ensure goods were received. Review of voucher packages to ensure vendors are on the approved vendor list. Analytical procedures to identify increases in expenditures for specific types of products (printing services). Analytical procedures to identify increases in expenditures to specific vendors. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

181) During the initial stages of the audit of Berkeley Company, the audit manager with day-today responsibility for the engagement is discussing how the audit of the inventory accounts should be handled with an audit staff associate. As the audit manager is much more experienced, he is attempting to give the staff associate some ideas of areas to consider checking. Which of the following would represent potential issues related to the audit of inventory that the staff associate may wish to check? A) The staff associate is likely to examine the valuation of inventory to ensure it has been recorded at the correct value, as well as checking to make sure that all decreases in inventory can be matched to the pertinent accounts payable. B) The staff associate is likely to determine if shipments of inventory out of the warehouse received the appropriate authorizations, as well as checking a sample of documents to ensure the completeness of documents supporting inventory shipments. C) The staff associate is likely to examine payables invoices related to inventory shipments to clients, and attempt to match them with sales order. D) The staff associate may wish to audit whether the inventory is obsolete and may need a valuation adjustment. If this turns out to be the case, then the auditor will request management obtain updated values for inventory accounts and make any necessary adjustments. Answer: B Explanation: The staff associate is likely to determine if shipments of inventory out of the warehouse received the appropriate authorizations, as well as checking a sample of documents to ensure the completeness of documents supporting inventory shipments. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None; AC: Risk Assessment, Analysis and Management; FN: Risk Analysis Section

182) During the audit of Gale LLC, the external auditors, Rothschild CPAs are examining sample documents related to client sales and revenue. It has been determined by the auditors that certain sales orders are missing, and in other cases credit sales entries do not appear to have a related receivable recorded. Based on this information, which of the following statements is most accurate? A) As the auditor has found instances whereby sales orders supporting revenue entries are missing, the client may have ineffective transaction level controls. The auditor may wish to spend more time auditing internal controls related to this area. B) The fact that the auditor has noted missing sales orders related to revenue entries point to likely fraud. The auditor should plan to audit all revenue entries in order to reduce control risk to an acceptable level. C) Upon determining that there are discrepancies in this area, the order should access control risk at the maximum and audit all entity-level controls related to this area to ensure their effectiveness. D) The deficiencies in this area likely point to ineffective entity-level and transaction-level controls. It is most likely that ineffective transaction-level controls relating to the revenuereceivables cycle have caused entity-level controls to also be ineffective. Answer: A Explanation: As the auditor has found instances whereby sales orders supporting revenue entries are missing, the client may have ineffective transaction level controls. The auditor may wish to spend more time auditing this area. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None; AC: Risk Assessment, Analysis and Management; FN: Risk Analysis Section

183) During the audit of Carnegie Enterprises, a national distributor of steel products throughout the continental United States, the external auditors, Bloom CPA firm are examining and auditing the client's accounts receivable and related allowance accounts. Two of the audit managers are meeting to discuss potential risks and areas worthy of closer attention pertaining to these accounts. Which of the following statements most accurately describes risks and areas that may require audit attention? A) Accounts receivable and the related allowance accounts typically carry higher audit risk, as management have incentive to understate accounts receivable and similarly overstate the allowance. This may cause an overstatement of assets on the balance sheet, and should be checked by the auditors. B) Auditors often spend considerable audit time checking accounts receivable and the related allowance accounts because management may wish to understate the allowance. This understatement may cause net receivables to be overstated, which translates into an overstatement of assets. C) As accounts receivable and the related allowance accounts represent areas where subjectivity and management estimation is required, control risk is usually assessed at the maximum by the auditors. An increase in control risk serves to lower audit risk and ensure that audit materiality is lowered in this area. D) Because of the subjectivity involved in these accounts, the risk of material misstatement is usually assessed as higher by the auditors. The auditors typically obtain written assurances from management that the determination of the allowance and calculation of net receivables has been calculated fairly. Answer: B Explanation: Auditors often spend considerable audit time checking accounts receivable and the related allowance accounts because management may wish to understate the allowance. This understatement may cause net receivables to be overstated, which translates into an overstatement of assets. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None; AC: Risk Assessment, Analysis and Management; FN: Risk Analysis Section

184) One of Johnson CPAs largest audit clients, Seaco Company has been hacked. The extent and breadth of the hack is still being determined by IT experts. The partners of the audit firm are meeting with senior management of the firm to discuss the breach. Historically, Seaco Company has had a strong system of internal control. Which of the following statements best describes the audit firms actions related to internal control during the next audit? A) The auditors have had prior experience with the client's system of internal control and know that it has historically been robust and effective. As a result, it is unlikely that the controls themselves have been compromised and thus the auditor should plan to audit the firm as normal with respect to internal control. B) Based on the information supplied to them by the client, the auditor should consider a reliance on controls strategy. This strategy will help the auditor to determine the extent to which the breach has affected internal controls, and will allow the auditor to supply management with a list of corrections. C) The auditor should assume that, as a result of the breach, all of the client's internal controls may have been breached and may now be ineffective. As a result, the auditors will likely spend increased time testing both the client's internal controls and performing additional substantive testing in order to gain the necessary assurance for the audit. D) Upon learning of this breach of a major client, the auditors should convene a private meeting among the partners to determine if the best course of action would be to no longer audit this client. The audit firm has worked hard to build up a good reputation, which could easily be damaged if they continue auditing this client. Answer: C Explanation: The auditor should assume that, as a result of the breach, all of the client's internal controls may have been breached and may now be ineffective. As a result, the auditors will likely spend increased time testing both the client's internal controls and performing additional substantive testing in order to gain the necessary assurance for the audit. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None; AC: Risk Assessment, Analysis and Management; FN: Risk Analysis Section

185) While performing the audit of Sunny Company, a large supplier and retailer of indoor pools and hot tubs, one of the auditors is examining a client system designed to initiate and process sales orders from other companies. The auditor attempts to input letters into the field requiring the customers EIN (Employer Identification Number) and is able to successfully do so. This field should only accept numbers and dashes. Based on this finding, which of the following statements is true? A) Upon this finding, the auditor should assume that all of the client's internal controls are ineffective and assess control risk at the maximum. This will lead to the auditor spending less time on substantive testing and more time on internal controls. B) The auditor is likely to determine that input controls related to this application are ineffective. This will likely lead to the auditor increasing substantive testing in this area to compensate for a weakness in internal control. C) The auditor is likely to conclude that internal controls and input controls related to this application are ineffective. As a result, the auditor will decrease substantive testing in this area as the controls cannot be relied upon. D) Upon concluding that internal controls in this area are not performing as designed, the auditor will most likely contact the IT function and request the control be corrected before performing any further audit procedures, in order to be able to issue a clean audit opinion. Answer: B Explanation: The auditor is likely to determine that input controls related to this application are ineffective. This will likely lead to the auditor increasing substantive testing in this area to compensate for a weakness in internal control. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None; AC: Risk Assessment, Analysis and Management; FN: Risk Analysis Section

186) Tommy Company, a regional retailer of fencing and other lumber products is being audited by their external auditors, Bolt CPA Firm. After some problems last year, the auditors are particularly interested in auditing the clients system of internal control. The auditors observe that for the client's revenue and receivable cycle transactions, the orders are entered into the system, the system processes the orders, and then exception reports are generated for any orders with issues which are flagged for further review. Based on this information, what types of internal controls has the client deployed? A) The client is using entity-level controls to ensure the processing system is operating effectively. The client is also using an IT general control in the exception reports. B) The client's exception reports represent an example of input controls, and the processing system itself represents an example of an IT general control. C) The client appears to be utilizing IT general controls in the processing system, and an example of an output control would be when an exception report is generated. D) Both the effective and efficient processing of sales transactions represent IT general controls, and the exception reports the system is generating would represent an example of an entity-level control. Answer: C Explanation: The client appears to be utilizing IT general controls in the processing system, and an example of an output control would be when an exception report is generated. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None; AC: Risk Assessment, Analysis and Management; FN: Risk Analysis Section

187) You have been hired to help a small start-up coffee shop set up their accounting information system and internal controls. The owner of the coffee shop, Patrick Lawson, asks you if he really needs to have a computerized system or if he can just use a manual system. Explain the benefits and risks of an IT system over a manual system to Patrick. Answer: Answers will vary but should address the following: In order to understand internal control in a computer environment, it is important to understand the benefits and risks of IT systems. The major benefits of IT systems over manual systems include the following: o IT systems can provide greater consistency in processing than manual systems because they uniformly subject all transactions to the same controls, o More timely computer-generated accounting reports may provide management with more effective means of analyzing, supervising, and reviewing the operations of the company, and o IT systems enhance the ability to monitor the entity's performance and activities. Important risks of IT systems over manual systems include the following: o The IT system may produce a transaction trail that is available for audit for only a short period of time, o There is often less documentary evidence of the performance of control procedures in computer systems, o Files and records in IT systems are usually in machine-sensible form and cannot be read without a computer, o The decrease of human involvement in computer processing can obscure errors that might be observed in manual systems, o IT systems may be more vulnerable to physical disaster, unauthorized manipulation, and mechanical malfunction than information in manual systems, o Various functions may be concentrated in IT systems, with a corresponding reduction in the traditional segregation of duties followed in manual systems, o Changes in the system are often more difficult to implement and control in IT systems than in manual systems, o IT systems are vulnerable to unauthorized changes in programs, systems, or data in master files, o Reliance is placed on systems that process inaccurate data, process data inaccurately, or both, o Unauthorized access to data may result in the destruction of data or improper changes to data, including the recording of unauthorized or nonexistent transactions, or inaccurate recording of transactions, and o There may be inappropriate or unauthorized manual intervention. Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

188) Compare and contrast computer general controls with computer application controls. Answer: The purpose of general controls is to control program development, program changes, computer operations, and to secure access to programs and data. The following five types of general controls are widely recognized: 1. Data center and network operations controls 2. System software acquisition, change and maintenance controls 3. Program change controls 4. Access controls 5. Application system acquisition, development and maintenance controls Computer general controls pertain to the IT environment and all IT activities as opposed to a single IT application. Because of the pervasive character of general controls, if the auditor is able to obtain evidence that general controls function effectively, then the auditor also has important assurance that individual application systems may be properly designed and operate consistently during the period under audit. The purpose of application controls is to use the power of information technology to control transactions in individual transaction cycles. Hence, applications controls will differ for each transaction cycle (e.g., sales vs. inventory controls). The following three groups of application controls are widely recognized: o Input controls o Processing controls o Output controls These controls are designed to provide reasonable assurance that the recording, processing, and reporting of data by an IT system are properly performed for specific applications. Thus, the auditor must consider these controls separately for each significant accounting application, such as billing customers or preparing payroll checks. Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: Decision Making

189) By eliminating the intermediary and harnessing the power of peer-to-peer networks, blockchain technology may provide opportunities to reduce transaction costs and decrease settlement time. However, blockchain technology is still emerging and, as such, so are the audit implications. Describe at least three audit risks associated with blockchain technology. Answer: The report, also identifies risks associated with a recorded blockchain transaction: The transaction may be: o Unauthorized, fraudulent, or illegal. o Executed between related parties. o Linked to a side agreement that is "off chain." o Incorrectly classified in the financial statements. Risks associated with a recorded blockchain transaction include: The transaction may be: o Unauthorized, fraudulent, or illegal. o Executed between related parties. o Linked to a side agreement that is "off chain." o Incorrectly classified in the financial statements. While verifying the occurrence of a transaction is a key aspect of the financial statement audit, it is just one of many assertions. Will blockchain provide sufficient, appropriate evidence for all assertions? An auditor will also need to consider whether the data from the blockchain is reliable. The auditor should not assume that because data comes out of a blockchain it is reliable. The auditor must still consider information technology general controls (ITGCs) related to the blockchain environment. It should also understand and assess the reliability of the consensus protocol for the specific blockchain. The auditor should also understand the linkage between the blockchain information and the information reported in the financial statements. Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

190) Your new client, Dallas Bread & Pastry, is a small bakery located in Dallas, TX. All sales are made at the local storefront on a cash or credit card basis. Dallas Bread & Pastry has 3 employees. The owner bakes and does the purchasing of ingredients and supplies. There is a second baker who arrives at 3am daily to bake and clean up the kitchen at the end of the day. There is an administrative employee who handles payroll and accounts payable processes. Describe which form of documentation you would use to document your understanding of Dallas Bread & Pastry's internal controls and provide a rationale for your decision. Answer: Dallas Bread & Pastry appears to be a small, and straightforward organization. Narratives are the most common form of documentation, particularly in smaller environments where accounting and internal control activities are simple or where a particular flow of a transaction is relatively simple and straightforward. It involves the auditor describing (in words) each step of the flow of a transaction from start to finish (that is, from initiation to reporting in the financial report). Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: Decision Making 191) Compare the advantages and disadvantages of narratives, flowcharts, and internal control questionnaires. Answer: Narratives – this is the most common form of documentation, particularly in smaller environments where accounting and internal control activities are simple or where a particular flow of a transaction is relatively simple and straightforward. It involves the auditor describing (in words) each step of the flow of a transaction from start to finish (that is, from initiation to reporting in the financial report). They can be cumbersome to read through, however. Flowcharts & Logic Diagrams – this form of documentation is used in larger and more complex environments. It involves the auditor summarizing (in flowcharts/boxes) each step of the flow of a transaction from start to finish (that is, from initiation to reporting in the general ledger). Flowcharts are not often used as they usually take longer to prepare than narratives or checklists. Instead, logic diagrams are more common. They provide a visual perspective of the flow of the transaction and key controls throughout the flow that is often simpler for the reader or reviewer to understand. The key to a good logic diagram is to keep it as simple as possible, with as few words as possible so as not to overload the reader with information. Checklists and preformatted questionnaires – an internal control checklist or questionnaire is another technique used to systematically identify the most common types of internal control procedures that should be present. This is particularly helpful in industries that the auditor may not personally be familiar with auditing, or when less experienced auditors find it difficult to identify which are the critical controls (for example, when documenting entity-level controls. However, they don't provide the same level of detail as a narrative or flowchart. Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: Decision Making 93

192) Honey Company, a national distributor of candy and other confectionary products is being audited by Slater & Co. CPA Firm. As the audit is currently in its initial stages, the auditors are spending time understanding the client, the client's industry, and documenting their understanding of internal control. The auditors assigned to the engagement have noted that Honey Company has efficient and very methodical/logical operations. The auditors are attempting to determine which procedure would help them best document their understanding of internal control. Which of the following would be the most appropriate answer to this question? A) Depending on the auditor's preference and who will need to view the documents and procedures, the auditor is likely to choose from narratives, flowcharts, or questionnaires. The auditor should keep in mind that the overarching goal is to ensure simplicity and understandability to the greatest extent possible. B) The auditor is likely to consult generally accepted auditing standards, which set forth strict rules and guidelines pertaining to what procedure should be used depending on the size of the firm and the effectiveness of internal control. C) The auditor will likely consult with the firm's senior management and request guidance on which system of documentation would be most suitable. As the audit is being conducted for the client, it is up to the client's management to make this determination. D) The best entity within the firm to perform these procedures is the internal control function. These internal auditors understand the client, including any areas of higher risk better than the auditor, and are able to maintain independence from management. Answer: A Explanation: Depending on the auditor's preference and who will need to view the documents and procedures, the auditor is likely to choose from narratives, flowcharts, or questionnaires. The auditor should keep in mind that the overarching goal is to ensure simplicity and understandability to the greatest extent possible. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; FN: Risk Analysis Section; PC: None

193) Rodney and Co. CPA Firm is currently conducting the audit of Monington Industries, a large, nationwide client with an extremely decentralized structure. The auditors have noted that both the client's industry and operations are extremely complex, along with the processes the client uses to transact it's business. Based on this information, which of the following choices best describes the procedure the auditors are most likely to use in order to document their understanding of internal control? A) As the client is decentralized, generally accepted auditing standards require the auditing firm to utilize checklists. This methodical approach to documenting an understanding of internal control helps to ensure that nothing is missed pertaining to internal control. B) Due to the client's size and complexity, it is more likely that the auditing firm will utilize flowcharts. Flowcharts represent an easily understandable and graphic way for auditors to describe processes from start to finish. C) The auditor is likely to consult with the client's management and discuss the preferred approach to documenting an understanding of internal control. Once senior management approves the auditors approach, the auditors can begin their documentation procedures. D) The auditor may wish to employ a narrative system, whereby the auditor describes in words and paragraphs the client's system of internal control. A benefit to using this system is that the auditor can usually create the narrative quickly, and is usually well understood by others. Answer: B Explanation: Due to the client's size and complexity, it is more likely that the auditing firm will utilize flowcharts. Flowcharts represent an easily understandable and graphic way for auditors to describe processes from start to finish. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; FN: Risk Analysis Section; PC: None

194) As part of the audit of McGraw Enterprises, a global distributor of engine and other vehicle parts, the external auditors, DayGlo CPA Firm, are examining the client's system of internal controls, specifically controls related to credit sales and approvals. The credit manager has apprised the auditors that in certain cases, inventory has been shipped on credit terms to clients who have already exceeded their credit limit. Based on this finding, which of the following represents the auditors most likely conclusion? A) Entity level controls pertaining to sales and accounts receivable are deficient, as evidenced by goods shipped to clients who should not be receiving inventory shipments. B) At least some transaction level controls that pertain to the sales-receivables cycle are not operating effectively or as designed. As a result, the auditor will likely focus further audit attention in this area and notify those charged with governance of the deficiencies. C) The auditors are likely to conclude that clients who have received inventory shipments despite exceeding their credit limit have already been checked and approved by client staff, thus there is no need for the auditors to be concerned over this. D) This finding represents a weakness in IT general controls. The auditors will consult applicable generally accepted auditing standards to determine the best course of action, and may either issue a quailed opinion on this area or disclaim an opinion completely. Answer: B Explanation: At least some transaction level controls that pertain to the sales-receivables cycle are not operating effectively or as designed. As a result, the auditor will likely focus further audit attention in this area and notify those charged with governance of the deficiencies. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; FN: Risk Analysis Section; PC: None

195) The senior audit partners of Jensen CPA firm are discussing their ongoing audit of Cavanagh Enterprises, a regional purveyor of rustic and antique furniture. Because the client is a publicly-traded firm, the auditors are required to perform an integrated audit of both internal control and the financial statements. The auditors have determined that the client's system of internal control is weaker and less robust than had been expected. As a result of this finding, which of the following best represents the auditors' most likely strategy? A) The auditors are likely to consult generally accepted auditing standards which provide specific guidance to the external auditors related to additional procedures that must be performed in order to be able to issue a clean audit opinion. B) As the auditors have determined that internal control is not functioning as effectively has had been first thought, the auditors are likely to adopt a reliance strategy. This will cause a decrease in substantive testing. C) As the auditors have determined that the client's system of internal control is less robust than had been previously thought, the auditors will likely rely less on the client's system of internal controls. As a result, the auditors are likely to increase substantive testing. D) The auditors should consult with the client's internal audit function, requesting that they provide additional documentation and written assurances that internal control is functioning properly, despite what the auditor has found. These written assurances are added to the audit file and are used to help the audit partner with overall responsibility for the engagement come to an appropriate audit conclusion. Answer: C Explanation: As the auditors have determined that the client's system of internal control is less robust than had been previously thought, the auditors will likely rely less on the client's system of internal controls. As a result, the auditors are likely to increase substantive testing. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; FN: Risk Analysis Section; PC: None

196) As the audit of PeaGram LLC a publicly traded company draws to a close, the external auditors have noted multiple deficiencies in the client's system of internal control. The audit partners with overall responsibility for the engagement have met and it has been agreed that due to the large number of deficiencies, a material weakness in the client's internal control system exists. As a result of this, which of the following choices best describe the auditors' actions upon conclusion of the audit? A) The auditors will likely meet with the client's senior management before conclusion of the audit and present them with an opportunity to correct all errors. If management corrects all internal control deficiencies before the conclusion of the audit, the auditor will issue a clean opinion on internal control. B) Any material weaknesses in a client's system of internal control must be reported to the public. As a result of this, the auditor will be required to note this material weakness in the audit report. C) As a material weakness in internal control exists, the auditor is most likely to issue a qualified opinion on internal control. This effectively means that the auditor is not expressing an opinion in this area. D) It is typical that when faced with a material weakness in a client's system of internal control, the auditor will typically disclaim an opinion on the clients' system of internal control, and only express an opinion on the financial statements. This is acceptable under generally accepted auditing standards. Answer: B Explanation: Any material weaknesses in a client's system of internal control must be reported to the public. As a result of this, the auditor will be required to note this material weakness in the audit report. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

197) As part of the audit of Wyoming Enterprises, a regional distributor of linoleum and other carpet products in the northwestern United States, the external auditors, Alan CPA Firm, have determined that their client's system of internal control is more effective and robust than had been determined in prior audits. As a result of this finding, what are the auditors likely to do differently on this audit? A) The auditors will likely adopt a reliance strategy. As a result of this reliance strategy, the auditors will typically perform less substantive procedures. B) The auditors are more likely to spend less time auditing the client's system of internal control, and will instead focus more time on substantive testing, including tests of details. C) The auditors will focus all resources on substantive testing, and will simply request management provide written assurances regarding internal control and details of any changes made, for inclusion in the current year's audit file. D) Generally accepted auditing standards allow external auditors to rely on the opinion of and documents provided by the internal audit function, if their initial assessment of internal control is that it is strong, robust and effective. Answer: A Explanation: The auditors will likely adopt a reliance strategy. As a result of this reliance strategy, the auditors will typically perform less substantive procedures. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; FN: Risk Analysis Section; PC: None

198) During the audit of FarmHouse Enterprises LLC, a provider of farming and agricultural equipment throughout the Midwestern United States, the external auditors, Mellon CPAs have noted that several internal controls related to the purchases-payable cycle do not appear to be operating as expected. As a result, the auditors have determined that some payables have been paid twice and other payables are overdue. The auditors conclude that key controls that would prevent these errors are not operating as designed. As a result of these findings, the auditors conclude that multiple deficiencies in internal controls exist related to accounts payable. Which of the following choices most accurately reflects the auditors' likely conclusions at this juncture? A) The auditor is likely to request a meeting with the client's senior management, and apprise management that the auditor will issue a disclaimer of opinion on the area of payables. B) The auditor should document the deficiencies and increase substantive testing in this area, while allowing management and the internal audit function time to fix the deficiencies and weaknesses. C) The auditor may conclude that the deficiencies, when taken together, constitute a material weakness. Such a material weakness may mean the client's financial statements are materially misstated. D) At this stage, the auditors are most likely to meet with the internal audit function and apprise the function of the deficiencies that have been found. The internal audit function is ultimately responsible for internal control deficiencies and weaknesses, and will have until the conclusion of the audit to fix them. Answer: C Explanation: The auditor may conclude that the deficiencies, when taken together, constitute a material weakness. Such a material weakness may mean the client's financial statements are materially misstated. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; FN: Risk Analysis Section; PC: None

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199) Lucas Edgerton is a staff auditor at Jansen, Smith, and Bryan, LLP. During the audit of a regional pizza franchise, Lucas discovers several deficiencies in internal controls. Explain how Lucas should determine whether or not these deficiencies are significant and/or material weaknesses. Answer: Significant professional judgement is necessary in deciding whether a weakness identified is significant enough to warrant communicating to management and those charged with governance. When the auditor identifies risks of material misstatement that the entity has not controlled (or has not adequately controlled), or if in the auditor's judgement there is a material weakness in the entity's design or implementation of internal control, the audit is required to communicate these weaknesses as soon as practicable to those charged with governance. Deciding whether an observation should be reported to those charged with governance is often a matter of consultation and discussion amongst the audit team. Diff: 3 LO: 6 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making 200) What kind of error or fraud could happen if the inventory warehouse manager also had responsibility for making the physical inventory count and reconciling discrepancies to the perpetual inventory records? Answer: The inventory manager could 1. Commit an inadvertent error of miscounting and adjust the error into the accounts and inventory records. 2. Steal inventory and adjust the inventory records permanently to cover up the theft. Diff: 2 LO: 6 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

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201) What constitutes a material weakness? Answer: A material weakness in internal control is defined as a deficiency, or combination of deficiencies, that results in a reasonable possibility that a material misstatement would not be prevented or detected on a timely basis. The following circumstances should be regarded as strong indicators that a material weakness exists: Restatement of previously issued financial statements to reflect the correction of a misstatement. Evidence of material misstatements (caught by the audit team) that were not prevented or detected by the client's internal controls. Ineffective oversight of the financial reporting process by the entity's audit committee. Indication of fraud (either material or immaterial) by senior management. Diff: 2 LO: 6 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Research; PC: Decision Making

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202) Sammy, an audit intern at Tie-dye CPAs has been helping with the audit of Rigel LLC. As the audit nears its conclusion, the audit partner with overall responsibility for the engagement is attempting to familiarize Sammy with the purpose and reasons for the management letter which the partner is currently drafting. Which of the following statements best encompasses the reasons for sending the management letter to the audit client? A) The overarching purpose of the management letter is to ensure that client management is firmly aware of their responsibilities and obligations with respect to the financial statements. The management letter also ensures that the auditors avoid being named in future litigation involving the client. B) A management letter is prepared by the auditing firm and outlines the auditing firm's findings and responsibilities with respect to the system of internal control. The management letter is typically delivered to management upon conclusion of the audit. C) The main purpose of the management letter is to apprise the client's management of the auditors' findings and opinion related to the client's system of internal control. The auditor will typically also provide recommendations to management with respect to improving internal control if any are noted. D) Generally accepted auditing standards require the external auditors to work in conjunction with the internal auditors in drafting management letters for delivery to the client. The standards also require that management formally acknowledge the joint internal control recommendations provided by the internal and external auditors in written form. Answer: C Explanation: The main purpose of the management letter is to apprise the client's management of the auditors' findings and opinion related to the client's system of internal control. The auditor will typically also provide recommendations to management with respect to improving internal control if any are noted. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

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203) Craig, an audit partner assigned to the engagement of Rostrum Enterprises is discussing the management letter with one of the audit interns, Kia. Kia is struggling to understand why the auditing firm would spend time and resources preparing and sending this letter. Which of the following choices would represent Craig's best response to Kia's question? A) The management letter allows the external auditing firm to document weaknesses in internal control which management needs to fix. So long as these weaknesses are formally documented and delivered to management in a management letter, the auditor can check during future year's audits to ensure these weaknesses have been corrected and will not be held liable for misstatements related to these controls. B) The drafting and transmittal of the management letter allows the auditor to notify management of observed and documented weaknesses in internal control. This communication to management also allows the auditor to observe how management responds to this notification, which provides a measure of management's concern with effective internal control. C) The management letter is required by generally accepted auditing standards for all publiclytraded companies, and must be submitted to both the client's management and the audit committee by the last day of the audit. D) The external auditors' role in providing the management letter is to help itself avoid future litigation pertaining to areas of material weaknesses in internal control that the client has not corrected. If the auditor fails to deliver this notification in a timely manner, the audit firm may be jointly liable for suits brought against the client by third parties. Answer: B Explanation: The drafting and transmittal of the management letter allows the auditor to notify management of observed and documented weaknesses in internal control. This communication to management also allows the auditor to observe how management responds to this notification, which provides a measure of management's concern with effective internal control. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

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204) Ja'Niya, a recent college graduate has started working for Cline CPA Firm. Ja'Niya is currently taking part in her first audit, and is discussing the management letter with her supervisor, Jamie. Jamie has just explained why the CPA firm sends management letters to its audit clients, however Ja'Niya is still confused as to the purpose of the letter and asks Jamie to provide some examples of items that might be in the letter. Which of the following would represent examples of items that an auditor might apprise management of in a management letter? A) The external auditing firm might use a management letter to communicate important matters and details about the audit to the client's management. For example, a proposed auditing schedule and estimated fees are likely to be included. B) The auditor may use the management letter to note areas of deficiency in internal control. Examples of such deficiencies could relate to accounts receivable processing and cash receipts and disbursements. The external auditors may also include recommendations to remedy any weaknesses noted. C) The external auditing firm typically uses a management letter to communicate deficiencies and weaknesses in internal control to a client's management, and solicits recommendations from client management to remedy these weaknesses. D) Generally accepted auditing standards require drafting and transmittal of the management letter by the external auditors for all public and private clients. Once the management letter has been received by management, the auditors' requests written assurances from management confirming the effectiveness of internal controls in the noted areas. Answer: B Explanation: The auditor may use the management letter to note areas of deficiency in internal control. Examples of such deficiencies could include accounts receivable processing and cash receipts and disbursements. The external auditors may also include recommendations to remedy any weaknesses noted. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

Auditing, 2e (Johnson) Chapter 7 Risk Response: Performing Tests of Controls 1) Assessing control risk begins with understanding entity-level controls. Answer: TRUE Explanation: Assessing control risk begins with understanding entity-level controls. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 2) The flow of a transaction, and the documents involved, will be the same from transaction class to transaction class. Answer: FALSE Explanation: The flow of a transaction, and the documents involved will DIFFER from transaction class to transaction class. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 3) Strong entity-level controls make it less likely that transaction-level controls will operate effectively. Answer: FALSE Explanation: Strong entity-level controls make it MORE likely that transaction-level controls will operate effectively. They are a necessary, but not sufficient, element of a strong system of internal control. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

4) Preventive controls are those applied to each transaction during normal processing that are intended to stop fraud or errors from occurring. Answer: TRUE Explanation: Preventive controls are those applied to each transaction during normal processing that are intended to stop fraud or errors from occurring. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 5) Detective controls are those applied before transactions have been processed to identify whether fraud or errors have occurred. Answer: FALSE Explanation: Detective controls are those applied AFTER transactions have been processed to identify whether fraud or errors have occurred. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 6) Detective controls are those applied to each transaction that stop fraud or errors from occurring. Answer: FALSE Explanation: Preventive, not Detective, controls are applied to each transaction to stop fraud or errors from occurring. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 7) The two levels of internal control are entity-level controls and auditor-level controls. Answer: FALSE Explanation: There are two levels of internal control: entity-level controls and transaction-level controls. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 2

8) In inquiry, the auditor is not allowed to ask the employee who prepares the bank reconciliation how reconciling items are identified and the reasons for them. Answer: FALSE Explanation: In inquiry, the auditor MAY ask the employee who prepares the bank reconciliation how reconciling items are identified, the reasons for them and the procedures in place to ensure that the accounting records are corrected on a timely basis. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 9) The auditors should plan to test each and every control. Answer: FALSE Explanation: Auditors do not need to test each and every client control. Rather, auditors identify key controls that might be relevant to financial statement assertions and WCGW. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 10) Tolerable deviation rate is the maximum rate of deviation from a prescribed control that an auditor is willing to accept and still use the planned assessed level control risk. Answer: TRUE Explanation: Auditors often perform tests of controls only when the expected deviation rate is very low (e.g., less than 1% or 2%). Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 11) Attribute sampling is a technique used to reach a conclusion about a sample in terms of a rate of occurrence. Answer: FALSE Explanation: Attribute sampling is a technique used to reach a conclusion about a POPULATION in terms of a rate of occurrence. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 3

12) When performing tests of controls, the auditor is making a "yes or no" decision. Answer: TRUE Explanation: When performing tests of controls the auditor is making a "yes or no" decision as to whether the control is effective. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 13) A material weakness is a deficiency where there is more than a remote possibility that a misstatement that is less than material, but still significant enough that it should be reported to those charged with governance. Answer: FALSE Explanation: A material weakness is a deficiency where it is reasonably possible that a material misstatement could occur in the financial statements due to a breakdown in the system of internal control. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 14) Once controls have been tested, the auditors document their work in a representation letter. Answer: FALSE Explanation: Once controls have been tested, the auditors document their work in a working paper. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: N/A AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

15) The more complex the client's operations and its internal controls, the more experienced the auditor who performs the work needs to be. Answer: TRUE Explanation: The more complex the client's operations and its internal controls, the more experienced the auditor who performs the work needs to be. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 16) The first step in assessing control risk is to ________. A) understand entity-level controls B) understand the flow of transactions C) identify relevant controls to test D) determine preliminary audit strategy Answer: A Explanation: The first step in assessing control risk is to understand entity-level controls. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 17) Entity-level controls involve ________. A) all five components of internal controls B) all four components of internal controls C) all auditor and client controls D) all controls recommended by the internal audit function Answer: A Explanation: Entity level controls involve all five components of internal controls. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

18) Strong entity-level controls ________. A) make it less likely that transaction-level controls will operate effectively B) make it more likely that transaction-level controls will operate effectively C) generally increase inherent risk D) have no bearing on inherent risk Answer: B Explanation: Strong entity level controls make it more likely that transaction level controls will operate effectively. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 19) Once auditors understand the flow of transactions, ________. A) they will use their knowledge of assertions to understand what can go wrong B) they will use their knowledge of the client's legal history to understand what can go wrong C) they are ready to issue a clean audit opinion D) they should request the internal audit function begin the audit Answer: A Explanation: Once auditors understand the flow of transactions, they will use their knowledge of assertions to understand what can go wrong. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 20) If the audit firm is performing an integrated audit for a public company, ________. A) there is an expectation that the auditor will test controls in order to support an opinion on Internal Control over Financial Reporting (ICFR) B) there is an expectation that the auditor will audit the financial statements only in order to support an opinion on ICFR C) the audit should be conducted in conjunction with the internal auditors D) the auditor should request the assistance of the prior auditor Answer: A Explanation: If the audit firm is performing an integrated audit for a public company, there is an expectation that the auditor will test controls in order to support an opinion on ICFR. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 6

21) If a client has strong entity-level controls, ________. A) it is less likely that transaction-level controls will operate effectively B) it is more likely that transaction-level controls will operate effectively C) it is likely that the client has an ineffective audit committee D) it is likely that the client has a higher assessed level of inherent risk Answer: B Explanation: If a client has strong entity-level controls, it is more likely that transaction level controls will operate effectively Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 22) Which of the following should be done by the auditor if tests of controls indicate that a key control is not functioning as designed? A) Increase the assessed level of control risk B) Increase the level of assessed Detective risk C) Stabilize the nature, timing, and extent of substantive tests related to the assertion D) Rely on external controls Answer: A Explanation: If tests of controls indicate that a key control is not functioning as designed, and if other compensating controls do not exist, the auditor should increase the assessed level of control risk, decrease the level of assessed Detective risk, and make appropriate changes to the nature, timing and extent of substantive tests related to the assertion. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 23) Assessing control risk begins with understanding which of the following? A) Entity-level controls B) Transaction-level controls C) Internal controls D) External controls Answer: A Explanation: Assessing control risk begins with understanding entity-level controls. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 7

24) Which of the following refer(s) to the audit procedures designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level? A) Tests of controls B) Financial auditing C) External controls D) Transaction-level controls Answer: A Explanation: Tests of controls are the audit procedures designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 25) The two levels of internal control are ________. A) entity-level controls and transaction-level controls B) entity-level controls C) transaction-level controls D) transaction-level and auditor-level controls Answer: A Explanation: The two levels of internal control are entity-level controls and transaction-level controls. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

26) Transaction-level controls are ________. A) implemented by businesses to reduce the risk of misstatement due to error or fraud, and to ensure that business processes are operating effectively B) implemented by the auditors to reduce the risk of misstatement due to error or fraud, and to ensure that business processes are operating effectively C) the same as entity-level controls D) tested by the internal auditors Answer: A Explanation: Transaction-level controls are implemented by businesses to reduce the risk of misstatement due to error or fraud, and to ensure that business processes are operating effectively. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 27) Preventive controls are those applied ________. A) at both the entity and transaction levels B) at the transaction level only C) to each transaction during normal processing and are intended to stop fraud or errors from occurring D) to each entity during normal processing and are intended to stop fraud or errors from occurring Answer: C Explanation: Preventive controls are those applied to each transaction during normal processing and are intended to stop fraud or errors from occurring. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

28) Preventing errors during processing ________. A) is an important objective of every accounting system B) is an optional objective of every accounting system C) is the responsibility of the auditor D) is the responsibility of the internal auditors Answer: A Explanation: Preventing errors during processing is an important objective of every accounting system. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 29) Preventive controls ________. A) should always have physical evidence indicating whether the control was performed B) will rarely have physical evidence indicating whether the control was performed C) do not always have physical evidence indicating whether the control was performed D) are the same as detect controls Answer: C Explanation: Preventive controls do not always have physical evidence indicating whether the control was performed. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 30) Absence of effective Preventive controls ________. A) decreases the risk that errors or fraud may occur B) increases the risk that errors or fraud may occur C) decreases the overall risk of the audit D) has no bearing on the risk of the audit Answer: B Explanation: Absence of effective Preventive controls increases the risk that errors or fraud may occur and therefore increases the need for controls that are sensitive enough to detect these errors should they occur. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

31) Most companies design Detective controls ________. A) to ensure that if Preventive controls are not effective, errors or fraud will be detected and corrected on a timely basis B) to ensure that if Detective controls are not effective, errors or fraud will be detected and corrected on a timely basis C) to catch errors or fraud before the transactions have been processed D) to catch errors or fraud while the transactions are being processed Answer: A Explanation: Most companies design Detective controls to ensure that if Preventive controls are not effective, errors or fraud will be detected and corrected on a timely basis. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 32) Detective controls vary ________. A) from year-to-year with the same client B) from client to client to a greater extent than Preventive controls C) from client to client to a lesser extent than Preventive controls D) depending on managements desire to override controls Answer: B Explanation: Detective controls vary from client to client to a greater extent than Preventive controls. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

33) An example of a purely manual control is a ________. A) computerized batch processing system B) locked inventory cage for high dollar-value items to which only a few authorized staff have a key to access C) requirement for employees to login to computer systems using validating credentials D) automated Preventive and Detective controls Answer: B Explanation: Purely manual controls are those that do not rely on the client's information technology (IT) environment for their operation. An example is a locked inventory cage for high dollar-value items to which only a few authorized staff have a key to access. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 34) An auditor asking the employee who prepares the bank reconciliation how reconciling items are identified would be an example of ________. A) observation B) reperformance C) inquiry D) statistical testing Answer: C Explanation: This would be an example of inquiry. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

35) Internal controls can ________. A) only include certain procedures approved by management and the auditor B) include any procedure used and relied upon by the client to prevent errors from occurring when processing transactions, or to detect and correct errors that may occur in these transactions C) include any procedure used and relied upon by the auditor to prevent errors from occurring when processing transactions, or to detect and correct errors that may occur in these transactions D) never be subject to senior management override Answer: B Explanation: Internal controls can include any procedure used and relied upon by the client to prevent errors from occurring when processing transactions, or to detect and correct errors that may occur in these transactions. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 36) Which of the following best defines Detective controls? A) Controls that are applied after transactions have been processed to identify whether fraud or errors have occurred, and to rectify the fraud or errors on a timely basis B) The collective assessment of the client's control environment, risk assessment process, information system, control activities and monitoring of controls C) Controls that affect a particular transaction cycle or group of transactions D) Controls that determine the flow of documents through the system Answer: A Explanation: Detective controls are those applied after transactions have been processed to identify whether fraud or errors have occurred and to rectify the fraud or errors on a timely basis. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

37) Which of the following controls are designed to prevent misstatements from happening (prevent controls) and/or detect and correct misstatements on a timely basis (detect controls)? A) Internal controls B) External controls C) Entity-level controls D) Transaction-level controls Answer: A Explanation: Internal controls are designed to prevent misstatements from happening (prevent controls) or detect and correct misstatements on a timely basis (detect controls). Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 38) Dan and Steven, two new audit staff associates at Bailey CPA Firm, are discussing why it is important that auditors understand internal controls. Dan is unsure as to the importance of this, and asks Steven to explain further. Which of the following would be the most appropriate response to this question? A) There really isn't a connection between internal control and the actual audit performed by the external auditors. It simply allows the auditors to charge more money for the audit. B) Auditors concern themselves with a client's system of internal control because it helps the auditors to assess control and fraud risk, and also where potential misstatements in the financial statements may be. C) Auditors are concerned with control risk because if a client's system of internal control is weak, it may be more appropriate for the auditors to disclaim an opinion on internal control, and instead just focus on the financial statements. D) None of these answer choices are correct. Answer: B Explanation: Auditors concern themselves with a client's system of internal control because it helps the auditors to assess control and fraud risk, and also where potential misstatements in the financial statements may be. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

39) Sue and Andy are discussing internal control with a new audit intern, Mark. Mark has heard about the importance of internal control from his professor; however he still fails to see why internal control is important. Which of the following represent Sue and Andy's best response to this question? A) Internal control is optional for larger companies, as their processes and operations are usually efficient enough to where this type of system is not needed. B) Internal control is required to be implemented by all companies, and is designed to ensure that no misstatements whatsoever exist in the firm's financial statements. C) Internal control is designed and implemented by the client, and helps to prevent and detect misstatements in the firm's financial statements. D) None of these answer choices are correct. Answer: C Explanation: Internal control is designed and implemented by the client, and helps to prevent and detect misstatements in the firm's financial statements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 40) Laney and Derek are discussing the audit of Parker Enterprises, which is soon to begin. Laney would like to get an idea of the first steps they should take as part of the audit. Derek, a more experienced auditor advises Laney that one of the first things they will do is ________. A) have senior management sign written assurances that there are no misstatements in the financial statements, in order for a clean audit opinion to be issued B) conduct a 'what can go wrong' analysis to determine where areas with increased fraud and error risk may be C) conduct a 'where did it go wrong' analysis to determine what errors and inconsistencies existed during the external audit D) look at Parker Enterprises competitors, so they can determine where financial statement misstatements have occurred Answer: B Explanation: conduct a 'what can go wrong' analysis to determine where areas with increased fraud and error risk may be Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

41) Marty and Sandra, two CPAs, are completing the audit of McFly LLC, a regional distributor of food products in the southeastern United States, and are discussing the client's system of internal control. Which of the following statements pertaining to internal control is accurate? A) McFly LLC is required by generally accepted auditing standards to use both preventive and detective controls in all areas of the business. B) McFly LLC is likely to employ detective controls to detect errors that have occurred after the fact. C) McFly LLC is likely to employ detective controls to each transaction to prevent errors from occurring during processing. D) McFly LLC should allow the external auditors to determine where preventive and controls are most effective, and allow the auditors to implement accordingly. Answer: B Explanation: McFly LLC is likely to employ detective controls to detect errors that have occurred after the fact. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 42) Neil, an audit manager at Bullock CPAs is currently working on the audit of Sandringham Enterprises, LLC. Neil is examining a sample of customers to check their payment history and credit limits. What type of control is Neil examining? A) Neil is examining a preventive control, which should stop customers who have exceeded their credit limits from purchasing more goods. B) Neil is examining a detective control designed to identify customers who have exceeded their credit limits. C) Neil is examining an accuracy control to determine if payments were made on time and if customer credit limits have been exceeded. D) Neil is checking a classification control which ensures that customers who have exceeded their credit limits are classified separately for further follow up. Answer: A Explanation: Neil is examining a preventive control, which should stop customers who have exceeded their credit limits from purchasing more goods. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

43) Joan is working on the audit of Bloom Company, a provider of furniture in a regional market in the United States, and is examining whether any unauthorized employees have received payment from the firm. Which of the choices below best represents the type of control this pertains to? A) This represents a Human Resources IT control, as no employee should be in the system who is not authorized to be paid by the firm. B) This represents a preventive control, as no unauthorized firm employee should be receiving payment if they did not work the appropriate number of hours. C) This represents an IT application control, as evidence of unauthorized payments indicates a failure of the IT system of internal control. D) This represents a detective control, as Joan is attempting to detect whether any firm employees have received unauthorized payments. Answer: B Explanation: This represents a preventive control, as no unauthorized firm employee should be receiving payment if they did not work the appropriate number of hours. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 44) Colin is working on the audit of Bagram LLC and is currently checking the sales and revenue accounts. Colin decides to check whether a sample of sales invoices match the company's predetermined price list. Which of the following controls does this represent? A) This is an example of a detective control, as Colin is attempting to detect whether any unauthorized or different amounts have been input. B) This is an example of an IT accuracy control, as if amounts are noted on the sales invoices that don't match the company's price list; they are likely to be inaccurate. C) This represents an example of a preventive control, as sales invoices should be priced automatically using the company's predetermined prices. D) None of these answer choices are correct. Answer: C Explanation: This represents an example of a preventive control, as sales invoices should be priced automatically using the company's predetermined prices. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

45) John and Josephine are working on the audit of Crabtree Enterprises, and are discussing detective controls. John advises Josephine that while he's heard of these controls, he's not really sure where they're used. Which of the following represents Josephine's best response to this question? A) Detective controls are rarely used by firms these days, as most processes are automated, eliminating the need for them. B) Detective and preventive controls are really one in the same. They just deal with different a process, that's all. C) Detective controls typically look for misstatements that have already occurred, and are often enacted through IT application controls. D) Detective controls look for issues during processing, and are designed to prevent errors and misstatements from occurring at all. Answer: C Explanation: Detective controls typically look for errors and misstatements that have already occurred, and are often enacted through IT application controls. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 46) Dan and Asher are discussing the system of internal control for their current audit client, SeaBreeze LLC. Asher has inquired of Dan as to why the auditor needs to test a client's system of internal controls. Dan's most appropriate response to this question would be which of the following? A) The auditors will want to test SeaBreeze's system of internal control to determine whether or not the controls the client has put in place are operating effectively or not. B) The auditors will test SeaBreeze's system of internal control to ensure that it is functioning properly and eliminating all misstatements. C) The auditors will test SeaBreeze's system of internal control to ensure that detective controls are appropriately preventing errors during processing. D) None of these answer choices are correct. Answer: A Explanation: The auditors will want to test SeaBreeze's system of internal control to determine whether or not the controls the client has put in place are operating effectively or not. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

47) Candy and Steve are working on the audit of Peagram Enterprises, LLC, a distributor of frozen foods throughout the continental United States, and are attempting to assess the firm's level of segregation of duties. Which of the following represents a possible procedure they could perform to document this for the audit? A) The auditors should compile questionnaires to be distributed to all employees, requesting they attest to how well duties are segregated. B) The auditors should request written assurances from senior management which can be documented and added to the audit file. C) The auditors could opt to use an observation procedure, whereby they observe selected employees performing their duties. D) The auditors should document their understanding of the client's structure, and then prepare a flowchart as confirmation of segregation of duties. Answer: C Explanation: The auditors could opt to use an observation procedure, whereby they observe selected employees performing their duties. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 48) An auditor is working on the audit of the inventory accounts for a major client, and is attempting to determine if controls related to the valuation and completeness assertions are operating effectively for inventory. Which of the following would be a good way for the auditor to test this? A) The auditor could employ a questioning procedure whereby inventory employees are questioned as to inventory levels, and the results documented. B) The auditor could employ an observation procedure whereby the auditor physically observes a sample of inventory and matches it to the client's accounting records. C) The auditor could inspect evidence related to inventory purchases and sales and determine key ratios such as days sales in inventory. D) None of these answer choices are correct. Answer: B Explanation: The auditor could employ an observation procedure whereby the auditor physically observes a sample of inventory and matches it to the client's accounting records. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

49) Renee and Bruce are discussing the best way to audit one of their clients IT application controls. Different ideas have been discussed, but neither Renee nor Bruce is sure which would be most effective. They approach you, their supervisor, for suggestions on how to test this. Which of the following suggestions would be the most viable? A) Generally accepted auditing standards do not require the external auditors to test the client's IT application controls. This falls under the purview of the internal audit function. B) Consider entering fictitious 'test' data into the client's system to ensure that the related controls are functioning properly, and appropriately flag or don't flag transactions. C) Consider retaining the services of a specialist IT firm to audit all IT related controls. The costs associated with these specialists can be billed directly to the client. D) None of these answer choices are correct. Answer: B Explanation: Consider entering fictitious 'test' data into the client's system to ensure that the related controls are functioning properly, and appropriately flag or don't flag transactions. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 50) The technique that involves the auditor using questioning skills to determine how the control is completed and whether it appears to have been carried out properly and on a timely basis is known as ________. A) inquiry B) observation C) reperformance D) recalculation Answer: A Explanation: The technique that involves the auditor using questioning skills to determine how the control is completed and whether it appears to have been carried out properly and on a timely basis is known as inquiry. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

51) An auditor watching an employee prepare a bank reconciliation would be an example of ________. A) observation B) professional skepticism C) recalculation D) inquiry Answer: A Explanation: An auditor watching an employee prepare a bank reconciliation would be an example of observation. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 52) Processing auditor test data using the client's software application ________. A) will allow the auditor to verify that the software application is functioning as designed B) will allow the auditor to verify manual controls within the software application are functioning as designed C) may corrupt the client's system, and should not be attempted D) should be performed without the knowledge of the client's senior management Answer: A Explanation: Processing auditor test data to the client's program will allow the auditor to verify that the software application is functioning as designed. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 53) The procedure that relies on the auditor testing the physical evidence to verify that a control has been performed properly ________. A) is referred to as reperformance B) is referred to as recalculation C) is known as inspection of physical evidence D) is known as inspection of computer systems Answer: C Explanation: The procedure that relies on the auditor testing the physical evidence to verify that a control has been performed properly is known as inspection of physical evidence. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 21

54) When an auditor asks management how it makes sure the reconciliation is prepared correctly and on a timely basis, this is an example of ________. A) inquiry B) interrogation C) audit scanning techniques D) professional skepticism Answer: A Explanation: When an auditor asks management how it makes sure the reconciliation is prepared correctly and on a timely basis, this is an example of inquiry. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 55) Reperformance ________. A) should be delegated to the internal audit function B) should be the responsibility of the client's legal counsel C) is mandatory at every client audit D) is likely to be used, but would be determined by the auditor's professional judgment Answer: D Explanation: Reperformance is likely to be used, but would be determined by the auditor's professional judgment. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 56) Important information obtained through inquiry ________. A) should be forwarded to the client's legal counsel for review and approval B) should be disregarded if it contradicts management's statements and intentions C) should be corroborated with other evidence D) should be used in isolation Answer: C Explanation: Important information obtained through inquiry should be corroborated with other evidence. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 22

57) A common software-based audit technique involves ________. A) requesting management complete flowcharts and questionnaires related to the audit B) submitting certain test data into the client's software application while the auditor is in control of the software C) allowing the internal auditors access to the external auditor's software application in order to assist with the audit D) deleting client files and transactions to ensure that the client's software appropriately alerts the correct staff Answer: B Explanation: A common software-based audit technique involves submitting certain test data into the client's software application while the auditor is in control of the software. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 58) Which of the following is NOT a part of tests of control? A) Performance B) Observation C) Inquiry D) Inspection of physical evidence Answer: A Explanation: Tests of controls include inquiry, observation, inspection of physical evidence, reperformance, and software-based audit techniques. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

59) The auditor testing the effectiveness of manual follow-up to see whether items put on an exception report were appropriately cleared is an example of ________. A) reperformance B) observation C) inquiry D) inspection of physical evidence Answer: A Explanation: The auditor testing the effectiveness of manual follow-up to see whether items put on an exception report were appropriately cleared is an example of reperformance. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 60) When the auditor inspects initials and dates on bank reconciliation, he or she is doing ________. A) inspection of physical evidence B) inquiry C) observation D) reperformance Answer: A Explanation: When the auditor inspects initials and dates on bank reconciliation, he or she is inspecting physical evidence. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

61) An auditor is attempting to determine the best way to audit a major client's accounts receivable. The client is a large firm with thousands of accounts receivable and a high level of automation. What might be a viable procedure the auditor could consider using to audit these accounts and balances? A) The auditor should refer these accounts to the internal audit function due to the voluminous nature of the associated transactions. B) The auditor should consider adopting a reliance strategy, whereby the auditor tests a sample of documents and transactions and performs substantive tests accordingly. C) The auditor might wish to adopt an audit data analytics (ADA) procedure due to the high level of automation and voluminous nature of the account transactions. D) None of these answer choices are correct. Answer: C Explanation: The auditor might wish to adopt an audit data s (ADA) procedure due to the high level of automation and voluminous nature of the account transactions. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 62) While auditing the accounts payable accounts of Janar LLC, a medium-size distributor of tools and mechanical appliances, the external auditors, Freeman CPAs are attempting to determine whether exception reports generated have been dealt with in an appropriate and timely manner by accounts payable staff. Which of the following choices would be the best way for the auditors to test this? A) The auditors should request written assurances from senior management that all controls pertaining to accounts payable are functioning effectively. B) The auditor may opt to perform tests of entity-level controls related to accounts payable, to ensure their operating effectiveness. C) The auditor may adopt a reperformance procedure whereby the auditor attempts to reperform staff follow-up procedures to ensure they appropriately clear the exceptions. D) The auditor may decide to assess control risk at its maximum level, and simply rely on IT internal controls as providing reasonable assurance of their operating effectiveness. Answer: C Explanation: The auditor may adopt a reperformance procedure whereby the auditor attempts to reperform staff follow-up procedures to ensure they appropriately clear the exceptions. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

63) As part of a consulting job that Burkholder CPA firm has recently taken on, the client is requesting assistance with redesigning their system of internal controls related to accounts receivable. Which of the following choices might the CPA firm recommend with respect to controls related to receivables? A) The updated system of internal control should be designed such that all misstatements related to receivables are eliminated. B) The updated system of internal control should include controls to ensure the customer is authorized for credit purchases and is not able to exceed their credit limit. C) The updated system of internal control should ensure that all customers who purchase on credit are fully vetted by the accounts payable manager, as his or her staff will ultimately handle any issues that arise. D) The updated system of internal control should be designed such that all transactions are flagged and verified to ensure a higher quality of accounts receivables. Answer: B Explanation: The updated system of internal control should include controls to ensure the customer is authorized for credit purchases and is not able to exceed their credit limit. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 64) Stephen and Andrea have recently been assigned to the audit of Duck Enterprises, a manufacturer of personal and commercial fishing products. The pair are deciding how best to audit the client's system of internal controls. Which of the following choices correctly represent considerations for Stephen and Andrea with respect to internal controls? A) How long it will take the auditing firm to find a specialist to audit the client's system of internal control. B) How easy it will be to obtain written assurances from senior management pertaining to internal control, to include in the audit file and as part of the audit opinion. C) Which controls should be selected for testing, and when the most appropriate time for testing those controls may be. D) To what extent should internal controls be tested, and how much time will be needed to effectively audit the population of transactions. Answer: C Explanation: Which controls should be selected for testing, and when the most appropriate time for testing those controls may be. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

65) Darius and Kylee, two recently hired audit staff associates, are discussing the audits of public companies one day at lunch. Kylee tells Darius that she recently overhead two audit managers talking about an integrated audit for public companies, and does not know what this means or entails. Which of the following represents Darius' best response to this question? A) I think it has something to do with how the external auditors work with the internal audit function. B) The idea of an integrated audit is to carefully integrate the audit around the businesses core functions and processes, so as to cause the minimum disruption to operations during the audit itself. C) An integrated audit speaks to the integration of the audit of the client's system of internal control with the audit of the financial statements, as these are linked. D) An integrated audit speaks to integrating financial statement audits into audits of internal control in order to ensure that misstatements are eliminated and a clean audit opinion can be issued. Answer: C Explanation: An integrated audit speaks to the integration of the audit of the client's system of internal control with the audit of the financial statements, as these are linked. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 66) During the initial stages of the audit of Xenon Company, the external auditors, Fairway CPAs have noted that the firm's senior management appear to have extremely aggressive sales and growth targets for the company, as well as the client having high staff turnover levels in many other key positions. Based on this information, which of the following represents an appropriate response by the auditor with respect to testing of the client's internal controls? A) The auditors should consult with the predecessor auditor and consider withdrawing from the engagement, as this will help preserve the auditors' reputation. B) The auditors should carefully consider entity-level controls and consider assessing control risk as higher. C) The auditors should conduct a trend analysis using audit data analytics (ADA) and determining if the turnover trend is customary for the client. D) The auditors should begin by examining transaction-level controls and working their way up to entity-level controls Answer: B Explanation: The auditors should carefully consider entity-level controls and consider assessing control risk as higher. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 27

67) John and Sally are discussing a client's system of internal control, and how that system relates to financial statement assertions. John advises Sally that despite what he has been told, he doesn't really understand the connection between these two areas. Which of the following represents Sally's best response to this? A) There isn't really a connection between these two areas, as assertions themselves are separate and only relate to the financial misstatements. B) These two areas are closely tied together, in that the assertions the auditor tests are implicit with the client's system of internal control, and substantive testing is used to test internal control. C) A client's system of internal control and assertions are related, in the sense that the auditor attempts to determine where internal control weaknesses may affect assertions. D) None of these answer choices are correct. Answer: C Explanation: A client's system of internal control and assertions are related, in the sense that the auditor attempts to determine where internal control weaknesses may affect assertions. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 68) The external auditors testing of internal controls typically represents a major component of the audit. Every audit client is different, as are the industries they operate in, which affects the auditors' assessment of the client's system of internal control. Which of the following is correct with respect to the external auditor's testing of internal control? A) Generally accepted auditing standards require that in most circumstances, the external auditors defer internal control testing to the internal audit function. B) The external auditors typically determine where internal control weaknesses may be by gaining an understanding of the client and then testing selected controls. C) The external auditors typically attempt to gain an understanding of the client, and then test all controls in order to be able to issue a clean opinion on internal control. D) The external auditors often adopt a reliance strategy whereby control risk is assessed as high and then auditors adopt increased substantive procedures. Answer: B Explanation: The external auditors typically determine where internal control weaknesses may be by gaining an understanding of the client and then testing selected controls. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

69) Carla and Steve are discussing a major audit client's system of internal control with a new audit intern, Jeremy. Jeremy is excited to learn more about internal control and asks what types of considerations go into determining what and how to test internal control. Which of the following responses represents the most appropriate answer to this question? A) The choice of what to test, and when to test it is a subjective decision made by the external auditor in conjunction with senior management of the client. B) The decision as to what to test, and when to test is objectively determined per guidelines and standards set forth by generally accepted auditing standards. C) Factors that an auditor may consider in determining what controls to test and when may be how complex the control is and whether any changes have occurred in the design of the control. D) None of these answer choices are correct. Answer: C Explanation: Factors that an auditor may consider in determining what controls to test and when may be how complex the control is and whether any changes have occurred in the design of the control. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 70) Janice and Tom are discussing the audit of Peabody Enterprises, a large audit client, at lunch one day. Janice is a recent addition to the CPA firm and is being mentored by Tom. With respect to internal control, Janice asks Tom how he has historically assessed the reliability of a particular internal control. Which of the following choices represents Tom's best answer to this question? A) I typically assess reliability levels as the same for all controls unless I can prove any different. Then, I furnish a different internal control opinion for each control. B) When assessing the reliability of controls, I examine whether any changes in the accounting system have occurred, and also the quality of the overall control environment. C) When I'm examining the reliability of a client's internal controls, I typically think about the competence of the person(s) who implemented them, and make sure that each control has effectively eliminated errors and fraud. D) I typically examine control reliability at an overall level, as opposed to testing individual controls. This is more efficient, and cheaper for the client. Answer: B Explanation: When assessing the reliability of controls, I examine whether any changes in the accounting system have occurred, and also the quality of the overall control environment. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

71) Colin and Derek are discussing internal controls, and how those controls relate to the financial statement audit. Colin explains to Derek about integrated audits for public companies. Derek inquires of Colin as to how an auditor determines the appropriate mix of internal control and substantive testing. Which of the following represents Colin's best response to this question? A) The determination as to the extent of internal control testing and substantive testing is set forth in generally accepted auditing standards. The auditor simply needs to follow those. B) The determination of substantive testing will be driven by the auditor's assessment of the effectiveness of internal control. If internal control is effective, the auditor can increase substantive testing. C) The balance of internal control testing versus substantive testing is subjectively determined by the auditor. If the auditor assesses internal controls as more reliable, less substantive testing may be performed. D) None of these answer choices are correct. Answer: C Explanation: The balance of internal control testing versus substantive testing is subjectively determined by the auditor. If the auditor assesses internal controls as more reliable, less substantive testing may be performed. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 72) Kerry and her supervisor Martha are discussing the audit of one of their largest clients. Kennedy Enterprises, LLC. Kerry asks Martha how they will be able to test all of the client's accounts and transactions in the limited time they have to perform the audit. Martha should answer this question in which of the following ways? A) That is a good question. We may have to hire more staff or increase the planned number of billable audit hours to get it all done. B) We will plan to obtain a representative sample of the population of each account we test. If our sample is representative, then we will likely be able to obtain reasonable assurance. C) Our audit firm routinely uses audit data s to test samples of all accounts for all of our clients. In so doing, we are able to offer absolute assurance of no errors or fraud in the financial statements. D) We effectively utilize audit sampling to determine control exceptions, and then perform substantive test on those control exceptions. Answer: B Explanation: We will plan to obtain a representative sample of the population of each account we test. If our sample is representative, then we will likely be able to obtain reasonable assurance. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 30

73) Carly has just started an internship with a local CPA firm, and is currently working on her first audit with her supervisor, Satvinder. Carly has noticed that for different accounts tested during the audit, sample sizes have been different. Carly asks Satvinder to explain why this is the case. What is Satvinder's most appropriate response to this question? A) The determination as to sample size is made randomly by our audit software. This helps to keep the audit objective and unbiased. B) If we are concerned about a potential high rate of deviation, it is likely that we will decrease the sample size to compensate for this. C) If a particular account is one that we would like to obtain a higher level of assurance on, we will typically increase sample size. D) It really depends on the population size. We use an inverse relationship which dictates that larger population sizes are compensated for by smaller sample sizes. Answer: C Explanation: If a particular account is one that we would like to obtain a higher level of assurance on, we will typically increase sample size. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 74) Two audit staff associates, Johnny and Carson are discussing internal control over lunch one day at one of their client's locations. Johnny has spent the morning working on determining tolerable deviation rates for some of the client's controls. Carson is intrigued by this, and asks Johnny to explain what is meant by tolerable deviation rates and how they are connected to the client's internal control audit. Which of the following represents Johnny's best response to this? A) The tolerable deviation rate can be best thought of as the most deviation the auditor is willing to accept before reassessing control risk for a client. B) Tolerable deviation rate relates to internal control and is used to determine the maximum variance over the number of agreed upon billable hours. C) The tolerable deviation rate is used by the auditor to determine the maximum acceptable deviation before internal control risk must be reassessed. Ideally, the actual deviation rate should exceed the tolerable deviation rate. D) The tolerable deviation rate is increased as the level of assurance increases. The auditor works carefully to align these. Answer: A Explanation: The tolerable deviation rate can be best thought of as the most deviation the auditor is willing to accept before reassessing control risk for a client. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 31

75) Joan and one of her staff members Elaine are working on the audit of Mulberry Enterprises, LLC, a distributor of skincare and other beauty products throughout the United States. Joan and her team have recently completed the planning stages for the testing of the client's system of internal controls, and Elaine has noticed that some controls will be tested at different times than others. Elaine asks Joan why this is the case? Which of the following responses by Joan would be the most appropriate answer to this question? A) It is generally easier for the audit firm to spread testing of controls out over a period of a few months, as it requires too much audit time and resources to test all controls at once. B) It is customary for auditing firms to test transaction-level controls first, and then move on to testing entity-level controls. This typically takes a few months. C) The auditors typically prefer to tests internal controls which are assessed as riskier closer to the client's year-end. D) None of these answer choices are correct. Answer: C Explanation: The auditors typically prefer to tests internal controls which are assessed as riskier closer to the client's year-end. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 76) When performing an integrated audit (to issue an opinion on the financial statements and an opinion on internal controls over financial reporting), ________. A) the auditor uses a top-down approach to determine which controls to select B) the auditor uses a bottom-up approach to determine which controls to select C) the auditor should be careful to issue the same audit opinion for both the financial statements and internal control D) the auditor should be careful to issue different audit opinions for the financial statements and internal control Answer: A Explanation: When performing an integrated audit (to issue an opinion on the financial statements and an opinion on ICFR), the auditor uses a top-down approach to determine which controls to select. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

77) The auditor begins selecting controls to test by ________. A) asking management which controls they would prefer the auditor to test B) checking the same controls as the prior year C) by understanding the entity and the business and determining the risk of material fraud or error at the financial statement level D) by understanding the entity and all other industries and determining the risk of material fraud or error at the financial statement level Answer: C Explanation: The auditor begins selecting controls to test by understanding the entity and the business, and determining the risk of material fraud or error at the financial statement level. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 78) If there is a high risk of material fraud related to an assertion, ________. A) the auditor will want to test controls over that assertion B) the auditor will want to test controls over other assertions C) the auditor should request the audit be conducted by the internal audit function D) the auditor should withdraw from the engagement, to avoid risk exposure Answer: A Explanation: If there is a high risk of material fraud related to an assertion, the auditor will want to test controls over that assertion. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

79) In the audit of a private company, ________. A) an auditor's tests of controls are unrelated to the planned audit strategy B) an auditor's tests of controls are largely dictated by the planned audit strategy C) the auditor is not subject to reporting and notification requirements D) the auditors should preemptively determine the entities ability to pay for the audit and request a certain percentage in advance Answer: B Explanation: In the audit of a private company (when an auditor is only issuing an opinion on the financial statements) an auditor's tests of controls are largely dictated by the planned audit strategy. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 80) In order to determine the extent of testing of controls, ________. A) the auditor should inquire of management as to their preferences B) the auditor can use statistically based sampling techniques only C) the auditor can use either statistically based sampling techniques or nonstatistical techniques D) the auditor can use non nonstatistical techniques only Answer: C Explanation: In order to determine the extent of testing of controls the auditor can use either statistically based sampling techniques or nonstatistical techniques. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

81) The tolerable deviation rate ________. A) is the maximum rate of deviation from a prescribed control that an auditor is willing to accept and still use the planned assessed level of control risk B) is the minimum rate of deviation from a prescribed control that an auditor is willing to accept and still use the planned assessed level of control risk C) refers to the extent that audit fees can go over the roughly agreed amount D) relates to how many immaterial misstatements the auditor finds Answer: A Explanation: The tolerable deviation rate is the maximum rate of deviation from a prescribed control that an auditor is willing to accept and still use the planned assessed level of control risk. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 82) With respect to audit sampling, ________. A) there is no relationship between assurance and sample size B) there is a direct relationship between assurance and sample size C) the choice of which accounts to sample should be as non-random as possible D) the auditors should ideally select a sample size which is larger than the population Answer: B Explanation: With respect to audit sampling, there is a direct relationship between assurance and sample size. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

83) The more assurance the auditor wants, ________. A) the less representative a sample should be of the population, and the more testing the auditor needs to do B) the more representative a sample should be of the population, and the less testing the auditor needs to do C) the more representative a sample should be of the population, and the more testing the auditor needs to do D) the less representative a sample should be of the population, and the less testing the auditor needs to do Answer: C Explanation: The more assurance the auditor wants, the more representative a sample should be of the population, and the more testing the auditor needs to do. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 84) If the auditor intends to assess control risk at a low level, ________. A) he or she performs more testing than if he or she is planning to obtain only limited assurance from tests of controls B) he or she performs less testing than if he or she is planning to obtain only limited assurance from tests of controls C) he or she performs the same amount of testing if he or she is planning to obtain only limited assurance from tests of controls D) he or she performs more testing than if he or she is planning to obtain unlimited assurance from tests of controls Answer: A Explanation: If the auditor intends to assess control risk at a low level, he or she performs more testing than if he or she is planning to obtain only limited assurance from tests of controls. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

85) The expected rate of deviation in the population ________. A) is the rate at which the auditor expects controls not to function as planned B) is the rate at which the auditor expects controls to function as planned C) relates to how many accounts within the population will be stated correctly D) relates to how many accounts within the population will be consistent with the auditor's expectation Answer: A Explanation: The expected rate of deviation in the population is the rate at which the auditor expects controls not to function as planned. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 86) With respect to timing, tests of controls ________. A) are usually carried out after the firm's financial statement date B) are usually carried at the firm's financial statement date C) will usually be carried out at an interim date, often about three months prior to year-end D) will usually be carried out at an interim date, often about six months prior to year-end Answer: C Explanation: With respect to timing, tests of controls will usually be carried out at an interim date, often about three months prior to year-end. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 87) The greater the amount of difference between tolerable deviation rate and expected deviation rate, ________. A) the larger the sample size B) the lower any statistical variance should be C) the smaller the sample size D) the smaller the population being sampled should be Answer: C Explanation: The greater the amount of difference between tolerable deviation rate and expected deviation rate, the smaller the sample size. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 37

88) An audit testing strategy that can be used to allow evidence obtained in prior audit periods to support a conclusion about IT application controls in the current audit period is known as ________. A) statistical benchmarking B) benchmarking C) nonstatistical sampling D) prior period inference Answer: B Explanation: Benchmarking is an audit testing strategy that can be used to allow evidence obtained in prior audit periods to support a conclusion about IT application controls in the current audit period. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 89) The assurance that the ________ is not exceeded by the actual rate of deviation is influenced by the degree to which the auditor intends to rely on the control as a basis for limiting substantive tests or for supporting an opinion on internal control over financial reporting (ICFR). A) tolerable rate of deviation B) expected rate of deviation in the population C) desired level of assurance D) control exception Answer: A Explanation: The assurance that the tolerable rate of deviation is not exceeded by the actual rate of deviation is influenced by the degree to which the auditor intends to rely on the control as a basis for limiting substantive tests or for supporting an opinion on ICFR. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

90) Which of the following refers to a sampling technique used to reach a conclusion about a population in terms of a rate (frequency) of occurrence? A) Attribute sampling B) Control exception C) Tests of control D) Benchmarking Answer: A Explanation: Attribute sampling is a sampling technique used to reach a conclusion about a population in terms of a rate (frequency) of occurrence. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 91) Define expected rate of deviation. A) It is the rate at which the auditor expects controls to not function as planned. B) It is the maximum rate of deviation from a prescribed control that an auditor is willing to accept. C) It is the rate that represents the confidence that the evidence obtained is representative of the underlying population from which the sample was taken. D) It is similar to the actual rate of deviation in the population. Answer: A Explanation: The expected rate of deviation in the population is the rate at which the auditor expects controls to not function as planned. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

92) An auditor is working on the most recent year's audit of a large audit client, and is testing the client's system of internal control. Based on prior year's audits, the auditor has noted that the client has historically had a robust and effective system of internal control. Based on this knowledge, which of the following represents a strategy the auditor might adopt? A) The auditor might choose to adopt a reliance strategy, assessing control risk as high and performing increased substantive procedures accordingly. B) The auditor is likely to consider decreasing sample size unless he or she has reason to believe that a deviation from prescribed control procedures may exist. C) Generally accepted auditing standards require the external auditors to initially assess control risk at the maximum level even for continuing audit clients, until substantive procedures justify a lowering of control risk. D) It is acceptable for the auditor to simply obtain written assurances from senior management that there have been no changes in the system of internal control since the prior audit. Answer: B Explanation: The auditor is likely to consider decreasing sample size unless he or she has reason to believe that a deviation from prescribed control procedures may exist. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 93) During the audit of internal control of Partham LLC, a regional distributor of foodstuffs, an audit manager is working on the audit of notes payable and the related interest accounts. The auditor has noted that interest payable accruals related to the loans do not appear to have been entered into the client's general ledger accounts. As a result of this, what action should the auditor take with respect to internal control? A) The auditor should not adjust his or her assessed level of control risk, and should refer the discrepancy to the internal audit function for further investigation. B) The auditor should immediately contact management and advise that the audit firm will be issuing a disclaimer of opinion on all accounts related to notes payable and associated interest expense. C) The auditor should consider this as a control exception, and adjust his or her assessed level of control risk accordingly. D) None of these answer choices are correct. Answer: C Explanation: The auditor should consider this as a control exception, and adjust his or her assessed level of control risk accordingly. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

94) While working on an attestation engagement for one of their largest audit clients, it has been brought to the partner's attention that some exceptions have been noted as part of the testing of the client's system of internal control. As a result of this notification, what action might the partner decide to take? A) The partner is likely to advise the client's senior management that the firm will be issuing a qualified opinion on internal control. B) The partner may attempt to ascertain whether any other, compensating controls exist. If this is the case, and these controls are functioning effectively, the planned audit strategy can be followed. C) The partner is likely to advise the team working on the internal control audit that a reliance strategy should be adopted, and increased substantive procedures should be planned accordingly. D) All of these answer choices are options the partner may take. Answer: B Explanation: The partner may attempt to ascertain whether any other, compensating controls exist. If this is the case, and these controls are functioning effectively, the planned audit strategy can be followed. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 95) During the most recent year's audit of Hoover Enterprises, senior management has advised the auditors that a new and more effective system of internal control has been designed and implemented by external consultants and the internal audit function. As a result of this information, what approach might the auditing firm take with respect to internal control? A) The external auditors will be required to obtain written assurances from senior management, documenting the effectiveness of the new system of internal control, for inclusion in the audit file. B) The external auditors will focus the audit time and resources on solely testing the client's system of internal control. No substantive testing will be performed. C) The auditor may presume that their previous understanding of internal control is no longer valid, and will likely amend audit procedures to document the effectiveness of the new system. D) The auditor is likely to proceed with testing of the new controls, and if the new system is determined to be robust and effective, the auditor will issue a qualified opinion on internal control. Answer: C Explanation: The auditor may presume that their previous understanding of internal control is no longer valid, and will likely amend audit procedures to document the effectiveness of the new system. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 41

96) If tests of controls indicate that a key control is not functioning as designed, and if other compensating controls do not exist, the auditor should ________. A) increase the assessed level of control risk B) decrease the level of assessed Detective risk C) make appropriate changes to the nature, timing and extent of substantive tests related to the assertion D) All of these answer choices are correct. Answer: D Explanation: If tests of controls indicate that a key control is not functioning as designed, and if other compensating controls do not exist, the auditor should: 1. increase the assessed level of control risk, 2. decrease the level of assessed Detective risk, 3. and make appropriate changes to the nature, timing and extent of substantive tests related to the assertion. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 97) If the auditor is auditing a public company in the United States and must report on internal controls over financial reporting (ICFR), the identification of one or more material weaknesses ________. A) will result in the auditor issuing an adverse opinion on the financial statements B) will result in the auditor issuing a disclaimer of opinion on the financial statements C) will result in an adverse opinion on ICFR D) will result in an unmodified opinion on ICFR Answer: C Explanation: If the auditor is auditing a public company in the United States and must report on ICFR, the identification of one or more material weaknesses will result in an adverse opinion on ICFR. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

98) When performing tests of controls, the auditor is making ________. A) a "yes or no" decision with respect to effectiveness B) multiple decisions C) sure that all controls are working perfectly, with no errors, material or immaterial D) certain that he or she will ultimately be in a position to render absolute assurance on the financial statements and internal control Answer: A Explanation: When performing tests of controls the auditor is making a "yes or no" decision with respect to effectiveness. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 99) When testing controls, ________. A) the auditor must be alert for evidence that the control might be effective, even if only once or twice B) the auditor must be alert for evidence that the control might be ineffective, even if only once or twice C) the auditor should delegate audit procedures to the internal auditors where possible D) it is possible for the auditor to rely on the opinion of the prior auditor Answer: B Explanation: When testing controls, the auditor must be alert for evidence that the control might be ineffective, even if only once or twice. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 100) A control would be ineffective ________. A) if it was performed B) if it was not performed, or if it failed to function as designed C) if it was not performed only D) if it failed to function as designed only Answer: B Explanation: A control would be ineffective if it was not performed, or if it failed to function as designed. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 43

101) An IT application control will be ineffective ________. A) if the entity is hacked or experiences some form of phishing B) if it lists an appropriate transaction on an exception report C) if it fails to put an invalid transaction on an exception report D) if it is consistently used Answer: C Explanation: A computer application control will be ineffective if it fails to put an invalid transaction on an exception report. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 102) Manual follow-up procedures are ineffective ________. A) if they are not acted upon on a timely basis, or if client personnel fail to clear items noted on an exception report B) if they are acted upon on a timely basis, or if client personnel fail to clear items noted on an exception report C) if they are not acted upon on a timely basis only D) if client personnel fail to clear items noted on an exception report only Answer: A Explanation: Manual follow-up procedures are ineffective if they are not acted upon on a timely basis, or if client personnel fail to clear items noted on an exception report. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

103) If the test results do not confirm the preliminary evaluation of controls, ________. A) the auditor will consider whether there is a compensating control that might prevent and correct a misstatement missed by the original control being tested B) the auditor will consider whether there is a compensating control that might detect and correct a misstatement missed by the original control being tested C) the auditor should obtain additional written assurances from management D) the auditor should consider withdrawing from the engagement Answer: B Explanation: If the test results do not confirm the preliminary evaluation of controls, the auditor will consider whether there is a compensating control that might detect and correct a misstatement missed by the original control being tested. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 104) In trying to determine whether there is a need for additional tests of controls, which of the following factors are considered? A) Results of inquiries and observations B) Evidence provided by other tests C) Changes in the overall control environment D) All of these answer choices are correct Answer: D Explanation: In trying to determine whether there is a need for additional detailed tests of controls, the auditor would consider results of inquiries and observations, evidence provided by other tests, and changes in the overall control environment. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

105) If the auditor determines that an effective compensating control does not exist, or tests of controls show that the compensating control is not functioning as designed, ________. A) the auditor revises the overall audit risk assessment for the related account and assertion, and the planned audit strategy B) the auditor makes no changes to the overall audit risk assessment for the related account and assertion, and the planned audit strategy C) the auditor concludes that internal control is weak, and issues an appropriate opinion D) the auditor would lower inherent risk surrounding the engagement as a whole Answer: A Explanation: If the auditor determines that an effective compensating control does not exist, or tests of controls show that the compensating control is not functioning as designed, the auditor revises the overall audit risk assessment for the related account and assertion, and the planned audit strategy. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 106) The auditor always needs to investigate any control exceptions (deviations) that he or she identifies during testing to find out, to the extent practical, ________. A) the causes and the amounts involved B) the financial statement accounts affected C) the potential effect on other audit procedures D) All of these answer choices are correct. Answer: D Explanation: The auditor always needs to investigate any control exceptions (deviations) that he or she identifies during testing to find out, to the extent practical, the causes, the amounts involved, the financial statement accounts affected, and the potential effect on other audit procedures. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

107) Which of the following refers to a deficiency where there is more than a remote possibility that a material misstatement could occur in the financial statements due to a breakdown in the system of internal control? A) Material weakness B) Significant deficiency C) Control deficiency D) Insignificant deficiency Answer: A Explanation: Material weakness is a deficiency where there is more than a remote possibility that a material misstatement could occur in the financial statements due to a breakdown in the system of internal control. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 108) An observed condition that provides evidence that the control being tested did not operate as intended is called a/an ________. A) control exception B) significant deficiency C) attribute sampling D) material weakness Answer: A Explanation: A control exception is an observed condition that provides evidence that the control being tested did not operate as intended. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

109) As part of the audit of Newberry LLC, the external auditors, Parker CPAs have noted that multiple credit sales are missing from accounts receivable. As the audit partner with overall responsibility for the engagement prepares to communicate this to the client's senior management, which of the following should be noted in the management letter? A) This issue represents a significant deficiency. Per generally accepted auditing standards, the client has ten business days from receipt of the letter to correct the deficiency. B) The auditors have classified this as a significant deficiency due to its pervasive nature. All significant deficiencies are required to be reported to the Securities and Exchange Commission. C) The auditors have classified this as a material weakness and are required to immediately disclaim an audit opinion in order to preserve the reputation of the CPA firm. D) This represents a significant deficiency due to its pervasive nature. The identified weaknesses must be remedied by the fiscal year-end date in order to receive a clean audit opinion on internal control. Answer: D Explanation: This represents a significant deficiency due to its pervasive nature. The identified weaknesses must be remedied by the fiscal year-end date in order to receive a clean audit opinion on internal control. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 110) An audit manager working on the audit of Jackson LLC has received a Service Organization and Controls (SOC) 1 Type 1 report from the service auditor. The service auditor's report indicates that the client's service company has a strong and effective system of internal control. As a result of this finding, what might the auditor decide to do with respect to the client's system of internal control? A) The auditor should focus on substantive testing only, and can use the service auditor's report to provide reasonable assurance on internal control. B) The auditor should perform planned procedures on the client's system of internal control, as a Type 1 report does not permit the auditor to assess control risk below the maximum. C) The auditor should plan to amend the planned procedures of the client's system of internal control, to match the audit procedures conducted by the service auditor. D) None of these answer choices are correct. Answer: B Explanation: The auditor should perform planned procedures on the client's system of internal control, as a Type 1 report does not permit the auditor to assess control risk below the maximum. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

111) Wyoming CPAs have just received a Service Organization and Controls (SOC) 1, Type 2 report from a service auditor in conjunction with the audit of Johnson Enterprises, LLC. Johnson CPAs are discussing how receipt of this report may affect the audit. Which of the following statements is true with respect to the action Wyoming CPAs may decide to take? A) Wyoming CPAs should look to confirm the conclusions reached in the service auditor's report by requesting a separate service auditor perform the same tests. B) Wyoming CPAs should adhere to generally accepted auditing standards which do not permit the auditor to assess control risk below the maximum level based on the service auditor's report. C) If the service auditor did not note any exceptions in the service companies internal control, Wyoming CPAs should plan to rely on the report and may assess control risk lower than the maximum. D) Wyoming CPAs should consider adopting a reliance strategy whereby the report of the service auditor is relied upon, and Wyoming CPAs plan more substantive procedures in these areas to compensate. Answer: C Explanation: If the service auditor did not note any exceptions in the service companies internal control, Wyoming CPAs should plan to rely on the report and may assess control risk lower than the maximum. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

112) Brian, an audit manager assigned to the audit of Dojo Enterprises has just completed the audit of their system of internal control. One of Brian's newer audit staff associates, Delacie, is curious as to what types of detail Brian will include about internal control, and where he will document it. Which of the following represents Brian's most appropriate response? A) Each year's testing of internal control is included in the client's permanent file. Internal control doesn't generally change much, so there is no reason to test it every year. B) We typically document our understanding of internal control in the working papers, and may include details like the controls we tested and our resultant conclusion about control risk. C) The majority of the auditors understanding of internal control is documented in a formal letter to the client's senior management, who are asked to review and confirm that the auditor's understanding is correct. D) The auditor typically documents their understanding of internal control in the working papers associated with the audit, and include details of the substantive tests they performed on internal control. Answer: B Explanation: We typically document our understanding of internal control in the working papers, and may include details like the controls we tested and our resultant conclusion about control risk. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 113) Brian, an audit partner assigned to the audit of Macon LLC has just completed the audit of internal control. All documentation gathered and conclusions reached have been documented in the working papers associated with the audit. Which of the following is correct with respect to the conclusions reached by the audit partner? A) The conclusions reached by the audit partner should be such that another auditor could review the audit and documentation gathered, and reach a similar conclusion on internal control. B) The audit documentation and conclusions reached pertaining to internal control should be passed to senior management for review and modification as necessary. C) Any conclusions reached by the audit partner must be agreed upon by both management and the internal audit function before being formally included in the audit report. D) None of these answer choices are correct. Answer: A Explanation: The conclusions reached by the audit partner should be such that another auditor could review the audit and documentation gathered, and reach a similar conclusion on internal control. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 50

114) The partners of Seagrove CPAs have just completed their audit of a publicly-traded client's system of internal control, and have documented their understanding and conclusions accordingly. At this juncture, what are the auditors' next steps likely to be? A) The auditing firm is ready to issue an opinion on the financial statements, and should proceed with doing so after a careful review of all evidence gathered. B) The auditing firm should review the assessed level of control risk, and proceed with determining the nature, timing, and extent of substantive procedures accordingly. C) The auditors are required to submit a formal report on internal control to client management, for review and approval. D) The auditors will assess control risk and make any necessary modifications, and then proceed with determining the nature, timing, and extent of necessary tests of controls. Answer: B Explanation: The auditing firm should review the assessed level of control risk, and proceed with determining the nature, timing, and extent of substantive procedures accordingly. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 115) Since last year's audit of Bagley LLC, the external auditors, Cape Fear CPAs have been apprised by the client that a number of changes have been made to systems and processes as well as internal control, increasing the complexity of these items. As a result of this notification, which of the following may be true regarding the auditors working papers for the next audit? A) The working papers for the next year's audit should be adhered to closely during the next audit, as this will help the auditor determine if any differences really exist. B) The auditor should be prepared to possibly collect more documentation in the working papers as a result of this increased complexity. C) The auditor should obtain a list of all changes from senior management for inclusion in the audit file. The list should be used by the auditor to focus on solely testing any changes in these controls. D) None of these answer choices are correct. Answer: B Explanation: The auditor should be prepared to possibly collect more documentation in the working papers as a result of this increased complexity. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

116) Once controls have been tested, ________. A) the auditors immediately issue an unqualified opinion on internal control B) the auditors document their work in a working paper C) the auditors should request all fees due for this part of the audit, before moving on to the financial statement audit D) the auditors should document their understanding in a memo addressed to the client's legal counsel Answer: B Explanation: Once controls have been tested, the auditors document their work in a working paper. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 117) Working paper documentation for test of controls should include ________. A) all client-owned documents which will be returned to the client once audit fees are paid B) comments on this year's audit by the prior auditor C) the auditors' opinion of absolute assurance about control risk, and the basis for their conclusion (e.g., underlying evidence) D) the auditors' conclusion about control risk, and the basis for their conclusion (e.g., underlying evidence) Answer: D Explanation: Once controls have been tested, the auditors document their work in a working paper. Working paper documentation should include: o the auditors' conclusion about control risk, and o the basis for their conclusion (e.g., underlying evidence). Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

118) After the auditor has completed test of controls and drawn a conclusion about control risk, ________. A) the auditor will want to make decisions about the nature, timing and extent of substantive testing B) the auditor will want to make decisions about the nature of substantive testing C) the auditor will want to make decisions about the timing of substantive testing D) the auditor will want to make decisions about the extent of substantive testing Answer: A Explanation: After the auditor has completed testing controls, and drawn a conclusion about control risk, the auditor will want to make decisions about the nature, timing and extent of substantive testing. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 119) In preparing a working paper for tests of controls, ________. A) the auditor would ordinarily set out the purpose of the financial statements audited B) the auditor would ordinarily set out the purpose of the tests of the controls identified C) the auditor would request input and amendments from senior management D) the auditor would complete the working paper with the help of the client's legal counsel Answer: B Explanation: In preparing a working paper for tests of controls, the auditor would ordinarily set out the purpose of the tests of the controls identified. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

120) Regardless of how the working papers are prepared and documented, ________. A) the extent of the auditor's documentation will increase as the complexity of the client's operations, systems, and controls increases B) the extent of the auditor's documentation will decrease as the complexity of the client's operations, systems, and controls increases C) the extent of the auditor's documentation will increase as the complexity of the client's operations, systems, and controls decrease D) the extent of the auditor's documentation will decrease as the complexity of the client's operations, systems, and controls decrease Answer: A Explanation: Regardless of how the working papers are prepared and documented, the extent of the auditor's documentation will increase as the complexity of the client's operations, systems, and controls increases. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 121) The more complex the client's operations and its internal controls, ________. A) the lower inherent risk is assessed by the auditor B) the less audit staff should be assigned to the client engagement C) the more experienced the auditor who performs the work needs to be D) the more inexperienced the auditor who performs the work needs to be Answer: C Explanation: The more complex the client's operations and its internal controls, the more experienced the auditor who performs the work needs to be. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

122) Auditors of both public companies and private entities ________. A) have a responsibility to report internal control weaknesses to those charged with governance of the entity B) have a responsibility to report internal control weaknesses directly to the SEC C) have a responsibility to report internal control weaknesses to the internal audit function, for immediate rectification D) have a responsibility to report internal control weaknesses directly to the shareholders of an entity, who in turn should address their concerns to management Answer: A Explanation: Auditors of both public companies and private entities have a responsibility to report internal control weaknesses to those charged with governance of the entity. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 123) In preparing a working paper for tests of controls, ________. A) the auditor should defer preparation to the internal audit function B) the auditor would ordinarily set out the purpose of the tests of the financial statement accounts identified C) the auditor would ordinarily set out the purpose of the tests of the controls identified D) the auditor should be careful to avoid bringing to management's attention any defective controls Answer: C Explanation: In preparing a working paper for tests of controls, the auditor would ordinarily set out the purpose of the tests of the controls identified. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

124) The extent of the auditor's documentation will increase if ________. A) the complexity of the client's operations, systems, and controls increases B) the complexity of the client's operations, systems, and controls decreases C) the auditor making on the documentation is more experienced D) the auditor making on the documentation is less experienced Answer: A Explanation: Regardless of how the working papers are prepared and documented, the extent of the auditor's documentation will increase as the complexity of the client's operations, systems, and controls increases. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 125) Which of the following is true of working papers? A) Working papers document the auditors' conclusion about control risk and the basis for that conclusion. B) Working papers are necessary for the junior auditor to keep track of the daily work, but are not important to the overall audit. C) Working papers document the results of the tests but not the purpose of the control selected for testing. D) Working papers document the purpose of the control selected for testing and the conclusion made by the auditor, but not the results of the test. Answer: A Explanation: Working paper documentation should include the auditors' conclusion about control risk and the basis for their conclusion (e.g., underlying evidence). Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

126) The ________ clearly lays out the purpose of the test of the control, the nature and extent of the work performed at an interim date, the results of the audit tests, and the auditor's conclusion about control risk. A) working paper B) audit documentation C) controls testing paper D) audit report Answer: A Explanation: The working paper clearly lays out the purpose of the test of the control, the nature and extent of the work performed at an interim date, the results of the audit tests, and the auditor's conclusion about control risk. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 127) Evan and Sally are completing their first audit of internal control for Newsome Enterprises, and are discussing issuance of the management letter with the audit partner assigned to the engagement, Rodney. Evan and Sally are not familiar with a management letter and ask Rodney to explain its overarching purpose. Which of the following statements by Rodney represents the most appropriate response to this query? A) The auditing firm uses management letters to communicate deficiencies and weaknesses in internal control to client management, who are then tasked with fixing any noted issues. B) Issuance of a management letter by the auditor is typically only required for public companies, in which case a copy is sent to the Securities and Exchange Commission. C) The purpose of a management letter is to indemnify the external auditors against any future lawsuits against the client pertaining to internal control. D) None of these answer choices are correct. Answer: A Explanation: The auditing firm uses management letters to communicate deficiencies and weaknesses in internal control to client management, who are then tasked with fixing any noted issues. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

128) Carrie and her supervisor Michael, an audit manager assigned to the attestation engagement of Southwood Enterprises are discussing management letters. Carrie advises Michael that she understands what a management letter is, but isn't really sure of what benefits sending such a letter provides for the auditors. What is the most appropriate response by Michael to this question? A) Auditing firms typically spend a considerable amount of time carefully crafting management letters, as this can be used to increase the number of billable hours associated with the audit. B) One of the benefits to the auditing firm of sending a management letter is that in so doing, the client is accepting any and all legal liability for misstatements in the financial statements caused by internal control. C) Upon sending management letters to a client's senior management, the auditors are able to gauge management's response to any notable items, which provides a measure of how management prioritizes internal control. D) The auditors typically send management letters to the client's senior management to confirm that upon receipt of the auditors assessment of internal control, management will work to eliminate all potential misstatements caused by any deficiencies or weaknesses. Answer: C Explanation: Upon sending management letters to a client's senior management, the auditors are able to gauge management's response to any notable items, which provides a measure of how management prioritizes internal control. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 129) The auditor performs ________ once she has determined to follow a reliance strategy for an assertion and identified the key controls to test. Answer: tests of controls Explanation: The auditor performs tests of controls once he/she has determined to follow a reliance strategy for an assertion and identified the key controls to test. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

130) When designing tests of controls, consideration is given to ________ with the transaction (the risk of material misstatement) at the assertion level. Answer: WCGW, what can go wrong, or what can go wrong (WCGW) Explanation: When designing test of controls, consideration is given to WCGW with the transaction (the risk of material misstatement) at the assertion level. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 131) The procedure that relies on the auditor testing the physical evidence to verify that a control has been performed properly is known as ________. Answer: inspection Explanation: The procedure that relies on the auditor testing the physical evidence to verify that a control has been performed properly is known as inspection. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 132) The procedure that involves the auditor performing the control in the same manner as an employee in order to test its effectiveness is known as ________. Answer: reperformance Explanation: The procedure that involves the auditor performing the control in the same manner as an employee in order to test its effectiveness is known as reperformance. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 133) Techniques that involve the auditor's use of computers to assist in verification are known as software-assisted ________ techniques. Answer: audit Explanation: Techniques that involve the auditor's use of computers to assist in verification are known as software-assisted audit techniques. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 59

134) If the auditor wants to test using the ________ technique, he must find evidence that the control was performed on a timely basis. Answer: reperformance Explanation: If the auditor wants to test using a reperformance technique, he or she must find evidence that the control was performed on a timely basis. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 135) A ________ is an observed condition that provides evidence that the control being tested did not operate as intended. Answer: control exception Explanation: A control exception is an observed condition that provides evidence that the control being tested did not operate as intended. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 136) Working paper documentation includes the auditors' conclusion about ________ and the basis for their conclusion. Answer: control risk Explanation: Working paper documentation includes the auditors' conclusion about control risk and the basis for their conclusion. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

137) Match the steps in assessing control risk with their details. A. Understand entity-level controls. B. Understand the flow of documents through the system. C. Identify what can go wrong (WCGW). D. Identify relevant controls to test. ____ This involves all five components of internal controls, which are the client's control environment, risk assessment, information system, control activities, and monitoring of controls. ____ This describes where material misstatements due to error or fraud could occur in a flow of transactions or source and preparation of information that affects a relevant financial statement assertion. ____ Once the auditor identifies what can go wrong, the auditor will look for relevant internal controls that will either prevent them or detect and correct them. ____ The common steps in any transaction stream are authorization, executing the transaction, recording the transaction, and consideration. Answer: Understand entity-level controls: This involves all five components of internal controls which are the client's control environment, risk assessment, information system, control activities, and monitoring of controls. Understand the flow of documents through the system: The common steps in any transaction stream are authorization, executing the transaction, recording the transaction, and consideration. Identify what can go wrong (WCGW): This describes where material misstatements due to error or fraud could occur in a flow of transactions or source and preparation of information that affects a relevant financial statement assertion. Identify relevant controls to test: Once the auditor identifies what can go wrong, the auditor will look for relevant internal controls that will either prevent them or detect and correct them. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

138) Match the concepts related to control risks with their descriptions. A. Desired level of assurance B. Attribute sampling C. Benchmarking D. Control exception ____ It is used to reach a conclusion about a population in terms of a rate (frequency) of occurrence. ____ It provides evidence that the control being tested did not operate as intended. ____ It represents the confidence that the evidence obtained is representative of the underlying population from which the sample was taken. ____ It can be used to allow evidence obtained in prior audit periods to support a conclusion about IT application controls in the current audit period. Answer: The desired level of assurance represents the confidence that the evidence obtained is representative of the underlying population from which the sample was taken. Attribute sampling is a sampling technique that is used to reach a conclusion about a population in terms of a rate (frequency) of occurrence. Benchmarking is an audit testing strategy that can be used to allow evidence obtained in prior audit periods to support a conclusion about IT application controls in the current audit period. Control exception is an observed condition that provides evidence that the control being tested did not operate as intended. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

139) Match the steps of assessing control risks to their details. A. Additional tests of controls B. Results of inquiries and observations C. Control deficiency D. Significant deficiency ____ It is a deficiency where there is more than a remote possibility that a misstatement that is less than material, but still significant enough that it should be reported to those charged with governance. ____ They are required if the auditor becomes aware of adverse changes in the overall control environment of the entity. ____ The magnitude is such that it does not need the attention of those charged with governance of the entity. ____ The auditor may need to identify and test other controls, perform additional tests of controls, or increase the level of substantive testing performed at year-end. Answer: Additional tests of controls: They are required if the auditor becomes aware of adverse changes in the overall control environment of the entity. Results of inquiries and observations: The auditor may need to identify and test other controls, perform additional tests of controls or increase the level of substantive testing performed at yearend. Control deficiency: The magnitude is such that it does not need the attention of those charged with governance of the entity. Significant deficiency: It is a deficiency where there is more than a remote possibility that a misstatement that is less than material, but still significant enough that it should be reported to those charged with governance. Diff: 1 LO: 3, 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

140) Match the components of working paper with their details. A. Test results table B. Conclusion C. Actual controls selected D. Deciding the nature, timing, and extent of substantive testing ____ It assists the person reviewing the working paper to determine if enough work has been performed and if the right conclusion regarding the controls testing has been reached. ____ It is specific to whether the test results support the overall purpose of the test. ____ After the auditor has completed testing controls and drawn a conclusion about control risk, it is the last step in working paper documentation. ____ There should be enough details in the working paper to allow another auditor to review the working paper, reperform the steps, and reach the same conclusion as the auditor who prepared the working paper. Answer: A test results table assists the person reviewing the working paper to determine if enough work has been performed and if the right conclusion regarding the controls testing has been reached. The conclusion is specific to whether the test results support the overall purpose of the test. Actual controls selected should have enough details in the working paper to allow another auditor to review the working paper, reperform the steps, and reach the same conclusion as the auditor who prepared the working paper. After the auditor has completed testing controls and drawn a conclusion about control risk, deciding the nature, timing, and extent of substantive testing is the last step in working paper documentation. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

141) Entity-level controls involve which of the following three components of internal controls? A) Client's control environment B) Risk assessment C) Information system D) External activities Answer: A, B, C Explanation: Entity-level controls involve all five components of internal controls, which are the client's control environment, risk assessment, information system, control activities, and the monitoring of controls. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 142) Which three of the following are types of controls? A) Manual control B) Software application control C) Information technology general controls (ITGCs) D) Automated controls Answer: A, B, C Explanation: Controls can be also be classified as one of four types: 1. manual controls; 2. computer application controls (also known as automated controls); 3. information technology general controls (ITGCs); and 4. a combination of control types referred to as IT-dependent manual controls. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; PC: None

143) Derek and Sue, audit managers assigned to the audit of Peabody Enterprises LLC, a national distributor of skincare and other beauty products, are discussing the client's system of internal control with a new audit staff associate, Janiya. Janiya has spent considerable time during this audit working on the testing of internal controls. Janiya inquires as to why auditors appear to spend so much time auditing internal controls, when it would appear to make more sense to just test financial statement accounts. Select all of the answer choices which represent correct responses to this question. A) Auditing internal control is important because it may help the auditor determine where misstatements may be in the financial statements. B) An effective system of internal control can be very effective in helping to prevent misstatements in the financial statements. C) A robust system of internal control is generally ineffective in detecting and correcting financial statement misstatements. D) If the auditor can determine that the client's system of internal control is effective, there is no need to perform substantive testing, which reduces the cost of the audit. Answer: A, B, D Explanation: Auditing internal control is important because it may help the auditor determine where misstatements may be in the financial statements. An effective system of internal control can be very effective in helping to prevent misstatements in the financial statements. If the auditor can determine that the client's system of internal control is effective, there is no need to perform substantive testing, which reduces the cost of the audit. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

144) Caroline, the audit partner with overall responsibility for the audit of Beaman LLC is discussing the various types of controls with one of her audit interns, Mike. Mike is curious to understand more about preventive controls, as he has been advised by various other audit associates that these types of controls are very important. Which of the following statements accurately describe preventive controls? Select all that apply. A) Preventive controls are examined by the external auditors upon conclusion of the audit, to confirm the audit opinion reached. B) Preventive controls are designed by a firm to help stop errors and fraud occurring during routine processing of transactions. C) Preventive controls are typically designed as a result of a careful analysis as to what might go wrong during processing. D) Preventive controls are routinely audited by the external auditors using substantive tests of details on the controls. Answer: B, C Explanation: Preventive controls are designed by a firm to help stop errors and fraud occurring during routine processing of transactions. Preventive controls are typically designed as a result of a careful analysis as to what might go wrong during processing. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None

145) During the audit of South Enterprises, one of the audit staff associates working on the engagement, Mike, is discussing how the client's internal controls are actually tested by the auditors with his supervisor, Sarah. Mike asks Sarah to provide some examples of procedures the auditors might conduct in order to gather evidence on the effectiveness of internal control. Which of the following examples represent procedures an auditor might conduct in order to test internal controls? Select all that apply. A) An audit manager observes the accounts receivable function performing their daily tasks and documents this accordingly. B) An audit staff associate is assigned the task of counting the client's inventory, which is matched to the client's inventory records. C) The client provides documentation to the external auditors of accounts payable transactions and associated credit terms. D) The internal auditors agree to complete the audit of all stockholder's equity accounts, and provide details of the audit to the external auditors. Answer: A, B Explanation: An audit manager observes the accounts receivable function performing their daily tasks and documents this accordingly. An audit staff associate is assigned the task of counting the client's inventory, which is matched to the client's inventory records. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 146) Jarvis, an audit partner assigned to the engagement of Jackson LLC, is interested in assigning a team to audit the client's software controls. Jarvis has convened a meeting to discuss ideas to accomplish this with his audit team. Which of the following choices correctly represent audit evidence that Jarvis would wish to obtain as a result of this testing? Select all that apply. A) Evidence that the client's system of IT internal controls correctly identified any exceptions and forwarded them to the appropriate authority. B) Evidence that no unauthorized changes have been made to the client's IT systems. C) Evidence that the appropriate staff are following up on system exception notifications, and are doing so in a timely manner. D) Evidence that the internal audit function is conducting the appropriate level of substantive testing on IT internal controls to ensure its operating effectiveness. Answer: A, B, C Explanation: Evidence that the client's system of IT internal controls correctly identified any exceptions and forwarded them to the appropriate authority. Evidence that no unauthorized changes have been made to the client's IT systems. Evidence that the appropriate staff are following up on system exception notifications, and are doing so in a timely manner. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None 68

147) Which two of the following are examples of the inquiry technique in tests of controls? A) The auditor asks the employee who prepares the bank reconciliation how reconciling items are identified. B) The auditor asks management how it makes sure the reconciliation is prepared correctly and on a timely basis. C) The auditor observes the preparation of the bank reconciliation. D) The auditor inspects initials and dates on bank reconciliation. Answer: A, B Explanation: The following two are examples of inquiry technique in tests of control: 1. The auditor asks the employee who prepares the bank reconciliation how reconciling items are identified. 2. The auditor asks management how it makes sure the reconciliation is prepared correctly and on a timely basis. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 148) Keona and Mike, two audit managers assigned to the audit of Valley Enterprises are discussing which internal controls should be selected for testing based on their experience with this particular client. Which of the following choices would represent considerations for Keona and Mike with respect to internal controls? A) As it is not feasible to select all internal controls, which controls should the auditors select to be tested? B) How many items should be tested in conjunction with the audit of a particular internal control? C) To what extent should the auditors rely on the substantive testing of internal controls performed by the client's internal audit function. D) As levels of control risk vary depending on the controls, when is the best time for the auditor to test selected controls? Answer: A, B, D Explanation: As it is not feasible to select all internal controls, which controls should the auditors select to be tested? How many items should be tested in conjunction with the audit of a particular internal control? As levels of control risk vary depending on the controls, when is the best time for the auditor to test selected controls? Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None

149) Martha, the audit manager assigned to the attestation engagement of Greenleaf Enterprises is discussing sample size with a new audit staff associate, Johnny. Johnny is working on his first audit, and is confused as to why all sample sizes are not the same for different accounts. Martha explains that the determination of sample size depends on a number of factors. Which of the following represents factors that may cause an adjustment in sample size? Select all that apply. A) Martha advises Johnny that in some cases, the auditor seeks higher levels of assurance, particularly for accounts with higher inherent risk. B) Martha explains to Johnny that auditors typically determine what they consider to be a tolerable deviation rate. C) Martha advises Johnny that regardless of the population size, the auditor typically maintains the same sample size in order to assurance consistency across the audit. D) Martha explains that the aggressiveness of management in setting goals for the firm, as well as the perceived independence of the board of directors affect sample sizes for large firms. Answer: A, B Explanation: Martha advises Johnny that in some cases, the auditor seeks higher levels of assurance, particularly for accounts with higher inherent risk. Martha explains to Johnny that auditors typically determine what they consider to be a tolerable deviation rate. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None

150) Janice and Derek, two audit managers working for Jeter CPA Firm are at lunch, and are discussing some of the tests of controls they recently performed on one of their largest audit clients. Janice notes that during the course of the audit, there were some issues noted with the client's controls. Which of the following represent scenarios whereby an exception would be noted with respect to the client's controls? A) An audit staff associate reported that an exception list of transactions that had not been processed appeared to be assigned to the wrong client staff member. B) An audit manager had conducted a separate, independent bank reconciliation for one of the client's major bank accounts, and was able to account for all transactions. C) An audit staff associate working on the audit of bonds payable and the associated interest accounts noted that interest accruals were not always recorded correctly. D) An audit intern working on the audit of the revenue-receivables cycle noted that the client's collection of accounts receivable was higher than in previous years. Answer: A, C Explanation: An audit staff associate reported that an exception list of transactions that had not been processed appeared to be assigned to the wrong client staff member. An audit staff associate working on the audit of bonds payable and the associated interest accounts noted that interest accruals were not always recorded correctly. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 151) Tests of various manual controls have which two requirements? A) Testing to see that the person who performed the control provided their initials B) Reperforming the checking routine itself C) Checking the nature of the control implemented by management D) Professional judgment is not applied in manual controls Answer: A, B Explanation: Tests of various manual controls have the following two requirements: 1) testing to see that the person who performed the control provided their initial and 2) reperforming the checking routine itself. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

152) Hannah and Joe, two auditors assigned to the attestation engagement for Babin LLC, a service firm, are discussing the client's accounting system, which is in part outsourced to a thirdparty service firm, Dixon LLC. The auditors have received the report from the service company's auditors which have concluded that Dixon LLC's internal controls are operating effectively, and that no issues with internal control are noted. Hannah and Joe are pleased to receive this report, however are cognizant that problems may still exist in the service firm's system of internal control. Which of the following represent reasons why Hannah and Joe may still be skeptical? Select all that apply. A) It is possible that the report received on internal control from the service firm's auditors do not cover every aspect of the client's system of internal control. B) The audit report received, despite noting no issues in internal control, cannot provide a guarantee that no weaknesses exist. C) Because Hannah and Joe's firm did not complete this audit of the client's system of internal control, the report does not offer any assurance. D) Unless the third-part auditors report can offer absolute assurance of no problems or weaknesses in internal control, the auditors cannot rely on the report. Answer: A, B Explanation: It is possible that the report received on internal control from the service firm's auditors do not cover every aspect of the client's system of internal control. The audit report received, despite noting no issues in internal control, cannot provide a guarantee that no weaknesses exist. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

153) Sally and Warren, two audit managers assigned to the audit of Blade Enterprises, a regional distributor of knives and other cutlery products throughout the southwestern United States are discussing various ways to document their tests of internal controls with Kendra, a recent college graduate and addition to the firm. Kendra has heard about working papers being used by the auditors for this purpose, and asks Sally and Warren for examples of what might be found in such working papers. Which of the following represent examples of what might be found in these working papers? Select all that apply. A) Details of substantive procedures, including tests of details, performed on the client's system of internal control. B) The particular controls that were selected for testing, and the results of the tests themselves. C) Details of written notifications sent to those charged with governance, documenting the state of the client's system of internal controls and what recommendations the auditors have made to fix any issues. D) Whether the auditors performing the tests of controls believe that the results obtained support the purpose of testing. Answer: B, C, D Explanation: The particular controls that were selected for testing, and the results of the tests themselves. Whether the auditors performing the tests of controls believe that the results obtained support the purpose of testing. Details of written notifications sent to those charged with governance, documenting the state of the client's system of internal controls and what recommendations the auditors have made to fix any issues. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 154) Which of the following are set out by the working paper? A) The purpose of the test of control B) The nature and extent of the work performed at an interim date C) The auditor's conclusion about audit risk D) The auditor's conclusion about control exceptions Answer: A, B, C Explanation: The following are set out by the working paper: 1) the purpose of the test of control; 2) the nature and extent of the work performed at an interim date; and 3) the auditor's conclusion about audit risk. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

155) Ramsey and Anna, two audit staff associates, are discussing the audit of Parkberry Enterprises with their supervisor, audit manager Lisa; specifically the area of internal control. Lisa is explaining the importance of this function to Ramsey and Anna, and why it is critical for the auditor to gain a clear and in-depth understanding of this area. Which of the following responses by Lisa would best help Ramsey and Anna understand the necessity of the auditor gaining a clear understanding of internal control? A) It is very important for the auditor to gain a clear understanding of a client's system of internal control because the auditor is solely liable for any misstatements that a poor system of internal control causes. This could prove very costly for the firm. B) If the auditor is able to gain a thorough understanding of a client's system of internal control, it is more likely that less time and attention will need to be spent in this area. This can help reduce the cost of the audit and make the audit firm more competitive in its bidding and pricing. C) It is crucial for the auditor to gain a sound understanding of a client's system of internal control because such an understanding will help the auditors determine where financial statement misstatements may be. It will also help the auditor effectively assess control risk. D) The auditor should invest considerable time gaining an understanding of a client's system of internal control. Once such an understanding is obtained, the auditor should perform substantive procedures on the population of controls in order to provide an assessment of control risk. Answer: C Explanation: It is crucial for the auditor to gain a sound understanding of a client's system of internal control because such an understanding will help the auditors determine where financial statement misstatements may be. It will also help the auditor effectively assess control risk. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

156) Janice, an audit partner assigned to the engagement of Griffin LLC is discussing internal control with one of the audit staff associates also assigned to this client, Ken. Ken is relatively new to the world of auditing and attestation services, and is keen to learn more about internal controls. Ken asks Janice to explain why systems of internal control include preventive and detective controls. Which of the following responses by Janice would best answer Ken's question? A) Systems of internal control often include preventive and detective controls. These controls are put in place by the client's management, and are designed to ensure that no misstatements occur in the financial statements. Without these controls, the auditor would not be able to rely on a client's system of internal control. B) A client's system of internal control typically includes both preventive and detective controls. Preventive controls are usually applied during transaction processing and detective controls are typically applied thereafter. C) A client's system of internal control usually includes both detective and preventive controls. Detective controls are typically applied during the processing of transactions, whereas the preventive controls are typically applied after transactions have occurred. D) A system of internal control that employs both detective and preventive controls are usually only seen in larger companies because implementation of both types of controls is very expensive. For this reason, smaller firms do not typically rely on both types of controls, and instead focus their resources on detective controls. Answer: B Explanation: client's system of internal control typically includes both preventive and detective controls. Preventive controls are usually applied during transaction processing and detective controls are typically applied thereafter. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

157) Sharon, an audit manager assigned to the audit of Newsome Corporation is observing the client's revenue-receivables cycle. Sharon observes that the IT system responsible for processing and posting receivable transactions produces a daily exceptions report which is emailed to an accounts receivable clerk responsible for investigating the exceptions. Which of the following most accurately describes the type of control that is responsible for determining possible exceptions and forwarding them on to the accounts receivable clerk? A) This type of control is typically referred to as an IT general control. A control that functions in this manner helps to ensure questionable transactions are not processed, and that potential misstatements in the financial statements are subsequently eliminated. B) A control of this nature is usually referred to as a preventive control. The control assumes this name because by generating notable items and exception reports for further investigation, the control prevents errors and fraud from occurring. C) This type of control is typically referred to as a detective control. These types of controls usually assist the client in detecting items that need further investigation. These controls help to minimize misstatements in the financial statements. D) This type of control is typically known as a manual IT control. This name is derived from the fact that although the control allows initial processing by the client's IT system, it is flagged for manual follow up. Answer: B Explanation: A control of this nature is usually referred to as a preventive control. The control assumes this name because by generating notable items and exception reports for further investigation, the control prevents errors and fraud from occurring. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

158) Hewitt CPA Firm is currently completing the audit of Aston Enterprises, LLC, a manufacturer and retailer of specialty and luxury automobiles, and a long-time audit client. The partners assigned to the engagement are currently meeting to discuss the most appropriate way to gather evidence in order to support their tests of controls, based on their knowledge of the client. Which of the following choices most accurately describes what methods the partners of Hewitt CPA Firm will use in order to gather this type of evidence? A) Because the audit client operates in a specialized industry, it is most likely that the auditors will decide to flowchart their understanding of internal control via a questionnaire. This will help to ensure that other staff members assigned to the audit will be able to quickly and fully understand the client's system of internal control. B) Because the auditors and the audit firm have prior experience auditing this particular client, it is most likely that they will be able to rely on previous evidence gathered to support a conclusion on internal control, and only minimal procedures will be required this year. C) The most appropriate method of testing the client's internal controls is ultimately a matter of auditor judgment. The auditor may decide to employ one or perhaps even more methods to gather evidence on internal control in order to support the conclusion they reach. D) None of these answer choices are correct. Answer: C Explanation: The most appropriate method of testing the client's internal controls is ultimately a matter of auditor judgment. The auditor may decide to employ one or perhaps even more methods to gather evidence on internal control in order to support the conclusion they reach. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

159) During the audit of Rosso Enterprises, a large distributor of industrial cleaning products throughout the continental United States, Abby, the audit manager with day-to-day responsibility for the engagement is working on testing the clients internal controls related to the receivables function. Abby has entered purposefully invalid data into the system to check the system's response. Abby notes that the system correctly flags the invalid fictitious data and forwards an exception report on to one of the accounts receivable clerks. Which of the following most appropriately describes the type of control that processed this? A) This would be an example of a preventive control at work as part of the client's overall system of internal control. The auditor can now be sure that there are no misstatements in the client's financial statements as a result of ineffective internal control. B) The control that correctly flagged this transaction and the invalid data is most likely to be an IT application control. As a result of the effective application of this control, the auditor may decide to decrease control risk. C) The control that identified and flagged this transaction and the invalid data is most likely an example of an observation control. This type of control operates on the premise that when exceptions are noted and flagged, an employee who is familiar with the area investigates and watches to see what caused the data to be flagged. D) This is most likely to be an example of an IT general control. These types of controls routinely flag a preselected sample of data and transactions to ensure accuracy. When the external auditor is confident that IT general controls are effective, he or she can increase substantive testing and procedures. Answer: B Explanation: The control that correctly flagged this transaction and the invalid data is most likely to be an IT application control. As a result of the effective application of this control, the auditor may decide to decrease control risk. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

160) Dan, an audit partner assigned to the engagement of Bone Enterprises Inc. is discussing the client's system of internal control with Mandy, an audit staff associate also assigned to the engagement. As a relatively new auditor, Mandy is struggling to understand the idea of the audit firm using a top-down approach to determine which of the client's internal controls to test as part of the audit. Which of the following would represent Dan's best response to this question? A) When considering a client's system of internal control as part of an integrated audit, the auditor typically utilizes a top-down approach. This approach starts by considering the client at an entity-level and works its way down to the transaction level. B) Using a top-down approach to audit a client's system of internal control is extremely popular in the auditing profession. Use of this approach is popular because it helps the auditor to determine where higher risk areas may be, and allows the auditor to focus on those areas and thus charge the highest audit fees possible. C) A top-down approach is popular among both auditors and client management, because it puts management in the driving seat with respect to testing internal control and making any recommendations. This frees up the external auditors to focus on substantive testing in other areas. D) None of these answer choices are correct. Answer: A Explanation: When considering a client's system of internal control as part of an integrated audit, the auditor typically utilizes a top-down approach. This approach starts by considering the client at an entity-level and works its way down to the transaction level. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

161) During the audit of Sloan Enterprises, one of the audit managers assigned to the engagement, Diane, is discussing the client's internal controls with an audit team that is getting ready to begin testing these internal controls. One of the audit staff associates mentions that the client has historically had robust controls in place, which has enabled the auditor to previously adopt a reliance strategy. Another staff associate agrees, and notes that the client has a large number of new employees this year. Based on this information, which of the following responses would best represent the auditor's approach to auditing the client's system of internal control? A) The auditor has had prior experience with the client's system of internal control, and has found it to be robust and effective. As a result, it is more likely that the auditors will focus on increasing substantive procedures and only minimally auditing internal control. B) While it is likely that the client's system of internal control is still robust and effective, the auditor is likely to employ professional skepticism and consider the competence and integrity of employees who perform the controls. C) The auditor is required by generally accepted auditing standards to perform the same extensive audit each year on the client's system of internal control. As a result, the audit of internal control will remain largely unchanged from prior years, but the auditor may wish to obtain assurances from new employees that they are competent with the new controls. D) As the client's system of internal control has historically proved to be robust and effective, it is most likely that the auditors will deem this to be a lower risk area of the audit. As a result, the auditors will formally request that the internal audit function complete the audit of internal control. Answer: B Explanation: While it is likely that the client's system of internal control is still robust and effective, the auditor is likely to employ professional skepticism and consider the competence and integrity of employees who perform the controls. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

162) Two audit staff associates, Pamela and Katie, are working on the audit engagement of Dryspot LLC; a regional provider of drywall and other building supplies. Pamela and Katie are discussing the client's system of internal control as they are soon to begin testing in this area. Katie, a newer and less experienced employee, asks Pamela to explain the concept of tolerable deviation rate, and how it is tied to internal control. Which of the following responses represents Pamela's best answer to this question? A) There really isn't any defined relationship between tolerable deviation rate and a client's system of internal controls. We typically set the tolerable deviation rate long before we start the audit of internal controls, and the rate does not change throughout the audit. B) Tolerable deviation rate can be best thought of as the maximum level of deviation an auditor can accept from a particular internal control without having to change the planned assessed level of control risk. If the auditor determines that the tolerable deviation rate has been surpassed, the auditor is likely to assess control risk as lower and adopt a reliance strategy. C) Tolerable deviation rate is best conceptualized as the maximum deviance an auditor is willing to accept from an internal control, without considering adjusting the planned level of control risk. D) Tolerable deviation rate is tied to the auditors' use of substantive testing. When the auditor determines that the tolerable deviation rate has been surpassed, the auditor will typically adopt and increase substantive tests of details and account balances on internal control. Answer: C Explanation: Tolerable deviation rate is best conceptualized as the maximum deviance an auditor is willing to accept from an internal control, without considering amending the planned level of control risk. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 163) Identify the types of audit evidence that are tested using audit sampling techniques. Answer: Some audit procedures involve sampling, while others do not. The following types of audit evidence can be tested using audit sampling techniques: 1. Inspection of tangible assets 2. Inspection of records or documents 3. Reperformance 4. Recalculation 5. Confirmation Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

164) Indicate which of the following audit procedures, used as tests of controls, do not involve audit sampling: 1. Observing and evaluating segregation of duties. 2. Testing of whether sales invoices are supported by authorized customer orders and shipping documents. 3. Reviewing client's procedures for accounting for the numerical sequence of shipping documents. 4. Examining sales orders for proper credit approval. 5. Recomputing the information on copies of sales invoices. 6. Comparing the average days outstanding in accounts receivable with industry averages. Answer: 1. Does not involve sampling. 2. Involves sampling. 3. Does not involve sampling. 4. Involves sampling. 5. Involves sampling. 6. Does not involve sampling. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

165) Blake and Caroline, two audit managers assigned to the audit of Legolas Enterprises are discussing samples and sample sizes in conjunction with the audit of the client's system of internal control. Blake mentions that back in college when he took an auditing class, he recalled the professor saying that audit sample size was tied to the level of assurance that the auditor ultimately wished to obtain. Which of the following responses by Caroline is most likely to help Blake understand this connection? A) The professor was mistaken. There really isn't any relationship between the level of assurance the auditor wishes to obtain and the sample sizes used in an audit. B) Generally speaking, if an auditor wishes to increase the desired level of assurance, he or she will typically increase sample size. A larger sample size is more representative of the population of interest to the auditor. C) The relationship between sample size and desired level of assurance is an inverse one. If the auditor wishes to increase his or her desired level of assurance, then he or she will typically decrease sample size proportionately to the desired increase in assurance. D) Although there is a definite relationship between desired level of assurance and sample size, most auditors simply audit the population of interest when they wish to increase the desired level of assurance. Answer: B Explanation: Generally speaking, if an auditor wishes to increase the desired level of assurance, he or she will typically increase sample size. A larger sample size is more representative of the population of interest to the auditor. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 166) As technology continues to advance, will technology reduce the number of situations in which audit sampling is necessary and perhaps eliminate the need for auditors to rely on sampling? Answer: Even with sophisticated advances in technology, it will not likely eliminate the need for auditors to rely on sampling to some degree because: (1) many control processes require human involvement to operate effectively, (2) many testing procedures require the auditor to physically examine certain items (such as tangible assets), and (3) in many cases auditors are required to obtain and examine evidence from third parties. In a large population, these situations all require both sampling and an auditor's "hands-on" attention. Diff: 3 LO: 3 Bloom: Synthesis Min: 1 AACSB: Technology AICPA: BC: None; PC: None 83

167) Matthew and Co. CPAs has audited Tigre Enterprises' system of internal control and financial statements for the last seven years. During last year's audit, it was noted that the client made significant improvements to the system of internal control and considerably strengthened the internal audit function, including enhanced training and the opportunity to obtain professional credentials at the company's expense. As a result of this information, what are the auditors likely to conclude about the expected deviation rate for this year's audit? A) The auditors are likely to conclude that expected deviation rate is unchanged from the prior year. Just because the client has strengthened their system of internal control and implemented enhanced training programs does not automatically make them effective. B) The auditors are likely to conclude that expected deviation rate may decrease as a result of an enhanced system of internal control and improvements in training for the internal audit function. Despite this, the auditor is likely to employ professional skepticism and perform audit procedures to form a reasonable basis for a conclusion that the deviation rate has decreased. C) It is likely that the auditors will conclude that due to the implementation of a strengthened system of internal control and enhanced training for the internal audit function, expected deviation rate has increased as employees may be less familiar with the improvements and it may take some time for them to become proficient. D) None of these answer choices are correct. Answer: B Explanation: The auditors are likely to conclude that expected deviation rate may decrease as a result of an enhanced system of internal control and improvements in training for the internal audit function. Despite this, the auditor is likely to employ professional skepticism and perform audit procedures to form a reasonable basis for a conclusion that the deviation rate has decreased. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

168) Megan, an auditor working on the audit of Weisz Enterprises, is currently testing the client's internal controls related to loans payable and associated interest expense. Megan wants to make sure that interest expense is valued and classified appropriately. During the audit, Megan notes that a preventive control associated with the calculation of interest expense appears to be defective. As a result of this finding, what might Megan decide to do? A) Upon realizing that the control is not operating effectively, Megan should notify the audit partner with overall responsibility for the engagement. It is likely at this juncture that the audit firm will disclaim an audit opinion on the client's interest-related accounts. B) Megan should document her findings, which should then be passed to the client's internal audit function for further investigation and auditing. The internal auditors are likely to be more familiar with the client's operations and finances, and thus are better placed to audit this area. C) Upon determining that the control may be deficient, Megan may decide to investigate whether there is a compensating control that would still detect and correct any misstatements missed by the original control. D) Megan is most likely to document her findings and opinion on this control, and then advise the audit partner assigned to the engagement that the firm should issue a qualified opinion on the client's system of internal control. Answer: C Explanation: Upon determining that the control may be deficient, Megan may decide to investigate whether there is a compensating control that would still detect and correct any misstatements missed by the original control. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

169) As part of the audit of Seagram Enterprises, LLC, a national distributor of sheet metal and similar products, the external auditors, Guerrera CPAs have completed their tests of internal control and have concluded that internal control is effective. A few weeks later, the firms Chief Financial Officer unexpectedly resigns, citing personal reasons for the sudden departure. What would be the most appropriate response to this departure by the audit firm? A) The audit firm should simply document the reasons behind the recently-departed CFO. A departure of this nature is suspicious and the executive may be leaving the firm for reasons other than the personal reasons cited. B) The audit firm should consider employing additional tests of the client's system of internal control. It is possible with the sudden departure of a key employee that the client's system of internal control may be affected or compromised, and so it would be prudent of the auditor to conduct additional tests. C) The auditor should consult generally accepted auditing standards which require the external auditors to notify the Securities and Exchange Commission in writing within ten business days of the departure of a key employee. D) As a result of the departure of the Chief Financial Officer, the auditors should disregard all prior tests of and opinions formed on internal control, and instead should fully audit internal control. This would require the auditor to adopt a reliance strategy. Answer: B Explanation: The audit firm should consider employing additional tests of the client's system of internal control. It is possible with the sudden departure of a key employee that the client's system of internal control may be affected or compromised, and so it would be prudent of the auditor to conduct additional tests. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

170) During the audit of publicly traded Parkland LLC, the external auditor, Hewsome CPA Firm is testing the client's system of internal control early in the fiscal year. One of the auditors CPAs noted a significant internal control deficiency, of which the client's management was apprised. Upon learning of the significant deficiency in internal control, the Chief Financial Officer apprised the auditors that the firm would work to correct the deficiency as soon as possible. If Parkland LLC is able to remedy this deficiency before conclusion of the audit, what action should the auditors take? A) The auditors should document the actions taken by management to fix the significant deficiency in internal control. The auditors will want to test this control during the following year's audit to ensure it is working effectively. B) The auditors should consider retesting the corrected internal control to ensure that the control is now effective. If evidence is gathered of the control's effectiveness, the auditors should issue a clean audit opinion on the client's system of internal control. C) Generally accepted auditing standards require that when the auditor finds a significant deficiency in internal control, the auditor reports the deficiency to those charged with governance and the Securities and Exchange Commission. D) The auditors should accept management's offer to remedy the defective control, but for this year's audit, the audit firm should issue a qualified opinion on the client's system of internal control. Answer: B Explanation: The auditors should consider retesting the corrected internal control to ensure that the control is now effective. If evidence is gathered of the control's effectiveness, the auditors should issue a clean audit opinion on the client's system of internal control. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

171) During your audit of Bricks, Inc., your test of a control over revenue recognition shows that the control is ineffective. Explain what you should do next. Answer: If the test results do not confirm the preliminary evaluation of controls, the auditor will consider whether there is a compensating control that might detect and correct a misstatement missed by the original control being tested. If the compensating control proves effective, the evidence now supports the auditor's preliminary evaluation of controls, and control risk and planned substantive audit procedures are not modified. If the auditor extends the testing and another control exception is identified, the auditor should change the decision to rely on that control. If another (compensating) control is not available to be substituted for the control being tested, or it is not considered efficient to continue testing controls, the auditor should modify (and potentially increase) the nature, timing and extent of the planned substantive procedures. That is, the audit strategy is altered, and Detective risk is reduced. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 172) Explain the differences in auditor responsibility for reporting control deficiencies, significant deficiencies, and material weaknesses to management and those charged with governance. Answer: Auditors of both public companies and private entities have a responsibility to report internal control weaknesses to those charged with governance of the entity. This is a requirement of both PCAOB AS 2201 and AU-C 265. This is usually done through a management letter. The auditor includes a discussion of both material weaknesses and significant deficiencies in the management letter. It is also important to note that all internal control deficiencies should be reported to management. If a control weakness is sufficiently small in magnitude such that it is not reported to those charged with governance, it should still be verbally reported to management, at least one level above where the weakness occurred. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

173) Bob Jensen is the staff auditor on the Banson Fashion audit. Bob performed tests of controls over the control "the accounts receivable subsidiary ledger reconciliation is reviewed by the financial controller". The objective of the test was to verify that a review by the financial controller occurred on a timely basis. When performing the testing, however, Bob found that while there was evidence of the review (a signature), there was no date, so timeliness could not be verified. What can Bob conclude from this test result and what should Bob do next? Answer: Bob is able to conclude that the control operated, but he is not able to conclude as to whether it operated on a timely basis. Bob needs to determine whether a compensating control should be tested, or whether or not the timeliness of the review is critical to the auditor's ability to rely on the accounts receivable reconciliation as audit evidence. Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; PC: None 174) As part of the audit of Segal Enterprises, the external auditors, Hansen CPAs are meeting with client management to discuss which areas of the business are outsourced to third party firms. Management advises the auditors that they have recently outsourced their receivables function to a third-party service firm which now handles all recording and processing of receivables. As a result of this, which action would be the most appropriate for Hansen CPAs to take? A) Hansen CPA Firm should document this notification, and should consider how this may affect their auditing of the accounts receivable function. Hansen will likely assign a special team to focus on the client's receivables, and may adjust the risk of material misstatement accordingly. B) In response to this notification, Hansen CPA Firm should advise the client's management that due to the function being outsourced, Hansen will issue either a scope limitation or qualified opinion on the client's accounts receivable function, as they will not be able to audit this area. C) Hansen CPA Firm should advise the client's management that due to this function being outsourced, Hansen will need to obtain a Service Organization and Controls Report from whomever audits the firm the receivables are handled by. D) Hansen CPA Firm should explain to client management that they will need to conduct a Service Organization and Controls audit, which comprises special audit procedures designed especially for outsourced client functions. Answer: C Explanation: Hansen CPA Firm should advise the client's management that due to this function being outsourced, Hansen will need to obtain a Service Organization and Controls Report from whomever audits the firm the receivables are handled by. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None

175) Kelly, a senior audit partner at Watson Durbin CPAs is discussing internal control with a new audit staff associate and recent college graduate, Kevin. Kevin is keen to learn more about internal control and has recently been exposed to a service auditors report due to a recent audit client outsourcing their payable function. Kevin asks Kelly to explain why auditors, during the course of the audit of certain clients, require the services of service auditors. Which of the following choices represents Kelly's most suitable response to this question? A) Service auditors are sometimes necessary because our audit firm doesn't always have the necessary in-house skill or expertise to audit certain areas of a client's business. Management usually hires another auditor to handle this, and we rely on their report for that area. B) When a client outsources certain operations or processes, it may be impractical for our firm for a variety of reasons to conduct this part of the audit. As a result, the firm the function has been outsourced to usually hires an auditor to audit their internal control and report back to the client and us on its effectiveness. C) Whenever a client outsources any part of their business operations, generally accepted auditing standards require a third-party auditing firm conduct the audit of the outsourced firm's system of internal control. This rule helps to ensure consistency and objectivity in all areas of the audit. D) None of these answer choices are correct. Answer: B Explanation: When a client outsources certain operations or processes, it may be impractical for our firm due to a variety of reasons to conduct this part of the audit. As a result, the firm the function has been outsourced to usually hires an auditor to audit their internal control and report back to the client and us on its effectiveness. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None

176) Fitzgerald CPA firm is preparing to start their first ever audit of American Enterprises, Inc., a wholesaler and distributor of car batteries and other electrical components throughout the continental United States. An initial meeting with the client caused the auditors to note that the client's systems and operations are technical and very complex, which is also reflected in a more complex system of internal control. As a result of this, which of the following represents the most prudent audit strategy? A) In consideration of this level of complexity in the client's operations and internal controls, the auditor should notify the client in writing that the auditing firm is preemptively withdrawing from the engagement. This is often prudent in order to protect the reputation of the firm. B) Upon learning of this increased level of complexity in the client's systems, processes and internal controls, the auditing firm should consider the extent of the documentation that will need to be gathered to support any conclusion on internal control. The auditor will also carefully consider the skills and experience levels of the auditors assigned to the engagement. C) Upon learning of how complex the client's systems, processes, and system of internal control is, the auditor is likely to adopt a reliance strategy and request that the client's internal audit function audit internal control, leaving the external auditors free to focus on the financial statements. D) None of these answer choices are correct. Answer: B Explanation: Upon learning of this increased level of complexity in the client's systems, processes and internal controls, the auditing firm should consider the extent of the documentation that will need to be gathered to support any conclusion on internal control. The auditor will also carefully consider the skills and experience levels of the auditors assigned to the engagement. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None

177) Steve and Betsy, two audit managers assigned to the audit of Merced LLC, are discussing how a client's system of internal control is related to the financial statement audit with a new staff associate, Kendra. Kendra is excited to learn more about internal control as she knows it will help her audit career, and asks Steve and Betsy to explain how a client's internal controls are related to the financial statements. Which of the following statements by Steve and Betsy would be most helpful to Kendra? A) The external auditors usually start by examining a client's system of internal control, as if controls are strong and effective, the auditor may be able to place more reliance on them. Once the auditor has tested selected controls, the auditor will be in a better position to determine the nature, timing, and extent of substantive procedures to conduct. B) Generally accepted auditing standards require the external auditors to first perform substantive testing on the client's financial statements. Once this is complete, the auditors will be in a better position to determine which controls they may need to test, and to what extent. C) Due to time and financial constraints, the external auditors typically audit either a client's system of internal control or the financial statements. While auditing both is ideal and represents a high level of assurance, it is typically impractical and rarely done by auditing firms. D) None of these answer choices are correct. Answer: A Explanation: The external auditors usually start by examining a client's system of internal control, as if controls are strong and effective, the auditor may be able to place more reliance on them. Once the auditor has tested selected controls, the auditor will be in a better position to determine the nature, timing, and extent of substantive procedures to conduct. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None

178) During the audit of Seahorse LLC, the external auditors, Packhorse CPAs, have just completed their audit of the clients system of internal control and have documented their findings accordingly. One of Packhorse CPAs audit managers is discussing the results of the internal control audit with an audit intern, Halle. Halle is curious as to what the auditing firm will do with this information and these findings, and whether it affects any future parts of the audit. Which of the following responses is correct with respect to helping Halle understand this? A) The audit of internal control is performed by the audit firm to comply with generally accepted auditing standards. With this part of the audit complete, the auditor can render an opinion on the client's financial statements. B) Once the audit of the client's system of internal control is complete, the auditor examines the findings and apprises the client's management of any weaknesses in a timely manner. If weaknesses in internal control have been identified by the auditor, then it is more likely that the firm will adopt a reliance strategy. C) Upon completion of the audit of internal controls, the auditing firm assesses the evidence gathered and typically notifies management of any deficiencies and weaknesses found. If the auditors' conclusion is that internal control is strong, then the auditor may perform less substantive testing. D) None of these answer choices are correct. Answer: C Explanation: Upon completion of the audit of internal controls, the auditing firm assesses the evidence gathered and typically notifies management of any deficiencies and weaknesses found. If the auditors' conclusion is that internal control is strong, then the auditor may perform less substantive testing. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; PC: None 179) Evaluate the following "procedures" section from a tests of controls working paper: Work performed: Selected several bank reconciliations from different months and matched to supporting documentation. Ensured the reconciliations had been prepared and reviewed on a timely basis. Answer: This working paper section is insufficient. There needs to be enough detail regarding the controls selected to allow another auditor to review the working paper, reperform the steps (if necessary) and reach the same conclusion as the auditor who prepared the working paper. Specifically, how many bank reconciliations were tested? What supporting documents were used? What months were tested? Diff: 3 LO: 6 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 93

180) Jarvis and Kendra, two audit staff associates, are discussing management letters with their supervisor, Liam. Liam is explaining to Jarvis and Kendra why management letters are important, and the types of issues that may be communicated in such letters. Jarvis and Kendra are curious as to when management letters are typically issued by the external auditors, and ask Liam to explain when a management letter may be sent to the client's management. Which of the following responses by Liam represents the most appropriate answer to this question? A) The decision as to when a management letter is sent to the audit client's management is determined solely by the partner with overall responsibility for the engagement. The decision is his or hers alone due to the partner's experience and professional credentials. B) Generally accepted auditing standards require management letters to be issued at the beginning of the audit of the client's system of internal control. This allows the client the maximum opportunity to fix any deficiencies and weaknesses before conclusion of the audit. C) When it comes to management letters, the decision as to when to send the management letter to the client's management is a more subjective one. The decision is likely to be made by the audit partner in consultation with the auditors assigned to the engagement. D) None of these answer choices are correct. Answer: C Explanation: When it comes to management letters, the decision as to when to send the management letter to the client's management is a more subjective one. The decision is likely to be made by the audit partner in consultation with the audit staff assigned to the engagement. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

181) Brad and Brandy, two college seniors majoring in accounting are discussing their auditing class. During their last class, the professor discussed management letters and emphasized the importance of the external auditors sending these in a timely basis. Brandy tells Brad that she doesn't see the importance of these letters, and why the auditors would spend time apprising management of things they should already know. Which of the following responses by Brad would be most appropriate? A) You're right! It does seem like a waste of time and resources. Surely the external auditors have more important things to focus on than advising management about things that they should already be aware of. B) The management letter is an important tool utilized by the external auditors to apprise management of deficiencies and weaknesses in internal control in a timely manner. The auditor can also use this communication to make recommendations to fix or improve any controls. C) An external auditing firm typically utilizes a management letter to notify management of material weaknesses in internal control which need to be remedied. This letter is an important component of the auditors' liability in any future litigation, and is used extensively by auditors to eliminate any potential liability. D) Generally accepted auditing standards require that for publicly-traded companies, the internal auditors draft the management letter and notify management of deficiencies which need to be remedied. Once management remedies any noted deficiencies, the internal auditors are in a position to issue a clean audit opinion on internal control. Answer: B Explanation: The management letter is an important tool utilized by the external auditors to apprise management of deficiencies and weaknesses in internal control in a timely manner. The auditor can also use this communication to make recommendations to fix or improve any controls. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

182) ________ are controls that do not rely on the client's information technology (IT) environment for their operation. A) Manual controls B) Automated controls C) IT general controls (ITGCs) D) Computer application controls Answer: A Explanation: Manual controls are those that do not rely on the client's IT environment for their operation. An example is a locked inventory cage for high dollar-value items to which only a few authorized staff have a key to access. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 183) ________ are a combination of testing procedures that provides the evidence that the control operated as intended throughout the period the auditor wishes to place reliance on the control. A) Tests of controls B) Observational methods C) Inquiry controls D) Inspection of physical evidence Answer: A Explanation: Tests of controls are a combination of testing procedures that provide evidence that the control operated as intended throughout the period the auditor wishes to place reliance on the control. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

184) ________ rate is the maximum rate of deviation from a prescribed control that an auditor is willing to accept and still use the planned assessed level of control risk. A) Tolerable deviation B) Expected deviation C) Attribute sampling D) Investigation Answer: A Explanation: Tolerable deviation rate is the maximum rate of deviation from a prescribed control that an auditor is willing to accept and still use the planned assessed level of control risk. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 185) If the auditor determines that an internal control deficiency is either a significant deficiency or a control deficiency, the auditor will issue a/an ________ on internal controls over financial reporting (ICFR). A) unqualified opinion B) adverse opinion C) modified opinion D) unmodified opinion Answer: A Explanation: If the auditor determines that an internal control deficiency is either a significant deficiency or a control deficiency, the auditor will issue an unqualified opinion on ICFR. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

186) After the auditor completes test of controls and draws conclusion about control risk, the auditor makes decisions about the nature, timing, and extent of ________. A) substantive testing B) sampling risk C) non-sampling risk D) control exception Answer: A Explanation: After the auditor completes testing controls and draws conclusion about control risk, the auditor makes decisions about the nature, timing, and extent of substantive testing. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

Auditing, 2e (Johnson) Chapter 8 Audit Data Analytics 1) The reliability of audit evidence is decreased when it is obtained from independent sources outside the entity. Answer: FALSE Explanation: The reliability of audit evidence is increased when it is obtained from independent sources outside the entity. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 2) It is common for data problems to arise when the auditor compares data over several years. Answer: TRUE Explanation: It is common for data problems to arise when the auditor compares data over several years. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 3) Audit data analytics (ADA) is effective only for identifying general types of misstatements and not for identifying specific transactions or accounts that are likely to be misstated. Answer: FALSE Explanation: ADA is effective not only for identifying general types of misstatements but also for identifying specific transactions or accounts that are likely to be misstated. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

4) A more complex model of regression analysis will provide worse results if it is not the most suitable model. Answer: TRUE Explanation: A more complex model of regression analysis will provide worse results if it is not the most suitable model. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 5) If the auditor is performing substantive tests at an interim date, the auditor must perform steps to update their conclusion to the date of the financial statements. Answer: TRUE Explanation: If the auditor is performing substantive tests at an interim date, the auditor must perform steps to update their conclusion to the date of the financial statements. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 6) A common use of audit data analytics (ADA) is matching information electronically, rather than the auditor performing the procedures manually. Answer: TRUE Explanation: Auditors use ADA to match information electronically. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 7) Auditors can leverage artificial intelligence and machine learning technologies in order to 'read' documents and other types of evidence and check for anomalies. Answer: TRUE Explanation: Auditors can use such technologies to scan documents and flag anomalies. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

8) Audit data analytics can be used ________. A) only at the beginning of the audit B) at virtually any phase of the audit C) only at the end of the audit D) by the internal audit function only Answer: B Explanation: Audit data analytics can be used at virtually any phase of the audit Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 9) Audit data analytics can be used ________. A) as a risk assessment tool B) as a test of controls C) as a test of details D) All these answer choices are correct. Answer: D Explanation: Audit data analytics can be used as a risk assessment too, as a test of controls, and / or as a test of details. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 10) As with all audit procedures, auditors must ________. A) pay little attention to the work of the prior auditor on a first-year engagement B) must carefully plan the nature, timing, and extent of audit data analytics (ADA) to be used for each client C) must let the client's management choose the nature, timing, and extent of ADA to be used for each client D) always outsource at least some of the audit work to the internal audit function Answer: B Explanation: As with all audit procedures, auditors must carefully plan the nature, timing, and extent of ADA to be used for each client. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

11) Audit data analytics should ________. A) be customized to the individual client and industry B) be tailored to the individual client but consistent across an industry C) should be the same for each client, but differ among industries D) should be the same for both client and the industry in which they operate Answer: A Explanation: Audit data analytics should be tailored to the individual client and industry. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 12) The initial planning of where to use audit data analytics ________. A) is typically left to the internal audit function B) may involve significant audit partner and manager time, or it may be combined with a brainstorming session that involves all members of the audit team C) is a legal question, and should be referred to the client's legal counsel D) is determined solely by the audit partner in charge of the audit Answer: B Explanation: The initial planning of where to use audit data analytics may involve significant audit partner and manager time, or it may be combined with a brainstorming session that involves all members of the audit team. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

13) Some key issues to consider when planning an audit data analytics application are: ________. A) What financial statement items, accounts or disclosures and related assertions are being audited? B) What is the overall purpose of the audit data analytics application and how will it contribute to the balance of the audit? For example, is audit data analytics being used as a risk assessment procedure or as a substantive test? C) What audit data analytics tool is best suited for the audit purpose? For example, which techniques, tools, graphics, tables or other analytical techniques should be used. D) All these answer choices are correct. Answer: D Explanation: All the answer choices would represent key issues to consider when planning an audit data analytics application. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 14) Once the auditor has planned the application of audit data analytics, the auditor should ________. A) access the data, make a copy of the client's data, and prepare the data for analysis B) seek the approval of management with respect to the tests C) determine how much these procedures will increase the cost of the audit and advise management accordingly D) access the data and prepare the data for the internal auditors to review Answer: A Explanation: Once the auditor has planned the application of audit data analytics, the auditor must access the data, make a copy of the client's data, and prepare the data for analysis. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

15) Some key issues to consider when preparing data for audit data analytics are: ________. A) Is the data complete? B) Does the data need to be cleaned? C) Does the data agree with the general ledger and the financial statements? D) All these answer choices are correct. Answer: D Explanation: All these answer choices would be correct with respect to key issues to consider when preparing data for audit data analytics. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 16) The first step in audit data analytics is ________. A) making sure the data is complete B) checking the numerical continuity of the data C) checking both of these simultaneously D) checking neither of these Answer: A Explanation: The first step in audit data analytics is making sure the data is complete Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 17) One of the steps in preparing data for analysis is ________. A) checking the numerical continuity of the data B) making sure there are fields with missing data C) ensuring the data is inconsistently formatted D) retrieving the data from the internal audit function Answer: A Explanation: One of the steps in preparing the data for analysis is checking the numerical continuity of the data. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

18) Some important aspects of any audit, including audit data analytics, pertain to the ________. A) nature, extent, and timing of the audit procedures B) prior auditor's assistance with audit procedures C) ultimate issuance of an audit opinion by senior management D) stock price, and ensuring it is not negatively affected by the audit Answer: A Explanation: Some important aspects of any audit, including audit data analytics, pertain to the nature, extent, and timing of the audit procedures. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 19) Hansel is a staff auditor from the audit firm Forrest and has recently heard that their client, Tasty Treat, a distributor of cookies, has started to use data analytics in their business. Hansel is very excited to hear this and shares it with the experienced auditor on the team, Gretel. Hansel expressed excitement in the use of Tasty Treat's data analytics to assist in Forrest's audit procedures. Which of the following responses would be the most appropriate from Gretel? A) This is good news. We should get a good understanding of Tasty Treat's data analytics. If the client has strong controls around the data analytics, we could have the client prepare various analyses in place of our audit procedures. B) This is good news. As auditors, we like to see that our clients are adapting best practices to help sustain and grow their business. However, we should instead hire an audit data analytics (ADA) specialist. This individual would be able to serve a large number of clients concurrently by serving as a consultant to our various audit teams. C) This is good news. Tasty Treat is taking great measures to better understand their organization, and accordingly drive their business. Yet, we should look to train members of our audit team to have audit data analytics (ADA) knowledge or hire individuals with ADA knowledge to be part of the audit team so we can integrate the procedures throughout the audit. D) None of these answer choices are correct. Answer: C Explanation: Individuals with data analytic skills are being fully integrated with the rest of the audit team so new opportunities for risk analysis and substantive testing can be identified and utilized. Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

20) When electronic data is obtained from an outside entity ________. A) the auditor should assume that it is valid and free from error B) the auditor should assume the data is inaccurate and unreliable C) the auditor should consider the reliability of the data D) it should be referred to management for vetting, before being submitted to the auditor for analysis Answer: C Explanation: When electronic data is obtained from an outside entity the auditor should consider the reliability of the data. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

21) You are auditing Calla's Cabins, a rustic vacation resort that specializes in weeklong singlefamily units. All units of the resort are similar to one another. Calla's Cabins typically receives payment from guests at the time a booking is made through their online booking system. Their largest expenses are real estate taxes, utilities, salaries, depreciation, and maintenance. You are considering using audit data analytics (ADA) to assist in your audit. Where could ADA be best utilized? A) You should consider using ADA to audit cash receipts and revenue. As there will be a relatively high-volume of sales and corresponding cash receipts that would be homogeneous to one another as all stays are for a similar time frame, ADA could facilitate the routine work of identifying anomalies which could allow for the audit team to spend more time on work that requires critical thinking and professional judgment. B) You should consider using ADA to audit real estate taxes. As real estate taxes are one of the largest expenses of the resort, it is an area of high risk. ADA can assist your efforts to ensure that these expenses occurred, are complete, and are valued at the correct amount through comparing the real estate tax bill to the real estate tax expense. C) You should consider using ADA to audit depreciation. As depreciation is one of the largest expenses of the resort, it is an area of high risk. ADA can assist your efforts to ensure that this amount has been calculated accurately for each of the similar units and is reflected appropriately in the financial statements. D) You should not use ADA for your audit of Calla's Cabins. Due to the basic nature of the client, the cost of ADA would outweigh the benefit. Answer: A Explanation: ADA could help in the audit of sales revenue and cash receipts as these are highvolume, low-judgment transactions that are significant to the client. Although real estate taxes and depreciation are significant expenses, real estate taxes occur one time during the year and would likely better be served through individual test of detail and depreciation of like units would likely be done through a single calculation verification. Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

22) A common problem with multinational organizations is ________. A) recording dates in different formats B) use of the same currency in different sales territories C) a lack of diversity due to a multinational workforce D) low cash reserves and retained earnings balances Answer: A Explanation: A common problem with multinational organizations is recording dates in different formats. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 23) Advances in the technological landscape ________. A) are providing opportunities to rethink how an audit is performed B) have rarely affected the profession of auditing and how an audit is conducted C) are providing opportunities to increase the cost of an audit D) have had no bearing on inherent risk whatsoever Answer: A Explanation: Advances in the technological landscape are providing opportunities to rethink how an audit is performed Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

24) Edgar, a staff accountant from the audit firm Allenton, wants to utilize audit data analytics (ADA) to support his audit of accounts receivable at Rushmoore, a company which sells custom portraits of ravens. Edgar knows the need to evaluate a complete listing of Rushmoore's accounts receivable in the analysis. Which of the following would be one step that Edgar could perform to be sure that Edgar is testing the complete listing of all accounts receivable? A) Edgar could verify the completeness of the listing by confirming accounts receivable balances with a selection of Rushmoore's customers on the listing. Edgar could make a sample selection of customers and obtain their contact information from Rushmoore. Edgar could then send confirmations to Rushmore's customers to confirm balances to Allenton directly to verify the completeness of the accounts receivable listing. B) Edgar could verify the completeness of the listing by reviewing the purchase order(s), invoice(s), and shipping documentation for a selection of Rushmore's customers on the listing. Edgar could make a sample selection of customers and obtain the corresponding documents that substantiate the balance the customer owed Rushmoore to verify the completeness of the accounts receivable listing. C) Edgar could verify the completeness of the listing by footing the listing and matching the total to Rushmoore's general ledger balance. By footing the listing, Edgar would be verifying the mathematical accuracy of the document. By matching the listing to the general ledger, Edgar would be ensuring that the population being tested matches the population which Allenton will opine on. D) Edgar is incorrect in his notion that there is a need to check an accounts receivable listing used for ADA for completeness. While completeness is an assertion that needs to be tested at the account level when doing substantive testing, checking an item that is used for ADA purposes is unnecessary as the auditor is not using this as a test of detail. Verifying the completeness of the accounts receivable listing would be time consuming and lead to an inefficient audit. Answer: C Explanation: In order to apply ADA, the auditor must ensure that data obtained from the client is complete. One step that an auditor could do to verify that a listing to be used is complete is footing the listing and matching total to the general ledger balance. Confirming accounts receivable balances with customers or reviewing substantiation documents are substantive tests that may be used to verify the existence of accounts receivable in substantive testing, but these would not provide assurance that the auditor is using a complete accounts receivable listing. Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

25) Before using client data for audit data analytics the auditor needs to consider which of the following? A) If the data obtained from the client is complete. B) If the data is in a consistent format and whether it needs to be cleaned before it can be used. C) Whether the data is relevant and reliable. D) All these answer choices are correct. Answer: D Explanation: Before using client data for audit data analytics the auditor needs to address several questions. First, the auditor needs to determine if the data obtained from the client is complete. Second, the auditor needs to determine if the data is in a consistent format and whether it needs to be cleaned before it can be used. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 26) If the auditor is auditing an accounts receivable file, the auditor will want to make sure the receivable file matched the ________. A) general ledger as of the date of the test B) trial balance as of the date of the test C) investing section of the statement of cash flows as of the date of the test D) general ledger as of any date before the test Answer: A Explanation: If the auditor is auditing an accounts receivable file, the auditor will want to make sure the receivable file matches the general ledger as of the date of the test. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

27) If the auditor is auditing revenues and identifies gaps in the sequence of pre-numbered sales invoices ________. A) the auditor is unlikely facing a completeness problem, even if the file reconciles with the general ledger B) the auditor may be facing a completeness problem, even if the file reconciles with the general ledger C) the auditor may be facing a valuation problem, even if the file reconciles with the general ledger D) the auditor is unlikely facing a valuation problem, even if the file reconciles with the general ledger Answer: B Explanation: If the auditor is auditing revenues and identifies gaps in the sequence of prenumbered sales invoices, the auditor may be facing a completeness problem, even if the file reconciles with the general ledger. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 28) Once the auditor has determined that the data is complete and data is available for all desired fields ________. A) the auditor must also make sure that the data is clean and ready for analysis B) the auditor must also make sure that the data is clean and ready for submittal to the internal auditors for analysis C) the auditor should seek management's permission to proceed D) the data set should be turned over to the client's legal counsel for further processing Answer: A Explanation: Once the auditor has determined that the data is complete and data is available for all desired fields, the auditor must also make sure that the data is clean and ready for analysis. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

29) If an existing customer number is taken from a former customer that no longer does business with the company and is assigned to a new customer ________. A) this may cause problems with the underlying data analysis B) then no problems should occur and the testing should be straightforward C) this should not complicate or cause issues with the data analysis D) the auditors should generate a new customer number and assign it to the old customer Answer: A Explanation: If an existing customer number is taken from a former customer that no longer does business with the company and is assigned to a new customer, it may cause problems with the underlying analysis. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 30) It is common for data problems to arise when a company ________. A) has no subsidiaries and has not acquired any other companies B) acquires another company C) changes accounting method D) changes an accounting estimate Answer: B Explanation: It is common for data problems to arise when a company acquires another company. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

31) When a new company is acquired ________. A) there is rarely any disruption to accounting and information technology (IT) systems B) there is frequently a period of transition and integration of accounting and IT systems when different formats are introduced C) there is infrequently a period of transition and integration of accounting and IT systems when different formats are introduced. D) the acquiring company's systems are immediately discontinued and replaced with the acquiring company's systems Answer: B Explanation: When a new company is acquired, there is frequently a period of transition and integration of accounting and IT systems when different formats are introduced. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 32) The auditor determines the relevance of data by ________. A) the nature of the audit question or assertion being tested B) confirming its relevancy with senior management C) ensuring the data is unrelated to any audit assertion the auditor wishes to test D) inquiring of the internal auditors Answer: A Explanation: The auditor determines the relevance of the data by the audit question or assertion the auditor is auditing, and the data must be relevant to the assertion or audit question. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

33) Some key questions that the AICPA Guide for Audit Data Analytics suggests that the auditor should address when evaluating the reliability of data used in an audit data analytics (ADA) application are: ________. A) What is the nature of the data? B) What is the source of the data? C) What is the process used to produce the data? D) All these answer choices are correct. Answer: D Explanation: All these answer choices pertain to key questions that the AICPA Guide for Audit Data Analytics suggests that the auditor should address when evaluating the reliability of data used in an ADA application. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 34) The auditor should always evaluate evidence ________. A) with a questioning mind and attitude of professional skepticism B) under the assumption that all information is correct C) under the assumption that all information is incorrect D) after senior management has had a chance to review and approve it Answer: A Explanation: The auditor should always evaluate evidence with a questioning mind and attitude of professional skepticism. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

35) One of the questions an auditor should consider related to the audit data analytics (ADA) application is ________. A) its purpose B) its potential use by the internal audit function C) its potential use by senior management D) ensuring all employees in the client organization has access to it Answer: A Explanation: One of the questions an auditor should consider relating to the ADA application is its purpose. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 36) Which of the following is a step associated with accessing and preparing data for audit data analytics (ADA)? A) Checking the completeness of the data set to be used for ADA B) Ensuring the match of ADA data with the balance sheet C) Presenting a data set or key information as a chart or other image D) Matching ADA with the general ledger Answer: A Explanation: Checking the completeness of the data set to be used for ADA is a step associated with accessing and preparing data for audit data analytics. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

37) A notable item is an item identified, from the population being analyzed, that has one or more characteristics that, for relevant assertions, may ________. A) be indicative of a risk of material misstatement B) provide information useful in designing procedures to address risks of material misstatement. C) provide information useful in tailoring procedures to address risks of material misstatement. D) All these answer choices are correct. Answer: D Explanation: A notable item is an item identified, from the population being analyzed, that has one or more characteristics that, for a relevant assertion, may do the following: (a) be indicative of a risk of material misstatement, or (b) provide information useful in designing or tailoring procedures to address risks of material misstatement. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 38) When performing audit data analytics (ADA) as a risk assessment procedure ________. A) the auditor will have first obtained an understanding of the entity and its environment B) the auditor is yet to obtain an understanding of the entity and its environment C) the auditor will work closely with client management to confirm which risk assessment procedures they would prefer the auditor conduct D) the auditor should contact the prior auditor for assistance with this procedure Answer: A Explanation: When performing ADA as a risk assessment procedure, the auditor will have first obtained an understanding of the entity and its environment because it takes a significant understanding of the entity to identify misstatements and anomalies. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

39) Audit data analytics (ADA) ________. A) is effective not only for identifying general types of misstatements, but is also capable of identifying specific transactions or accounts that are likely to be misstated B) is effective only for identifying general types of misstatements C) is only capable of identifying specific transactions or accounts that are likely to be misstated D) is effective neither at identifying general types of misstatements or capable of identifying specific transactions or accounts that are likely to be misstated Answer: A Explanation: ADA is effective not only for identifying general types of misstatements, but is also capable of identifying specific transactions or accounts that are likely to be misstated. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 40) When the auditor is performing audit data analytics (ADA) as a substantive test of details of a population of transactions or balances ________. A) the auditor will have evaluated inherent risk and will likely have performed tests of controls to assess control risk B) the auditor is yet to evaluate inherent risk but has likely performed tests of controls to assess control risk C) the auditor will have evaluated inherent risk, but not yet performed tests of controls to assess control risk D) the auditor has not yet assessed either control or inherent risk Answer: A Explanation: When the auditor is performing ADA as a substantive test of details of a population of transactions or balances, the auditor will have evaluated inherent risk and will likely have performed tests of controls to assess control risk. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

41) AU-C 315, Understanding the Entity and Its Environment, and Assessing the Risks of Material Misstatement, defines risk assessment procedures as ________. A) audit procedures performed to obtain an understanding of the auditor and its environment, including the entity's internal control, to identify and assess the risk of material misstatement at the financial statement level and relevant assertion levels, whether due to error or fraud B) audit procedures performed to obtain an understanding of the entity and its environment, including the entity's internal control, to identify and assess the risk of material misstatement, at the financial statement level and relevant assertion levels - whether due to error or fraud C) any procedure that involves international currency transactions D) any procedure that was performed by the prior auditor, which is repeated by the current auditor Answer: B Explanation: AU-C 315, Understanding the Entity and Its Environment, and Assessing the Risks of Material Misstatement, defines risk assessment procedures as "audit procedures performed to obtain an understanding of the entity and its environment, including the entity's internal control, to identify and assess the risk of material misstatement, whether due to error or fraud, at the financial statement level and relevant assertion levels." Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 42) When the auditor uses audit data analytics ________. A) the auditor is looking for anomalies, or balances or transactions that do not meet the auditor's expectations B) the auditor is looking for anomalies only C) the auditor is only looking for balances or transactions that do not meet the auditor's expectations D) the auditor is neither looking for anomalies, nor balances nor transactions that do not meet the auditor's expectations Answer: A Explanation: When the auditor uses audit data analytics, the auditor is looking for anomalies, or balances or transactions that do not meeting the auditor's expectations. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

43) Greenside, an audit firm, has chosen to use audit data analytics (ADA) to assist in the audit of accounts receivable of Fairway Inc., a manufacturer of golf club covers. In performing this analysis, Birdie, the staff auditor, notes that the average collection period for Fairway's customers is 35 days which approximates its general credit terms of net 30 days and aligns with the industry average of 38 days. However, Birdie identifies a notable item as Fairway's largest customer, Bogieville, has an average collection period of 58 days. In discussion with Fairway's controller, it is noted that due to their relationship with this customer, Bogieville is given net 60day terms to pay. How should Birdie react to this information? A) Birdie should confirm through reviewing contracts, purchase orders, and/or invoices that Bogieville does have net 60-day terms. If this is verified, the average collection period of 58 days is within the credit terms and does not appear to indicate a specific risk of uncollectibility. Birdie should document this false positive, and this notable item should not require further response or investigation. B) Birdie should confirm through reviewing contracts, purchase orders, and/or invoices that Bogieville does have net 60-day terms. If this is verified, Birdie should be concerned about Bogieville's ability to pay Fairway its full amounts due in a timely manner. Accordingly, Birdie should consider increasing the risk of material misstatement for the valuation of accounts receivable. C) Birdie should communicate this discrepancy to the management of Fairway. As a result of this notable item, Greenside should consider whether a qualified audit report should be issued, noting this exception for accounts receivable. D) None of these answer choices are correct. Answer: A Explanation: This instance would be indicative of a false positive, or when items are incorrectly identified as notable items, as the higher collection period is due to longer credit terms and is in line with the net 60-day terms. Accordingly, there is no increased risk of material misstatement and should not require further response or investigation beyond verifying the credit terms. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

44) Jovi, an experienced auditor at the firm Dash, used audit data analytics (ADA) to assist in assessing the risk of material misstatement for their client, Willis Engineering's, accounts receivable. Willis Engineering grants its customers credit terms of net 45 days. Accordingly, Dash expects Willis Engineering's average collection period to be between 40 and 50 days. During Jovi's analysis, it was noted that Willis Engineering's average collection period is closer to 60 days, with approximately 15% of Willis Engineering's customers taking on average more than 75 days. When discussing these results with the controller, the cause is undetermined. How should Jovi react to this information? A) Jovi should note results as a notable item. Dash should communicate these results with the company's management and the audit committee. Further, as these results fall outside of the expected range, Jovi will no longer need to test controls related to accounts receivable as this discrepancy has been noted as an exception. All other parts of the audit remain unchanged. B) Jovi should note results as a notable item. Dash will need to consider their assessment of the risk of material misstatement for the valuation of accounts receivable. Accordingly, Dash may need to update the audit plan to increase testing pertaining to this item. C) Jovi should note results as a notable item. As a result of this notable item, Dash should consider whether a qualified audit report should be issued, noting this exception for accounts receivable. D) None of these answer choices are correct. Answer: B Explanation: This instance would be a notable item. Accordingly, the audit firm should consider the impact on their analysis of risk of material misstatement and update their audit plan accordingly. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

45) A notable item is an item identified from the population being analyzed that has one or more characteristics that, for a relevant assertion, may I. Be indicative of a risk of an immaterial misstatement not previously identified. II. Be indicative of a risk of higher risk of material misstatement than anticipated by the auditor. III. Provide information useful in designing or tailoring procedures to address risks of material misstatement. Which items are correct? A) I, II, and III B) II and III C) I and III D) III only Answer: B Explanation: II and III are correct Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 46) The term notable item refers to something that ________. A) is indicative of a risk of material misstatement B) has not been previously identified (a new risk) C) represents a higher risk of material misstatement than anticipated by the auditor D) All these answer choices are correct. Answer: D Explanation: All these answer choices define a notable item. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

47) Identifying notable items depends on ________. A) the assertion being audited, and the auditor's understanding of the business and industry B) the assertion being audited only C) the auditor's understanding of the business and industry only D) neither the assertion being audited, nor the auditor's understanding of the business and industry Answer: A Explanation: Defining notable items depends on the assertion being audited, and the auditor's understanding of the business and industry. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 48) Popular ways that an auditor might search an audit population for notable items include ________. A) clustering transactions or balances based on a particular characteristic or multiple characteristics B) matching the characteristics of two populations to see if there are any overlaps C) statistical analysis, such as regression analysis, where the notable items are identified using statistics D) All these answer choices are correct. Answer: D Explanation: All these answer choices represent popular ways that an auditor might search an audit population for notable items. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

49) An issue addressed in the AICPA Guide to Audit Data Analytics is ________. A) what to do when initial investigation identifies a large number of notable items B) what to do when initial investigation identifies a small number of notable items C) how to reconcile data analytics and revenue recognition D) how to ensure adherence to matching of revenues and expenses using audit data analytics Answer: A Explanation: An issue addressed in the AICPA Guide to Audit Data Analytics is what to do when initial investigation identifies many notable items. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 50) For audits of very large organizations, the number of notable items ________. A) could number in the hundreds B) could number in the thousands C) could number in the hundreds or thousands D) could number in the millions Answer: C Explanation: For audits of very large organizations, the number of notable items could number in the hundreds or thousands. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 51) False positives refer to ________. A) items incorrectly identified as notable items B) items correctly identified as notable items C) negative confirmations incorrectly received from client vendors D) positive confirmations incorrectly received from client vendors Answer: A Explanation: False positives refer to items incorrectly identified as notable items. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

52) Audit data analytics (ADA) is effective for ________. A) identifying general types of misstatements, as well as identifying specific transactions or accounts that are likely to be misstated B) identifying general types of misstatements only C) identifying specific transactions or accounts that are likely to be misstated only D) none of the above Answer: A Explanation: ADA is effective for identifying general types of misstatements, and can identify specific transactions or accounts that are likely to be misstated. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 53) John, an experienced auditor from the audit firm Sherwood, wants to utilize audit data analytics (ADA) to support his audit of inventory at Robinhood, a distributor of bows and arrows. Which of the following would be an appropriate way for John to use ADA in auditing inventory at Robinhood? A) John could use ADA in the client acceptance decision. Using ADA, John could review the general ledger to determine if Robinhood has inventory that needs to be audited. If inventory is present at Robinhood, John could ensure that Sherwood has adequate experience and knowledge to audit this particular area of inventory. Further, this information could be used to assemble an appropriate audit team with appropriate backgrounds pertaining to inventory for the engagement. B) John could use ADA in risk assessment procedures. Using ADA, John could review inventory account trends and balances, various ratios, and inventory transactions. John would look for consistencies and anomalies that would either confirm or modify Sherwood's audit plan. C) John could use ADA in completing and reporting on the audit. John could use ADA to review the appropriate classification of inventory as a current asset. Further, John could use ADA to review the disclosures related to inventory. Using this information, Sherwood could opine on the appropriateness of inventory in the financial statements. D) All of these answer choices are correct. Answer: B Explanation: ADA may be used in risk assessment procedures to help form the audit plan. ADA would not be used to identify if the company has inventory to be audited during client acceptance; the existence of inventory needing to be audited would be evident by the inventory account balance. ADA would not be used to opine on the appropriateness of inventory in the financial statements; however, it could be used to support substantive testing procedures which would give evidence for the audit report. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management 26

54) The auditor first obtains an understanding of the entity and its environment in order to identify misstatements and anomalies when performing audit data analytics (ADA) as which of the following procedures? A) Risk assessment B) Auditing risk C) Material misstatement D) Control risk Answer: A Explanation: When performing ADA as a risk assessment procedure, the auditor first obtains an understanding of the entity and its environment to identify misstatements and anomalies. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 55) Footloose Footwear Company is currently undergoing an audit by their external auditors, Brightside Auditing Firm. Brightside has been advised by the client's internal auditors of potential problems with the collection and reporting of net receivables, specifically with respect to the amount of estimated uncollectible and management's estimate of bad debt expense as listed in the financial statements. Which of the following would be the most suitable approach for Brightside to take to audit the valuation assertion of accounts receivable? A) Perform an audit data analytics procedure to determine past collection patterns of accounts receivable and subsequently determine the suitability of management's estimates. B) Perform a substantive procedure whereby customers and the associated receivables are vouched to ensure existence of the underlying transaction and occurrence of the subsequent payment to Footloose Footwear Company. C) Perform an audit data analytics procedure to ensure that fraud risk should be assessed as high, and perform substantive procedures such as matching receivables and subsequent cash disbursements. D) Allow the internal audit function to handle this part of the audit, as they are more familiar with the company and its collection patterns. Answer: A Explanation: Perform an audit data analytics procedure to determine past collection patterns of accounts receivable and subsequently determine the suitability of management's estimates. The approach is intended for the valuation assertion by comparing actual collection patters to the estimate. Diff: 2 LO: 3, 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

56) Cluster analysis is defined as ________. A) the process of discovering groups (termed clusters in data science) of similar items in a set of data; items in the same group are similar, while items in different groups are not as similar B) the process of discovering individual pieces of similar items in a set of data; items in the same group are similar, while items in different groups are not as similar C) analyzing management techniques and administrative policies simultaneously D) determining which package of audit services can be sold to a client at the best possible price Answer: A Explanation: Cluster Analysis is the process of discovering groups (termed clusters in data science) of similar items in a set of data; items in the same group are similar, while items in different groups are not as similar. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 57) Matching information in key data fields ________. A) is a process where the auditor uses audit data analytics to search for key characteristics that may exist in several different databases B) is a process where the auditor uses audit data analytics to search for key characteristics that may exist in the same database C) is typically a task assigned to the internal audit function D) is a process where the auditor uses his or her understanding of inherent risk to search for key characteristics that may exist in several different databases Answer: A Explanation: Matching information in key data fields is a process where the auditor uses audit data analytics to search for key characteristics that may exist in several different databases. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

58) Regression analysis is ________. A) a non-statistical process which involves estimating a prediction equation that expresses an item of interest (commonly known as the y or dependent variable) in terms of other data fields (the x or independent variables) B) a statistical process which involves estimating a prediction equation that expresses an item of interest (commonly known as the y or dependent variable) in terms of other data fields (the x or independent variables) C) a non-statistical process which involves estimating a prediction equation that expresses an item of interest (commonly known as the x or dependent variable) in terms of other data fields (the y or independent variables) D) a statistical process which involves estimating a prediction equation that expresses an item of interest (commonly known as the x or dependent variable) in terms of other data fields (the y or independent variables) Answer: B Explanation: Regression analysis is a statistical process which involves estimating a prediction equation that expresses an item of interest (commonly known as the y or dependent variable) in terms of other data fields (the x or independent variables). Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 59) The simplest regression ________. A) is where the prediction equation is the average of the data B) is where the prediction equation is the median of the data C) involves the use of logistic regression D) involves the use of time-series regression Answer: A Explanation: The simplest regression is where the prediction equation is the average of the data. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

60) When using cluster analysis, the characteristics of the group ________. A) must be known beforehand, and are determined by the data B) need not be known beforehand, but are determined by the data C) must be known beforehand, but are typically not determined by the data D) need not be known beforehand, and are typically not determined by the data Answer: B Explanation: When using cluster analysis, the characteristics of the group need not be known beforehand, but are determined by the data. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 61) Clustering can also be performed ________. A) by graphing data in a way that allows for visual identification of groups B) by graphing data in a way that allows for a simple regression analysis C) by the internal audit function before the data is transferred to the external auditors D) by the client's legal counsel, if necessary Answer: A Explanation: Clustering can also be performed by graphing data in a way that allows for visual identification of groups. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 62) When the auditor uses the 'matching information in key data fields' process, the expectation is that ________. A) there should be minimal variances B) there should always be variances C) there should be no matches D) there should only be variances when two different databases are used Answer: C Explanation: When the auditor uses the 'matching information in key data fields' process, the expectation is that there should be no matches. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

63) Regression analysis is best defined as ________. A) a statistical process which involves estimating a prediction equation that expresses an item of interest (commonly known as the y or dependent variable) in terms of other data fields B) a non-statistical process which involves estimating a prediction equation that expresses an item of interest (commonly known as the y or dependent variable) in terms of other data fields C) a statistical process which involves estimating a prediction parameter that expresses an item of interest (commonly known as the y or dependent variable) in terms of other data fields D) a non-statistical process which involves estimating a prediction parameter that expresses an item of interest (commonly known as the y or dependent variable) in terms of other data fields Answer: A Explanation: Regression analysis is a statistical process which involves estimating a prediction equation that expresses an item of interest (commonly known as the y or dependent variable) in terms of other data fields (the x or independent variables). Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 64) The item of interest in a regression analysis is referred to as the ________. A) dependent variable B) independent variable C) any x variable D) hypotenuse Answer: A Explanation: The item of interest in a regression analysis is referred to as the dependent variable. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

65) Another name commonly given to a regression equation is ________. A) slope line intercept B) a prediction equation C) a statistical variance equation D) a population distribution equation Answer: B Explanation: Another name commonly given to a regression equation is a prediction equation. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 66) If revenue is strongly seasonal, the auditor might decide to ________. A) run a time-series regression that is based on the trend and seasonality in historical revenue figures B) run a non-statistical regression that is based on the seasonality in historical revenue figures C) run a time-series regression that is based on seasonality only D) run a time-series regression that is based on the trend only Answer: A Explanation: If revenue is strongly seasonal, the auditor might decide to run a time-series regression that is based on the trend and seasonality in historical revenue figures. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 67) As part of an audit data analytics (ADA) procedure, some steps that might be used for regression analysis are ________. A) estimate the prediction equation using data that is not currently being audited (usually historical data) B) validate the prediction equation from a statistics point of view C) use the regression equation to make predictions for the data being currently audited D) All these answer choices are correct. Answer: D Explanation: All these answer choices are steps that, might be used for regression analysis as part of an ADA. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 32

68) Regression analysis ________. A) comes in many forms, including simple linear regression analysis B) is rarely used in auditing, as it is too complex C) is best performed by the internal audit function D) should only be conducted with a data-set vetted and approved by management Answer: A Explanation: Regression analysis comes in many forms, including simple linear regression analysis. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 69) The simplest regression is where ________. A) the prediction equation is the lowest value of the data B) the prediction equation is the average of the data C) the prediction equation is the highest value of the data D) the prediction equation has removed any outlying data points Answer: B Explanation: The simplest regression is where the prediction equation is the average of the data. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 70) One of the benefits of a regression analysis is ________. A) understanding to what extent independent variables affect the dependent variable B) understanding to what extent dependent variables affect the independent variable C) understanding to what extent independent variables affect other independent variables D) understanding to what extent dependent variables affect other dependent variables Answer: A Explanation: One of the benefits of a regression analysis is understanding to what extent independent variables affect the dependent variable. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

71) Types of regression models include ________. A) simple linear regression B) local regression C) time-series regression D) All these answer choices are correct. Answer: D Explanation: All these represent types of linear regression analysis an auditor could run. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 72) Which of the following is not a type of regression analysis? A) Simple linear regression B) Time series regression C) Logistic regression D) Slope line intercept regression Answer: D Explanation: Slope line intercept is not a type of regression analysis. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 73) Which of these steps is not used in a regression analysis? A) Determining which assertions apply to which dependent variables B) Validate the prediction equation from a business logic point of view C) Validate the prediction equation from a statistics point of view D) Use the regression equation to make predictions for the data being currently audited Answer: A Explanation: Determining which assertions apply to which dependent variables is not used in a regression analysis. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

74) What is the first step in using regression analysis as part of audit data analytics? A) Estimate the prediction equation using data that is not currently being audited B) Validate the prediction equation from a statistics point of view C) Compare the predicted values (auditor's expectation) with the actual values D) Use the regression equation to make predictions for the data being currently audited Answer: A Explanation: The first step in using regression analysis as part of audit data analytics is to estimate the prediction equation using data that is not currently being audited. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 75) An issue that may affect a regression analysis used by an auditor as part of audit data analytics is ________. A) materiality B) seasonality C) faithful representation D) uniformity Answer: B Explanation: An issue that may affect a regression analysis used by an auditor as part of audit data analytics is seasonality. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 76) The next step after visually observing a linear relationship ________. A) is to observe more data sets to look for different patterns B) is to confirm the relationship with management C) is to confirm by estimating a linear regression D) is to confirm by estimating a slope line intercept value Answer: C Explanation: The next step after visually observing a linear relationship is to confirm by estimating a linear regression. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

77) The regression model should be estimated ________. A) based only on historical data to ensure it can be used to make predictions for the current period B) based only on predicted future data to ensure it can be used to make predictions for the current period C) based only on historical data to ensure it can be used to make predictions for prior periods D) based only on forecasted data to ensure it can be used to make predictions for prior periods Answer: A Explanation: The regression model should be estimated based only on historical data to ensure it can be used to make predictions for the current period. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 78) Visualization is defined as ________. A) a synonym for forecasting B) the representation of a data set or key information, such as a chart or another image C) transparency in financial reporting D) the calculation of material variances from predicted amounts Answer: B Explanation: Visualization is the representation of a data set or key information, such as a chart or another image. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 79) Visualizations are typically produced ________. A) to reveal information to people B) to assist with inputting complex information into computer systems C) by the client's legal counsel when a lawsuit has been threatened D) by management for the external auditors Answer: A Explanation: Visualizations are typically produced to reveal information to people. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

80) Effective visualizations ________. A) facilitate people making visual comparisons between data elements B) are generally understood by a smaller audience C) communicate a small amount of information efficiently D) are less likely to be remembered Answer: A Explanation: Effective visualizations facilitate people making visual comparisons between data elements. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 81) Some of the risks associated with visualization pertain to ________. A) the extreme accuracy of their results B) the risk that they are created in isolation C) visualizations always being useful and applicable D) no users misinterpreting them Answer: B Explanation: Some of the risks associated with visualization pertain to the risk that they are created in isolation. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 82) A risk associated with visualizations is ________. A) that the pretty picture of the visualization will be remembered and not the message it was intended to convey B) that the pretty picture of the visualization will not be remembered and instead the message it was intended to convey is remembered instead C) everyone will interpret them in the same way D) no one will understand the picture, just the words Answer: A Explanation: A risk associated with visualizations is that the pretty picture of the visualization will be remembered and not the message it was intended to convey. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 37

83) The most appropriate visualization to use, and the best parameters to use for the chosen visualization ________. A) should be decided by the internal auditors B) should be decided on a case by case basis C) should always be the same in similar circumstances D) should be determined by senior management Answer: B Explanation: The most appropriate visualization to use, and the best parameters to use for the chosen visualization, should be decided on a case by case basis. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 84) Which of the following is a risk associated with visualizations? A) They do not provide precise figures or tests of statistical significance that are often needed in ADAs. B) They fail to communicate information efficiently. C) They use a lot of jargon. D) They are unlikely to be remembered. Answer: A Explanation: A risk associated with visualizations is that they do not provide precise figures or tests of statistical significance that are often needed in ADAs. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 85) A good visualization is typically ________. A) clear and well-labelled B) concise and informative C) accurate and not misleading D) All these answer choices are correct. Answer: D Explanation: When producing visualizations, it is important to remember that a good visualization is clear and well-labelled, concise and informative, accurate and not misleading. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 38

86) Easy Auditing Company is currently performing an audit of a major client, Office Supply Company. The client is a large, well-established firm with offices all over the U.S. The client sells a variety of office and stationary supplies in both the wholesale and retail markets and is decentralized. Easy's auditors have decided to conduct a notable item check to see whether any employees are also set up in the client's system as vendors. The best approach to conduct this type of procedure involves ________. A) an audit data analytics procedure where the auditor may attempt to merge two or more databases and ensure evidence of notable items exists, in order to assess control risk as low B) obtaining written guarantees from senior management to serve as assurance, confirming that no employees are also vendors of the client C) an audit data analytics procedure where the auditor may attempt to merge two or more databases and look for evidence of overlapping details/fields, and potential notable items D) directly questioning employees whom the auditor suspects may also be receiving payments as vendors to ensure the legitimacy of the payments Answer: C Explanation: An audit data analytics procedure where the auditor may attempt to merge two or more databases and look for evidence of overlapping details/fields, and potential notable items. This approach identifies the relevant notable items for further investigation. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

87) During the audit of Lucky Company, the external auditor, Honest Auditors Inc. is deciding upon a procedure to help provide estimates and note actual items that may be outside of a certain range, which would then be classified as notable items and investigated further. The Audit Senior has determined that due to the seasonality of the client's business, the best procedure to use would be a regression analysis. Which of the following would provide the best rationale for this choice? A) Regression analysis is useful as a statistical procedure for estimating the value of notable items in small populations and correcting actual values to match the regression equation prediction. B) Regression analysis represents a powerful predictive statistical tool which can assist the auditor in determining expected values, and then comparing actual values to predicted values to determine notable items to investigate. C) Regression analysis works best when some of the historical data used for the analysis is missing as the auditor can substitute missing values with current audit values to ensure there are no notable items. D) Because the data used in the regression analysis includes current unaudited data which allows for more accurate predictions and smaller prediction intervals. Answer: B Explanation: Regression analysis represents a powerful predictive statistical tool which can assist the auditor in determining expected values, and then comparing actual values to predicted values to determine notable items to investigate. As a predictive tool, regression analysis identifies notable items outside of the expected pattern. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

88) During an audit of Beaver Company, Jackson Auditing Firm is attempting to determine notable items related to inventory. In order to assist with this, Jackson's auditing team has compiled the necessary historical data and conducted a regression analysis in order to attempt to identify any notable items. The Audit Senior in charge of the audit of Beaver Company has decided to set a prediction interval of 95%. Which of the following statements is true? A) Any value that falls outside of this prediction interval should be ignored as outliers are not relevant to the audit. B) Any value that falls within this prediction interval represents a notable item and will need to be investigated by the audit team. C) Any value that falls outside of the prediction interval represents a notable item, and the auditor must determine the legitimacy of the item. D) Any value that falls outside of the prediction interval should be noted and referred to senior management for investigation and assurances as to its legitimacy. Answer: C Explanation: Any value that falls outside of the prediction interval represents a notable item, and the auditor must determine the legitimacy of the item. The items within the prediction interval are as expected but the items outside of the interval are not characteristic of the expected norm. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

89) Brooklyn, an experienced auditor from the audit firm Liberty, noted a high risk of employee fraud schemes pertaining to cash disbursements at Dewey Doggy, a large-scale hotdog stand. Which of the following audit data analytic (ADA) techniques could best be used to test for fraudulent employee cash disbursements? A) Brooklyn could use a cluster analysis to search for fraudulent employee cash disbursements. Brooklyn could use ADA to gather information regarding what time of day cash disbursements are processed. Using this information Brooklyn could identify which, if any, times of day had cash disbursements incorrectly directed to employees. B) Brooklyn could use a matching analysis to search for fraudulent employee cash disbursements. Brooklyn could request the listing of bank accounts and routing numbers that are used for employee payroll. Brooklyn could use ADA to search for matches of bank account and routing numbers to those that are used for other cash disbursements. Any overlapping information could be further investigated for potential fraud. C) Brooklyn could use a visualization to search for fraudulent employee cash disbursements. Brooklyn could use ADA to create a bar graph that could depict cash disbursements by day of the week. Using this information, Brooklyn could identify which, if any days had cash disbursements incorrectly directed to employees. D) ADA techniques would not be able to assist in testing for fraudulent employee cash disbursements. Brooklyn will need to find another tool to assist in gathering evidence. Answer: B Explanation: ADA would be beneficial to search for employee fraud schemes pertaining to cash disbursements. Running a matching analysis for bank account numbers used for depositing employee payroll and bank account numbers used for cash disbursements would identify overlaps between these two groups which would highlight potential fraudulent payments. While clustering and visualizations may show some groupings which could indicate fraudulent activities, these techniques would need further testing to indicate specific potential fraudulent payments made by employees. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

90) You are the auditor of Stump Co., a logging company. Their CFO, Jamal, is concerned with decreasing net income and believes this trend to be attributable to weakening gross margins. However, Stump Co. has many different types of trees in its portfolio, and Jamal does not know which lumber type may be the issue. Jamal wants your firm's perspective on the matter. How could you use ADA to help address this issue? A) You could use a cluster analysis to group sales of lumber by type of tree. You could then evaluate gross margin rates for each of the clusters. Those trees that have lower gross margin rates than others in the portfolio could be communicated to Stump Co. for further evaluation for strategic planning decisions. B) You could use a regression analysis based on industry gross margin rates to project expected gross margin rates by type of tree. This analysis could then be compared to the company's actual gross margin rates by type of tree. Those trees that have lower gross margin rates than the industry could be communicated to Stump Co. for further evaluation for strategic planning decisions. C) You could create a visualization using a bar graph to compare yearly gross margin rates for each type of tree. Using this visualization, you could identify gross margin rates that are trending down for certain types of trees. Further, you could use this visualization to communicate the results of the analysis with Stump Co. for further evaluation for strategic planning. D) All of these answer choices are correct. Answer: D Explanation: All of the ADA techniques described above could provide feedback regarding the gross margin rates for the various lumber types to help identify the cause of the decreasing net income. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management 91) Today, much of the evidence that used to exist in paper form ________. A) is kept solely by the internal auditor B) now exists electronically C) no longer exists at all D) is retained by the client's legal counsel, in case of litigation Answer: B Explanation: Today, much of the evidence that used to exist in paper form now exists electronically. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

92) When the auditor is performing audit data analytics (ADA) as a substantive test of details of a population of transactions or balances, ________. A) the auditor will have evaluated inherent risk, and will likely have performed tests of controls to assess control risk B) the auditor will not have evaluated inherent risk, and will likely have performed tests of controls to assess control risk C) the auditor will have evaluated neither inherent risk, nor tests of controls to assess control risk D) the results should be immediately sent to management for vetting Answer: A Explanation: When the auditor is performing ADA as a substantive test of details of a population of transactions or balances, the auditor will have evaluated inherent risk and will likely have performed tests of controls to assess control risk. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 93) If the auditor is performing substantive tests at an interim date ________. A) the auditor need not perform any more tests through the financial statement date B) the auditor must perform steps to update their conclusion to the date of the financial statements C) the internal audit function should be advised to complete any further testing deemed necessary D) the client should not be billed for this work in case it needs to be repeated at the financial statement date Answer: B Explanation: If the auditor is performing substantive tests at an interim date, the auditor must perform steps to update their conclusion to the date of the financial statements. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

94) If the auditor is performing substantive tests at an interim date ________. A) then this testing will suffice and no further testing needs to be done B) the auditor should perform no further steps to update their conclusion through the date of the financial statements C) the auditor must perform steps to update their conclusion to the date of the financial statements D) the auditor should plan to conduct more tests once the audit report has been issued Answer: C Explanation: If the auditor is performing substantive tests at an interim date, the auditor must perform steps to update their conclusion to the date of the financial statements. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 95) Substantive tests could involve ________. A) testing the client's system of internal control B) withdrawing from the engagement C) matching information in the accounting records with information on underlying documents D) delegation to the internal audit function Answer: C Explanation: A number of substantive tests of details involve matching information in the accounting records with information on underlying documents. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 96) Much of today's evidence is now typically in ________. A) electronic form B) documentary form C) neither electronic or documentary form D) the custody of the client's legal counsel Answer: A Explanation: Today, much of the evidence that was previously in documentary form has been transferred to electronic form. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 45

97) If a confirmation of an accounts receivable balance is not returned by the customer, the auditor might validate the receivable by ________. A) confirming a different receivable with a different customer instead B) looking at evidence of subsequent cash receipt in the amount of the billing to the customer C) looking at evidence of subsequent cash receipt in the amount of the billing for a different customer D) confirming the receivable with senior management Answer: B Explanation: if a confirmation of an accounts receivable balance is not returned by the customer, the auditor might validate the receivable by looking at evidence of subsequent cash receipt in the amount of the billing to the customer. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 98) It is appropriate for the auditor ________. A) to compare electronically what was previously compared manually. B) to compare manually what was previously compared electronically. C) to do neither of these things D) to do both these things Answer: A Explanation: It is appropriate for the auditor to compare electronically what was previously compared manually. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

99) The auditor should make the same judgments about the relevance and reliability of information ________. A) when making an electronic comparison, as the auditor would consider when making a manual comparison B) for different audit clients within the same industry C) after confirming its relevance with senior management D) for all customers and vendors of a client Answer: A Explanation: the auditor should make the same judgments about the relevance and reliability of information when making an electronic comparison, as the auditor would consider when making a manual comparison. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 100) Data analytics can often be used ________. A) by the internal audit function as a test of controls B) by the external auditors as a substantive test C) by the firms' actuarial staff when testing controls D) by specialists only Answer: B Explanation: Data analytics can often be used by the external auditors as a substantive test. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

101) During the audit of Barron Company's receivables, the audit partner in charge of the audit noted that a common use of audit data analytics (ADA) during an audit is as a substantive test, because ADA gives the external auditor the power and ability to analyze large amounts of information simultaneously. The Audit Senior has approached you and asked you to determine an appropriate use of ADA in this context. The most appropriate response/strategy would be to use ADA in this context as ________. A) a tool to match credit sales, generation of accounts receivable and subsequent cash collections to ensure existence, valuation and accuracy assertions B) a method of ensuring that client sales data is appropriately matched to client receivables, to ensure timely collection C) a tool to match credit sales, generation of accounts receivable and subsequent cash collections to ensure cutoff, completeness and accuracy assertions D) a method of issuing confirmations to the holders of selected high dollar amount receivables to confirm that they have been paid Answer: A Explanation: A tool to match credit sales, generation of accounts receivable and subsequent cash collections to ensure existence, valuation and accuracy assertions. Matching sales to the corresponding receivable and subsequent payment tests existence but not completeness of receivables. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management 102) A number of substantive tests of details involve ________. A) matching information in the accounting records with information on underlying documents B) matching information in the accounting records with information evidence provided by the internal auditors C) matching information in the accounting records with evidence provided by the client's management D) making a determination on the effectiveness of the client's system of internal control Answer: A Explanation: A number of substantive tests of details involve matching information in the accounting records with information on underlying documents. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

103) AU-C 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement, A61-.A64 ________. A) provides a discussion about how the use of information technology results in benefits and risks that may affect the reliability of data B) provides a discussion about how the use of information technology only C) provides a discussion about risks that may affect the reliability of data only D) relates to neither the use of information technology and the reliability of data Answer: A Explanation: AU-C 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement, .A61-.A64 provides a discussion about how the use of information technology results in benefits and risks that may affect the reliability of data. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 104) AU — C 500 Audit Evidence, A 27-A.34 ________. A) provides a general discussion about the relevance and reliability of evidence B) provides a general discussion about the using the internal audit function C) provides a general discussion about the sufficiency of audit evidence D) dictates that an audit opinion must always be issued by the balance sheet date Answer: A Explanation: AU — C 500 Audit Evidence, A 27 -. A34 provides a general discussion about the relevance and reliability of evidence. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

105) If the auditor uncovers a misstatement while conducting substantive testing ________. A) The auditor should refer the misstatement to the internal auditors for further investigation B) The auditor should report the misstatement to the SEC C) The misstatement should immediately be reported to senior management D) The auditor needs to determine if the misstatement provides evidence of a weakness in internal controls Answer: D Explanation: If, when conducting substantive testing, the auditor uncovers a misstatement the auditor needs to determine if the misstatement provides evidence of a weakness in internal controls. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 106) If the evidence about internal controls does not support a previous conclusion regarding internal controls, the auditor should ________. A) reassess internal controls at a higher level, and reevaluate the implications of a high control risk assessment on detection risk and the auditor's audit strategy B) reassess internal controls at a lower level, and reevaluate the implications of a high control risk assessment on detection risk and the auditor's audit strategy C) consider the use of specialists to test the client's system of internal control D) wait until the end of the audit to perform further testing Answer: A Explanation: If the evidence about internal controls does not support a previous conclusion regarding internal controls, the auditor should reassess internal controls at a higher level, and reevaluate the implications of a high control risk assessment on detection risk and the auditor's audit strategy. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

107) If the auditor finds a misstatement when performing substantive tests ________. A) the auditor should immediately withdraw from the engagement B) the auditor needs to evaluate the materiality of the misstatement C) the auditor should immediately increase inherent risk related to the engagement D) the auditor should immediately decrease inherent risk related to the engagement Answer: B Explanation: If the auditor finds a misstatement when performing substantive tests, the auditor needs to evaluate the materiality the misstatement found. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 108) The auditor is most likely going to perform audit data analytics (ADA) as a substantive test when the auditor has performed tests of controls and concluded that the entity has ________. A) strong information technology (IT) general controls, including strong access controls B) strong IT application controls related to the assertion being tested C) strong controls over electronic data interchange and the exchange of electronic information about a transaction between the client and its customers or suppliers D) All these answer choices are correct. Answer: D Explanation: All these answer choices are correct, when an auditor has concluded that the entity has strong controls. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

109) An example of a vouching procedure might be ________. A) the auditor vouching the quantities on a sales invoice to the quantities on underlying shipping documents, the existence of a bill of lading, and prices to the sales order B) the auditor vouching the quantities on a sales invoice to the quantities on underlying shipping documents, the occurrence of a bill of lading, and prices to the sales order C) requesting the internal audit function vouch the accuracy of all sales transactions D) confirming with the client's legal counsel that there is no litigation outstanding Answer: A Explanation: An example of a vouching procedure might be the auditor vouching the quantities on a sales invoice to the quantities on underlying shipping documents, the existence of a bill of lading, and prices to the sales order. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 110) Substantive tests of details may involve ________. A) matching information in the accounting records with information on underlying documents B) testing of internal controls C) the clients legal counsel D) the approval of senior management Answer: A Explanation: A number of substantive tests of details involve matching information in the accounting records with information on underlying documents. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

111) If the auditor is performing substantive tests at an interim date ________. A) the auditor does not need to perform year-end testing procedures B) the auditor must perform steps to update their conclusion to the date of the financial statements C) the auditor must perform steps to update their conclusion for the next fiscal year of the firm D) this procedure should first be approved by management due to the extra cost involved Answer: B Explanation: If the auditor is performing substantive tests at an interim date, the auditor must perform steps to update their conclusion to the date of the financial statements. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 112) When the auditor is performing audit data analytics (ADA) as a substantive test of details of a population of transactions or balances, the auditor will have evaluated ________. A) inherent risk B) substantive risk C) fraud risk D) variance risk Answer: A Explanation: When the auditor is performing ADA as a substantive test of details of a population of transactions or balances, the auditor will have evaluated inherent risk, and will likely performed tests of controls to assess control risk. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 113) The concept of testing at an interim date relates to ________. A) testing at year-end B) testing at a point before year-end C) testing after year-end D) None of these answer choices is correct. Answer: B Explanation: The concept of testing at an interim date relates to testing at a point before yearend. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 53

114) The auditor is most likely going to perform audit data analytics (ADA) as a substantive test when the auditor has ________. A) performed tests of controls and concluded that the entity has strong controls B) performed tests of controls and concluded that the entity has weak controls C) completed the audit and is ready to issue the audit report D) confirmed the procedures to be conducted with the internal audit function Answer: A Explanation: The auditor is most likely going to perform ADA as a substantive test when the auditor has performed tests of controls and concluded that the entity has strong controls. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 115) The concept of a roll-forward process relates to ________. A) audit risk B) inherent risk C) the timing of audit procedures D) invoicing the client for work yet to be performed Answer: C Explanation: The concept of a roll-forward process relates to the timing of audit procedures. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 116) When tests of internal controls do not support a previous conclusion about internal controls, the auditor should ________. A) obtain assurances about internal control from senior management B) reassess internal controls at a higher level C) consider withdrawing from the engagement D) lower inherent risk related to internal control Answer: B Explanation: When tests of internal controls do not support a previous conclusion about internal controls, the auditor should reassess internal controls at a higher level. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 54

117) Sam, the manager leading the audit of Freedom, a firework manufacturer, wants to utilize audit data analytics (ADA) as a substantive test for the valuation of accounts payable. During the test of controls, although the IT system as a whole had weak controls pertaining to appropriate access, it was noted that there were strong internal controls pertaining to accounts payable and cash disbursements. Should Sam rely on ADA for substantive testing for the valuation of accounts payable? A) Sam could rely on ADA for substantive testing for the valuation of accounts payable. Although IT access controls are weak, the strong controls surrounding accounts payable and cash disbursements overcome this when addressing assertions pertaining to accounts payable. B) Sam should not rely on ADA for substantive testing for the valuation of accounts payable. As IT access controls are weak, the underlying data for all accounts and assertions has high control risk. Therefore, Freedom's auditors will utilize substantive tests of detail throughout their audit procedures. C) Sam should not rely on ADA for substantive testing for the valuation of accounts payable. Regardless of a company's internal control design and implementation, because of the high inherent risk associated with cash, ADA should not be used as part of the substantive testing procedures for cash disbursements. D) None of these answer choices are correct. Answer: B Explanation: The auditor will most likely use ADA as a substantive test when the auditor has performed test of controls and concluded that the entity has strong IT general controls, including strong access controls, strong IT application controls related to the assertion being tested, strong controls over electronic data interchange and the exchange of electronic information about a transaction between the client and its customers or suppliers. Diff: 2 LO: 5 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management 118) To validate sales revenue and accounts receivable, the auditor could ________. A) send confirmations to accounts payable holders B) attempt to reconcile the differences between gross and net sales C) use audit data analytics as a substantive test D) request that the internal audit function sign off on its accuracy Answer: C Explanation: To validate sales revenue and accounts receivable, the auditor could use the allowance for doubtful accounts account as a substantive test. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

119) If a confirmation of an accounts receivable balance is not returned by the customer, the auditor might validate the receivable by ________. A) looking at evidence of subsequent cash receipt in the amount of the billing to the customer B) asking the client to obtain the evidence and forward it to the auditor C) requesting the internal audit function contact the customer D) confirming prior receivables by the same client Answer: A Explanation: If a confirmation of an accounts receivable balance is not returned by the customer, the auditor might validate the receivable by looking at evidence of subsequent cash receipt in the amount of the billing to the customer. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

120) You are the auditor of Sand Dollar, Inc., a retailer of beachwear. You would like to utilize audit data analytics (ADA) to assist in the substantive testing pertaining to the valuation of inventory. Which of the following tests could you perform to substantiate the valuation of inventory? A) You could utilize ADA to verify inventory valuation by matching the most recent sales price of individual inventory items to their value in the inventory listing. This information, along with the cost to sell the product, could assist with verifying that Sand Dollar Inc. is using the conservative policy of lower of cost or net realizable value. B) You could utilize ADA to verify inventory valuation by searching for unrecorded inventory purchases in the cash disbursements journal. ADA could assist in identifying cash disbursements that were made to Sand Dollar's vendors. You could then trace these purchases to the inventory listing to validate that they have been included. C) You could utilize ADA to verify inventory valuation by assisting in the review of cutoff for inventory purchases in the correct period at the end of the fiscal year. ADA could assist in matching purchases by vendors with FOB terms given by that vendor. Using this information, you could ensure that all inventory purchases where ownership transferred prior to yearend were included in the inventory listing and that all purchases where ownership transferred subsequent to year end were excluded from the inventory listing. D) All of these answer choices are correct. Answer: A Explanation: ADA could be used to match sales price and cost information by individual inventory item to assist with the lower of cost or net realizable value analysis. While ADA could be utilized to search for unrecorded inventory purchases in the cash disbursements journal or in the review of cutoff for inventory transactions in the correct period at the end of the fiscal year, these tests would not facilitate an auditor's substantiation of inventory valuation. Diff: 2 LO: 6 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

121) Robert, an experienced auditor at the firm Kravas, used audit data analytics (ADA) to assist in substantive testing for their client, Bobbers, a distributor of fishing items. Robert used ADA to scan the sales journal for duplicate invoice numbers. Robert noted that from April 1 — April 15, all invoices were recorded twice. How should Robert react to this information? A) Robert should note results as a notable item. Kravas will need to consider their assessment of the risk of material misstatement for revenue. Accordingly, Kravas may need to update the audit plan to increase testing pertaining to this item. B) Robert should pass on further analysis of this item. As the misstatement is only 15 out of 365 days (approximately 4%), it would not impact the decision of financial statement users. Accordingly, further analysis is not deemed necessary and would create an inefficient audit. C) Robert should quantify this misstatement and compare it to the materiality threshold. If this item is above the materiality threshold, an audit adjustment will need to be made or the audit report will need to be modified. Kravas should also consider the impact this discovery would have on their assessment of internal controls pertaining to sales revenue. D) None of these answer choices are correct. Answer: C Explanation: As this discrepancy was found during substantive testing, the auditor will need to quantify the misstatement and consider it in regards to materiality for an audit adjustment. Further, the internal controls related to the sales process should be considered for potential deficiencies that may need to be communicated and/or reported that allowed this misstatement to occur. Diff: 2 LO: 6 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

122) Benjamin, an experienced auditor from the audit firm Vollcamp, has heard of firms trending to use artificial intelligence (AI) to support audit procedures. Benjamin is wondering what might be the best way to use AI to assist in auditing inventory at his new client, GarlicMart, a producer of garlic cloves. A) Benjamin could use AI to review all inventory purchase transactions made during the fiscal year. Benjamin could use AI to look through the purchases journal and scan for anomalies such as unexpected cost, quantity, or vendor that may require further investigation. B) Benjamin could use AI to use picture evidence to assist in the physical inventory of the garlic. The software could be trained and could learn to distinguish the individual garlic items in these pictures to facilitate the counting of the entire inventory. C) Benjamin could use AI to review all inventory sales transactions made during the fiscal year. Benjamin could use AI to look through the sales journal to identify the most recent sales price. Benjamin could then match sales revenue of individual inventory items with their cost. This information, along with the cost to sell the product, could assist with verifying that GarlicMart is using the conservative policy of lower of cost or net realizable value. D) All of these answer choices are correct. Answer: D Explanation: All of the AI procedures described above could be used to assist in the audit of inventory. Diff: 2 LO: 7 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

123) Orange, a seasoned external auditor, was having a meeting with an audit team. They were discussing the latest trends in technology that are of interest in the audit they are to conduct. However, a number of the audit team are junior audit staff who are not familiar with artificial intelligence and they would like to understand it more. How would you best describe the impact artificial intelligence will have on the audit? A) Using AI can help make audit work more efficient. By using technological advances, AI can replace humans doing routine audit work. This will allow an auditor more time to focus on the items that cannot be replicated by software such as critical thinking and professional judgment throughout the audit. B) Using AI can help make audits more effective. By using technological advances, AI can replace humans doing routine audit work. Since these tasks will be automated, there is a reduced risk of human error occurring. Accordingly, this will reduce the need for auditors to exercise critical thinking and professional judgment. C) Using AI can help make audits more effective. By using technological advances, Al can replace humans doing routine audit work. With these tasks being done by software that is learning automatically, the need for professional skepticism will be reduced. D) All of these answer choices are correct. Answer: A Explanation: AI will produce more efficient audits that will reduce the routine audit procedures that humans need to perform. Using AI will emphasize the need for critical thinking and exercising professional judgment in a given audit setting, along with demonstrating professional skepticism when performing the audit. Diff: 2 LO: 7 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: AC: Risk Assessment, Analysis and Management

124) Michael and Danielle are discussing artificial intelligence one day over lunch. Michael mentions to Danielle that he doesn't really understand what artificial intelligence is. Which of the following would be Danielle's most appropriate response to this question? A) Artificial intelligence represents the dummy audit data that we enter into a client's information system. B) Artificial intelligence is rarely used by the auditors in an attestation engagement, and focuses on the ability of machines to learn. C) Artificial intelligence is best described as a machine's ability to reason and problem solve. D) Artificial intelligence is a commonly used substitute for audit sampling and population testing. Answer: C Explanation: Artificial intelligence is best described as a machine's ability to reason and problem solve Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 125) Machine learning is becoming an increasingly important concept in the field of auditing. Which of the following most accurately describes this topic? A) Machine learning relates to a system being able to recognize objects, symbols, and language and to connect patterns using neural networks. B) Machine learning relates to the ability of a client's IT system of internal controls to learn to prevent misstatements C) Machine learning is best described as the ability of machines to recognize complex patterns in audit data and help to remove the auditor's liability for misstatements. D) None of these answer choices are correct. Answer: A Explanation: Machine learning relates to a system being able to recognize objects, symbols, and language and to connect patterns using neural networks Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

126) Ray and Joel are discussing machine learning one day over lunch while working on the audit of Blossom Enterprises, Inc. Joel mentions to Ray that he has heard his boss talking about supervised and unsupervised learning, but isn't sure of the difference. Which of the following choices would be Ray's most appropriate response? A) The difference between supervised and unsupervised learning is that in supervised learning, a human watches over the system for errors. B) The main difference between these two approaches is that in unsupervised learning, the system is left to determine which accounts to sample and audit. C) The main difference between supervised and unsupervised learning is that in supervised learning, labeling is used and thus inputs and outputs are known. D) The key difference between these two methods is when the system analyzes audit data, it either generates or doesn't generate exception reports for follow-up. Answer: C Explanation: The main difference between supervised and unsupervised learning is that in supervised learning, labeling is used and thus inputs and outputs are known Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 127) Machine learning is a technique and approach that is becoming increasingly prevalent in the world of auditing. Which of the following represents the best example of a scenario whereby machine learning could be used effectively? A) An auditor wishes to improve the response rate for accounts receivable positive confirmations. B) An auditor wishes to identify unauthorized revenue transactions in a client's general ledger. C) A Chief Financial Officer wishes to ensure that all bad debt expense write offs are personally approved by him before being authorized. D) None of these answer choices are correct. Answer: B Explanation: An auditor wishes to identify unauthorized revenue transactions in a client's general ledger Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

128) Dana and Casey are discussing the benefits of machine learning one day after auditing class. Dana mentions to Casey that he didn't catch all of the benefits of using such a system for an auditor, and asks Casey to explain the benefits. Which of the following represents Casey's most appropriate response to this query? A) Perhaps the main benefit of using a machine learning system is reducing the need for audit staff on the audit itself. B) A key benefit of machine learning is the system's ability to continually refine itself in a learning loop. C) One of the most optimal benefits of a machine learning system is the extra assurance that the offer can add in the audit report. D) One of the most wide-ranging benefits of such a system is its ability to audit an entire population with 100% accuracy. Answer: B Explanation: A key benefit of machine learning is the system's ability to continually refine itself in a learning loop Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 129) Machine learning is increasingly being used by auditors to assist with attestation engagements. Which of the following represents one of the key interactions an auditor may have with a machine learning system? A) The auditor will likely need to provide the system with feedback to help improve the accuracy of future performance. B) The auditor will need to audit the machine learning system to ensure that it is 100% accurate. C) The auditor will need to employ a team of staff to check the work that the machine learning system carries out to ensure it is accurate. D) None of these answer choices are correct. Answer: A Explanation: The auditor will likely need to provide the system with feedback to help improve the accuracy of future performance Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

130) Dan and Asher are discussing how a machine learning model might look one day after their auditing class. Dan mentions to Asher that in order for the model to be successful and accurate, which of the following would first have to happen? A) The firm installing the machine learning system and software would need to ensure that all scheduled updates are installed properly. B) The model itself would have to first make predictions in order to determine if the predictions were accurate once the data was analyzed. C) The model would first have to be fed raw, clean data. The system would need this data to proceed with any analyses. D) The auditor would need to evaluate the systems predictions in order to determine the accuracy of the model. Answer: C Explanation: The model would first have to be fed raw, clean data. The system would need this data to proceed with any analyses Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 131) Artificial intelligence and machine learning applications are becoming increasingly prevalent in the industry of auditing. Which of the following statements is most accurate with regard to the availability of this technology in the future? A) Due to the prohibitive cost of these types of applications and systems, it is most likely that only large auditing firms will be able to employ them. B) It is likely that over time, even smaller CPA firms will be able to leverage this type of technology in audits. C) It is most likely that the big accounting firms will compete with each other for this technology, driving up the cost. D) It is likely that standard-setting agencies and authoritative bodies will mandate use of this technology for publicly-traded firms. Answer: B Explanation: It is likely that over time, even smaller CPA firms will be able to leverage this type of technology in audits Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

132) As accounting firms continue to invest in artificial intelligence and machine learning technologies, it is likely that these tools will become more prevalent and widely used in the auditing profession. Which of the following represents the best example of how these technologies may be used in this field? A) Auditors may employ artificial intelligence and machine learning to determine which audit clients to accept and which to decline. B) Auditors may use these technologies to perform reviews of journal entries and derivative contracts. C) Auditors may leverage these technologies to audit 100% of account populations and thus guarantee assurance on the financial statements. D) None of these answer choices are correct. Answer: B Explanation: Auditors may use these technologies to perform reviews of journal entries and derivative contracts Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 133) Designing ________ includes identifying conditions relevant to the purpose of the test that constitute a misstatement in the relevant assertion. Answer: substantive procedures Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 134) The type of procedure the auditor will consider performing in regards to data reliability is a key question to be addressed in evaluating the ________ used in audit data analytics. Answer: relevance of data Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

135) While assessing the reliability of data used in performing ________, it is important that the auditor obtains an understanding of the system of internal control and performs tests of control. Answer: audit data analysis Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 136) ________ helps auditors to identify patterns and deviations from patterns and outliers in the analysis stage of an audit data analytics (ADA) procedure. Answer: Visualization Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 137) Which of the following key issues is/are considered when planning an audit data analytics (ADA) application? Select all that apply. A) Selection of financial statement items, accounts or disclosures, and related assertions to be audited B) The overall purpose of the audit data analytics application and how it will contribute to the balance of the audit C) Selection of the audit population being analyzed or tested using audit data analytics D) A comparison of the results of ADA with those of other audit analysis methods Answer: A, B, C Explanation: The following key issues are considered when planning an audit data analytics application: o Selection of financial statement items, accounts or disclosures and related assertions to be audited. o The overall purpose of the audit data analytics application and how it will contribute to the balance of the audit. o Selection of the audit population being analyzed or tested using audit data analytics. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

138) Which of the following is/are key issue/s when evaluating the reliability of data used in an audit data analytics (ADA) application? Select all that apply. A) Procedures regarding data reliability B) The matters the auditor considers in determining the nature, timing, and extent of procedures C) The process used to produce the data D) The process used to match the data with the general ledger Answer: A, B, C Explanation: The following are key issues when evaluating the reliability of data used in an ADA application: 1. Procedures regarding data reliability. 2. The matters the auditor considers in determining the nature, timing, and extent of procedures. 3. The process used to produce the data. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 139) Cartwright Enterprises is being audited by Glowbright External Auditors. The lead partner on the audit engagement has assigned the task of auditing the inventory accounts to a senior manager employed by the audit firm. After conversations with the internal audit staff, the senior manager is concerned about the client's net realizable value of inventory on hand and has decided to employ an ADA (Audit Data Analytics) procedure to investigate any items of inventory that may be taking unusually long to sell. In this context, the best application of an ADA risk assessment procedure would be ________. A) to investigate the inventory account in the search for anomalies warranting further investigation, which may require a markdown of particular items to lower of cost or net realizable value B) to examine a sample of inventory items that the external auditor suspects may be anomalous, and document any low turnover items as proof that these items must be marked down C) to investigate a population of inventory items to ensure that all items are appropriately valued and marked down as may be necessary D) as a substantive procedure conducted and documented by the internal audit function, with the results forwarded to senior management for review Answer: A, C Explanation: to investigate the inventory account in the search for anomalies warranting further investigation, which may require a markdown of particular items to lower of cost or net realizable value. to investigate a population of inventory items to ensure that all items are appropriately valued and marked down as may be necessary. Diff: 3 LO: 3 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 67

140) Which of the following are the characteristics of good visualizations? Select all that apply. A) They reduce the message to its core components and use minimal or no jargon. B) They are likely to be better remembered. C) They are generally understood by a wider audience. D) They provide precise figures or tests of statistical significance that are often needed in ADAs. Answer: A, B, C Explanation: The following three are the characteristics of good visualizations: 1. They reduce the message to its core components and use minimal or no jargon. 2. They are likely to be better remembered. 3. They are generally understood by a wider audience. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 141) Stateside External Auditors are currently conducting the audit of Safeway Enterprises; a large, decentralized client with seasonal variations in revenue and operations throughout the United States. As part of their risk assessment procedures, Stateside has decided to utilize a regression analysis in order to analyze Safeway's revenue accounts. Regression analysis is well suited to an investigation of this nature because ________. A) regression analysis can incorporate the seasonality of the client's business into the prediction equation B) regression analysis can help the auditor discover anomalous items which may be worthy of further investigation C) regression analysis can be used as a substitute for other, more time-consuming substantive procedures D) the prediction equation generated by the regression analysis will ensure that all unacceptable variations are removed from the analysis to ensure the robustness of the statistical test Answer: A, B Explanation: Regression analysis can incorporate the seasonality of the client's business into the prediction equation. Regression analysis can help the auditor discover anomalous items which may be worthy of further investigation Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

142) Sunnyside Inc. is being audited by Swan and Co. External Auditors. The lead partner on the engagement is interested in utilizing Audit Data Analytics (ADA) as a substantive test of details, and is discussing the most beneficial use of this technique with the audit manager who will assume responsibility for the day-to-day overseeing of the audit. Scenarios, whereby ADA can be utilized as a substantive test of details, include ________. A) matching information contained in shipping documents, bills of lading, and sales invoices B) vouching procedure whereby inventory quantities are matched to depreciation expenses and inventory acquisitions C) vouching accounts receivable balances to records of subsequent cash receipts from customers D) matching IT internal controls to the relevant audit assertions which will be used to test those controls Answer: A, C Explanation: Matching information contained in shipping documents, bills of lading, and sales invoices. Vouching accounts receivable balances to records of subsequent cash receipts from customers. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

143) High-Five Auditing Firm is currently conducting an audit of Bison Company. Bison is a provider of water and sewage services to a local municipality. After consulting with both senior management and the internal audit function, the external auditors have identified accounts receivable and the subsequent collection as an area of high inherent risk. As a result, the auditors plan to use ADA as a substantive test to assist in auditing this area. What is the most appropriate application of an audit data analytics technique in this context? What assertions are most likely to be tested? A) Utilization of audit data analytics as a technique to confirm prior audit findings in auditing the completeness and cutoff assertions of accounts receivable. B) Utilization of audit data analytics to assist in validating receivables and subsequent cash collections to assist in auditing the valuation and existence assertions of accounts receivable. C) Employ audit data analytics as a procedure to verify the work done by the internal audit function, in auditing the existence and completeness assertions of accounts receivable. D) Utilize audit data analytics to determine anomalous amounts relative to the existence and valuation assertions that may require future investigation by the external auditor. Answer: B, D Explanation: Utilization of audit data analytics to assist in validating receivables and subsequent cash collections to assist in auditing the valuation and existence assertions of accounts receivable., Utilize audit data analytics to determine anomalous amounts relative to the existence and valuation assertions that may require future investigation by the external auditor Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

144) Rightfit External Auditors are considering the use of Artificial Intelligence (AI) as a tool in their audit of Sunnyside Inc., a nationwide provider of cosmetic and beauty products. Specifically, the external auditing firm is interested in using artificial intelligence to review lengthy contracts the client has entered into. Some of the benefits of utilizing artificial intelligence in this scenario include ________. A) the ability of the artificial intelligence model to continuously learn via auditor feedback, and thus improve model outputs and predictions. B) using artificial intelligence to identify key terms and clauses in the contracts, which may help to determine the appropriate accounting for these contracts. C) Review the audit report generated by the internal audit function for accuracy, before release to the general public. D) reviewing debt and loan covenant documents for key metrics and accounting issues that the external auditor needs to be aware of. Answer: A, B, D Explanation: the ability of the artificial intelligence model to continuously learn via auditor feedback, and thus improve model outputs and predictions., using artificial intelligence to identify key terms and clauses in the contracts, which may help to determine the appropriate accounting for these contracts., reviewing debt and loan covenant documents for key metrics and accounting issues that the external auditor needs to be aware of. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 145) ________ is used for identifying anomalies and extracting other useful information in data related to the subject matter of an audit through analysis. A) Audit data analytics B) Audit sampling C) Statistical sampling D) Audit sampling analysis Answer: A Explanation: Audit data analytics is used for identifying anomalies and extracting other useful information in data related to the subject matter of an audit through analysis. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

146) When using audit data analytics, the balances or transactions that do not meet the auditor's expectations are defined as ________. A) notable items B) false positives C) high margin items D) material misstatements Answer: A Explanation: When using audit data analytics, the balances or transactions that do not meet the auditor's expectations are defined as notable items. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 147) As part of audit data analytics (ADA), any values that are unacceptable variations should be treated as notable items and be investigated further according to the ________ to determine whether their unusual characteristics are acceptable. A) risk analysis decision tree B) cluster analysis C) polynomial regression decision tree D) matching information in key data fields analysis Answer: A Explanation: As part of ADA, any values that are unacceptable variations should be treated as notable items and be investigated further according to the risk analysis decision tree to determine whether their unusual characteristics are acceptable. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 148) An auditor has determined through testing of controls, that his or her previously determined opinion on internal control is not accurate. What should the auditor consider doing? Answer: The auditor should consider amending his or her planned further tests of internal control to align with his or her amended opinion on internal control. This may demand more or less testing of internal control. Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

149) An auditor is performing interim testing of accounts. Should these same accounts be tested again at year-end? Answer: Yes, these accounts should be tested again at year-end. Interim testing helps provide assurance regarding financial statement assertions but does not mean that these same accounts should not be tested again at year-end. These accounts should have further, year-end testing performed on them. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 150) An auditor has sent out positive confirmations to a sample of accounts receivables customers. For confirmations that have not been returned, what should the auditor do to obtain assurance on these accounts? Answer: The auditor should consider following up with these clients or should adapt other audit procedures to reach a conclusion that there are no material misstatements in the population. Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

151) Cassidy and Chad are discussing the use of audit data analytics for an upcoming audit of one of their major attestation clients. The pair is considering the use of this technique to improve the efficiency and effectiveness of the audit. Cassidy asks Chad to detail any important considerations he sees in using this technique. Which of the following responses by Chad would be most appropriate in this situation? A) One of the most important considerations in utilizing an audit data analytics technique will be making sure that the selected population of data contains misstatements. This way, we can see if the system flags the misstatements. B) A consideration that is central to the use of audit data analytics will be ensuring that the data we input into the system for analysis is cleaned appropriately. If we enter bad data, we may get bad results. C) One of the key considerations in using an audit data analytics technique will be ensuring that we work closely with the client's management. Once misstatements are identified, they will need to provide written confirmations that the identified misstatements have been corrected, in order to justify a clean audit opinion. D) One of the key considerations we should be thinking about is how we can adjust the cost of the audit to recoup the expenditures on an audit data analytics system. That way, we can ensure the system pays for itself in as short a time as possible. Answer: B Explanation: A consideration that is central to the use of audit data analytics will be ensuring that the data we input into the system for analysis is cleaned appropriately. If we enter bad data, we may get bad results Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

152) During a firm's fiscal year, accounts receivable had a beginning balance of $750,000. Net credit sales during this fiscal year were $1,500,000, and accounts receivable had an ending balance of $1,000,000. Disregarding any allowances and bad debts, how much of their accounts receivable did the firm collect during the fiscal year? Answer: $1,250,000 ($750,000 beginning balance + $1,500,000 sales − $1,000,000 ending balance) Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 153) Delta Company has determined that, on average, it turns its receivables over 14.5 times per year. Last year its receivables turnover was 12.7. Calculate both year days in receivables, and indicate if this is a positive or negative trend. Answer: Current year days in receivables = 365/14.5 = approximately 25 days. Previous year days in receivables = 365/12.7 = approximately 29 days. This represents a positive trend, as this indicates receivables (on average) are being collected more quickly. Diff: 3 LO: 6 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

Auditing, 2e (Johnson) Chapter 9 Risk Response: Performing Substantive Procedures 1) When evidence is collected at an interim date, substantive tests are more effective. Answer: FALSE Explanation: When evidence is collected at an interim date, substantive tests are LESS effective. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 2) If the assessed risk of material misstatement for an assertion is high, auditors need to gather more persuasive audit evidence. Answer: TRUE Explanation: If the assessed risk of material misstatement for an assertion is high, auditors need to gather more persuasive audit evidence. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 3) When the entity's control environment has been assessed as effective, limited roll-forward procedures such as substantive analytical procedures are necessary. Answer: TRUE Explanation: When the entity's control environment has been assessed as effective, limited rollforward procedures such as substantive analytical procedures are necessary. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None

4) Determining the fair value of a transaction or financial statement item for inclusion in the financial statements is a type of accounting estimate. Answer: FALSE Explanation: Determining the fair value of a transaction or financial statement item for inclusion in the financial statements is a type of accounting estimate. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 5) The more judgment that is involved in conducting the substantive procedures and evaluating the results, the less documentation is needed. Answer: FALSE Explanation: The more judgment that is involved in conducting the substantive procedures and evaluating the results, the more documentation is needed. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: N/A AICPA: BC: None; AC: Reporting; PC: None 6) Finding an appropriate combination of audit procedures to minimize an engagement's audit risk ________. A) can be challenging B) is generally straightforward C) is the responsibility of the internal audit function D) is the responsibility of management Answer: A Explanation: Finding an appropriate combination of audit procedures to minimize an engagement's audit risk can be challenging. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

7) The types of substantive procedures discussed in this chapter include ________. A) analytical procedures B) substantive tests to follow-up on notable items identified when performing audit data analytics C) tests of details of transactions and balances including audit data analytics (ADA) used as a substantive test D) All of the choices are correct. Answer: D Explanation: The types of substantive procedures discussed in this chapter include all of these procedures. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 8) An audit strategy is developed ________. A) in response to the risk assessment for each significant account and assertion using the formula for audit risk B) in response to the risk assessment for each insignificant account and assertion using the formula for audit risk C) by the auditor, but must be reviewed and approved by management D) by the auditor, but must be reviewed and approved by the internal audit function Answer: A Explanation: An audit strategy is developed in response to the risk assessment for each significant account and assertion using the formula for audit risk. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

9) An audit strategy can take ________. A) a reliance on procedures approach, a substantive approach, or a combination of both B) a reliance on controls approach, a substantive approach, or a combination of both C) neither a reliance on controls approach, nor a substantive approach D) an approach whereby only internal control is audited Answer: B Explanation: An audit strategy can take a reliance on controls approach, a substantive approach, or a combination of both. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 10) The term "substantive" comes from ________. A) "substantiate," which means auditors gather evidence to verify the transactions, account balances, and disclosures provided by management in the financial statements B) "insubstantial," which means auditors gather evidence to support the transactions, account balances, and disclosures provided by management in the financial statements C) "insubstantial," which means auditors gather evidence to support only insubstantial transactions, account balances, and disclosures provided by management in the financial statements D) the fact that the audit report is designed to assist stockholders with substantial stock holdings in the client Answer: A Explanation: The term "substantive" comes from "substantiate," which means auditors gather evidence to verify the transactions, account balances, and disclosures provided by management in the financial statements. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

11) After auditors have completed testing controls and drawn a conclusion about control risk, they ________. A) make decisions about the nature and timing of substantive testing B) are ready to issue the audit opinion C) make decisions about the nature, timing, and extent of substantive testing D) should withdraw if control risk is assessed as high Answer: C Explanation: After auditors have completed testing controls and drawn a conclusion about control risk, they make decisions about the nature, timing, and extent of substantive testing. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 12) If internal controls are strong, the auditor ________. A) can usually assess control risk as low B) can usually assess control risk as high C) does not need to test the controls D) should allow the internal audit function to conduct any testing Answer: A Explanation: If internal controls are strong the auditor can usually assess control risk as low. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 13) An auditor mailing positive confirmations is an example of ________. A) a compilation engagement B) a review engagement C) a substantive procedure D) a test of internal control Answer: C Explanation: An auditor mailing positive confirmations is an example of a substantive procedure. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

14) When internal controls are strong, the auditor ________. A) should plan to conduct more substantive testing B) may be able to conduct less substantive testing C) need not test the internal controls D) is ready to issue an unmodified opinion Answer: B Explanation: When internal controls are strong, the auditor may be able to conduct less substantive testing. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 15) Assertions about classes of transactions and events typically include ________. A) occurrence, cutoff, and completeness B) existence, rights, and obligations C) existence, rights, and cutoff D) completeness, accuracy, and valuation Answer: A Explanation: Assertions about classes of transactions and events typically include occurrence, cutoff, and completeness. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 16) Assertions about account balances at year-end typically include ________. A) existence, completeness, and allocation B) existence, completeness, and rights and obligations C) existence, occurrence, and cutoff D) accuracy, valuation, and occurrence Answer: B Explanation: Assertions about account balances at year-end typically include existence, completeness, and rights and obligations. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

17) Assertions about presentation and disclosure typically include ________. A) completeness, accuracy and valuation, and classification and understandability B) existence, rights and obligations, and cutoff C) cutoff, presentation, and disclosure D) cutoff, accuracy, and valuation Answer: A Explanation: Assertions about presentation and disclosure typically include completeness, accuracy and valuation, and classification and understandability. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 18) The objective of auditors is to obtain ________. A) sufficient appropriate audit evidence regarding the assessed risks of immaterial misstatement B) insufficient appropriate audit evidence regarding the assessed risks of material misstatement C) sufficient appropriate audit evidence regarding the assessed risks of material misstatement D) sufficient appropriate audit evidence from internal control only regarding the assessed risks of material misstatement Answer: C Explanation: The objective of auditors is to obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 19) Substantive procedures are ________. A) audit procedures designed to detect material misstatements at the assertion level B) audit procedures designed to aid testing of controls C) audit procedures that are applied when internal controls are not functioning as designed D) audit procedures applied to gather appropriate relevant and reliable data Answer: A Explanation: Substantive procedures are audit procedures designed to detect material misstatements at the assertion level. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

20) During an audit of Stacy Corporation, the external auditors had assessed the combined levels of inherent risk and control risk for intangible assets as high. This is because of several research and development costs capitalized by the client during the year. Which of the following is the appropriate response by the auditors in terms of its substantive procedures? A) Design a less effective system of gathering of evidence B) Perform interim collection of evidence C) Test a larger sample size of the research and development costs D) Do not perform any substantive procedures Answer: C Explanation: When the combined assessed level of inherent risk and control risk is high, substantive procedures should be more effective, timing should be at year-end, and larger sample sizes should be tested. Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 21) Skyla, the lead auditor for Popcorn Corporation, is doing a planning session with the external audit team. During the discussion on the assertions to be tested, one of the junior auditors wanted to know which set of assertions is applicable when testing account balances at year-end. Which of the following is the correct response by Skyla? A) Occurrence, cutoff, completeness, accuracy, and classification B) Existence, rights and obligations, completeness, valuation, and allocation C) Occurrence, rights and obligations, completeness, accuracy, and valuation D) Classification, understandability, cutoff, and occurrence Answer: B Explanation: The assertions about balances at year-end are existence and rights and obligations, completeness, valuation, and allocation. Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

22) If the auditor determines that internal controls are not functioning as designed, and a compensating control does not exist, the auditor will assess control risk and the risk of material misstatement (RMM) as ________. A) high and set detection risk as low B) low and set detection risk as low C) high and set detection risk as high D) low and set detection risk as high Answer: A Explanation: If the auditor determines that internal controls are not functioning as designed, and a compensating control does not exist, the auditor will assess control risk and RMM as high and set detection risk as low. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 23) If the control environment is assessed to be weak ________. A) auditors may respond by altering the audit plan to include more audit procedures and expanding the scope of the audit to include more of the client's locations B) auditors may respond by altering the audit plan to include less audit procedures and expanding the scope of the audit to include more of the client's locations C) the auditor will likely consider withdrawing from the engagement D) the auditor will likely be able to perform the audit at a lower cost Answer: A Explanation: If the control environment is assessed to be weak, auditors may respond by altering the audit plan to include more audit procedures and expanding the scope of the audit to include more of the client's locations. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

24) If significant fraud risk exists, the auditors should ________. A) respond by including elements of predictability in their audit plan B) respond by including elements of unpredictability in their audit plan C) plan to place greater reliance on the internal audit function D) be able to place greater reliance on management assertions Answer: B Explanation: If significant fraud risk exists, auditors should respond by including elements of unpredictability in their audit plan. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 25) Management may feel pressure to maintain debt covenants ________. A) if a client is relying heavily on debt financing and struggling to make debt payments B) if a client is relying heavily on equity financing and struggling to make equity payments C) both the liquidity and solvency positions have improved D) the accounts receivable turnover ratio has increased Answer: A Explanation: Management may feel pressure to maintain debt covenants if a client is relying heavily on debt financing and struggling to make debt payments. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

26) AU-C 330 Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained and AS 2301 The Auditor's Responses to the Risks of Material Misstatement provide which of the following examples of responding to risk at the financial statement level? A) Emphasize that audit team members should not attempt to maintain professional skepticism. B) Assign less experienced staff to areas of higher risk of material misstatement. C) Provide less supervision. D) Include more elements of unpredictability in the selection of audit procedures. Answer: D Explanation: AU-C 330 Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained and AS 2301 The Auditor's Responses to the Risks of Material Misstatement provide all of these examples of responding to risk at the financial statement level. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 27) Risk response at the financial statement level is affected by ________. A) the auditor's understanding of the auditor's control environment and the assessed risk of material misstatement due to fraud B) the auditor's understanding of the entity's control environment and the assessed risk of material misstatement due to fraud C) the internal auditor's system of internal control D) the prior auditor's current assessment of audit risk Answer: B Explanation: Risk response at the financial statement level is affected by (1) the auditor's understanding of the entity's control environment and (2) the assessed risk of material misstatement due to fraud. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

28) An effective control environment suggests that ________. A) internal control risk should be assessed at the maximum B) management and those charged with the audit demonstrate a commitment to ethical values and strong internal control C) management and those charged with governance demonstrate a commitment to ethical values and strong internal control D) the system of internal control is ineffective Answer: C Explanation: An effective control environment suggests that management and those charged with governance demonstrate a commitment to ethical values and strong internal control. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: None; PC: Decision Making 29) Auditors will have more confidence in internal controls and audit evidence generated internally ________. A) with a client that maintains an effective control environment B) with a client that maintains a poor control environment C) if the controls are centralized and controlled by one department D) if the audit evidence is received from one department or function only Answer: A Explanation: Auditors will have more confidence in internal controls and audit evidence generated internally with a client that maintains an effective control environment. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

30) If the control environment is assessed to be weak, the auditors should ________. A) immediately consider withdrawal from the engagement B) address this by changing the audit plan to include more audit procedures and expanding the scope of the audit to include more of the client's locations C) plan to increase their reliance on the evidence generated by the system D) plan to increase their reliance on the internal audit function Answer: B Explanation: If the control environment is assessed to be weak, auditors may respond by altering the audit plan to include more audit procedures and expanding the scope of the audit to include more of the client's locations. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 31) After auditors have assessed control risk ________. A) they are in a good position to evaluate the risk of fraud B) the audit is ready to be finalized and the audit opinion issued C) the findings should be submitted to management for review and approval D) the findings should be referred to the internal audit function for investigation Answer: A Explanation: After auditors have assessed control risk, they are in an ideal position to evaluate the risk of fraud. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

32) Auditors will assess the risk of fraud by considering ________. A) fraud risk factors that may not be present, such as pressure and opportunities for management to commit fraud B) fraud risk factors that may be present, such as pressure and opportunities for management to commit fraud C) fraud risk factors that may be present, such as a lack of pressure and opportunities for management to commit fraud D) management's opinion and statements on whether fraud is occurring or not Answer: B Explanation: Auditors will assess the risk of fraud by considering fraud risk factors that may be present, such as pressure and opportunities for management to commit fraud. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 33) For clients with multiple locations, the auditors ________. A) could vary which locations are tested each year and the type of audit procedures that are performed at the different locations B) could vary which locations are tested each year and not change the type of audit procedures that are performed at the different locations C) could not vary which locations are tested each year, but instead vary the type of audit procedures that are performed at the different locations D) should hire another auditor to check other locations, and not attempt to do this themselves Answer: A Explanation: For clients with multiple locations, auditors could vary which locations are tested each year and the type of audit procedures that are performed at the different locations. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

34) In order to obtain more reliable evidence ________. A) the auditors should request the internal audit function generate it B) auditors must exercise professional skepticism and be prepared to modify the planned audit procedures as needed C) the auditors should request that management generate it D) auditors should only rely on internally generated evidence Answer: B Explanation: Ultimately, auditors must exercise professional skepticism and be prepared to modify the planned audit procedures, as needed, to obtain more reliable evidence. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 35) Which of the following factors is used by the audit team to assess the risk of fraud? A) Pressure and opportunities for management to commit forgery B) Inclusion of elements of unpredictability C) Misappropriation of assets D) Modification of planned audit procedures Answer: A Explanation: Pressure and opportunities for management to commit forgery is a risk factor that the auditing team considers in order to assess the risk of fraud. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 36) Which of the following is an audit procedure in response to assessed risks? A) Making changes to the nature, timing, or extent of audit procedures to obtain more persuasive evidence B) Developing an understanding of the entity's control environment C) Designing and implementing appropriate responses to financial statements D) Changing the recalculating procedures applied in financial statements Answer: A Explanation: Making changes to the nature, timing, or extent of audit procedures to obtain more persuasive evidence is an audit procedure in response to assessed risks. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 15

37) When analytical procedures are used to obtain audit evidence during the risk response phase ________. A) they are referred to as substantive analytical procedures B) they are referred to as tests of internal control C) the audit report is ready to be issued D) management should be allowed to select the procedures and tests Answer: A Explanation: When analytical procedures are used to obtain audit evidence during the risk response phase they are referred to as "substantive analytical procedures." Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 38) AU-C 330 Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained and AS 2301 The Auditor's Responses to the Risks of Material Misstatement state that ________. A) auditors are required to perform substantive procedures for all relevant assertions that have been identified during the report issuance phase B) auditors are required to perform substantive procedures for all relevant assertions that have been identified during the risk assessment phase C) the auditors must confer with the prior auditor before issuance of any audit report D) the accounting qualities of faithful representation and comparability are immaterial to the audit Answer: B Explanation: AU-C 330 and AS 2301 state that auditors are required to perform substantive procedures for all relevant assertions that have been identified during the risk assessment phase. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

39) The nature of an audit procedure refers to ________. A) its purpose (test of controls or substantive procedure) and its type B) its extent (test of controls or substantive procedure) and its type C) its timing (test of controls or substantive procedure) and its type D) its timing (test of controls only) and its type Answer: A Explanation: The nature of an audit procedure refers to its purpose (test of controls or substantive procedure) and its type. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 40) Collette, an external auditor, is planning to perform analytical procedures for Garfield Corporation. Which of the following information would make Collette conclude that there is less predictability in the data Collette is analyzing? A) Garfield Corporation has been in the industry for more than 50 years, and is not subject to rapid changes. B) There are large volumes of similar transactions. C) The related transactions which Collette is analyzing are subject to management discretion. D) The relationships being analyzed involve income statement accounts. Answer: C Explanation: Transactions that are subject to management discretion are typically less predictable. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

41) Coleen is the engagement partner for the audit of Blue Corporation. Coleen is discussing with the audit team about substantive analytical procedures and the factors that the team should consider regarding the reliability of data to be used. Which of the following statements is correct regarding reliability of data? A) Data obtained from independent sources outside of the client is less reliable. B) If data have not been tested yet in the current year or prior year, data is more reliable. C) Internally-generated data is more reliable if controls over the data are effective. D) Data is reliable even if it cannot be used to create an expectation that is relevant to the entity. Answer: C Explanation: If the data are internally generated are there are adequate internal controls over the data, the data are considered more reliable. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 42) Examples of substantive procedures include ________. A) observation B) inquiry C) confirmation D) All of the choices are correct. Answer: D Explanation: All of these answer choices are examples of substantive procedures. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 43) The MOST important factor when responding to assessed risks is ________. A) consideration of the nature of the audit procedure B) consideration of the nature of the associated internal control C) the opinion of management regarding the assessed risk D) the opinion of the internal auditor regarding the assessed risk Answer: A Explanation: The most important factor when responding to assessed risks is consideration of the nature of the audit procedure. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 18

44) AU-C 330 Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained and AS 2301 The Auditor's Responses to the Risks of Material Misstatement state that auditors ________. A) are required to perform substantive procedures for all relevant assertions that have been identified after issuance of the audit opinion B) are required to perform substantive procedures for all relevant assertions that have been identified during the risk assessment phase C) are required to perform tests of controls for all relevant assertions that have been identified during the risk assessment phase D) should notify the client immediately of a change in fee structure pertaining to the audit Answer: B Explanation: AU-C 330 and AS 2301 state that auditors are required to perform substantive procedures for all relevant assertions that have been identified during the risk assessment phase. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 45) Every audit will involve ________. A) conflicts with management pertaining to estimates B) relying on the internal audit function for production of evidentiary matter C) some amount of substantive testing because audit standards require it for relevant assertions D) no substantive testing because audit standards require it not to be conducted for relevant assertions Answer: C Explanation: Every audit will involve some amount of substantive testing because audit standards require it for relevant assertions. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

46) A reliance on controls strategy would involve ________. A) the auditor performing primarily tests of controls B) the auditor performing primarily substantive procedures C) obtaining written assertions and representations from management D) the external auditor relying on the internal audit function Answer: A Explanation: A reliance on controls strategy would involve the auditor performing primarily tests of controls. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 47) A dual-purpose test ________. A) involves the auditors designing a test of controls and a substantive test of details to be performed at the same time on different transactions B) involves the auditors designing a test of controls and a substantive test of details to be performed at the same time on the same transaction C) involves satisfying informational requests from management and the client's legal counsel simultaneously D) involves the auditor being able to bill the client for two tests when only one was performed Answer: B Explanation: A dual-purpose test involves the auditors designing a test of controls and a substantive test of details to be performed at the same time on the same transaction. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

48) A factor that auditors consider when determining the type of substantive procedure to use is ________. A) the assessed level of risk for the assertion B) the assessed level of risk for the control C) the cost of the procedure, and if management will be able to afford it D) the recommendations of management Answer: A Explanation: A factor that auditors consider when determining the type of substantive procedure to use is the assessed level of risk for the assertion. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 49) When the risk of material misstatement for an assertion is high, the auditors ________. A) must gather less reliable and persuasive evidence B) must gather more reliable and persuasive evidence C) should not attempt to audit this assertion D) should consider allowing the internal audit function to audit this assertion Answer: B Explanation: When the risk of material misstatement for an assertion is high, the auditors must gather more reliable and persuasive evidence. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 50) A significant risk is ________. A) a risk that the auditor should not attempt to address B) an identified and assessed risk of immaterial misstatement that, in the auditor's judgment, requires special audit consideration C) an identified and assessed risk of material misstatement that, in the auditor's judgment, requires special audit consideration D) a risk for which the auditor should immediately notify the SEC Answer: C Explanation: A significant risk is an identified and assessed risk of material misstatement that, in the auditor's judgment, requires special audit consideration. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 21

51) Examples of initial procedures that an auditor may perform include ________. A) trace beginning balances to working papers from the prior year's audit B) scan the transactions in the account for unusual items C) obtain a trial balance or other detailed report for the account D) All of the choices are correct. Answer: D Explanation: These are all examples of initial procedures that an auditor may perform. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 52) Analytical procedures ________. A) are evaluations of financial information through analysis of plausible relationships among both financial and non-financial data B) are evaluations of financial information through analysis of plausible relationships using financial data only C) are evaluations of financial information through analysis of plausible relationships using nonfinancial data only D) are optional, and generally unnecessary if the system of internal control is strong Answer: A Explanation: Analytical procedures are evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 53) The use of analytical procedures ________. A) is optional during risk assessment B) is prohibited during risk assessment C) is required during risk assessment D) is most effective as part of the testing of the system of internal control Answer: C Explanation: The use of analytical procedures is required during risk assessment. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 22

54) Examples of analytical procedures include ________. A) ratio analysis B) trend analysis C) complex statistical techniques D) All of the choices are correct. Answer: D Explanation: All of these answer choices represent potential analytical procedures. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 55) When conducting a substantive analytical procedure ________. A) auditors develop an expectation, or estimate, using data in the auditor's records or data from reliable outside sources, and then compare the expectation with the client's recorded amount B) auditors develop an expectation, or estimate, using data in the client's records or data from reliable outside sources, and then compare the expectation with the client's recorded amount C) auditors develop an expectation, or estimate, using data in the client's records or data from reliable internal sources, and then compare the expectation with the client's recorded amount D) the procedure should be approved by management beforehand Answer: B Explanation: When conducting a substantive analytical procedure, auditors develop an expectation, or estimate, using data in the client's records or data from reliable outside sources, and then compare the expectation with the client's recorded amount. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

56) Before auditors can use substantive analytical procedures ________. A) they must be ready to issue the preliminary audit opinion B) they must consider the availability and reliability of data to be used to develop their expectation C) they must consider the availability and reliability of data to be used to develop their audit opinion D) they must be approved by the internal auditors beforehand Answer: B Explanation: Before auditors can use substantive analytical procedures, they must consider the availability and reliability of data to be used to develop their expectation. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 57) The use of a substantive analytical procedure may be more appropriate and provide more persuasive audit evidence depending on ________. A) the nature of the assertion B) whether management agrees with its use C) the nature of the control D) whether the internal auditors are able to confirm the evidence Answer: A Explanation: The use of a substantive analytical procedure may be more appropriate and provide more persuasive audit evidence depending on the nature of the assertion. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 58) If the assessed risk of material misstatement for an assertion is high, the auditors ________. A) should avoid auditing the assertion in question B) need to gather less persuasive audit evidence C) need to gather more persuasive audit evidence D) should consider withdrawing from the engagement Answer: C Explanation: If the assessed risk of material misstatement for an assertion is high auditors need to gather more persuasive audit evidence. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 24

59) Which of the following factors impact the effectiveness and efficiency of using a substantive analytical procedure to respond to risk? A) nature of the assertion B) assessed risk of the material misstatement C) control over the data D) persuasiveness of the evidence Answer: A Explanation: Nature of the assertion impacts the effectiveness and efficiency of using a substantive analytical procedure to respond to risk. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 60) Testing of internal controls is typically conducted ________. A) during an interim period B) at the balance sheet date C) after the balance sheet date D) upon issuance of the audit report Answer: A Explanation: Testing of internal controls is performed during an interim period, which may be two or three months before the client's year-end. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 61) Roll-forward procedures relate to ________. A) auditors updating their audit findings from an interim period through year-end B) auditors updating their audit findings from year-end through an interim period C) any substantive procedure performed after the balance sheet date D) any procedure carried out by the auditor to update their audit findings through the date of the audit report Answer: A Explanation: Roll-forward procedures relate to auditors updating their audit findings from an interim period through year-end. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 25

62) Some substantive procedures can only be performed at year-end ________. A) due to management not allowing the auditors access beforehand B) because there have been no transactions occurring in these accounts during the year C) due to the nature of the assertion or the timing of the transactions D) once the internal audit function has completed its preliminary testing of the account Answer: C Explanation: Some substantive procedures can only be performed at year-end due to the nature of the assertion or the timing of the transactions. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 63) The cutoff assertion for sales means that ________. A) transactions have been recorded in the proper accounting period B) the auditor should check to make sure sales are being shipped to the correct customers C) transactions are being recorded in the correct accounts D) sales should be limited to certain clients who may not have the ability to pay Answer: A Explanation: The cutoff assertion for sales means that transactions have been recorded in the proper accounting period. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 64) If during risk assessment auditors have identified risks of material misstatement due to fraud ________. A) they may consider not changing the timing of audit procedures B) they may consider changing the timing of audit procedures C) the auditors should confront the employee(s) in question D) the auditors should immediately report this to the SEC Answer: B Explanation: If during risk assessment auditors have identified risks of material misstatement due to fraud, they may consider changing the timing of audit procedures. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 26

65) Which of the following procedures aim to provide sufficient appropriate audit evidence on which to base conclusions at year-end when substantive procedures were performed at an interim date? A) Roll-forward procedures B) Analytical procedures C) Auditing procedures D) Interim procedures Answer: A Explanation: Roll-forward procedures aim to provide sufficient appropriate audit evidence on which to base conclusions at year-end when substantive procedures were performed at an interim date. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 66) The extent of substantive procedures refers to ________. A) how much testing will be performed outside of a class of transactions or account balance B) how much testing will be performed within a class of transactions or account balance C) the extent of the cost associated with performing a particular audit procedure D) the extent to which management agree with the procedures performed Answer: B Explanation: The extent of substantive procedures refers to "how much" testing will be performed within a class of transactions or account balance. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 67) In general, an auditor is more likely to use audit data analytics (ADA) when which of the following conditions exist? A) Evidence to support the audit test is available in electronic form. B) Relevant data is reliable and internal controls over the reliability of data are strong. C) Relevant data is clean or can be cleaned up easily. D) All of the choices are correct. Answer: D Explanation: These are all conditions when an auditor is more likely to use ADA. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 27

68) The auditor is more likely to use audit sampling when ________. A) professional standards expect the auditor to perform certain audit procedures B) evidence to support the audit test is not available in electronic form C) the audit population is relatively small and can efficiently be tested using traditional audit tests D) All of the choices are correct. Answer: D Explanation: All of these answer choices relate to when an auditor is more likely to use audit sampling. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 69) If the risk of material misstatement is low and detection risk is high ________. A) then a smaller sample size should be selected B) then a larger sample size should be selected C) then control risk should be assessed as high D) the auditor should consider outsourcing the audit work to the internal audit function Answer: A Explanation: If the risk of material misstatement is low and detection risk is high, then a smaller sample size should be selected. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 70) An example of a qualitative factor auditors will consider when determining sample size is ________. A) the accounts receivable turnover ratio B) the days in receivables ratio C) the percentage of bad debt expense D) significant turnover in the accounts receivable department Answer: D Explanation: An example of a qualitative factor auditors will consider when determining sample size is significant turnover in the accounts receivable department. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 28

71) One method of selecting specific items from a population when testing for overstatement is to ________. A) select items that are over a certain dollar amount B) select items that are identical dollar amounts C) allow the internal auditors to select them D) allow management to select them Answer: A Explanation: Another method of selecting specific items from a population is to select items that are over a certain dollar amount when testing for overstatement. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 72) Auditors can use statistical audit sampling ________. A) to determine which clients to accept B) to select a sample of items to test C) as a means of testing the system of internal control D) to determine which accounts should not be audited Answer: B Explanation: Auditors can use statistical audit sampling to select a sample of items to test. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 73) Statistical sampling ________. A) should generally not be used for auditing engagements B) is typically less complicated than non-statistical sampling C) can be used in addition to testing specific items from a population D) can be used instead of testing specific items from a population Answer: C Explanation: Statistical sampling can be used in addition to testing specific items from a population. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

74) The auditor is likely to use audit sampling in which of the following cases? A) Evidence to support the audit test is not available in electronic form. B) The audit population is relatively large. C) Relevant data is not reliable. D) Relevant data is in different formats. Answer: D Explanation: The auditor is likely to use audit sampling when the evidence to support the audit test is not available in electronic form. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 75) When the audit population can efficiently be tested using traditional audit tests, the auditor is more likely to use ________. A) audit sampling B) audit data analytics C) substantive procedures D) None of the choices are correct. Answer: A Explanation: When the audit population can efficiently be tested using traditional audit tests, the auditor is more likely to use audit sampling. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

76) AU-C 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures states ________. A) the objective of the auditor is to obtain sufficient appropriate evidence that accounting estimates are reasonable and disclosures are adequate B) the objective of the internal auditor is to obtain sufficient appropriate evidence that accounting estimates are reasonable and disclosures are adequate C) the objective of the auditor is to obtain sufficient appropriate evidence that accounting estimates are reasonable only D) the objective of the auditor is to obtain sufficient appropriate evidence that disclosures are adequate only Answer: A Explanation: AU-C 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures states the objective of the auditor is to obtain sufficient appropriate evidence that accounting estimates are reasonable and disclosures are adequate. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 77) Financial statements include ________. A) a variety of items that cannot be measured precisely and must be estimated by client management B) a variety of items that can be measured precisely and must be estimated by client management C) a variety of items that cannot be measured precisely and must be estimated by the internal auditors D) a variety of items that can be measured precisely and should not be estimated by client management Answer: A Explanation: Financial statements include a variety of items that cannot be measured precisely and must be estimated by client management. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

78) An accounting estimate is ________. A) an exact monetary amount when a precise means of measurement is available B) an approximation of a monetary amount when a precise means of measurement is not available C) prohibited by GAAP and should be questioned by the auditor D) a figure that should be left to the external auditor to determine at the end of the year Answer: B Explanation: An accounting estimate approximates a monetary amount when a precise means of measurement is not available. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 79) AU-C 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures states the objective of the auditor is to obtain sufficient appropriate evidence that ________. A) the accounting estimates are reasonable B) accounting estimates are reasonable, but disclosures are not adequate C) accounting estimates are reasonable, and disclosures are adequate D) disclosures are adequate Answer: C Explanation: AU-C 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures states the objective of the auditor is to obtain sufficient appropriate evidence that accounting estimates are reasonable, and disclosures are adequate. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

80) Once the final outcome of a transaction or event occurs ________. A) it is expected that there will be a difference between the outcome of the accounting estimate and the amount originally recognized or disclosed in the financial statements B) it is expected that there will be no difference between the outcome of the accounting estimate and the amount originally recognized or disclosed in the financial statements C) the amount should be adjusted to match the estimated balance D) the auditor should not concern themselves with investigating abnormally large variances Answer: A Explanation: Once the final outcome of the transaction or event occurs, it is expected that there will be a difference between the outcome of the accounting estimate and the amount originally recognized or disclosed in the financial statements. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 81) Estimation uncertainty is defined as ________. A) the susceptibility of an accounting estimate and related disclosures to be accurate B) the susceptibility of an accounting estimate and related disclosures due to an inherent lack of precision in its measurement C) the uncertainty surrounding the ultimate cost of the audit D) the uncertainty surrounding which staff members to assign to a particular audit Answer: B Explanation: Estimation uncertainty is defined as the susceptibility of an accounting estimate and related disclosures due to an inherent lack of precision in its measurement. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

82) The amount of estimation uncertainty is affected by ________. A) the nature of the accounting estimate B) the subjectivity of the assumptions used to make the estimate C) the extent to which a generally accepted method or model is available to aid in developing the estimate D) All of the choices are correct. Answer: D Explanation: The amount of estimation uncertainty is affected by all of these answer choices. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 83) In general, accounting estimates with a high degree of estimation uncertainty ________. A) pose a greater risk of material misstatement B) pose a smaller risk of material misstatement C) pose no risk of material misstatement D) serve to lower inherent risk Answer: A Explanation: In general, accounting estimates with a high degree of estimation uncertainty pose a greater risk of material misstatement. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 84) Accounting estimates, by their nature ________. A) involve objective decision making on the part of management B) involve subjective decision making on the part of management C) should cause little or no variance at the end of the period D) should not be estimated by management, but rather by the auditor at the end of the period Answer: B Explanation: Accounting estimates, by their nature, involve subjective decision making on the part of management. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

85) Management bias is defined as ________. A) a lack of neutrality by management in the preparation and fair presentation of information B) evidence of neutrality by management in the preparation and fair presentation of information C) management hiring selectively for certain key positions D) management 'opinion shopping' among auditors for their desired opinion Answer: A Explanation: Management bias is defined as a lack of neutrality by management in the preparation and fair presentation of information. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 86) An example of possible management bias would be ________. A) changes in the method of making the accounting estimate that are based on subjective assumptions B) using management's own assumptions for fair value estimates when they are inconsistent with readily observable market assumptions C) selecting or developing significant assumptions that yield an estimate more favorable for management's objectives D) All of these choices are correct. Answer: D Explanation: All of these answer choices would be examples of possible management bias. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

87) In order to evaluate management's estimation process ________. A) auditors use the knowledge gained about the industry and the applicable financial reporting framework during risk assessment B) auditors use the knowledge gained about other industries and the applicable financial reporting framework during risk assessment C) auditors compare management estimates with other management estimates at other companies D) the auditors ask the internal audit function to review and come to a conclusion which can be included in the audit report Answer: A Explanation: In order to evaluate management's estimation process, auditors use the knowledge gained about the industry and the applicable financial reporting framework during risk assessment. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 88) If the client has well-designed, implemented, and documented controls over the preparation of accounting estimates, then an appropriate risk response would be ________. A) to focus this audit time on another area, and conclude there is no material risk in this area B) to test the operating effectiveness of the controls C) to test the operating effectiveness of the assertions D) to obtain written representations from management to this effect, which negates the need for any testing Answer: B Explanation: If the client has well-designed, implemented, and documented controls over the preparation of accounting estimates, then an appropriate risk response would be to test the operating effectiveness of the controls. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

89) If testing the operating effectiveness of controls surrounding an estimate alone does not provide sufficient appropriate audit evidence ________. A) the auditors should consider increasing the risk and cost associated with the audit B) auditors should also conduct tests of internal controls pertaining to the reasonableness of accounting estimates C) auditors should also conduct substantive procedures on the reasonableness of accounting estimates D) the auditors should disregard testing of controls completely, and instead focus on substantive testing Answer: C Explanation: If testing the operating effectiveness of controls alone does not provide sufficient appropriate audit evidence, auditors also conduct substantive procedures on the reasonableness of accounting estimates. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 90) Which of the following is an example of substantive procedures performed to test the reasonableness of accounting estimates? A) Inquiry about the method of measurement B) Inquiry about assumptions used by management C) Recalculation of accounting estimates D) All of the choices are correct. Answer: D Explanation: All of these answer choices represent examples of substantive procedures performed to test the reasonableness of accounting estimates. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

91) During the audit of Awesome Corporation, Johnny, the lead auditor assigned, has been discussing with the external audit team the different factors they need to assess to determine the inherent risks involved. Which of the following examples would result in lower inherent risk assessment in relation to accounting estimates? A) Management needs specialized skills or knowledge to develop estimates B) The process of deriving relevant and reliable data is simple C) The current business environment is in turmoil D) The applicable accounting framework does not specify a valuation approach Answer: B Explanation: Simple process of deriving relevant and reliable data means that that there is lower inherent risk of misstatement in the amounts estimated. Diff: 2 LO: 6 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 92) The amount of estimation uncertainty is affected by the nature of which of the following? A) Accounting estimate B) Auditing estimate C) Management bias D) Accounting disclosure Answer: A Explanation: The amount of estimation uncertainty is affected by the nature of the accounting estimate. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 93) A misstatement could occur ________. A) with an account balance B) with a transaction C) with a classification D) All of the choices are correct. Answer: D Explanation: A misstatement could occur with an account balance, transaction, classification, presentation, or disclosure; and can be caused by error or fraud. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 38

94) A misstatement is defined as ________. A) the auditor incorrectly billing the client for work that was not performed B) a difference between what is reported in the client prepared financial statements with what is required for the item to be presented fairly in accordance with the applicable financial reporting framework C) there being no difference between what is reported in the client prepared financial statements and what is required for the item to be presented fairly in accordance with the applicable financial reporting framework D) variances that only occur in the interim financial statements Answer: B Explanation: A misstatement is a difference between what is reported in the client prepared financial statements with what is required for the item to be presented fairly in accordance with the applicable financial reporting framework. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 95) A misstatement could occur with ________. A) an account balance B) a transaction C) a classification D) All of the choices are correct. Answer: D Explanation: All of these answer choices represent possible items in which misstatements could occur. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

96) Examples of causes of misstatements include which of the following? A) Intentional or unintentional omission of an amount or disclosure B) Incorrect accounting estimate caused by a misinterpretation of facts or by management bias C) Inappropriate selection of accounting policies D) All of the choices are correct. Answer: D Explanation: All of these answer choices represent possible causes of misstatements. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 97) Two things that auditors do with misstatements during the audit are ________. A) documenting and accumulating them B) documenting and referring them to the internal auditors C) documenting and referring them to senior management D) accumulating and immediately correcting them Answer: A Explanation: Auditors document and accumulate the misstatements identified during the audit. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 98) AU-C Section 450 Evaluation of Misstatements Identiﬁed During the Audit describes misstatements as ________. A) factual misstatements B) judgmental misstatements C) projected misstatements D) All of the choices are correct. Answer: D Explanation: All of these answer choices represent types of misstatement as specified in AU-C 450.A3. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

99) When auditors are performing substantive procedures and identify misstatements they did not expect, they ________. A) reconsider their audit strategy and audit plan, and determine if the nature, timing, or extent of internal control testing needs to be modified B) reconsider their audit strategy and audit plan, and determine if the nature, timing, or extent of substantive procedures need to be modified C) should seek to obtain written representations from management as to the accuracy of the balances in question D) should consider withdrawing from the engagement Answer: B Explanation: When auditors are performing substantive procedures and identify misstatements they did not expect, they reconsider their audit strategy and audit plan, and determine if the nature, timing, or extent of substantive procedures need to be modified. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 100) All substantive audit procedures performed ________. A) are approved by client management beforehand B) are documented in the working papers C) are documented in invoices sent to the client's legal counsel D) should be done before any testing of internal control Answer: B Explanation: All substantive audit procedures performed are documented in the working papers. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

101) In which of the following misstatements is there no doubt because there is no element of judgment involved? A) Factual misstatements B) Projected misstatements C) Accumulated misstatements D) Auditing misstatements Answer: A Explanation: In factual misstatements, there is no doubt because there is no element of judgment involved. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 102) The difference between what is reported in the client prepared financial statements and what is required for the item to be presented fairly in accordance with the applicable financial reporting framework is called ________. A) misstatement B) projected estimate C) auditing misappropriation D) accumulated inaccuracy Answer: A Explanation: A misstatement is the difference between what is reported in the client prepared financial statements and what is required for the item to be presented fairly in accordance with the applicable financial reporting framework. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 103) When internal controls are strong and the auditor is able to obtain relevant and reliable data, he or she usually considers using audit data analytics (ADA) as a ________. Answer: substantive test Explanation: When internal controls are strong and the auditor is able to obtain relevant and reliable data, he usually considers using ADA as a substantive test. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

104) Auditors performing audit procedures related to accounts, assertions, or disclosures that they normally would not test because they are immaterial or considered low risk is an example of an ________. Answer: element of unpredictability Explanation: Auditors performing audit procedures related to accounts, assertions, or disclosures that they normally would not test because they are immaterial or considered low risk is an example of an element of unpredictability. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 105) A ________ shows the balances of prepaid insurance for each insurance provider. Answer: trial balance Explanation: A trial balance shows the balances of prepaid insurance for each insurance provider. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 106) Substantive tests of details to test the ________ assertion for sales transactions are performed at year-end. Answer: cutoff Explanation: Substantive tests of details to test the cutoff assertion for sales transactions are performed at year-end. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

107) The auditor's tests supported by reliable and relevant data in electronic form make the choice of ________ an efficient approach. Answer: Audit data analytics (ADA) Explanation: The auditor's tests supported by reliable and relevant data in electronic form make the choice of ADA an efficient approach. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 108) If the client has well-designed, implemented, and documented controls over the preparation of ________, then an appropriate risk response is required to test the operating effectiveness of the controls. Answer: accounting estimates Explanation: If the client has well-designed, implemented, and documented controls over the preparation of accounting estimates, then an appropriate risk response is required to test the operating effectiveness of the controls. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 109) In the context of the impact of risk of material misstatement (RMM) on the level of substantive testing, which of the following statements is/are true in the case of small sample sizes? Select all that apply. A) The combined assessed level of inherent risk and control risk is low. B) The acceptable level of detection risk is high. C) Substantive tests are less effective. D) Evidence is collected at year-end. Answer: A, B, C Explanation: In the context of the impact of risk of material misstatement (RMM) on the level of substantive testing, the following are correct in the case of small sample sizes: 1. The combined assessed level of inherent risk and control risk is low. 2. The acceptable level of detection risk is high. 3. Substantive tests are less effective. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

110) Which of the following assertions relates to classes of transactions and events? Select all that apply. A) Occurrence and cutoff B) Completeness and cutoff C) Valuation and allocation D) Accuracy and classification Answer: A, B, D Explanation: Valuation and allocation are assertions relating to account balances at year-end. Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 111) Which of the following affects risk response at the financial statement level? Select all that apply. A) The auditor's understanding of the entity's control environment B) The assessed risk of material misstatement due to fraud C) The audit team maintaining professional skepticism D) Estimating high risk of material misstatement Answer: A, B Explanation: The auditor's understanding of the entity's control environment and the assessed risk of material misstatement due to fraud affect risk response at the financial statement level. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 112) Which of the following is/are examples of responding to risk at the financial statement level as provided by the auditing standards? Select all that apply. A) Emphasize that audit team members should maintain professional skepticism. B) Increase the audit fee to compensate for more extensive procedures. C) Assign more experienced staff to areas of higher risk of material misstatement. D) Include more elements of unpredictability in the selection of audit procedures. Answer: A, C, D Explanation: Increasing the audit fee is not an example of how to respond to risk at the financial statement level. Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 45

113) Which of the following is/are examples of analytical procedures? Select all that apply. A) Relate raw materials put into production and quantities sold to normal yield factors. B) Relate actual overhead for the period to actual direct labor, production volumes, or another appropriate measure. C) Relate average amounts invested to an average interest rate or yield. D) Relate school fee per each year level by number of students in each respective level. Answer: A, B, C, D Explanation: Analytical procedures involve analyzing plausible relationships between different accounts. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 114) Which of the following initial procedures do auditors perform before applying substantive procedures when auditing an account balance? Select all that apply. A) Trace the beginning balance of the prepaid insurance account to the auditor's working papers from the prior year's audit. B) Scan the transactions in the account for unusual items. C) Obtain a trial balance or other detailed report for the account. D) Check if appropriate and understandable terminology is used, as prescribed by the applicable financial reporting framework. Answer: A, B, C Explanation: Auditors perform the following initial procedures before applying substantive procedures when auditing an account balance: 1. Trace the beginning balance of the prepaid insurance account to the auditor's working papers from the prior year's audit. 2. Scan the transactions in the account for unusual items. 3. Obtain a trial balance or other detailed report for the account. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

115) When performing test of details on the disclosures of the financial statements, auditors should gather evidence relating to which of the following? Select all that apply. A) Management has adequately disclosed the significant accounting policies applied. B) Information in the notes is accurate and does not contain errors or inconsistencies. C) Appropriate and understandable terminology is used. D) All disclosures that are required by the financial reporting framework have been included. Answer: A, B, C, D Explanation: Auditors should read and inspect the notes and recalculate amounts, as needed, to gather sufficient appropriate evidence that: 1. Management has adequately disclosed the significant accounting policies applied in the financial statements. 2. Information in the notes is accurate and does not contain errors or inconsistencies with information presented in the financial statements. 3. Appropriate and understandable terminology is used, as prescribed by the applicable financial reporting framework. 4. All disclosures that are required by the financial reporting framework have been included. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 116) Which of the following is/are factors that impact the predictability of data? Select all that apply. A) Stability of the industry B) Volume of transactions C) Auditor competency D) Type of account Answer: A, B, D Explanation: Factors that impact the predictability of data are: 1. Stability of the industry 2. Volume of transactions 3. Type of account 4. Susceptibility to management bias Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

117) Which of the following is/are factors that impact the reliability of data? Select all that apply. A) Source of data B) Controls over data C) Current or prior year testing of the data D) Comparability of the data Answer: A, B, C, D Explanation: Factors that impact the reliability of data are: 1. Source of data 2. Controls over data 3. Current or prior year testing of the data 4. Comparability of the data Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 118) Which of the following will more likely lead to performance of substantive procedures at interim rather than at year-end? Select all that apply. A) Internal controls are effective. B) Major change is expected in an account balance during the period from interim to year-end. C) Additional procedures can be performed during the period after interim and after year-end, if necessary. D) Information is available during the interim period that may not be readily available at yearend. Answer: A, C, D Explanation: Major change expected between interim to year-end would more likely lead to performance of substantive procedures at year-end. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

119) Which of the following conditions is/are necessary when performing limited tests of details of transactions occurring between the interim period and the year-end? Select all that apply. A) The entity's control environment has been assessed as effective. B) Controls have been tested. C) No significant changes in the control environment have occurred. D) Major changes are required in internal controls. Answer: A, B, C Explanation: The following are the conditions when limited tests of details of transactions occurring between the interim period and the year-end are necessary: 1. The entity's control environment has been assessed as effective. 2. Controls have been tested. 3. No significant changes in the control environment have occurred. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 120) Which of the following is/are conditions which will more likely lead to the usage of ADA by the auditor? Select all that apply. A) Relevant data is clean or can be easily cleaned. B) Relevant data is reliable and internal controls over the reliability of data are strong. C) The audit population is large. D) Evidence to support the audit procedure is only available in physical form. Answer: A, B, C Explanation: Evidence should be available in electronic form to use ADA. Diff: 2 LO: 5 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

121) Which of the following is/are conditions which will more likely lead to the usage of audit sampling by the auditor? Select all that apply. A) Evidence to support the audit procedure is not available in electronic form. B) Relevant data is not reliable and internal controls over the reliability of data are weak. C) The audit population is small. D) Relevant data may be in different formats and is not easy to use. Answer: A, B, C, D Explanation: The auditor is more likely to use audit sampling when" 1. Professional standards expect the auditor to perform certain audit procedures (e.g., observe inventory or confirm receivables). 2. Evidence to support the audit procedure is not available in electronic form. 3. The population is small and can efficiently be tested using traditional audit procedures. 4. Relevant data is not reliable and internal controls over the reliability of data are weak. 5. Relevant data may be in different formats and is not easy to use. Diff: 2 LO: 5 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 122) Which of the following is/are indicators of possible management bias? Select all that apply. A) Changes in the method of making the accounting estimate that are based on subjective assumptions. B) Selecting or developing significant assumptions that yield an estimate more favorable for management's objectives. C) Selecting an estimate that indicates a pattern of optimism or pessimism. D) Inspecting the outcome of prior period accounting estimates. Answer: A, B, C Explanation: The following are indicators of possible management bias: 1. Changes in the method of making the accounting estimate that are based on subjective assumptions. 2. Selecting or developing significant assumptions that yield an estimate more favorable for management's objectives. 3. Selecting an estimate that indicates a pattern of optimism or pessimism. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

123) Which of the following examples would result in higher inherent risk assessment? Select all that apply. A) Current business environment is in turmoil or being disrupted. B) Process of deriving relevant and reliable data and maintaining its integrity is simple. C) Assumptions are based on data that is not readily observable in an open market. D) Management does not need specialized skills or knowledge to develop the estimate. Answer: A, C Explanation: If the current business environment is in turmoil or being disrupted or assumptions are based on data that is not readily observable in an open market, these would result in higher inherent risk assessment. Diff: 2 LO: 6 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 124) Which of the following is/are causes of misstatements? Select all that apply. A) Omission of an amount or disclosure B) Incorrect accounting estimate caused by a misinterpretation of facts C) Inappropriate selection of accounting policies D) Inaccurate substantive procedure used Answer: A, B, C Explanation: The following are causes of misstatements: 1. omission of an amount or disclosure; 2. incorrect accounting estimate caused by a misinterpretation of facts; and 3. inappropriate selection of accounting policies. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

125) Auditing standards require that the auditor appropriately document the processes, procedures, judgments, and results relating to the audit of internal control. Specifically, what must this documentation include? Answer: The auditor's documentation must include the auditor's understanding and evaluation of the design of each of the components of the entity's internal control over financial reporting. The auditor also documents the process used to determine and the points at which misstatements could occur within, significant accounts, disclosures, and major classes of transactions. The auditor must justify and document the extent to which he or she relied upon work performed by others. Finally, the auditor must describe the evaluation of any deficiencies discovered, as well as any other findings that could result in a modification to the auditor's report. Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 126) Describe the relationship between inherent risk, control risk, and detection risk, and discuss how to arrive at the acceptable level of detection risk. Answer: The auditor's assessed risk of material misstatement (RMM) which is the combined inherent risk and control risk has an inverse relationship with the acceptable level of detection risk. The lower the RMM, the higher the acceptable level of detection risk and vice versa. Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 127) Describe the relationship between the acceptable level of detection risk and the nature, timing, and extent of substantive procedures to be performed by the auditor. Answer: Assuming that there is a high acceptable level of detection risk, less effective substantive procedures may be used to collect evidence. For the timing, the procedures may be performed at interim rather than at year-end. While for the extent, smaller sample sizes may be used to determine how much evidence to collect. Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

128) Discuss the different assertions about classes of transactions and events related to the income statement and cash flow statement. Answer: For income statement accounts and cash flow statement, the assertions related are: 1. Occurrence and cutoff — transactions have been recorded in the correct accounting period (cutoff) and transactions have occurred 2. Completeness — transactions recorded are complete 3. Accuracy and classification — amounts recorded are accurate and transactions have been properly classified as to the correct accounts to be used Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 129) Discuss the different assertions about account balances at year-end related to the balance sheet. Answer: For balance sheet accounts, the assertions related are: 1. Existence and rights and obligations — accounts reflected in the balance sheet exist and the client holds the rights/obligations to these accounts 2. Completeness — accounts recorded are complete 3. Valuation and allocation — amounts recorded are accurate and any adjustments relating to the valuation of the accounts have been recorded Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 130) An auditor established a $60,000 tolerable misstatement for an asset with an account balance of $1,000,000. The auditor selected a sample of every twentieth item from the population of 1,000 items that represented the asset account balance and discovered overstatements of $3,700 and understatements of $200. Under these circumstances, what would the auditor MOST likely would conclude? Answer: The auditor might conclude that there is an unacceptably high risk that the actual misstatements in the population exceed the tolerable misstatement because the total projected misstatement is more than the tolerable misstatement. Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

131) Briefly discuss examples of how auditors should respond to risk at the financial statement level. Answer: The auditing standards provide the following examples of responding to risk at the financial statement level: 1. Emphasize that audit team members should maintain professional skepticism 2. Assign more experienced staff to areas of higher risk of material misstatement 3. Provide more supervision 4. Include more elements of unpredictability in the selection of audit procedures 5. Make general changes to the nature, timing, or extent of audit procedures to obtain more persuasive evidence Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 132) Briefly discuss the two factors that affect the auditor's risk response at the financial statement level. Answer: Risk response at the financial statement level is affected by (1) the auditor's understanding of the entity's control environment and (2) the assessed risk of material misstatement due to fraud. Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 133) Describe how the auditor should respond if significant fraud risk exists after evaluation. Answer: Auditors should respond by including elements of unpredictability in their audit plan. Ultimately, auditors must exercise professional skepticism and be prepared to modify the planned audit procedures, as needed, to obtain more reliable evidence. They may also need to expand audit procedures to gather evidence from independent sources to corroborate management's explanations and other internally generated evidence. Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

134) Briefly discuss initial procedures in the context of substantive procedures. Answer: Initial procedures when performing substantive procedures include recalling the auditor's understanding of the client's business and industry and how these factors may impact the account balance being audited. It also includes tracing beginning balances to the working papers of the prior year's audit, scanning transactions for unusual items, and obtaining a trial balance or other detailed report for the account being audited. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 135) Briefly discuss and explain analytical procedures. Answer: Evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation, as is necessary, of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 136) Briefly discuss the different factors that impact the predictability of data when performing analytical procedures. Answer: The factors that impact the predictability of data include the stability of the industry, volume of transactions, type of account, and susceptibility to management bias. Relationships will be more predictable in a stable industry, when there are large volumes of similar transactions, when it involves income statement accounts, or when transactions are not subject to management discretion. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

137) Briefly discuss the different factors that auditors consider regarding the reliability of data to be used for substantive analytical procedures. Answer: The factors that auditors consider regarding the reliability of data to be used for substantive analytical procedures are the source of data, controls over the data, current or prior year testing of data, and comparability of the data. Diff: 2 LO: 3 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 138) Briefly discuss and explain the relationship between the timing of audit procedures and the risk of material misstatement. Answer: For assertions that have a lower risk of material misstatement, it may be more efficient for auditors to perform substantive procedures on those assertions prior to year-end to allow more time for testing higher risk assertions at year-end. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 139) Explain what roll-forward procedures are and when these are commonly used. Answer: Roll-forward procedures are performed to update the auditor's audit findings from the time the interim procedures are performed through year-end. These are commonly performed when the auditor decided to perform substantive procedures at interim rather than at year-end because of low assessed risk of material misstatement. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

140) Provide an example of substantive procedures which can only be performed at year-end and explain why. Answer: Substantive tests of details to test the cutoff assertion for sales transactions are performed at year-end. The cutoff assertion for sales means that transactions have been recorded in the proper accounting period. Auditors inspect supporting documentation for sales transactions that occurred just before and after the year-end date. They compare the dates on sales invoices with the dates of shipment of inventory and the dates of recording the transaction in the sales journal to ensure that sales are recorded in the proper accounting period. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 141) Describe an advantage of using statistical sampling. Answer: By using statistical sampling, auditors can draw conclusions about an entire population based on the results of the sample testing. Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 142) A client has 100 customers constituting a total accounts receivable balance of $2 million. Twenty of the client's customers currently have balances over $50,000, with the remainder having balances less than this amount. If auditors decide to send confirmations to the twenty customers with balances of at least $50,000, what percentage of the total accounts receivable will the auditor ultimately audit? Answer: If the auditor proceeds with this plan, the auditor will audit at least $1 million ($50,000 x 20 customers) of the total $2 million in accounts receivable, thus auditing at least 50% of the account. Diff: 2 LO: 5 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

143) Explain the relationship between the acceptable level of detection risk and the sample size to be used. Answer: If the RMM is high and acceptable level of detection risk is low, a larger sample size should be selected to increase chances of detecting material misstatements. Diff: 2 LO: 5 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 144) Discuss when it is appropriate for an auditor to perform a substantive test of details on an entire population. Answer: It may be appropriate and feasible for auditors to perform a substantive test of details on an entire population when account balances have a small population of transactions, but the transactions are large in dollar value. In addition, 100% testing may also be appropriate when there is a significant risk for a class of transactions or account balances. Diff: 2 LO: 5 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 145) Discuss the different methods that an auditor can perform when auditing selected items from a population. Answer: A common method when auditing selected items from a population is to select items which have a high dollar value, and those which are unusual, suspicious, or have a history of error. Another method of selecting specific items from a population is to select items that are over a certain dollar amount when testing for overstatement. Finally, auditors can use statistical audit sampling to select a sample of items to test. Diff: 2 LO: 5 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

146) A client currently being audited has an inventory with a historical cost of $1,450,000 and an NRV (net realizable value) of $1,200,000. What is the correct value of the inventory, and why? Answer: The correct value of the inventory based on the LCM (lower of cost or market) rule requires that inventory be carried at the lower of the two numbers. As a result, the client should record the inventory's value at $1,200,000. This is an example of the accounting principle of conservatism. Diff: 2 LO: 6 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 147) Discuss indicators of possible management bias regarding accounting estimates which auditors must be aware of. Answer: Auditors should be aware of the following indicators of possible management bias: 1. Changes in an accounting estimate, or the method for making it, that are based on subjective assumptions. 2. Selecting or developing significant assumptions that yield an estimate more favorable for management's objectives. 3. Selecting an estimate that indicates a pattern of optimism or pessimism. Diff: 2 LO: 6 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 148) Discuss risk response procedures for accounting estimates. Answer: During risk response, the auditor's procedures should include one or more of the following approaches: 1. Obtaining evidence from events occurring up to the date of the auditor's report (the end of fieldwork) 2. Testing how management made the accounting estimate 3. Developing an auditor's estimate or range Diff: 2 LO: 6 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

149) Discuss the common items which an auditor should inquire about relating to internal controls over accounting estimates. Answer: When gaining an understanding of internal control relevant to accounting estimates, the auditor should inquire about the following: 1. Governance — what type of oversight and governance is in place 2. Specialized skills — how does management identify the need for specialized skills 3. Risk assessment — what is management's process in identifying and assessing risks related to estimates 4. Information system — how does the management address estimation uncertainty 5. Control activities — which control activities are relevant to the process of making estimates 6. Outcome of previous estimates — how does management review and respond to the outcome of prior-period estimates Diff: 2 LO: 6 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 150) Discuss the three categories of misstatements. Answer: The three categories of misstatements are as follows: 1. Factual misstatements — there is no doubt it is a misstatement because there is no element of judgment involved 2. Judgmental misstatements — these differences are caused by management judgment regarding accounting estimates 3. Projected misstatements — these are the auditor's best estimate of the misstatement in a population based on a sample drawn from the population Diff: 2 LO: 7 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 151) Discuss what should be included in the documentation of substantive audit procedures performed. Answer: Documentation of substantive audit procedures performed should include: 1. The objective of the test 2. The substantive procedure performed 3. What items were selected for testing 4. The results of the testing Diff: 2 LO: 7 Bloom: Application Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 60

152) The relationship between the auditor's assessed risk of material misstatement (combined inherent and control risk) and detection risk is ________. A) inverse B) direct C) no relation D) cannot be determined Answer: A Explanation: The relationship between the auditor's assessed RMM (combined inherent and control risk) and detection risk is inverse. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 153) Including more elements of unpredictability in the selection of audit procedures is an auditor's response to the risks of ________. A) material misstatement B) financial misstatement C) auditing misstatement D) audit evidence Answer: A Explanation: Including more elements of unpredictability in the selection of audit procedures is an auditor's response to the risks of material misstatement. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

154) When substantive procedures are performed during an interim period, auditors perform ________ to update their audit findings from the time of the interim procedures through to yearend. A) roll-forward procedures B) audit evidence procedures C) tests of control D) analytical procedures Answer: A Explanation: When substantive procedures are performed during an interim period, auditors perform roll-forward procedures to update their audit findings from the time of the interim procedures through to year-end. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 155) _______ is the MOST effective way of gathering sufficient appropriate audit evidence. A) Audit data analytics B) Audit sampling C) Substantive procedure D) Analytical procedure Answer: A Explanation: Audit data analytics is the most effective way of gathering sufficient appropriate audit evidence. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

156) For accounting estimates that have been identified as ________, auditors perform additional substantive procedures. A) significant risks B) inherent risks C) control risks D) detection risks Answer: A Explanation: For accounting estimates that have been identified as significant risks, auditors perform additional substantive procedures. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 157) In ________, differences are caused by management's opinion regarding accounting estimates that auditors find unreasonable. A) judgmental misstatements B) projected misstatements C) factual misstatements D) accumulated misstatements Answer: A Explanation: In judgmental misstatements, differences are caused by management's opinion regarding accounting estimates that auditors find unreasonable. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

Auditing, 2e (Johnson) Chapter 10 Risk Response: Audit Sampling for Substantive Procedures 1) The choice of using audit sampling vs. audit data analytics (ADA) is often a matter of what is MOST effective and efficient in determining whether an assertion is presented fairly, in all material respects. Answer: TRUE Explanation: The choice of using audit sampling vs. ADA is often a matter of what is most effective and efficient in determining whether an assertion is presented fairly, in all material respects. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 2) The auditor is more likely to use audit sampling when internal controls are strong and reliable data does not exist to support audit data analytics (ADA). Answer: FALSE Explanation: the auditor is more likely to use audit sampling when internal controls are weak and reliable data does not exist to support ADA. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 3) The client's data is MOST reliable when internal controls are weak. Answer: FALSE Explanation: An underlying requirement of ADA is that the client's data must be reliable. Client data is most reliable when internal controls are strong. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

4) In some cases, it is feasible to audit the entire population. Answer: TRUE Explanation: In some cases, it is feasible to audit the entire population. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 5) Whenever the auditor draws a conclusion about the entire population based on a sample, there is some level of uncertainty about the auditor's conclusion. Answer: TRUE Explanation: Whenever the auditor draws a conclusion about the entire population based on a sample, there is some level of uncertainty about the auditor's conclusion. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 6) Control risk is the risk that the sample chosen by the auditor is not representative of the population of transactions or items within an account balance and, as a consequence, the auditor arrives at an inappropriate conclusion. Answer: FALSE Explanation: Sampling risk is the risk that the sample chosen by the auditor is not representative of the population of transactions or items within an account balance and, as a consequence, the auditor arrives at an inappropriate conclusion. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

7) Non-sampling risk is typically controlled by a firm's quality control procedures and the review of audit work performed by a manager or partner on the audit team or an engagement quality control reviewer. Answer: TRUE Explanation: Non-sampling risk is typically controlled by a firm's quality control procedures and the review of audit work performed by a manager or partner on the audit team or an engagement quality control reviewer. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 8) When conducting substantive procedures, sampling risk is the risk that an auditor concludes that a material misstatement does not exist when it actually does, or an auditor concludes that a material misstatement exists when it actually does not. Answer: TRUE Explanation: When conducting substantive procedures, sampling risk is the risk that an auditor concludes that a material misstatement does not exist when it actually does, or an auditor concludes that a material misstatement exists when it actually does not. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 9) In the non-statistical sampling method, the sample results are evaluated on the basis of the professional judgment and the auditor's own experience. Answer: TRUE Explanation: In the non-statistical sampling method, the sample results are evaluated on the basis of the professional judgment and the auditor's own experience. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

10) Systematic selection involves the selection of a population for testing by dividing the number of items in a population by the sample size, resulting in the sampling interval (n). Answer: TRUE Explanation: Systematic selection involves the selection of a sample for testing by dividing the number of items in a population by the sample size, resulting in the sampling interval (n). Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 11) Professional judgment is needed in applying both statistical and non-statistical sampling. Answer: TRUE Explanation: Professional judgment is needed in applying both statistical and non-statistical sampling. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 12) It is common to use audit sampling when performing substantive procedures on a population of transactions or account balances, such as taking a sample of total sales or a sample of total receivable balances. Answer: TRUE Explanation: It is common to use audit sampling when performing substantive procedures on a population of transactions or account balances, such as taking a sample of total sales or a sample of total receivable balances. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

13) Audit sampling can be used for all substantive procedures. Answer: FALSE Explanation: The auditor must recognize when the concepts associated with audit sampling apply or do not apply to substantive procedures. In a few instances the logic behind audit sampling does not apply to substantive procedures. For example, audit sampling does not apply to initial procedures, substantive analytical procedures, and many tests of details of accounting estimates and tests of details of disclosures. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 14) The tolerable misstatement is equal to or more than the materiality level set for the class of transactions or balances being tested. Answer: FALSE Explanation: The tolerable misstatement is equal to or less than the materiality level set for the class of transactions or balances being tested. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 15) The ultimate purpose of a test of controls is to obtain reasonable assurance that an assertion is presented fairly in all material respects. Answer: FALSE Explanation: The ultimate purpose of a substantive procedure is to obtain reasonable assurance that an assertion is presented fairly in all material respects. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

16) The choice of statistical or non-statistical sampling affects the selection of procedures or the competence of evidence obtained about individual sample items. Answer: FALSE Explanation: The choice of statistical or non-statistical sampling does not affect the selection of procedures or the competence of evidence obtained about individual sample items. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 17) Probability Proportionate to Size (PPS) sampling is an approach that uses firm structure theory to express a conclusion in dollar amounts. Answer: FALSE Explanation: Probability Proportionate to Size (PPS) sampling is an approach that uses attribute sampling theory to express a conclusion in dollar amounts. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 18) The MOST common selection method used in Probability Proportionate to Size (PPS) sampling is systematic selection. Answer: TRUE Explanation: The most common selection method used in PPS sampling is systematic selection. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 19) Probability Proportionate to Size (PPS) evaluation may understate the Allowance for Sampling Risk (ASR) when misstatements are found in the sample. Answer: FALSE Explanation: PPS evaluation may overstate the Allowance for Sampling Risk (ASR) when misstatements are found in the sample. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 6

20) Applying audit procedures is different for statistical and for non-statistical sampling. Answer: FALSE Explanation: Applying audit procedures is the same for statistical and for non-statistical sampling. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 21) The auditor may use a classical variables sampling approach in substantive testing. Answer: TRUE Explanation: The auditor may indeed use a classical variables sampling approach in substantive testing. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 22) An auditor is MOST likely to use audit data analytics (ADA) when ________. A) data is available that is relevant to an audit assertion of interest, whether as a risk assessment procedure or a substantive procedure B) the available data is reliable and comes from a strong system of internal controls C) the available data is relatively clean and does not require significant work to make it usable D) All of the choices are correct. Answer: D Explanation: The auditor is most likely to use audit data analytics (ADA) when: o Data is available that is relevant to an audit assertion of interest, whether as a risk assessment procedure or a substantive procedure. o The available data is reliable and comes from a strong system of internal controls. o The available data is relatively clean and does not require significant work to make it usable. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

23) An important audit planning question involves ________. A) determining whether the auditor plans to use audit data analytics, or audit sampling, to evaluate an audit population B) determining the estimated amount of audit fees the client will generate C) deciding the audit opinion to be issued and collecting evidence to support that opinion D) contacting the client's creditors to determine pending litigation Answer: A Explanation: An important audit planning question involves determining whether the auditor plans to use audit data analytics, or audit sampling, to evaluate an audit population Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 24) The choice of using audit sampling vs. audit data analytics (ADA) ________. A) is typically left up to senior management B) is often a matter of what is most effective and efficient in determining whether an assertion is presented fairly, in all material respects C) is often a matter of what is most effective and efficient in determining whether a control is presented fairly, in all material respects D) should be determined by the client's legal counsel Answer: B Explanation: The choice of using audit sampling vs. ADA is often a matter of what is most effective and efficient in determining whether an assertion is presented fairly, in all material respects. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 25) The auditor is more likely to use audit sampling ________. A) when internal controls are weak B) when internal controls are strong C) when the audit committee requests the auditor do so D) if the client agrees to pay extra fees associated with this procedure Answer: A Explanation: The auditor is more likely to use audit sampling when internal controls are weak Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 8

26) The use of audit sampling ________. A) is prohibited by the AICPA B) is mandatory for all publicly traded companies C) may be a function of the efficiency and effectiveness of the audit procedure D) may be a function of the efficiency and effectiveness of the internal auditors Answer: C Explanation: The use of audit sampling may be a function of the efficiency and effectiveness of the audit procedure. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 27) The choice of using audit sampling ________. A) is a matter of determining which audit procedure will be most effective, and efficient in the circumstances B) is a matter of determining which audit procedure will be most cost effective, and efficient in the circumstances C) should be left to the internal auditors D) should be confirmed with senior management before any procedures are undertaken Answer: A Explanation: In many cases, the choice of using audit sampling is a matter of determining which audit procedure will be most effective, and efficient in the circumstances. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

28) When auditing a construction company, the auditor might use audit data analytics (ADA) to determine ________. A) the likelihood of receiving audit fees upon conclusion of the audit B) the gross margin on each construction contract C) the inherent riskiness of the client's industry D) if appropriate receivables balance confirmations have been returned Answer: B Explanation: When auditing a construction company, the auditor might use ADA to determine the gross margin on each construction contract Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 29) The auditor is MOST likely to use ________ when the data available is relevant to an audit assertion of interest. A) audit data analytics B) audit sampling C) statistical sampling D) substantive testing Answer: A Explanation: The auditor is most likely to use audit data analytics when the data available is relevant to an audit assertion of interest. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

30) The choice of using audit sampling versus audit data analytics (ADA) is often a matter of ________. A) determining which method management would prefer the auditor use B) what is most effective and efficient in determining whether a control is presented fairly, in all material respects C) what is most effective and efficient in determining whether an assertion is presented fairly, in all material respects D) which method will be more cost efficient for the client Answer: C Explanation: The choice of using audit sampling vs. ADA is often a matter of what is most effective and efficient in determining whether an assertion is presented fairly, in all material respects. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 31) When creating an audit program and designing audit procedures ________. A) an auditor also decides how to select appropriate items for testing B) an auditor also decides how to select appropriate items for removal from the test sample C) the auditors should defer sample selection to the internal auditors D) the auditors should consider use of the cheapest statistical selection methods possible, to lower the cost of the audit Answer: A Explanation: When creating an audit program and designing audit procedures an auditor also decides how to select appropriate items for testing. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

32) In which of the following situations is the auditor MOST likely to use audit data analytics? A) The available data is reliable and comes from a strong system of internal controls. B) Internal controls are weak. C) Certain audit procedures are required by professional standards. D) The auditor needs to have data that is relevant to the audit test. Answer: A Explanation: The auditor is most likely to use audit data analytics when the available data is reliable and comes from a strong system of internal controls. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 33) Which method would the auditor MOST likely use when the relevant data is clean or can be cleaned up easily? A) Audit data analytics B) Audit sampling C) Statistical sampling D) Substantive testing Answer: A Explanation: The auditor would most likely use audit data analytics when the relevant data is clean or can be cleaned up easily. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 34) When an audit procedure is tested on an entire group of transactions ________. A) sampling is not required B) non-statistical sampling is required C) statistical sampling is required D) the sample should be discarded, and a new random sample drawn Answer: A Explanation: When an audit procedure is tested on an entire group of transactions, sampling is not required. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

35) The auditor's conclusion based on the sample ________. A) should always be applied to the sample only and not the population B) should always be applied to the population only and not the sample C) may be different than the conclusion drawn if the auditor had audited the entire population D) will always be the same as the conclusion drawn if the auditor had audited the entire population Answer: C Explanation: The auditor's conclusion based on the sample may be different than the conclusion drawn if the auditor had audited the entire population. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 36) AS 2315 and AU-C 530 on Audit Sampling ________. A) provide guidance on audit sampling B) provide guidance on client acceptance C) relate only to private companies D) relate only to companies with subsidiaries Answer: A Explanation: AS 2315 and AU-C 530 Audit Sampling provide guidance on audit sampling. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 37) Audit sampling is when ________. A) the auditor selects certain accounts to audit from the client's chart of accounts B) an auditor selects the total population C) an auditor selects less than 100% of a population D) a client requests a sample of accounts be audited Answer: C Explanation: Audit sampling is when an auditor selects less than 100% of a population Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

38) A representative audit sample ________. A) is likely to provide a reasonable basis for drawing a conclusion about an entire population B) is unlikely to provide a reasonable basis for drawing a conclusion about an entire population C) should be agreed upon by management and the auditor D) should not involve the auditor Answer: A Explanation: A representative audit sample is likely to provide a reasonable basis for drawing a conclusion about an entire population. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 39) Audit sampling is defined as ________. A) allowing engagement team members to rotate across different types of audits B) the probability that the auditor will receive full compensation for all services rendered C) the selection and evaluation of less than 100 percent of the population such that the auditor expects the items selected (the sample) to be representative of the population, and thus, likely to provide a reasonable basis for conclusions about the population D) the selection and evaluation of 100 percent of the population such that the auditor expects the items selected (the sample) to be representative of the population, and thus, likely to provide a reasonable basis for conclusions about the population Answer: C Explanation: Audit sampling is defined as the selection and evaluation of less than 100 percent of the population such that the auditor expects the items selected (the sample) to be representative of the population, and thus, likely to provide a reasonable basis for conclusions about the population. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

40) The decision to audit an entire population is usually dependent upon ________. A) the assertion and the evidence available to support the assertion B) management's express written approval to do so C) the associated controls and the evidence available to support them D) the auditors budget plan for the audit Answer: A Explanation: In some cases, it is feasible to audit the entire population. This decision depends on the assertion and the evidence available to support the assertion. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 41) Sometimes an audit population may be sufficiently small so that ________. A) the auditor can ignore the account in question B) the auditor can audit every item in the population C) the account in question can be outsourced to the internal audit function for auditing D) expressed written assurance from senior management pertaining to the account is satisfactory Answer: B Explanation: Sometimes an audit population may be sufficiently small so that the auditor can audit every item in the population. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 42) When sampling, the risk always exists ________. A) that the auditor's conclusion based on the sample may be different than the conclusion drawn if the auditor had audited the entire population B) that the auditor's conclusion based on the sample may be the same as the conclusion drawn if the auditor had audited the entire population C) that audit fees may be lowered as a result of auditing a sample D) that management may request a new sample Answer: A Explanation: When sampling, the risk always exists that the auditor's conclusion based on the sample may be different than the conclusion drawn if the auditor had audited the entire population. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 15

43) Which of the following refers to the selection and evaluation of less than 100 percent of a population of audit relevance such that the auditor expects the items selected to be representative of the population? A) Audit sampling B) Audit data analysis C) Statistical analysis D) Haphazard sampling Answer: A Explanation: Audit sampling refers to the selection and evaluation of less than 100 percent of a population of audit relevance such that the auditor expects the items selected (the sample) to be representative of the population. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 44) What is the resulting condition when an audit population is sufficiently small? A) It is feasible to audit the entire population. B) It is more efficient to select a sample of population. C) Auditing the entire population may not give correct results. D) Randomly selecting a sample representative of the entire population would help. Answer: A Explanation: When the audit population is sufficiently small, the auditor can audit every item in the population. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

45) In which of the following circumstances must an auditor decide how best to select a sample that is representative of the entire population of items? A) There are numerous transactions or items within an account balance. B) An audit population is sufficiently small. C) A client has a large balance of notes payable, and the notes payable are with several banks. D) There are few transactions or few items within an account balance. Answer: A Explanation: When an audit procedure is tested on an entire group of transactions or 100% of items within an account balance, sampling is not required. However, when there are numerous transactions or items within an account balance, an auditor must decide how best to select a sample that is representative of the entire population of items. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 46) The risk accepted by the auditor with respect to the sample not being representative of the population is known as ________. A) control risk B) inherent risk C) sampling risk D) audit risk Answer: C Explanation: The risk borne by the auditor with respect to the sample not being representative of the population is known as sampling risk. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

47) When a customer fails to reply to a confirmation and the auditor is unable to obtain other evidence about the existence of the receivable ________. A) the auditor must conclude that these balances are 100% misstatements and project the misstatements on the remaining portion of the population B) the auditor must conclude that these balances are 50% misstatements and project the misstatements on the remaining portion of the population C) the auditor must conclude that these balances are 100% misstatements and project the misstatements on the remaining portion of the sample D) the auditor should notify management of the auditor's intention to withdraw from the engagement Answer: A Explanation: When a customer fails to reply to a confirmation and the auditor is unable to obtain other evidence about the existence of the receivable, the auditor must conclude that these balances are 100% misstatements and project the misstatements on the remaining portion of the population. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 48) A common practice in attestation engagements is auditors selecting samples for review and testing. Why do auditors select samples and not simply perform tests on the entire population which would increase the level of assurance that could be provided? A) Auditors are required by generally accepted auditing standards to only test up to twenty percent of any given population, thus sampling is required. B) Auditors select samples for testing, because the testing of an entire population is unnecessary due to the statistical methods performed as part of sampling. C) Auditors test samples as opposed to the entire population because testing the entire population would be cost prohibitive and too time consuming. D) None of the choices is correct. Answer: B Explanation: Auditors only test samples as opposed to the entire population because testing the entire population would be cost prohibitive and too time consuming. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

49) Jenkins CPA firm is about to begin the audit of Macaroni, Inc., a regional purveyor of pasta products. The partner assigned to the audit has noted that although Macaroni, Inc. is making attempts to modernize, currently many of its records are maintained in paper format. Based on this, which of the following might apply? A) The auditors are likely to consider using audit data analytics techniques to audit the entire population. B) The auditors are likely to consider using audit sampling techniques due to the paper format of many records. C) The auditors are likely to consider using audit data analytics techniques to audit a selected randomized sample. D) The auditors are likely to consider using audit sampling techniques to perform substantive procedures on internal control. Answer: B Explanation: The auditors are likely to consider using audit sampling techniques due to the paper format of many records. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 50) Martin and Co. CPAs are beginning the audit of McKeown LLC, a large, multi-national provider of rubber products in domestic and overseas markets. It has been determined by the partner with overall responsibility for the engagement that the client's accounts contain voluminous amounts of transactions due to the size of the company and its overseas activities. Based on this information, which of the following is correct? A) As the client has a large number of transactions in each account to be audited, this may lend itself to the auditor performing audit data analytics (ADA) procedures. B) As the client has a large number of transactions in each account to be audited, this may lend itself to the auditor performing traditional audit sampling procedures. C) Because the client is a large, multi-national firm with a large amount of transactions representing the total audit population, it is likely that the auditor will need to consult with management to determine the higher risk areas to be audited. D) None of the choices is correct. Answer: A Explanation: As the client has a large number of transactions in each account to be audited, this may lend itself to the auditor performing audit data analytics (ADA) procedures. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

51) Joe and Mickey are working on the audit of Towson LLC, a small firm engaged in the enterprise of candy and confectionary sales. Joe is attempting to explain audit assertions to Mickey, and how these assertions relate to the audit. Which of the following is accurate regarding audit assertions? A) Assertions are extremely important in the world of auditing. Every assertion affects every account and is thus tested by the auditor. B) Assertions are implicit within the financial statements and are made by the auditor during testing of a client's accounts. C) Assertions are key to understanding the world of auditing. Not every assertion will apply to every account, and sometimes evidence supporting an assertion is not available in electronic format. D) Assertions are key to understanding the world of auditing. Not all assertions apply to all accounts, and if a firm's system of internal control is strong, electronic evidence will be available for all assertions tested. Answer: C Explanation: Assertions are key to understanding the world of auditing. Not every assertion will apply to every account, and sometimes evidence supporting an assertion is not available in electronic format. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 52) What is tolerable misstatement? A) The maximum dollar amount of misstatement that an auditor is willing to accept in a transaction class or an account balance. B) The amount of misstatement the auditor expects in a transaction class or account balance. C) The level of assurance that the sample is representative of the population. D) A high level of assurance leading to a lower level of sampling risk. Answer: A Explanation: Tolerable misstatement is the maximum dollar amount of misstatement that an auditor is willing to accept in a transaction class or an account balance and conclude that the population is presented fairly. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

53) An auditor is attempting to determine the best sampling method for the audit population of a major client's accounts receivable. The auditor has noted that the client's accounts receivable accounts have a lot of missing data. Based on this finding, which of the following is accurate? A) The auditor should consider using an audit data analytics (ADA) technique, as this will be an efficient way to audit the population. B) The auditor should consider using a traditional audit sampling technique due to accounts receivable having a lot of missing data. C) The auditor should request that the internal audit function audit all accounts receivables, and formally report their findings to the external auditors for inclusion in the audit report. D) None of the choices is correct. Answer: B Explanation: The auditor should consider using a traditional audit sampling technique due to accounts receivable having a lot of missing data. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 54) Which of the following defines a population from a sampling perspective? A) It consists of a class of transactions, or the account balance to be tested. B) It consists of a subset of the class. C) It consists of a class that is overstated. D) None of the answer choices are correct. Answer: A Explanation: A population consists of a class of transactions, or the account balance to be tested. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

55) Joseph and Samantha are discussing the relationship between a client's system of internal control and the reliability of the audit evidence gathered. Joseph tells Samantha that he sees how both of these components are important but doesn't see a relationship between the two. How should Samantha best explain this relationship? A) There isn't really a defined relationship between these two factors per se, but we know that if a client's audit evidence is considered more reliable, this helps strengthen the system of internal control. B) No relationship exists between these two areas. Internal control and the reliability of audit evidence gathered are completely unrelated. C) It is fair to say that these two areas are related. Generally speaking, we know that if a client's system of internal control is stronger, the audit evidence gathered from the client is typically more reliable. D) A client's system of internal control is absolutely related to the reliability of audit evidence gathered. If internal control is strong, then the auditor would expect the audit evidence gathered to be less reliable. Answer: C Explanation: It is fair to say that these two areas are related. Generally speaking, we know that if a client's system of internal control is stronger, the audit evidence gathered is typically more reliable. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 56) What is risk of incorrect acceptance? A) The risk that the auditor concludes that a material misstatement does not exist when it does exist. B) The risk that the auditor concludes that a material misstatement exists when it does not exist. C) The risk that the auditor concludes that a material misstatement does not exist when it actually does not. D) The risk that the auditor concludes that a material misstatement exists when it actually does. Answer: A Explanation: Risk of incorrect acceptance is the risk that the auditor concludes that a material misstatement does not exist when it does exist. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

57) Which of the following refers to an approach to sampling that involves a random selection of sample items and the use of an appropriate statistical technique to determine sample size and evaluate sample results? A) Statistical sampling. B) Non-statistical sampling. C) Haphazard sampling. D) Audit data sampling. Answer: A Explanation: Statistical sampling is an approach to sampling that involves a random selection of sample items and the use of an appropriate statistical technique to determine sample size and evaluate sample results, including the measurement of sampling risk. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 58) An advantage of statistical sampling ________. A) is that it allows an auditor to measure control risk, that is, the risk that the sample chosen by the auditor is not representative B) is that it allows an auditor to measure sampling risk, that is, the risk that the sample chosen by the auditor is not representative C) is that it allows an auditor to measure inherent risk, that is, the risk that the sample chosen by the auditor is not representative D) is that it is cheaper to perform, resulting in lower audit fees for the client Answer: B Explanation: An advantage of statistical sampling is that it allows an auditor to measure sampling risk, that is, the risk that the sample chosen by the auditor is not representative. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

59) Risk of incorrect rejection is defined as ________. A) the risk that the auditor concludes that a material misstatement does not exist when it does exist B) the risk that the auditor concludes that a material misstatement exists when it does not exist C) the risk that an auditor incorrectly rejects a client D) the risk that management may reject the audit opinion issued by the auditor Answer: B Explanation: Risk of incorrect rejection is defined as the risk that the auditor concludes that a material misstatement exists when it does not exist. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 60) Jessie and Susan are working on the audit of Parker LLC, a medium-sized firm and distributor of cotton products throughout the continental United States. Jessie has just finished explaining why auditors obtain samples rather than test entire populations to Susan. Susan replies that although she understands, it would seem safer for the auditor just to test the entire population in order to be able to offer a higher level of assurance. Which of the following represents Jessie's best response to this? A) Auditors only obtain and test samples because statistical theory holds that if the auditor obtains a sample size of at least ten percent of the population, the conclusions reached will be the same either way. B) Auditors obtain and test a sample instead of the entire population because it would take too much time and be too expensive for the auditor to test the populations of all accounts. C) The auditors tend to test samples more so than populations because the internal audit function routinely tests populations throughout the year D) None of the choices is correct. Answer: B Explanation: Auditors obtain and test a sample instead of the entire population because it would take too much time and be too expensive for the auditor to test the populations of all accounts. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

61) An important concept in the world of auditing is that of sampling risk. Auditors routinely must consider sampling risk as part of any audit and attestation engagement. Which of the following MOST accurately encapsulates sampling risk? A) Sampling risk is best defined as the risk that the auditor reaches a different conclusion based on the sample than he or she would have if they'd tested the entire population. B) Sample risk can be best thought of as the risk that the sample reveals the same results as the audit population. C) Sampling risk is best defined as the risk that the auditor, by only selecting a sample, has to adopt a reliance strategy with respect to internal controls. D) Sampling risk can be best thought of as the risk that the auditor ultimately has to modify his or her opinion on the financial statements. Answer: A Explanation: Sampling risk is best defined as the risk that the auditor reaches a different conclusion based on the sample than he or she would have if they'd tested the entire population. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 62) An auditor working for Musgrave CPA firm has just finished the audit of a sample of accounts receivables and has concluded that no material misstatements are present. This finding could be an example of ________. A) incorrect rejection because the auditor may incorrectly be concluding that no material misstatements exist when they actually do B) incorrect acceptance, because the auditor may incorrectly be concluding that no material misstatements exist when they actually do C) incorrect rejection, because the auditor is only testing a sample instead of the entire population, and thus may draw an incorrect conclusion D) incorrect acceptance, because the auditor is only testing a sample instead of the entire population, and thus may draw an incorrect conclusion Answer: B Explanation: incorrect acceptance, because the auditor may incorrectly be concluding that no material misstatements exist when they actually do Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

63) An auditor working for Musgrave CPA firm has just finished the audit of a sample of accounts receivables and has concluded that material misstatements are present. This finding could be an example of ________. A) incorrect acceptance, because the auditor may incorrectly be concluding that material misstatements exist when they actually do not B) incorrect rejection because the auditor may incorrectly be concluding that material misstatements exist when they actually do not C) incorrect rejection, because the auditor is only testing a sample instead of the entire population, and thus may draw an incorrect conclusion D) incorrect acceptance, because the auditor is only testing a sample instead of the entire population, and thus may draw an incorrect conclusion Answer: B Explanation: incorrect rejection because the auditor may incorrectly be concluding that material misstatements exist when they actually do not Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 64) Sampling risk is ________. A) the same thing as audit risk B) the risk that the sample chosen by the auditor is not representative of the population of transactions or items within an account balance and, as a consequence, the auditor arrives at an inappropriate conclusion C) the risk that the sample chosen by the auditor is representative of the population of transactions or items within an account balance and, as a consequence, the auditor arrives at an inappropriate conclusion D) inversely related to inherent risk Answer: B Explanation: Sampling risk is the risk that the sample chosen by the auditor is not representative of the population of transactions or items within an account balance and, as a consequence, the auditor arrives at an inappropriate conclusion. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

65) When conducting substantive procedures, sampling risk is ________. A) ignored, due to substantive procedures providing a compensating control B) considered to be the risk that the random sample selected will be representative of the population C) the risk that an auditor concludes that a material misstatement does not exist when it actually does, or an auditor concludes that a material misstatement exists when it actually does not D) the risk that an auditor concludes that a material misstatement does exist when it actually does, or an auditor concludes that a material misstatement exists when it actually does not Answer: C Explanation: When conducting substantive procedures, sampling risk is the risk that an auditor concludes that a material misstatement does not exist when it actually does, or an auditor concludes that a material misstatement exists when it actually does not. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 66) Risk of incorrect acceptance is defined as ________. A) the risk that the auditor concludes that a material misstatement does not exist when it does exist B) the risk that the auditor concludes that a material misstatement does exist when it does exist C) the risk that an audit firm incorrectly accepts a client D) the risk that an audit firm incorrectly issued an unmodified opinion Answer: A Explanation: Risk of incorrect acceptance is defined as the risk that the auditor concludes that a material misstatement does not exist when it does exist. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

67) Non-sampling risk is the risk that ________. A) an auditor arrives at an inappropriate conclusion for a reason unrelated to sampling issues B) an auditor arrives at an inappropriate conclusion for a reason related to sampling issues C) the auditor inadvertently does not include any sampling procedures in the audit D) the audit firm does not send sample questionnaires to management related to certain note disclosures Answer: A Explanation: Non-sampling risk is the risk that an auditor arrives at an inappropriate conclusion for a reason unrelated to sampling issues. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 68) Non-sampling risk is typically controlled by ________. A) the internal audit function B) a firm's quality control procedures and the review of audit work performed by a manager or partner on the audit team or an engagement quality control reviewer C) a client's quality control procedures and the review of audit work performed by a manger or partner on the audit team or an engagement quality control reviewer D) an increased confidence level when performing statistical tests Answer: B Explanation: Non-sampling risk is typically controlled by a firm's quality control procedures and the review of audit work performed by a manager or partner on the audit team or an engagement quality control reviewer. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

69) What is sampling risk? A) The risk that the auditor's conclusion based on a sample may be different from the conclusion if the entire population were subjected to the same audit procedure. B) The risk that the auditor expresses an opinion on the financial statements based on other audits. C) The risk that the auditor reaches an erroneous conclusion for any reason not related to sampling risk. D) The risk that the auditor concludes that a material misstatement exists when it does not. Answer: A Explanation: Sampling risk is the risk that the auditor's conclusion based on a sample may be different from the conclusion if the entire population were subjected to the same audit procedure. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 70) With regard to statistical sampling ________. A) sample size is determined subjectively, or quantitatively, using appropriate statistics B) sample size is determined objectively, or quantitatively, using appropriate statistics C) this function should be outsourced by the auditor to a qualified professional D) management should be heavily involved with sample selection Answer: B Explanation: With regard to statistical sampling, sample size is determined objectively, or quantitatively, using appropriate statistics. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

71) In non-statistical sampling ________. A) the auditor determines sample size B) the auditor determines sample selection methods C) the auditor evaluates the sample results on the basis of the professional judgment and the auditor's own experience D) All of the choices are correct. Answer: D Explanation: In non-statistical sampling the auditor determines sample size and sample selection methods and evaluates the sample results on the basis of the professional judgment and the auditor's own experience. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 72) According to AU-C 530 Audit Sampling, statistical sampling ________. A) should only be conducted for public companies B) is an approach to sampling that involves a random selection of sample items and the use of an appropriate statistical technique to determine sample size and evaluate sample results, including measurement of sampling risk C) is an approach to sampling that involves a random selection of sample items and the use of an appropriate non-statistical technique to determine sample size and evaluate sample results, including measurement of sampling risk D) should only be conducted for private companies Answer: B Explanation: According to AU-C 530 "statistical sampling is an approach to sampling that involves a random selection of sample items and the use of an appropriate statistical technique to determine sample size and evaluate sample results, including measurement of sampling risk." Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

73) A statistical sample ________. A) should be picked carefully to ensure certain clients are audited B) should be selected by senior management C) should be selected randomly so it is the auditor's best estimate of a representative sample D) should be selected randomly so it is management's best estimate of a representative sample Answer: C Explanation: A statistical sample should be selected randomly so it is the auditor's best estimate of a representative sample. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 74) Non-statistical sampling ________. A) involves any sample selection and evaluation method that does not have the characteristics of statistical sampling B) involves any sample selection and evaluation method that has the characteristics of nonstatistical sampling C) may only be used for publicly traded companies with market capitalizations of less than a certain threshold D) may only be used for publicly traded companies with market capitalizations above a certain threshold Answer: A Explanation: Non-statistical sampling involves any sample selection and evaluation method that does not have the characteristics of statistical sampling. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

75) In non-statistical sampling ________. A) the auditor determines samples size, sample selection methods, and evaluates the sample results on the basis of the professional judgment and the auditor's own experience B) the auditor determines samples size, sample selection methods, and evaluates the sample results entirely on the basis of predetermined statistical parameters C) the auditor uses the internal audit function to gather samples D) the auditor selects a sample of certain balance sheet accounts and exclusively audits them Answer: A Explanation: In non-statistical sampling the auditor determines samples size, sample selection methods, and evaluates the sample results on the basis of the professional judgment and the auditor's own experience. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 76) Most audit firms use ________. A) statistical sampling only B) non-statistical sampling only C) a combination of statistical and non-statistical sampling D) neither statistical nor non-statistical sampling Answer: C Explanation: Most audit firms use a combination of statistical and non-statistical sampling. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

77) Using statistical sampling ________. A) involves training in the use of the statistical technique and the professional judgments involved in planning and setting up the sample, as well as in evaluating sample results B) involves training in the use of non-statistical techniques and the professional judgments involved in planning and setting up the sample, as well as in evaluating sample results C) typically increases inherent risk D) typically decreases inherent risk Answer: A Explanation: Using statistical sampling involves training in the use of the statistical technique, and the professional judgments involved in planning and setting up the sample, as well as in evaluating sample results. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 78) The risk that the auditor concludes that a material misstatement exists when it does not is called ________. A) risk of incorrect rejection B) risk of incorrect acceptance C) risk of incorrect statement D) risk of incorrect valuation Answer: A Explanation: Risk of incorrect rejection is the risk that the auditor concludes that a material misstatement exists when it does not. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

79) Which of the following is a characteristic of non-statistical sampling? A) It allows selecting an appropriate sample. B) It helps determine sample size objectively. C) It allows selecting sample size quantitatively. D) It allows a random selection of sample items. Answer: A Explanation: Non-statistical sampling allows an auditor to select a sample he or she believes is appropriate. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 80) In which of the following sampling techniques does the auditor not use a formal statistical technique to select the sample or to evaluate the sample results? A) Non-statistical sampling B) Statistical Sampling C) Monetary-unit sampling D) Block selection Answer: A Explanation: In non-statistical sampling the auditor does not use a formal statistical technique to select the sample or to evaluate the sample results. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 81) An important aspect of selecting a sample ________. A) involves determining the population and sampling unit B) involves determining the sample and sampling unit C) involves conferring with senior management with respect to their sampling preferences D) involves being as subjective as possible Answer: A Explanation: An important aspect of selecting a sample involves determining the population and sampling unit. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

82) When performing a substantive procedure ________. A) the population consists of a transaction and the account balance to be tested B) the population consists of the class of transactions or the account balance to be tested C) the auditor should report all immaterial findings to management D) the auditor should withdraw from the engagement if any material misstatements are located Answer: B Explanation: When performing a substantive procedure, the population consists of the class of transactions or the account balance to be tested. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 83) High levels of assurance mean ________. A) lower levels of sampling risk that the sample is not representative of the population B) higher levels of sampling risk that the sample is not representative of the population C) lower levels of non-sampling risk that the sample is not representative of the population D) higher levels of non-sampling risk that the sample is not representative of the population. Answer: A Explanation: High levels of assurance mean lower levels of sampling risk that the sample is not representative of the population. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 84) An important aspect of selecting a sample ________. A) involves determining the population and population unit B) involves determining the population and sampling unit C) is ensuring certain accounts are selected for audit D) is ensuring certain accounts are not selected for audit Answer: B Explanation: An important aspect of selecting a sample involves determining the population and sampling unit. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

85) When performing a substantive procedure ________. A) the population consists of the class of transactions or the account balance to be tested B) the sample consists of the class of transactions or the account balance to be tested C) the auditor should confirm acceptance by senior management of the test D) the auditor should perform the test in conjunction with the internal audit function Answer: A Explanation: When performing a substantive procedure, the population consists of the class of transactions or the account balance to be tested. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 86) Statistical sampling requires ________. A) the auditor to ignore any sampling issues raised during the sampling process B) a sample be selected randomly, and the results of the test be evaluated using management theory C) a sample be selected randomly, and the results of the test be evaluated using probability theory D) a sample be selected randomly, and the results of the test be evaluated using game theory Answer: C Explanation: Statistical sampling requires a sample be selected randomly and the results of the test be evaluated using probability theory. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 87) Random selection requires that ________. A) the person selecting the sample does not influence the choice of items selected B) the person selecting the sample influences the choice of items selected C) the auditors selecting the sample be randomized D) management be allowed to select the sample Answer: A Explanation: Random selection requires that the person selecting the sample does not influence the choice of items selected. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 36

88) A popular way to select a sample is ________. A) using random number generators B) asking management to select the sample C) asking the internal auditors to select a sample D) to pick accounts with large balances, on the basis that inherent risk related to these accounts is higher Answer: A Explanation: A popular way to select a sample is using random number generators. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 89) Stratification is ________. A) a process of dividing a population into groups of sampling units with similar characteristics that are more heterogeneous B) a process of dividing a population into groups of sampling units with similar characteristics that are more homogenous C) unrelated to the work of an auditor D) used only in non-statistical sampling techniques Answer: B Explanation: Stratification is a process of dividing a population into groups of sampling units with similar characteristics and are more homogenous. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 90) In which selection method does the person selecting the sample NOT influence the choice of items selected? A) Random selection B) Systematical selection C) Haphazard selection D) Selection based on professional judgment Answer: A Explanation: In the random selection method, the person selecting the sample does not influence the choice of items selected. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 37

91) What is systematic selection? A) The selection of a sample for testing by dividing the number of items in a population by the sample size, determining a sampling interval (n), and then selecting every nth item in the population. B) The selection of a sample free from bias, where each item in a population has an equal chance of selection. C) The selection of a sample without the use of a methodical technique. D) The selection of a sample based on professional judgment and evaluating the evidence obtained by sampling. Answer: A Explanation: Systematic selection involves the selection of a sample for testing by dividing the number of items in a population by the sample size, determining a sampling interval (n), and then selecting every nth item in the population. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 92) Which method of selection appears quite similar to random selection? A) Haphazard selection B) Systematic selection C) Block selection D) Selection based on professional judgment Answer: A Explanation: Haphazard selection involves the selection of a sample by an auditor without using a methodical technique. This technique appears to have much in common with random selection. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

93) If the auditor arrives at an incorrect conclusion based on a reason other than the sample that was collected which was intended to be representative of the population, this will represent which of the following? A) This is referred to as sampling risk, because the auditors are still only testing a sample rather than the entire population. B) This is generally known as audit risk, because the auditor only tested a sample, and did not test the entire population. C) This is typically referred to as non-sampling risk because the auditor's incorrect conclusion is based on factors other than sampling. D) None of the choices is correct. Answer: C Explanation: This is typically referred to as non-sampling risk because the auditor's incorrect conclusion is based on factors other than sampling. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 94) Jackson Inc. has been an audit client of Wyoming CPA Firm for many years. Historically, Wyoming CPA Firm has found Jackson Inc. to have an effective and robust system of internal controls and has always been able to issue a clean audit opinion on the client. To save time and money on this year's audit, Wyoming CPA Firm has decided to rely more on written assurances from management, as opposed to tests of internal control and substantive procedures. What type of risk does this represent to Wyoming CPA Firm? A) Wyoming CPA Firm may be exposing itself to decreased audit risk, as testing of internal control and substantive testing has been decreased. B) Wyoming CPA Firm may be exposing itself to decreased control risk, due to less internal controls being tested. C) Wyoming CPA Firm may be exposing itself to non-sampling risk, because the auditors have chosen to rely heavily on management representations and assurances. D) Wyoming CPA Firm may be exposing itself to inherent risk, because the audit strategy makes the auditor's position more inherently risky. Answer: C Explanation: Wyoming CPA Firm may be exposing itself to non-sampling risk, because the auditors have chosen to rely heavily on management representations and assurances. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

95) Beth and Steve are discussing the various types of sampling methods available to auditors. Beth mentions that she believes statistical sampling methods are better, whereas Steve thinks that non-statistical sampling methods are more effective. Which of these arguments is correct? A) Beth is correct. Statistical sampling procedures, through their use of mathematical probability, are always superior to non-statistical sampling procedures. B) Steve is correct. Non-statistical sampling procedures are superior to statistical sampling procedures because non-statistical sampling methods take into account subjective factors also. C) Neither Beth nor Steve is correct. Neither method is particularly effective for gathering representative samples. D) Neither Beth nor Steve is correct. The choice of auditing method is more a matter of auditor judgment, based on experience and professional judgment. Answer: D Explanation: Neither Beth nor Steve is correct. The choice of auditing method is more a matter of auditor judgment, based on experience and professional judgment. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 96) Statistical and non-statistical sampling are both routinely used by auditors on attestation engagements. Which of the following correctly describes non-statistical sampling? A) Non-statistical sampling relies on the auditor's judgment, and is considered easier to use as the time spent training staff is decreased. B) Non-statistical sampling relies on the auditors' professional experience and judgment, and is able to be measured precisely. C) Non-statistical sampling could be considered more subjective than statistical sampling, but is typically more expensive to construct and evaluate. D) None of the choices is correct. Answer: A Explanation: Non-statistical sampling relies on the auditor's judgment and is considered easier to use as the time spent training staff is decreased. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

97) During the audit of Seabreeze Enterprises, the auditors are preparing to audit accounts receivable. The audit manager has advised the audit staff associates that the current balance of accounts receivable is $15,563,212. This amount represents which of the following? A) The account balance represents the sample to be tested, and the staff associates should now determine whether statistical or non-statistical sampling procedures will be most appropriate. B) The account balance represents a sampling unit, as the accounts receivable account is one of many client accounts. C) The account balance represents a population. In this instance, the population is all accounts receivable customers and dollars. D) The account balance represents a stratification, as the auditor is only selecting one asset account, in this case, accounts receivable. Answer: C Explanation: The account balance represents a population. In this instance, the population is all accounts receivable customers and dollars. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 98) Margate LLC is being audited by GlowBright CPA Firm. Glowbright are examining the client's accounts payable accounts and have noted that a wide range of balances exist within accounts payable, with varying levels of customers with different balances. Which of the following techniques might be an appropriate method for GlowBright to consider in these circumstances? A) Glowbright should consider using a stratification technique, whereby the accounts payable population is subdivided into groups representing different strata. B) Glowbright should consider using a random selection technique when they test the population, to make sure all items tested have an equal chance of being selected. C) Glowbright should consider using a haphazard selection technique, whereby individual clients, especially those with larger balances, are selected for testing. D) None of the choices is correct. Answer: A Explanation: Glowbright should consider using a stratification technique, whereby the accounts payable population is subdivided into groups representing different strata. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

99) Carly and Simon, two audit staff associates, are discussing audit sampling. Carly tells Simon that although she understands the premise of audit sampling, she does not understand why sampling techniques need to be randomized. What is Simon's best response to this query? A) Simon should explain to Carly that randomization is not really important in sample selection. Rather, the auditors will deliberately want to select clients with large balances. B) Simon should inform Carly that randomization is important because if the same accounts are selected too often for testing and verification, this could lead to litigation for the client. C) Simon should explain to Carly that the auditors try to randomize sample selection to the greatest extent possible because randomization helps to avoid bias which may otherwise cause a sample to not be representative of a population. D) Simon should advise Carly that generally accepted auditing standards require randomized sample selection techniques for all publicly traded clients. Answer: C Explanation: Simon should explain to Carly that the auditors try to randomize sample selection to the greatest extent possible because randomization helps to avoid bias which may otherwise cause a sample to not be representative of a population. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 100) It is common to use audit sampling ________. A) if no other non-statistical tests are available or appropriate B) when performing substantive procedures on a population of transactions or account balances C) when performing tests of controls on a population of transactions or account balances D) if no other statistical tests are available or appropriate Answer: B Explanation: It is common to use audit sampling when performing substantive procedures on a population of transactions or account balances. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

101) James and Elizabeth are discussing misstatements one day during lunch at an audit client's office. James tells Elizabeth that he spent the morning learning about tolerable misstatements as part of audit samples. Elizabeth is intrigued and asks James to explain exactly what this means. Which of the following responses by James would be MOST appropriate? A) James should advise Elizabeth that tolerable misstatement refers to the level of misstatement the auditor can accept before modifying his or her opinion that the population is presented fairly. B) James should explain to Elizabeth that tolerable misstatement refers to the level of assurance deviation the auditor can tolerate before modifying his or her opinion. C) James should advise Elizabeth that tolerable misstatement refers to the level of audit risk the auditor can accept before modifying control risk. D) None of the choices is correct. Answer: A Explanation: James should advise Elizabeth that tolerable misstatement refers to the level of misstatement the auditor can accept before modifying his or her opinion that the population is presented fairly. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 102) During the second-year audit of Marzipan LLC, Custard CPAs are reviewing their prior year audit files. Custard CPAs note that during this year's audit, they wish to increase their level of assurance in certain areas such as accounts receivable, which have been deemed to be higher risk. Which of the following strategies would help the auditors achieve this objective? A) Custard CPAs could increase their level of assurance by lowering sample risk. This would mean that the auditor selects a larger sample than in the prior year. B) Custard CPAs could increase their level of assurance by increasing sample risk. If sample risk increases, the auditors would need to gather a larger sample size. C) Custard CPAs could request that the client's internal audit function perform testing of accounts receivable, as they are likely to be more familiar with the client's accounts. D) Custard CPAs should consider increasing control risk, which would lower inherent risk. As a result, the auditors would be able to collect a smaller sample and still offer the same level of assurance. Answer: A Explanation: Custard CPAs could increase their level of assurance by lowering sample risk. This would mean that the auditor selects a larger sample than in the prior year. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

103) Janeway CPA Firm is performing an attestation engagement for Ridgeway Enterprises, LLC, a distributor of bicycles and other cycling equipment throughout the continental United States. A member of the internal audit function has mentioned to the partner in charge of the engagement that several discrepancies have been noted in the accounts receivable area over the past year. As a result of this notification, what might the auditors do to modify their approach? A) The external auditors should request written assurances from senior management that there are no misstatements present in accounts receivable. B) The external auditors should delegate authority to audit the accounts receivable function to the internal auditors, as they are more familiar with where misstatement may be. C) The external auditors should consider increasing sample size, in order to try and gain a better estimate of the population misstatement. D) The external auditors should consider adopting a reliance strategy, whereby the auditors rely on the sample results rather than auditing the entire population and make this clear in the audit report. Answer: C Explanation: The external auditors should consider increasing sample size, in order to try and gain a better estimate of the population misstatement. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

104) Terry and Monique, two audit staff associates, are working on the audit of Peabody Enterprises, a large, national retailer of frozen foods. Terry has been assigned to the audit of the clients' notes receivable balances and has noted that there is a wide variance in the terms and balances of the various notes. At lunch one day, he is discussing this with Monique, and asks for her advice on how he might approach the task of selecting an audit sample. Which of the following would be the MOST appropriate advice from Monique? A) Monique should advise Terry that the best course of action with respect to audit sampling would be to stratify the population into more homogenous subgroups, as this will make the sampling more efficient. B) Monique should explain to Terry that he should consider auditing the entire population of notes receivables, as the wide variance in balances might be indicative of fraud. C) Monique should advise Terry that the best course of action with respect to audit sampling would be to consider obtaining multiple samples and comparing them against each other to look for variances. D) None of the choices is correct. Answer: A Explanation: Monique should advise Terry that the best course of action with respect to audit sampling would be to stratify the population into more homogenous subgroups, as this will make the sampling more efficient. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 105) Tolerable misstatement when performing a substantive procedure ________. A) is the maximum dollar amount of misstatement that an auditor is willing to accept within the population tested and conclude that the population is presented fairly B) is the minimum dollar amount of misstatement that an auditor is willing to accept within the population tested, and conclude that the population is presented fairly C) does not apply if the auditor plans to issue an unmodified opinion D) does not apply if the auditor plans to issue a modified opinion Answer: A Explanation: Tolerable misstatement when performing a substantive procedure is the maximum dollar amount of misstatement that an auditor is willing to accept within the population tested, and conclude that the population is presented fairly. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

106) The amount of expected misstatement in the population when performing a substantive procedure ________. A) relates to the risk that the audit opinion is misstated B) is the amount of misstatement the client expects in a transaction class or account balance C) is the amount of misstatement the auditor expects in a transaction class or account balance D) should be ignored if the misstatement is less than 20% Answer: C Explanation: The amount of expected misstatement in the population when performing a substantive procedure is the amount of misstatement the auditor expects in a transaction class or account balance. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 107) If the risk of material misstatement is low (e.g., the combined inherent risk and control risk assessments are low) ________. A) then the auditor does not need as much assurance from substantive procedures, and the auditor can reasonably accept a lower level of assurance from substantive procedures and use smaller sample sizes for substantive testing B) then the auditor needs more assurance from substantive procedures, and the auditor can reasonably accept a higher level of assurance from substantive procedures and use greater sample sizes for substantive testing C) then the auditor would set audit risk at the highest possible level D) then the auditor should consider lowering the engagement fees Answer: A Explanation: If the risk of material misstatement is low (e.g., the combined inherent risk and control risk assessments are low) then the auditor does not need as much assurance from substantive procedures, and the auditor can reasonably accept a lower level of assurance from substantive procedures and use smaller sample sizes for substantive testing. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

108) The more procedures that are directed to the same audit assertion ________. A) the less procedures should be directed to other audit assertions B) the less an auditor will need to rely on the evidence provided by one test alone and the smaller the sample size required C) the more an auditor will need to rely on the evidence provided by one test alone and the smaller the sample size required D) the less an auditor will need to rely on the evidence provided by one test alone and the greater the sample size required Answer: B Explanation: The more procedures that are directed to the same audit assertion the less an auditor will need to rely on the evidence provided by one test alone and the smaller the sample size required. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 109) If analytical procedures provide evidence that interest expense is presented fairly ________. A) the auditor can appropriately limit the assurance needed from tests of details of transactions and related sample sizes when testing interest expense B) the auditor can appropriately increase the assurance needed from tests of details of transactions and related sample sizes when testing interest expense C) then there is no need for the auditor to audit any related accounts, such as notes payable D) then the auditor should direct management to pay the associated expense Answer: A Explanation: If analytical procedures provide evidence that interest expense is presented fairly, the auditor can appropriately limit the assurance needed from tests of details of transactions and related sample sizes when testing interest expense. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

110) The level of assurance that the sample is representative of the population is referred to as ________. A) the desired level of assurance that tolerable misstatement is not exceeded by the actual misstatement in the population B) tolerable misstatement C) the amount of expected misstatement in the population D) the amount of misstatement in the population Answer: A Explanation: The desired level of assurance that tolerable misstatement is not exceeded by the actual misstatement in the population is the level of assurance that the sample is representative of the population. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 111) Smaller amounts of ________ in the population will result in smaller sample sizes. A) expected misstatement B) tolerable misstatement C) misstatement D) stratification of the population Answer: A Explanation: Smaller amounts of expected misstatement in the population will result in smaller sample sizes. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 112) A reciprocal population is ________. A) a population that is overstated if the population of interest is understated (or vice versa) B) a population that is understated if the population of interest is understated (or vice versa) C) a metric that is typically found on the income statement D) a population who have received varying audit opinions Answer: A Explanation: A reciprocal population is a population that is overstated if the population of interest is understated (or vice versa). Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 48

113) The choice of statistical or non-statistical sampling ________. A) affects the selection of procedures, or the competence of evidence obtained about individual sample items B) does not affect the selection of procedures, or the competence of evidence obtained about individual sample items C) does not affect the selection of procedures, or the competence of evidence obtained about individual population items D) is best determined by management, who know the company best Answer: B Explanation: The choice of statistical or non-statistical sampling does not affect the selection of procedures, or the competence of evidence obtained about individual sample items. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 114) The ultimate purpose of a substantive procedure is to ________. A) ensure that all controls are functioning properly B) obtain absolute assurance that an assertion is presented fairly in all material respects C) obtain reasonable assurance that an assertion is presented fairly in all material respects D) guarantee that no error or fraud exists in the financial statements Answer: C Explanation: The ultimate purpose of a substantive procedure is to obtain reasonable assurance that an assertion is presented fairly in all material respects. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

115) At the outset of substantive testing, the auditor needs to ________. A) determine the population being tested B) the assertion or assertions being tested C) if the auditor is trying to estimate the total dollar value of the population, or the total amount of misstatement that might exist in the population D) All of the choices are correct. Answer: D Explanation: At the outset of substantive testing, the auditor needs to determine the population being tested, the assertion or assertions being tested, and whether the auditor is trying to estimate the total dollar value of the population, or the total amount of misstatement that might exist in the population. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 116) Important substantive procedures include ________. A) tests of details of transactions and tests of details of balances B) tests of details of transactions C) tests of details of balances D) neither tests of details of transactions and tests of details of balances Answer: A Explanation: Important substantive procedures include tests of details of transactions and tests of details of balances. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 117) The population consists of ________. A) all accounts in the client's chart of accounts B) the class of transactions or the account balance to be tested C) neither the class of transactions nor the account balance to be tested D) account balances only Answer: B Explanation: The population consists of the class of transactions or the account balance to be tested. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 50

118) A reciprocal population is a population that is ________. A) always understated B) always overstated C) overstated if the population of interest is overstated (or vice versa) D) overstated if the population of interest is understated (or vice versa) Answer: D Explanation: A reciprocal population is a population that is overstated if the population of interest is understated (or vice versa). Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 119) What is a sampling unit? A) A subset of population B) A class that is overstated C) The class of transactions to be tested D) The reciprocal population Answer: A Explanation: A sampling unit consists of a subset of population, which forms the basis for sampling. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 120) A/An ________ is a population that is overstated if the population of interest is understated. A) reciprocal population B) adverse population C) recurrent population D) overstated population Answer: A Explanation: A reciprocal population is a population that is overstated if the population of interest is understated. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

121) Miranda and Alan are discussing audit sampling procedures one day over lunch. Miranda tells Alan that the choice of statistical versus non-statistical sampling procedure is extremely important because this will help the auditor determine the selection of actual audit procedures performed. What should Alan's response to this be? A) That is correct. If the auditor selects statistical sampling procedures, then he or she is likely to select less actual audit procedures, including substantive procedures. B) That is correct. If the auditor opts for non-statistical sampling procedures, then he or she is likely to perform less substantive procedures. C) That is incorrect. The choice of statistical versus non-statistical audit sampling procedure should not have any bearing on the procedures the auditor performs after obtaining a sample. D) That is incorrect. The auditor performs exactly the same procedures and substantive procedures regardless of whether statistical or non-statistical sampling is performed. Answer: C Explanation: That is incorrect. The choice of statistical versus non-statistical audit sampling procedure should not have any bearing on the procedures the auditor performs after obtaining a sample. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 122) Kyle, an audit intern working for Excel CPA Firm is being mentored by Caroline, an experienced auditor and CPA. Kyle mentions to Caroline one day that he has heard a lot of talk in the office about substantive procedures, but isn't exactly sure what they are, or how they relate to an audit. Which of the following represents Caroline's best response? A) Substantive procedures are only related tangentially to the work the auditor does. These procedures can be best thought of as how we check a client's system of internal control. B) Substantive procedures pertain to procedures the auditor performs such as sending confirmations or inspecting assets, in order to obtain reasonable assurance about any material misstatements contained in the financial statements. C) Substantive procedures can be best thought of as the procedures an external auditor performs to lend assurance that there are no material misstatements contained in the client's system of internal control. D) None of the choices is correct. Answer: B Explanation: Substantive procedures pertain to procedures the auditor performs such as sending confirmations and reperforming certain processes undertaken regularly by client staff, in order to obtain reasonable assurance about any material misstatements contained in the financial statements. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 52

123) Traverse CPA Firm is auditing Michigan Industries, a small client and retailer of specialty jewelry in the northern United States. An audit manager is preparing to begin the audit of the client's inventory balances, which due to the size of the client and the niche industry in which the client operates are relatively small. As a result of the small inventory balances and population, what approach might the auditor decide to take? A) The auditor might decide to adopt a reliance approach, whereby the auditor relies on internal controls and does not directly perform substantive procedures on inventory accounts. B) The auditor might opt to audit the entire population, due to its specialized nature and the population being smaller. C) The auditor might decide to use audit data analytics, which is particularly suited to this type of inventory and size of population. D) The auditor might decide to use a statistical sampling procedure to identify accounts which are riskier than others. Answer: B Explanation: The auditor might opt to audit the entire population, due to its specialized nature and the population being smaller. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 124) Darren is an audit manager working on the attestation engagement for Summer Enterprises, LLC, a large and diversified client. Darren has reviewed the audit file pertaining to accounts receivable from the current year and noted various overstatements at the end of the year which the client had attempted to correct at the beginning of the following period. As Darren plans this year's audit of accounts receivable, what approach might he decide to take? A) Darren may decide to adopt a reliance strategy, whereby Darren delegates responsibility for this part of the audit to the internal audit function and relies on their findings. B) Darren may opt to audit the entire population. This will help ensure that no misstatements are present in accounts receivable, and that any overstatements can be immediately corrected. C) Darren may decide to adopt a reciprocal population technique for the sampled accounts, to attempt to locate any overstatements corrected in the following period. D) None of the choices is correct. Answer: C Explanation: Darren may decide to adopt a reciprocal population technique for the sampled accounts, to attempt to locate any overstatements corrected in the following period. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

125) As part of the audit of Newsome Enterprises, LLC, the audit team is preparing to audit the accounts receivable balances of the client. It has been noted that the client has some accounts in this population that represent both large dollar balances and that also take longer than the average number of days to pay their balances. Based on this finding, what might be an appropriate audit sampling strategy? A) The auditor should consider adopting a statistical sampling procedure only, as this will ensure that all dollars in the population have an equal chance of being selected. B) The auditor should consider adopting a non-statistical sampling procedure whereby the auditor relies on judgment to only audit accounts that have larger balances and are riskier. C) The auditor should consider adopting a probability-proportionate-to-size sampling procedure, whereby accounts with higher balances are more likely to be audited. D) The auditor should consider adopting a reliance audit sampling strategy, which entails the auditor requesting the internal audit function determine a representative sample and relying on their findings. Answer: C Explanation: The auditor should consider adopting a probability-proportionate-to-size sampling procedure, whereby accounts with higher balances are more likely to be audited. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 126) Steve and Janie are discussing audit sampling one day at lunch. Steve has spent the morning working with his supervisor and has learned about the risk of incorrect acceptance. Janie asks Steve how an auditor goes about determining the risk of incorrect acceptance. Which of the following represents Steve's MOST accurate reply to this question? A) The risk of incorrect acceptance helps an auditor to determine control risk and has an inverse relationship with audit risk. B) The risk of incorrect acceptance is calculated by the auditor using assessed levels of control and inherent risk. C) The auditor uses the risk of incorrect acceptance to determine audit risk and is calculated by dividing inherent risk by control risk. D) None of the choices is correct. Answer: B Explanation: The risk of incorrect acceptance is calculated by the auditor using assessed levels of control and inherent risk. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

127) Jason and Marco are working on the audit of Jackson Enterprises, Inc., a large national retailer of fireworks and other pyrotechnic products. Jason, an audit intern has been learning about audit sampling techniques, in particular probability-proportionate-to-size sampling. Marco asks Jason how auditors using this sampling method determine the risk of incorrect rejection. What should Jason's response be to this? A) When using this particular sampling method, the auditors typically do not concern themselves with the risk of incorrect rejection, as this sampling method tests the entire population. B) When using this sampling method, the auditors specify the risk of incorrect rejection as the assessed level of audit risk multiplied by the determined level of inherent risk. C) When it comes to probability-proportionate-to-size sampling, the auditors do not specify a risk of incorrect rejection; rather auditors control this risk indirectly. D) When it comes to probability-proportionate-to-size sampling, the auditors specify a precise risk of incorrect rejection, and use assessed risk of material misstatement to adjust it accordingly. Answer: C Explanation: When it comes to probability-proportionate-to-size sampling, the auditors do not specify a risk of incorrect rejection; rather auditors control this risk indirectly. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 128) Deana and David, two audit staff associates are discussing sampling one day after work. Deana has spent some time working with an audit team on sample selection for a major audit client. Deana tells David that she has heard the auditors on the team talking about representative samples, and asks David if he understand what this means? What should David's response be to this? A) When it comes to audit sampling, obtaining representative samples is important. A representative sample helps the auditor guarantee that there are no misstatements in the population. B) Audit sampling works on the premise that a representative sample is obtained from the population. This helps the auditor to ensure that different samples are obtained which fully cover the population. C) Obtaining a representative sample is important in an audit because the auditor may otherwise draw incorrect conclusions about the population. D) The auditor needs to obtain a representative sample in order to be able to issue a clean audit opinion on the client's financial statements. Answer: C Explanation: Obtaining a representative sample is important in an audit because the auditor may otherwise draw incorrect conclusions about the population. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 55

129) Diane and Lynn are completing the audit of Huckleberry Enterprises and are meeting with the client to discuss the samples they plan to collect. Diane mentions that all samples collected will be randomized by the audit firm. The client asks Diane to elaborate further on the meaning of randomized samples. Which of the following represents Diane's best response to this query? A) Randomized sampling is used to ensure that a certain level of statistical bias exists in all samples obtained by the auditor. B) Randomized sampling is used by the auditor to ensure that the population the auditor is testing is representative of the sample obtained. C) Randomized sampling is used by the auditor to obtain a representative sample of the population and reduce any bias that might otherwise exist. D) None of the choices is correct. Answer: C Explanation: Randomized sampling is used by the auditor to obtain a representative sample of the population and reduce any bias that might otherwise exist. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 130) During the course of any audit, the external auditors are likely to apply selected substantive procedures as well as perform any number of sampling techniques. Which of the following MOST accurately describes the relationship between these two areas? A) An auditor is first likely to obtain a random sample, and then apply substantive procedures to the selected sample. B) An auditor is most likely to perform substantive procedures in order to determine which accounts to sample, and then perform sampling procedures. C) An auditor is likely to perform substantive procedures on the population and perform audit sampling techniques on just the sample. D) An auditor is likely to perform audit sampling techniques on the population, and then proceed to apply audit sampling techniques on the selected sample. Answer: A Explanation: An auditor is first likely to obtain a random sample, and then apply substantive procedures to the selected sample. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

131) Kylee and Jason, two audit interns from a local university, have been assigned to the attestation engagement for Lucky Enterprises, a distributor of playing cards and other games across the southern United States. One day during lunch, the topic of misstatements comes up. Jason asks Kylee to explain what misstatements are, and why auditors concern themselves with them. Which of the following responses represents Kylee's best reply to these questions? A) Auditors are employed by the client to eliminate all misstatements from the financial statements, as they may be held liable if they do not accomplish this. Misstatements refer to any amounts that are misstated. B) Auditors are concerned with misstatements because a large number of misstatements typically results in an auditor disclaiming an opinion on the financial statements. C) Auditors are concerned with material misstatements in the financial statements of a client. Misstatements refer to any amounts that are misstated. D) None of the choices is correct. Answer: C Explanation: Auditors are concerned with material misstatements in the financial statements of a client. Misstatements refer to any amounts that are misstated. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 132) Jamika and Tony are completing the audit of Toytree Enterprises, a retailer of children's toys across the northeastern United States and Canada. They have been assigned to help obtain an audit sample for accounts payable. The audit team has performed substantive procedures on the sample and not detected any misstatements. As a result of this finding, which of the following is true? A) The auditors should conclude that there are no misstatements in the population of accounts payable. B) The auditors should assume the sample was not representative and should obtain a new sample. C) The auditors should be cognizant that although no misstatements were found in the sample, there may still be misstatements in the population. D) The auditors should continue to perform alternative substantive procedures until misstatements are found in the sample. Answer: C Explanation: The auditors should be cognizant that although no misstatements were found in the sample, there may still be misstatements in the population. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

133) Probability Proportionate to Size (PPS) sampling is ________. A) an approach that uses attribute sampling theory to express a conclusion in dollar amounts B) an approach that uses non-statistical sampling theory to express a conclusion in dollar amounts C) rarely used in auditing, due to its prohibitive cost D) required to be used in the auditing of publicly traded companies Answer: A Explanation: Probability Proportionate to Size (PPS) sampling is an approach that uses attribute sampling theory to express a conclusion in dollar amounts. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 134) The PPS (probability proportional to size) sampling technique is such that ________. A) the probability that a particular sampling unit will be chosen in the sample is inversely proportionate to the monetary size of the item B) the probability that a particular sampling unit will be chosen in the sample is proportionate to the monetary size of the item C) clients with larger balances are less likely to be sampled and audited D) only large firms can afford the extra cost associated with this procedure Answer: B Explanation: The PPS (probability proportional to size) sampling technique is such that the probability that a particular sampling unit will be chosen in the sample is proportionate to the monetary size of the item. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

135) Probability proportionate to size sampling ________. A) should only be used in substantive testing of transactions B) should only be used in substantive testing of balances C) should not be used for substantive testing of transactions and balances D) can be used for substantive testing of transactions and balances Answer: D Explanation: Probability proportionate to size sampling can be used for substantive testing of transactions and balances. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 136) When using PPS (probability proportionate to size) sampling ________. A) the population consists of the class of transactions or the account balance to be tested B) the population consists of a particular transaction or the account balance to be tested C) the population consists of the class of transactions or multiple account balances to be tested D) management should be allowed some latitude in selecting which accounts to be sampled Answer: A Explanation: When using PPS (probability proportionate to size) sampling the population consists of the class of transactions or the account balance to be tested. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 137) The sampling unit in PPS (probability proportionate to size) sampling ________. A) is the account itself B) is determined by the class of account C) is an aggregated dollar amount D) is the individual dollar amount Answer: D Explanation: The sampling unit in PPS (probability proportionate to size) sampling is the individual dollar. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

138) A Logical Sampling Unit is defined as ________. A) the item snagged by the sampling plan for audit, such as an individual customer, or individual sales invoice. Tests of controls are performed on the logical sampling unit B) the item snagged by the sampling plan for audit, such as an individual customer, or individual sales invoice. Auditing procedures are performed on the logical sampling unit C) a department within the client's firm, which will be audited by the external auditor D) the item snagged by the sampling plan for audit, such as an aggregated group of customers, or sales invoices. Auditing procedures are performed on the logical sampling unit Answer: B Explanation: A Logical Sampling Unit is defined as the item snagged by the sampling plan for audit, such as an individual customer, or individual sales invoice. Auditing procedures are performed on the logical sampling unit. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 139) What is the amount of estimated misstatement in the population called? A) Basic precision B) Projected misstatement C) Logical sampling unit misstatement D) Audit data sampling Answer: A Explanation: Basic precision is the amount of estimated misstatement in the population. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 140) The results of the sample are used to estimate the ________ in the population. A) total projected misstatement B) upper misstatement limit C) lower misstatement limit D) probability proportionate to size Answer: A Explanation: The results of the sample are used to estimate the total projected misstatement in the population. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 60

141) What is statistical allowance for sampling risk? A) A measure of the uncertainty associated with not sampling the entire population B) A projection of misstatement in the population based on the findings in the sample C) A statistical estimate of the maximum misstatement in the population based on the sample D) The amount of estimated misstatement in the population Answer: A Explanation: Statistical allowance for sampling risk is a measure of the uncertainty associated with not sampling the entire population. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 142) The common steps in any transaction stream are ________. A) authorization B) executing the transaction C) recording the transaction, and transfer of consideration D) All of the choices are correct. Answer: D Explanation: The common steps in any transaction stream are authorization, executing the transaction, recording the transaction, and payment of consideration. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 143) The major advantages of non-statistical sampling include ________. A) decreased complexity B) lower training costs C) it is less time consuming D) All of the choices are correct. Answer: D Explanation: The major advantages of non-statistical sampling include: o Decreased complexity, o Lower training cost, and o It may be less time consuming. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 61

144) The major disadvantages of non-statistical sampling include ________. A) sampling risk cannot be quantified B) sufficiency of evidence cannot be measured C) inefficiency D) All of the choices are correct. Answer: D Explanation: The major disadvantages of non-statistical sampling include the facts that the auditor: o Cannot quantify sampling risk. o Cannot measure the sufficiency of evidence, and o May not get the most efficient sample. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 145) The process of selecting a sample ________. A) should be biased, and the auditor should attempt to obtain a representative sample of the items in the balance or transaction class being sampled B) should be unbiased, and the auditor should attempt to obtain a representative sample of the items in the balance or transaction class being sampled C) should be unbiased, and the auditor should attempt to obtain a certain sample of the items in the balance or transaction class being sampled D) should be determined in conjunction with the client's internal auditors Answer: B Explanation: The process of selecting a sample should be unbiased and the auditor should attempt to obtain a representative sample of the items in the balance or transaction class being sampled. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

146) The auditor can ________. A) never be certain that a representative sample has been achieved B) always be certain that a representative sample has been achieved C) request management check the sample for evidence of bias D) request the internal auditor check the sample for evidence of bias Answer: A Explanation: The auditor can never be certain that a representative sample has been achieved. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 147) The concept of sampling risk ________. A) is closely tied to the concept of non-statistical sampling risk B) is a measure of whether the sample is unrepresentative or not C) is a measure of whether the sample is representative or not D) is rarely of concern to the auditor Answer: C Explanation: The concept of sampling risk is a measure of whether the sample is representative or not. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 148) An allowance for sampling risk is ________. A) an evaluation of the certainty associated with not sampling the entire population B) an evaluation of the uncertainty associated with not sampling the entire sample C) an evaluation of the uncertainty associated with not sampling the entire population D) an evaluation of the certainty associated with not sampling the entire sample Answer: C Explanation: An allowance for sampling risk is an evaluation of the uncertainty associated with not sampling the entire population. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

149) Lower training cost is a major advantage of ________. A) non-statistical sampling B) statistical sampling C) random sampling D) systematic sampling Answer: A Explanation: Lower training cost is a major advantage of non-statistical sampling. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 150) In ________ the auditor estimates the audited value of the population (or each strata) based on a ratio of the audited value of the sample divided by the book value of the sample. A) ratio method B) difference method C) statistical method D) populate method Answer: A Explanation: In ratio method, the auditor estimates the audited value of the population (or each strata) based on a ratio of the audited value of the sample divided by the book value of the sample. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 151) Which of the following may not get the MOST efficient sample? A) Non-statistical Sampling B) Statistical sampling C) Stratified sample D) Advance statistical method Answer: A Explanation: Non-statistical Sampling may not get the most efficient sample. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

152) An auditor is examining samples from the audit of accounts receivable and has noticed that the audit team split the sample into different strata based on dollar amount of balances owed. All accounts with balances over $150,000 were selected to be audited. What is the sampling risk associated with this strata? A) The sampling risk associated with this strata is the same level of sampling risk for all other strata, and is objectively determined by the auditor. B) The sampling risk associated with this strata is zero because the auditor is auditing the population of this strata. C) The sampling risk associated with this strata is 100%, because the auditor can never eliminate the risk of misstatement entirely. D) None of the choices is correct. Answer: B Explanation: The sampling risk associated with this strata is zero because the auditor is auditing the population of this strata. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 153) John and Renee have just finished their first audit and have met to discuss what they learned. John mentions to Renee that he was particularly interested in the sampling techniques used in the audit, both statistical and non-statistical. Renee agrees, and asks John if any auditor judgment is involved in statistical sampling techniques. What should John's reply be to this? A) There isn't really much difference between statistical and non-statistical sampling techniques. For instance, they both rely on mathematical models. B) Both statistical and non-statistical sampling rely on the application of auditor judgment to some degree. C) Both statistical and non-statistical sampling rely on the application of similar auditor procedures to audit the population and attempt to detect misstatements. D) The main difference between statistical and non-statistical sampling techniques is the application of strict generally accepted auditing standards to statistical sampling techniques. Answer: B Explanation: Both statistical and non-statistical sampling rely on the application of auditor judgment to some degree. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

154) Johnson CPA Firm is auditing Micro Controls, Inc., a manufacturer of computer processors and microchips. Upon obtaining a sample of notes payable via the application of statistical sampling techniques, it has been determined by the auditors that the results of their obtained sample do not support the book value. As a result of this finding, what might the auditors decide to do? A) The auditors should attempt to obtain another sample or multiple samples to see if the discrepant findings hold. B) The auditors should request written assurances from senior management, confirming that book values of the population in question are correct. C) The auditors should consider the application of alternative auditing procedures. The auditors should then reassess the results. D) None of the choices is correct. Answer: C Explanation: The auditors should consider the application of alternative auditing procedures. The auditors should then reassess the results. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 155) Whenever auditors obtain and test a sample for any population, an element of uncertainty exists with respect to the whole population not being tested. Which of the following best describes the risk that the auditor is exposed to in such situations? A) In these instances, the auditor is exposed to audit risk, which is defined as the risk that the auditor Is taking for having expressed an incorrect opinion on the financial statements. B) In such situations, the auditor is exposed to sampling risk, which is defined as the risk associated with reaching an incorrect conclusion based on testing a sample and not the entire population. C) In these cases, the auditor is exposed to control risk, which is defined as the risk that the auditor unknowingly modifies his or her opinion on the financial statements due to poor internal controls. D) In these instances, the auditor is exposed to a risk of material misstatement, which is defined as the risk that the auditors only catch material misstatements and not all misstatements in the financial statements. Answer: B Explanation: In such situations, the auditor is exposed to sampling risk, which is defined as the risk associated with reaching an incorrect conclusion based on testing a sample and not the entire population. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 66

156) Mike and Annie are discussing audit sampling at lunch one day. Annie mentions that she heard the term 'stratification' mentioned in an audit meeting this morning and wasn't sure what it meant or how it would relate to audit sampling. How should Mike best answer these questions? A) Stratification is used in audit sampling to subdivide an audit population. This strategy helps auditors focus on areas that may be higher risk. B) Stratification is required to be used for the audits of publicly traded companies per generally accepted auditing standards and requires the auditor to subdivide the sample into logical populations. C) Stratification pertains to separating an audit population into different groups or strata and comparing them against each other to search for anomalies. D) None of the choices is correct. Answer: A Explanation: Stratification is used in audit sampling to subdivide an audit population. This strategy helps auditors focus on areas that may be higher risk. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 157) An important component in statistical sampling techniques is understanding the variability of the population, as expressed by the standard deviation. Which of the following MOST accurately captures the relationship between the standard deviation and the sample size typically required by an auditor? A) If the population standard deviation is higher, the auditor will typically adjust for this by lowering the sample size to compensate. B) If the population standard deviation is lower, the auditor typically increases sample size to compensate. C) If the population standard deviation is higher, the auditor will typically increase sample size to compensate. D) There is no relationship between the standard deviation of the population and sample size required by the auditor. Answer: C Explanation: If the population standard deviation is higher, the auditor will typically increase sample size to compensate. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

158) Joe, an experienced auditor, and CPA is attempting to give some advice on audit sampling to Sally, a new CPA and less experienced auditor. Sally tells Joe that she has read about classical variables sampling, and is trying to understand what this is, and how this works. Which of the following choices represent Joe's MOST appropriate response to these questions? A) Classical variables sampling is an extremely popular non-statistical auditing technique used on many attestation engagements. B) Classical variables sampling relies on the theory of a normal distribution to select a population and perform testing procedures accordingly. C) Classical variables sampling uses normal distribution theory to select a sample and evaluate its characteristics with respect to the population. D) Classical variables sampling uses normal distribution theory to select a population and perform appropriate testing procedures in order to reach a conclusion about the sample. Answer: C Explanation: Classical variables sampling uses normal distribution theory to select a sample and evaluate its characteristics with respect to the population. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 159) Classical variables sampling is best described as ________. A) a sampling method that uses normal distribution theory to select a sample and evaluate the characteristics of a population based on the results of a sample drawn from the population B) a non-statistical sampling technique C) a procedure conducted by the internal auditors only D) a sampling technique only applied to receivables Answer: A Explanation: Classical variables sampling is best described as a sampling method that uses normal distribution theory to select a sample and evaluate the characteristics of a population based on the results of a sample drawn from the population. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

160) The concept of stratification relates to ________. A) only targeting certain accounts for audit procedures to be applied to B) the idea of categorizing a sample based on certain sample characteristics C) liability accounts only D) equity accounts only Answer: B Explanation: The concept of stratification relates to the idea of categorizing a sample based on certain sample characteristics. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 161) The sampling plan for classical variables sampling ________. A) involves the same steps required in PPS (probability proportional to size) sampling B) should be identical for all clients within the same industry C) is an example of a non-statistical sampling technique D) should be determined by client management Answer: A Explanation: The sampling plan for classical variables sampling Involves the same steps required in PPS (probability proportional to size) sampling. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 162) Mean per Unit (MPU) Estimation involves ________. A) sampling involving determining an audit value for each item in the sample B) complicated statistical regression techniques C) complicated non-statistical regression techniques D) procedures completed by the client's legal counsel Answer: A Explanation: MPU Estimation involves sampling involving determining an audit value for each item in the sample. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

163) Generally speaking, the larger the population ________. A) the smaller the sample size B) the larger the sample size C) the less expensive the audit should be D) the more help will be required from the internal audit function Answer: B Explanation: Generally speaking, the larger the population, the larger the sample size. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 164) Classical variables sampling uses ________. A) normal distribution theory B) probability proportional to size theory C) non-statistical theories D) hypergeometric distribution theory Answer: A Explanation: Classical variables sampling uses normal distribution theory. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 165) An auditor can reduce the impact of variability by using ________. A) indemnification B) stratification C) a variety of statistical techniques D) a variety of non-statistical techniques Answer: B Explanation: An auditor can reduce the impact of variability by using stratification. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

166) The planned allowance for sampling risk is also related to ________. A) the desired level of assurance from the sample B) the desired level of assurance from the population C) a decrease in inherent risk D) an increase in audit risk Answer: A Explanation: The planned allowance for sampling risk is also related to the desired level of assurance from the sample. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 167) Smaller populations with fewer number of units ________. A) should result in a larger sample size B) should result in a smaller sample size C) have no bearing on sample size D) should result in a smaller population size Answer: B Explanation: Smaller populations with fewer number of units should result in a smaller sample size. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 168) If an auditor desires more precise estimates ________. A) the larger the sample size should be B) the smaller the sample size should be C) this judgment would have no bearing on sample size D) he or she should request them from management Answer: A Explanation: If the auditor desires more precise estimates, the sample size should be larger. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

169) The smaller the amount of misstatement that the auditor can tolerate ________. A) the smaller the sample size B) the larger the sample size C) the larger the population size D) the lower inherent risk becomes Answer: B Explanation: The smaller the amount of misstatement that the auditor can tolerate, the larger the sample size should be. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 170) It is critical to have accurate knowledge of the number of units in the population because ________. A) this factor enters into the calculation of sample size only B) this factor enters into the calculation of both the sample size and sample results C) this factor enters into the calculation of the sample results only D) this factor enters into neither the calculation of the sample size or the sample results Answer: B Explanation: It is critical to have accurate knowledge of the number of units in the population because this factor enters into the calculation of both the sample size and sample results. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 171) Stratification is often advantageous because ________. A) the combined sample size often will be significantly less than a single sample size based on a non-stratified population B) the combined sample size often will be significantly more than a single sample size based on a non-stratified population C) it is a cheaper approach and will usually result in lower audit fees for the client D) it is usually more expensive and will result in higher audit fees for the client Answer: A Explanation: Stratification may be advantageous because the combined sample size often will be significantly less than a single sample size based on a non-stratified population. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 72

172) The risk of incorrect acceptance has ________. A) a proportional effect on sample size B) inverse effect on sample size –the lower the specified risk, the larger the sample size C) direct effect on sample size –the lower the specified risk, the lower the sample size D) no effect on sample size Answer: B Explanation: The risk of incorrect acceptance has an inverse effect on sample size–the lower the specified risk, the larger the sample size. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 173) Evaluating sample results involves making ________. A) a quantitative assessment only in order to reach an overall conclusion B) a qualitative assessment only in order to reach an overall conclusion C) both a quantitative and a qualitative assessment of the results in order to reach an overall conclusion D) neither a quantitative nor qualitative assessment in order to reach an overall conclusion Answer: C Explanation: Evaluating sample results involves making both a quantitative and a qualitative assessment of the results in order to reach an overall conclusion. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

174) When either the auditor's quantitative (statistical) or qualitative assessments of sample results support the conclusion that the population is materially misstated ________. A) professional judgment should be used in deciding on an appropriate course of action B) the auditor should immediately withdraw from the engagement C) the auditor should consider notifying the audit committee and SEC D) the auditor should proceed to issue an unqualified (clean) audit opinion Answer: A Explanation: When either the auditor's quantitative (statistical) or qualitative assessments of sample results support the conclusion that the population is materially misstated, professional judgment should be used in deciding on an appropriate course of action. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 175) In Mean per Unit (MPU) estimation, the sample size required to achieve specified statistical objectives ________. A) is related directly to the variability of the values of the population items B) is not related to the variability of the values of the population items C) should be determined by specialists employed by the auditors D) should be determined by senior management and communicated to the auditor Answer: A Explanation: In MPU estimation, the sample size required to achieve specified statistical objectives is related directly to the variability of the values of the population items. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

176) The optimal number of strata depends on ________. A) a determination by senior management B) the pattern of variation in the population values and the additional costs associated with designing, executing, and evaluating each stratified sample C) the pattern of variation only D) the additional costs associated with designing, executing, and evaluating each stratified sample only Answer: B Explanation: The optimal number of strata depends on the pattern of variation in the population values and the additional costs associated with designing, executing, and evaluating each stratified sample. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 177) The auditor would MOST likely use ________ when the audit population is large, and the auditor's tests are supported by reliable and relevant data in electronic form. Answer: audit data analytics or ADA Explanation: When the audit population is large and the auditor's tests are supported by reliable and relevant data in electronic form, the auditor is MOST likely to do ADA. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 178) When an audit procedure is tested on an entire group of transactions, ________ is not required. Answer: sampling Explanation: When an audit procedure is tested on an entire group of transactions (for example, all borrowing activities), sampling is not required. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

179) ________ is the risk that the sample chosen by the auditor is not representative of the population of transactions or items within an account balance and, as a consequence, the auditor arrives at an inappropriate conclusion. Answer: Sampling risk Explanation: Sampling risk is the risk that the sample chosen by the auditor is not representative of the population of transactions or items within an account balance and, as a consequence, the auditor arrives at an inappropriate conclusion. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 180) ________ is an approach to sampling that involves a random selection of sample items and the use of an appropriate statistical technique to determine sample size and evaluate sample results, including measurement of sampling risk. Answer: Statistical sampling Explanation: Statistical sampling is an approach to sampling that involves a random selection of sample items and the use of an appropriate statistical technique to determine sample size and evaluate sample results, including measurement of sampling risk. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 181) ________ involves any sample selection and evaluation method that does not have the characteristics of statistical sampling. Answer: Non-statistical sampling Explanation: Non-statistical sampling involves any sample selection and evaluation method that does not have the characteristics of statistical sampling. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

182) The ________ method includes both an estimate of the audited value of the population (or the amount of misstatements in the population) and an estimate of a statistical confidence interval, or allowance for sampling risk associated with the estimate. Answer: statistical sampling Explanation: The statistical sampling method includes both an estimate of the audited value of the population (or the amount of misstatements in the population) and an estimate of a statistical confidence interval or allowance for sampling risk, associated with the estimate. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 183) ________ can be used prior to random selection to improve audit efficiency. Answer: Stratification Explanation: Stratification can be used prior to random selection to improve audit efficiency. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 184) ________ of the population is a way to group the population into more homogenous subgroups, which will result in more efficient sampling and reduce the size of the sample required. Answer: Stratification Explanation: Stratification of the population is a way to group the population into more homogenous subgroups, which will result in more efficient sampling and reduce the size of the sample required. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

185) Determining a sample size is one step in planning and executing a ________ sample. Answer: statistical Explanation: Determining a sample size is one step in planning and executing a statistical sample. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 186) With respect to sample size, ________ risk of incorrect acceptance is equivalent to having a higher desired level of assurance from the sample. Answer: lower Explanation: With respect to sample size, lower risk of incorrect acceptance is equivalent to having a higher desired level of assurance from the sample. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 187) ________ is generally easier to use than classical variables sampling because the auditor can calculate sample sizes and evaluate sample results by hand or with the assistance of tables. Answer: PPS Sampling or Probability Proportionate to Size sampling Explanation: PPS Sampling is generally easier to use than classical variables sampling because the auditor can calculate sample sizes and evaluate sample results by hand or with the assistance of tables. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

188) In ________ the auditor estimates the audited value of the population by adding the projected difference between audited value and book value of each strata to the book value of that strata. Answer: difference method Explanation: In difference method the auditor estimates the audited value of the population by adding (or subtracting) the projected difference between audited value and book value of each strata to the book value of that strata. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 189) Match the entities related to audit data analysis and sampling with their explanations. A. Audit data analytics B. Audit sampling C. Audit data D. Internal control ____ It is likely to be used when the audit population is large, and the auditor's tests are supported by reliable and relevant data. ____ It is required by the auditor to do audit sampling test. ____ It is likely to be used when evidence to support the audit test is not available in electronic form. ____ When it is not effective, the client data may not be reliable. Answer: Audit data analytics is likely to be used when the audit population is large, and the auditor's tests are supported by reliable and relevant data. Audit sampling is likely to be used when evidence to support the audit test is not available in electronic form. Audit data is required by the auditor to do audit sampling test. When internal controls are weak, client data may not be reliable. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

190) Match the details of sampling with their explanations. A. Sampling is not required when B. Audit sampling C. Sample D. Whenever the auditor draws a conclusion about the entire population based on a sample ____ It is a representative of the population. ____ There is some level of uncertainty about the auditor's conclusion. ____ An auditor selects less than 100% of a population and the sample is likely to provide a reasonable basis for drawing a conclusion about an entire population. ____ An audit procedure is tested on an entire group of transactions. Answer: Sampling is not required when an audit procedure is tested on an entire group of transactions. Audit sampling: an auditor selects less than 100% of a population and the sample is likely to provide a reasonable basis for drawing a conclusion about an entire population. Sample is a representative of the population. Whenever the auditor draws a conclusion about the entire population based on a sample, there is some level of uncertainty about the auditor's conclusion. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

191) Match the terms related to sampling with their details. A. Risk of incorrect acceptance B. Risk of incorrect rejection C. Sampling risk D. Non-sampling risk ____ It is typically controlled by a firm's quality control procedures. ____ It is the risk that the sample chosen by the auditor is not representative of the population of transactions or items within an account balance and, as a consequence, the auditor arrives at an inappropriate conclusion. ____ It is the risk in which the auditor concludes that a material misstatement exists when it does not exist. ____ It is the risk in which the auditor concludes that there is no material misstatement when in fact there is a material misstatement. Answer: The risk of incorrect acceptance is the risk in which the auditor concludes that there is no material misstatement, when in fact there is a material misstatement. The risk of incorrect rejection is the risk in which the auditor concludes that a material misstatement exists when it does not exist. Sampling risk is the risk that the sample chosen by the auditor is not representative of the population of transactions or items within an account balance and, as a consequence, the auditor arrives at an inappropriate conclusion. Non-sampling risk is typically controlled by a firm's quality control procedures. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

192) Match the concepts related to sampling with their details. A. Non-statistical sampling B. Statistical sampling C. Sampling risk D. Non-sampling risk ____ It requires less staff training. ____ It involves modest cost and time involved in setting up, selecting, and evaluating the sample. ____ It involves risk of incorrect acceptance and incorrect rejection. ____ It is involved when an auditor spends most of his or her time testing assertions where the risk of material misstatement is modest. Answer: Non-statistical sampling requires less staff training. Statistical sampling involves modest cost and time involved in setting up, selecting, and evaluating the sample. Sampling risk includes the risks of incorrect acceptance and incorrect rejection. Non-sampling risk is involved when an auditor spends most of his or her time testing assertions where the risk of material misstatement is modest. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

193) Match the concepts below with their definitions. A. Stratification B. Random selection C. Haphazard selection D. Systematic selection ____ A process of dividing population into groups of sampling units with similar characteristics. ____ The selection of a sample without the use of a methodical technique. ____ Selecting a sample that is free from bias and each item in a population has an equal chance of selection. ____ The selection of a sample for testing by dividing the number of items in a population by the sample size, determining a sampling interval (n), and then selecting every nth item in the population. Answer: Stratification is a process of dividing a population into groups of sampling units with similar characteristics. Random selection involves selecting a sample that is free from bias and each item in a population has an equal chance of selection. Haphazard selection is the selection of a sample without use of a methodical technique. Systematic selection is the selection of a sample for testing by dividing the number of items in a population by the sample size, determining a sampling interval (n), and then selecting every nth item in the population. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

194) Match the factors influencing the sample size with their details. A. Stratification of the population B. Tolerable misstatement C. Desired level of assurance D. The amount of expected misstatement ____ The misstatement amount that the auditor expects to find in certain class of transactions ____ If it is not obtained from other substantive procedures, the auditor needs larger samples. ____ It is the maximum dollar amount of misstatement that an auditor is willing to accept in a transaction class. ____ It is an effective way to reduce sample size for substantive procedures. Answer: Stratification of the population is an effective way to reduce sample size for substantive procedures. Tolerable misstatement is the maximum dollar amount of misstatement that an auditor is willing to accept in a transaction class. If the desired level of assurance is not obtained from other substantive procedures, the auditor needs larger samples. The amount of expected misstatement occurs when control risk is high. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

195) Match the steps in planning and evaluating the sample with their details. A. Audit objective B. Procedure to meet objectives C. Population D. Sampling unit ____ It includes tests of details of transactions and tests of details of balances. ____ It encompasses obtaining a reasonable assurance that an assertion is presented fairly in all material respects. ____ It consists of a subset of the population, which forms the basis for sampling. ____ It consists of the class of transactions or the account balance to be tested. Answer: The audit objective is to obtain reasonable assurance that an assertion is presented fairly in all material respects. Procedures to meet objectives include tests of details of transactions and tests of details of balances. A population consists of the class of transactions or the account balance to be tested. A sampling unit consists of a subset of the population, which forms the basis for sampling. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

196) Match the concepts below with their details. A. Population B. Probability Proportionate to Size (PPS) Sampling C. Limitation of PPS sampling D. Disadvantage of PPS sampling ____ It includes special considerations required in the evaluation of the sample. ____ It includes the exclusion of zero and negative balances from the population. ____ It consists of the class of transactions or the account balance to be tested. ____ It uses attribute sampling theory to express a conclusion in dollar amounts. Answer: Population consists of the class of transactions or the account balance to be tested. Probability Proportionate to Size (PPS) sampling uses attribute sampling theory to express a conclusion in dollar amounts. Limitation of PPS sampling includes the exclusion of zero and negative balances from the population. Disadvantage of PPS sampling includes special considerations required in the evaluation of the sample. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

197) Match the concepts below with their details. A. Non-statistical Sampling B. Allowance for sampling risk C. Sampling risk D. Selection of a sample ____ It should be unbiased. ____ It is a measure of whether the sample is representative or not. ____ It involves evaluation of the uncertainty associated with not sampling the entire population. ____ It relies on the auditor's judgment to determine sample size, select the sample, and project sample results on the population. Answer: Non-statistical sampling relies on the auditor's judgment to determine sample size, select the sample, and project sample results on the population. Allowance for sampling risk involves evaluation of the uncertainty associated with not sampling the entire population. Sampling risk is a measure of whether the sample is representative or not. Selection of a sample should be unbiased. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 198) Which of the following are situations where the auditor is likely to use audit sampling? Select all that apply. A) Relevant data is not reliable and internal controls over the reliability of data are weak. B) Relevant data may be in different formats and is not easy to use. C) Relevant data is reliable and internal controls over the reliability of data are strong. D) Relevant data is clean or can be cleaned up easily. Answer: A, B Explanation: The auditor is likely to use audit sampling when 1) relevant data is not reliable and internal controls over the reliability of data are weak and 2) relevant data may be in different formats and is not easy to use. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

199) In which of the following cases is audit sampling is not required? Select all that apply. A) An audit procedure is tested on an entire group of transactions. B) Auditing is done on 100% of items within an account balance. C) There are numerous transactions or items within an account balance. D) The audit population is very large. Answer: A, B Explanation: When an audit procedure is tested on an entire group of transactions (for example, all borrowing activities) or 100% of items within an account balance (for example, all loan balances), sampling is not required. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 200) Johnny and Sarah are discussing audit sampling with their supervisor, Samantha. Johnny and Sarah are relatively new employees to Hudson CPA Firm, and are learning about audit sampling. Johnny mentions to Samantha that auditors would be able to offer a higher level of assurance if they simply tested the populations of each account, so as not to risk missing any errors or fraud. Which of the following represent Samantha's best responses to this query? Select all that apply. A) Auditors do typically check the populations of larger accounts, as that is how they are able to offer reasonable assurance. B) Auditors generally select a sample from a population that they wish to test which they try to ensure is representative of the population. C) Sampling the population might sound ideal, but in practice, it would be too expensive and time-consuming, and is thus not practical. D) Auditors generally avoid auditing techniques involving samples as they are not trained statisticians and generally prefer non-statistical sampling procedures. Answer: B, C Explanation: Auditors generally select a sample from a population that they wish to test which they try to ensure is representative of the population. Sampling the population might sound ideal, but in practice, it would be too expensive and time-consuming, and is thus not practical. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

201) During the audit of a major attestation client, two audit staff associates, Kendra and Asher are discussing a recent meeting where the partner with overall responsibility for the engagement discussed occasions and scenarios whereby audit sampling might be used instead of audit data analytics (ADA) and vice-versa. Which of the following choices represent scenarios where audit data analytics may be used instead of audit sampling? Select all that apply. A) The client has advised that thanks to the installation of a new IT system, the majority of records are now available in electronic format. B) The client has advised that due to recent installation of a new IT system, stored data is much more standardized and would be easy to clean. C) Because of the client's large size and voluminous transactions, many accounts have hundreds of thousands of entries. D) The client's senior management has noted that with the switch to the new system, the number of processes and stored data/records has shrunk drastically. Answer: A, B, C Explanation: The client has advised that thanks to the installation of a new IT system, the majority of records are now available in electronic format. The client has advised that due to recent installation of a new IT system, stored data is much more standardized and would be easy to clean. Because of the client's large size and voluminous transactions, many accounts have hundreds of thousands of entries. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

202) June and Lisa, two audit interns working on the audit of Margram Enterprises, LLC are discussing sampling. The idea of sampling is new to them both, so they ask their supervisor, Rich, to explain why sampling is used, and if there is any risk associated with sampling. Which of the below represent Rich's MOST accurate response to this question? Select all that apply. A) Sampling is often used by external auditors because, due to time and financial constraints, testing every transaction in every account is typically impractical. B) Whenever a sample is selected, there is always a risk that the sample won't be representative of the population. This is known as sampling risk C) Whenever the auditors select a sample instead of the entire population, there is a risk that incorrect conclusions will be drawn. This is referred to as audit risk. D) With sampling comes the risk of incorrect acceptance, whereby the auditor determines that a material misstatement exists, when it does not actually exist. Answer: A, B Explanation: Sampling is often used by external auditors because, due to time and financial constraints, testing every transaction in every account is typically impractical. Whenever a sample is selected, there is always a risk that the sample won't be representative of the population. This is known as sampling risk Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

203) Samson and Claire are eating lunch one day and are discussing sampling and non-sampling risk. Claire advises Samson that as far as she sees it, these risks really mean the same thing. Samson replies that his understanding is that these risks are a little different, so Claire asks him to explain. Which of the following choices represent correct responses by Samson? Select all that apply. A) Sampling and non-sampling risk are different in the sense that non-sampling risk relates to the risk of misstatement when an auditor tests the population instead of a sample. B) Sampling risk pertains to the auditor drawing different conclusions based on the sample than he or she would if they tested the population. C) Non-sampling risk relates to the risk that the auditor may form an incorrect conclusion, but for reasons unrelated to sampling procedures. D) Sampling risk is best thought of as the risk that is inherent in any sample selected by the auditor. Auditors reduce sampling risk by testing the population of an account. Answer: B, C Explanation: Sampling risk pertains to the auditor drawing different conclusions based on the sample than he or she would if they tested the population. Non-sampling risk relates to the risk that the auditor may form an incorrect conclusion, but for reasons unrelated to sampling procedures. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 204) What are the consequences of sampling risk? Select all that apply. A) The risk that the audit will be ineffective. B) The risk that the audit will be inefficient. C) The risk that the audit will be incomplete. D) The risk that the audit will be inconclusive. Answer: A, B Explanation: The two consequences of sampling risk are the risk that the audit will be ineffective (fail to find material misstatements) and the risk that the audit will be inefficient (the auditor will do more audit work than is necessary). Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

205) Which of the following are the characteristics of non-statistical sampling? Select all that apply. A) It allows selecting the sample without using a formal statistical technique. B) It allows determining samples size entirely on the basis of the professional judgment. C) It helps measure sampling risk. D) It helps evaluate the sample results mathematically. Answer: A, B Explanation: Non-statistical sampling does not have the characteristics of statistical sampling. The auditor does not use a formal statistical technique to select the sample. In this technique, the auditor determines samples size entirely on the basis of the professional judgment. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 206) Which of the following are the characteristics of random sampling? Select all that apply. A) It requires that the person selecting the sample does not influence the choice of items selected. B) It is free from bias. C) Each item within the population has an equal chance of being selected for testing. D) It involves the selection of a sample for testing by dividing the number of items in a population by the sample size. Answer: A, B, C Explanation: Random selection requires that the person selecting the sample does not influence the choice of items selected. A random sample is free from bias and each item within the population has an equal chance of being selected for testing. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

207) During the audit of Seagram LLC, the external auditors, Moonlight CPA firm are preparing to test the accounts receivable and related allowance accounts. One of the internal audit staff members has mentioned a couple of accounts which it has been recommended the external auditors check due to the estimates that have been used. As a result of this, the supervisor assigned to this area of the audit is attempting to determine which audit sampling technique would be best. Which of the below answers is correct? Select all that apply. A) The auditor should select a statistical sampling procedure, ensuring that all accounts recommended by the internal audit function are included. B) The auditor should consider nonstatistical sampling, which will allow the auditor judgment to select certain samples. C) The auditor should consider adopting a statistical sampling procedure to allow the auditor to subjectively evaluate the results. D) The auditor should consider adopting a non-statistical sampling procedure in order to be able to evaluate the results more subjectively. Answer: B, D Explanation: The auditor should consider nonstatistical sampling, which will allow the auditor judgment to select certain samples. The auditor should consider adopting a non-statistical sampling procedure in order to be able to evaluate the results more subjectively. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

208) An audit manager assigned to the attestation engagement of Parker Enterprises is discussing sample size determination with an audit staff associate. The audit staff associate is questioning why samples may be different sizes, as it would seem to make more sense to keep sample sizes consistent to add an element of uniformity to the audit. Which of the following factors could the audit manager use as reasons why sample sizes might differ? Select all that apply. A) If the auditors determine that the tolerable misstatement is lower, then the sample size will need to be larger. B) If the auditors expect a large amount of misstatements in a particular population, they will typically want smaller sample sizes to compensate for this. C) If the auditors determine that it is unlikely that assurance will be obtained from other tests, sample size will typically be increased. D) If auditors determine that the risk of material misstatement is high, then the sample size is typically lowered to obtain additional assurance. Answer: A, C Explanation: If the auditors determine that the tolerable misstatement is lower, then the sample size will need to be larger. If the auditors determine that is unlikely assurance will be obtained from other tests, sample size will typically be increased. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 209) Which of the following are factors that influence the sample size when testing transactions and balances? Select all that apply. A) Stratification of the population B) The amount of expected misstatement in the population C) Tolerable misstatement D) Demographics Answer: A, B, C Explanation: The following are factors that influence the sample size when testing transactions and balances: stratification of the population, the amount of expected misstatement in the population, and tolerable misstatement. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

210) Which of the following steps are involved in planning and executing a non-statistical sample? Select all that apply. A) Judgmentally select a representative sample B) Apply audit procedures C) Randomly select a representative sample D) Determine sample size statistically Answer: A, B Explanation: Two steps involved in planning and executing a non-statistical sample are judgmentally select representative sample and apply audit procedures. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 211) Carson and Kenny are discussing audit sampling and substantive procedures. Carson, a recent addition to the CPA firm is attempting to understand what the connection is between these two components, and asks Kenny, a more experienced auditor, to explain. Which of the following are appropriate responses by Kenny? Select all that apply. A) There is no relationship between audit sampling and substantive procedures per se. Auditors just discuss sampling because of the statistics involved in sampling and substantive procedures. B) There is a relationship between these two things. Auditors use audit sampling to help select which items to perform substantive procedures on. C) Auditors typically use substantive testing and procedures in order to select a randomized sample from the population. D) Substantive procedures are ultimately designed to help the auditor obtain reasonable assurance about an item's fair presentation in all respects. Answer: B, D Explanation: There is a relationship between these two things. Auditors use audit sampling to help select which items to perform substantive procedures on. Substantive procedures are ultimately designed to help the auditor obtain reasonable assurance about an item's fair presentation in all respects. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

212) Sarah, an audit manager assigned to the audit of Seaberry Enterprises, LLC is discussing audit sampling with one of her staff interns, Jared. Jared has recently overhead Sarah mention probability-proportionate-to-size (PPS) sampling in a meeting and is curious to learn more about what this means. Which of the following responses would help Jared understand this better? Select all that apply. A) Probability-proportionate-to-size sampling is based on the theory that the larger the account, the more likely fraud or errors will be present in that account. B) This particular sampling technique is an extremely common nonstatistical sampling technique used by many prominent auditing firms. C) Probability-proportionate-to-size sampling works on the premise that the likelihood of the account being selected is proportionate to the balance of the account. D) As opposed to particular clients or accounts, the units associated with the sample are actually individual dollars in the population. Answer: C, D Explanation: Probability-proportionate-to-size sampling works on the premise that the likelihood of the account being selected is proportionate to the balance of the account. As opposed to particular clients or accounts, the units associated with the sample are actually individual dollars in the population. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 213) The Probability Proportionate to Size (PPS) sampling approach is primarily applicable in testing transactions of which of the following tests? Select all that apply. A) Receivables when unapplied credits to customer accounts are insignificant B) Investment securities C) Inventory price tests when few differences are anticipated D) Asset payables if misstatements are found Answer: A, B, C Explanation: The PPS sampling approach is primarily applicable in testing transactions of the following tests: 1. Receivables when unapplied credits to customer accounts are insignificant 2. Investment securities 3. Inventory price tests when few differences are anticipated Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

214) Which of the following are the factors that influence sample size in a substantive procedure? Select all that apply. A) The desired level of assurance that tolerable misstatement is not exceeded by the actual misstatement in the population B) Tolerable misstatement C) Stratification of the population into more homogenous subgroups D) The amount of expected level of assurance of misstatement Answer: A, B, C Explanation: Following are the factors that influence sample size in a substantive procedure: · The desired level of assurance that tolerable misstatement is not exceeded by the actual misstatement in the population · Tolerable misstatement · Stratification of the population into more homogenous subgroups Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 215) Two audit interns, Mike and Caroline are discussing the use of nonstatistical sampling procedures which are being used on the audit they are currently assigned to. Mike and Caroline approach their supervisor, Geoff, to ask why the audit firm would use nonstatistical procedures when there are a variety of statistical options available. Which of the following should Geoff respond with? Select all that apply. A) The decision as to whether to use statistical or non-statistical procedures is made on a caseby-case basis by the external auditors in conjunction with client management. B) Nonstatistical sampling is typically less complex than statistical sampling procedures, and thus are easier to understand and implement. C) Oftentimes, nonstatistical sampling procedures are able to be performed more quickly than statistical sampling procedures. D) Nonstatistical sampling techniques make it easier for the auditor performing the procedures to quantify the precise level of sampling risk. Answer: B, C Explanation: Nonstatistical sampling is typically less complex than statistical sampling procedures, and thus are easier to understand and implement. Oftentimes, nonstatistical sampling procedures are able to be performed more quickly than statistical sampling procedures. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

216) During a meeting of the senior managers and audit partners of Huckleberry CPAs, an audit intern hears one of the partners mention classical variables sampling in discussions surrounding a new client. After the meeting, the intern asks her supervisor to explain what this means. Which of the following responses to this question would be appropriate? Select all that apply. A) Classical variables sampling is only used on the audit of publicly traded firms due to their voluminous accounts and high number of transactions. B) Classical variables sampling is based on the statistical theory of a normal distribution and compares a selected sample with a sample drawn from the population. C) Classical variables sampling often utilizes mean per unit estimation techniques to attempt to determine where any misstatements may be. D) Classical variables sampling is used by the external auditors to determine which accounts are most likely to contain misstatements. The auditor can then issue a qualified opinion on those accounts. Answer: B, C Explanation: Classical variables sampling is based on the statistical theory of a normal distribution and compares a selected sample with a sample drawn from the population. Classical variables sampling often utilizes mean per unit estimation techniques to attempt to determine where any misstatements may be. Diff: 3 LO: 8 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 217) An underlying requirement of ________ is that the client's data be reliable. A) ADA B) Audit sampling C) Random sampling D) Block selection Answer: A Explanation: An underlying requirement of ADA is that the client's data be reliable. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

218) The auditor uses ________ when certain audit procedures are required by professional standards. A) audit sampling B) modified sampling C) audit data analytics D) statistical sampling Answer: A Explanation: The auditor will usually use audit sampling when certain audit procedures are required by professional standards. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 219) The risk of ________ represents a situation where the auditor has conducted substantive procedures on a sample and concluded that there is a material misstatement in an assertion, when in fact there is no material misstatement. A) incorrect acceptance B) incorrect rejection C) non-sampling D) incorrect valuation Answer: B Explanation: The risk of incorrect rejection represents a situation where the auditor has conducted substantive procedures on a sample and concluded that there is a material misstatement in an assertion, when in fact there is no material misstatement. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

220) When an auditor uses his/her judgment alone to select a sample for testing, it is called the ________ method of sampling. A) non-statistical B) statistical C) haphazard D) substantive Answer: A Explanation: When an auditor uses his/her judgment alone to select a sample for testing, it is called the non-statistical method of sampling. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 221) Higher levels of ________ result in larger sample size. A) desired assurance B) tolerable misstatement C) expected misstatement D) stratification Answer: A Explanation: Higher levels of assurance result in larger sample size. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 222) ________ requires a sample be selected randomly and the results of the test be evaluated using probability theory. A) Statistical sampling B) Non-statistical sampling C) Haphazard sampling D) Systematic sampling Answer: A Explanation: Statistical sampling requires a sample be selected randomly and the results of the test be evaluated using probability theory. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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223) ________ will be MOST effective when the auditor wants particular evidence to support a conclusion about fair presentation of an account. A) Audit sampling B) Audit data analytics C) Non-statistical sampling D) Block selection Answer: A Explanation: Audit sampling will be most effective when the auditor wants particular evidence to support a conclusion about fair presentation of an account. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 224) Probability Proportionate to Size (PPS) sampling is not suitable in A) testing liabilities B) testing assets C) cases when there are zero and negative balances D) overstating accounts payable Answer: C Explanation: PPS sampling is not suitable when there are zero and negative balances. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 225) The auditor's best opportunity to obtain a representative sample is to select a ________. A) random sample B) systematic sample C) haphazard sample D) judgmental sample Answer: A Explanation: The auditor's best opportunity to obtain a representative sample is to select a random sample. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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226) Ron and Jayne are discussing audit sampling, and how this technique is typically used by auditors as part of an attestation engagement. Jayne is a recent addition to Martin CPA Firm and mentions to Ron that if auditors are concerned with misstatements and potential litigation stemming from misstatements, they should just audit the population instead. Which of the following responses by Ron would best address Jayne's statement? A) Auditors would like to be able to analyze entire populations of clients' accounts, but statistical theory indicates that a sample of 5-10% of the population provides the same results, hence there is no need. B) Auditors routinely employ both statistical and nonstatistical audit sampling techniques as part of an audit. Testing the population of a client's transactions and balances in cases where ADA cannot be used would be too time and cost prohibitive, C) Auditing the population of a client's accounts is typically performed by the internal auditors, as they are employed by the client permanently. The external auditor's job is thus to just examine exceptions noted by the internal auditors. D) Generally accepted auditing standards prescribe strict rules on the percentage of a population the external auditor should examine. For example, a publicly traded company can expect to have around seventy five percent of its accounts tested as part of a normal sample. Answer: B Explanation: Auditors routinely employ both statistical and nonstatistical audit sampling techniques as part of an audit. Testing the population of a client's transactions and balances in cases where ADA cannot be used would be too time and cost prohibitive. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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227) Derek and Wayne, two audit managers assigned to the audit of Fitzgerald Enterprises, LLC are discussing how best to audit the inventory accounts of the client. Derek suggests that because the client maintains all records in electronic format, this would be a good use of audit data analytics (ADA). Wayne disagrees that audit data analytics is the MOST appropriate choice in this case for which of the following reasons? A) At some point, we are going to need to check the physical existence of inventory. It may be beneficial to us that the records are in electronic form, but that doesn't help us with checking it really exists. B) The records being in electronic format are certainly beneficial to us, but we will need to employ physical sampling techniques in order to test the completeness assertion associated with the inventory accounts. C) It would be easier and more appropriate for us to use an audit sampling technique, as the client doesn't maintain a large amount of inventory and keeps basic records only. D) None of the choices is correct. Answer: A Explanation: At some point, we are going to need to check the physical existence of inventory. It may be beneficial to us that the records are in electronic form, but that doesn't help us with checking it really exists. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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228) Carly and Simon are discussing how best to approach the audit of accounts receivable and the related allowance accounts for one of their major audit clients. Carly suggests that in order to save time, they simply obtain a small sample of around one percent of the population of receivables. Simon agrees, adding that if they do that, they can focus more time on other areas of the audit. What is the risk associated with Carly and Simon's plan, and how is the risk best explained? A) The risk associated with Carly and Simon's plan is referred to as audit risk. This is the risk associated with the auditor rendering a different opinion on internal control than misstatements within the financial statements. B) The risk associated with Carly and Simon's plan is referred to as inherent risk. This risk is present in all accounts for all firms in every industry It is the auditor's job to identify and eliminate inherent risk in order to be able to render a clean audit opinion. C) The risk associated with Carly and Simon's plan is known as sampling risk. This type of risk pertains to the risk that the auditor reaches a different opinion based on the sample tested than he or she would if they tested the population as a whole. D) This type of risk is termed the risk of material misstatement. The risk of material misstatement is typically assessed as higher by the auditors when they have gained an understanding of the client and have determined that entity-level controls are effective and robust. Answer: C Explanation: The risk associated with Carly and Simon's plan is known as sampling risk. This type of risk pertains to the risk that the auditor reaches a different opinion based on the sample tested than he or she would if they tested the population as a whole. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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229) An external auditor is working on the audit of the notes receivable accounts for a major audit client. The client has five major notes receivable outstanding from different parties. The auditor is already behind schedule on the audit and decides to audit just one of the five notes receivable to try and get back on schedule. What risk does this represent, and why? A) This audit strategy represents an example of the risk of incorrect acceptance, as by only auditing one of the five notes receivable accounts, the auditor may incorrectly conclude that no material misstatements exist when in fact misstatements are present. B) This audit strategy is an example of the risk of material misstatement. This risk is best defined as the risk that the auditor incorrectly modifies his or her opinion on financial statements from a clean opinion to either a qualified or adverse opinion, when no misstatements are actually present. C) This type of audit strategy represents an example of the risk of incorrect rejection because the auditor only tested one of the five notes receivable outstanding. As a result of this, the auditor may incorrectly reject the one notes receivable account tested as not being materially misstated. D) None of the choices is correct. Answer: A Explanation: This audit strategy represents an example of the risk of incorrect acceptance, as by only auditing one of the five notes receivable accounts, the auditor may incorrectly conclude that no material misstatements exist when in fact misstatements are present. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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230) During the audit of SeaBreeze enterprises, the external auditors, Cannon CPAs are discussing ways to cut the number of billable hours for the overall audit. An audit manager suggests that, for the notes payable and related interest accounts, the auditors decrease the nature, timing, and extent of procedures conducted. If this audit strategy is adopted pertaining to the notes payable and related interest accounts, what risk may the audit firm be exposing itself to? A) By adopting this audit strategy, the auditing firm may be exposing itself to the risk of incorrect acceptance. This is because as a result of the decreased nature, timing, and extent of audit procedures, the auditor may incorrectly accept a sample that is not representative of the population. B) If the audit firm adopts this strategy, the auditing firm may be exposing itself to the risk of incorrect rejection due to the decreased nature, timing, and extent of audit procedures. Alternative, less substantive procedures may cause the auditor to believe a misstatement exists when this is not the case. C) If the audit firm proceeds with adopting this strategy, the auditors conducting the audit may expose the firm to the risk of material misstatement. This is because when the auditors decide to decrease the nature, timing, and extent of audit procedures conducted, inherent risk automatically increases. D) None of the choices is correct. Answer: A Explanation: By adopting this audit strategy, the auditing firm may be exposing itself to the risk of incorrect acceptance. This is because as a result of the decreased nature, timing, and extent of audit procedures, the auditor may incorrectly accept a sample that is not representative of the population. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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231) Two audit staff associates, Sue and Ken are working on their first audit, and are discussing audit sampling over lunch one day. Ken has spent the morning working on selection of audit sampling procedures with his supervisor and is keen to discuss his experiences with Sue. Sue is yet to work on sampling as part of an audit and asks Ken to explain what types of procedures the auditor can use, and how an audit firm would pick one type of sampling procedure over another. Which of the following is Ken's best response to this question? A) Audit sampling is generally split into quantitative and qualitative sampling techniques. Quantitative techniques are generally used more for public companies and quantitative techniques for private firms. B) Generally accepted auditing standards have strict rules for auditors to follow when it comes to audit sampling. Auditors are bound to follow these rules, which require statistical techniques for account balances over a certain threshold dollar amount. C) Audit sampling techniques used by auditing firms are generally split into statistical and nonstatistical sampling techniques. It is really a subjective decision made by the audit firm as to which type of procedure to use. D) Audit sampling procedures are typically determined by the auditing firm and vary depending on whether the client's system of internal control or the financial statements themselves are being tested. Answer: C Explanation: Audit sampling techniques used by auditing firms are generally split into statistical and non-statistical sampling techniques. It is really a subjective decision made by the audit firm as to which type of procedure to use. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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232) Marty has been assigned to the audit of Jackson Enterprises, LLC, a large firm and nationwide distributor of candy and other confectionary products throughout the continental United States. For this particular week, Marty's supervisor has advised him that he will be working on the audit of accounts receivable and will need to select an appropriate and representative sample from the population. Marty is confused and asks his supervisor to clarify what the population would be in this case? Which of the following represents Marty's supervisor's best response to this question? A) The population in this case would be all client accounts from the general ledger. You will need to make sure you select a nonrandomized sample, so you only get accounts receivable accounts in your sample. B) For this, the population in question would be all of the client's accounts receivables. Due to time and financial constraints, you will need to determine how to obtain an accurate and representative sample of that population. C) For the accounts receivable accounts, the population in question will be the client's allowance accounts. Because of their close relationship to accounts receivable, they are counted as the population for receivables. D) None of the choices is correct. Answer: B Explanation: For this, the population in question would be all of the client's accounts receivables. Due to time and financial constraints, you will need to determine how to obtain an accurate and representative sample of that population. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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233) Stephen and Anna are working on the audit of Flower Enterprises, a regional distributor of floral bouquets and other decorations in the southwestern United States. The Chief Financial Officer of Flower Enterprises has advised that the variance in balances for accounts receivable is extremely wide, with some corporate clients maintaining large receivables balances, and other individual clients keeping smaller balances. Based on this information, which of the following sampling strategies is MOST likely to be adopted by the auditing firm? A) The auditing firm is likely to adopt a reliance sampling strategy. This strategy allows the auditor to place reliance on a randomized sample and extrapolate conclusions and findings to the entire population. B) The auditing firm will likely adopt a non-statistical sampling procedure whereby the auditor uses experience and judgment to only select clients and balances that the auditor feels may be prone to error and/or fraud. C) The auditing firm may decide to adopt a stratified random sampling technique whereby the auditor separates a population into different levels or strata prior to sampling. Use of this technique allows the auditor to determine strata which may represent higher risk and need more items tested. D) The auditing firm may decide to adopt a haphazard selection process. This process involves the auditor performing a randomized statistical sample and then haphazardly selecting items from that sample to test. Answer: C Explanation: The auditing firm may decide to adopt a stratified random sampling technique whereby the auditor separates a population into different levels or strata prior to sampling. Use of this technique allows the auditor to determine strata which may represent higher risk and need more items tested. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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234) During the prior year's audit of Buttercup Industries, Inc., the auditors, Squash CPAs noted a number of misstatements in the client's financial statements. As a result of this, there has been discussion among the audit managers and partners assigned to this years' audit with respect to the level of tolerable misstatement for this year's audit. It has been decided by the partner with overall responsibility for the engagement that tolerable misstatement for this year's audit should be decreased. As a result of this, which of the following is true? A) If tolerable misstatement is to be decreased for the forthcoming year's audit, then risk of material misstatement must also be increased. If both of these factors are increased, this will help the audit firm to decrease overall audit risk. B) If the goal for this year's audit is to reduce the level of tolerable misstatement, then the auditors should plan to keep the audit population as one group, as opposed to stratifying the population. By keeping the population together, the auditor is more likely to detect misstatements. C) If the audit partner with overall responsibility for the engagement wishes to decrease the level of tolerable misstatement, it is likely that the auditors will need to increase sample size to compensate for this. A larger sample size should provide the auditor with greater assurance that the level of tolerable misstatement has not been exceeded. D) None of the choices is correct. Answer: C Explanation: If the audit partner with overall responsibility for the engagement wishes to decrease the level of tolerable misstatement, it is likely that the auditors will need to increase sample size to compensate for this. A larger sample size should provide the auditor with greater assurance that the level of tolerable misstatement has not been exceeded. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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235) Adam and Steve, two audit managers employed by Manchester CPAs are discussing sampling risk, and how sampling risk pertains to the audit itself; specifically, the level of assurance provided by the auditing firm. Adam tells Steve that although he understands why auditing firms want to be in a position to provide the highest level of assurance possible, he doesn't really see what this has to do with sampling risk. Which of the following represent Steve's best response to this question? A) Sampling risk and the level of assurance the auditing firm can provide are closely related. If an auditor wishes to provide higher levels of assurance, then sampling risk is usually increased to ensure this is the case. B) The level of assurance offered by the auditing firm and the level of sampling risk the firm is willing to accept are related. If the auditors determine that they wish to provide higher levels of assurance, then sampling risk is decreased. C) Sampling risk is not related to the level of assurance the auditing firm wishes to provide and is inversely related to inherent risk. It is also directly related to detection risk. D) None of the choices is correct. Answer: B Explanation: The level of assurance offered by the auditing firm and the level of sampling risk the firm is willing to accept are related. If the auditors determine that they wish to provide higher levels of assurance, then sampling risk is decreased. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 236) Hannah McGregor is auditing the accounts receivable for GDI Printing, Inc. She plans to use sampling to select accounts for confirmations. Explain the effect each of the following factors will have on the sample size: o Hannah has determined that she needs a higher level of assurance that tolerable misstatement is not exceeded by the actual misstatement in the population. o Hannah has determined that the tolerable misstatement should be smaller. o Hannah is expecting small amounts of misstatement in the population. Answer: o Higher levels of assurance should result in larger sample size. o If the auditor can only tolerate small amounts of misstatement and conclude that the account balance is presented fairly, the auditor will need larger sample sizes. o Smaller amounts of expected misstatements in the population will result in smaller sample sizes. Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

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237) The accounting department of the client reports that the balance of accounts receivable is $210,000. The auditor is willing to accept that balance if it is within $15,000 of the actual balance. Using a variables sampling plan, the auditor computes a 95% confidence interval of $208,000 to $225,000. Should the auditor accept this balance? Answer: The auditor can accept the $210,000 balance because the confidence interval is within the materiality limits. Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 238) Important substantive procedures include tests of details of transactions and tests of details of balances. These are the most common procedures where the auditor would use audit sampling for substantive procedures. List two examples of tests an auditor might choose to use audit sampling for. Answer: Student answers will vary but may include: o The auditor might audit the existence of accounts receivable by sending confirmations. o The auditor might audit the existence of inventory by physically inspecting inventory. o The auditor might focus audit procedures related to the existence of property, plant, and equipment (PP&E) on starting with a beginning audited balance and then audit changes to PP&E. o The auditor might test the additions to PP&E by vouching to the documentation underlying the transaction. Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

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239) Dave and Sandra, audit staff associate and manager respectively, are discussing audit sampling and its relationship to evidence collected one day over lunch. Dave, a relatively new employee, is keen to learn more about this area. Dave mentions to Sandra that he would think statistical sampling procedures would yield better, more reliable evidence than non-statistical sampling procedures. How should Sandra respond MOST appropriately to this statement? A) Sandra should explain to Dave that statistical sampling procedures do indeed yield better evidence than non-statistical sampling procedures. This is because statistical sampling procedures are more randomized and thus more objective in selecting evidence. B) Sandra should explain to Dave that when an auditor elects to use a statistical or non-statistical sampling procedure, the choice of sampling method affects the evidence gathered and selection of audit procedures. C) Sandra should explain to Dave that the easiest thing to do is consult generally accepted auditing standards which set forth rules on when statistical versus non-statistical sampling should be used. For example, it is recommended that statistical sampling be used for publicly traded companies. D) None of the choices is correct. Answer: B Explanation: Sandra should explain to Dave that when an auditor elects to use a statistical or non-statistical sampling procedure, the choice of sampling method affects the evidence gathered and selection of audit procedures. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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240) Charlotte and Ben, two new audit staff associate at Wallace CPA Firm and recent college graduates are discussing substantive testing and its relationship to audit sampling. There is some debate between the two as to what this relationship is, so they approach you, their supervisor, for explanation and clarification. Which of the below responses would be MOST appropriate to explain this relationship? A) Substantive testing is used to help the auditors determine what exactly to sample. In other words, substantive testing is used to determine the sample itself and the sample size. B) Substantive testing is really more focused on a client's system of internal control. Substantive testing is used more heavily in audits of private companies, as larger, publicly traded companies typically have well-developed systems of internal control which do not require sampling techniques. C) Substantive testing and audit sampling are related. The best way to think about it is that audit sampling is used to determine what items in a population to test, and substantive testing are the actual procedures used to obtain reasonable assurance that the assertion being tested is presented fairly. D) Substantive testing and audit sampling are related. Statistical audit sampling is used extensively by the auditors, however for cases when non-statistical sampling is more appropriate, the auditors will often perform substantive testing also to gain additional assurance. Answer: C Explanation: Substantive testing and audit sampling are related. The best way to think about it is that audit sampling is used to determine what items in a population to test, and substantive testing are the actual procedures used to obtain reasonable assurance that the assertion being tested is presented fairly. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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241) Joan and Colin, two audit managers are discussing audit sampling with an audit staff associate, Phil. As a recent hire, Phil is keen to learn more about the different types and methods of audit sampling, and when it is best to use each sampling type. The current audit client is a large company with a strong system of internal control and reliable electronic records and documentation. Phil asks Colin and Joan which audit sampling method would be best for this client. Which of the following represents Colin and Joan's MOST appropriate response to this question? A) The choice of auditing method is always a subjective decision. It really comes down to auditor experience and judgment. In this case, as the client has a strong system of internal control and its transactions and records are in electronic form, audit data analytics might be used to search for anomalies. B) The choice of auditing method is a subjective decision in almost all cases. It is customary for the auditor to make the decision as to which sampling method to use in conjunction with client management, as management know the firm's data and systems better than the auditor. C) The choice of auditing method is usually determined toward the end of the audit by the auditor. The auditor will typically examine the firm structure, the strength of the system of internal control, and the client's internal audit function, and then decide accordingly. D) Generally accepted auditing standards require that auditors use statistical sampling methods for publicly traded companies and are free to use non-statistical sampling methods for private companies. Answer: A Explanation: The choice of auditing method is always a subjective decision. It really comes down to auditor experience and judgment. In this case, as the client has a strong system of internal control and its transactions and records are in electronic form, audit data analytics might be used to search for anomalies. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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242) Ben and Wallace are discussing audit sampling over lunch one day. Ben is being mentored by Wallace and is keen to learn more about this area of auditing. Ben and Wallace have spent the morning working on the audit of a major attestation client, in particular determining which sampling procedure to use for the client's large accounts receivable files. Ben has heard Wallace talking about probability-proportionate-to-size sampling and asks Wallace to elaborate on what exactly this is. Which of the following would be Wallace's best response? A) Probability-proportionate-to-size sampling is a non-statistical sampling procedure. It is used in cases where the auditors are dealing with low-risk accounts and low balances in those accounts. B) Probability-proportionate-to-size sampling is used more on publicly traded companies. The auditors randomly select accounts in conjunction with client's management, and the larger accounts are always audited via this procedure. C) Probability-proportionate-to-size sampling is a type of sampling procedure whereby the higher the balance in a particular account relative to all accounts in the population, the greater the likelihood of that account being audited. D) None of the choices is correct. Answer: C Explanation: Probability-proportionate-to-size sampling is a type of sampling procedure whereby the higher the balance in a particular account relative to all accounts in the population, the greater the likelihood of that account being audited. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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243) June and Sam are discussing audit sampling one day while at lunch. June is an audit intern from a local state university and is fascinated by the various sampling methods at the auditor's disposal. June has heard Sam mentioning representative samples in various meetings both with audit colleagues and with the audit client, and asks Sam to explain what this is, and why it is important. Which of the following responses by Joel would be MOST appropriate? A) A representative sample is extremely important in the world of auditing. As auditors routinely test the populations of accounts, the representative sample ensures the auditor can provide reasonable assurance. B) A representative sample is extremely important in the world of auditing. Auditors need to employ procedures to try and ensure to the best extent possible that the sample they obtain is representative of the population. If the sample is not representative of the population, it may cause the auditor to draw incorrect conclusions about the population being tested. C) Auditors routinely attempt to obtain representative samples of the population they are attempting to test. If the auditors are able to determine that the sample is representative when they test the whole population, this will ensure that reasonable assurance can be offered by the auditor. D) Representative samples of an audit population are extremely important. Generally accepted auditing standards require the auditor to consult with both client management and the internal audit function to determine what a representative sample may be. Answer: B Explanation: A representative sample is extremely important in the world of auditing. Auditors need to employ procedures to try and ensure to the best extent possible that the sample they obtain is representative of the population. If the sample is not representative of the population, it may cause the auditor to draw incorrect conclusions about the population being tested. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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244) You are the audit senior on a large engagement. You have decided to use Probability Proportionate to Size sampling in testing plant asset additions for overstatement. The new intern working with you has questioned why you are using PPS sampling. Draft an answer to the intern, explaining at least three advantages of using PPS sampling. Answer: The advantages of PPS sampling are: o It is generally easier to use PPS than classical variables sampling because the auditor can calculate sample sizes and evaluate sample results by hand or with the assistance of tables. o The size of a PPS sample is not based on any measure of the estimated variation of audit values. o PPS sampling automatically results in a stratified sample because items are selected in proportion to their dollar values. o PPS systematic sample selection automatically identifies any item that is individually significant if its value exceeds an upper monetary cutoff. o If the auditor expects no misstatements, PPS sampling will usually result in a smaller sample size than under classical variables sampling. o A PPS sample can be designed more easily, and sample selection may begin before the complete population is available. Diff: 3 LO: 6 Bloom: Synthesis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 245) In an accounts receivable sample with a sampling interval of $5,000 an auditor identifies a recorded amount of $10,000 which has an audited amount of $8,000. If this was the only error that the auditor discovered, what would the projected misstatement for this sample be? Answer: $2,000 Diff: 3 LO: 7 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 246) An account balance is $300,000 and there are 25 items in the account, six of which have balances that equal or exceed $15,000. To ensure that all accounts with balances of at least $15,000 are selected, what would the sampling interval be? Answer: $ 15,000 Diff: 3 LO: 7 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

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247) Joe Cool, CPA is reviewing a sample of his client's accounts payable. Joe finds evidence that the account may be materially misstated. What are Joe's options? Answer: Joe Cool's options are: (1) increase the sample size (2) perform additional substantive procedures (3) adjust the account (4) issue a qualified or adverse opinion if management refuses to adjust the account Diff: 2 LO: 7 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 248) Abbie, the owner of a small CPA firm and her new employee Richard are working on the audit of Janeway Enterprises, Inc., a distributor of household appliances throughout the southeastern United States. Abbie has selected a sample for the accounts receivable population she wishes to test and has performed substantive procedures accordingly. Richard overhears Abbie discussing an allowance for sampling risk with the Chief Financial Officer of the client. Once the client has left, Richard asks Abbie to explain what an allowance for sampling risk is, and why the auditors would allow this. Which of the following represents the MOST appropriate response to these questions? A) An allowance for sampling risk is built into every audit. This allowance allows us to be less precise on each account we audit and still provide reasonable assurance and a clean audit opinion on the financial statements. B) An allowance for sampling risk speaks to the probability that the auditor will select a sample which is not representative of the population. In instances where the auditor is only selecting a sample and not the entire population, the auditor will only offer limited assurances and make clear disclosures in the audit report. C) An allowance for sampling risk relates to the fact that in most cases, the auditor is not auditing the entire population. Instead, the auditor typically audits a sample which the auditor believes is representative of the population being tested. Due to the uncertainty associated with not auditing the entire population, an allowance for sampling risk is included. D) None of the choices is correct. Answer: C Explanation: An allowance for sampling risk relates to the fact that in most cases, the auditor is not auditing the entire population. Instead, the auditor typically audits a sample which he or she believes is representative of the population being tested. Due to the uncertainty associated with not auditing the entire population, an allowance for sampling risk is included. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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249) Dan and Lily, two audit staff associates are discussing audit sampling while working on the audit of a major client. Dan is explaining to Lily the various audit sampling methods that he has seen being used by audit managers. Dan asks Lily if she has ever heard of the ratio method with respect to evaluating sample results. Lily replies that she has not, so they decide to ask their supervisor, Brad. Which of the following responses from Brad would be MOST appropriate to answer this question? A) The ratio method is set forth in generally accepted auditing standards and is required to be used for the audits of public companies. The ratio method calculates the ratio of tolerable misstatement to actual misstatement and then extrapolates that ratio to the population. B) The ratio method is used by auditors in conjunction with the internal audit function. The method compares the level of misstatements found by the external auditors to that found by the internal auditors and a ratio is calculated accordingly. C) The ratio method is typically used by the external auditors when evaluating sample results and is used to estimate the projected audit value of the population. The auditor obtains the ratio by examining the ratio of the audited value and dividing it by the book value for each strata used as part of the sample. D) The ratio method is typically used by the external auditors when evaluating sample results and is designed to assist the auditor in determining a projected audit value for the population. The ratio is calculated by dividing the tolerable misstatement for each sample by the reliability factor. Answer: C Explanation: The ratio method is typically used by the external auditors when evaluating sample results and is used to estimate the projected audit value of the population. The auditor obtains the ratio by examining the ratio of the audited value and dividing it by the book value for each strata used as part of the sample. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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250) John and Susan are discussing the various audit sampling techniques available to auditing firms after their auditing class one day. John mentions to Susan that he heard the auditing professor discussing standard deviation and sample size as part of classical variables sampling and was confused as he always thought standard deviation had more to do with statistics than auditing. John asks Susan if she understood what the professor was referring to, and if there is any connection to classical variables sampling. Which of the following would be Susan's best response to this question? A) Classical variables sampling is one of the many audit sampling options available to auditing firms undertaking an attestation engagement. There is an inverse relationship between standard deviation and sample size, in that when estimated standard deviation is lower, sample size should be higher. B) Classical variables sampling is one of a large number of audit sampling options available to auditing firms. If an auditor is using classical variables sampling, then a direct relationship exists between estimated standard deviation and sample size, in that the larger the expected standard deviation, the larger the sample size, and vice-versa. C) There is a relationship between classical variables sampling and audit sample size. If more variables are to be sampled as part of the audit, then sample size is typically assessed as higher. Standard deviation refers to where the average point in the sample will lie, and how far it may deviate from the population average. D) None of the choices is correct. Answer: B Explanation: Classical variables sampling is one of a large number of audit sampling options available to auditing firms. If an auditor is using classical variables sampling, then a direct relationship exists between estimated standard deviation and sample size, in that the larger the expected standard deviation, the larger the sample size, and vice-versa. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

Auditing, 2e (Johnson) Chapter 11 Auditing the Revenue Process 1) For companies that sell goods or services on account, there is significant interaction between sales and accounts receivable. Answer: TRUE Explanation: For companies that sell goods or services on account, there is significant interaction between sales and accounts receivable. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 2) Understanding how the entity earns and recognizes revenue assists the auditor in developing an expectation of total revenues by understanding the client's capacity, marketplace, and customers. Answer: TRUE Explanation: Understanding how the entity earns and recognizes revenue assists the auditor in developing an expectation of total revenues by understanding the client's capacity, marketplace, and customers. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 3) Analytical procedures are an optional part of every audit as part of audit planning. Answer: FALSE Explanation: Analytical procedures are required in every audit as part of audit planning. They are cost effective, and they are often effective in identifying potential misstatements in the financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

4) Management often has more incentives to understate revenues than to overstate revenues. Answer: FALSE Explanation: Management often has more incentives to overstate revenues than to understate revenues. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 5) Risks associated with revenue recognition are such that auditors often consider the occurrence of revenues and the existence of receivables assertions to be a significant inherent risk. Answer: TRUE Explanation: Risks associated with revenue recognition are such that auditors often consider the occurrence of revenues and the existence of receivables assertions to be a significant inherent risk. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 6) A debit memo is a form stating the particulars of a credit to accounts receivable, including the specific items returned, prices, and amount credited to a customer's account. Answer: FALSE Explanation: A credit memo is a form stating the particulars of a credit to accounts receivable, including the specific items returned, prices, and amount credited to a customer's account. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

7) The cash receipts function, which includes the process of receipts from cash and credit sales, involves the following subfunctions: (1) disbursing cash, (2) depositing cash, and (3) recording the receipts. Answer: FALSE Explanation: The cash receipts function, which includes the process of receipts from cash and credit sales, involves the following sub functions: (1) receiving cash (2) depositing cash and (3) recording the receipts. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 8) The effectiveness of IT controls usually depends on both effective entity level controls and effective IT general controls. Answer: TRUE Explanation: If the client relies on IT controls and the auditor plans to assess control risk as low for specific (e.g., revenue process) assertions, the auditor will usually test the effectiveness of IT general controls. The auditor will usually test the effectiveness of IT general controls as part of testing entity-level controls. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 9) Most auditors plan to test controls in the revenue cycle because of the relatively low volume of routine transactions in this cycle. Answer: FALSE Explanation: Most auditors plan to test controls in the revenue cycle because of the high volume of routine transactions in this cycle. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

10) An audit must be customized each year because inherent risk factors for a client ________. A) will vary from year to year B) should be invariant throughout the industry C) should be fixed over time D) should be discussed with regulatory agencies Answer: A Explanation: As inherent risk factors vary from industry to industry, from client to client, and from year to year, each audit must be custom made to address unique risks. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 11) There is significant interaction between cash receipt transactions and accounts receivable because ________. A) the creation of an account receivable indicates receipt of cash B) a misstatement of cash receipts will result in a misstatement of accounts receivable. C) a misstatement of cash receipts will result in a misstatement of interest payments D) the settlement of an account receivable will result in a decrease to the cash account Answer: B Explanation: There is significant interaction between cash receipt transactions and accounts receivable because a misstatement of cash receipts will result in a misstatement of accounts receivable. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 12) If discounts are given for early payment, ________. A) sales discounts are recorded when recording the cash receipt and reducing a customer's receivable B) the customer's account payable balance should be decreased accordingly C) the company should credit the Sales Discount account D) an increase in equity will result from a customer taking the discount Answer: A Explanation: If discounts are given for early payment, sales discounts are recorded when recording the cash receipt and reducing a customer's receivable. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 4

13) Gross sales refers to ________. A) total revenues before any deductions, such as deductions for sales returns and allowances. B) total revenues, net of deductions for sales returns and allowances C) earnings before interest and taxes D) operating income Answer: A Explanation: Gross sales refers to total revenues before any deductions, such as deductions for sales returns and allowances. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 14) A primary account balance in the revenue cycle is ________. A) accounts payable B) accounts receivable C) cost of goods sold D) gross profit Answer: B Explanation: A primary account balance in the revenue cycle is accounts receivable. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 15) For companies that sell goods or services on account, if revenue is recognized prematurely, what would be overstated: sales or accounts receivable? A) Both sales and accounts receivable B) Sales, not accounts receivable C) Accounts receivable, not sales D) Neither sales nor accounts receivable Answer: A Explanation: For companies that sell goods or services on account, there is significant interaction between sales and accounts receivable. If revenue is recognized prematurely, both sales and accounts receivable will be overstated. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 5

16) In the revenue cycle, which of the following assertions does not apply to the relevant account balances in the revenue cycle? A) Existence B) Completeness C) Valuation D) Classification Answer: D Explanation: In the revenue cycle, the assertions made by relevant account balances are existence, rights and obligations, completeness, and valuation and allocation. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 17) To which part of the revenue cycle does the assertion of valuation at historical cost and at net realizable value pertain? A) Account balances B) Transaction classes C) Disclosures D) All of these answer choices are correct Answer: A Explanation: In the revenue cycle, the assertion of valuation at historical cost and at net realizable value pertains to account balances. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

18) Sue and Carrie are discussing the audit of one of their major client's revenue accounts. Sue mentions to Carrie that being a relatively new and inexperienced auditor, she is unsure as to what would need to be audited. Which of the following represents Carrie's best response to this question? A) Auditing revenue accounts for clients is relatively homogenous. Although there is a little variation from industry to industry, the audit procedures are generally the same. B) Auditing revenue accounts is likely to involve testing the revenue accounts themselves as well as cash and receivables accounts, depending on the terms of the sales transaction. C) When auditing revenue accounts, it is customary for the auditor to start with contra-revenue accounts such as sales discounts and allowances, and work backwards to the revenue accounts themselves. D) None of these answer choices apply. Answer: B Explanation: Auditing revenue accounts is likely to involve testing the revenue accounts themselves as well as cash and receivables accounts, depending on the terms of the sales transaction. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 19) The market share ratio is useful in assessing the reasonableness of ________. A) both total revenues and gross margins B) total revenues, not gross margins C) gross margins, not total revenues D) None of these answer choices are correct. Answer: A Explanation: The market share ratio is useful in assessing the reasonableness of both total revenues and gross margins. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

20) A credit sale should always include debits to accounts receivable and cost of goods sold, and credits to ________. A) sales discounts and allowances B) sales and inventory C) sales and sales discounts D) sales discounts and inventory Answer: B Explanation: A credit sale should always include debits to accounts receivable and cost of goods sold, and credits to sales and inventory. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 21) During the audit of Newsome Enterprises, LLC, a retailer of hang gliders and other sporting equipment, the auditors are about to begin testing of credit sales. Which of the following correctly represent accounts that the auditors would likely test as part of this process? A) The auditors would likely test the cash account to confirm receipt of sales-related cash, and accounts payable accounts, to ensure the transaction was initially recorded correctly. B) The auditors would typically audit the notes receivable accounts to ensure credit sales were recorded correctly initially, and the cash account to account for outgoing cash. C) The auditors are likely to audit revenue accounts to confirm the occurrence of revenue, and cash accounts to confirm collection of subsequent receivables. D) The auditors are likely to audit revenue accounts to confirm the existence of revenue, and receivables accounts to confirm the occurrence of related receivables. Answer: C Explanation: The auditors are likely to audit revenue accounts to confirm the occurrence of revenue, and cash accounts to confirm collection of subsequent receivables. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

22) The uncollectible accounts expense to net credit sales ratio is useful in evaluating the reasonableness of ________. A) uncollectible accounts expense B) total revenues C) gross margins D) prior period's uncollectible accounts expense Answer: A Explanation: The uncollectible accounts expense to net credit sales ratio is useful in evaluating the reasonableness of uncollectible accounts expense. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 23) During the audit of Thiago Company, the auditors have noted that the days in receivables ratio has substantially increased, relative to the ratio the auditors calculated in the prior year's audit. As a result of this, which of the following might the auditors choose to examine? A) As a result of this finding, the auditors would likely choose to examine the revenue and related payables accounts, to determine customers taking longer to pay. B) As a result of this finding, the auditors would likely choose to examine the revenue and accumulated depreciation accounts. C) As a result of this finding, the auditors would likely choose to examine the receivables and related allowance accounts. D) None of these answer choices are correct. Answer: C Explanation: As a result of this finding, the auditors would likely choose to examine the receivables and related allowance accounts. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

24) During the early stages of the audit of Margate Company, the auditors are examining the client's revenue accounts and attempting to develop an expectation of what might go wrong in this area. Which of the following represents the best method of achieving this? A) The auditors should familiarize themselves with the client's revenue accounts by developing an expectation based on the prior year's receivables and payables. B) The auditors should carefully examine the client's customers, marketplace standing, and the size/capacity of the client. C) The auditors should obtain written assurances from senior management pertaining to what has gone wrong in this area. D) The auditors should perform an industry analysis using statistical regression techniques to develop a forecast of the client's expected revenues for comparison purposes. Answer: B Explanation: The auditors should carefully examine the client's customers, marketplace standing, and the size/capacity of the client. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 25) Doran CPAs is currently performing the audit of one of its largest clients; a multinational pharmaceutical company. During an initial planning meeting, the partner with overall responsibility for the audit has noted that the client operates in an industry which is very highly regulated, and that the client spends considerable sums of money each year on compliance. As a result of this finding, which of the following is correct? A) The client is likely to represent lower inherent risk because the industry the client operates in is highly regulated. B) The client is likely to represent higher inherent risk because the client operates in an industry that is highly regulated. C) Generally accepted accounting standards require the external auditors to obtain specific written assurances from senior management for all audit areas deemed to be higher inherent risk. D) The client is likely to represent higher inherent risk because the clients revenue recognition procedures are considered by the auditor to be straightforward. Answer: B Explanation: The client is likely to represent higher inherent risk because the client operates in an industry that is highly regulated. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

26) With respect to understanding the client's revenue process, it is particularly important that the auditor ________. A) makes some preliminary inquiries with the client's attorney B) be knowledgeable about the entity, how the entity earns revenues, and particular revenue recognition issues that may be relevant to the entity C) examines other firms within the client's industry to determine acceptable practices D) uses accounting standards as an optional guide to determining what the client should be recording Answer: B Explanation: It is particularly important that the auditor be knowledgeable about the entity, how the entity earns revenues, and particular revenue recognition issues that may be relevant to the entity. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 27) During an initial client meeting with Junebug LLC, it has been disclosed to the external auditors, Farrington CPAs, that the wife of the Chief Financial Officer is the head of the internal control function, as well as being a prominent shareholder. As the auditors plan their audit strategy, which of the following is true? A) The external auditors are likely to assess inherent risk as lower, because of the existence of related party transactions. B) The external auditors are likely to issue a disclaimer of opinion on the client's financial statements, due to this disclosure by management. C) The external auditors are likely to assess inherent risk as higher, due to the possible extent of related party transactions. D) The external auditors are likely to assess control risk as low, which will cause the risk of material misstatement to also decrease. Answer: C Explanation: The external auditors are likely to assess inherent risk as higher, due to the possible extent of related party transactions. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

28) Key factors for the auditor to consider regarding the entity and its environment in the revenue process are ________. A) corporate governance and related party transactions B) regulatory oversight of the profession C) recent actions of competitors inside and outside the industry D) the client's maintenance of an attorney on retainer Answer: A Explanation: Key factors for the auditor to consider regarding the entity and its environment are corporate governance and related party transactions. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 29) With respect to performing analytical procedures to understand total revenue, the auditor should understand ________. A) revenue recognition methods of all firms within the industry B) how the firm relates its cost of goods sold to revenue recognition C) the entity's capacity, the maximum volume of sales that it could generate if it fully utilized its facilities and employees to manufacture and deliver products and services D) how the client firm handles depreciation entries related to contra-revenue accounts Answer: C Explanation: With respect to revenue, the auditor should understand the entity's capacity, the maximum volume of sales that it could generate if it fully utilized its facilities and employees to manufacture and deliver products and services. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

30) The starting point for every audit test is ________. A) agreeing fee schedules and compensation B) contact with the predecessor auditor C) is obtaining an understanding of the business and industry D) agreement with the client as to what kind of audit opinion they can expect Answer: C Explanation: The starting point for every audit test is obtaining an understanding of the business and industry. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 31) It is particularly important in growth companies for auditors to monitor the entity's collection period because any growth in sales is usually accompanied by ________. A) growth in accounts receivables that consume operating cash B) increase in premium gross margins C) decrease in the client's collection period D) increase in the market share for the client's product Answer: A Explanation: It is particularly important in growth companies for auditors to monitor the entity's collection period because any growth in sales is usually accompanied by growth in accounts receivable that consumes operating cash. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 32) Which of the following ratios, when small, may indicate an inadequate estimation process? A) Uncollectible accounts expense to accounts receivable write-offs B) Uncollectible accounts expense to net credit sales C) Accounts receivable growth to sales growth D) Accounts receivable turnover in days Answer: A Explanation: The uncollectible accounts expense to accounts receivable write-offs ratio is useful in evaluating the reasonableness of prior period's uncollectible accounts expense. Smaller ratios may indicate an inadequate estimation process. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 13

33) The accounts receivable growth to sales growth ratio = ________. A) ((Accounts Receivable t ÷ Accounts Receivable t − 1) — 1) ÷ ((Sales t ÷ Sales t −1) — 1) B) ((Accounts Receivable t ÷ Accounts Receivable t − 1) + 1) ÷ ((Sales t ÷ Sales t − 1) + 1) C) ((Accounts Receivable t ÷ Accounts Receivable t + 1) — 1) ÷ ((Sales t ÷ Sales t + 1) — 1) D) ((Accounts Receivable t ÷ Accounts Receivable t + 1) + 1) ÷ ((Sales t ÷ Sales t + 1) + 1) Answer: A Explanation: Accounts receivable growth to sales growth ration = ((Accounts Receivable t ÷ Accounts Receivable t − 1) − 1) ÷ ((Sales t ÷ Sales t − 1) − 1). Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 34) Among analytical procedures commonly used to audit the revenue cycle, what is the audit significance of the sales to capacity ratio? A) Assessing the reasonableness of total revenues B) Comparing manufacturing to other asset-based companies C) Evaluating the reasonableness of uncollectible accounts expense D) Evaluating the reasonableness of prior period's uncollectible accounts expense Answer: A Explanation: The sales to capacity ratio is helpful in assessing the reasonableness of total revenues. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 35) If receivables are growing faster than sales, it may be an indication that the company is ________. A) accomplishing sales growth by taking on increased credit risk B) accomplishing sales growth by taking steps to reduce credit risk C) slowing down sales growth by taking on increased credit risk D) slowing down sales growth by taking steps to reduce credit risk Answer: A Explanation: If receivables are growing faster than sales, it may be an indication that the company is accomplishing sales growth by taking on increased credit risk. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 14

36) Understanding how the entity earns and recognizes revenue assists the auditor in ________. A) determining control risk related to accounts payable B) discussing the audit with the predecessor auditor C) developing an expectation of total revenues by understanding the client's capacity, marketplace, and customers D) developing an expectation of total revenues by understanding the capacities of the client's key competitors Answer: C Explanation: Understanding how the entity earns and recognizes revenue assists the auditor in developing an expectation of total revenues by understanding the client's capacity, marketplace, and customers. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 37) An example of a sales-related factor that would increase inherent risk would be ________. A) significant legal compliance issues when making sales B) a history of complying with all laws and regulations C) strong oversight of management by the board of directors D) revenue recognition is relatively straightforward, with no significant accounting issue Answer: A Explanation: An example of a sales-related factor that would increase inherent risk would be significant legal compliance issues when making sales. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

38) An example of a sales-related factor that would decrease inherent risk would be ________. A) complicated revenue recognition policies B) lax oversight of management by the board of directors C) nominal legal compliance issues when making and collecting sales D) existence of excessive sales goals and/or targets Answer: C Explanation: An example of a sales-related factor that would decrease inherent risk would be nominal legal compliance issues when making and collecting sales. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 39) Which of the following may occur in a transaction between a manufacturer and a wholesaler when the seller retains title to inventory in the wholesaler's possession, and the sale is completed when the wholesaler sells the inventory forward? A) Consignment sales B) Bill and hold transactions C) Refund rights D) Write-off of accounts receivable Answer: A Explanation: Consignment sales may occur in a transaction between a manufacturer and a wholesaler when the seller retains title to inventory in the wholesaler's possession, and the sale is completed when the wholesaler sells the inventory forward. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 40) When rights of return exist, or are likely to be accepted, ________. A) the firm should simply expense them as incurred B) should restrict cash to cover any potential right of return or warranty claim C) a reasonable estimate of refunds should be made when revenue is recognized. D) a company should consult with other firms in the industry with respect to best practices Answer: C Explanation: When rights of return exist, or are likely to be accepted, a reasonable estimate of refunds should be made when revenue is recognized. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 16

41) If a reasonable estimate of potential refunds cannot be made, ________. A) the firm should simply disregard any expense and handle on a case-by-case basis B) revenue should not be recognized until the material uncertainty is resolved C) a portion of the revenue should recognized immediately upon sale D) no revenue recognition should occur during the life of the refund obligation Answer: B Explanation: If a reasonable estimate of potential refunds cannot be made, revenue should not be recognized until the material uncertainty is resolved. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 42) What is the nature of a sale under refund rights? A) The sale is made with the right to return the goods for a full refund, even if the goods are not defective. B) The sale is made with the right to return the goods for a full refund if the goods are defective. C) The sale is made with no right to return the goods for a refund, even if the goods are defective. D) The sale is made with no right to return the goods for a refund, even if the goods are not defective. Answer: A Explanation: Under refund rights a sale is made with the right to return the goods for a full refund, even if the goods are not defective. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

43) Recognizing revenues without shipping would lead to ________ gross margins and ________ accounts receivable turnover in days. A) increased; low B) decreased; low C) increased; high D) decreased; high Answer: A Explanation: Recognizing revenues without shipping goods will cause gross margins to improve and accounts receivable turnover in days to slow. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 44) The classification of the transaction as a sale or a borrowing may be incorrect when ________. A) factoring receivables with recourse B) estimating the likelihood of collection within the next year C) writing off customers' balances as uncollectible D) debating over the timing and amount of revenue to be recognized Answer: A Explanation: When receivables are factored with recourse, the classification of the transaction as a sale or a borrowing may be incorrect. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

45) An audit manager and an audit staff associate are discussing the attestation engagement of a major audit client. The staff associate notes that the client has been with the external auditors for a number of years. The staff associate also notes that she would like to find a way to determine any anomalous areas from last year when compared to this year. Which of the following should the audit manager advise the staff associate to consider? A) The staff associate should consider employing ratio analysis in order to search for amounts that seem anomalous compared to the previous year. B) The staff associate should devise a questionnaire for senior management, asking them to identify areas where anomalies may be present. C) The staff associate should compare key client ratios with firms from other industries to determine areas that may represent higher inherent risk. D) None of these answer choices are correct. Answer: A Explanation: The staff associate should consider employing ratio analysis in order to search for amounts that seem anomalous compared to the previous year. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 46) Claire and Billy, two audit managers, are working on the audit of StayBright LLC, a regional retailer of paint and other acrylic products. The auditors have noted that StayBright LLC has some complicated processes in place, and wish to understand more about these processes. Which of the following would be the best strategy for the auditors to employ to understand these processes better? A) The auditors should consider requesting senior management complete a flowchart detailing the processes, to help the auditors understanding. B) The auditors should consider conducting a walkthrough procedure of key transaction processes, in order to understand them better. C) The auditors should consider requesting the internal audit function document all key processes and summarize them accordingly for the external auditors. D) The auditors should consider retaining specialists in order to ensure key processes are properly understood and documented. Answer: B Explanation: The auditors should consider conducting a walkthrough procedure of key transaction processes, in order to understand them better. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

47) Janice and Bruce are discussing the revenue-receivables cycle one day at lunch. Janice tells Bruce that she has been working on credit sales, and is wondering what applicable internal controls she may need to test. Which of the following represents Bruce's most helpful response? A) In order to audit clients with credit sales, Janice should consider testing controls related to all revenue and associated payables accounts. B) Janice should consider testing all revenue sales that have been made on credit, as well as the associated allowance accounts. C) Janice should not consider testing controls as controls over revenue-receivables cycle is generally considered as high risk. D) Janice should consider testing a sample of credit sales and looking for evidence of appropriate authorizations. Answer: D Explanation: Janice should consider testing a sample of credit sales and looking for evidence of appropriate authorizations. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 48) Harry and Paula are discussing how it is customary for firms to offer credit terms to their customers. Harry asks Paula how they should go about determining which customers get particular credit terms. How should Paula best answer this question? A) We should offer everyone the same credit terms, in order to be fair to all our customers and not lose sales revenue. B) We should consider credit checking our customers, and offering older, more established customers better credit terms. C) We should preemptively set a defined credit term such as 1/10, N30 for all customers and adjust as necessary. D) We should only accept cash sales, to make sure that one hundred percent of sales are collected. Answer: B Explanation: We should consider credit checking our customers, and offering older, more established customers better credit terms. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

49) Carly and Simon, the proprietors of Janeway Enterprises, are discussing ways that they can improve their controls over cash and receivables, having recently experienced some issues with employee theft. Which of the following represents a suitable method for achieving this? A) Carly and Simon should consider outsourcing collections of all payables to a factoring company. B) Carly and Simon should consider switching their sales policies to cash only, to avoid the risk associated with non-collection. C) Carly and Simon should consider allowing their bank to collect receivables on their behalf, eliminating the handling of cash associated with receivable payments. D) None of these answer choices are correct. Answer: C Explanation: Carly and Simon should consider allowing their bank to collect receivables on their behalf, eliminating the handling of cash associated with receivable payments. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 50) While examining internal control weaknesses, the auditor may need to change the timing of planned substantive tests related to an assertion from interim testing to testing ________ balances. A) year-end B) end-of-quarter C) month-end D) None of these answer choices are correct. Answer: A Explanation: While examining internal control weaknesses, the auditor may need to change the timing of planned substantive tests related to an assertion from interim testing to testing year-end balances. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

51) Which of the following computer actions is a control for the classification assertion of the sales and receivables? A) Starts with the population of daily sales invoices and compares the date on the sales invoice with the date on the underlying bill of lading. B) Starts with the population of daily sales invoices and compares customer numbers with the sales order, specifically addressing customer account coding errors. C) Starts with the population of daily sales invoices and compares quantities with the underlying packing slips, compares prices to the underlying sales order, and checks the mathematical accuracy of the sales invoice. D) Starts with the population of daily sales invoices and develops a one for one match with underlying shipping documents to ensure that each sales invoice is supported by a bill of lading. Answer: B Explanation: As a control for the classification of the sales and receivables assertion, the computer starts with the population of daily sales invoices and compares customer numbers with the sales order. Both customer account coding and general ledger coding are compared with the sales order if a sales invoice bills for both goods and services, as these need to be recorded in separate accounts. A reports generated daily of any sales invoices showing incorrect account coding, for example, billing the wrong customer or recording revenue for selling goods when services are sold. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 52) As an important control for the occurrence assertion related to sales, the computer starts with the population of daily sales invoices and develops a one for one match with underlying shipping documents to ensure that each sales invoice is supported by a ________. A) bill of lading B) packing slip C) sales order D) sales invoice Answer: A Explanation: As an important control for the occurrence (of sales) assertion, the computer starts with the population of daily sales invoices and develops a one for one match with underlying shipping documents to ensure that each sales invoice is supported by a bill of lading. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

53) A walkthrough is important as ________. A) different companies often have different documents and transaction flows B) the volume of routine transactions in the revenue cycle is very high C) companies with dominant market shares often obtain premium gross margins D) any growth in sales is usually accompanied by receivable growth that consumes operating cash Answer: A Explanation: A walkthrough is important as different companies often have different documents and transaction flows. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 54) The process used for developing an audit strategy for various assertions begins with ________. A) understanding the flow of transactions in a given transaction cycle B) identifying what can go wrong from initiating the transaction to the recording in the general ledger C) assessing whether controls exist to mitigate what can go wrong D) identifying relevant controls, performing tests of controls, and evaluating results Answer: A Explanation: The process used for developing an audit strategy for various assertions begins with understanding the flow of transactions in a given transaction cycle. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 55) Which of the following provides the basis for recording a sale in the sales journal? A) Sales invoice B) Packing slip C) Bill of lading D) Master price file Answer: A Explanation: A sales invoice is used to bill customers, and it provides the basis for recording a sale in the sales journal. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 23

56) Which of the following represents the start of the transaction trail of documentary evidence? A) Sales order B) Credit approval C) Sales journal D) Bill of lading Answer: A Explanation: The sales order represents the start of the transaction trail of documentary evidence. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 57) Many clients build in redundant controls such that if one control does not detect a misstatement, ________. A) no other control will find the same misstatement B) an exception report is generated C) another control will detect the problem D) the control should immediately be eliminated Answer: C Explanation: Many clients build in redundant controls such that if one control does not detect a misstatement, another control will detect the problem. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

58) At the warehouse, when goods are pulled from inventory, which of the following is normally produced to detail the items that will be shipped to the customer and the quantity of each item shipped? A) Packing slip B) Sales order C) Sales invoice D) Bill of lading Answer: A Explanation: At the warehouse, when goods are pulled from inventory, a packing slip is normally produced to detail the items that will be shipped to the customer and the quantity of each item shipped. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 59) During which of the following functions is the auditor primarily concerned that sales invoices are recorded accurately and in the proper period? A) Recording sales B) Shipping sales orders C) Filling sales orders D) Accepting customer orders Answer: A Explanation: The auditor's primary concerns pertaining to the recording sales function are that sales invoices are recorded accurately and in the proper period. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

60) A major risk in processing cash receipts transactions ________. A) is that the bank often erroneously double-counts entries B) is the possible theft of cash before or after a record of the receipt is made C) is the possible theft of cash only before record of the receipt is made D) relates to inaccuracies caused by only one person counting the cash receipts Answer: B Explanation: A major risk in processing cash receipts transactions is the possible theft of cash before or after a record of the receipt is made. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 61) A lockbox system ________. A) is only used by large companies that can afford to pay for this service B) deals with cash being received at a post office box that is controlled by the company's bank C) increases a company's inherent risk, as the firm is now more susceptible to fraud and error D) enables a firm to completely eliminate/outsource its accounts receivable function Answer: B Explanation: A lockbox system is where cash is received at a post office box that is controlled by the company's bank. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 62) Recording cash receipts involves ________. A) journalizing cash received by a bank B) receiving cash over-the-counter C) recording cash received via mail receipt D) all the above Answer: D Explanation: Recording cash receipts involves journalizing cash received by a bank, over-thecounter, and mail receipts and posting receipts to customer accounts. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

63) Which of the following risks is addressed by preparing periodic independent bank reconciliations? A) Errors being made in journalizing cash receipts B) Receipts being posted to the wrong customer account C) Cash sales may not be recorded. D) Cash not being deposited intact daily Answer: A Explanation: Preparation of periodic independent bank reconciliations addresses the risk of errors being made in journalizing cash receipts. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 64) As a control for the assertion of cutoff of cash receipts, a daily exception report is generated for which of the following? A) Any cash receipts recorded in the incorrect time period B) Any recorded values of cash received not supported by an underlying remittance report C) Any recorded cash receipts not supported by the bank remittance report D) Any cash receipts posted to the incorrect customers Answer: A Explanation: When controlling for the assertion of cutoff of cash receipts, an exception report is generated daily for any cash receipts recorded in the incorrect time period. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

65) What do over-the-counter receipts devices such as a cash register or point-of-sale terminal provide? A) All of these answer choices are correct. B) Immediate visual display for the customer of the amount of the cash sale and the cash tendered C) An internal record of the transaction on a computer file or a tape locked inside the register D) Printed control totals of the day's receipts processed on the device Answer: A Explanation: For over-the-counter receipts, the use of a cash register or point-of-sale terminal is indispensable. These devices provide: 1. Immediate visual display for the customer of the amount of the cash sale and the cash tendered. 2. A printed receipt for the customer and an internal record of the transaction on a computer file or a tape locked inside the register. 3. Printed control totals of the day's receipts processed on the device. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 66) What is a remittance advice? A) A document prepared by the bank showing the details of electronic funds transfers received by the bank from customers B) A receipt from the bank showing the total amount deposited to the client's account at the bank C) A document received from the customer showing the details of payments made by the customer D) A daily report showing cash recorded in the cash receipts journal identifying customers making payments on account and the amounts received Answer: C Explanation: A remittance advice is a document received from the customer showing details of payments made by the customer. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

67) Which of the following is a receipt from the bank showing the total amount deposited to the client's account at the bank? A) Remittance advice B) Remittance report from the bank C) Monthly statements of receivable balances D) Bank deposit slip Answer: D Explanation: A bank deposit slip is a receipt from the bank showing the total amount deposited to the client's account at the bank. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 68) In the performance of which transaction(s) does segregation of duties serve as an important internal control? A) Cash receipts, not credit sales B) Credit sales, not cash receipts C) Both cash receipts and credit sales D) None of these answer choices are correct. Answer: C Explanation: As in the case of credit sales transactions, segregation of duties is an important internal control in performing the sub-function of cash receipts. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

69) As a control for cash receipts, which assertion is addressed when the computer starts with the population of daily cash receipts recorded in the daily remittance report (or cash receipts journal) and develops a one for one match with the underlying bank remittance report? A) Accuracy B) Classification C) Occurrence D) Completeness Answer: C Explanation: As a control for the occurrence of cash receipts assertion, the computer starts with the population of daily cash receipts recorded in the daily remittance report (daily cash receipts journal) and develops a one for one match with the underlying bank remittance report (or prelist of cash received). Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 70) Which of the following is a control for the completeness (of cash receipts assertion)? A) The computer compares each item on the underlying information in the bank remittance report to develop a one for one match with recorded cash receipts in the daily remittance report. B) The computer starts with the population of daily cash receipts recorded in the daily remittance report and develops a one for one match with the underlying bank remittance report. C) The computer starts with the population of daily cash receipts recorded in the daily remittance report and it compares the dollar amount of each recorded cash receipt with the underlying bank remittance report. D) The computer starts with the population of daily cash receipts recorded in the daily remittance report and compares the date recorded in the daily remittance report with the date received and deposited by the bank. Answer: A Explanation: As a control for the completeness of cash receipts assertion, the computer compares each item on the underlying information in the bank remittance report (or the prelist of cash receipts if cash and checks are received by the client) to develop a one for one match with recorded cash receipts in the daily remittance report. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

71) Gail, an audit partner is discussing methods of improving internal controls for an attestation client, Gator LLC. Gator has experienced some issues with incoming cash payments being intercepted by employees and has hired Gail's firm to recommend some improvements in internal control. Which of the following would be Gail's most appropriate recommendation? A) Gail should recommend to the client that moving forward, no cash or check payments should be accepted. This will alleviate the problem and improve internal controls in this area. B) Gail should consider recommending the client adopt electronic funds transfer policies, as transfer of funds in this manner will reduce the risk associated with intercepting incoming cash payments. C) Gail should recommend to the client that in the future, no credit terms are extended to any clients. This will eliminate the need for incoming cash payments. D) Gail should consider recommending that the client deposit weekly cash remittances to their bank at least weekly, to minimize the risk associated with theft of cash. Answer: B Explanation: Gail should consider recommending the client adopt electronic funds transfer policies, as transfer of funds in this manner will reduce the risk associated with intercepting incoming cash payments. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 72) Barnum Company has hired Janice & Co. CPAs to perform the audit of their financial statements. During the audit, Barnum's senior management advises the CPAs running the audit that a firm-wide effort is currently being made to reduce the costs associated with paper documentation which currently accompany the majority of the firm's transactions. Based on this what might be an appropriate recommendation by Janice & Co. CPAs? A) Janice & Co. CPAs should advise the client to consider outsourcing all key processes. This will save the client the associated printing costs. B) Janice & Co. CPAs should consider using an audit data analytics procedure to evaluate the population of the client's transactions and determine where paper processes could be eliminated. C) Janice & Co. CPAs should consider adopting an evaluated receipts settlement system to help eliminate the number of printed documents for the client. D) None of these answer choices are correct. Answer: C Explanation: Janice & Co. CPAs should consider adopting an evaluated receipts settlement system to help eliminate the number of printed documents for the client. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

73) Jack is an audit intern assigned to the attestation engagement of Margo LLC, a medium-size firm and distributor of pearl necklaces and other fine jewelry. Jack has been tasked with testing controls over the sales and receivables cycles, and has decided to examine a sample of the client's invoices. Which of the following represent controls Jack might decide to test? A) Controls to ensure that each invoice can be matched to a sales receipt and associated accounts payable entry. B) Controls that ensure that invoices are matched with outgoing inventory shipments and the creation of a receivable. C) Controls to ensure that invoices are numerically accurate, and match the details contained in the customer and cash master lists. D) Controls to ensure that sales invoices are recorded in the correct time period, and that interest accruals for related notes payable are accurate. Answer: B Explanation: Controls that ensure that invoices are matched with outgoing inventory shipments and the creation of a receivable. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 74) Sam and Dorsey are discussing their firms' ongoing audit of Welcome Enterprises, a distributor of bargain-priced clothing in the southeastern United States. Sam advises Dorsey that he has been tasked with testing a sample of controls related to customers that have returned products, and asks Dorsey if he has any recommendations for associated internal controls he should consider testing. Which of the following represents Dorsey's best response to this query? A) As revenue accounts are generally associated with higher inherent risk, it would be more prudent to allow the internal audit function to test this area. B) It might be worth testing controls pertaining to whether the proper authorizations were received in order for the goods to be returned. C) You would likely want to test controls related to the original revenue transaction, to determine what percentage of goods on average are being returned. D) None of these answer choices are correct. Answer: B Explanation: It might be worth testing controls pertaining to whether the proper authorizations were received in order for the goods to be returned. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

75) Alan is an audit intern from a local state university, and is working on his first audit with his supervisor, Jared; an audit senior manager. Alan approaches Jared for advice as another, more experienced member of his team has asked him to select and examine documentation associated with sales returns. Alan is unsure as to what documentation he should check. Which of the following represents Jared's most appropriate response to this question? A) Jared should advise Alan to approach the internal audit function and request they gather appropriate documentation and evidence for this area. B) Jared should advise Alan that he may wish to consider selecting a sample of credit memos associated with sales returns to check the amounts credited back to the customer's account. C) Jared should advise Alan that he should calculate a percentage of goods returned relative to overall credit sales to determine if the amount is material. D) Jared should advise Alan that he should consider a reperformance procedure whereby Jared walks through the sales return process as a fictitious customer. Answer: B Explanation: Jared should advise Alan that he may wish to consider selecting a sample of credit memos associated with sales returns to check the amounts credited back to the customer's account. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 76) Control activities useful in reducing the risk of fraud focus on establishing the validity and occurrence of such transactions and include ________. A) a portion of sales returns should be authorized by sales management B) all sales returns should be authorized by sales management C) the computer should match the debit memo information with the sales order D) ensuring top management approves all credit memos before agreeing to a reduction in accounts receivable Answer: B Explanation: Control activities useful in reducing the risk of fraud focus on establishing the validity and occurrence of such transactions and include the following - All sales returns should be authorized by sales management. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

77) What is a credit memo? A) A form stating the particulars of a credit to accounts receivable, including the specific items returned, prices, and amount credited to a customer's account B) A document used to record adjustments such as a provision for bad debt expense or an accounts receivable write-off in the general ledger C) A report prepared on the receipt of goods from customers showing the kinds and quantities of goods received D) A form showing the description, quantity, and other data pertaining to goods the customer is authorized to return Answer: A Explanation: A credit memo is a form stating the particulars of a credit to accounts receivable, including the specific items returned, prices, and amount credited to a customer's account. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 78) Which of the following serves as the basis for initiating the sales return and internal processing of the customer return by the seller? A) Cash receipts journal B) Sales return authorization C) Credit memo D) Receiving report Answer: B Explanation: A sales return authorization serves as the basis for initiating the sales return and internal processing of the customer return by the seller. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

79) Which of the following is a form showing the description, quantity, and other data pertaining to goods the customer is authorized to return? A) Sales return authorization B) Authorization for accounts receivable write-off C) Cash receipts journal D) Journal entry Answer: A Explanation: A sales return authorization is a form showing the description, quantity, and other data pertaining to goods the customer is authorized to return. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 80) Good internal controls over the write-off of uncollectible accounts include appropriate review of ________ by management to ensure the appropriateness of the transaction. A) journal entries B) debit memos C) receiving reports D) cash receipts journal Answer: A Explanation: Good internal controls over the write-off of uncollectible accounts include appropriate review of journal entries by management to ensure the appropriateness of the transaction. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 81) The purpose of a disclosure committee ________. A) is to supervise the internal audit function B) is to handle all communications with firm attorneys C) is to work with the CFO or controller to review disclosures D) is to ensure that the firm receives a 'clean' audit opinion Answer: C Explanation: The purpose of a disclosure committee is to work with the CFO or controller to review disclosures. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 35

82) The fraud risk assessment is an important part of the audit that the auditor needs to approach with ________. A) due diligence B) professional skepticism C) the assistance of the internal audit function D) careful consideration Answer: B Explanation: The fraud risk assessment is an important part of the audit that the auditor needs to approach with professional skepticism. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 83) The document that serves as the basis for initiating the sales return and internal processing of the customer return by the seller is referred to as a ________. A) credit memo B) receiving report C) sales return authorization D) debit memo Answer: C Explanation: A sales return authorization is a form showing the description, quantity, and other data pertaining to goods the customer is authorized to return. It serves as the basis for initiating the sales return and internal processing of the customer return by the seller. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

84) The auditor often makes inquiries of personnel responsible for clearing exceptions ________. A) to determine that all exceptions have been automatically approved B) to ensure that no employees that handle exception reports are lapping C) to determine their awareness of the types of misstatements that might appear on exception reports D) to ensure that it is always one type of misstatement that will appear on the report Answer: C Explanation: The auditor might make inquiries of personnel responsible for clearing exceptions in order to determine their awareness of the types of misstatements that might appear on exception reports. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 85) Segregation of duties ________. A) should always be considered an important internal control B) should be of primary concern to larger, more complex companies C) should be instituted by the auditor D) refers to ensuring employees take on as many tasks as possible, to save labor costs Answer: A Explanation: Segregation of duties should always be considered an important internal control. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 86) Good internal controls over the write-off of uncollectible accounts ________. A) are optional if the company is smaller in size B) are typically expensive and cumbersome to implement C) are important to prevent write-offs from being used to conceal fraud in processing cash receipts D) are less important if accounts receivable are outsourced Answer: C Explanation: Good internal controls over the write-off of uncollectible accounts are important to prevent write-offs from being used to conceal fraud in processing cash receipts. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 37

87) If the client relies on computer controls and the auditor plans to assess control risk as low for revenue cycle assertions, the auditor will usually ________. A) test the effectiveness of general controls B) perform substantive testing, to increase the confidence level C) test the whole population as opposed to a sample D) drastically increase the sample size Answer: A Explanation: If the client relies on computer controls and the auditor plans to assess control risk as low for revenue cycle assertions, the auditor will usually test the effectiveness of general controls. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 88) The auditor will usually test the effectiveness of computer general controls as part of testing ________ level controls. A) entity B) division C) transaction D) function Answer: A Explanation: The auditor will usually test the effectiveness of computer general controls as part of testing entity level controls. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

89) After evaluating inherent risk and control risk, the auditor ________. A) is in a position to begin the audit work B) can conclude the audit and issue an audit opinion C) should confirm with management to ensure the auditors findings are agreed with D) is in a position to evaluate fraud risk Answer: D Explanation: After evaluating inherent risk and control risk, the auditor is in a position to evaluate fraud risk. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 90) A common scheme to conceal the misappropriation of cash receipts ________. A) is known as lapping B) is known as kiting C) is usually committed by senior management and members of the board of directors D) should be handled by the internal audit function, not the external auditors Answer: A Explanation: A common scheme to conceal the misappropriation of cash receipts is known as lapping Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 91) Which of the following is an act of fraud? A) Lapping B) Lockbox C) Walkthrough D) Disclosure Answer: A Explanation: Lapping is a scheme where an accounting clerk incorrectly classifies cash receipts from one customer to another in order to cover up the diversion of funds from a customer for personal gain. Lapping is an act of fraud. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

92) Kaylee and Nicholas, two audit staff associates are working on an audit of JayTee Industries, Inc., a national provider of golf and dune buggies across the United States. Kaylee asks Nicholas if the auditors typically make any assumptions pertaining to a client's system of internal control. Which of the following represents Nicholas' best response to this question? A) Internal control is typically tested by the internal audit function more so than the external auditors, as they are more familiar with areas of high risk in the client's operations. B) The external auditors typically assess control risk at its lowest at the beginning of the audit, and adjust accordingly as the audit progresses. C) Generally accepted auditing standards require the external auditors to assess control risk at its highest level at the beginning of the audit, and make subsequent adjustments as necessary. D) The external auditors typically rely on the results of previous years audits and/or professional experience and judgment in forming a preliminary opinion on a client's system of internal control. Answer: D Explanation: The external auditors typically rely on the results of previous years audits and/or professional experience and judgment in forming a preliminary opinion on a client's system of internal control. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 93) Phillips CPA Firm is auditing the accounts of Tojo Enterprises, Inc., a national distributor of kitchen appliances. After reviewing the minutes of board of directors meetings as well as recent SEC filings, Phillips CPA firm have noted that key executives are extremely close to achieving a substantial bonus if the firm's stock price achieves a certain level in the market. Based on this finding, what might Phillips CPA Firm decide to do? A) Phillips CPA Firm are likely to audit competing companies within the same industry as a basis for comparison. B) Phillips CPA Firm are likely to assess control risk as low on the premise that management's desire to achieve stock price forecasts will increase fraud risk. C) Phillips CPA Firm are likely to assume fraud risk is high, due to senior management's proximity to achieving certain desired stock prices. D) None of these answer choices are correct. Answer: C Explanation: Phillips CPA Firm are likely to assume fraud risk is high, due to senior management's proximity to achieving certain desired stock prices. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

94) June CPAs are auditing Decker & Co., a large, national retailer of household appliances and other wares. During the initial phase of the audit, as June CPAs were gaining an understanding of the client, it was noted that Decker & Co. operate in a highly seasonal business. As a result of this finding, which of the following approaches might June CPAs take? A) June CPAs may decide to inform client management in writing of their intention to withdraw from the engagement due to the volatility associated with seasonal businesses. B) June CPAs may opt to allow the internal audit function to audit higher volume months due to their increased familiarity with the client. C) June CPAs may decide to increase inherent risk associated with the client due to the seasonality of demand, and possible incentives to smooth income during slower months. D) Generally accepted auditing standards require that additional substantive testing and tests of internal control are performed for clients in seasonal industries. Answer: C Explanation: June CPAs may decide to increase inherent risk associated with the client due to the seasonality of demand, and possible incentives to smooth income during slower months. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 95) Daisy CPAs are auditing the accounts of Focus Inc., a regional power cooperative. The audit team assigned to the audit of accounts receivable has noted from prior audit experience that the majority of clients pay their bills on time and in the correct amount. One of the audit team has also noted that the cooperative has hundreds of thousands of customers. Based on this information, what might be a prudent approach to substantive testing by Daisy CPAs? A) Daisy CPAs should consider sending negative confirmations to all of Focus Inc's customers, requesting they notify the auditor if balance information is incorrect. B) Daisy CPAs should consider a walkthrough procedure whereby a fictitious customer is created and used to test internal controls. C) Daisy CPAs should consider using audit data analytics (ADA) as a substantive test, given the large population size. D) None of these answer choices are correct. Answer: C Explanation: Daisy CPAs should consider using audit data analytics (ADA) as a substantive test, given the large population size. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

96) An analytical procedure related to substantive testing of revenue would be ________. A) developing an understanding of the client's system of internal control B) ensuring that all efficiency audits conducted by the internal audit function are properly planned C) to check revenue and the related accounts payable accounts on a sample basis D) to analyze ratio results relative to expectations based on prior years Answer: D Explanation: An analytical procedure related to substantive testing of revenue would be to analyze ratio results relative to expectations based on prior years. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 97) An example of a factor that provides the incentive for management to misstate revenue cycle assertions would be ________. A) realistic sales targets within the firm B) strong support from top management of an ethical culture C) pressures to overstate revenues to achieve revenue or profitability targets that were not achieved D) pressures to accurately report revenues to achieve revenue or profitability targets that were achieved Answer: C Explanation: An example of a factor that provides the incentive for management to misstate revenue cycle assertions would be pressures to overstate revenues to achieve revenue or profitability targets that were not achieved. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

98) Auditing the cutoff assertion pertaining to cash receipts is important because ________. A) the auditor needs to ensure expenses are being matched with revenues B) the bank may have recorded cash receipts in incorrect period C) the client should have recorded cash receipts in the correct period D) the recording of revenue and the corresponding receipt of cash should always be in the same fiscal period Answer: C Explanation: Auditing the cutoff assertion pertaining to cash receipts is important because the client should have recorded cash receipts in the correct period. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 99) Public company auditors test controls in order to ________. A) determine if they should be eliminated B) support an opinion on internal controls C) decide if responsibility for internal control should be reassigned from management to the internal auditors D) determine their audit opinion without regard to substantive testing Answer: B Explanation: Public company auditors test controls in order to support an opinion on internal controls over financial reporting because the Sarbanes-Oxley Act of 2002 (Section 404) requires such an independent opinion for public companies. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

100) If the auditor's expectations regarding effective controls are not confirmed, ________. A) the auditor should proceed with testing of controls B) the auditor will need to evaluate the significance of the weaknesses noted and determine if the client has a compensating control in place that the auditor might rely on C) the auditor will need to evaluate the significance of the weaknesses noted and simply document this D) the auditor should withdraw from the engagement Answer: B Explanation: If the auditor's expectations regarding effective controls are not confirmed the auditor will need to evaluate the significance of the weaknesses noted and determine if the client has a compensating control in place that the auditor might rely on. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 101) An auditor's use of analytical procedures ________. A) should be the same for every audit client, for reasons of uniformity B) may be tailored to the particular client and the industry in which the client operates C) is not required if an auditor has assessed control risk as low D) are designed to help the auditor provide absolute assurance Answer: B Explanation: An auditor may want to develop analytical procedures that are custom made for the client. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 102) The first step in planning the use of audit data analytics ________. A) is determining the overall purpose of the test B) is collection of evidence C) is collection of data D) is to poll management to determine which data they would like included Answer: A Explanation: The first step in planning the use of audit data analytics is determining the overall purpose of the test. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 44

103) The sales cutoff test is designed to obtain reasonable assurance that ________. A) sales were actually made B) sales have been recorded for the correct amounts C) sales have been recorded in the correct accounts D) sales and accounts receivable are recorded in the accounting period in which the transactions occurred Answer: D Explanation: The sales cutoff test is designed to obtain reasonable assurance that sales and accounts receivable are recorded in the accounting period in which the transactions occurred. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 104) Confirmation of accounts receivable involves ________. A) confirming accounts receivable with the client B) confirming accounts receivable with the bank C) direct written communication between the client's customers and the auditor D) direct written communication between the client's customers and the client Answer: C Explanation: Confirmation of accounts receivable involves direct written communication between the client's customers and the auditor. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 105) When no response has been received after the second or third positive confirmation request to a customer, ________. A) alternative procedures should ordinarily be performed B) the auditor should assume that no news is good news C) the auditor should simply confirm with the client instead D) the auditor should make inquiries of the client's legal counsel Answer: A Explanation: When no response has been received after the second or third positive confirmation request to a customer, alternative procedures should ordinarily be performed. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 45

106) Which of the following involves direct written communication between the client's customers and the auditor? A) Confirmation of accounts receivable B) Performing cutoff tests for sales and sales returns C) Trace revenue transactions D) Bank confirmations Answer: A Explanation: Confirmation of accounts receivable involves direct written communication between the client's customers and the auditor. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 107) Which assertion do auditors test when they trace a sample of sales, cash receipts, and sales adjustment transactions to their recording in the accounting records? A) Completeness B) Accuracy C) Cutoff D) Classification Answer: A Explanation: To test the completeness assertion, the auditor should trace a sample of sales, cash receipts, and sales adjustment transactions to their recording in the accounting records. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 108) Under an FOB shipping point arrangement, title passes from seller to buyer when goods ________. A) are shipped B) are invoiced C) arrive at the customer's warehouse D) arrive at the seller's warehouse Answer: A Explanation: In FOB shipping point, title passes from seller to buyer when goods are shipped. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 46

109) To which of the following tests is the determination of FOB destination and FOB shipping point critical? A) Sales cutoff test B) Details of balances C) Vouch revenue transactions D) Trace revenue transactions Answer: A Explanation: The determination of FOB destination and FOB shipping point is critical in the cutoff test. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 110) Match each of the ratios commonly used in analytical procedures for auditing the revenue cycle with its formula. A. Sales to Capacity B. Market Share C. Sales to Total Assets D. Accounts Receivable Turnover in Days ____ Sales ÷ Average Total Asset ____ Average Accounts Receivable ÷ Sales × 365 ____ Net Sales ÷ Nonfinancial Measure of Capacity ____ Client's Net Sales ÷ Net Sales of Industry Answer: Sales to Capacity = Net Sales ÷ Nonfinancial Measure of Capacity; Market Share = Client's Net Sales ÷ Net Sales of Industry; Sales to Total Assets = Sales ÷ Average Total Assets; and Accounts Receivable Turnover in Days = Average Accounts Receivable ÷ Sales × 365. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

111) What are the classes of transactions in the revenue cycle included for a merchandising company? A) Credit sales B) Cash receipts C) Sale adjustments D) Gross sales Answer: A, B, C Explanation: For a merchandising company, the classes of transactions in the revenue cycle include (1) credit sales, (2) cash receipts (collection of receivables and cash sales), and sale adjustments (discounts, sales returns and allowances, and uncollectible account provisions and write-offs). Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 112) Shanta and Thomas are two audit staff associates working for McGraw CPA Firm. The pair is currently working on the audit of Ocean, Inc., a national provider of specialty fishing boats across the eastern United States seaboard, and have been tasked with gaining an understanding of the firms' processes surrounding revenue generation. Which of the following represent strategies Shanta and Thomas may wish to conduct to understand Ocean Inc's revenue generation procedures better? Select all that apply. A) Shanta and Thomas may wish to adopt a reliance strategy whereby the auditor relies on the audit client's internal controls and conducts increased substantive procedures. B) Shanta and Thomas will likely wish to gain an understanding of the entity, as well as the industry in which the client operates. C) Shanta and Thomas will likely wish to perform substantive procedures such as analytical procedures on various parts of the revenue process. D) Shanta and Thomas will probably wish to perform tests of the client's system of internal controls to confirm the results of an inherent risk analysis Answer: B, C Explanation: Shanta and Thomas will likely wish to gain an understanding of the entity, as well as the industry in which the client operates. Shanta and Thomas will likely wish to perform substantive procedures such as analytical procedures on various parts of the revenue process. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

113) Joe and Selena, two audit interns working for Burkholder CPA Firm are discussing the revenue-receivables cycle one day over lunch at the office of a major client. Joe mentions to Selena that he has been given the task of identifying key components of the cycle, and asks for Selena's help in identifying these key components. Which of the following represent correct responses by Selena with respect to key components of the cycle? Select all that apply. A) When the client firm makes the initial revenue sale for cash, necessitating the entry of a debit to an accounts receivable account. B) When a transaction is recorded for the purchase of goods to be sold to customers. C) When the client subsequently collects cash on accounts payable invoices, necessitating an entry to the cash account. D) When a revenue transaction is recorded for a credit sale, with a corresponding debit to a receivables account. Answer: D Explanation: When a revenue transaction is recorded for a credit sale, with a corresponding debit to a receivables account. When a revenue transaction is recorded for a credit sale, with a corresponding debit to a receivables account. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

114) Jim and Caroline are beginning the audit of a major client, and are discussing methods by which they can gain a better understanding of the client and the industry in which the client operates. Jim advises Caroline that the easiest way to do this would be to simply look at market intelligence reports issued by analysts' firms; however Caroline disagrees, saying that other options are available to help the auditors gain an increased understanding of the client. Which of the following represent ways that this could be achieved? Select all that apply. A) Examining competing companies within the same industry to develop an understanding of key financial metrics and ratios which might pertain to the client. B) Developing a questionnaire to be given to the client's senior management, requesting full disclosure of all high-risk areas within the firm. C) Developing an expectation for days sales in inventory, based on calculating this metric for the client and the industry in which the client operates. D) Examining similar sized firms in other industries to develop an expectation for key ratios such as days in receivables and times interest earned. Answer: A, C Explanation: Examining competing companies within the same industry to develop an understanding of key financial metrics and ratios which might pertain to the client. Developing an expectation for days sales in inventory, based on calculating this metric for the client and the industry in which the client operates. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

115) Norma and David are both CPAs and managing partners of Hollbreck Firm, a small CPA firm performing attestation engagements for small and medium-sized clients. An audit intern has approached Norma and David and requested assistance. The intern has noticed that the client has inventory amounts on consignment, and is unsure what key issues might arise with respect to gaining an understanding of this area. Which of the following are key areas for consideration that Norma and David should advise the intern? Select all that apply. A) Because the inventory is consigned, a question may arise as to who holds legal title to the inventory, affecting the completeness and rights assertions. B) Because the inventory is being held under consignment, neither the consignee nor consignor should list the inventory as an asset on their balance sheets. C) As the intern has determined the inventory is being held on consignment, key details of the arrangement such as right of return period may need to be examined. D) Because the client's inventory is being held on a consignment basis, the intern should check to ensure that the consigned inventory is listed as a liability rather than an asset on the balance sheet. Answer: A, C Explanation: Because the inventory is consigned, a question may arise as to who holds legal title to the inventory, affecting the completeness and rights assertions. As the intern has determined the inventory is being held on consignment, key details of the arrangement such as right of return period may need to be examined. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 116) Which of the following describe analytical procedures in audit planning? A) They are required in every audit. B) They are often effective in identifying potential misstatements in the financial statements. C) The most effective analytical procedures rely on the auditor's knowledge of the business and industry. D) They form an effective method but present a huge burden in relation to cost. Answer: A, B, C Explanation: Analytical procedures are required in every audit as part of audit planning. They are cost effective, and they are often effective in identifying potential misstatements in the financial statements. The most effective analytical procedures rely on the auditor's knowledge of the business and industry. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

117) Under which of the following conditions could consignment sales occur in a transaction between a manufacturer and a wholesaler? A) Seller retains title to inventory in the wholesaler's possession B) Sale is completed when the wholesaler sells the inventory forward C) Seller retains title to inventory in the manufacturer's possession D) Sale is completed before the wholesaler sells the inventory forward Answer: A, B Explanation: Consignment sales may occur in a transaction between a manufacturer and a wholesaler when the seller retains title to inventory in the wholesaler's possession, and the sale is completed when the wholesaler sells the inventory forward. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics, Ethics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 118) If a selling company changes the right of return near the end of the period to offer more generous terms, the company should not be able to recognize revenue until ________. (Select two conditions.) A) material uncertainties are resolved B) subsequent cash collections are assured C) all goods that the company has billed are shipped D) the company forfeits all rights associated with the goods Answer: A, B Explanation: If a selling company changes the right of return near the end of the period to offer more generous terms, the company should not be able to recognize revenue until material uncertainties are resolved and subsequent cash collections are assured. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

119) Which two of the following are true of bill and hold transactions? A) A customer is billed for goods, but goods are not shipped. B) The customer must have a sound economic reason for purchasing the goods and asking the seller to continue to hold the goods. C) The transaction must be initiated by the seller. D) Accounting principles have very broad criteria for when revenue can be recognized for a bill and hold transaction. Answer: A, B Explanation: In bill and hold transactions, a customer is billed for goods, but goods are not shipped. Accounting principles have very narrow criteria for when revenue can be recognized for a bill and hold transaction. The transaction must be initiated by the customer, and the customer must have a sound economic reason for purchasing the goods and asking the seller to continue to hold the goods. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 120) Which of the following factors could contribute to misstatements in the revenue cycle? A) Misappropriation of liquid assets generated through cash receipt transactions B) Difficulties in estimating the likelihood of collection within the next year C) Low volume of sales, cash receipts, and sales adjustment transactions D) Strict definition of the timing and amount of revenue to be recognized Answer: A, B Explanation: Receivables may be misclassified as current or noncurrent owing to difficulties in estimating the likelihood of collection within the next year or a source of events upon which collection is contingent. Cash receipt transactions generate liquid assets that are particularly susceptible to misappropriation. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Ethics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

121) Which of the following actions may lead to sales adjustment transactions being used to conceal thefts of cash received from customers? A) Overstating discounts B) Recording fictitious sales returns C) Writing off customers' balances as uncollectible D) Misclassifying receivables as current or noncurrent Answer: A, B, C Explanation: Sales adjustment transactions may be used to conceal thefts of cash received from customers by overstating discounts, recording fictitious sales returns (occurrence or accuracy of discounts or sales returns), or writing off customers' balances as uncollectible (occurrence of writeoff of accounts receivable). Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 122) Basille Enterprises, Inc., a nationwide distributor of rubber parts has just accepted a new, large customer. Basille Enterprises expects this account to become one of their largest and most prominent. During their yearly audit, the external auditors, Duckworth CPA Firm has questioned the client as to what controls are in place surrounding sales orders to this new client. Which of the following controls should the external auditor reasonably expect the client to have in place? Select all that apply. A) When a sales order is initiated, an automated check should be made to ensure the customer exists and key details such as addresses match. B) A check should be made to ensure that the amount of the most recent sales order does not cause the customer to exceed their approved credit limit C) An automated check should be in place to ensure that when inventory is shipped to clients on credit terms, a payable in the same amount as the goods shipped is recorded in the client's general ledger. D) An automated check should be in place to match the customers shipping address against the master list of all employees and vendors before shipment. Answer: A, B Explanation: When a sales order is initiated, an automated check should be made to ensure the customer exists and key details such as addresses match. A check should be made to ensure that the amount of the most recent sales order does not cause the customer to exceed their approved credit limit. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

123) Sigma CPA Firm is performing the audit of Phillips Industries, Inc., a national retailer of inhome electronic equipment, and is preparing to begin auditing the client's revenue accounts. One of the audit staff associates asks what documentation might need to be collected as part of this audit. Which of the following would be appropriate documentation for the audit team to collect? Select all that apply. A) The auditor should examine, on a test basis, remittance advices from selected clients detailing payments made. B) The auditor should examine, on a test basis, the sales processing database to test key controls over the revenue-receivables cycle. C) The auditor should examine, on a test basis, bank deposit slips showing amounts deposited into the clients account at their bank. D) The auditor should examine, on a test basis, monthly revenue and payable reconciliations to ensure no material discrepancies exist. Answer: A, C Explanation: The auditor should examine, on a test basis, remittance advices from selected clients detailing payments made. The auditor should examine, on a test basis, bank deposit slips showing amounts deposited into the clients account at their bank. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 124) Which two of the following primarily constitute the process of recording sales? A) Preparing and sending pre-numbered sales invoices to customers B) Recording sales invoices accurately and in the proper accounting period C) Determining that goods pulled from the warehouse are appropriately authorization D) Determining that goods taken from the warehouse agree with the details of the sales order Answer: A, B Explanation: The process of recording sales involves preparing and sending pre-numbered sales invoices to customers (billing customers) and recording sales invoices accurately and in the proper accounting period (recording sales). Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

125) During the recording sales function, which of the following are the auditor's major concerns regarding billing of customers? A) Billing for all shipments B) Billing only for actual shipments C) Billing at authorized prices D) Billing to match sales journal posts Answer: A, B, C Explanation: During the recording sales function, the auditor's major concerns regarding billing are that customers are billed (1) for all shipments, (2) only for actual shipments (no duplicate billings or fictitious transactions), and (3) at authorized prices. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 126) Which elements of the transaction flow for sales are associated with unauthorized customers? A) Customer master file B) Sales order C) Receivable statement D) Sales invoice Answer: A, B Explanation: Early in the transaction flow, the customer master file and sales order present a greater likelihood of a sale being made to unauthorized customers. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

127) What risks are not eliminated through the use of electronic funds transfers directly to bank or establishing a lockbox arrangement with the bank? A) Mail receipts lost or misappropriated after receipt B) Cash not deposited intact daily C) Inappropriate cash discounts taken by customers D) A customer's credit may not be properly approved. Answer: D Explanation: The use of electronic funds transfers directly to bank or establishing a lockbox arrangement with the bank eliminates the risks of (1) mail receipts lost or misappropriated after receipt, (2) cash deposited intact daily, and (3) inappropriate cash discounts taken by customers. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 128) To address the assertion of accuracy for cash receipts, which of the following are exception reports generated daily? A) Any recorded values of cash received not supported by an underlying remittance report or cash receipts journal B) Inappropriate discounts taken by customers for early payment C) Any cash receipts recorded in the incorrect time period D) Any recorded cash receipts not supported by the bank remittance report Answer: A, B Explanation: To address the assertion of accuracy for cash receipts, an exception report is generated daily for any recorded values of cash received not supported by an underlying remittance report or for inappropriate discounts taken by customers for early payment. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

129) What controls will address the risk of mail receipts being lost or misappropriated after receipt? A) Immediate preparation of prelist of mail receipts B) Restrictive endorsement of checks immediately upon receipt C) Preparation of periodic independent bank reconciliations D) Independent check of agreement of remittance advices with prelisting of cash received Answer: A, B Explanation: In order to address the risk of mail receipts being lost or misappropriated after receipt, two controls may be put in place: (1) Immediate preparation of prelist of mail receipts and (2) Restrictive endorsement of checks immediately upon receipt. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 130) Johnson CPAs have been hired by Longstaff LLC to examine their revenue-receivables cycle, and the associated processes. Johnson CPAs, upon reviewing Longstaff's revenuereceivables cycle have made the recommendation that the client should consider switching to an evaluated receipts settlement system. One of Longstaff's senior managers asks the CPAs about what details would be contained in an agreement with a customer if they switched to this type of system. Which of the following are likely to represent components of such an agreement? Select all that apply. A) A clause in the agreement specifying that all inventory shipped by the client and delivered to customers would be on cash on delivery terms. B) How information shared electronically between the parties would be stored and safeguarded. C) A clause discussing key payment terms, such as discounts for early payments. D) A component outlining who is responsible for interest accrued on receivables and payables with other clients. Answer: B, C Explanation: How information shared electronically between the parties would be stored and safeguarded. A clause discussing key payment terms, such as discounts for early payments. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

131) Ian and Samantha are two audit staff associates working on the audit of McKinsey, Inc., a regional distributor of candy and other fine confectionary products. Ian has spent the morning preparing to audit sales adjustments for the client, and asks Sam if she has any ideas as to what type of documentation he could gather on a test basis to support any conclusions reached? Which of the following options represent helpful suggestions by Samantha? Select all that apply. A) It would be worth selecting a sample of accounts receivables and checking to make sure that the allowance for bad debt and associated expense has been properly recorded. B) You might want to consider checking to make sure that any sales returns were properly authorized by appropriate client personnel. C) You should think about selecting a sample of credit memos associated with returns, and checking to make sure the correct quantities returned have been credited to the client's account. D) You should consider selecting a sample of transactions and tracing them from the initial revenue transactions to subsequent payment of the associated payable. Answer: B, C Explanation: You might want to consider checking to make sure that any sales returns were properly authorized by appropriate client personnel. You should think about selecting a sample of credit memos associated with returns, and checking to make sure the correct quantities returned have been credited to the client's account. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 132) Which of the following may be found in a journal entry in the general ledger? A) A provision for bad debt expense B) An accounts receivable write-off C) A procedure taken to attempt collection D) A sales adjustment for damaged goods Answer: A, B Explanation: A journal entry is a document used to record adjustments such as a provision for bad debt expense or an accounts receivable write-off. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

133) Which of the following are part of a sales adjustment transaction? A) Granting sales returns and allowances B) Determining uncollectible accounts C) Showing the procedures taken to attempt collection D) Listing cash receipts from cash sales Answer: A, B Explanation: A sales adjustment transactions includes (1) Granting sales returns and allowances and (2) Determining uncollectible accounts. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 134) Which of the following control activities are useful in reducing the risk of fraud? A) All sales returns should be authorized by sales management B) Goods should be received only with a proper sales return authorization C) An independent count of goods returned should be recorded on a receiving report D) The duties of authorizing sales returns and receiving goods should be combined Answer: A, B, C Explanation: Control activities useful in reducing the risk of fraud focus on establishing the validity and occurrence of such transactions and include the following: (1) All sales returns should be authorized by sales management. (2) Goods should be received only with a proper sales return authorization. (3) An independent count of goods returned should be recorded on a receiving report. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

135) In order to serve as a control activity useful in reducing the risk of fraud, the computer should match the credit memo information with the ________ (choose three). A) sales order B) authorization of sales return C) receiving report D) sales invoice Answer: A, B, C Explanation: In order to serve as a control activity useful in reducing the risk of fraud, the computer should match the credit memo information with the sales order, authorization of sales return, and receiving report. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 136) By sending monthly statements to customers, most companies control three assertions related to receivables at historical cost. Which ones are those? A) Completeness B) Existence C) Valuation D) Classification Answer: A, B, C Explanation: Most companies control the completeness, existence, and valuation of receivables at historical cost by sending monthly statements to customers. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 137) Which two of the following individuals often lead a disclosure committee? A) Chief finance officer B) Chief legal officer C) Verification officer D) Chief operating officer Answer: A, B Explanation: A disclosure committee is a committee often led by the CFO or Chief Legal Officer. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 61

138) In order to test programmed application controls in the revenue cycle and determine whether expected results appear on exception reports, an auditor might submit a/an ________ (choose two options). A) missing customer code B) order that exceeds a customer's credit limit C) valid product code D) invoice quantity matching quantity on shipping documents Answer: A, B Explanation: Auditors often use test data to test programmed application controls and determine whether expected results appear on exception reports. For example, in the revenue cycle the auditor might submit: (1) Missing or invalid customer code; (2) An invalid product code; (3) An order that exceeds a customer's credit limit; (4) Invoice quantities that do not match quantities on shipping documents. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 139) Which of the following help the fraudster sometimes solve the problem of having to continue the process of lapping? A) Falsifying a sale adjustment to reduce the receivable B) Writing off part of a customer's balance through a journal entry C) Covering the shortage from a customer with funds from another customer D) Accounting for a payment as coming from two different customers Answer: A, B Explanation: Sometimes the fraudster can solve the problem of having to continue the process of lapping by falsifying a sale adjustment to reduce the receivable, or by writing off part of a customer's balance through a journal entry. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

140) Suzie has been tasked by her supervisor to audit the IT application controls of Switch Industries, Inc., a national retailer of electronic switching devices for both the home and industrial markets. Suzie is unsure as to methods by which testing of IT application controls could be accomplished, and has approached you to ask for advice. Which of the following would be viable suggestions to offer Suzie? Select all that apply. A) Suzie could attempt to enter fictitious data into the system such as an erroneous or fictitious customer ID to see if the system correctly flags the transaction. B) Suzie could attempt to enter a fictitious order that would cause an existing customer to exceed their credit limit, to observe if the transaction is flagged. C) Suzie could attempt to obtain written assurances from senior management for inclusion in the audit file with respect to the effective functioning of IT application controls. D) Suzie could ensure that segregation of duties is effectively controlled by ensuring inventory shipments match to underlying sales documents and orders. Answer: A, B Explanation: Suzie could attempt to enter fictitious data into the system such as an erroneous or fictitious customer ID to see if the system correctly flags the transaction. Suzie could attempt to enter a fictitious order that would cause an existing customer to exceed their credit limit, to observe if the transaction is flagged. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

141) Jason and Millie are two audit managers working on the attestation engagement for Dryco Enterprises, a nationwide supplier of hand cleaners and other sanitary products. Jason and Millie have been tasked by their supervisor to perform substantive procedures related to accounts receivable. Which of the following represent audit procedures Jason and Millie could employ to accomplish this? Select all that apply. A) Jason and Millie could consider obtaining an aging of receivables and footing the balances in each category to check for numerical accuracy. B) Jason and Millie could discuss and evaluate management's methodology and techniques for estimating uncollectible accounts. C) Jason and Millie could compare the clients' collection patterns and trends with other firms within the same industry. D) Jason and Millie could meet with the internal audit function to discuss key ratios pertaining to collectability such as the days in payables ratio. Answer: A, B, C Explanation: Jason and Millie could consider obtaining an aging of receivables and footing the balances in each category to check for numerical accuracy. Jason and Millie could discuss and evaluate management's methodology and techniques for estimating uncollectible accounts. Jason and Millie could compare the clients' collection patterns and trends with other firms within the same industry. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 142) In the initial procedures of the audit program for substantive tests of revenue cycle assertions, to determine that the trial balance is an accurate and complete representation of the underlying accounting records, the auditor should compare a sample of the customer balances shown in the ________ with that in the ________. A) aged trial balance; subsidiary ledger B) subsidiary ledger; aged trial balance C) general ledger control account; allowance account D) sales journal; general ledger control account Answer: A, B Explanation: In the initial procedures of the audit program for substantive tests of revenue cycle assertions, the auditor should compare a sample of the customer balances shown on the aged trial balance with that in the subsidiary ledger and vice versa to determine that the trial balance is an accurate and complete representation of the underlying accounting records. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

143) In the initial procedures of the audit program for the revenue cycle, which of the following substantive tests come under the category of tests of details of transactions? A) Vouch recorded revenue transactions to supporting sales invoices, shipping documents, and sales orders. B) Vouch cash receipt transactions to supporting bank remittance reports, remittance advices. C) Vouch sales adjustment transactions to authorizations for sales returns and allowance or uncollectible account write-offs. D) Vouch subsequent cash receipts identifiable with items comprising account balance at confirmation date to supporting documentation. Answer: A, B, C Explanation: In the initial procedures of the audit program for the revenue cycle, the following substantive tests come under the category of tests of details of transactions: (a) Vouch recorded revenue transactions to supporting sales invoices, shipping documents, and sales orders. (b) Vouch cash receipt transactions to supporting bank remittance reports, remittance advices. (c) Vouch sales adjustment transactions to authorizations for sales returns and allowance or uncollectible account write-offs. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 144) In vouching revenue transactions, the auditor selects a sample of sales invoices to vouch to the supporting source documents in order to provide evidence pertaining to four assertions. Which ones are these (choose two options)? A) Occurrence and accuracy B) Classification and cutoff C) Completeness and existence D) Understandability and classification Answer: A, B Explanation: In vouching revenue transactions, the auditor will select a sample of sales invoices to vouch to the supporting source documents to provide evidence pertaining to the occurrence, accuracy, classification, and cutoff assertions. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

145) In Which of the following cases are revenue transaction vouching tests performed more extensively? A) When the applicable level of detection risk to be achieved is low B) When confirmation procedures are not practicable C) When used to supplement confirmation procedures D) When confirming receivables and the related follow-up procedures Answer: A, B, C Explanation: Revenue transactions vouching tests are performed more extensively when the applicable level of detection risk to be achieved is low, when confirmation procedures are not practicable, or to supplement confirmation procedures. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 146) When performing cutoff tests for sales, a misstatement of which two assertions will be caused if January sales are recorded in December for a calendar-year client? A) Existence and occurrence B) Occurrence and completeness C) Completeness and existence D) Accuracy and occurrence Answer: A Explanation: A possible cutoff issue: for a calendar-year client, if January sales are recorded in December, there is a misstatement of the existence or occurrence assertion. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

147) PCAOB AS 2310, The Confirmation Process and AU-C 505 state there is a presumption that the auditor will request the confirmation of receivables during an audit unless there are special conditions. Which of the following are among these conditions? A) Accounts receivable are immaterial to the financial statements. B) The use of confirmations would be ineffective as an audit procedure. C) The auditor's assessed level of risk of material misstatement at the relevant assertion level is high. D) No other planned substantive procedures address the assessed risk. Answer: A, B Explanation: PCAOB AS 2310, The Confirmation Process and AU-C 505 state there is a presumption that the auditor will request the confirmation of receivables during an audit unless: (1) Accounts receivable are immaterial to the financial statements, (2) The use of confirmations would be ineffective as an audit procedure, and (3) The auditor's assessed level of risk of material misstatement at the relevant assertion level is low, and the other planned substantive procedures address the assessed risk. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 148) Dawn and Guy are working on the audit of the revenue-receivables cycle for Nexus Enterprises, LLC, a provider of gym equipment throughout the United States and Canada. Dawn has heard one of the audit partners discussing this cycle, and asks Guy to explain what exactly this cycle is. Which of the following most accurately describe the revenue-receivables cycle? A) The revenue-receivables cycle involves multiple steps. Typically, the first step is a customer placing an order for goods and inventory being shipped out. If the sale is made on credit, then a receivable is created for the customer, who will subsequently remit payment at a future date. B) The revenue-receivables cycle typically is initiated by a customer ordering products from the client. Once the product is ordered, a payable will be created and the customer allowed a certain number of days to pay. Once the customer remits payment, the cycle starts over again. C) The revenue-receivables cycle is one of the most common cycles in any business, regardless of the industry. The client records a receivable in the amount of the sale, and remits payment to the customer within a prespecified number of days. D) None of these answer choices are correct. Answer: A Explanation: The revenue-receivables cycle involves multiple steps. Typically, the first step is a customer placing an order for goods and inventory being shipped out. If the sale is made on credit, then a receivable is created for the customer, who will subsequently remit payment at a future date. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 67

149) Maria, a student at a local state university is interning at a local CPA Firm. Maria is discussing the audit of accounts receivable and the related allowance accounts with her supervisor, audit manager Steven. Maria advises Steven that she remembers the professor discussing the allowance accounts in one of the lectures, but doesn't remember how these accounts are connected to accounts receivable. Which of the following represents Steven's best response to this question? A) The relationship between the allowance accounts and accounts receivable is such that when accounts receivable turnover increases, the allowance is usually also increased. This is an application of the accounting principles of conservatism. B) The allowance account for accounts receivable exists because in the normal course of business, some customers ultimately do not remit the balances they owe to the client. The client attempts to estimate this ahead of time; hence the need for an allowance account. C) All accounts receivable accounts have an allowance account associated with them. The reason for this is to record bad debt expense as and when customers don't pay their bills owed to the client. D) The allowance accounts for accounts receivable are created to provide a preemptive estimate of bad debt expense that the client will ultimately have to record. The relationship between the allowance accounts and bad debt expense is inverse, so when an allowance account increases, bad debt expense decreases and vice-versa. Answer: B Explanation: The allowance account for accounts receivable exists because in the normal course of business, some customers ultimately do not remit the balances they owe to the client. The client attempts to estimate this ahead of time; hence the need for an allowance account. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

150) Joanna and Marvin are eating lunch one day at a client's office where they are working on an attestation engagement. Marvin mentions to Joanna that his supervisor has tasked him with understanding more about the client and the environment in which the client operates, as this is the first year audit. Marvin mentions to Joanna that he is not exactly sure what methods might be appropriate in order to achieve this understanding, and asks Joanna for any helpful suggestions. Which of the following represents Joanna's most appropriate response? A) Joanna should advise Marvin that the best thing to do would be to request a meeting with senior management. Once the meeting is convened, Marvin should request written information and assurances from management pertaining to the client itself and the industry in which the client operates. B) Joanna should advise Marvin that one of the most prudent courses of action would be to examine competing companies in the same industry. If Marvin can develop such an understanding, it would help him to determine what might be notable and worth investigating with respect to the client. C) Joanna should explain to Marvin that he should focus only on the most current available fiscal year's data to calculate ratios, as this represents the most up-to-date information available for the client. Looking at older information is generally obsolete due to its age. D) None of these answer choices are correct. Answer: B Explanation: Joanna should advise Marvin that one of the most prudent courses of action would be to examine competing companies in the same industry. If Marvin can develop such an understanding, it would help him to determine what might be notable and worth investigating with respect to the client. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

151) John, the audit partner in charge of Hasbro CPA Firm has called a meeting of his audit teams to discuss the upcoming audit of Tyson Enterprises LLC, a large multinational retailer of clothes and other fashionable apparel throughout the United States and Latin America. John wants to brainstorm and discuss the possible risks of material misstatement that may be present with this client. Which of the following represents the most likely risk of material misstatement for this client? A) The client operates in the fashion industry, which changes rapidly. In addition, this industry is often fickle with consumer demands and tastes shifting rapidly. B) The client sells its goods in other countries, not just the United States. This exposes the client to additional risks pertaining to foreign currency exchange rates, and also the risk of noncollection of receivables from foreign customers. C) The client is a large firm, so it is possible that the client's reporting hierarchy and decentralized system of governance and operation might increase the risk of material misstatement due to local managers circumventing rules and procedures. D) The client operates its production facilities in the United States, which could expose the client to overseas labor union disputes as well as having to contend with foreign strikes and collective bargaining issues. Answer: B Explanation: The client sells its goods in other countries, not just the United States. This exposes the client to additional risks pertaining to foreign currency exchange rates, and also the risk of non-collection of receivables from foreign customers. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

152) Johnson and Co. CPA firm has been invited to submit a bid to audit Morriston State University, a private, traditional brick-and-mortar school. Before submitting the bid, the partners of Johnson and Co. are meeting to discuss inherent risks that may be present, and associated with this type of industry. Which of the following represents the most likely inherent risk the partners will want to consider before submitting a bid? A) Colleges and Universities in recent years have moved a large part of their class offerings online. This could increase the risk of material misstatement related to academic fraud and cheating. B) Colleges and Universities are mostly not-for-profit organizations. These organizations are notorious for having poor internal controls over cash receipts and disbursements; thus the auditor's most prudent course of action would be to not submit a bid. C) Colleges and Universities often have a large amount of fixed assets and corresponding fixed costs. These institutions must still cover these fixed costs during times of lower enrollment, increasing the risk of material misstatement. D) Colleges and Universities operate in an extremely competitive marketplace. Students have many options among educational institutions, and can easily transfer from one institution to another; increasing inherent risk and risk of material misstatement. Answer: C Explanation: Colleges and Universities often have a large amount of fixed assets and corresponding fixed costs. These institutions must still cover these fixed costs during times of lower enrollment, increasing the risk of material misstatement. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

153) Towson CPAs have convened a meeting to discuss potential risks of material misstatement associated with the upcoming audit of Baltimore Enterprises, LLC, a retailer of residential and commercial plumbing equipment throughout the United States. One of the audit partners running the meeting notes that in a prior year's audit, the auditors discovered bill-and-hold transactions, and made a recommendation that the client make adjusting entries accordingly. Which of the following best encapsulates the risk associated with bill-and-hold transactions? A) Bill-and-hold transactions occur when a customer requests goods from the audit client. Once the audit client ships the goods to the customer, the customer subsequently returns part or all of the goods in a future period and requests a refund accordingly. B) Bill-and-hold transactions represent situations whereby the customer is billed for the goods by the audit client, but the goods are not actually shipped. These transactions generally increase the risk of material misstatement, as in many cases, the client uses such transactions to overstate revenue. C) Bill-and-hold transactions represent scenarios where the audit client ships goods to the customer that the customer did not request. At a future date, the customer returns the goods to the audit client. Generally accepted auditing standards prohibit all types of bill-and-hold transactions. D) Bill-and-hold transactions are typically initiated by the customer of an audit client. The customer requests the audit client ship goods to them and bill them in a future period. This scheme is used by customers of audit clients to overstate assets and understate expenses. Answer: B Explanation: Bill-and-hold transactions represent situations whereby the customer is billed for the goods by the audit client, but the goods are not actually shipped. These transactions generally increase the risk of material misstatement, as in many cases, the client uses such transactions to overstate revenue. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

154) Mike and Keona are meeting for coffee to discuss their new positions as staff associates at Barker CPA Firm. Mike is keen to move up in the organization and is thus keen to learn as quickly as possible. Mike tells Keona that he has heard a lot of talk among the audit team about entity-level controls and transaction-level controls, but is not really sure he understands the difference. Which of the following responses by Keona would best help Mike with this understanding? A) The best way to think about these controls is that they all are designed to achieve the same goal, i.e. help the client controls its operations. Use of controls helps the client eliminate misstatements in the financial statements. B) You should think of entity-level controls as controls that the client has enacted at a more topological level. On the other hand, transaction-level controls are typically instituted by the board of directors and will usually apply firm-wide. C) These are both examples of internal controls. Entity-level controls represent controls that focus more on the organization as a whole. On the other hand, transaction-level controls are usually geared more toward specific processes. D) None of these answer choices are correct. Answer: C Explanation: These are both examples of internal controls. Entity-level controls represent controls that focus more on the organization as a whole. On the other hand, transaction-level controls are usually geared more toward specific processes. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

155) Felix CPA Firm is in the beginning stages of the audit of Nexam LLC, a large distributor of feline food and other products. There has been some discussion among the auditors and the client's senior management with respect to a new leasing standard that was recently introduced by the Financial Accounting Standards Board. Which of the following represents an area related to the standard that the auditor may consider increases inherent risk? A) The new leasing standard is somewhat complicated in nature, and requires capitalization of lease assets and associated liabilities on the client's balance sheet. B) Generally accepted auditing standards require adoption of the standard by all publicly-traded companies. The uniformity contained in this standard is likely to increase inherent risk. C) The auditor observes that management's reaction to the new leasing standard is to attempt to restructure leases in order to circumvent the capitalization requirements of the act. D) The auditors note that the client's internal audit function has convened a task force to analyze the new leasing standard. The task force's main role is to ensure the client's compliance with the new standard. Answer: C Explanation: The auditor observes that management's reaction to the new leasing standard is to attempt to restructure leases in order to circumvent the capitalization requirements of the act. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

156) Byrum CPAs are currently working on the audit of Longfellow Industries, a producer of sheet metal in the Midwestern region of the United States. One of the audit partners assigned to the engagement has mentioned that he believes that when it comes to the client's revenuereceivables cycle transactions, the auditors should consider having a couple of staff associates perform a walkthrough. Which of the following best elicits the reasons for performing a walkthrough? A) If an auditor performs a walkthrough of a client's transactions, he or she will become more familiar with that particular cycle and/or process. As many auditors often go to work for their audit clients, this would serve the auditor well. B) If an auditor performs a walkthrough of a client's transactions, it will enable to the auditor to understand the processes and associated documentation better from beginning to end. This increased understanding will help the auditor to potentially locate areas of higher inherent risk which may be worthy of further audit attention. C) If an auditor performs a walkthrough of a client's business cycle, it will help the auditor to identify business and operational efficiencies that could be recommended to the client. The auditor can then charge the client advisory fees for these services. D) When an auditor performs a walkthrough of a client's operational and business cycles, it helps the auditor to identify specific misstatements present in processes, and eliminate them. Answer: B Explanation: If an auditor performs a walkthrough of a client's transactions, it will enable to the auditor to understand the processes and associated documentation better from beginning to end. This increased understanding will help the auditor to potentially locate areas of higher inherent risk which may be worthy of further audit attention. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

157) With respect to the risk of material misstatement, an area of major concern to all firms is the handling of cash, and subsequent cash receipts and disbursements. As part of their system of internal control, most if not all firms introduce controls over cash transactions in an attempt to lower the risk of material misstatement in this area. Which of the following scenarios represent a situation whereby the risk of material misstatement has likely been decreased? A) Johnson Company has recently laid off many higher paid, more experienced employees that dealt with cash receipts and disbursements. This move was part of a major cost-cutting exercise by Johnson Company. B) Sadler Firm has recently entered into a major contract with a new customer to provide goods shipments bi-weekly. Because the client represents a source of major potential revenue for Sadler, the decision was made by senior management to immediately extend generous credit terms. C) Berry & Co. have recently undergone installation of a new IT system companywide. As part of the installation of this new system, Berry & Co. have switched over to an electronic funds transfer (EFT) system for all cash receipts. D) As part of an investigation into cash handling practices at Dewey Firm, the internal audit function has determined a number of employees colluding to embezzle cash from the firm, and has notified management accordingly. Answer: C Explanation: Berry & Co. have recently undergone installation of a new IT system companywide. As part of the installation of this new system, Berry & Co. have switched over to an electronic funds transfer (EFT) system for all cash receipts. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

158) Two audit staff associates, Gemma and Barkley have been tasked by their supervisor to devise ways that one of their audit clients could improve controls over the receipt of cash. Gemma tells Barkley that she is not really sure where to start, or what controls might be effective, and asks for suggestions. Which of the following would represent Barkley's best suggestions? A) We should convene a meeting with the client's senior management and recommend that all future cash receipt payments be eliminated. Instead, clients should be made to use electronic funds transfers, which would drastically improve the control over incoming cash. B) We might want to consider recommending to the client that cash collected at the business is deposited in the bank at least weekly. If the client agrees to this, they will benefit from extra interest payments on their higher bank balances. C) We should consider recommending to the client that cash received by the business is deposited daily, and that the receipts confirming the bank deposits are forwarded to accounting update the general ledger as expeditiously as possible. D) We should explain to the client that we wish to immediately convene a task force to examine incoming cash receipts from clients setting their accounts payable balances with the client, and to find ways to speed up the collection time and how long it takes for the funds to be deposited in the client's bank. Answer: C Explanation: We should consider recommending to the client that cash received by the business is deposited daily, and that the receipts confirming the bank deposits are forwarded to accounting update the general ledger as expeditiously as possible. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

159) Steve, the owner of a small CPA firm has been hired on a consulting basis by GlowBright, Inc. to evaluate their process for accepting new clients. Steve has analyzed the previous system and noted that many clients were accepted by the firm who were often either late settling receivables, or didn't settle their receivables at all. As a result of this, Steve has formulated some new considerations for the firm when considering accepting new clients. Which of the following would best represent these considerations? A) Before accepting a new customer, the client firm should request references from previous vendors of that firm so that payment history and terms can be documented. This will help the client firm determine the suitability of the prospective customer. B) Before accepting a new customer, the client firm should consider credit checking the prospective new client to gauge creditworthiness. Such a check will also help determine what, if any initial credit terms should be offered. C) When considering a new customer, the safest option for the client firm is to request that for the first year, all sales will be made on a cash basis only. This will allow the client firm to build a history with the customer and reevaluate the credit decision in the future. D) None of these answer choices are correct. Answer: B Explanation: Before accepting a new customer, the client firm should consider credit checking the prospective new client to gauge creditworthiness. Such a check will also help determine what, if any initial credit terms should be offered. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

160) Madison and Steve are working on the audit of Bestway LLC and have been tasked with examining the client's controls surrounding inventory shipments. Madison and Steve's supervisor has noted issues in this area in prior audits and asked the two to audit controls in this area. Which of the following most accurately represents controls in this area that Madison and Steve would likely wish to check? A) Madison and Steve will likely want to audit inventory shipment controls to ensure that goods are shipped out to the correct addresses. In addition, they will want to ensure that the appropriate payables accounts are credited. B) Madison and Steve will want to ensure that good are shipped out to the correct addresses, and with the appropriate authorizations. They will probably also want to check to makes sure the inventory shipment paperwork matches the sales invoice. C) Madison and Steve will probably want to investigate controls relating to the cutoff assertion. This will ensure that sales invoices are recorded in a separate period than when the goods were shipped. D) Madison and Steve will likely want to examine controls pertaining to timely shipment of goods upon receipt of a properly approved sales invoice. They will likely also want to follow up on controls ensuring that the appropriate payable accounts are credited with the customer's balance owed. Answer: B Explanation: Madison and Steve will want to ensure that good are shipped out to the correct addresses, and with the appropriate authorizations. They will probably also want to check to makes sure the inventory shipment paperwork matches the sales invoice. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

161) Jemimah and Peter have been given the task of auditing the sales accounts of Starbright LLC; a supplier of telescopes and other astronomical equipment throughout the United States. Their supervisor has told them that their focus should be on testing the occurrence assertion of sales. Based on this notification, which of the following represents the most suitable way for Peter and Jemimah to consider auditing this assertion? A) Peter and Jemimah should consider obtaining a sample of sales transactions and matching them up one-for-one with their associated receivables. This will help them to confirm the occurrence assertion does not contain any misstatements. B) Peter and Jemimah should think about obtaining a representative sample of revenue transactions and matching them up against their respective bills of lading. This will help them to audit the occurrence assertion of revenue. C) Peter and Jemimah should think about obtaining a sample of transactions and matching the respective bills of lading with the associated payable. This would help audit the existence assertion for this area. D) None of these answer choices are correct. Answer: B Explanation: Peter and Jemimah should think about obtaining a representative sample of revenue transactions and matching them up against their respective bills of lading. This will help them to audit the occurrence assertion of revenue. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 162) During an audit of LCG, Co, you discover that one employee is responsible for receiving cash and recording the cash receipts in the accounting system. A second employee is responsible for making the daily deposits to cash. Evaluate the segregation of duties over cash receipts. Answer: The cash receipt's function involves the following sub-functions: (1) receiving cash, (2) depositing cash, and (3) recording the receipts. As in the case of credit sales transactions, segregation of duties in performing these sub-functions is an important internal control. If one employee has responsibility for receiving cash and recording receipts, the possibility for lapping exists. All three sub-functions should be segregated in order to achieve separation in the custody and recording of assets. Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

163) When shopping at Lucky Donuts for coffee and a bagel before heading into work, the cashier asked Susan Donahue if she wanted her receipt. Susan had paid cash, so she didn't really need her receipt. However, she noticed a sign on the register that said "please ask for a receipt". Why is it in the interest of the owner of Lucky Donuts to have the customer ask for a receipt? Answer: The customer's expectation of a printed receipt and supervisory surveillance of overthe-counter sales transactions helps to ensure all cash sales are processed through the cash registers or terminals (completeness and accuracy of cash received). If the customer does not get their receipt, what is there to prevent the cashier from pocketing the cash and not finalizing the sale in the register? In that case, Lucky Donuts would not receive the cash from the customer. The cashier would! Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 164) Evaluate the following segregation of duties concerning accounts receivable write-offs. Erica Snoder is an accounts receivable clerk for Wonder Entertainment, Inc. Wonder Entertainment runs a lean accounting team. As such, Erica is responsible for collecting cash receipts in the mail and creating the listing of checks received and making the bank deposit. Another employee, Gretchen Baxter, uses the listing of checks received to record the cash receipts in the accounts receivable ledger. Because Gretchen records the accounts receivable, Erica has been assigned the authorization and recording of customer write-offs. Answer: Good internal controls over the write-off of uncollectible accounts is important to prevent write-offs from being used to conceal fraud in processing cash receipts. For example, Erica might misappropriate cash received from a customer and cover up the fraud by writing the customer's account off against the allowance for uncollectible accounts. Good internal controls include the following procedures: o All write-offs of uncollectible accounts should be authorized by an appropriate level of management and supported by documentation, such as correspondence with the customer or collection agencies, and o Appropriate review of journal entries by management to ensure the appropriateness of the transaction. Diff: 3 LO: 6 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

165) An account receivable confirmation is returned with a note to the auditor describing a difference between your client's records and the customer's records. Provide two potential non-misstatement timing differences that could cause a discrepancy between a client's receivable records and his/her customer's records. Answer: Two potential timing differences would be: 1. Client shipped to customer before year-end, but customer received after year-end 2. Customer sent payment to client before year-end, but client received after year end. Diff: 3 LO: 6 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 166) Louis and Catherine are working on the audit of Aqua Enterprises, a regional distributor of bottled water and other bottled products throughout the southeastern United States. They have been tasked with auditing a sample of accounts receivable to check for adjustments that may have not been authorized by management. What would be the best way for Louis and Catherine to audit this? A) Louis and Catherine should consider obtaining, on a test basis, receiving reports pertaining to accounts receivable settlements. The information contained in these reports will help audit the existence assertion. B) Louis and Catherine should think about obtaining a sample of debit memos and examining each memo to determine if sales returns were appropriately authorized. C) Louis and Catherine should consider examining, on a test basis, credit memos pertaining to accounts receivable. The information contained in this memo should help the auditors determine whether the appropriate authorizations have been obtained. D) Louis and Catherine should think about contacting senior management and requesting written representations pertaining to accounts receivable reductions. They can then corroborate these representations by examining the accounts receivable allowance accounts. Answer: C Explanation: Louis and Catherine should consider examining, on a test basis, credit memos pertaining to accounts receivable. The information contained in this memo should help the auditors determine whether the appropriate authorizations have been obtained. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

167) As part of the audit of an attestation client, the auditors will typically examine, on a test basis, a sample of accounts receivable and the related allowance accounts. If an auditor suspects that the client's customers are taking longer to settle their accounts receivable balances, what might the auditor decide to do to check this? A) The auditor should consider sending positive confirmations to all holders of the client's accounts receivable. The auditor will be able to confirm upon receipt of the confirmations whether receivables are taking longer to collect. B) The auditor should consider sending negative confirmations to a selected sample of the client's accounts receivable holders. Upon receipt of the completed confirmations, the auditor will be able to determine whether days in receivables are increasing. C) The auditor should consider obtaining an aging of receivables schedule. This schedule breaks down how much the customers in the sample owe the client and will help provide the auditor with an indication of how long customers are taking to settle receivables. D) None of these answer choices are correct. Answer: C Explanation: The auditor should consider obtaining an aging of receivables schedule. This schedule breaks down how much the customers in the sample owe the client and will help provide the auditor with an indication of how long customers are taking to settle receivables. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

168) Stormy and Daniel are working on the audit of McBride LLC, an international retailer of farm equipment and other heavy machinery. Stormy and Daniel have been tasked by their supervisor to audit the client's revenue accounts and look for any evidence of misstatements. The pair has decided to use a proprietary audit software program to enter fictitious data into the client's system and check for errors etc. Which of the following represents a way that Stormy and Daniel could verify the effectiveness of controls related to the revenue process? A) Stormy and Daniel could consider obtaining a sample of exception reports generated by the clients' system in response to the fictitious data entered into the system by the audit software and look for evidence of the exceptions being cleared in a timely and appropriate manner. B) Stormy and Daniel could consider employing extra IT entity-level controls in order to provide an audit opinion on entity-level controls related to the revenue-receivables cycle. C) Stormy and Daniel should consider requesting written assurances by both senior management and the internal audit function pertaining to no misstatements being present in the revenuereceivables cycle. Once obtained, these representations should be added to the current year's audit file. D) Stormy and Daniel should consider examining similarly sized firms in other industries in order to check for anomalous ratios and other financial metrics which might warrant further investigation by the audit team. Answer: A Explanation: Stormy and Daniel could consider obtaining a sample of exception reports generated by the clients' system in response to the fictitious data entered into the system by the audit software and look for evidence of the exceptions being cleared in a timely and appropriate manner. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

169) McKay CPA Firm is currently working on the audit of McKeown Enterprises, Inc., a large building firm that provides construction services across the southern United States. One of the partners assigned to the audit has noted that the client uses the percentage-of-completion method for their building services and would like to audit revenues associated with this method. Which of the following techniques would be the most appropriate way for the auditors to test this? A) The auditors should consider confirming the clients recorded revenue percentages with the pertinent clients. This would enable the auditors to accurately test the occurrence assertion of revenue. B) The auditors should consider utilizing an audit data analytics (ADA) technique to investigate gross margins for construction projects in progress compared with completed construction jobs. C) The auditors should think about the appropriateness of the percentage-of-completion method, and possibly recommend to the audit client that a different revenue recognition method be used. D) None of these answers is correct. Answer: B Explanation: The auditors should consider utilizing an audit data analytics (ADA) technique to investigate gross margins for construction projects in progress compared with completed construction jobs. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 170) Dirk Westfall is a staff auditor serving two clients: ABC Manufacturing and XYZ Food Services. ABC is a public company. XYZ is a private company. Explain how the tests of controls of the revenue cycle would be used differently for the audits of the two clients. Answer: Most auditors plan to test controls in the revenue cycle because of the high volume of routine transactions in this cycle. Public company auditors test controls to support an opinion on internal controls over financial reporting because the Sarbanes-Oxley Act of 2002 (Section 404) requires such an independent opinion for public companies. In contrast, auditors of private companies will test controls that appear to be effective because of the audit efficiencies that exist when the client has effective controls in place. Diff: 3 LO: 7 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

171) Explain what a lapping scheme is, provide an example of a lapping scheme, and explain what the auditor should be alert for to detect a lapping scheme. Answer: Lapping is a common scheme to conceal the misappropriation of cash receipts. A lapping scheme begins when a customer pays cash toward an accounts receivable balance. Then an employee steals the cash that is received from the customer. Say an employee is able to steal a $1,000 payment from Customer A. To prevent Customer A from complaining, when $1,500 is received from Customer B, it is accounted for as $1,000 from Customer A and $500 from Customer B. Subsequently, the accounts receivable clerk must cover the shortage from Customer B, with funds from another customer, and so on. Sometimes the fraudster can solve the problem of keeping this going by falsifying a sale adjustment to reduce the receivable, or by writing off part of a customer's balance through a journal entry. The auditor should be alert to the possibility of fraud when a cash receipt is credited to the wrong customer, or there is little or no justification for a sales adjustment or receivable write-off. Diff: 3 LO: 7 Bloom: Synthesis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 172) What procedures should an auditor perform for a positive confirmation that is not returned by the client's customer? Answer: Auditors have to perform alternative procedures to ensure existence. These include examining (1) subsequent cash receipts, (2) sales orders, invoices, and shipping documents, and (3) correspondence files for past-due accounts. Examining subsequent cash receipts is a particularly effective test because if the customer paid the account, this is strong evidence that the receivable existed. The cash receipt should be traced to the remittance advice and the deposit into cash. Diff: 2 LO: 7 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

173) Is the confirmation of cash and accounts receivable required according to auditing standards? Explain. Answer: In general, the use of confirmations for cash balances and accounts receivable is considered a requirement under auditing standards. However, auditors may decide not to use them if suitable alternative procedures are available and applicable in certain circumstances. Justifications for not using confirmations include: (1) receivables are not material, (2) confirmations would not be effective, (3) analytical procedures and other substantive test of details procedures would provide sufficient, competent evidence Diff: 2 LO: 7 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Research; PC: None 174) The financial records of the Murray Company show that Mr. Donaldson owes $4,100 on an account receivable. An independent audit is being carried out and the auditors send a positive confirmation to Mr. Donaldson. What is the most likely reason as to why a positive confirmation rather than a negative confirmation was used here? Answer: The inherent risk was high for accounts receivable with this audit. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

175) Identify whether the following tests are tests of controls, substantive analytical procedures, tests of details of transactions, or tests of details of account balances: 1) Select a sample of customer receivables and send positive confirmations to each one 2) Examine monthly bank reconciliations for the internal auditors' initials indicating internal verification and review of the reconciliation. 3) Select a sample of entries in sales journal and trace each to the shipping documents 4) Compute receivable turnover and compare with previous years 5) For a sample of new customers, determine whether credit approval was properly administered and documented 6) Compare the dates on a sample of sales invoices with the dates of shipment and the dates they were recorded in the sales journal Answer: 1) Tests of details of account balances 2) Tests of controls 3) Tests of details of transactions 4) Substantive analytical procedures 5) Tests of controls 6) Tests of details of transactions Diff: 3 LO: 8 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 176) Assume you are currently performing analytical procedures over the sales cycle for Huron Manufacturing, Inc., a company that manufactures plastic toys. Prepare an audit program you might use for analytical procedures to test the relevant assertions over the sales cycle? Answer: Perform analytical procedures: 1. Develop an expectation for accounts receivable using knowledge of the entity's business activity, market share, normal trade terms, and its history of accounts receivable turnover in days. 2. Calculate ratios: 3. Compare sales to the entity's capacity. 4. Compare sales growth and receivable growth. 5. Accounts receivable turnover in days. 6. Uncollectible accounts expense to net credit sales 7. Uncollectible accounts expense to accounts receivable write-offs 8. Analyze ratio results relative to expectations based on prior years, industry data, budgeted amounts, or other data. Diff: 3 LO: 8 Bloom: Synthesis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 88

177) You are the auditor for DBA Health Products, Inc. As part of the audit of account receivable, DBA has provided to you the electronic file containing its accounts receivable as of its fiscal year end. The file includes the customer name, customer address, customer number, sales invoice number, sales invoice date, and account balance. Describe three or more substantive audit procedures you might perform using computer assisted audit tools and techniques (CAATs) with this computer file. Answer: The following substantive tests could be performed with CAATs. 1. Compute the total accounts receivable by adding the sales invoice amounts. Compare to general ledger control account total (manual). 2. Scan the sales invoice date field for any dates after the year-end. 3. Prepare an aged accounts receivable trial balance using the sales invoice date and amount. 4. Select and print accounts for confirmation of accounts receivable. 5. Scan the sales invoice amount for negative balances. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 178) Juan and Jenny have been assigned to the audit of Luxor Enterprises, LLC, a retailer of cleaning detergents and other cleaning products throughout the United States and Mexico. Juan has mentioned to Jenny that one of the first things they should do is attempt to obtain an understanding of the client, and the industry in which the client operates. Which of the following most appropriately represents ways that this could be accomplished? A) Juan and Jenny could examine how affected the client and the client's industry is by key economic cycles, as well as examining any seasonality that may be present in the client's industry. B) Juan and Jenny could consider examining competing industries to determine the variability that may exist with respect to revenue generation and receivables collection patterns. C) Juan and Jenny could formally request from senior management a written report detailing any areas of higher inherent risk in this area that were noted by predecessor auditors. D) Juan and Jenny could consider hiring an industry specialist to investigate and formally report on the nuances and particulars of the industry, and how these nuances affect the audit client with respect to revenue generation. Answer: A Explanation: Juan and Jenny could examine how affected the client and the client's industry is by key economic cycles, as well as examining any seasonality that may be present in the client's industry. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

179) Cedric is the audit partner assigned to the engagement of Wolfram Enterprises, LLC. Cedric is interested in assigning a team to audit the client's revenue procedures and has picked a team to perform these procedures. The team manager is meeting with Cedric to discuss what analytical procedures might be appropriate to effectively audit the client's revenue process. Which of the following choices best represents procedures the audit team might undertake to audit this area? A) The audit team should consider developing an expectation of accounts payable balances based on information from prior years audits. The audit team can also examine competing firms within the same industry to help develop this expectation. B) The audit team should consider calculating key ratios that pertain to revenue generation. Examples of such ratios would be accounts receivable turnover ratio and times interest earned. C) The audit team should consider examining key metrics pertaining to sales such as accounts receivable turnover. Such ratios can be analyzed relative to prior years and industry averages. D) The audit team should consider selecting, on a test basis, a sample of revenue and receivables transactions to ensure that they are recorded in the correct periods respectively. Such a procedure would assist the auditor in testing the accuracy assertion. Answer: C Explanation: The audit team should consider examining key metrics pertaining to sales such as accounts receivable turnover. Such ratios can be analyzed relative to prior years and industry averages. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

Auditing, 2e (Johnson) Chapter 12 Auditing the Purchasing and Payroll Processes 1) An entity's purchasing process consists of activities related to the acquisition of, and payment for, goods and services. Answer: TRUE Explanation: An entity's purchasing process consists of activities related to the acquisition of, and payment for, goods and services. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 2) Purchasing goods and services and making payments are NOT considered core purchase transactions. Answer: FALSE Explanation: The core purchase transactions are (1) purchasing goods and services (purchase transactions), (2) making payments (cash disbursement transactions), and (3) making purchase adjustments. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 3) As inherent risk factors vary from industry to industry, from client to client, and from year to year, each audit should be identical to address unique risks. Answer: FALSE Explanation: As inherent risk factors vary from industry to industry, from client to client, and from year to year, each audit must be custom made to address unique risks. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

4) The purchasing or procurement process involves selecting customers, establishing payment terms, negotiating contracts, purchasing goods, receiving goods, and recording of purchases and payment of liabilities. Answer: FALSE Explanation: The purchasing or procurement process involves selecting vendors, establishing payment terms, negotiating contracts, purchasing goods, receiving goods, and recording of purchases and payment of liabilities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 5) Prior experience in accounts payable turnover days combined with knowledge of current purchases can be useful in estimating current payables. Answer: TRUE Explanation: Prior experience in accounts payable turnover days combined with knowledge of current purchases can be useful in estimating current payables. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 6) The expenditure process is particularly prone to a risk of employee fraud through unauthorized disbursements of cash. Answer: TRUE Explanation: The expenditure process is particularly prone to a risk of employee fraud through unauthorized disbursements of cash. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

7) The first category of misstatements that is relevant to the purchasing and payroll cycles is "expense (payroll, selling, general, administration, other) recording issues." Answer: TRUE Explanation: The first category of misstatements that are relevant to the purchasing and payroll cycles is "expense (payroll, SGA, other) recording issues." Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 8) A strong tone at the top about the importance of accurate financial reporting encourages the understatement of expenses and liabilities. Answer: FALSE Explanation: A strong tone at the top about the importance of accurate financial reporting discourages the understatement (and other deliberate misstatements) of expenses and liabilities. Diff: 1 LO: 3 Bloom: Knowledge, Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 9) The transaction flow in a typical purchases process for a client purchasing goods includes approving purchases, shipping goods, recording purchases and recording accounts payable. Answer: FALSE Explanation: The transaction flow in a typical purchases process for a client purchasing goods includes approving purchases, receiving goods, recording purchases and recording accounts payable. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

10) An approved vendor master file is a computer file containing pertinent information on vendors and suppliers that have been approved to purchase services from and make payments to. Answer: TRUE Explanation: An approved vendor master file is a computer file containing pertinent information on vendors and suppliers that have been approved to purchase services from and make payments to. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 11) A Cash Disbursements Journal is a daily report showing checks written or electric funds transferred to vendors and amounts paid. Answer: TRUE Explanation: Cash Disbursements Journal is a daily report showing checks written or electric funds transferred to vendors and amounts paid. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 12) A voucher is an external document indicating the vendor, the amount due, and payment terms for the purchases received. Answer: FALSE Explanation: A voucher is an INTERNAL document indicating the vendor, the amount due, and payment terms for the purchases received. It is used to authorize recording and paying a liability. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

13) A cash disbursements journal is a daily report showing checks written or electronic funds transferred to vendors and amounts paid. Answer: TRUE Explanation: A cash disbursements journal is a daily report showing checks written or electronic funds transferred to vendors and amounts paid. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 14) Electronic Invoice Presentment and Payment (EIPP) systems use an independent third party to settle business to business (B2B) transactions. Answer: TRUE Explanation: Electronic Invoice Presentment and Payment (EIPP) systems use an independent third party to settle business to business (B2B) transactions. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 15) Many Evaluated Receipt Systems (ERS) use Electronic Invoice Presentment and Payment (EIPP) systems. Answer: TRUE Explanation: Many ERS systems use Electronic Invoice Presentment and Payment (EIPP) systems. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 16) A shipping report is one of the important documents and records used in processing purchase adjustments in traditional or Evaluated Receipts Settlement (ERS) systems. Answer: TRUE Explanation: A shipping report is one of the important documents and records used in processing purchase adjustments in traditional or ERS systems. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 5

17) A Purchase Return Authorization is a form showing the description, quantity, and other data pertaining to the goods the vendor has authorized the purchaser to return. Answer: TRUE Explanation: A Purchase Return Authorization is a form showing the description, quantity, and other data pertaining to the goods the vendor has authorized the purchaser to return. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 18) Many frauds can be avoided with strong controls over the vendor master files, determining the appropriateness of support for payments to vendors before recording a liability (voucher), and the willingness to dispute inappropriate items with vendors. Answer: TRUE Explanation: Many frauds can be avoided with strong controls over the vendor master files, determining the appropriateness of support for payments to vendors before recording a liability (voucher), and the willingness to dispute inappropriate items with vendors. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 19) The purchase cutoff test involves determining that purchase transactions occurring near the balance sheet date are recorded in the proper period. Answer: TRUE Explanation: The purchase cutoff test involves determining that purchase transactions occurring near the balance sheet date are recorded in the proper period. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

20) An entity's purchasing process consists of ________. A) activities related to the acquisition of, and payment for, goods and services. B) activities related to the selling of, and payment received for, goods and services. C) repurchasing shares of stock from shareholders D) refinancing loans and notes payable with a bank Answer: A Explanation: An entity's purchases process consists of activities related to the acquisition of, and payment for, goods and services. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 21) Purchases of inventory on credit should involve ________. A) debits to inventory and credits to Account Payables B) debits to payables and credits to inventory C) debits to payables and credits to expenses D) debits to expenses and credits to cash Answer: A Explanation: Purchases of inventory on credit should involve debits to inventory and credits to account payables. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 22) For companies that purchase goods on account, the transaction should ________. A) record purchases and accounts payable upon ordering of the goods B) record purchases and accounts payable upon the receipt of goods C) be input into the ledger by the auditor once it has been reviewed D) overstate equity until the goods are paid for Answer: B Explanation: For companies that purchase goods on account, the transaction should record purchases and accounts payable upon the receipt of goods. Purchases and accounts payable may be understated if a company receives goods but then waits to record the transaction until a vendor's invoice is received. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 7

23) If a company receives goods but waits to record the transaction until a vendor's invoice is received, ________. A) purchases and accounts payable will be understated B) purchases and accounts payable will be overstated C) purchases will be overstated and accounts payable will be understated D) purchases will be understated and accounts payable will be overstated Answer: A Explanation: If a company receives goods but waits to record the transaction until a vendor's invoice is received, purchases and accounts payable will be understated. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 24) If discounts are taken for early payment, ________. A) purchase discounts are deferred when recording the cash disbursement B) purchase discounts are recorded when recording the cash disbursement C) accounts receivable should be debited for the amount of the discount D) accounts payable should be credited for the amount of the discount Answer: B Explanation: If discounts are taken for early payment, purchase discounts are recorded when recording the cash disbursement. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 25) The rights and obligations assertion with respect to accounts payable relates to whether the ________. A) accounts receivable reflect the recorded asset of the entity B) accounts receivable reflect the recorded liability of the entity C) accounts payable reflect the recorded liability of the entity D) accounts payable reflect the recorded asset of the entity Answer: C Explanation: The rights and obligations assertion with respect to accounts payable relates to whether the accounts payable reflect the recorded liability of the entity. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 8

26) Relevant assertions relating to purchases of materials or goods are ________. A) occurrence, completeness, accuracy, cutoff, classification B) going concern, completeness, accuracy, cutoff, classification C) occurrence, completeness, accuracy, cutoff, verifiability D) occurrence, completeness, accuracy, comparability Answer: A Explanation: Relevant assertions relating to purchases of materials or goods are occurrence, completeness, accuracy, cutoff, and classification. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 27) Key assertions relating to accounts payable account balances are ________. A) existence, rights and obligations, completeness, valuation and allocation B) existence, rights and obligations, truthfulness, valuation and allocation C) existence, rights and obligations, going concern, valuation and allocation D) presentability, rights and obligations, completeness, valuation and allocation Answer: A Explanation: Key assertions relating to accounts payable account balances are existence, rights and obligations, completeness, valuation and allocation. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 28) Key assertions relating to relevant disclosures for payables are ________. A) going concern, completeness, classification and understandability, accuracy and valuation B) occurrence and rights and obligations, completeness, classification and understandability, accuracy and valuation C) occurrence and rights and obligations, completeness, classification and understandability, note disclosure D) credibility, completeness, classification and understandability, accuracy and valuation Answer: B Explanation: Key assertions relating to relevant disclosures for payables are occurrence and rights and obligations, completeness, classification and understandability, accuracy and valuation. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 9

29) Which of the following is in an assertion of relevant account balances of a key purchase transaction? A) Valuation and allocation at historical cost B) Accounts payable C) Purchase returns and allowances D) Purchase returns Answer: A Explanation: Valuation and allocation at historical cost is an assertion of relevant account balances of key purchase transaction. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 30) The "classification and understandability" assertion describing relevant disclosures is part of which of the following? A) Key purchasing cycle assertions B) Cash and purchase discounts C) Purchase returns and allowances D) Purchase transactions Answer: A Explanation: The "classification and understandability" assertion describing relevant disclosures is part of key purchasing cycle assertions. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 31) Which of the following refer to making payments? A) Cash disbursement transactions B) Transactions C) Net sale transactions D) Purchase adjustments Answer: A Explanation: Cash disbursement transactions refer to making payments. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 10

32) During the initial phases of any audit engagement, it is customary for the auditor to spend time attempting to gain an understanding of the client and the industry in which the client operates. This phase of the audit is best described as ________. A) the initial audit planning stage, characterized by understanding key features of the client and the industry such as transactions and balances B) the audit planning stage, characterized by performing tests of controls to determine an appropriate audit strategy for the client C) the substantive planning stage, characterized by the undertaking of preliminary audit strategies such as issuance of an initial audit opinion D) the controls testing phase, characterized by the auditor gaining an understanding of which controls are typically tested in the client's industry Answer: A Explanation: the initial audit planning stage, characterized by understanding key features of the client and the industry such as transactions and balances. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 33) An audit firm is performing the audit of a client's purchases-payable cycle. As part of the audit of this cycle, it is routine for the auditors to check which of the following? A) The auditors should check to make sure credit sales have been recorded with a credit to the appropriate payables accounts. B) The auditors may wish to check that goods or services the audit client has purchased on credit have been recorded to the appropriate payables accounts. C) The auditors are likely to check that inventory that the client has sold as part of the purchasespayables cycle has appropriately been credited from the inventory account. D) None of these answer choices are correct. Answer: B Explanation: The auditors may wish to check that goods or services the audit client has purchased on credit have been recorded to the appropriate payables accounts. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

34) An audit manager is discussing the audit of a tech company with an audit staff associate. The topic of the tech company's operating cycle comes up, and the staff associate asks the audit manager to explain what exactly this is, and why it is important. Which of the following best answers these questions? A) The operating cycle can be best thought of as the time it takes for the firm to hire competent employees and train them properly. B) The operating cycle is best thought of as the length of time it takes for the company to collect cash on sales, having previously purchased inventory in order to be able to sell it. It is an important liquidity metric. C) The operating cycle is best thought of as the time it takes for the firm to purchase inventory, sell it, and return any inventory that was sent back to the audit client. D) The operating cycle can be best thought of as a profitability metric which speaks to turnaround time on inventory. Firms that have faster operating cycles are typically less liquid than their competitors. Answer: B Explanation: The operating cycle is best thought of as the length of time it takes for the company to collect cash on sales, having previously purchased inventory in order to be able to sell it. It is an important liquidity metric. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 35) The purchasing or procurement process involves ________. A) selecting customers, establishing payment terms, negotiating contracts, purchasing goods, receiving goods, and recording of purchases and payment of liabilities B) selecting vendors, establishing payment terms, negotiating contracts, purchasing goods, receiving goods, and recording of purchases and payment of liabilities C) selecting vendors, establishing payment terms, negotiating contracts, selling goods, receiving goods, and recording of purchases and payment of liabilities D) selecting vendors, establishing payment terms, negotiating contracts, purchasing goods, shipping goods, and recording of purchases and payment of liabilities Answer: B Explanation: The purchasing or procurement process involves selecting vendors, establishing payment terms, negotiating contracts, purchasing goods, receiving goods, and recording of purchases and payment of liabilities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

36) If a company is growing, it is common to expect purchases, inventory, and ________. A) accounts receivable to grow at different rates B) accounts payable to grow at different rates C) accounts payable to grow at approximately the same rates D) accounts receivable to grow at approximately the same rates Answer: C Explanation: If a company is growing, it is common to expect purchases, inventory, and accounts payable to grow at approximately the same rates. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 37) The purchasing or procurement process typically involves ________. A) the revenue and receivables accounts B) selecting vendors, establishing payment terms, negotiating contracts, selling goods, receiving goods, and recording of purchases and payment of liabilities C) selecting vendors, establishing payment terms, negotiating contracts, purchasing goods, receiving goods, and recording of purchases and payment of liabilities D) the revenue and cost of goods sold accounts Answer: C Explanation: The purchasing or procurement process involves selecting vendors, establishing payment terms, negotiating contracts, purchasing goods, receiving goods, and recording of purchases and payment of liabilities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 38) Purchasing/procurement is concerned with ________. A) acquiring all of the goods and services that are vital to an organization B) selling all of the goods and services that are vital to an organization C) disposing of all of the goods and services that are vital to an organization D) acquiring all of the goods and services that are vital to an organization's customers Answer: A Explanation: Purchasing/procurement is concerned with acquiring (procuring) all of the goods and services that are vital to an organization. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 13

39) With respect to the purchasing cycle, it is particularly important for the auditor ________. A) to closely check the revenue and associated contra-revenue accounts B) to be knowledgeable about the entity, the types of sales the entity makes, and how those sales support the earnings generation of the entity C) to be knowledgeable about the entity, the types of purchases the entity makes, and how those purchases support the earnings generation of the entity D) to determine the net realizable value of accounts receivable Answer: C Explanation: With respect to the purchasing cycle, it is particularly important for the auditor to be knowledgeable about the entity, the types of purchases the entity makes, and how those purchases support the earnings generation of the entity. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 40) An entity's net operating cycle represents ________. A) the time from using cash to purchasing goods or services to collecting cash from the sale of goods or services B) the time from receiving cash to purchasing goods or services to collecting cash from the sale of goods or services C) the time from using cash to selling goods or services to collecting cash from the sale of goods or services D) the time from using cash to purchase property, plant, and equipment to collecting on the sale of receivables. Answer: A Explanation: An entity's net operating cycle represents the time from using cash to purchasing goods or services to collecting cash from the sale of goods or services. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

41) Every business has ________. A) different market forces that place differing demands on the company's cash flow B) identical market forces that place differing demands on the company's cash flow C) different market forces that place identical demands on the company's cash flow D) identical market forces that place similar demands on the company's cash flow Answer: A Explanation: Every business has different market forces that place differing demands on the company's cash flow. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 42) For a manufacturer or retailer, the gross operating cycle is estimated by ________. A) the average number of days it takes to turn over receivables and collect receivables B) the average number of days it takes to turn over inventory and collect receivables C) the average number of days it takes to turn over payables and collect receivables D) the length of time it takes to request and receive funds for a loan Answer: B Explanation: For a manufacturer or retailer, the gross operating cycle is estimated by the average number of days it takes to turn over inventory and collect receivables. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

43) The net operating cycle represents ________. A) the gross operating cycle reduced by accounts payable turnover days, the amount of time that an entity's customers will let it use trade credit before requiring payment for goods and services B) the gross operating cycle reduced by accounts receivable turnover days, the amount of time that an entity's suppliers will let it use trade credit before requiring payment for goods and services C) the gross operating cycle reduced by accounts payable turnover days, the amount of time that an entity's suppliers will let it use trade credit before requiring payment for goods and services D) the gross financing cycle reduced by accounts payable turnover days, the amount of time that an entity's suppliers will let it use trade credit before requiring payment for goods and services Answer: C Explanation: The net operating cycle represents the gross operating cycle reduced by accounts payable turnover days, the amount of time that an entity's suppliers will let it use trade credit before requiring payment for goods and services. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 44) Many analytical procedures focus on ________. A) the relationship between purchases and accounts payable B) the relationship between purchases and accounts receivable C) the relationship between sales and accounts payable D) the relationship between sales and purchases Answer: A Explanation: Many analytical procedures focus on the relationship between purchases and accounts payable. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

45) When reviewing the results of analytical procedures, the auditor needs to bring an appropriate level of ________. A) professional skepticism B) professional confidence C) statistical sampling D) nonstatistical sampling Answer: A Explanation: When reviewing the results of analytical procedures, the auditor needs to bring an appropriate level of professional skepticism. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 46) When an auditor updates his or her understanding of the entity and its environment, ________. A) each audit should be viewed identically to previous audits B) each audit should be viewed independently from previous audits C) each audit should be viewed with respect to the current audit of other clients D) the auditor should be sure that senior management agrees with the auditor's understanding, and modify appropriately if not Answer: B Explanation: When an auditor updates his or her understanding of the entity and its environment each audit should be viewed independently from previous audits. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

47) What is the procurement process? A) A process that involves selecting vendors, establishing payment terms, negotiating contracts, purchasing goods, receiving goods, and recording of purchases and payment of liabilities. B) A process in which a significant increase in the current ratio compared to prior years' experience may indicate completeness problems. C) A process in which a significant decline in payables as a percent of total assets may indicate completeness problems. D) The purchase returns process involving return of goods. Answer: A Explanation: The purchasing process (purchasing cycle)/procurement process involves selecting vendors, establishing payment terms, negotiating contracts, purchasing goods, receiving goods, and recording of purchases and payment of liabilities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 48) Which of the following may NOT be significantly affected by price increase for purchased goods? A) Purchases made by colleges, universities, and professional schools B) Purchases made by hotels and motels C) Purchases made by supermarkets D) Purchases made by electronic computer manufacturing firms Answer: A Explanation: As purchases and accounts payable are not central to the core business, they may not be significantly affected by price increases for purchased goods. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

49) Which of the following purchases must be managed aggressively to minimize inventory obsolescence? A) Electronic computer manufacturing B) Hotels and motels C) Universities and colleges D) Supermarkets and grocery stores Answer: A Explanation: In the case of the electronic computer manufacturing industry, purchases must be managed aggressively to minimize inventory obsolescence. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 50) Pervasive factors that might motivate management to misstate purchases process assertions include ________. A) pressure to understate expenses in order to report achieving announced profitability targets or industry norms, which were not achieved in reality B) pressure to understate payables in order to report a higher level of working capital when the entity is experiencing liquidity problems C) pressure to understate payables in order to report a higher level of working capital when the entity is experiencing going concern doubts D) All of these answer choices are correct Answer: D Explanation: Pervasive factors that might motivate management to misstate purchases process assertions include: pressure to understate expenses in order to report achieving announced profitability targets or industry norms which were not achieved in reality and pressure to understate payables in order to report a higher level of working capital when the entity is experiencing liquidity problems or going concern doubts. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

51) In assessing inherent risk for purchasing process assertions, the auditor should ________. A) rely on the opinions formed by the internal audit function B) consider pervasive factors influencing the understatement or overstatement of payables and expenses C) consider pervasive factors influencing the understatement or overstatement of receivables and expenses D) consider pervasive factors influencing the correct statement of payables and expenses Answer: B Explanation: In assessing inherent risk for purchase process assertions, the auditor should consider pervasive factors influencing the understatement or overstatement of payables and expenses. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 52) The expenditure process is particularly prone to a risk of employee fraud through ________. A) unauthorized receipts of cash B) authorized disbursements of cash C) unauthorized disbursements of cash D) authorized receipts of cash Answer: C Explanation: The expenditure process is particularly prone to a risk of employee fraud through unauthorized disbursements of cash. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

53) The category of misstatements relevant to the purchasing and payroll cycles that consists of error or irregularities in approach, theory, or calculation associated with the expensing of assets or understatement of liabilities is ________. A) expense recording issues B) liabilities and payables C) accrual estimate failure D) reserve recording issues Answer: A Explanation: The category of misstatements relevant to the purchasing and payroll cycles that consists of error or irregularities in approach, theory, or calculation associated with the expensing of assets or understatement of liabilities is "expense recording issues." Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 54) The second category of misstatements is "________," which includes the failure to record deferred revenue obligations or normal accruals. A) liabilities, payables, reserves, and accrual estimate failure B) expenses, payables, and reserves C) expense recording issues D) debt and equity issues Answer: A Explanation: The second category of misstatements is "liabilities payables, reserves, and accrual estimate failure," which includes the failure to record deferred revenue obligations or normal accruals. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

55) In assessing inherent risk for the purchasing process assertions, the auditor should consider pervasive factors that ________. A) influence the understatement or overstatement of payables and expenses B) influence the understatement of expenses only C) influence the overstatement of payables only D) lead to risk factors associated with purchases Answer: A Explanation: In assessing inherent risk for purchasing process assertions, the auditor should consider pervasive factors influencing the understatement or overstatement of payables and expenses. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 56) When auditors perform analytical procedures during the risk assessment for purchases and payables, they should ________. A) develop a skill in analyzing the likely assertions that might be misstated based on the data B) develop a skill in analyzing the likely assertions that might be correctly stated based on the data C) specifically request the help of the internal auditors D) report any misstatements immediately to the SEC Answer: A Explanation: When auditors perform analytical procedures during risk assessment, they should develop a skill in analyzing the likely assertions that might be misstated based on the data. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

57) Management and the auditor have to be alert to the risk of collusion with ________. A) vendors and vendor kickbacks to employees B) customers and vendor kickbacks to employees C) customers and customer kickbacks to employees D) vendors and vendor kickbacks to stockholders Answer: A Explanation: Management and the auditor have to be alert to the risk of collusion with vendors and vendor kickbacks to employees. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 58) A risk related to what can go wrong with respect to authorizing purchases relates to ________. A) purchases being made from unauthorized vendors B) purchases being made from authorized vendors C) goods received that were not ordered D) foods ordered that have not been received Answer: A Explanation: A risk related to what can go wrong with respect to authorizing purchases relates to purchases being made from unauthorized vendors. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 59) A risk related to what can go wrong with respect to receiving goods is ________. A) that purchases have been made from unauthorized vendors B) that purchases have been made from authorized vendors C) goods received may not have been ordered D) goods received may have been ordered Answer: C Explanation: A risk related to what can go wrong with respect to receiving goods is goods received may not have been ordered. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

60) Many clients build in redundant controls ________. A) so if one control does not find a misstatement, another control will detect the problem B) so if one control does not find a misstatement, another control will also not detect the problem C) to increase automation and reduce human error D) due to their large size and lack of communication across the organization Answer: A Explanation: Many clients build in redundant controls so if one control does not find a misstatement, another control will detect the problem. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 61) The quality of entity level controls is important to ________. A) the ineffective functioning of transaction level controls B) the effective functioning of transaction level controls C) the differences between book and taxable income D) the quantity of transaction level controls Answer: B Explanation: The quality of entity level controls is important to the effective functioning of transaction level controls. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 62) A strong tone at the top about the importance of accurate financial reporting ________. A) discourages the under accrual of expenses and liabilities B) discourages the over accrual of expenses and liabilities C) encourages the under accrual of expenses and liabilities D) encourages the over accrual of expenses and liabilities Answer: A Explanation: A strong tone at the top about the importance of accurate financial reporting discourages the under accrual and other misstatements of expenses and liabilities. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

63) Steps used in developing an audit strategy for management assertions include ________. A) understanding the flow of transactions in a given transaction cycle B) assessing whether controls exist to mitigate what can go wrong C) determining an audit strategy at the assertion level D) All of these answer choices are correct Answer: D Explanation: Some of the steps used in developing an audit strategy for management assertions are understanding the flow of transactions in a given transaction cycle, assessing whether controls exist to mitigate what can go wrong, and determining an audit strategy at the assertion level. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 64) The transaction flow in a typical purchasing process for a client purchasing goods includes ________. A) approving purchases, shipping goods, and recording purchases and accounts payable B) approving purchases, receiving goods, and recording purchases and accounts payable C) approving purchases, receiving goods, and recording purchases and accounts receivable D) approving sales, receiving goods, and recording purchases and accounts receivable Answer: B Explanation: The transaction flow in a typical purchasing process for a client purchasing goods includes approving purchases, receiving goods, and recording purchases and accounts payable. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

65) Common documents and files that are found in the process of buying goods include_______. A) purchase requisition B) approved vendor master file C) purchase order D) All of these answer choices are correct. Answer: D Explanation: Common documents and files that are found in the process of buying goods include: Purchase requisition Approved vendor master file Purchase order Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 66) When management grants greater latitude to a department in initiating transactions, ________. A) strong budget and accountability controls over a department's expenditures are usually established B) weak budget and accountability controls over a department's expenditures are usually established C) strong budget and accountability controls over a department's receipts are usually established D) weak budget and accountability controls over a department's receipts are usually established Answer: A Explanation: When management grants greater latitude to a department in initiating transactions, strong budget and accountability controls over a department's expenditures are usually established. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

67) If the purchasing department establishes strong controls over putting authorized vendors on an authorized vendor list, ________. A) it is easy for employees to initiate transactions with fictitious vendors B) it is difficult for employees to initiate transactions with fictitious vendors C) it is difficult for employees to initiate transactions with legitimate vendors D) it is easy for employees to initiate transactions with legitimate vendors Answer: B Explanation: If the purchasing department establishes strong controls over putting authorized vendors on an authorized vendor list, it is difficult for employees to initiate transactions with fictitious vendors. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 68) The master vendor file should be reviewed ________. A) on a regular basis to remove old vendors or potential duplicate vendors B) every five years to remove old vendors or potential duplicate vendors C) on a regular basis to remove new vendors or potential duplicate vendors D) every five years to remove new vendors or potential duplicate vendors Answer: A Explanation: The master vendor file should also be reviewed on a regular basis to remove old vendors or potential duplicate vendors. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

69) The purchase requisition is often prepared ________. A) manually, and it represents the end of the transaction trail of documentary evidence in support of management's assertion of occurrence of purchase transactions B) electronically, and it represents the end of the transaction trail of documentary evidence in support of management's assertion of occurrence of purchase transactions C) electronically, and it represents the start of the transaction trail of documentary evidence in support of management's assertion of occurrence of purchase transactions D) manually, and it represents the start of the transaction trail of documentary evidence in support of management's assertion of occurrence of purchase transactions Answer: C Explanation: The purchase requisition is often prepared electronically, and it represents the start of the transaction trail of documentary evidence in support of management's assertion of occurrence of purchase transactions. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 70) The accuracy of purchases can be verified by which of the following processes? A) A computer starts with the population of daily vouchers and compares quantities with the underlying receiving report, compares prices to the underlying purchase order, and checks the mathematical accuracy of the voucher. B) A computer starts with the population of daily receiving reports and develops a one for one match with vouchers to ensure that each receiving report results in a voucher (the recording of a payable). C) A computer starts with the population of daily vouchers and compares the date on the voucher with the date on the underlying receiving report. D) Identifying what can go wrong (WCGW) from initiating the transaction to recording it in the general ledger. Answer: A Explanation: The accuracy of purchases can be verified when a computer starts with the population of daily vouchers and compares quantities with the underlying receiving report, compares prices to the underlying purchase order, and checks the mathematical accuracy of the voucher. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

71) What is a voucher? A) It is an internal document used to record a purchase on account and has information about the vendor, amount due, payment date, and due date. B) It is an electronic file that accumulates data on purchases, accounts payable, and cash disbursements. C) The journal of original entry where each purchase is recorded. D) It is the bill from the vendor stating the number of items shipped or services rendered, the amount due, the payment terms, and the date billed. Answer: A Explanation: A voucher is an internal document used to record a purchase on account and has information about the vendor, amount due, payment date, and due date. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 72) Which of the following is included in a three-way match? A) Voucher B) Accuracy of purchases C) Receiving report D) Occurrence of purchases Answer: C Explanation: Many purchase systems require a complete packet of purchase information (e.g., purchase order, receiving report, and vendor invoice) before approving purchase for payment. This is referred to as a three-way match. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

73) Marie and David are discussing the topic of internal control while working on the audit of one of their attestation clients. Marie mentions to David that she is keen to understand more about internal controls. Which of the following statements by David is accurate and would be helpful to Marie? A) Internal controls are generally pretty standardized throughout all of our audit clients. B) During most audits, we start by examining entity-level controls, and work our way down to transaction-level controls. C) We don't spend much time auditing internal control for ongoing attestation clients as there's really no need. D) We typically start the audit of internal control by obtaining written assurances from management. These assurances help to indemnify the auditor in the event of a lawsuit. Answer: B Explanation: During most audits, we start by examining entity-level controls, and work our way down to transaction-level controls. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 74) Satvinder and Danielle are discussing internal control one day at lunch in the cafeteria of their local state university. Danielle mentions to Satvinder that her auditing professor had delivered a lecture on controls over the purchasing process. Which of the following is a control that the auditing professor may have discussed? A) The auditing professor may have mentioned segregation of duties in the purchasing process as a key control. B) The auditing professor may have mentioned an electronic receipts settlement system as a control over the purchasing process. C) The auditing professor may have discussed the cash disbursements journal as a key control over the client's cash receipts system. D) The auditing professor may have talked about monthly bank statements as a key control over the client's vendor invoices. Answer: A Explanation: The auditing professor may have mentioned segregation of duties in the purchasing process as a key control. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

75) Clara and David are working on the audit of Treadway Enterprises, and are meeting to discuss the client's internal controls; specifically controls over the cash disbursements process. Which of the following statements most accurately describes the controls that should be in place for this function? A) Before payment of any cash disbursements, the appropriate authorizations should be received, and the correct dollar amounts paid. B) Before the audit client proceeds with any cash disbursements, the firm should have appropriate entity-level controls in place to ensure transactional accuracy. C) As part of the cash disbursement cycle, the auditor is likely to examine a sample of receivables controls to ensure their effectiveness. D) None of these answer choices are correct. Answer: A Explanation: Before payment of any cash disbursements, the appropriate authorizations should be received, and the correct dollar amounts paid. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 76) The cash disbursements process involves the following sub-processes: ________. A) approving cash receipts and recording cash disbursements B) approving cash disbursements and recording cash disbursements C) approving cash receipts and recording cash receipts D) approving payables disbursements and recording cash disbursements Answer: B Explanation: The cash disbursements process involves the following sub-processes: approving cash disbursements and recording cash disbursements. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

77) Key assertions related to cash disbursements are ________. A) completeness, occurrence, accuracy, and cutoff B) verifiability, occurrence, accuracy, and cutoff C) going concern, occurrence, accuracy, and cutoff D) completeness, occurrence, accuracy, and comparability Answer: A Explanation: Key assertions related to cash disbursements are completeness, occurrence, accuracy, and cutoff. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 78) The cash disbursements process involves which two following sub-processes? A) Approving cash disbursements and recording cash disbursements. B) Approving cash receipts and recording cash disbursements. C) Approving cash disbursements and recording cash receipts. D) Approving cash receipts and recording cash receipts. Answer: A Explanation: The cash disbursements process involves the following sub-processes: (1) approving cash disbursements, and (2) recording cash disbursements. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 79) In the United States, many businesses ________. A) continue to write checks to stockholders for payment of goods received B) continue to write checks to vendors C) continue to write checks to their customers D) continue to write checks to employees in order to account for cost of goods sold Answer: A Explanation: In the United States many businesses continue to write checks to vendors. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

80) A treasury or cash management function is responsible for determining that ________. A) unpaid payables are processed for payment on their due dates B) paid payables are processed for payment on their due dates C) unpaid receivables are processed for payment on their due dates D) unpaid dividends are processed for payment on their due dates Answer: A Explanation: A treasury or cash management function is responsible for determining that unpaid payables are processed for payment on their due dates. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 81) A company should make all payments by ________. A) cash B) check or electronic funds transfer C) cash or electronic funds transfer D) liquidating investments Answer: B Explanation: All payments should be by check or electronic funds transfer. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 82) The client should receive both a bank statement from the bank and a statement from vendors on a ________. A) weekly basis B) quarterly basis C) monthly basis D) yearly basis Answer: C Explanation: On a monthly basis, the client should receive both a bank statement from the bank and a monthly statement from vendors. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

83) Which of the following describes a purchases database? A) Electronic files that accumulate data on purchases, accounts payable, and cash disbursements. B) The check (EFT) information with purchase order and receiving. C) The check (EFT) information with the underlying information on the voucher. D) Electronic files that contain information on the cash disbursements journal with the related voucher information. Answer: A Explanation: Purchases databases are electronic files that accumulate data on purchases, accounts payable and cash disbursements. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 84) Which of the following assertions is tested by comparing information on the cash disbursements journal with the related voucher information? A) Classification of cash disbursements B) Cutoff of cash disbursements C) Completeness of cash disbursements D) Completeness, existence, and valuation of cash balances Answer: A Explanation: The classification of cash disbursements can be tested by comparing information on the cash disbursements journal with the related voucher information. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 85) Why does the client prepare independent bank reconciliation? A) To check for the completeness, existence, and valuation of cash balances B) To check accounts payable C) To record purchase returns and allowances D) To validate purchase returns Answer: A Explanation: The client performs independent bank reconciliation to check for the completeness, existence, and valuation of cash balances. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 34

86) Upon the receipt of goods, ________. A) the purchaser should match the goods shipped per the receiving report, to the purchase order, and advanced shipping notice (ASN) B) the purchaser should match the goods received per the receiving report, to the purchase order, and advanced shipping notice (ASN) C) the client should immediately debit the payable account and credit the cash account D) the client should accrue a related receivable Answer: B Explanation: Upon the receipt of goods the purchaser should match the goods received per the receiving report, to the purchase order, and advanced shipping notice (ASN). Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 87) Evaluated Receipts Settlement (ERS) is ________. A) a highly-automated business process between suppliers and purchasers to exchange data electronically and electronically execute a purchase transaction B) a highly-manual business process between suppliers and purchasers to exchange data electronically and electronically execute a purchase transaction C) a highly-automated business process between suppliers and stockholders to exchange data electronically and electronically execute a purchase transaction D) a highly-manual business process between creditors and purchasers to exchange data electronically and electronically execute a purchase transaction Answer: A Explanation: Evaluated Receipts Settlement (ERS) is a highly-automated business process between suppliers and purchasers to exchange data electronically and electronically execute a purchase transaction. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

88) In larger public companies, Evaluated Receipts Settlement (ERS) transactions represent ________. A) 50 — 75% of all transactions B) 75 — 90% of all transactions C) 0 — 25% of all transactions D) 25— 50% of all transactions Answer: B Explanation: In larger public companies, ERS transactions represent 75 — 90% of all transactions. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 89) In smaller, privately owned companies, not-for-profit organizations, or governments, Evaluated Receipts Settlement (ERS) transactions are ________. A) rare B) commonplace C) increasing being used D) prohibited. Answer: A Explanation: In smaller, privately owned companies, not-for-profit organizations, or governments, ERS transactions are rare. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

90) Evaluated Receipts Settlement (ERS) recognizes the key elements of a purchase transaction involving ________. A) the nature and quantity of the goods received B) the price of the goods received C) the payment terms for the goods received D) All of these answer choices are correct Answer: D Explanation: ERS recognizes the key elements of a purchase transaction involve: o The nature and quantity of the goods received, o The price of the goods received, and o The payment terms for the goods received. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 91) The first step in initiating an Evaluated Receipts Settlement (ERS) transaction is the ________. A) contract, which may be the only "electronic" element in the process B) payment, which may be the only "paperwork" in the process C) contract, which may be the only "paperwork" in the process D) payment, which may be the only "electronic" element in the process Answer: C Explanation: The first step in initiating an ERS transaction is the contract, which may be the only "paperwork" in the process. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

92) Internal controls in an Evaluated Receipts Settlement (ERS) system ________. A) are generally not required B) are dissimilar to internal controls in a traditional computerized system C) are similar to internal controls in a traditional computerized system D) should be audited by the internal audit function, due to their increased familiarity with this function Answer: C Explanation: Internal controls in an ERS systems are similar to internal controls in a traditional computerized system. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 93) What is a highly-automated business process between suppliers and purchasers to exchange data electronically and electronically execute a purchase transaction called? A) Evaluated Receipts Settlement B) Completeness of cash disbursements C) Evaluation of Receipts Settlement D) Cash disbursements Answer: A Explanation: Evaluated Receipts Settlement (ERS) is a highly-automated business process between suppliers and purchasers to exchange data electronically and electronically execute a purchase transaction. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

94) Which of the following is performed by Electronic Invoice Presentment and Payment (EIPP) systems? A) Purchasing an electronic system that uses a third-party payment process to settle a business to business transaction B) Creating a shipping notice system C) Purchasing an evaluated receipt system D) Processing a payment from the purchaser to the supplier as an independent third party Answer: A Explanation: Electronic Invoice Presentment and Payment (EIPP) systems purchase an electronic system that uses a third-party payment process to settle a business to business transaction. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 95) Which of the following is one of the key controls that are often found in the purchaser's Evaluated Receipts Settlement (ERS) system for cash disbursements, categorized by relevant assertion? A) Completeness of cash disbursements B) Cash payments C) Evaluation of Receipts Settlement D) Evaluation of Receipts Statement Answer: A Explanation: Completeness of cash disbursements is one of the key controls that are often found in the purchaser's ERS system for cash disbursements, categorized by relevant assertion. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

96) Bayside Company has decided to switch from a legacy payment system to an evaluated receipt settlement system on the recommendation of its external auditors. As Bayside begins negotiations with different ERS system suppliers, which of the following represents key considerations for Bayside? A) How many business days the float period will be for each ERS transaction initiated by the company or its suppliers. B) How much interest the company will be able to earn by accelerating receipt of payments for goods and services. C) What processes will be enacted by the firm and its suppliers to verify quantities of goods shipped and received. D) How much labor cost will be saved by the implementation of an ERS system. Answer: C Explanation: What processes will be enacted by the firm and its suppliers to verify quantities of goods shipped and received. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 97) Janice and Stephen are discussing the recent installation of an evaluated receipt settlement system by one of their major audit clients. Janice notes that there are various types of controls in an ERS system. Stephen asks Janice to provide an example of such a control. Which of the following represents her best response? A) An ERS system generates regular reports pertaining to receiving reports that do not have a corresponding liability recorded, which pertains to the cutoff assertion. B) An ERS system generates reports relating to the period in which goods were received compared to the period the goods were recorded in the general ledger, pertaining to the completeness assertion. C) An ERS system generates regular reports on discrepancies that have arisen when comparing the receiving report to the associated liability, pertaining to the occurrence assertion. D) None of these answer choices are correct. Answer: C Explanation: An ERS system generates regular reports on discrepancies that have arisen when comparing the receiving report to the associated liability, pertaining to the occurrence assertion. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

98) Alice has been tasked by her supervisor to audit an attestation client's purchasing process and cycle. Her supervisor has mentioned that in prior audits, the client has returned a relatively high percentage of goods purchased, and wants Alice to focus on this. Which of the following would be prudent for Alice to check based on this? A) Alice should consider checking the client's contra-revenue accounts, such as sales discounts and sales allowances. B) Alice should consider checking purchase return authorizations, which should show goods that the client's vendors have approved for return. C) Alice should consider checking credit memos issued by the client pertaining to reductions in accounts payables related to returns. D) Alice should consider checking debit memos issued by the client pertaining to reductions in accounts receivables related to returns. Answer: B Explanation: Alice should consider checking purchase return authorizations, which should show goods that the client's vendors have approved for return. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 99) One of the common disclosures in the ________ is reclassification of material debit balances in accounts payable as accounts receivable. A) purchase transactions B) net sale transactions C) purchase adjustments D) purchasing process Answer: D Explanation: One of the common disclosures in the purchasing process is reclassification of material debit balances in accounts payable as accounts receivable. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

100) Important documents and records used in processing purchase adjustments in traditional or Evaluated Receipts Settlement (ERS) systems include which of the following? A) Purchase Return Authorization B) Shipping Report C) Debit Memo D) All of these answer choices are correct. Answer: D Explanation: Important documents and records used in processing purchase adjustments in traditional or ERS systems include the following: Purchase Return Authorization Shipping Report Debit Memo. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 101) Purchase returns and allowances involve ________. A) reducing payables and expenses, improving reported liquidity and earnings B) increasing payables and expenses, improving reported liquidity and earnings C) reducing payables and expenses, decreasing reported liquidity and earnings D) increasing payables and expenses, decreasing reported liquidity and earnings Answer: A Explanation: Purchase returns and allowances involve reducing payables and expenses, improving reported liquidity and earnings Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

102) There should be adequate segregation of duties between ________. A) obtaining authorization for purchase returns, shipping goods, and recording debit memos B) obtaining authorization for purchase returns, selling goods, and recording debit memos C) obtaining authorization for purchase returns, shipping goods, and recording credit memos D) obtaining authorization for purchase returns, selling goods, and recording payables memos Answer: A Explanation: There should be adequate segregation of duties between obtaining authorization for purchase returns, shipping goods, and recording debit memos. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 103) When there is the potential for material misstatements from purchase adjustments transactions, ________. A) the auditor should obtain an understanding of all immaterial aspects of the internal control structure components and consider the factors that affect the risk of such misstatements B) the auditor should obtain an understanding of all relevant aspects of the internal control structure components and consider the factors that affect the risk of such misstatements C) the auditor should obtain an understanding of all relevant aspects of the client legal counsel's internal control structure components and consider the factors that affect the risk of such misstatements D) the auditor should obtain an understanding of all relevant aspects of the external control structure components and consider the factors that affect the risk of such misstatements Answer: B Explanation: When there is the potential for material misstatements from purchase adjustments transactions, the auditor should obtain an understanding of all relevant aspects of the internal control structure components and consider the factors that affect the risk of such misstatements. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

104) If purchase adjustments are estimated at quarter-end, ________. A) management should establish controls to ensure adjustments are made based on analysts' information and that adjustments are consistent from quarter to quarter B) the auditor should establish controls to ensure adjustments are made based on reliable information and that adjustments are consistent from quarter to quarter C) management should establish controls to ensure adjustments are made based on reliable information and that adjustments are consistent from quarter to quarter D) management should establish controls to ensure adjustments are made based on regulatory information and that adjustments are consistent from quarter to quarter Answer: C Explanation: If purchase adjustments are estimated at quarter-end, management should establish controls to ensure adjustments are made based on reliable information and that adjustments are consistent from quarter to quarter. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 105) What is a shipping report? A) A report prepared on the shipment of goods being returned to vendors and showing the type and quantities of goods shipped B) A return authorization report C) A report stating the particulars of a debit to accounts payable, including the specific items returned, prices, and amount debited D) A report stating the particulars of a debit to accounts payable, including the specific items returned, prices, and the amount credited Answer: A Explanation: A shipping report is a report prepared on the shipment of goods being returned to vendors and showing the type and quantities of goods shipped. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

106) Which of the following is a form showing the description, quantity, and other data pertaining to the goods the vendor has authorized the purchaser to return? A) Purchase return authorization B) Report return authorization C) Return authorization D) Form authorization Answer: A Explanation: A purchase return authorization is a form showing the description, quantity, and other data pertaining to the goods the vendor has authorized the purchaser to return. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 107) Most auditors plan to test controls in the purchases cycle because of the ________. A) high volume of routine transactions in this process B) low volume of routine transactions in this process C) high volume of irregular transactions in this process D) low volume of irregular transactions in this process Answer: A Explanation: Most auditors plan to test controls in the purchases cycle because of the high volume of routine transactions in this process. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 108) Auditors often use test data on programmed application controls ________. A) to determine how likely the system is to hacking and phishing attempts B) to ensure expected results do not appear on exception reports C) to determine whether expected results appear on exception reports D) as a way to enter dummy transactions designed to increase audit fees Answer: C Explanation: Auditors often use test data on programmed application controls to determine whether expected results appear on exception reports. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

109) Procurement fraud risks include ________. A) phantom vendors B) fictitious invoices C) kickbacks and bid rigging D) All of these answer choices are correct. Answer: D Explanation: Procurement fraud risks include: o Phantom vendors, o Fictitious invoices, o Kickbacks and bid rigging. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 110) Phantom vendors involve ________. A) purchases that are made from fictitious vendors B) purchases that are made from fictitious employees C) payments received from fictitious vendors D) payments received from fictitious employees Answer: A Explanation: Phantom vendors involve purchases made from fictitious vendors. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 111) Kickbacks and bid-rigging typically involve ________. A) collusion between an employee and a customer B) collusion between an employee and a vendor C) paying for the same item twice D) invoices that are submitted for services not received by the entity Answer: B Explanation: Kickbacks and bid-rigging typically involve collusion between an employee and a vendor. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

112) Which of the following may be a risk when internal controls are poor over recording payables and cash disbursements? A) Duplicate payments B) Financial payments C) Fictitious invoices D) Phantom vendors Answer: A Explanation: Duplicate payments may be a risk when internal controls are poor over recording payables and cash disbursements. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 113) Which of the following risks are included in procurement fraud risks? A) Kickbacks and bid-rigging B) Account fraud risks C) Purchase fraud risks D) Purchase returns fraud risks Answer: A Explanation: Kickbacks and bid-rigging are included in procurement fraud risks. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 114) In which of the following fraud risks is the payment usually made to an employee who submitted a fake invoice? A) Fictitious invoices B) Phantom vendors C) Kickbacks and bid-rigging D) Duplicate payments Answer: A Explanation: In the case of fictitious invoices, the payment is usually made to an employee who submitted a fake invoice Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

115) Mark, an audit manager working on the attestation engagement for Seaberry Enterprises has just learned from the client's Chief Financial Officer that the firm recently completed a major update and upgrade of their purchasing system. As a result of this information, what might Mark decide to do as part of the audit of this area? A) Mark may decide to issue a qualified opinion on the audit of the client's purchasing process, as the recent upgrade has increased inherent risk. B) Mark may decide to obtain written assurances from senior management to gain extra assurance in this area. C) Mark may decide to evaluate segregation of duties in this area, to determine how access to the purchasing system is controlled. D) None of these answer choices are correct. Answer: C Explanation: Mark may decide to evaluate segregation of duties in this area, to determine how access to the purchasing system is controlled. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 116) Jerry and Melinda are working on the audit of a large attestation client, and are discussing the client's system of internal control one day over lunch. Jerry mentions to Melinda that he believes the client has a strong system of internal control. Which of the following might give Jerry a reason to make this statement? A) This is the first year audit of the client, and the current auditors have confirmed that the predecessor auditor did not withdraw due to the client's internal control. B) Jerry has noted that the client's system of internal control over the purchasing cycle has correctly identified and flagged exceptions. C) The client has recently spent a large sum of money upgrading internal controls over the purchasing process. D) Jerry has received written assurances from the head of the internal audit function pertaining to the strength of controls over the purchasing cycle. Answer: B Explanation: Jerry has noted that the client's system of internal control over the purchasing cycle has correctly identified and flagged exceptions. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

117) Donna is a CPA working on the audit of McGregor LLC, a large, publicly-traded client. Donna has recently completed her audit of the client's system of internal control and found it to be both robust and effective. Based on this finding, which of the following is Donna in a position to do? A) Donna can issue a clean audit opinion on the client's system of internal control and the client's financial statements. B) Donna can issue a clean audit opinion on the client's financial statements only. C) Donna can issue a clean audit opinion on the client's system of internal control only. D) Donna can only issue a clean audit opinion on the client's system of internal control once she has also completed the audit of the client's financial statements. Answer: C Explanation: Donna can issue a clean audit opinion on the client's system of internal control only. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 118) Marissa and Joe are discussing substantive procedures that could be used to help audit an attestation client's purchasing process. Marissa has been tasked with performing substantive procedures in this area and has asked Joe for advice. Which of the following suggestions by Joe represents the most appropriate substantive procedure? A) Marissa could select a sample of purchase transactions and attempt to trace them back to underlying supporting documents such as purchase orders. B) Marissa could obtain a test sample of receivables transactions and examine documents corroborating their existence such as bills of lading. C) Marissa could attempt to obtain written assurances by senior management and the internal audit function attesting to the client's appropriate segregation of duties. D) None of these answer choices are correct. Answer: A Explanation: Marissa could select a sample of purchase transactions and attempt to trace them back to underlying supporting documents such as purchase orders. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

119) Understanding the significance of the purchasing cycle to the entity ________. A) provides a context for important risk assessments B) helps the auditor to understand if the entity is overstaffed or understaffed C) has important implications on the financing cycle D) is of only peripheral importance to the auditor, due to its extremely low risk assessment. Answer: A Explanation: Understanding the significance of the purchasing cycle to the entity provides a context for important risk assessments. Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 120) The purchases cutoff test involves determining that ________. A) purchase transactions occurring near the balance sheet date are recorded in the proper period B) sales transactions occurring near the balance sheet date are recorded in the proper period C) purchase transactions occurring near the balance sheet date are recorded at the correct amounts D) sales and purchasing transactions occurring after the balance sheet date are recorded at the correct amounts Answer: A Explanation: The purchases cutoff test involves determining that purchase transactions occurring near the balance sheet date are recorded in the proper period. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

121) Goods in transit shipped FOB (free-on-board) destination should ________. A) remain in the inventory of the buyer and be excluded from the purchaser's inventory and accounts payable until arrival at the purchasing entity's receiving department B) remain in the inventory of the seller and be excluded from the purchaser's inventory and accounts payable until arrival at the purchasing entity's receiving department C) remain in the inventory of the buyer and be included from the purchaser's inventory and accounts payable until arrival at the purchasing entity's receiving department D) remain in the inventory of the seller and be included from the purchaser's inventory and accounts payable until arrival at the purchasing entity's receiving department Answer: B Explanation: Goods in transit shipped FOB destination should remain in the inventory of the seller and be excluded from the purchaser's inventory and accounts payable until arrival at the purchasing entity's receiving department. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 122) Goods shipped FOB (free on board) shipping point should be ________. A) included in inventory by both the buyer and seller upon shipment B) included in the inventory and accounts payable of the selling entity upon shipment C) included in the inventory and accounts payable of the purchasing entity upon shipment D) excluded by both the buyer and seller upon shipment Answer: C Explanation: Goods shipped FOB (free on board) shipping point should be included in the inventory and accounts payable of the purchasing entity upon shipment by the vendor Diff: 1 LO: 8 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

123) The search for unrecorded liabilities consists of procedures designed specifically to detect ________. A) significant unrecorded obligations at the balance sheet date (or as of an interim date) B) insignificant unrecorded obligations at the balance sheet date (or as of an interim date) C) significant unrecorded obligations at the income statement date (or as of an interim date) D) significant recorded obligations at the balance sheet date (or as of an interim date) Answer: A Explanation: The search for unrecorded liabilities consists of procedures designed specifically to detect significant unrecorded obligations at the balance sheet date (or as of an interim date). Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 124) When auditors choose to send confirmations of accounts payable, accounts with ________. A) zero or small balances should be among those selected for negative confirmation because they may be more understated than accounts with large balances B) zero or small balances should be ignored because they are likely immaterial C) zero or small balances should be among those selected for confirmation because they may be more understated than accounts with large balances D) extremely large balances should be among those selected for confirmation because they may be more understated than accounts with smaller balances Answer: C Explanation: When auditors choose to send confirmations of accounts payable, accounts with zero or small balances should be among those selected for confirmation because they may be more understated than accounts with large balances. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

125) In which of the following shipment arrangements does title pass from seller to buyer when goods arrive at the purchasing entity's warehouse? A) FOB destination B) FOB shipping point C) FOB shipping stop D) FOB port Answer: A Explanation: With FOB destination, title passes from seller to buyer when goods arrive at the purchasing entity's warehouse. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 126) In which of the following shipment arrangements does title pass from seller to buyer when goods are shipped? A) FOB shipping point B) FOB destination C) FOB port D) FOB location Answer: A Explanation: With FOB shipping point, title passes from seller to buyer when goods are shipped. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 127) Which of the following consists of procedures designed specifically to detect significant unrecorded obligations at the balance sheet date? A) Search for unrecorded liabilities B) Vouching of recorded purchase transactions C) Confirmation of accounts payable D) Procedures for purchase returns Answer: A Explanation: The search for unrecorded liabilities consists of procedures designed specifically to detect significant unrecorded obligations at the balance sheet date (or as of an interim date). Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 53

128) The payroll process includes transactions and balances related to which of the following? A) Rebates B) Contractor payments C) Expense reimbursements D) Commissions Answer: D Explanation: The payroll process includes transactions and balances related to the payment of salaries, hourly wages, incentive compensation, commissions, and bonuses. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 129) If the pay period does not coincide with the end of the accounting period, which of the following is true? A) Payroll entries are not made until payroll is paid. B) Payroll payable must be accrued. C) Overtime must be recalculated. D) None of the answer choices is correct. Answer: B Explanation: If the pay period does not coincide with the end of the accounting period, accruals must be made for payroll payable and payroll expense. Diff: 1 LO: 9 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

130) All of the following are true about payroll accrual entries, EXCEPT: ________. A) Payroll tax expense is debited. B) They may be charged to manufactured inventory. C) Overtime is not included. D) All of the answer choices are correct. Answer: C Explanation: Payroll accrual expense entries include debits to payroll and payroll tax expense and credits to payroll and payroll taxes payable. They might be charged to manufactured inventory via direct or indirect labor accounts, or they might be charged to various accounts associated with selling, general, and administrative expenses. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 131) All of the following transactions would be considered part of the payroll process, EXCEPT ________. A) payment of payroll taxes B) payment of commissions C) payment of incentives D) payment of hourly wages Answer: A Explanation: The payroll process includes transactions and balances related to the payment of salaries, hourly wages, incentive compensation, commissions, and bonuses. Payroll taxes are NOT paid through an imprest payroll bank account. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

132) Which of the following is a key payroll process assertion for relevant transaction classes? A) Valuation B) Existence C) Accuracy D) All of the answer choices are correct. Answer: C Explanation: Key payroll process assertions for relevant transaction classes include occurrence, completeness, accuracy, cutoff, and classification. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 133) All of the following are key payroll process assertions for relevant account balances, EXCEPT ________. A) occurrence B) existence C) completeness D) rights and obligations Answer: A Explanation: Key payroll process assertions for relevant account balances include existence, rights and obligations, completeness, and valuation and allocation at historical cost. Diff: 1 LO: 9 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

134) Kevin has been tasked with the audit of the payroll function for one of his firm's attestation clients. Kevin has noted that the firm's payroll period ends on the 22nd of each month. As a result of this determination, which of the following is Kevin likely to see? A) Kevin is likely to see an accrual each month to wages payable to account for the timing difference. B) Kevin is likely to see a deferral each month to either salaries or wages payable on account of the timing difference. C) Kevin is likely to see discrepancies in the wage expense account because of the timing differences. D) Kevin is likely to observe an accrual made each month to an imprest account in preparation for wage disbursements to employees. Answer: A Explanation: Kevin is likely to see an accrual each month to wages payable to account for the timing difference. Diff: 2 LO: 9 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 135) Kacey and David are working on the beginning stages of the audit of Arrow Enterprises, a large firm and major retailer of sports equipment throughout the southern United States. Kacey asks David if he has any suggestions on gaining an understanding of this client. Which of the following represents David's most accurate response? A) The easiest thing for us to do would be to look at previous audits, and if nothing has changed, our understanding of the entity will be the same as last year. B) We should simply examine the industry as a whole, and look to see if anything has changed. C) We should not assume that our understanding of the entity will be the same as in prior years until we can confirm this is the case. D) None of these answer choices are correct. Answer: C Explanation: We should not assume that our understanding of the entity will be the same as in prior years until we can confirm this is the case. Diff: 2 LO: 10 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

136) Which of the following is important for the auditor to understand before proceeding with an audit of the payroll process? A) Knowledge of whether the entity is labor or capital intensive B) The nature of compensation (hourly vs. salaried) C) The importance of bonuses or other compensation arrangements D) All of the answer choices are correct. Answer: D Explanation: Before beginning an audit of the payroll process, it is important to understand: 1) the importance of human resources to the overall entity, 2) the nature of compensation, and 3) the importance of various compensation packages. Diff: 1 LO: 10 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 137) Which of the following is tested by dividing current year payroll expenses by prior year payroll expenses? A) Revenue per employee B) Percentage change in payroll expenses from the prior year C) Total payroll costs as a percent of revenues D) Compare current year payroll liability with prior year payroll liability Answer: B Explanation: Percentage change in payroll expenses is tested by dividing current year payroll expenses by prior year payroll expenses. Diff: 1 LO: 10 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

138) When an entity has more than one class of employees, it is important to evaluate the reasonableness of payroll based on employee class. Which of the following procedures is commonly used to test this? A) Calculate revenue per employee B) Calculate total payroll costs as a percent of revenue C) Comparing payroll expenses with prior year balances or budgets D) Calculate average payroll cost per employee classification Answer: D Explanation: Average payroll cost per employee classification is effective to evaluate the reasonableness of payroll based on employee class. Diff: 2 LO: 10 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 139) Which of the following is a reasonableness test of gross payroll for a group of employees? A) Revenue per employee B) Total payroll costs as a percent of revenue C) Comparing payroll expenses with prior year balances or budgets D) Average payroll cost per employee classification Answer: D Explanation: Average payroll cost per employee classification is effective to evaluate the reasonableness of payroll based on employee class. Diff: 1 LO: 10 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 140) Which of the following is a measure of productivity per employee? A) Revenue per employee B) Total payroll costs as a percent of revenue C) Comparing payroll expenses with prior year balances or budgets D) Average payroll cost per employee classification Answer: A Explanation: Revenue per employee serves as a measure of productivity per employee. Diff: 1 LO: 10 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

141) Suppose an auditor is preparing for an audit of the payroll process of an entity and has identified that the entity is labor-intensive and depends largely on hourly compensation. The auditor still needs to understand all of the following about the entity, EXCEPT ________. A) the capital intensiveness of the entity B) the importance of bonuses or other compensation arrangements C) the level of variability of pay throughout the period D) None of the answer choices are correct. Answer: A Explanation: Before beginning an audit of the payroll process, it is important to understand: 1) if the entity is labor-intensive or capital intensive, 2) the nature of compensation (hourly vs salary), and 3) the importance of various compensation packages. Also, if compensation expenses are based on hourly pay and there is a high degree of variability throughout the period, the auditor may choose to emphasize testing controls. The amount and intensity of capital does not come into play. Diff: 2 LO: 10 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 142) Payroll fraud may occur in which of the following ways? A) Payroll transactions are processed for fictitious employees and the funds are diverted for personal use. B) When there is frequent turnover, there is risk that a new employee will not get on the payroll promptly. C) Management may misclassify or understate labor costs for government contract work. D) All of the answer choices are correct. Answer: A Explanation: Payroll fraud may occur in several ways, including: 1) payroll transactions are processed for fictitious employees and the funds are diverted for personal use, 2) when there is frequent turnover, there is risk that a terminated employee will remain on the payroll, and 3) management may misclassify or "pad" labor costs for government contract work. Diff: 1 LO: 10 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

143) If pay periods do not align well with month-end, quarter-end, or year-end, which of the following key assertions is most at risk of misstatement? A) Accuracy B) Cutoff C) Completeness D) None of the answer choices is correct. Answer: B Explanation: If pay periods do not align well with month-end, quarter-end, or year-end, then the risk of cutoff problems associated with accruing unpaid payroll increases. Diff: 1 LO: 10 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 144) If factory workers are paid based on time and/or productivity, there is likely high inherent risk for which of the following key assertions? A) Accuracy B) Cutoff C) Completeness D) None of the answer choices is correct. Answer: A Explanation: If factory workers are paid based on time and/or productivity, inherent risk for accuracy may be high. Diff: 1 LO: 10 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 145) All of the following are risks associated with payroll, EXCEPT ________. A) paying fictitious payroll B) inaccurate period-end cutoff C) "padded" labor costs in contract arrangements D) All of the answer choices are correct. Answer: D Explanation: Risks associated with payroll include paying fictitious payroll, inaccurate periodend cutoff, and misclassified or "padded" labor costs in contract arrangements. Diff: 1 LO: 11 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 61

146) All of the following are source documents or files related to the payroll process, EXCEPT ________. A) payroll authorization B) time card C) vacation request form D) All of the answer choices are correct. Answer: C Explanation: Source documents or files related to the payroll process include the payroll authorization, approved payroll master file, and time cards. Diff: 1 LO: 11 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 147) Data controls over payroll processing relate to which of the following assertions? A) Completeness and accuracy B) Accuracy and classification C) Completeness, accuracy, and classification D) Occurrence, completeness, accuracy, and classification. Answer: D Explanation: Data controls over payroll processing relate to the occurrence, completeness, accuracy, and classification assertions Diff: 1 LO: 11 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

148) Which of the following is a control to address the risk that payroll may not be recorded? A) Supervisory review of hours worked for hourly and salaried employees B) Accounting software prints a report of all hours employees have worked that have not yet been paid C) Accounting software matches hours with the time card information and wage rate with the master payroll file D) Accounting software matches employee number on the time card with the employee number on the master payroll file Answer: B Explanation: To address the risk that payroll may not be recorded, accounting software prints a report of all hours employees have worked that have not yet been paid. A month-end accrual is made for hours worked between the last pay period and the period end. Diff: 1 LO: 11 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 149) All of the following controls relate to the process of preparing payroll, EXCEPT: A) Information from electronic time cards should be forwarded to the supervisor for review and electronic approval. B) Before processing, the payroll program should check the employee name and payroll rates against the employee master file. C) The payroll program places a limit test on hours worked or gross payroll expenses. D) All of the answer choices are correct. Answer: D Explanation: For the process of preparing payroll, Information from electronic time cards should be forwarded to the supervisor for review and electronic approval. Before processing, the payroll program should check the employee number and payroll rates against the employee master file. The payroll program may also place a limit test on hours worked or gross payroll expenses. Diff: 1 LO: 11 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

150) Accounting software starts with the population of payroll disbursements and develops a one-for-one match with underlying approved hours worked. A report is generated each pay period disclosing any payroll that is not supported by hours worked. The employee number is also compared with the approved master payroll file. A report is generated listing any transactions that are not supported by underlying documents or files. This is a description of a control over which of the following assertions for the payroll process? A) Accuracy of payroll B) Completeness of payroll C) Occurrence of payroll D) Completeness of payroll payables Answer: C Explanation: As a key control for the occurrence of payroll, accounting software starts with the population of payroll disbursements and develops a one-for-one match with underlying approved hours worked. A report is generated each pay period disclosing any payroll that is not supported by hours worked. The employee number is also compared with the approved master payroll file. A report is generated listing any transactions that are not supported by underlying documents or files. Diff: 2 LO: 11 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 151) Ken is working on the audit of a major client's payroll cycle and has been tasked by his supervisor to verify the accuracy of cash disbursement transactions related to payroll. Which of the following would be most useful to Ken in helping confirm the accuracy of transactions related to payroll? A) Ken could consider examining a sample of employees from the master employee file to ensure that all payments to these employees have been appropriately authorized. B) Ken could consider checking with local governments and governmental authorities to make sure that remittance of taxes by the client is both accurate and timely. C) Ken could consider examining the client's payroll process database, which would show key information such as payroll expenses and cash disbursements. D) Ken could consider requesting the internal audit function audit a sample of payroll transactions, as they are more familiar with the client. Answer: C Explanation: Ken could consider examining the client's payroll process database, which would show key information such as payroll expenses and cash disbursements. Diff: 2 LO: 11 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

152) IT controls related to a client's hiring processes are routinely checked by external auditors as part of an attestation engagement. Which of the following pertains to an important control and safeguard that should be enacted by all audit clients with respect to IT systems? A) Employees responsible for design and maintenance of an IT system should be separate from employees with routine system access. B) Employees that design and maintain IT systems should be contracted employees only, and should not work directly for the client. C) Senior management of an attest client should routinely document and provide written updates and assurances to their external auditors pertaining to the IT function and associated controls. D) None of these answer choices are correct. Answer: A Explanation: Employees responsible for design and maintenance of an IT system should be separate from employees with routine system access. Diff: 2 LO: 12 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 153) During the audit of Carnegie Enterprises, LLC, it has been determined by the external auditor that several employees have been paid for overtime hours that were not actually worked. As a result of this finding, which of the following would represent an appropriate recommendation of an internal control that senior management should enact? A) All employees should be made to sign a weekly attestation that all of the hours they worked are complete and correct. B) Existing supervisory staff should be either terminated or reassigned to other areas of the business, and new supervisory staff hired. C) In the future, supervisory staff should regularly review and document hours worked by their subordinates. D) None of these answer choices are correct. Answer: C Explanation: In the future, supervisory staff should regularly review and document hours worked by their subordinates. Diff: 2 LO: 12 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

154) If a client relies on information technology (IT) controls and the auditor plans to assess control risk as low for payroll assertions, the auditor will usually do all of the following, EXCEPT ________. A) test the effectiveness of manual controls B) use computer-assisted audit techniques (CAATs) to evaluate the effectiveness of IT application controls C) test the effectiveness of manual procedures to follow up on exceptions D) All of the answer choices are correct. Answer: A Explanation: If a client relies on IT controls and the auditor plans to assess control risk as low for payroll assertions, the auditor will usually: 1) test the effectiveness of general controls, 2) use computer-assisted audit techniques (CAATs) to evaluate the effectiveness of IT controls, and 3) test the effectiveness of manual procedures to follow up on exceptions. Diff: 1 LO: 12 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 155) All of the following are true when an auditor uses audit data analytics, EXCEPT: ________. A) Knowledge of the audit client helps refine the auditor's ability to identify potential anomalies B) There may be legitimate business reasons for some anomalies C) Because of the analytics, it is not necessary for the auditor to investigate flagged items D) All of the answer choices are correct. Answer: C Explanation: When using audit data analytics, the auditor's knowledge of the audit client helps refine the auditor's ability to identify potential anomalies and there may be legitimate business reasons for some anomalies. The auditor should investigate flagged items with appropriate professional skepticism. Diff: 1 LO: 12 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

156) When testing the effectiveness of information technology (IT) general controls in payroll, the auditor may do any of the following, EXCEPT ________. A) collect supporting evidence regarding employee awareness of IT security issues B) determine how program access is controlled and monitored C) pay attention to the effectiveness of password controls D) All of the answer choices are correct. Answer: D Explanation: When testing the effectiveness of IT general controls in payroll, the auditor may: 1) collect supporting evidence regarding employee awareness of IT security issues, 2) determine how program access is controlled and monitored, 3) look at logs of program access or incident reports, 4) pay attention to segregation of duties regarding access to programs and access to data, 5) pay attention to the effectiveness of password controls, and 6) follow-up regarding any incident reports regarding unauthorized access. Diff: 1 LO: 12 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 157) When testing informational technology (IT) application controls in payroll, the auditor may do any of the following, EXCEPT ________. A) test important manual controls by reperforming the controls B) use test data and determine whether expected results appear in financial statements C) test the appropriateness of manual follow-up of exceptions D) All of the answer choices are correct. Answer: B Explanation: When testing the effectiveness of IT application controls in payroll, the auditor may: 1) test important manual controls by reperforming the controls, 2) use test data and determine whether expected results appear in exception reports, and 3) test the appropriateness of manual follow-up of exceptions. Diff: 1 LO: 12 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

158) After evaluating inherent risk and control risk, the auditor is in a position to evaluate which of the following types of risk? A) Transaction risk B) Loss risk C) Fraud risk D) None of the answer choices is correct. Answer: C Explanation: After evaluating inherent risk and control risk, the auditor is in a position to evaluate fraud risk. Diff: 1 LO: 12 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 159) Assume you are involved in an audit and your expectations regarding effective controls are not confirmed. In this situation, you will need to take all of the following steps, EXCEPT ________. A) determining if the client has a compensating control B) evaluating the significance of the weaknesses C) communicating the control weaknesses to management and those charged with governance D) All of the answer choices are correct. Answer: C Explanation: Additional steps need to be taken before it is determined whether or not the control weaknesses should be reported to management and those charged with governance. Only significant deficiencies or material weaknesses need to be reported. Diff: 2 LO: 12 Bloom: Application Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

160) Jarvis, an audit staff associate assigned to the audit of Marberry LLC has been working on the audit of the client's internal controls for payroll. Upon completion of testing, Jarvis has noted various weaknesses in internal controls. As a result of this, what recommendation might Jarvis make to the audit team? A) The auditors should consider adopting a reliance strategy, and performing decreased substantive testing as a result. B) The auditors should plan to increase substantive testing to compensate for the noted weaknesses in internal control. C) The auditors should consider issuing a qualified opinion on the client's system of internal controls over the payroll cycle, and proceeding directly to the audit of the client's financial statements. D) The auditors should consider performing substantive tests on the system of internal control to attempt to corroborate this initial finding. Answer: B Explanation: The auditors should plan to increase substantive testing to compensate for the noted weaknesses in internal control. Diff: 2 LO: 12 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 161) Derek and Linda are working on the audit of an attestation client and are discussing the timing of audit procedures one day over lunch in the client's cafeteria. Derek advises Linda that there is a correlation between the timing of procedures and the strength of the client's system of internal control. Linda asks Derek to elaborate further on this statement. Which of the following correctly explains this relationship? A) There is an inverse relationship between the timing of audit procedures and the strength of the client's system of internal control. B) If a client's system of internal control is found to be weak by the auditor, then substantive procedures are more likely to be conducted at interim dates. C) If a client's system of internal control is found to be strong by the auditor, then the auditor is more likely to conduct substantive procedures at an interim date. D) If a client's system of internal control is found to be weak by the auditor, then it is likely that the auditor will not conduct any substantive procedures, and will instead focus on strengthening internal control. Answer: C Explanation: If a client's system of internal control is found to be strong by the auditor, then the auditor is more likely to conduct substantive procedures at an interim date. Diff: 2 LO: 13 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 69

162) All of the following are tests of details of balances for auditing the payroll process, EXCEPT ________. A) verifying totals of payroll registers B) recalculating accrued payroll liabilities at year-end C) determining that accrued payroll payables are the obligations of the entity D) recalculating accrued payroll tax liabilities at year-end Answer: A Explanation: Tests of details of balances for auditing the payroll process include: 1) recalculating accrued payroll liabilities at year-end, 2) determining that accrued payroll payables are the obligations of the entity, and 3) recalculating accrued payroll tax liabilities at year-end. Diff: 1 LO: 13 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 163) All of the following are tests of presentation and disclosure for auditing the payroll process, EXCEPT ________. A) reviewing presentation and disclosure for payroll costs in drafts of financial statements B) evaluating the completeness of presentation and disclosure for receivables in drafts of financial statements C) reading disclosures and independently evaluate their understandability D) verifying accrued payroll was reported and in the drafts of the financial statements Answer: D Explanation: Tests of presentation and disclosure for auditing the payroll process include: 1) reviewing the presentation and disclosure for payroll costs in drafts of financial statements, 2) evaluating the completeness of presentation and disclosure for receivables in drafts of financial statements, and 3) reading disclosures and independently evaluating their understandability. Diff: 1 LO: 13 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

164) When performing substantive tests of the payroll process, recalculating accrued payroll tax liabilities at year-end to underlying payroll records is a test of which of the following key assertions? A) Occurrence, accuracy, and classification B) Occurrence, completeness, and valuation C) Occurrence, completeness, and accuracy D) Completeness, valuation, and existence Answer: D Explanation: Recalculating accrued payroll tax liabilities at year-end to underlying payroll records is a test of the completeness, existence, and valuation assertions. Diff: 1 LO: 13 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 165) The use of audit data analytics as a substantive test in auditing the payroll process depends on which of the following? A) The substance of the client's data B) The quantity of the client's data C) The quality of the client's data D) The nature of the client's data Answer: C Explanation: The use of audit data analytics as a substantive test in auditing the payroll process depends on the quality of the client's data. Diff: 1 LO: 13 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

166) Determining that accrued payroll payables are the obligations of the entity is an example of which of the following? A) Substantive analytical procedures B) Tests of details of transactions C) Tests of details of balances D) Audit data analytics Answer: C Explanation: Determining that accrued payroll payables are the obligations of the entity is an example of tests of details of balances. Diff: 1 LO: 13 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 167) Which of the following tests or procedures are primarily focused on the completeness, existence, and valuation assertions? A) Vouching payroll transactions to supporting documentation B) Recalculating accrued payroll liabilities at year-end to underlying payroll records C) Reviewing activity in payroll accounts and investigate entries that appear unusual D) None of the answer choices is correct. Answer: B Explanation: Recalculating accrued payroll liabilities at year-end to underlying payroll records relates to the completeness, existence, and valuation assertions. Diff: 1 LO: 13 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 168) Cash disbursement transactions are one of the major transactions classes with significant volumes of transactions in the ________. Answer: purchases cycle Explanation: The core purchases transactions are (1) purchasing goods and services (purchase transactions), (2) making payments (cash disbursement transactions) and (3) purchases adjustments. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

169) The procurement process involves selecting vendors, establishing payment terms, negotiating contracts, purchasing goods, receiving goods, and recording of purchases and ________. Answer: payment of liabilities Explanation: The purchasing process (purchases cycle) / procurement process involves selecting vendors, establishing payment terms, negotiating contracts, purchasing goods, receiving goods, and recording of purchases and payment of liabilities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 170) "Liabilities, payables, reserves, and accrual estimate failure" is one of the categories of ________ related to expense recording and liabilities. Answer: misstatements Explanation: "Liabilities, payables, reserves, and accrual estimate failure" is one of the categories of misstatements related to expense recording and liabilities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 171) Often vendors will send a ________ showing the beginning payable balance, transactions during the month, and the ending payable balance. Answer: monthly statement Explanation: Often vendors will send a monthly statement showing the beginning payable balance, transactions during the month, and the ending payable balance (even if it is zero). Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

172) An internal document indicating the vendor, the amount due, and payment terms for the purchases received is referred to as a ________. Answer: voucher Explanation: A voucher is an internal document indicating the vendor, the amount due, and payment terms for the purchases received. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 173) Many audit clients build in ________ controls so if one control does not find a misstatement, another control is designed to surface the problem. Answer: redundant Explanation: Many clients build in redundant controls so if one control does not find a misstatement, another control is designed to surface the problem. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 174) A ________ is a formal order to a bank to pay the payee the indicated amount. Answer: check or electronic funds transfer (EFT) Explanation: A check or electronic funds transfer (EFT) is a formal order to a bank to pay the payee the indicated amount. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 175) ________ systems use an independent third party to settle a business to business (B2B) transaction. Answer: EIPP, Electronic Invoice Presentment and Payment, or Electronic Invoice Presentment and Payment (EIPP) Explanation: EIPP systems use an independent third party to settle a business to business (B2B) transaction. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 74

176) A ________ is a form showing the description, quantity, and other data pertaining to the goods the vendor has authorized the purchaser to return. It serves as the basis for initiating the purchase return. Answer: Purchase Return Authorization Explanation: A Purchase Return Authorization is a form showing the description, quantity, and other data pertaining to the goods the vendor has authorized the purchaser to return. It serves as the basis for initiating the purchase return. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 177) A key tenet of internal control is ________ of duties. Answer: segregation Explanation: A key tenet of internal control is the segregation of duties. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 178) ________ involve collusion between an employee and a vendor. Answer: Kickbacks and bid-rigging Explanation: Kickbacks and bid-rigging involve collusion between an employee and a vendor. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

179) Examining ________ involves checking vouchers paid after balance sheet date to determine if the payment is for an obligation that existed as of the balance sheet date and whether the obligation was in fact recorded as of the balance sheet date. Answer: subsequent payments Explanation: Examining subsequent payments involves checking vouchers paid after balance sheet date (or an interim date) to determine if the payment is for an obligation that existed as of the balance sheet date (or an interim date) and whether the obligation was in fact recorded as of the balance sheet date (or an interim date). Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 180) Match the categories below with their corresponding categories. A. Relevant transaction classes B. Relevant account balances C. Assertions of relevant transaction classes D. Relevant disclosures ____ Payable disclosures, asset and expenditure disclosures, and cash disbursements (primarily focused on payment of payables) ____ Occurrence, completeness, accuracy, cutoff, and classification ____ Accounts payable and various purchased assets ____ Purchases of materials or goods and various expenses Answer: Relevant transaction classes: purchases of materials or goods and various expenses Relevant account balances: accounts payable and various purchased assets Assertions of relevant transaction classes: occurrence, completeness, accuracy, cutoff, and classification Relevant disclosures: payable disclosures, asset and expenditure disclosures, and cash disbursements (primarily focused on payment of payables) Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

181) Match the names of industries with the industry traits. A. Hotels and motels B. Colleges, universities, and other professional institutions C. Oil and gas field machinery and equipment manufacturing D. Supermarkets and other grocery stores _____ Their purchases are less significant operating costs compared to those of retailers or manufacturers. ____ Their purchases are incidental to the core product and their core process may not be significantly affected by price increases for purchased goods. ____ Their purchases include raw materials (where quality is essential) for equipment. ____ Their purchases include a wide array of products including products with perishable characteristics. Answer: The purchases of hotels and motels are less significant operating costs compared to those of retailers or manufacturers. The purchases of colleges, universities and other professional Institutions are incidental to the core product and their core process may not be significantly affected by price increases for purchased goods. The purchases of oil and gas field machinery and equipment manufacturing include raw materials (where quality is essential) for equipment. The purchases of supermarkets and other grocery stores include a wide array of products including products with perishable characteristics. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

182) Match the concepts related to risks in the purchasing with their descriptions. A. Liabilities, payables, reserves, and accrual estimate failure B. Cut-off problems due to failure to accrue liabilities C. Expense recording issues D. Liquidity problems or going concern doubts ____ They create pressures to understate payables in order to report a higher level of working capital. ____ They arise from any number of areas including failure to record certain expenses, reconcile certain amounts, or record certain payables on a timely basis. ____ They may contribute to misstatements in the purchasing cycle. ____ They consist of errors, irregularities, or omissions associated with the accrual or identification of liabilities on the balance sheet. Answer: Liabilities, payables, reserves, and accrual estimate failure consist of errors, irregularities or omissions associated with the accrual or identification of liabilities on the balance sheet. Cut-off problems due to failure to accrue liabilities may contribute to misstatements in the purchasing cycle. Expense recording issues arise from any number of areas including failure to record certain expenses, reconcile certain amounts, or record certain payables on a timely basis. Liquidity problems or going concern doubts create pressures to understate payables in order to report a higher level of working capital. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

183) Match the categories with their explanations. A. Purchases database B. Vendor invoice C. Receiving report D. Purchase order ____ It is prepared on the receipt of goods showing the kinds and quantities of goods received from vendors. ____ The written offer from the purchasing department to a vendor or supplier to purchase goods or services specified in the order. ____ Electronic files that accumulate data on purchases, accounts payable, and cash disbursements. ____ It is from the vendor stating the number of items shipped or services rendered, the amount due, the payment terms, and the date billed. Answer: Common documents and files that are found in the process of selling goods include the following: Purchases database: Electronic files that accumulate data on purchases, accounts payable, and cash disbursements. Vendor invoice: It is from the vendor states the number of items shipped or services rendered, the amount due, the payment terms, and the date billed. Receiving report: It is prepared on the receipt of goods showing the kinds and quantities of goods received from vendors. Purchase order: The written offer from the purchasing department to a vendor or supplier to purchase goods or services specified in the order. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

184) Match the terms related to cash disbursements with their details. A. Check or Electronic Funds Transfer (EFT) B. Voucher C. Cash disbursements journal D. Treasury or cash management function ____ It is a formal order to a bank to pay the payee the indicated amount. ____ It is a daily report showing checks written or electric funds transferred to vendors and amounts paid. ____ It is an internal document used to authorize recording and paying a liability. ____ It is responsible for determining that unpaid payables are processed for payment on their due dates. Answer: A check or Electronic Funds Transfer (EFT) is a formal order to a bank to pay the payee the indicated amount. A voucher is an internal document used to authorize recording and paying a liability. A cash disbursements journal is a daily report showing checks written or electric funds transferred to vendors and amounts paid. A treasury or cash management function is responsible for determining that unpaid payables are processed for payment on their due dates. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

185) Match the internal controls in an Evaluated Receipts Settlement (ERS) system with their descriptions. A. Occurrence of purchases B. Accuracy of purchases C. Purchase cutoff D. Classification of expenses and payables ____ A computer develops a daily report of any discrepancies between the vendor account coding and general ledger coding, which is compared with the purchase order and purchase requisition. ____ A computer develops a daily report of any discrepancies between the recorded payable and quantities on the receiving report. ____ A computer develops a daily report of any discrepancies between the recorded payable and quantities on the receiving report or prices on the purchase order, and other information such as freight and taxes on the advance shipping notice from the vendor. ____ A computer develops a daily report of any discrepancies between the accounting period on the receiving report and the accounting period on the recording of the purchase and liability. Answer: Occurrence of purchases: A computer develops a daily report of any discrepancies between the recorded payable and quantities on the receiving report. Accuracy of purchases: A computer develops a daily report of any discrepancies between the recorded payable and quantities on the receiving report or prices on the purchase order, and other information such as freight and taxes on the advance shipping notice from the vendor. Purchase cutoff: A computer develops a daily report of any discrepancies between the accounting period on the receiving report and the accounting period on the recording of the purchase and liability. Classification of expenses and payables: A computer develops a daily report of any discrepancies between the vendor account coding and general ledger coding, which is compared with the purchase order and purchase requisition. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

186) Match the concepts related to controls in the purchasing process with their details. A. Additional controls over payables B. Sound controls over the cash balance C. Reclassification of material debit balances and expenses reportable by business segment D. Purchase returns ____ They involve performing a bank reconciliation shortly after the month-end. ____ They should be authorized by the vendor. ____ They include comparing vendor statements with the balance in the accounts payable subsidiary ledger. ____ They are common disclosures in the purchasing process. Answer: Additional controls over payables include comparing vendor statements with the balance in the accounts payable subsidiary ledger. Sound controls over the cash balance involve performing a bank reconciliation shortly after the month end. Reclassification of material debit balances and expenses reportable by business segment are common disclosures in the purchasing process. Purchase returns should be authorized by the vendor. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

187) Match the statements below with the corresponding phrases. A. This is often accomplished by setting up a fictitious vendor on the master vendor file, vendor information relates to an address or post office box controlled by an employee, and payments are made to that employee. B. These are submitted for services not received by the entity, usually involving a fake vendor. C. It involves collusion between an employee and a vendor to pay an inflated price and the employee receives a kickback associated with the product involved in a bidding situation. D. This involves paying for the same item twice. ____ Duplicate invoicing ____ Bid rigging ____ Fictitious invoices ____ Phantom vendor invoices Answer: Phantom vendor purchases are made from fictitious vendors. This is often accomplished by setting up a fictitious vendor on the master vendor file, vendor information relates to an address or post office box controlled by an employee, and then payments are made to the employee. Fictitious invoices: Invoices are submitted for services not received by the entity, usually involving a fictitious vendor. Payment is then made to an employee who submitted the fictitious invoice. Kickbacks and bid rigging: These involve collusion between an employee and a vendor. The entity pays inflated prices to the vendor, and the employee get a kickback for facilitating the inflated transactions with vendor. Bid rigging also involves collusion between an employee and a vendor to pay an inflated price and the employee receives a kickback associated with the product involved in a bidding situation. Duplicate payments: This involves paying for the same item twice. This is a risk when internal controls are poor over recording payables and cash disbursements. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

188) Match the statements below with the corresponding phrases. A. This is often accomplished by setting up a fictitious vendor on the master vendor file, vendor information relates to an address or post office box controlled by an employee, and then payments are made to the employee. B. These are submitted for services not received by the entity, usually involving a fake vendor. C. It also involves collusion between an employee and a vendor to pay an inflated price and the employee receives a kickback associated with the product involved in a bidding situation. D. This involves paying for the same item twice. ____ Duplicate payments ____ Phantom vendors ____ Fictitious invoices ____ Bid rigging Answer: Phantom vendor purchases are made from fictitious vendors. This is often accomplished by setting up a fictitious vendor on the master vendor file, vendor information relates to an address or post office box controlled by an employee, and then payments are made to the employee. Fictitious invoices: Invoices are submitted for services not received by the entity, usually involving a fictitious vendor. Payment is then made to an employee who submitted the fictitious invoice. Kickbacks and bid rigging: These involve collusion between an employee and a vendor. The entity pays inflated prices to the vendor, and the employee get a kickback for facilitating the inflated transactions with vendor. Bid rigging also involves collusion between an employee and a vendor to pay an inflated price and the employee receives a kickback associated with the product involved in a bidding situation. Duplicate payments: This involves paying for the same item twice. This is a risk when internal controls are poor over recording payables and cash disbursements. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

189) Match the statements below with the corresponding phrases. A. Substantive tests B. Examining vouchers paid after balance sheet date to determine if the payment is for an obligation that existed as of the balance sheet date. C. Procedures designed specifically to detect significant unrecorded obligations as of balance sheet date (or as of an interim date). D. Title passes from seller to buyer when goods are shipped ____ Examining subsequent payments ____ FOB Shipping Point ____ Perform substantive audit procedures ____ Search for unrecorded liabilities Answer: Substantive tests perform substantive audit procedures. Examining subsequent payments: examining vouchers paid after balance sheet date (or an interim date) to determine if the payment is for an obligation that existed as of the balance sheet date (or an interim date) and whether the obligation was in fact recorded as of the balance sheet date (or an interim date). Search for unrecorded liabilities: procedures designed specifically to detect significant unrecorded obligations as of balance sheet date (or as of an interim date). FOB Shipping Point: title passes from seller to buyer when goods are shipped. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

190) Which three of the following are assertions of relevant transaction classes which belong to the key purchasing cycle assertion? A) Occurrence B) Completeness C) Accuracy D) Rights and obligations Answer: A, B, C Explanation: The assertions of relevant transaction classes, which belong to the key purchase assertion, are as follows: 1) occurrence; 2) completeness; 3) accuracy; 4) cutoff; and 5) classification. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 191) During the audit of Newberry Enterprises, Inc., a nationwide retailer of Tupperware and other plastics, the external auditors, Huckleberry CPA Firm are attempting to gain an understanding of the client's internal controls in order to more effectively plan their audit strategy. Which of the following represent prudent actions at this stage of the audit? Select all that apply. A) The external auditors should consider requesting senior management compile a list of all high risk areas, so the auditors can focus their attention on these areas. B) The external auditors should attempt to understand internal controls that the client has enacted, such as entity-level controls. C) The external auditors may wish to examine the clients' processes and attempt to understand the flow of transactions. D) The external auditors should consider performing substantive procedures on the client's internal controls to ensure their effectiveness. Answer: B, C Explanation: The external auditors should attempt to understand internal controls that the client has enacted, such as entity-level controls. The external auditors may wish to examine the clients' processes and attempt to understand the flow of transactions. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

192) The partners of Greenfield CPA Firm have convened a planning meeting to discuss the best approach to auditing the purchasing cycle of one of their largest clients, Drake Inc., a supplier of kitchen appliances throughout the southeastern United States. The partners want to brainstorm and compile a list of key activities that would occur in the client's purchasing cycle. Which of the following would likely be considered key activities in this cycle? Select all that apply. A) Determining the client's vendors and what payment terms have been established with each particular vendor. B) Receiving goods via the receiving function and recording a liability in the general ledger for the goods received. C) Shipping goods and recording an appropriate receivable in the general ledger for all goods shipped on credit. D) Payment of accounts receivable for goods that have been received from the client's vendors. Answer: A, B Explanation: Determining the client's vendors and what payment terms have been established with each particular vendor. Receiving goods via the receiving function and recording a liability in the general ledger for the goods received. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 193) Which three of the following are involved in the purchasing cycle? A) Establishing payment terms B) Selecting vendors C) Purchasing goods D) Selling goods Answer: A, B, C Explanation: The purchasing process (purchasing cycle)/procurement process involves selecting vendors, establishing payment terms, negotiating contracts, purchasing goods, receiving goods, and recording of purchases and payment of liabilities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

194) Which two of the following categories of misstatements are relevant to the purchasing and payroll cycles? A) Expense (payroll, selling, administrative, general, and, other) recording issues B) Liabilities, payables, reserves, and accrual estimate failure C) Purchase failure D) Account transaction issues Answer: A, B Explanation: Two categories of misstatements relevant to the purchasing and payroll cycles are 1) expense (payroll, SGA, other) recording issues and 2) liabilities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 195) Which of the following are source documents and related computer files for the transaction flow in credit purchases? A) Receiving report B) Vendor invoice C) Purchase requisition D) Purchases database Answer: A, B Explanation: The following are source documents and related computer files for the transaction flow in credit purchases: receiving report, vendor invoice, and purchase requisition. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

196) Laura and Joey, two audit staff associates at Wolfram CPAs are discussing one of their audit client's purchases cycle over lunch one day while working at the client. Laura tells Joey that she has been assigned to the team tasked with auditing internal controls over this area, and that her supervisor has requested she come up with a list of potential things that could go wrong. Laura asks Joey if he has any suggestions. Which of the following represent appropriate suggestions by Joey? Select all that apply. A) It is possible that more than one payment has been made to a vendor, which would indicate failure of internal controls in this area. B) The clients vendors may have been billed more than once for the same goods or services; indicating a failure of an internal control over payables. C) Expenses and payables have not been accrued properly and/or in the correct periods, indicating a problem with internal controls related to the cutoff assertion. D) Sales returns made to the client by customers have been incorrectly recorded in the sales discounts account, indicating a problem with internal controls related to the completeness assertion. Answer: A, C Explanation: It is possible that more than one payment has been made to a vendor, which would indicate failure of internal controls in this area. Expenses and payables have not been accrued properly and/or in the correct periods, indicating a problem with internal controls related to the cutoff assertion. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

197) Joseph, an audit intern working for Steele CPAs has been tasked by his supervisor to examine documents and records supporting cash disbursements. As Joseph is new, he approaches you and asks for some assistance and guidance in what documents and records might be appropriate to examine and corroborate cash disbursements. Which of the following represent viable suggestions to help Joseph with this? Select all that apply. A) Joseph could consider examining the client's monthly bank statements to corroborate cash disbursements recorded by the client actually occurred. B) Joseph could consider examining periodic statements sent to the client by its vendors, showing payments received and balances owed. C) Joseph could consider examining a sample of selected receivables accounts, and tracing the accounts through to subsequent payment by the client. D) Joseph could examine a selected sample of vendors from the purchases-payables cycle, and trace cash received from the vendors to shipments received. Answer: A, B Explanation: Joseph could consider examining the client's monthly bank statements to corroborate cash disbursements recorded by the client actually occurred. Joseph could consider examining periodic statements sent to the client by its vendors, showing payments received and balances owed. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 198) Which two of the following are involved in recording cash disbursements? A) Check or electronic funds transfer B) Cash disbursements journal C) Voucher D) Purchases database Answer: A, B Explanation: The documents required in recording cash disbursements are a check or electronic funds transfer, and a cash disbursements journal. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

199) Which three of the following are steps involved in controlling activities in an Evaluated Receipts Settlement (ERS) system? A) Initiating an ERS transaction B) Receiving goods C) Recording payables D) Processing cash payments Answer: A, B, C Explanation: The following are steps involved in controlling activities in an Evaluated Receipts Settlement system: 1) recording payables; 2) receiving goods; and 3) initiating an ERS transaction. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 200) Which three of the following are included in common disclosures in the purchases process? A) Reclassification of material debit balances in accounts payable as accounts receivable B) Segregation of short-term payables from long-term payables C) Dependence on a single vendor or a small number of vendors D) Credit Memo Answer: A, B, C Explanation: Common disclosures in the purchases process include the following: 1) reclassification of material debit balances in accounts payable as accounts receivable; 2) segregation of short-term payables from long-term payables; and 3) dependence on a single vendor or a small number of vendors. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

201) Marlene and Susan are working on the audit of Parker Enterprises, LLC, a distributor of fine jewelry throughout the continental United States. Their supervisor has just finished a meeting with the client's top management and apprised Marlene and Susan that beginning next week; they need to work on the audit of purchase adjustments as this has been identified as an area of higher inherent risk. Which of the following are appropriate recommendations with respect to documentation the pair should consider examining? Select all that apply. A) Marlene and Susan should examine bills of lading to ensure that shipping and billing addresses match for the client. B) Marlene and Susan may wish to examine purchase return authorizations to confirm goods returned against the general ledger. C) Marlene and Susan should consider examining debit memos issued by the client to ensure accounts payable reductions have been appropriately authorized. D) Marlene and Susan should consider examining credit memos issued by the client to confirm that decreases to accounts receivable have been approved by appropriate management. Answer: B, C Explanation: Marlene and Susan may wish to examine purchase return authorizations to confirm goods returned against the general ledger. Marlene and Susan should consider examining debit memos issued by the client to ensure accounts payable reductions have been appropriately authorized. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

202) Darren and Kaitlin have convened a meeting to discuss their upcoming audit of Somerset Products, Inc., a retailer of dairy products throughout the Midwestern United States. Somerset Products has historically had a strong and effective system of internal controls based on prior audits, and thus the auditors plan to assess control risk for the client as low. Based on this information, which of the following methods might the auditors employ to test internal controls? Select all that apply. A) The external auditors might decide to examine and test the effectiveness of the client's internal controls. B) The external auditors might decide to test the client's IT application controls via the use of generalized audit software. C) The external auditors might decide to select and test a sample of the client's internal controls over purchasing via use of substantive procedures. D) The external auditors might opt to examine and test the effectiveness of IT general controls by sending confirmations to major customers to ensure balances are correct. Answer: A, B Explanation: The external auditors might decide to examine and test the effectiveness of the client's internal controls. The external auditors might decide to test the client's IT application controls via the use of generalized audit software. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 203) Which three of the following will the auditor usually do if the client relies on computer controls and the auditor plans to assess control risk as low for purchasing process assertions? A) Test the effectiveness of general controls. B) Use computer-assisted audit techniques (CAATs) to evaluate the effectiveness of programmed application controls. C) Test the effectiveness of manual procedures to follow-up on exceptions identified by programmed application controls. D) Account transactions invoices. Answer: A, B, C Explanation: If the client relies on computer controls and the auditor plans to assess control risk as low for purchase process assertions, the auditor will usually do the following: *Test the effectiveness of general controls, *Use computer-assisted audit techniques (CAATs) to evaluate the effectiveness of programmed application controls, and *Test the effectiveness of manual procedures to follow-up on exceptions identified by programmed application controls. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 93

204) Caitlin and Robbie are about to begin the audit of a major clients' purchasing process. Their supervisor Maggie has suggested to them that they should spend some time attempting to gain a better understanding of the client and the client's industry before performing any analytical procedures. Which of the following represent techniques Caitlin and Robbie could perform to help them gain a better understanding? A) Caitlin and Robbie should consider economic drivers that might influence key areas of the client's business, such as purchases. B) Caitlin and Robbie should consider performing substantive procedures on a selected sample of the clients' internal controls to ensure robustness and effectiveness of the controls. C) Caitlin and Robbie should consider familiarizing themselves with key industry characteristics such as average payment periods and seasonality. D) Caitlin and Robbie should consider a procedure to vouch recorded purchase transactions to underlying bills of lading etc. Answer: A, C Explanation: Caitlin and Robbie should consider economic drivers that might influence key areas of the client's business, such as purchases. Caitlin and Robbie should consider familiarizing themselves with key industry characteristics such as average payment periods and seasonality. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 205) Which three of the following categories focus on identifying the appropriate substantive tests for relevant assertions in the purchases process? A) Tests of details of transactions B) Analytical procedures as a substantive test C) Data analytics D) Audit tests for electronic systems Answer: A, B, C Explanation: The following three categories focus on identifying the appropriate substantive tests for relevant assertions in the purchases process: 1) tests of details of transactions; 2) analytical procedures as a substantive test; and 3) data analytics. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

206) Before attempting to audit a client's payroll processes and procedures, it is important that the auditor gain a better understanding of this area to help ensure the audit is conducted effectively and efficiently. Which of the following represent areas the auditor should attempt to gain a better understanding of in this area in order to conduct the audit efficiently and effectively? A) The auditor should become familiar with compensation structures, such as whether employees are salaried, compensated on an hourly basis, or both. B) How labor-intensive or capital-intensive the client is with respect to the organization as a whole. C) Stock option plans offered to senior management, including key terms and vesting period details. D) Obtain a sample of accounts payable records and match the records to the appropriate employee's payroll records. Answer: A, B Explanation: The auditor should become familiar with compensation structures, such as whether employees are salaried, compensated on an hourly basis, or both. How labor-intensive or capital-intensive the client is with respect to the organization as a whole. Diff: 2 LO: 10 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 207) Mike and his supervisor Claire are having a conversation one morning about one of their current audit client's internal controls over the payroll. Mike mentions to Claire that he has considered conducting a walkthrough of the client's payroll system, but isn't exactly sure what documentation he might collect to support this walkthrough. Which of the following represent appropriate recommendations by Claire with respect to documentation Mike could collect? A) Mike should consider collecting source documents to support payroll transactions, such as bills of lading. B) Mike should consider selecting and reviewing a sample of employee time cards for hourly employees, to verify hours worked. C) Mike could think about selecting a sample of payroll authorizations, to ensure only authorized new employees are added to the payroll. D) Mike could examine payroll tax returns for the client, to ensure that employees are currently remitting federal, state and local taxes to the appropriate authorities. Answer: B, C Explanation: Mike should consider selecting and reviewing a sample of employee time cards for hourly employees, to verify hours worked. Mike could think about selecting a sample of payroll authorizations, to ensure only authorized new employees are added to the payroll. Diff: 2 LO: 11 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 95

208) Jean is working on the audit of Farside Enterprises, LLC, a medium-sized firm and distributor of glassware and other glass products in the United States and Canada. Jean is keen to try an audit data analytics (ADA) procedure as part of the audit of payroll, and has asked you, her supervisor, for suggestions on what might be possible indicators of fraud in this area. Which of the following represent possible indications of fraud? Select all that apply. A) More than one employee in the client's payroll system has the same routing and bank account number. B) Some employees are paid monthly and others are paid bi-weekly. C) Employees with the same job titles and responsibilities within the client's firm have large variances in hourly pay rates. D) Some employees who used to be listed as hourly employees are now listed as salaried employees and paid accordingly. Answer: A, C Explanation: More than one employee in the client's payroll system has the same routing and bank account number. Employees with the same job titles and responsibilities within the client's firm have large variances in hourly pay rates. Diff: 2 LO: 12 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 209) Besides occurrence and completeness, ________ is the most common assertion in key purchasing cycle assertions. A) accuracy B) allocation C) valuation D) existence Answer: A Explanation: Besides occurrence and completeness, accuracy is the most common assertion in key purchasing cycle assertions. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

210) The number of accounts payable turnover days is 30 for the ________ industry. A) electronic computer manufacturing B) hotels and motels C) supermarkets and other grocery stores D) colleges universities and other professional institutions Answer: A Explanation: The number of accounts payable turnover days is 30 for the electronic computer manufacturing industry. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 211) The lack of growth in ________ should heighten the auditor's professional skepticism with respect to the completeness of payables and cutoff of purchases and payables. A) accounts payable B) cash C) cutoff category D) existing category Answer: A Explanation: The lack of growth in accounts payable should heighten the auditor's professional skepticism with respect to the completeness of payables and cutoff of purchases and payables. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 212) A ________ is a written request for goods or services by an authorized individual or department. A) purchase requisition B) purchase order C) receiving report D) vendor invoice Answer: A Explanation: A purchase requisition is a written request for goods or services by an authorized individual or department. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 97

213) A cash disbursements journal is a daily report showing checks written or electric funds transferred to ________ and amounts paid. A) vendors B) purchaser C) bank D) EFT Answer: A Explanation: A cash disbursements journal is a daily report showing checks written or electric funds transferred to vendors and amounts paid. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 214) An independent, ________, such as a bank or payment processor, is used to make the payment from the purchaser to the supplier. A) third party payment processor B) transaction processor C) cutoff payer D) payment processor Answer: A Explanation: An independent, third party payment processor, such as a bank or payment processor, is used to make the payment from the purchaser to the supplier. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

215) A/an ________ reviews the estimates and aggregates with other adjustments to determine if an amount is material to the financial statements. A) disclosure committee B) audit committee C) control committee D) purchasing process committee Answer: A Explanation: A disclosure committee reviews the estimates if they could aggregate with other adjustments to an amount that is material to the financial statements. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 216) ________ involve paying for the same item twice. A) Duplicate payments B) Phantom vendors C) Kickbacks D) Phantom vendors Answer: A Explanation: Duplicate payments involve paying for the same item twice. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 217) Confirming accounts payable is one of the two tests included in the ________. A) tests of details of balances B) obligations C) cutoff obligation D) existence Answer: A Explanation: Two tests included in the tests of details of balances are (1) confirming accounts payable and (2) reconciling unconfirmed payables to monthly statements received by the client from vendors. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

218) Carrie, an audit intern assigned to the audit of Weatherford Enterprises has been tasked by her supervisor with auditing the purchases cycle. Carrie has also heard her supervisor mention substantive procedures, and is confused as to the relationship between the auditors' assessment of internal control and extent of any subsequent substantive procedures. Which of the following responses would be most appropriate to help Carrie understand this relationship? A) The first thing we'll need to do is audit and assess internal control. If internal control is strong, then we can adopt a reliance strategy and perform no further substantive tests. B) You should begin by assessing the strength of the client's system of internal control. If you determine that internal controls are strong, then it is permissible to perform less substantive procedures. C) You should start by conducting substantive procedures in order to assess the strength of the client's system of internal control. If you determine that internal control is weak, then no further substantive procedures should be performed. D) None of these answer choices are correct. Answer: B Explanation: You should begin by assessing the strength of the client's system of internal control. If you determine that internal controls are strong, then it is permissible to perform less substantive procedures. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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219) John is discussing the audit of Flower Enterprises, LLC with his boss Karen. John heard Karen mention a few days ago that a good way to understand auditing was to think of its cyclical nature. John is unsure as to how this cyclical nature would apply to the client's purchasing process, and asks Karen to explain this in some more detail. Which of the following choices represent Karen's most appropriate response to this question? A) Generally speaking, everything in audit runs in cycles. The best way to understand these cycles is to calculate ratios such as inventory turnover and receivables turnover. B) When we think of the client's purchases-payable cycle, we think of the client selling goods to customers on various credit terms. At some point in the future, the customer remits payment to our audit client, and the payables cycle ends there. C) The purchases-payables cycle is a very common cycle in the world of business. Our audit client purchases various goods and services on credit terms, and then is required to settle the payable at a future point in time. D) The purchases-payable cycle is very similar to the revenue-receivables cycle. In both cycles, our audit client is required to pay for goods or services purchased on credit, with various credit terms. Answer: C Explanation: The purchases-payables cycle is a very common cycle in the world of business. Our audit client purchases various goods and services on credit terms, and then is required to settle the payable at a future point in time. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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220) John and Millie are working on the audit of Bloom LLC and have been asked by their supervisor to help plan the audit. Their supervisor has informed them that the audit planning stage is one of the most important because the auditors need to accurately gauge the client's level of inherent risk. Which of the following statements best describes the relationship between the audit planning stages and evaluation of inherent risk? A) The client is heavily involved with assisting the auditor in planning the audit. The client should help the auditor determine what areas to audit, and when each part of the audit should be conducted. B) The auditor should spend considerable time in the planning stages of the audit. For a multitude of reasons, including potential future liability for the auditor, the audit firm should gain a sound understanding of the client and areas where inherent risk may be higher. C) The auditors typically spend a considerable amount of time gaining an understanding of the client, as well as the industry in which the client operates. This increased understanding helps the auditor to form qualified opinions on certain areas of the client's business which have been deemed to represent higher inherent risk. D) None of these answer choices are correct. Answer: B Explanation: The auditor should spend considerable time in the planning stages of the audit. For a multitude of reasons, including potential future liability for the auditor, the audit firm should gain a sound understanding of the client and areas where inherent risk may be higher. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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221) Milton is a CPA and partner of Milton & Co. CPAs. A new client has approached Milton and requested his CPA firm provide attestation services. Upon completing some research on the client, Milton has determined that the client firm operates in an extremely technical industry, heavily laden with government regulations and compliance requirements. Based on this finding, which of the following statements related to inherent risk may be true? A) Due to the technical nature of the client's industry, and the complex regulatory and compliance environment, it is likely that inherent risk is lower. This is because the client's industry is heavily regulated. B) Based on the technical nature of the client's industry, it is likely that inherent risk is higher. Inherent risk is also likely to be higher because of the complex regulatory and compliance environment. C) As the client's industry is very heavily regulated by the government, and is also extremely complex, the auditor should consider not accepting the engagement. By declining such an engagement, the auditor can preserve the firm's reputation. D) The auditor should consider the increased liability associated with the complex regulatory environment in which the client operates. The auditors should consider obtaining written assurances from senior management pertaining to inherent risk to protect them from liability. Answer: B Explanation: Based on the technical nature of the client's industry, it is likely that inherent risk is higher. Inherent risk is also likely to be higher because of the complex regulatory and compliance environment. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 222) An auditor must consider industry factors when auditing the purchasing process. Name two industry factors and explain why they are important. Answer: A. The adequacy of the supply of raw materials is important to consider. If there is a shortage of key materials, it could significantly affect the operational and financial performance of the organization. B. The stability of the price of raw materials is also important. An increase in the price of materials increases the cost to make the product. If the company cannot raise their prices to match the increase, the company's earnings will suffer. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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223) Identify whether the following tests are substantive analytical procedures, tests of details of transactions, or tests of details of account balances: 1) Test a sample of purchase requisitions for proper authorization. 2) Test transactions around year-end to determine if they are recorded in the proper period. 3) Review results of confirmation of selected accounts payable. 4) Compare payables turnover to previous years' data. 5) Obtain selected vendors' statements and reconcile to vendor accounts. 6) Compare purchase returns and allowances as a percentage of revenue or cost of sales to industry data. Answer: 1) Tests of details of transactions 2) Tests of details of transactions 3) Tests of details of account balances 4) Substantive analytical procedures 5) Tests of details of account balances 6) Substantive analytical procedures Diff: 3 LO: 3 Bloom: Evaluation Min: 1 AACSB: Communication AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None 224) Identify the types of substantive procedures used by the auditor to test accounts payable and accrued expenses. Also state whether the substantive procedures could be used as a test of controls or a dual-purpose test. Answer: The auditor uses substantive procedures to detect material misstatements in accounts payable and related accounts. There are two categories of substantive procedures: (1) substantive analytical procedures and (2) tests of details of classes of transactions, account balances, and disclosures. Substantive analytical procedures are used to examine plausible relationships among accounts payable and related accounts. Tests of details focus on transactions, account balances, or disclosures. In the purchasing cycle, tests of details of transactions (also called substantive tests of transactions) focus mainly on the purchases and cash disbursement transactions. Tests of details of disclosures are concerned with the presentation and disclosures related to accounts payable and accrued expenses. Tests of details of transactions (substantive tests of transactions) can be used as a test of controls or a dual-purpose test. However, if the tests of controls indicate that the controls are not operating effectively, the auditor may need to test transactions at the date the account balance is tested. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Communication AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None 104

225) Johnny and Clyde are two audit staff associates working on the audit of Peabody Enterprises, a supplier of frozen foods and other frozen goods throughout the continental United States. At lunch one day, Johnny mentions to Clyde that he overheard his supervisor discussing a voucher system with respect to audit documentation supporting the purchases-payables cycle. Johnny asks Clyde to explain what exactly the voucher system is. Which of the following represents Clyde's best response to this question? A) The voucher system is used heavily by senior management. The idea behind the voucher system is that senior management vouches for purchases and payable transactions by providing written assurances to the auditors. This helps decrease inherent risk associated with this area. B) The voucher system is associated heavily with the client's system of internal control. The voucher system is specifically used to support and document all receivables and payables transactions. This creates an audit trail which helps decrease inherent risk. C) The voucher system is associated with the client's system of internal control. The system helps to match documents together that represent different parts of the same cycle. This matching of information helps to ensure the accuracy of transactions in the cycle and also helps the auditor corroborate the occurrence of transactions. D) The voucher system is required per generally accepted auditing standards for all publiclytraded companies. The system works on the premise that as statements are received from vendors with respect to balances owed by the audit client, the statements can be used to vouch the accuracy of the client's outstanding payables in the general ledger. Answer: C Explanation: The voucher system is associated with the client's system of internal control. The system helps to match documents together that represent different parts of the same cycle. This matching of information helps to ensure the accuracy of transactions in the cycle and also helps the auditor corroborate the occurrence of transactions. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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226) Sue has been tasked by her supervisor with the audit of a major audit client's purchases cycle. Sue has decided to initiate the audit by examining the client's vendor list to see if any discrepancies are noted. Which of the following represent items that Sue would likely flag for further review during her audit of the client's vendor list? A) The client maintains one vendor list. Authority over amending the list is centralized to certain key employees who have received prior approval to update the list. B) Due to a recent merger, the client currently maintains two separate vendor lists. Some of the vendors previously supplied both firms, and thus are on the list twice. C) The client's vendor list is controlled by the Chief Financial Officer. No other employee is allowed to make any adjustments to the list. D) The client's internal audit function performs regular audits over the approved vendor list. The internal auditors typically check to ensure only authorized vendors are on the list, and that there are no duplications. Answer: B Explanation: Due to a recent merger, the client currently maintains two separate vendor lists. Some of the vendors previously supplied both firms, and thus are on the list twice. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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227) Sue and Malcolm have convened a meeting to discuss the upcoming audit of one of their biggest audit clients, Tojo Enterprises, LLC. Sue has tasked Malcolm this year with auditing the client's cash disbursements. This will be Malcolm's first year auditing this area, and asks Sue what the main audit concerns in this area are likely to be? Which of the following choices represents Sue's most accurate response to this question? A) The main issues we are likely to run into here revolve around the client's incoming cash. These incoming funds are usually from settlement of receivables, and in many cases are large dollar amounts. B) The main areas of audit focus in the cash disbursement area ensuring that the correct approvals have been received to disburse cash and making sure that the client's cash disbursements are appropriately and timely recorded. C) The main concern for the area of cash disbursements is ensuring that cash disbursements are appropriately authorized by the client. The easiest way to check this is by obtaining a sample of payables and vouching them back to the underlying revenue transactions. D) None of these answer choices are correct. Answer: B Explanation: The main areas of audit focus in the cash disbursement area ensuring that the correct approvals have been received to disburse cash and making sure that the client's cash disbursements are appropriately and timely recorded. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 228) You are a senior auditor on a new audit client. Your supervisor has asked you to audit the cash disbursements of the new client. You begin by gaining an understanding of the flow of transactions. You now need to identify what could go wrong. Identify at least three risks (what could go wrong) for paying the liability and recording cash disbursements. Answer: A check (EFT) may not be recorded. A check (EFT) may not be recorded promptly. Checks (EFT) may be issued for unauthorized purchases. A vendor's invoice may be paid twice. A check (EFT) may be issued for the wrong amount. A check (EFT) may be posted to the wrong account. Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Measurement; PC: None

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229) You are a senior auditor on a new audit client. Your supervisor has asked you to audit the cash disbursements of the new client. You begin by gaining an understanding of the flow of transactions and have identified the following risk (what could go wrong): A check may not be recorded. Identify at least two controls that may address this risk. Answer: The computer reports any breaks in the sequence of a prenumbered check series and electronic funds transfers. The computer compares the daily total in the cash disbursements journal with the total vouchers submitted for payment. Access to blank checks and signature plates is controlled. Independent bank reconciliation Diff: 3 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 230) Assume you are an audit manager for a middle market manufacturing company. Your client is interested in using Evaluated Receipts Settlement (ERS) with their primary supplier; however, your client is unsure of how the process works and asks about the process of initiating an ERS transaction. Draft a note to your client describing the process of initiating a purchase order through shipment of the goods. Answer: The purchase order is prenumbered to establish control over the population of purchases. The purchase order is usually sent electronically to the vendor (although it may be faxed or sent by mail). The supplier will normally acknowledge the transaction electronically by sending an advance shipping notice (ASN) indicating the goods to be shipped, prices, and other information (e.g., freight costs or taxes). Upon shipment, the vender will create normal shipping documents such as a bill of lading and packing slip. Diff: 3 LO: 5 Bloom: Synthesis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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231) Explain how an Electronic Invoice Presentment and Payment (EIPP) system works and why they are used to settle business to business transactions. Answer: Many ERS systems use what is called Electronic Invoice Presentment and Payment (EIPP) systems. EIPP systems use an independent third party to settle the business to business (B2B) transaction. An independent, third party payment processor, such as a bank or payment processor, is used to make the payment from the purchaser to the supplier. In an EIPP system the purchasing entity: (a) receives an electronic invoice from the vendor, (b) validates the invoice (using a three-way match), (c) cancels the vendor's invoice so it is not paid twice, and (d) approves the invoice for payment (usually taking advantage of early payment discounts). Once the invoice is approved for payment, the third-party payment processor transfers funds from the purchasing entity to the vendor on the due date. A third-party payment processor is often used to may payments because entities that store checking account number information must be Payment Card Industry (PCI) security compliant according to federal regulations, which requires investing in secure computer systems and paying for regular recertification. Diff: 3 LO: 5 Bloom: Synthesis Min: 1 AACSB: Communication AICPA: BC: Global and Industry Perspectives; AC: Reporting; PC: None

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232) Carrie, a CPA and owner of Blasé-Roscoe CPA Firm has been working on the audit of a client's purchases-payable cycle. Carrie has determined that internal controls over the cash disbursements process are weak, and has been tasked by the client's senior management with providing appropriate recommendations to correct this issue. Which of the following would represent a viable recommendation by Carrie to the client's senior management? A) The client's senior management should consider switching to an evaluated receipt settlement system. This would provide increased internal control over this area, and help the client's management to better control cash disbursements. B) The client's senior management should think about outsourcing the area of cash disbursements to their bank. The bank already has strong internal controls in place to help avoid cash disbursement problems. C) The client's senior management should attempt to implement a system where only prenumbered checks are authorized for all future cash disbursements. This system would ensure that no outgoing cash payments are deliberately not recorded. D) The client's senior management should consider requesting that the internal audit function increase the regularity of its audits over the cash receipts and disbursements process. This will help eliminate discrepancies and fraud. Answer: A Explanation: The client's senior management should consider switching to an evaluated receipt settlement system. This would provide increased internal control over this area, and help the client's management to better control cash disbursements. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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233) John and Makayla are working on the audit of Marmaduke Enterprises, LLC, a large, national retailer of soft drinks across the United States. Marmaduke Enterprises is using an evaluated receipt settlement system in its cash disbursements process. John is planning to audit this system, and asks Makayla which assertions might be applicable to this system. Which of the following represents Makayla's most appropriate response to this question? A) As you are going to be auditing the client's cash disbursements processes and cycle, all auditing assertions will be applicable. As a result, you should plan on performing audit procedures to test all assertions. B) The main assertions you are likely going to need to test are the occurrence and cutoff assertions. By testing these assertions, you will be able to confirm that the correct dollar amounts for cash disbursements have been recorded, as well as having been recorded in the correct period. C) You should think about auditing the completeness and cutoff assertions for the client's cash disbursements cycle. In so doing, you will be able to confirm that cash disbursement transactions have all been recorded, as well as having been recorded in the correct period. D) None of these answer choices are correct. Answer: C Explanation: You should think about auditing the completeness and cutoff assertions for the client's cash disbursements cycle. In so doing, you will be able to confirm that cash disbursement transactions have all been recorded, as well as having been recorded in the correct period. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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234) Gina is currently working on the audit of a major attestation client. Gina has been tasked by her supervisor to audit the client's purchases process, and is preparing this week to audit purchase adjustments. During lunch on Monday, Gina asks her supervisor Steve what documentation she should collect that would support any purchase adjustments made by the client. Which of the following represents Steve's most appropriate response to this question? A) You should consider collecting credit memos. These memos are what the client uses to document and record purchase adjustments to payables accounts. B) You should consider collecting debit memos. The client uses these debit memos to document purchases returns by clients, and subsequent adjustment to the liability accounts. C) You should consider collecting credit memos. These memos are used extensively by the client to document and record return shipments of goods sold on credit. D) You should consider examining a sample of debit memos. The client uses these debit memos to document returns made by customers and the subsequent lowering of its asset accounts. Answer: B Explanation: You should consider collecting debit memos. The client uses these debit memos to document purchases returns by clients, and subsequent adjustment to the liability accounts. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 235) Provide two examples of transactions that result in reducing payables and expenses in the form of purchase returns and allowances. Answer: Student answers will vary. On occasion, goods received from vendors are defective and must be returned. In addition, vendors offer a number of inducements to purchase inventory. In some cases, vendors will agree to reduce the price for goods rather than have goods returned. Some vendors offer incentives depending on the volume of their products sold. Other vendors offer various advertising allowances. For example, in the retail grocery industry, many vendors will pay some of the advertising costs for their products in the advertisements of the grocery store. Diff: 3 LO: 6 Bloom: Synthesis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: Global and Industry Perspectives; AC: Reporting; PC: None

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236) You are the auditor of Swanson Glass, Inc., a manufacturer of glass vases. Your intern has asked for clarification on the controls over the purchase returns and allowances for Swanson Glass. Provide your intern with an example of two control activities useful in reducing the risk of misstatements over purchase returns and allowances, focusing on the occurrence of such transactions. Answer: Student answers will vary. Control activities useful in reducing the risk of misstatements focus on establishing the occurrence of such transactions and include the following: o All purchase returns should be authorized by the vendor, o Goods should be returned only with a proper purchase return authorization, and an independent count of goods returned should be recorded on shipping documents such as packing slips and bills of lading, and o The computer should match the debit memo information with the authorization for purchase return and the shipping documents and report any discrepancies. Further, there should be adequate segregation of duties between obtaining authorization for purchase returns, shipping goods, and recording debit memos. Diff: 3 LO: 6 Bloom: Synthesis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 237) You are auditing the purchasing process of Smithwick Spices. Give at least two examples of test data you might use on programmed application controls to determine whether expected results appear on exception reports. Answer: Student answers will vary. The auditor might submit the following in testing the purchases: o A missing or invalid vendor code, o An invalid product code, o Transactions reporting receiving in quantities different from the amount ordered (both over and under), o Prices, vendor numbers, or other information on vouchers that do not match information on the purchase order, or o Voucher quantities that do not match quantities on receiving documents. Diff: 3 LO: 7 Bloom: Synthesis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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238) The risk of misappropriation of assets and procurement fraud is particularly prevalent in the purchasing process. Contrast two different types of frauds commonly perpetrated in the purchases process. Answer: Student answers will vary. Procurement fraud risks include: o Phantom vendors, o Fictitious invoices, o Kickbacks and bid rigging, o Personal purchases with entity funds, o Duplicate payments, and o Product substitution. Phantom vendors: purchases are made from fictitious vendors. This is often accomplished by setting up a fictitious vendor on the master vendor file, vendor information relates to an address or post office box controlled by an employee, and then payments are made to the employee. Fictitious invoices: invoices are submitted for services not received by the entity, usually involving a fictitious vendor. Payment is then made to an employee who submitted the fictitious invoice. Kickbacks and bid rigging: These involve collusion between an employee and a vendor. The entity pays inflated prices to the vendor and the employee gets a kickback for facilitating the inflated transaction. Bid rigging also involves collusion between an employee and a vendor to pay an inflated price and the employee receives a kickback associated with the product involved in a bidding situation. Duplicate payments: this involves paying for the same item twice. This is a risk when internal controls are poor over recording payables and cash disbursements. Diff: 3 LO: 7 Bloom: Synthesis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 239) Which type of confirmation is used more frequently by auditors - accounts receivable confirmations or accounts payable confirmations? Why? Answer: Auditors typically use confirmations for accounts receivable rather than accounts payable because of the reliability of other evidence. To test accounts payable, the auditor can examine vendor invoices and vendor statements. These documents originate from sources outside of the entity being audited and are therefore considered very reliable. Documentation for accounts receivable is normally generated within the entity, so confirmations provide a more reliable way of testing the account. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

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240) There are several important disclosure items to consider when auditing the purchasing process. Name three (3) and discuss what they are and why they are important. Answer: Answer must include three (3) of the following: 1. Payables by type. This allows the user to determine how much of the payables relate to the normal trade or business compared to other payables (i.e. employees). 2. Short and long-term payables. For purposes of a classified balance sheet. 3. Long-term purchase contracts, including any unusual purchase commitments. This requirement is to inform the users of what the agreement entails and can help them make decisions about the company. 4. Related-party transactions. These transactions must be identified separately on the financial statements, since they are not made at arms-length and are considered differently by potential users of the financial statements. 5. Dependence on a single vendor or a small number of vendors. This is to inform the users how much exposure the company would have if a significant vendor were to become unavailable for some reason. 6. Costs by reportable segment of the business. This would allow the users to evaluate separate segments of the entity individually. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

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241) Charlie and Sue are working on the audit of Parkberry Enterprises, a medium-sized company and distributor of wooden cabinetry across the southeastern United States. Charlie is working on his first audit of a client's purchasing process and Sue is assisting him. Charlie asks Sue why the auditors spend a comparatively large amount of time auditing the client's purchasing cycle. Which of the following responses by Sue most appropriately answers this question? A) Our audit firm determined during the initial audit of this client a few years back that we could bill the client for a relatively large number of billable hours due to the time we could spend auditing this area. B) The audit firm typically spends a relatively large amount of time auditing this area. The reason for this is because there is a large volume of transactions in this area and the transactions are generally routinized. C) The audit firm spends a considerable amount of time auditing the purchases cycle for this client because this area represents increased inherent risk for the client. Because of this increased risk, we amend our audit strategy to more of a reliance approach. D) None of these answer choices are correct. Answer: B Explanation: The audit firm typically spends a relatively large amount of time auditing this area. The reason for this is because there is a large volume of transactions in this area and the transactions are generally routinized. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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242) Colin and Joan have been assigned to the attestation engagement for Duck LLC, a provider of fishing goods and other maritime supplies across the east coast of the United States. Joan explains to Colin that in the client's purchasing cycle, the risk of asset misappropriation is typically higher than in other areas. Which of the following represents examples of asset misappropriation that the external auditors may need to be alert for? A) The external auditors should be alert to the possibility that some sales transactions may have been recorded twice. This is typically done to increase sales revenue accounts, which overstates assets and stockholder's equity. B) The external auditors should be on the lookout for evidence of bid rigging. This is a scheme whereby an employee sets up a fake vendor in the client's system and directs payments for goods that were never received to the fake vendor. C) The external auditors should be alert for kickbacks. An example of a kickback could be an employee paying higher prices than normal for goods, and subsequently receiving payments in return. D) The external auditors should be careful to check for phantom vendors in a client's system. This is typically evidenced by the existence of two vendors with the same address in a system. Answer: C Explanation: The external auditors should be alert for kickbacks. An example of a kickback could be an employee paying higher prices than normal for goods, and subsequently receiving payments in return. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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243) Mayberry Auditors are currently working on the audit of Griffith Enterprises, LLC. One of Mayberry's audit managers has been assigned the task of auditing the client's purchasing cycle, specifically examining a sample of recorded transactions. Which of the following most accurately represents a procedure the auditor may conduct, and the relevant assertion(s) that the procedure would check? A) The auditor may opt to audit a sample of purchasing transactions. The auditor would achieve this by selecting a sample of transactions and attempting to vouch them with underlying supporting documents such as vendors' invoices. This would help support the occurrence assertion. B) The auditor may decide to audit a sample of purchasing transactions; examining them for mathematical accuracy. This procedure would help the auditor to check the classification assertion. C) The auditor may decide to select a sample of purchasing transactions; and attempt to determine if the transactions have been recorded in the correct accounting period. This procedure would help the auditor check both the classification and cutoff assertions. D) None of these answer choices are correct. Answer: A Explanation: The auditor may opt to audit a sample of purchasing transactions. The auditor would achieve this by selecting a sample of transactions and attempting to vouch them with underlying supporting documents such as vendors' invoices. This would help support the occurrence assertion. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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244) An audit intern from a local state university is assisting with the audit of a major attestation client. The audit intern has been tasked with auditing the client's purchases-payables cycle. As this is the audit intern's first ever audit, the intern approaches you, their supervisor, to help gain an understanding and general overview of the process. Which of the following statements would be the most helpful for the audit intern in understanding the overarching goal of auditing the purchases-payables cycle? A) The overarching goal of auditing the purchases-payables cycle is to help the auditor determine if improvements can be made to this cycle. If improvements are noted, the auditor can help the client implement such improvements and become more profitable. B) The overarching goal of auditing the purchases-payables cycle is to help the auditor determine if purchases made by the client occurred, and if associated payables subsequently recorded by the client exist and where paid in a timely manner. C) The main purpose of the audit of the purchases-payables cycle is for the auditor to determine the attestation client's profitability. The auditor can achieve this by examining selected revenue transactions and vouching them to appropriate underlying source documents. D) The overarching goal of the audit of a client's purchases-payables cycle is to ensure that the client's vendors actually exist and are not fictitious, and also to ensure that the client's receivables are being settled in a timely manner. Answer: B Explanation: The overarching goal of auditing the purchases-payables cycle is to help the auditor determine if purchases made by the client occurred, and if associated payables subsequently recorded by the client exist and where paid in a timely manner. Diff: 2 LO: 8 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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245) You are auditing the purchasing process for Nation's Best Pizza, Co. Provide an example of three types of tests of details of transactions you might perform and list the relevant assertion(s) being tested for each procedure. Answer: Vouch a sample of recorded purchases cycle transactions to supporting documentation. (Occurrence, Accuracy, Cutoff, Classification) o Vouch recorded purchase transactions to supporting vendor's invoices, receiving documents, and purchase orders. o Vouch disbursement transactions to underlying vouchers and supporting documents. o Vouch purchase returns to supporting shipping documents and subsequent recognition of return by the vendor. o Trace a sample of purchase transactions from receivings to their recording in the purchases journal. Also trace a sample of cash disbursements and purchases returns to their recording in the accounting records. (Completeness) o Perform cutoff tests for purchases and purchase returns. (Cutoff) o Select a sample of receiving reports in the warehouse for several days before and after yearend and examine supporting vouchers to determine that purchases were recorded in the proper period. o Select a sample of purchases returns from the shipping dock for several days before and after year end to determine that debits to accounts payable were recorded in the proper period. o Perform cash disbursements cutoff tests by observing that all cash disbursed through the close of business on the last day of the fiscal year is included in the cash disbursements journal. (Cutoff) o Perform a search for unrecorded liabilities. (Completeness) o Examine subsequent payments between balance sheet date and end of field work, and when related documentation indicates payment was for an obligation in existence at balance sheet date, trace to accounts payable listing. o Examine documentation for payables recorded at year-end that are still unpaid at end of field work. o Investigate unmatched purchase orders, receiving reports, and vendor invoices at year-end. o Inquire of accounting and purchasing personnel about unrecorded payables. o Review capital budgets, work orders, and construction contracts for evidence of unrecorded payables. Diff: 1 LO: 8 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

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246) As the audit of Drawbridge LLC nears its conclusion, the external auditors, Roth CPAs are reviewing their work and the overall audit findings. One of the CPA firm's more notable findings pertained to multiple instances and occurrences of fraud in the area of cash disbursements. The auditors discovered employees who were circumventing internal controls to pay themselves increased rates of pay. Which of the following represents an appropriate recommendation by the auditors to help avoid this situation occurring in the future? A) The auditors may wish to recommend that senior management consider setting up an imprest bank account specifically for payroll transactions. Once payroll transactions had been completed each month, the account would maintain a zero balance. B) The auditors should recommend to management that moving forward, all firm employees should be paid by check only, and should be made to sign for the checks they receive. Implementation of such a control would prohibit employees from receiving extra pay. C) The auditors may wish to recommend that management install an evaluated receipts settlement system. Installation of such a system would make it impossible for employees to circumvent payroll-related controls. D) None of these answer choices are correct. Answer: A Explanation: The auditors may wish to recommend that senior management consider setting up an imprest bank account specifically for payroll transactions. Once payroll transactions had been completed each month, the account would maintain a zero balance. Diff: 2 LO: 9 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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247) Juan is a recent graduate from a local state university, and has just accepted a position as a staff associate at a local CPA firm. As Juan prepares to begin his first attestation engagement, his supervisor tells Juan that one of the first things he'll need to do is attempt to gain an understanding of the client and the environment in which the client operates in order to better understand the payroll process. Juan asks his supervisor to explain some areas he may wish to explore. Which of the following represent areas Juan may wish to consider examining further? A) Juan should consider examining the broader industry that the client operates in. Gaining an understanding of the wider industry will help Juan to potentially spot red flags during the audit of the client's payroll process. B) Juan may wish to consider examining other, similar industries. The reason for this is because many other industries have identical payroll characteristics and thus are useful to help gain a benchmark. C) Juan should consider examining the stock option plans and incentive options that senior management are partaking in. Examination of this area may help the audit firm make recommendations for future stock option plans. D) Joan may wish to think about examining the ratio of hourly to salaried employees. If Juan determines that the client's ratio is drastically different to industry averages, the audit firm may wish to issue a qualified opinion on this area. Answer: A Explanation: Juan should consider examining the broader industry that the client operates in. Gaining an understanding of the wider industry will help Juan to potentially spot red flags during the audit of the client's payroll process. Diff: 2 LO: 10 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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248) During the audit of Treeleaf LLC, the external auditors are examining the client's payroll function and cycle. The audit manager with responsibility for this area approaches you and asks you to spend the next couple of days ensuring that the client is only disbursing payroll funds to approved employees. Which of the following represents the most suitable audit approach to test this? A) You should consider requesting written assurances from senior management. The assurances should focus on management asserting that all employees being paid by the company are authorized and the amounts disbursed are correct. B) You should consider requesting the assistance of the internal audit function. Specifically, you should request that the internal audit function check to make sure all employees are appropriately authorized by the firm, and that all disbursed amounts are correct. C) You should consider requesting access to and subsequently examining the audit client's payroll master file. This file should contain all pertinent information on employees who are authorized to be paid by the firm. D) None of these answer choices are correct. Answer: C Explanation: You should consider requesting access to and subsequently examining the audit client's payroll master file. This file should contain all pertinent information on employees who are authorized to be paid by the firm. Diff: 2 LO: 11 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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249) Janeway CPA Firm is currently working on the audit of Neelix LLC, a large firm and nationwide distributor of copper piping and other metals. Janeway CPA Firm has just completed testing the client's internal controls related to the payroll process and has determined that control weaknesses exist in this area. Based on this finding, which of the following would represent the most appropriate audit strategy? A) Based on this finding, Janeway CPA Firm should consider adopting a reliance strategy. Such a strategy would mean the audit firm would increase substantive testing. B) Based on this finding, Janeway CPA Firm would likely perform increased substantive testing. Such increased substantive testing would help the auditors offer higher levels of assurance. C) Janeway CPA Firm should consider disclaiming an opinion on the client's system of internal control. If Janeway chooses to do this, the auditing firm can instead focus solely on the audit of the client's financial statements. D) Janeway CPA Firm should consider testing all of the client's internal controls related to the payroll process. In so doing, the auditors will be able to eliminate the risk of material misstatement related to the payroll cycle. Answer: B Explanation: Based on this finding, Janeway CPA Firm would likely perform increased substantive testing. Such increased substantive testing would help the auditors offer higher levels of assurance. Diff: 2 LO: 12 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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250) Vulcan Metals Company is currently being audited by Bright CPA Firm. The CPA Firm has convened a meeting of the partners and senior managers to discuss how best to audit the client's system of internal controls related to the payroll function. Which of the following choices represent an appropriate audit strategy which could be used to test internal controls related to payroll? A) Bright CPA Firm could consider employing test data to enter fictitious data into a client's payroll system. This fictitious data can be used by the auditor to determine if appropriate internal controls are effective. B) Bright CPA Firm could decide to request written assurances related to the payroll function from the client's senior management. These written assurances can be used to indemnify the auditor if the client is ever sued. C) Bright CPA Firm could consider adopting an audit strategy whereby the auditor enters test data into the clients system to ensure that false data is flagged. If the auditor can substantiate the effectiveness of internal controls related to payroll, then no substantive testing is necessary. D) None of these answer choices are correct. Answer: A Explanation: Bright CPA Firm could consider employing test data to enter fictitious data into a client's payroll system. This fictitious data can be used by the auditor to determine if appropriate internal controls are effective. Diff: 2 LO: 12 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

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251) Junebug CPA firm is currently working on the audit of Maze Enterprises, Inc., and has determined that the client's system of internal controls relating to the payroll function are not as strong as previously thought. As a result of this finding, which of the following is most likely? A) If the external auditors have determined that the client's system of internal controls is weaker than previously thought, the auditors may adopt a reliance strategy. This would involve the auditors focusing more on substantive testing. B) If it has been determined by the external auditors that the client's system of internal controls is weaker than previously thought, the auditors may decide to increase substantive testing at an interim date. C) If the auditors have determined that internal controls related to the client's payroll function are weaker than previously thought, the auditors may decide to perform increased substantive testing closer to a year-end date. D) If it has been determined by the external auditors that the clients internal controls related to the payroll process are weaker than previously thought, the auditors are likely to issue a qualified opinion on internal control. This will help preserve the firm's reputation should the client be sued in the future. Answer: C Explanation: If the auditors have determined that internal controls related to the client's payroll function are weaker than previously thought, the auditors may decide to perform increased substantive testing closer to a year-end date. Diff: 2 LO: 13 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

Auditing, 2e (Johnson) Chapter 13 Auditing Cash, Inventory and Related Income Statement Accounts 1) Operating decisions are the only type of management operating decisions that significantly affect cash balances. Answer: FALSE Explanation: Management's operating, investing, and financing decisions and strategies significantly affect cash balances. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 2) The nature of cash balances makes them susceptible to theft. Answer: TRUE Explanation: The nature (desirability and ease of transfer) of cash balances makes them susceptible to theft. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 3) Comparing financial statement presentation with Generally Accepted Accounting Principles (GAAP) requirements is part of presentation and disclosure verification. Answer: TRUE Explanation: Comparing financial statement presentation with GAAP requirements is part of presentation and disclosure verification. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

4) Inventory in the manufacture of oil and gas field machinery and equipment is less subject to significant obsolescence risk than inventory for a high tech company. Answer: TRUE Explanation: Inventory in the manufacture of oil and gas field machinery and equipment is less subject to significant obsolescence risk. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 5) Prior experience in inventory turnover days, combined with knowledge of cost of sales, can be useful in estimating current inventory levels. Answer: TRUE Explanation: Prior experience in inventory turnover days, combined with knowledge of cost of sales, can be useful in estimating current inventory levels. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 6) A shortening of inventory turnover days may indicate existence or valuation problems. Answer: FALSE Explanation: A lengthening of inventory turnover days may indicate existence or valuation problems. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 7) An inventory risk occurs when inventory may not exist for which we can use SKU (Stock Keeping Unit) and UPC (Universal Product Numbers) bar codes for identification of each number. Answer: TRUE Explanation: An inventory risk occurs when inventory may not exist for which we can use SKU and UPC numbers and bar codes for identification of each number. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 2

8) Cash and cash equivalents typically include ________. A) cash in the bank B) imprest accounts, such as a payroll account C) cash equivalents, such as money market funds D) All of these answer choices are correct. Answer: D Explanation: Cash and cash equivalents include cash, imprest accounts, and cash equivalents. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 9) An important aspect of developing a preliminary audit strategy involves ________. A) understanding the entity and its environment B) understanding the industry that the auditor operates in C) determining what audit opinion management would like the auditor to issue D) confirming certain account balances with the internal audit function Answer: A Explanation: An important aspect of developing a preliminary audit strategy involves understanding the entity and its environment. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 10) Cash equivalents include ________. A) short-term time deposits B) certificates of deposits C) short-term government bonds D) All of the answer choices are correct. Answer: D Explanation: Cash equivalents include short-term time deposits, certificates of deposits, shortterm government bonds, and / or money market funds - These are highly liquid investments having a maturity of three months or less. Further, these accounts usually result in the recognition of interest income. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 3

11) Top performing companies within an industry generate significant free cash flow and ________. A) are more likely to have significant balances of cash and cash equivalents B) are more likely to have lower balances of cash and cash equivalents C) typically incur higher rates of interest on greater debt balances D) should consider returning the cash to the firm's stockholders and creditors in the form of stock dividends Answer: A Explanation: Top performing companies within an industry generate significant free cash flow (the excess of cash flow from operations over capital expenditures), and therefore are more likely to have significant balances of cash and cash equivalents. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 12) Some companies, such as Apple, Inc., ________. A) have significant negative cash flow from operations, and positive free cash flow B) have struggled to obtain financing, due to liquidity issues C) have significant positive cash flow from operations, and positive free cash flow D) have seen corporate credit ratings downgraded, due to defaults on debt payments Answer: C Explanation: Some companies, such as Apple, Inc., have significant positive cash flow from operations, and positive free cash flow, which has resulted in significant cash and cash equivalents, and significant investments in marketable securities. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

13) Management's operating, investing, and financing decisions and strategies ________. A) have relatively little effect on cash balances B) significantly affect cash balances C) have no bearing on cash balances D) should be approved by the client's vendors before implementation Answer: B Explanation: Management's operating, investing, and financing decisions and strategies significantly affect cash balances Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 14) Cash receipts and disbursement transactions ________. A) are subject to minimal inherent risk B) are subject to increased inherent risk C) should be recorded weekly by the client D) should be approved by the bank before recording in the ledger Answer: B Explanation: Significant inherent risks relate to cash receipts and disbursement transactions. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 15) The most important control over the existence, completeness, and valuation of cash balances ________. A) is immediate collection of cash by companies B) is to defer cash collection for as long as possible C) is an independent bank reconciliation D) is written representation by senior management with respect to the accuracy of the cash balance Answer: C Explanation: The most important control over the existence, completeness, and valuation of cash balances is an independent bank reconciliation. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

16) Controls over cash receipts and cash disbursements ________. A) are usually tested as part of testing controls in the revenue process and the purchasing process B) are usually tested as part of testing controls in the financing process and the purchasing process C) receive relatively little auditor attention due to their low inherent risk D) should not be tested as part of the external audit Answer: A Explanation: Controls over cash receipts and cash disbursement are usually tested as part of testing controls in the revenue process and the purchasing process. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 17) Many smaller businesses, not-for-profit organizations, and smaller governments ________. A) may have inadequate segregation of duties, which results in strong internal controls over cash B) may have adequate segregation of duties, which results in weak internal controls over cash C) may have inadequate segregation of duties, which results in weak internal controls over cash D) utilize their own internal audit function to attest to the accuracy and fairness of their financial statements Answer: C Explanation: Many smaller businesses, not-for-profit organizations, and smaller governments may have inadequate segregation of duties, which results in weak internal controls over cash. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

18) If control risk is high or maximum, and there are no compensating controls, the auditor should ________. A) assume that fraud risk is high, and design appropriate substantive tests, particularly substantive tests of transactions B) assume that fraud risk is low, and design appropriate substantive tests, particularly substantive tests of transactions C) consider withdrawing from the engagement D) request additional written representation from management Answer: A Explanation: If control risk is high or maximum, and there are no compensating controls, the auditor should assume that fraud risk is high and design appropriate substantive tests, particularly substantive tests of transactions. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 19) In larger public companies where the internal auditor tests controls over cash and cash budgeting, the external auditor ________. A) should ignore the results of the internal audit B) will automatically rely on the work performed and results obtained C) will determine if it is appropriate to use the work of a specialist to support the audit conclusion D) will determine if it is appropriate to use the work of the internal auditor to support the audit conclusion Answer: D Explanation: In larger public companies where the internal auditor tests controls over cash and cash budgeting, the external auditor will determine if it is appropriate to use the work of the internal auditor to support the audit conclusion. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

20) Tests of cash balances focus on the account balance assertions of ________. A) completeness, right and obligations, and valuation B) completeness, right and obligations, and disclosure C) existence, cutoff, and valuation D) cutoff, existence, going concern Answer: A Explanation: Tests of cash balances focus on the account balance assertions of existence, completeness, right and obligations, and valuation. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 21) An example of a substantive test for cash balances would be to ________. A) obtain written representations from management pertaining to cash balances B) trace the beginning balance for cash on-hand and in bank to prior year's working papers C) rely on the internal audit function for this part of the audit D) send a confirmation to the client's legal counsel Answer: B Explanation: An example of a substantive test for cash balances would be to trace the beginning balance for cash on-hand and in bank to prior year's working papers. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 22) An analytical procedure related to the substantive testing of cash balances would be to ________. A) calculate cash as a percent of total assets and compare with auditor expectations B) calculate cash as a percent of total assets and compare with internal auditor expectations C) send notes payable confirmations to creditors D) send confirmations to the client firm's stockholders Answer: A Explanation: An analytical procedure related to the substantive testing of cash balances would be to calculate cash as a percent of total assets and compare with auditor expectations. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

23) Before proceeding with tests of details of cash balances, the auditor should ________. A) attempt to confirm cash balances with the firms' creditors B) ensure that an understanding has been obtained regarding the auditor and its environment and the importance of cash balances to the entity C) ensure that an understanding has been obtained regarding the entity and its environment and the importance of cash balances to the entity D) issue a tentative audit opinion related to cash Answer: C Explanation: Before proceeding with tests of details of cash balances the auditor should ensure that an understanding has been obtained regarding the entity and its environment and the importance of cash balances to the entity. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 24) Which of the following include cash in the bank, such as the primary bank account of the company? A) Cash and cash equivalents B) Transaction classes C) Disclosures D) Debt assets Answer: A Explanation: Cash and cash equivalents include cash in the bank, such as the primary bank account of the company. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

25) Which of the following is/are essential to the proper statement of cash at the balance sheet date? A) Proper cutoff of cash receipts and cash disbursements at the end of the year B) Proper cutoff of cash receipts, but not disbursements, at the end of the year C) Cash disbursements at the end of the year D) Cash assets at the end of the year Answer: A Explanation: Proper cutoff of cash receipts and cash disbursements at the end of the year is essential to the proper statement of cash at the balance sheet date. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 26) In which of the following assertions is inherent risk moderate as cash does not usually have significant disclosures? A) Presentation and disclosure B) Valuation and allocation C) Rights and obligations D) Completeness Answer: A Explanation: In the presentation and disclosure assertion, inherent risk is moderate as cash does not usually have significant disclosures. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

27) Dave and Susan are beginning the audit of Ramsey Inc., a food service firm and food retailer throughout the continental United States. Dave has been tasked by his supervisor to audit the cash and cash equivalents accounts for the firm, and has asked Susan for guidance on what exactly would comprise cash and cash equivalents. Which of the following is Susan's most appropriate response? A) Cash and cash equivalents are all the audit clients cash accounts, regardless of which bank they are on deposit at. B) Cash and cash equivalents represent all of the client's cash accounts plus ancillary items such as commercial paper and treasury bills. C) Cash and cash equivalents are all of the attest client's bank accounts, plus money market funds and bonds. D) Cash and cash equivalents represent all cash accounts held by the client, as well as highly liquid investments and loans held by the client. Answer: B Explanation: Cash and cash equivalents represent all of the client's cash accounts plus ancillary items such as commercial paper and treasury bills. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 28) While working on the audit of Sandpiper Enterprises, LLC, an audit staff associate is meeting with one of the attest client's internal auditors to discuss the audit of cash and cash equivalents. The internal auditor notes that the client firm uses imprest accounts, and reminds the staff associate to include these in the audit. Which of the following is the best example of an imprest account? A) The client holds a special account which is used to account for stock returns and buybacks. B) The client has a high-yield savings account at a local bank. The funds are only to be used for the payment of bonds in the future. C) The client transfers funds each month to a special account which is only used to disburse payroll liabilities. D) None of these answer choices are correct. Answer: C Explanation: The client transfers funds each month to a special account which is only used to disburse payroll liabilities. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

29) Johnson and Co CPAs are currently working on the audit of cash and cash equivalents for Feathertree Enterprises, LLC. Feathertree is a large company that supplies various types of real Christmas trees during the holiday season. Which of the following is an area that Johnson & Co. will need to gain a better understanding of? A) Market price fluctuations and demand for Christmas trees, which will affect the client's revenue and ultimately cash. B) How the seasonality of the client's business affects cash flows throughout the year. C) The demand trends for Christmas trees sold by the client, to understand if demand is increasing or decreasing. D) The average rate of return on cash held on deposit at the client's banks. Answer: B Explanation: How the seasonality of the client's business affects cash flows throughout the year. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 30) The cash and cash equivalents accounts of Appleseed Corporation are being audited by Junebug CPA Firm. Junebug has determined that Appleseed has large amounts of excess cash on hand. Senior management of Appleseed has asked the audit firm for recommendations for the excess cash. Which of the following would constitute a prudent recommendation by the audit firm? A) Appleseed Corporation should consider paying off all low-interest rate debt with the excess cash. B) Appleseed Corporation should consider leaving the cash where it is as a hedge against future financial risks. C) Appleseed Corporation should consider investing excess cash in short-term, liquid investments. D) None of these answer choices are correct. Answer: C Explanation: Appleseed Corporation should consider investing excess cash in short-term, liquid investments. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

31) During the audit of Poindexter Corporation, the external auditors, Liberty CPA Firm have noted that the client's cash and cash equivalents balances are slowly decreasing. As a result of this finding, what might the CPA Firm need to recommend to the audit client? A) The client should consider filing bankruptcy and liquidating the entity as a going concern. B) The client may need to consider selling assets or issuing debt or equity in order to raise more capital. C) The client may need to consider purchasing assets or repurchasing debt/equity in order to raise more capital. D) The client should think about acquiring a more profitable firm in the same industry in order to strengthen cash flow. Answer: B Explanation: The client may need to consider selling assets or issuing debt or equity in order to raise more capital. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 32) As part of the audit of Spring Corporation, the external auditors, Mayflower CPA Firm are examining the client's cash and cash equivalent balances. Which of the following scenarios would be most problematic for the auditors as they investigate this area? A) Spring Corporation has strong cash flows from financing activities due to a recent secondary stock offering. B) Spring Corporation has decreasing cash flows from operating activities due to a recession. C) Spring Corporation has increasing cash flows from operating activities due to the launch of a new product line. D) Spring Corporation has decreasing cash flows from operating activities due to a previous large bond issue being called in by the firm. Answer: B Explanation: Spring Corporation has decreasing cash flows from operating activities due to a recession. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

33) Joan & Co. CPA Firm is currently working on the audit of Lather LLC, a regional provider of soap and other cosmetic products in the southeastern United States. The auditor working on the audit of cash and cash equivalents has determined that internal controls in this area are strong and effective. As a result, which of the following might the auditors decide to do? A) Perform no substantive testing in this area, due to the proven effectiveness of internal controls. B) The auditors may decide to perform substantive testing closer to the client's year-end date. C) The auditors may decide to perform substantive testing at an interim date as well as confirming balances at year-end. D) The auditors will likely proceed with issuance of a clean audit opinion over cash and cash equivalents. Answer: C Explanation: The auditors may decide to perform substantive testing at an interim date as well as confirming balances at year-end. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 34) Jones CPA Firm is currently completing the audit of Smith & Co. LLC, a national retailer of carpet and underlay products in both the domestic and commercial markets in the United States. Upon completion of the testing of internal controls over cash, Jones has noted several weaknesses in this area. As a result, which of the following might Jones decide to adopt? A) Jones CPA Firm may decide to adopt a reliance strategy, which will mean decrease substantive testing in this area. B) Jones CPA Firm may decide to assess control risk as high and perform increased substantive testing to compensate for this. C) Jones CPA Firm may decide to request extra written assurances from management in this area to help indemnify the auditors against any future litigation. D) Jones CPA Firm is likely to request the internal auditors perform substantive testing and further tests of controls to see if the same conclusion is reached. Answer: B Explanation: Jones CPA Firm may decide to assess control risk as high and perform increased substantive testing to compensate for this. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

35) Grossman & Co. CPA Firm is currently working on the audit of cash and cash equivalents for Pairtree Enterprises, LLC. One of the internal auditors has mentioned to an employee of Grossman & Co. that he has reason to suspect that an employee has set up a fictitious vendor and is redirecting company funds to this vendor. Which of the following would be an appropriate audit strategy for Grossman to try to substantiate this claim? A) Grossman & Co. could examine a sample of the client's accounts receivable to see if any evidence exists of sales to this vendor. B) Grossman & Co. could consider checking receiving documents to see if shipments have been received from this vendor. C) Grossman & Co. could attempt to perform substantive procedures on all cash and cash equivalent accounts to see if funds have been received from this vendor. D) Grossman & Co. could attempt to interview the employee in question and advise the employee that they will be investigating this claim. Answer: B Explanation: Grossman & Co. could consider checking receiving documents to see if shipments have been received from this vendor. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 36) During the audit of the cash and cash equivalents of Bloom Company, the external auditors, Brightside CPAs have noted that the client maintains a restricted cash account which has been earmarked for the repayment of a bond in five years. Based on this information, which assertion would be most pertinent to this scenario? A) The occurrence assertion, because the auditor will want to ensure that transactions that preceded cash deposit into the account actually occurred. B) The rights and obligations assertion, as the auditor will want to check to make sure the restricted funds are not being held in a fiduciary capacity for a third party. C) The presentation and disclosure assertion, as the auditor will want to make sure that the restricted account is properly presented in the notes to the financial statements. D) The completeness assertion, because the auditor will want to check to ensure there are no missing funds that should be in the restricted account. Answer: C Explanation: The presentation and disclosure assertion, as the auditor will want to make sure that the restricted account is properly presented in the financial statements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

37) During the beginning stages of the audit of Seaford Corporation, the external auditor, Jackson CPA Firm is determining which procedures would be most appropriate to audit the client's cash and cash equivalent accounts. If the auditor is interested in a procedure to investigate variances in these accounts, which of the following would be an appropriate technique? A) The auditor should consider performing substantive procedures on all cash accounts and highly liquid assets to check for completeness. B) The auditor should consider comparing cash balances to budgeted amounts and/or prior year balances. C) The auditor should consider tracing bank transfers to look for any signs of irregularity. D) None of these answer choices are correct. Answer: C Explanation: The auditor should consider comparing cash balances to budgeted amounts and/or prior year balances. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 38) Joe has been assigned the task of auditing the inventory accounts for Marigold LLC, a nationwide provider of fertilizer and other lawn care products. Before Joe starts the audit of these accounts, which should he attempt to gain an understanding of? A) How quickly the client settles account payables related to the selling of inventory. B) Any potential issues with inventory obsolescence and seasonality that may affect risk associated with these accounts. C) The results of analytical procedures associated with revenue accounts that relate to inventory credit sales. D) Days sales in receivables, as this directly impacts the client's revenue and inventory accounts. Answer: B Explanation: Any potential issues with inventory obsolescence and seasonality that may affect risk associated with these accounts. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

39) Marissa and Alan are working on the audit of Tigre Enterprises, and have been tasked by their supervisor to independently determine a correct amount for cost of goods sold. Which of the following would be the most appropriate method to do this? A) Marissa and Alan should consult the client's records pertaining to cost of goods sold and record this figure in the current year's audit file. B) Marissa and Alan should consider determining beginning and ending inventory and purchases made during the year. C) Marissa and Alan should subtract ending inventory from purchases made during the year by the client. D) Marissa and Alan should add beginning inventory and ending inventory together, and then subtract purchases made during the year by the client. Answer: B Explanation: Marissa and Alan should consider determining beginning and ending inventory and purchases made during the year. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 40) Two audit staff associates are discussing their upcoming audit of a major client's inventory accounts. The pair is keen to understand which assertions apply to the client's inventory accounts. Which of the following assertions would likely apply? A) The completeness assertion because the auditor will want to be sure all inventories are accounted for. B) The existence assertion, because the auditor will want to ensure revenue transactions that preceded inventory shipments existed. C) The rights and obligations assertion, because the auditor will want to make sure that inventory is listed in the correct accounts. D) The valuation and allocation assertion, as the auditor will want to be sure that the inventory is valued appropriately and allocated to the correct revenue accounts. Answer: A Explanation: The completeness assertion because the auditor will want to be sure all inventories are accounted for. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

41) Millie and Oliver are beginning the audit of Seagroves LLC, a regional purveyor of fine chocolates and other confectionary products. Millie approaches Oliver and mentions that she has noticed that inventory represents a relatively large amount of the client's total assets. Based on this finding, which of the following is true? A) Because inventory is immaterial to the financial statements, the auditors should plan to spend less time auditing this area. B) Because inventory is material to the financial statements, the auditors will spend more time on this area. C) Because the client maintains a large store of inventory, there is less risk of obsolescence. D) The risk of material misstatement is likely to be assessed as low by the auditor because the client maintains such a large inventory store. Answer: B Explanation: Because inventory is material to the financial statements, the auditors will spend more time on this area. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 42) Carrie and Harper have been tasked by their supervisor to work on the audit of the inventory accounts for one of their major clients, Sage LLC. As this is the first audit of inventory accounts, they ask their supervisor for any guidance she can offer. Which of the following is the best example of such guidance? A) The best strategy is to request senior management provide written assurances pertaining to inventory which we can include in the audit file. B) As inventory is an asset account, you need to pay attention for any potential overstatements. C) As the client is always concerned with inventory turnover, you should lookout for manipulation of associated receivables and payables. D) None of these answer choices are correct. Answer: B Explanation: As inventory is an asset account, you need to pay attention for any potential overstatements. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

43) Gladco Partners CPA Firm has been invited to consider auditing the firm of McRoss LLC, a medium sized firm and provider of outsourced payroll services. One of the CPA firms' staff associates asks you, their supervisor, what the risks surrounding inventory will be for this client. Which of the following is the most accurate response? A) Audit risk associated with inventory is likely to be assessed as high because the client maintains either very small amounts or no inventory. B) Inherent risk associated with inventory misstatement is likely to be assessed as low by the CPA firm. C) Inherent risk associated with inventory misstatement is likely to be assessed as high by the CPA firm. D) Control risk associated with inventory misstatement is likely to be assessed as low by the audit firm, upon completion of substantive testing of internal controls. Answer: B Explanation: Inherent risk associated with inventory misstatement is likely to be assessed as low by the CPA firm. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 44) Jackson CPAs are preparing to begin the audit of McIlwee Enterprises. During an initial meeting with the client, it was noted that the client maintains a large amount of inventory on a consignment basis. Based on this information, which of the following is true? A) The auditors should consider obtaining written assurances from senior management attesting to the accuracy and valuation of the inventory. B) The auditors should consider issuing a qualified opinion on the client's inventory accounts due to the difficulty associated with auditing them. C) The auditors should consider performing procedures to test the rights and obligation assertion associated with the client's inventory. D) The auditors should consider requesting the client perform a formal, manual count of inventory which the auditor can use as evidence. Answer: C Explanation: The auditors should consider performing procedures to test the rights and obligation assertion associated with the client's inventory. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

45) Costner Corporation is being audited by Brightside CPAs. As the audit focus turns to the client's inventory accounts, one of the partners in charge of the audit notes that the client maintains excellent and robust electronic records pertaining to inventory. Based on this finding, which of the following might the auditors decide to do? A) The auditors may decide to preemptively issue a clean audit opinion on the client's inventory, as the electronic records will suffice. B) The auditors may decide to use an audit data analytics (ADA) procedure to test the population of inventory. C) The auditors may opt to perform substantive procedures on the client's records system in lieu of directly auditing the client's inventory accounts. D) The auditors may choose to defer this part of the audit to the client's internal audit function. Answer: B Explanation: The auditors may decide to use an audit data analytics (ADA) procedure to test the population of inventory. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 46) James CPAs are currently working on the audit of Henderson LLC, a large firm and national distributor of coffee mugs and others plastic wares. Henderson LLC has been a client of James CPAs for a number of years. During the most recent year's audit, James CPAs have noted that the client's finished goods inventory account appears to have increased relative to prior years. Which of the following represents the best possible explanation for this? A) This is probably because Henderson LLC is producing more inventory and is of no concern to the auditors. B) This may just be because Henderson LLC has switched to a different inventory costing method and is of no concern to the auditor. C) This may be a sign that demand for Henderson LLCs' products is decreasing, and worthy of further attention. D) This is probably because Henderson LLC is trying to overstate its assets, and the auditor will need to adjust the inventory value down accordingly. Answer: C Explanation: This may be a sign that demand for Henderson LLCs' products is decreasing, and worthy of further attention. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

47) When an auditor is auditing a client's inventory accounts, the primary focus is on the assertions of ________. A) cutoff, accuracy, and completeness B) completeness, existence, valuation and allocation, and rights and obligations C) completeness,verifiability, valuation and allocation, and rights and obligations D) rights and obligations, existence and occurrence, disclosure Answer: B Explanation: When an auditor is auditing a client's inventory accounts, the primary focus is on the assertions of completeness, existence, valuation and allocation, and rights and obligations. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 48) An audit of inventory ________. A) will vary from client to client B) is a systematic approach, and rarely varies between clients C) is typically left to the internal auditors D) is prescribed by GAAP standards, which must be adhered to closely Answer: A Explanation: The audit of inventory will vary from client to client. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 49) Inventory held by the client should be classified as ________. A) revenue, on the income statement B) cost of goods sold on the income statement C) an asset, on the balance sheet D) a liability, on the balance sheet Answer: C Explanation: Inventory held by the client should be classified as an asset, on the balance sheet. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

50) Analytical procedures performed as part of risk assessment activities ________. A) are typically cost effective and may alert the auditor to potential misstatements B) are typically expensive to perform but may alert the auditor to potential misstatements C) should only be performed with the express approval of senior management D) should be coordinated with the client's legal counsel beforehand Answer: A Explanation: Analytical procedures performed as part of risk assessment activities are typically cost effective and may alert the auditor to potential misstatements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 51) If the financial statements show a trend of increased profit margin combined with an increase in the number of inventory turnover in days ________. A) inventory may be overstated B) inventory may be understated C) inventory may be becoming obsolete D) inventory turnover to payables should increase also Answer: A Explanation: If the financial statements show a trend of increased profit margin combined with an increase in the number of inventory turnover in days, inventory may be overstated. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 52) An important rights and obligations issue ________. A) deals with senior managements potential ownership of inventory B) involves consignment inventory C) deals with inventory that has been sold in the normal course of business D) deals with the valuation of inventory on the income statement Answer: B Explanation: An important rights and obligations issue involves consignment inventory. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

53) Tests of inventory controls often involve ________. A) observing the client's controls and reperforming the client's controls B) observing the auditor's controls and reperforming the client's controls C) observing the client's controls and reperforming the auditor's controls D) determining that the inventory is correctly valued on the statement of cost of goods sold Answer: A Explanation: Tests of inventory controls often involve observing the client's controls and reperforming the client's controls. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 54) In the case of a merchandiser, the company ________. A) purchases inventory with the intention of reselling B) manufactures its own inventory C) is service-based and retains no inventory D) is not part of the value chain Answer: A Explanation: In the case of a merchandiser a company purchases inventory with the intention of reselling. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 55) The assertions pertaining to inventory typically tested by the auditor are ________. A) cutoff, existence, disclosure B) rights and obligations, disclosure, going concern C) completeness, valuation, cutoff D) completeness, existence, valuation, and rights & obligations Answer: D Explanation: The assertions pertaining to inventory typically tested by the auditor are completeness, existence, valuation, and rights & obligations. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

56) The auditor needs to be attuned to ________. A) changes in an audit client, and tailor the audit to the circumstances that the auditor finds B) changes in an auditor, and tailor the audit to the circumstances that the auditor finds C) the results of firms in other industries, and how they compare to the client D) certain profitability ratios only Answer: A Explanation: The auditor needs to be attuned to changes in an audit client, and tailor the audit to the circumstances that the auditor finds. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 57) The computer manufacturing industry ________. A) is subject to high inherent risk and should be avoided by the auditor B) is subject to technological obsolescence C) is not subject to technological obsolescence D) is very profitable for the auditor due to high inherent risk and the greater extent of needed audit procedures Answer: B Explanation: The computer manufacturing industry is subject to technological obsolescence. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 58) The auditor should be alert to cutoff problems ________. A) that might have resulted in overstating inventory B) that might have resulted incorrect inventory balances C) which relates to revenues being valued improperly D) which relates to expenses being misclassified Answer: A Explanation: The auditor should be alert to cutoff problems that might have resulted in overstating inventory. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

59) The inherent risk of material misstatement arising from inventory transactions for a hotel chain or a university is relatively ________. A) high, because inventory is not a material part of the entity's core process B) low, because inventory is not a material part of the entity's core process C) low, because inventory is a material part of the entity's core process D) high, because inventory is a material part of the entity's core process Answer: B Explanation: The inherent risk of material misstatement arising from inventory transactions for a hotel chain or a university is relatively low, because inventory is not a material part of the entity's core process. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 60) With a manufacturer, wholesaler, or retailer ________. A) inventory is not typically a major part of a client's assets, and thus is not audited B) inherent risk for inventory may be assessed at or near the minimum C) inherent risk for inventory may be assessed at or near the maximum D) inventory is typically a major part of a client's assets, and thus is not audited Answer: C Explanation: With a manufacturer, wholesaler, or retailer inherent risk for inventory may be assessed at or near the maximum. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

61) With a manufacturer, wholesaler, or retailer, inherent risk for inventory may be assessed at or near the maximum due to ________. A) a large volume of inventory purchases B) a wide diversity of inventory items C) inventories being stored at multiple sites D) All of these answer choices are correct. Answer: D Explanation: With a manufacturer, wholesaler, or retailer, inherent risk for inventory may be assessed at or near the maximum due to a large volume of inventory purchases, a wide diversity of inventory items, and inventories being stored at multiple sites. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 62) Many elements of valuing inventory ________. A) should be handled by the internal auditors B) involve professional judgment and accounting estimates C) involve professional judgment and strict accounting rules D) should be ignored by the auditor due to complicated valuation issues Answer: B Explanation: Many elements of valuing inventory involve professional judgment and accounting estimates. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 63) Many of the controls over inventory ________. A) overlap with other cycles B) work in isolation C) are typically redundant and should not be tested by the auditor D) are tested by the internal audit function and can be ignored by the external auditor Answer: A Explanation: Many of the controls over inventory overlap with other cycles. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

64) A perpetual inventory system ________. A) involves counting inventory at period end because inventory is not tracked during the year B) keeps track of the quantity of each item in inventory and where it is located C) is not allowed as part of US GAAP D) should be used for overseas inventories only Answer: B Explanation: Most clients keep a perpetual inventory for inventory quantities, which perpetually (continually) keeps track of the quantity of each item in inventory and where it is located. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 65) The value of goods available for sale consists of ________. A) beginning inventory plus purchases B) ending inventory minus purchases C) calculating the inventory turnover ratio for the period D) calculating days sales in inventory for the period Answer: A Explanation: The value of goods available for sale is determined by adding beginning inventory and purchases. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 66) Cost of goods sold is determined by calculating ________. A) beginning inventory plus purchases B) beginning inventory minus ending inventory C) value of goods available for sale minus ending inventory D) value of goods available for sale plus ending inventory Answer: C Explanation: Cost of goods sold is determined by calculating value of goods available for sale minus ending inventory. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

67) If ending inventory is overstated ________. A) cost of goods sold will be understated B) cost of goods sold will be overstated C) beginning inventory will be correctly valued D) the value of purchases will be understated Answer: A Explanation: If ending inventory is overstated cost of goods sold will be understated. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 68) If ending inventory is understated ________. A) cost of goods sold will also be understated B) cost of goods sold will be overstated C) accounts receivable balances will be overstated D) accounts payable balance will be understated Answer: B Explanation: If ending inventory is understated cost of goods sold will be overstated. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 69) Consigned inventory held by the client ________. A) should be listed as an asset by the client B) should appear on the client's balance sheet C) should not be listed by the client because the client does not legally own the consigned goods D) should be listed as part of cost of goods sold by the client Answer: C Explanation: Consigned inventory held by the client should not be listed by the client because the client does not legally own the consigned goods. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

70) The auditor should be alert to ________. A) incentives and pressures that may motivate management to misstate inventory B) incentives and pressures that may motivate management to correctly state the value of inventory C) sound policies relating to inventory management D) a relatively stable inventory turnover ratio Answer: A Explanation: The auditor should be alert to incentives and pressures that may motivate management to misstate inventory. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 71) Weak internal control over inventory ________. A) may lead to decreased theft of inventory by employees B) may lead to increased theft of inventory by employees C) will automatically mean the inventory balance is misstated D) will serve to decrease inherent risk related to inventory Answer: B Explanation: Weak internal control over inventory may lead to increased theft of inventory by employees. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 72) An inventory markdown by a client ________. A) could indicate obsolescence B) is required every three years as part of GAAP C) means the client has violated the accounting principle of conservatism D) is not the responsibility of the auditor to check Answer: A Explanation: An inventory markdown by a client could indicate obsolescence. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

73) The audit strategy pertaining to inventory is highly dependent ________. A) upon senior management B) upon the internal audit function C) on the client's system of internal controls D) upon the client's legal counsel Answer: C Explanation: The auditor's audit strategy pertaining to inventory is highly dependent on the client's system of internal controls. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 74) In tracing beginning inventory balances to prior year working papers ________. A) the auditor should make certain that any audit adjustments agreed upon in the prior year did in fact get recorded B) the auditor should make certain that any audit adjustments agreed upon in the subsequent years did in fact get recorded C) the auditor should be mindful of the relationship between inventory sales and accounts payable D) the auditor should be mindful of the relationship between inventory sales and notes payable Answer: A Explanation: In tracing beginning inventory balances to prior year working papers, the auditor should make certain that any audit adjustments agreed upon in the prior year did in fact get recorded. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

75) The application of substantive analytical procedures to inventories ________. A) should be conducted by the internal audit function, as this is an area of lower inherent risk B) should be conducted by the internal audit function, as this is an area of higher inherent risk C) uses management's knowledge of the entity and its environment to develop expectations about the financial statements D) uses the auditor's knowledge of the entity and its environment to develop expectations about the financial statements Answer: D Explanation: The application of substantive analytical procedures to inventories uses the auditor's knowledge of the entity and its environment to develop expectations about the financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 76) While conducting which type of inventory count will the client frequently identify a small portion of items in the perpetual inventory, count actual inventory, and investigate discrepancies? A) Cycle B) Perpetual C) Virtual D) Accuracy Answer: A Explanation: While conducting a cycle count,the client will frequently identify a small portion of items in the perpetual inventory, count actual inventory, and investigate discrepancies. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

77) Which of the following is usually determined by taking the book value of beginning inventory, adding purchases or production costs, and subtracting the book value of ending inventory? A) Cost of goods sold B) Cost of goods purchased C) Cost of total assets D) Cost of total deliverables Answer: A Explanation: Cost of goods sold is usually determined by taking the book value of beginning inventory, adding purchases or production costs, and subtracting the book value of ending inventory. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 78) Which of the following is sent by its owner to an agent who undertakes to sell the goods? A) Consignment inventory B) Testing Inventory C) Disclosure inventory D) Auditing inventory Answer: A Explanation: Consignment inventory is sent by its owner (consignor) to an agent (consignee) who undertakes to sell the goods. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 79) A ________ refers to a bank statement for the period subsequent to the date of the balance sheet that the client requests the bank to send directly to the auditor. Answer: bank cutoff statement Explanation: A bank cutoff statement refers to a bank statement for the period subsequent to the date of the balance sheet that the client requests the bank to send directly to the auditor. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

80) A ________ company purchases inventory for resale, as opposed to manufacturing it themselves. Answer: merchandising Explanation: A merchandising company purchases inventory for resale, as opposed to manufacturing it. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 81) A regular independent comparison of perpetual records with actual inventory can be done if ________ are inflated. Answer: inventory counts Explanation: A regular independent comparison of perpetual records with actual inventory can be done if inventory counts are inflated. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 82) Match the concepts related to cash balance with their details. A. Bank cutoff statement B. Proof of cash C. Testing bank reconciliation D. Testing cutoff ____ It is essential to the proper statement of cash at the balance sheet date. ____ It is a bank statement for the period subsequent to the date of the balance sheet that the client requests the bank to send directly to the auditor. ____ It establishes the correct cash in bank balance at the balance sheet date. ____ It is usually performed when fraud risk is high. Answer: A bank cutoff statement is a bank statement for the period subsequent to the date of the balance sheet that the client requests the bank to send directly to the auditor. A proof of cash is usually performed when fraud risk is high. Testing bank reconciliation establishes the correct cash in bank balance at the balance sheet date. Testing cutoff is essential to the proper statement of cash at the balance sheet date. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 33

83) Match the analytical procedure ratios with their audit significance. A. Finished goods produced to raw material used B. Finished goods produced to direct labor C. Product defects per million D. Inventory turnover days ____ This ratio combined with knowledge of cost of sales can be useful in estimating current inventory levels. ____ This ratio is useful in estimating the effectiveness of the manufacturing process. ____ This ratio is useful in estimating the efficiency of the manufacturing process. ____ This ratio is useful in estimating the efficiency of the manufacturing process. Answer: The ratio of finished goods produced to raw material used is useful in estimating the efficiency of the manufacturing process. The ratio of finished goods produced to direct labor is useful in estimating the efficiency of the manufacturing process. Product defects per million is useful in estimating the effectiveness of the manufacturing process. Inventory turnover days combined with knowledge of cost of sales can be useful in estimating current inventory levels. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

84) Which of the following should be done by the auditor on receipt of the cutoff statement? Select all that apply. A) Trace a sample of all checks dated in the prior year to the outstanding checks listed on the bank reconciliation. B) Vouch a sample of deposits in transit on the bank reconciliation to deposits on the cutoff statement. C) Scan the cutoff statement and enclosed data for unusual items. D) Consider performing a proof of cash. Answer: A, B, C Explanation: 1. Trace a sample of all checks dated in the prior year to the outstanding checks listed on the bank reconciliation. 2. Vouch a sample of deposits in transit on the bank reconciliation to deposits on the cutoff statement. 3. Scan the cutoff statement and enclosed data for unusual items. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 85) Which of the following are inventory controls used when inventory counts are inflated? Select all that apply. A) A regular independent comparison of perpetual records with actual inventory B) Accurate recording of all scrap transactions or spoilage C) Auditing of bank transfers D) Processing of accounts receivables Answer: A, B Explanation: If inventory counts are inflated, inventory controls to be taken are 1) a regular independent comparison of perpetual records with actual inventory and 2) accurate recording of all scrap transactions or spoilage. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

86) Which of the following are account balance assertions? Select all that apply. A) The completeness of inventory B) The existence of inventory C) The valuation of inventory and the allocation of costs to cost of goods sold D) Purchases related to inventory Answer: A, B, C Explanation: Three of the account balance assertions are 1) the completeness of inventory, 2) the existence of inventory, and 3) the valuation of inventory and the allocation of costs to cost of goods sold. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 87) Diane and Stan are discussing their upcoming audit of cash and cash equivalents for Newsome Enterprises, a furniture manufacturer serving the New England area. As they brainstorm during this audit planning session, which of the following would be important areas for Diane and Stan to consider? Select all that apply. A) Diane and Stan should attempt to learn more about the industry the client operates in for the area of cash and cash equivalents. B) Diane and Stan should consider examining similarly sized firms in other industries to determine average account balances for cash and cash equivalents. C) Diane and Stan should consider examining the results of any analytical procedures they performed during the planning stage. D) Diane and Stan should think about obtaining written confirmations and assurances from the internal audit function, confirming there are no problems with cash and cash equivalents. Answer: A, C Explanation: Diane and Stan should attempt to learn more about the industry the client operates in for the area of cash and cash equivalents. Diane and Stan should consider examining the results of any analytical procedures they performed during the planning stage. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

88) Trey and Barbara are discussing one of their audit client's cash and cash equivalent accounts one day while at lunch. Trey mentions to Barbara that his supervisor has asked him to check what the client is holding in cash equivalents. Which of the following are items that Trey could reasonably expect to find in this account? Select all that apply. A) Amounts on deposit that the client is holding in various bank accounts. B) Money market funds, treasury bills, and, long-term bonds payable. C) Treasury bills, money market funds, and other liquid investments. D) Treasury bills, certificates of deposit, and investments with maturities of ninety days or less. Answer: C, D Explanation: Treasury bills, money market funds, and other liquid investments. Treasury bills, certificates of deposit, and investments with maturities of ninety days or less. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 89) Tom and Wilma are working on the audit of internal control for Progress Enterprises and are interested in understanding and examining the client's policies surrounding segregation of duties. Which of the following scenarios best represents an effective system of internal controls? Select all that apply. A) One of Progress Enterprises' accountants is responsible for updating the general ledger to reflect cash deposits, and has custody over physical cash. B) Progress Enterprises has recently switched to using a local bank to collect all incoming cash payments in settlement of receivables. C) Progress Enterprises' Chief Financial Officer is responsible for signing all checks as well as depositing the firm's daily cash deposits at the client's bank. D) One of Progress Enterprises' staff accountants performs monthly bank reconciliations. The reconciliations are checked twice-yearly by the firm's internal audit function. Answer: B, D Explanation: Progress Enterprises has recently switched to a local bank to collect all incoming cash payments in settlement of receivables. One of Progress Enterprises' staff accountants performs monthly bank reconciliations. The reconciliations are checked twice-yearly by the firm's internal audit function. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

90) During a meeting of the partners of Raythorpe CPA Firm, the issue of a major client's liquidity arose. As a result of this meeting, your supervisor has tasked you with further investigating the liquidity of this client to determine if any potential issues exist. Which of the following would be prudent items to check? Select all that apply. A) Calculate and examine the cash to total assets ratio for the last three years, which would provide evidence of changing liquidity. B) Scan the client's industry and if necessary, the wider economy to determine if any wider issues may be causing a decrease in demand for the client's products. C) Request the client's internal audit function provide all recent audit documentation pertaining to the client's liquidity, for comparison purposes. D) None of these answer choices are correct. Answer: A, B Explanation: Calculate and examine the cash to total assets ratio for the last three years, which would provide evidence of changing liquidity. Scan the client's industry and if necessary, the wider economy to determine if any wider issues may be causing a decrease in demand for the client's products. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 91) Michaela and Dave are working on the audit of Rainbow Enterprises, LLC and have been tasked with confirming the client's bank deposit and, loan balances. As Dave and Michaela prepare to do this, which of the following items would be prudent for the pair to check? Select all that apply. A) Dave and Michaela should consider requesting a full listing of all bank accounts that have been opened and closed during the year. B) Details of any pledged property or other assets that the bank is holding for other similar customers. C) Details of any loans, including repayment terms and interest charged by the bank. D) Details of any contingent liabilities held by the client that the bank has assumed legal and financial responsibility for. Answer: A, C Explanation: Dave and Michaela should consider requesting a full listing of all bank accounts that have been opened and closed during the year. Details of any loans, including repayment terms and interest charged by the bank. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

92) Jerry has been assigned to the audit of Strongbow LLC, a large, decentralized provider of soft drinks throughout the United States and Canada. This audit will be Jerry's first working with the client's inventory accounts, and so he has approached his supervisor Dana for assistance. Jerry asks Dana if the client's decentralized structure will create any problems with the audit of inventory. Which of the following are appropriate responses by Dana? Select all that apply. A) The client's decentralized structure should not cause any problems at all, as our firm only audits a small sample of the client's inventory. B) Because the client has a decentralized structure and inventory is more spread out, this may raise inherent risk associated with the existence assertion for inventory. C) The best advice here is to contact senior management and formally request written assurances pertaining to inventory stored at other locations we are unable to audit. D) Depending on the levels of inventory stored at other locations, we may need to have another auditor check this inventory for us. Answer: B, D Explanation: Because the client has a decentralized structure and inventory is more spread out, this may raise inherent risk associated with the existence assertion for inventory. Depending on the levels of inventory stored at other locations, we may need to have another auditor check this inventory for us. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 93) Auditing an attestation client's inventory accounts can vary widely in complexity and time required because of which of the following factors? Select all that apply. A) What type of inventory the client holds, and the quantities the client holds the inventory in. B) Whether the client is a manufacturing entity, a merchandising entity, or a service firm. C) The level of access the client is willing to provide to physical inventory and the inventory accounts. D) Whether the audit is for a publicly or privately traded firm, as generally accepted auditing standards only require inventory audits for publicly-traded firms. Answer: A, B Explanation: What type of inventory the client holds, and the quantities the client holds the inventory in. Whether the client is a manufacturing entity, a merchandising entity, or a service firm. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

94) Millie and Michael have been working on auditing the inventory accounts of Stone Cold Ice Cream Co. Millie has noticed that compared to prior years, the client's inventory turnover ratio appears to have decreased fairly substantially. Which of the following may be plausible causes for this decreased inventory turnover ratio? Select all that apply. A) This is very likely because the client has increased sales revenue, which would cause a decrease in inventory turnover. B) This may be because the client is now paying less for raw material, which has caused this ratio to decrease accordingly. C) This may be because demand for the client's products has slackened, causing a subsequent decrease in inventory turnover. D) This could be due to the client having to pay more for the constituent ingredients due to vendors charging more. Answer: C, D Explanation: This may be because demand for the client's products has slackened, causing a subsequent decrease in inventory turnover. This could be due to the client having to pay more for the constituent ingredients due to vendors charging more. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 95) Janessa and Oakley have been tasked by their supervisor to audit the inventory accounts of Marin Co., a retailer of exercise equipment in the United States and Europe. Janessa has learned that consumer tastes and preferences in Marin's industry change rapidly, meaning the inventory may fast become obsolete. As a result of this finding, which of the following would be pertinent considerations for Janessa and Oakley? Select all that apply. A) They should pay careful attention to inventory valuation issues; being cognizant of the need for the inventory to be valued at the lower-of-cost-or-market. B) They should closely review inventory turnover ratios to determine if any notable inventory trends can be determined. C) The pair should consider investigating whether physical inventory exists, to match up with the inventory records in the ledger. D) They should investigate whether inventory returns by the client have been appropriately recorded. Answer: A, B Explanation: They should pay careful attention to inventory valuation issues; being cognizant of the need for the inventory to be valued at the lower-of-cost-or-market. They should closely review inventory turnover ratios to determine if any notable inventory trends can be determined. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 40

96) During the audit of Jaycee Enterprises, LLC, the external auditors, Darkside CPA Firm have noted that the client has pledged a significant amount of inventory to help secure a lower interest rate on an outstanding long-term loan. As a result of this determination, which of the following would the auditors likely need to evaluate? Select all that apply. A) The auditors may wish to examine the pledging agreement to determine if it matches details contained in the client's records. B) The auditors will likely examine the client's notes to the financial statements to ensure key disclosures pertaining to the pledged inventory are present. C) Determine the average interest rate for similar loans to determine if the pledged value of inventory is valued appropriately. D) Determine the net realizable value of accounts receivable related to inventory sold on credit. Answer: A, B Explanation: The auditors may wish to examine the pledging agreement to determine if it matches details contained in the client's records. The auditors will likely examine the client's financial statements to ensure key disclosures pertaining to the pledged inventory are present. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 97) Identify whether the following tests are tests of controls, substantive analytical procedures, tests of details of transactions, or tests of details of account balances: 1) Select a sample of customer receivables and send positive confirmations to each one of those customers 2) Select a sample of entries in sales journal and trace each to the shipping documents 3) Compute receivable turnover and compare with previous years 4) Compare the dates on a sample of sales invoices with the dates of shipment and the dates they were recorded in the sales journal Answer: 1) Tests of details of account balances 2) Tests of details of transactions 3) Substantive analytical procedures 4) Tests of details of transactions Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

98) Juan and Amy are discussing one of their audit client's cash and cash equivalents accounts while at lunch one day. Juan mentions to Amy that his supervisor has informed him that cash is considered to be a higher risk account, and that he will be responsible for auditing the payroll imprest accounts. Juan is unsure as to what exactly an imprest account is, and asks Amy to explain. Which of the following represents Amy's best response? A) Imprest accounts are used widely in various industries. The best way to understand them is to think of them as being a type of high-yield savings account which the client deposits funds it is unlikely to need in the near future in order to earn higher rates of return on invested capital. B) Imprest accounts are rarely used these days due to the advent of technology. It is unlikely that the client would have any imprest accounts so you should just audit the regular cash accounts and ignore these. C) Imprest accounts can be best thought of as accounts that are used for a particular purpose. A good example of such an account would be a client transferring funds to settle payroll liabilities. D) Per generally accepted accounting standards, imprest accounts can only be used by publiclytraded companies because they can be used to circumvent internal controls. Answer: C Explanation: Imprest accounts can be best thought of as accounts that are used for a particular purpose. A good example of such an account would be a client transferring funds to settle payroll liabilities. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

99) Shabaz and Tina have been tasked by their supervisor to audit the cash and cash equivalents accounts of Mercy Enterprises, LLC. Their supervisor has explained the importance of a firm's liquidity to them in order to highlight the importance of the audit of these accounts. Shabaz wants to take a closer look at the clients operating, investing and financing activities, and asks Tina if she has any suggestions on how this could be accomplished. Which of the following would be Tina's best response? A) The easiest thing to do would be to carefully examine the client's income statements. If you pay close attention to the operating and non-operating sections, you should be able to see how the client is spending money in these areas. B) I would recommend taking a look at the client's statement of cash flows. This statement breaks down the client's cash receipts and disbursements into these three areas and is prepared on the cash basis. C) The best thing to do would be to analyze the last two balance sheets for the client. This will give you an idea of how various current asset accounts have changed, which would speak to changes in their liquidity. D) None of these answer choices are correct. Answer: B Explanation: I would recommend taking a look at the client's statement of cash flows. This statement breaks down the client's cash receipts and disbursements into these three areas and is prepared on the cash basis. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

100) Jennifer has just left her auditing class at a local state university and is walking across campus thinking about her professor mentioning during the lecture about the relationship between cash and inherent risk. Jennifer is not sure she fully understands the relationship between these two components and emails the professor to ask for clarification. Which of the following would represent the professor's best response? A) There isn't really any defined relationship between cash and inherent risk. It is just easier to discuss them both at the same time, as they both represent areas of increased audit risk. B) The best way to understand this relationship is to think of cash being a highly illiquid asset. As a result, inherent risk is typically assessed as higher by the auditor because cash is usually subject to strict segregation of duties and thus is hard to manipulate. C) The easiest way to think of the relationship between these two items is to think that cash is perhaps one of the easier assets to manipulate, and as a result, inherent risk is usually assessed as higher by the auditor. D) The research literature indicates that there is an inverse relationship between cash and inherent risk, in the sense that when cash fraud risk increases, inherent risk decreases and viceversa. Answer: C Explanation: The easiest way to think of the relationship between these two items is to think that cash is perhaps one of the easier assets to manipulate, and as a result, inherent risk is usually assessed as higher by the auditor. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

101) Maurice and Janet are working on the audit of Rainbow Enterprises, LLC and are meeting to discuss the forthcoming audit of the client's cash and cash equivalents accounts. Maurice is interested in understanding more about the client's internal controls in this area, to which Janet replies that he should consider checking with the client's senior management. Which of the following represents the most likely reason Janet would say this? A) If Maurice approaches senior management and requests written assurances and assertions pertaining to internal controls over cash and cash equivalents, these audit hours can be allocated elsewhere. B) It might be worth meeting with senior management to understand more about the client's tone at the top, as internal controls of this nature often filter down and permeate an organization. C) Maurice should check with senior management, as these key employees are likely to know and keep records of where the client's cash and cash equivalents are being held and invested. D) None of these answer choices are correct. Answer: B Explanation: It might be worth meeting with senior management to understand more about the client's tone at the top, as internal controls of this nature often filter down and permeate an organization. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

102) While performing the audit of Grover Enterprises, LLC, the external auditors, Davis CPAs have noticed that the client's gross margin ratio appears to have declined relative to prior periods. A meeting has been convened among the audit staff to discuss this issue and brainstorm any suggestions the team might have. Which of the following is a possible reason that might explain the declining gross margins? A) The declining gross margins are probably related to the clients increasing sales and revenue, which is explained by the increase in demand in this market segment for the client's products. B) The fact that the client's gross margins have declined is likely due to warranty issues with some of the client's product lines which have caused a larger percentage than normal of customers to return products, decreasing contra revenue accounts such as sales returns and allowances. C) The declining gross margin may be because one or more employees are skimming cash. When employees do this, no sale is recorded which serves to deflate the gross margin. D) The underlying course of the client's declining gross margin may be to do with one or more employees laundering funds from the client. When this occurs, a client's gross margins often appear to be notably lower than in prior periods. Answer: C Explanation: The declining gross margin may be because one or more employees are skimming cash. When employees do this, no sale is recorded which serves to inflate the gross margin. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

103) During the audit of Ballantyne Enterprises, the audit team of Ray CPA Firm has noted that the client has a noticeably higher gross margin on sales than in prior periods. A meeting has been convened to discuss this issue and invite any suggestions from the audit team as to why the client's gross margin is noticeably higher. Which of the following constitutes the most plausible reason for this? A) The notably higher gross margin is probably industry-wide, and as a result, there is nothing untoward occurring at the client's place of business that needs further investigation. B) The unusually high gross margin could be a result of one or more employees laundering client funds. When this type of scheme occurs, it often shows up in notably higher gross margins. C) The reason for the unusually high gross margin is probably due to the client increasing demand for its products. When sales revenue accounts, gross margins would also increase, so there is nothing worthy of further investigation here. D) None of these answer choices are correct. Answer: B Explanation: The unusually high gross margin could be a result of one or more employees laundering client funds. When this type of scheme occurs, it often shows up in notably higher gross margins. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

104) Johnson CPA Firm is beginning the audit of cash and cash equivalents for Madras Company, a purveyor of fine jewelry throughout the continental United States. One of the audit partners assigned to the engagement notes that Madras has historically had strong internal controls over cash and cash equivalents, with no audit issues noted in prior years. As a result of this information, which of the following is most accurate? A) The auditor is likely to conclude that cash and cash equivalents for the client do not need to be audited. These billable audit hours can instead be redirected to another area. B) The auditor is likely to conclude that control risk for this year's audit of this area should be assessed as high. This will involve the auditor adopting a reliance strategy and relying more on the client's internal controls. C) The auditor is likely to assess control risk as low, based on the results of previous years and a demonstrated strong system of internal control. Despite this, the auditor will perform tests of internal controls. D) The auditor is likely to determine that control risk is low, and as a result, formally request the internal audit function perform the audit of this area as they are more familiar with the client's cash and cash equivalents. Answer: C Explanation: The auditor is likely to assess control risk as low, based on the results of previous years and a demonstrated strong system of internal control. Despite this, the auditor will perform tests of internal controls. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

105) Jackson and Marie are sitting at lunch one day and are discussing the relationship between a client's system of internal control and substantive testing. Jackson explains to Marie that as far as he sees it, there is no relationship between these two components, and asks Marie what her understanding is. Which of the following represents Marie's best response to this question? A) As far as I can tell, you are exactly right. I think they just happen to represent two areas that the auditors tests. I don't believe they have to be done in any particular order either. B) My understanding is that there is something of an inverse relationship here. For example, if an auditor determines a client has a strong system of internal controls, they may decide to perform less substantive testing as a result. C) As far as I understand it, these two items work in tandem. That is to say that if an auditor performs testing on a client's system of internal controls and determines it is weak, the auditor will perform less substantive procedures in order to form an opinion on the client's financial statements. D) None of these answer choices are correct. Answer: B Explanation: My understanding is that there is something of an inverse relationship here. For example, if an auditor determines a client has a strong system of internal controls, they may decide to perform less substantive testing as a result. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

106) Mike and Jessica are working on the audit of Forerunner Enterprises, a medium-sized firm and distributor of carburetors and other engine parts across the United States and Canada. Mike tells Jessica that he heard one of the audit managers discussing the importance of testing the cutoff assertion for cash and cash equivalents, but doesn't understand what this means. Which of the following represents Jessica's best reply to this question? A) The cutoff assertion speaks to ensuring that cash is recorded in its entirety and is important because assets may otherwise be understated. B) The cutoff assertion focuses on ensuring that cash is recorded in the correct period, and is important because clients may attempt to overstate cash balances. C) Focusing on the cutoff assertion enables the auditors to ensure that cash is valued appropriately and classified correctly, and helps to ensure that client management has not overstated assets. D) The cutoff assertion really deals with ensuring that float periods for checks the client has received and written have been recorded properly, as otherwise cash balances may be incorrectly classified. Answer: B Explanation: The cutoff assertion focuses on ensuring that cash is recorded in the correct period and is important because clients may attempt to overstate cash balances. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

107) Harry and Maria have been assigned to audit the cash and cash equivalents of Layman Enterprises, LLC, a large audit client and retailer of luxury furniture throughout the United States and Europe. One of the audit partners assigned to the engagement has mentioned to Harry and Maria that they need to pay particular attention to auditing the presentation and disclosure assertion. Which of the following is the most likely reason for this request? A) The client may be hiding cash in offshore accounts and either not presenting it or presenting it incorrectly in the financial statements. If this is found to be the case, correcting entries will need to be proposed while auditing the presentation and disclosure assertion. B) It is possible that the client is restricting certain elements of its cash balances to pay for future expenses such as pension payments when employees retire. The auditor should check to make sure such pension assets are appropriately disclosed on the balance sheet. C) The client may be restricting certain element of cash to pay for anticipated future expenses such as bond sinking funds. As a result, this needs to be clearly disclosed and presented in notes to the financial statements. D) None of these answer choices are correct. Answer: C Explanation: The client may be restricting certain element of cash to pay for anticipated future expenses such as bond sinking funds. As a result, this needs to be clearly disclosed and presented in the financial statements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

108) Renee and Deana are discussing the audit of inventory accounts one day after work at a local coffee shop. Renee is a new auditor with the CPA firm and Deana has been assigned as her mentor. Renee asks Deana if she can provide her with an overview of auditing a client's inventory accounts. Which of the following would be the most appropriate response from Deana? A) The auditing of a client's inventory accounts is generally pretty standardized. We always test the same assertions and run into the same errors, thus it is not overly complicated. B) The level of complexity pertaining to the client's inventory accounts really depends on the type of company. For example, a manufacturing company will involve a more complex audit than a service company. C) There is a large amount of variance in different audit clients' inventory accounts; even for clients within the same industry. For example, inherent risk is always higher for clients using FIFO inventory costing compared to LIFO inventory costing. D) We generally follow the same audit plan as the previous year. If we are auditing a first-time client, then we are required to obtain assurances from senior management pertaining to inventory accounts for inclusion in the permanent audit file. Answer: B Explanation: The level of complexity pertaining to the client's inventory accounts really depends on the type of company. For example, a manufacturing company will involve a more complex audit than a service company. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

109) Mike and Daryl are discussing auditing various attestation clients one day over lunch. Mike is an audit intern and has been assigned to Daryl as a mentee. Mike asks Daryl whether their upcoming audit of a manufacturing entity will be any different from their last audit which involved a service firm. Which of the following represents the most appropriate response by Daryl? A) There won't really be any difference. Most of the clients we audit operate in different industries but thankfully the inventory accounts and cost flows are generally the same. B) When we audit a service firm, we have to plan the audit of inventory accounts a little differently. This is because of the increased complexity surrounding multiple inventory accounts with highly varying balances. C) When we audit a manufacturing entity, we have to plan the audit around auditing raw materials inventories, work in process accounts, and finished goods accounts, which adds to the complexity and risk of the audit. D) None of these answer choices are correct. Answer: C Explanation: When we audit a manufacturing entity, we have to plan the audit around auditing raw materials inventories, work in process accounts, and finished goods accounts, which adds to the complexity and risk of the audit. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

110) Raytheon CPA Firm is currently completing an attestation engagement for Pantheon Enterprises, LLC, a regional distributor of decorative stone monuments and other garden ornaments. The head of the client's internal audit function advises Raytheon that right before the audit commenced, the firm undertook a complete inventory account. Which of the following methods of completing the inventory account represents the lowest level of inherent risk for the auditors? A) Pantheon Enterprises advises the auditors that the inventory count was completed in two stages. Stage one involved physically counting the inventory, and stage two involved having the same team account for and resolve any discrepancies. B) Pantheon Enterprises advises the auditors that the inventory count was completed in two stages. Stage one involved physically counting the inventory, and stage two involved having a different team account for and resolve any discrepancies. C) Pantheon Enterprises advises the auditors that the inventory count was completed by a thirdparty firm. Pantheon Enterprises Chief Financial Officer is a major shareholder in this firm and has vouched for the quality of their work. D) None of these answer choices are correct. Answer: B Explanation: Pantheon Enterprises advises the auditors that the inventory count was completed in two stages. Stage one involved physically counting the inventory, and stage two involved having a different team account for and resolve any discrepancies. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

111) Parkland CPAs have been approached by a local university who require an audit to obtain a bank loan. When the staff of Parkland CPAs meets to discuss this potential client, an audit staff associate mentions the auditing of inventory for this client. Which of the following is true with respect to the audit of inventory in this type of industry? A) The client is likely to maintain large amounts of inventory. As a result, inherent risk should be assessed as higher by the auditors. B) The client operates in a relatively specialized niche industry, which means inventory will also be specialized. As a result, the auditors may need to hire a specialist firm to audit inventory. C) Because the potential audit client operates in an industry that provides educational services, the client is likely to have little or no inventory. Thus, this will not be a main focus of the audit. D) Because the client provides services in higher education, generally accepted auditing standards require the audit to be completed by the government audit office. Answer: C Explanation: Because the potential audit client operates in an industry that provides educational services, the client is likely to have little or no inventory. Thus, this will not be a main focus of the audit. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 112) Mason CPAs is completing the audit of Dixon LLC, a provider of cement and other building materials in the southeastern United States. The current year's audit is the second year that Mason CPAs have provided attestation services for Dixon LLC. One of Mason's audit staff associates has determined that Dixon's 'days in inventory' ratio has increased substantially since last year's audit. Which of the following is the most likely reason for this change? A) An increase in this ratio is usually indicative of increased sales by the client. As demand for the client's products increases, this ratio typically also increases. B) An increase in this ratio may be due to a decrease in demand for the client's products, which is causing inventory to turnover more slowly than in the prior year. This should be investigated by the auditors. C) An increase in this ratio is most likely due to the client's customers returning abnormally large amounts of inventory to the client. Such returns increase inventory and cause this ratio to also increase. D) None of these answer choices are correct. Answer: B Explanation: An increase in this ratio may be due to a decrease in demand for the client's products, which is causing inventory to turnover more slowly than in the prior year. This should be investigated by the auditors. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 55

113) During the audit of Appletree Enterprises, LLC, a regional provider of apple juice and orange juice throughout the United States, the auditing firm has determined that the client's inventory appears to be growing faster than its sales. You have been tasked by your supervisor to help uncover why this is happening, in order that appropriate recommendations can be made to the client. Which of the following represents the most likely reason for this occurrence? A) This occurrence is likely due to the client's inventory turnover ratio having decreased. It is expected that when a client's sales increase, inventory will also increase. B) This may be because the client has experienced a decrease in demand for its products, but is still ordering higher inventory levels. A recommendation to decrease inventory purchases should be made to the client. C) This occurrence is likely due to the client's sales model. The majority of sales are made on a credit basis, and it may be because the client is not collecting receivables efficiently. D) This occurrence is probably because the client is accepting too many sales returns and making too many sales allowances. This would cause a detrimental effect on the client's gross margin and would negatively impact the inventory accounts. Answer: B Explanation: This may be because the client has experienced a decrease in demand for its products but is still ordering higher inventory levels. A recommendation to decrease inventory purchases should be made to the client. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

114) Sandra's auditing class is discussing inherent risk related to manufacturing entities inventory accounts. Sandra explains to her class that inherent risk is often higher for manufacturing entities and asks the class why they think this might be? Which of the following responses would be most appropriate from the class? A) Inherent risk is probably higher for manufacturing entities because they are having to process raw materials into finished goods. This is more complex than just selling premade inventory, so inherent risk would be higher. B) Inherent risk is likely to be higher for manufacturing entities because their inventory turnover cycles are much slower than in other industries. As a result, they run a much greater risk of obsolescence. C) Inherent risk is probably higher for manufacturing entities because of the judgment and subjectivity involved with the allocation of costs for items such as indirect materials. D) None of these answer choices are correct. Answer: C Explanation: Inherent risk is probably higher for manufacturing entities because of the judgment and subjectivity involved with the allocation of costs for items such as indirect materials. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 115) Maggie and Eric are currently working on the audit of Bloomtree Enterprises, a provider of horticultural services in the southern United States. Maggie mentions to Eric that during the prior year's audit of the firm, internal controls over inventory were robust and effective. As a result of this, what might Maggie and Eric decide do this year with respect to inventory? A) Maggie and Eric may decide to simply rely on the previous year's audit findings. If they adopt this strategy, all they would need to do this year is obtain written assurances from management. B) Maggie and Eric may decide to audit inventory at an interim date. If this strategy is adopted, it will be because the pair believe internal controls over inventory are still effective. C) Maggie and Eric may decide to audit inventory closer to the balance sheet date. If the prior year's audit found that internal controls in this area were effective, the pair can focus their audit attentions elsewhere. D) If the client's inventory represents a significant amount of total assets, Maggie and Eric may decide to request that the internal audit function audit these accounts, as they are more familiar with the client's operations. Answer: B Explanation: Maggie and Eric may decide to audit inventory at an interim date. If this strategy is adopted, it will be because the pair believes internal controls over inventory are still effective. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 57

116) Basille CPA firm is currently working on the audit of Jetta Enterprises and is preparing to begin the audit of the client's inventory accounts. Jetta Enterprises is a provider of modems and wireless routers in both the individual and commercial markets. Which of the following may be true of a client in this industry? A) The external auditors may wish to consider hiring a specialist to audit the existence assertion of inventory. This is due to the specialized nature of the client's industry. B) The external auditors may wish to consider auditing the population of inventory accounts due to the increased inherent risk associated with the client's specialized nature. C) The external auditors may wish to consider product and inventory obsolescence as part of the auditing of the valuation assertion associated with inventory. D) None of these answer choices are correct. Answer: C Explanation: The external auditors may wish to consider product and inventory obsolescence as part of the auditing of the valuation assertion associated with inventory. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

117) DeBole CPAs are currently completing the audit of McKeown Enterprises, a regional distributor of sheet metal and other building supplies in the Midwestern United States. The CPA firm has noted that the client maintains a wide range of inventory, with varying levels of inventory kept in stock for each type. Which of the following procedures would be most appropriate for the CPA firm to identify slow moving inventory? A) The auditors should consider adopting an audit data analytics (ADA) procedure to help them identify slow-moving inventory as they audit the valuation assertion associated with inventory. B) The auditors should consider formally requesting written assurances from senior management as to which inventory items are taking the longest to sell. This will assist the auditors with the cutoff assertion. C) The auditors should consider auditing a representative cross sample of inventory types, and attempt to calculate an average inventory turnover ratio. This average can then be compared to industry averages. D) The auditors should consider deferring identification of slow-moving inventory to the internal audit function. The internal auditors are more familiar with the client, and thus are more likely to accurately determine which inventory types are slowest moving. Answer: A Explanation: The auditors should consider adopting an audit data analytics (ADA) procedure to help them identify slow-moving inventory as they audit the valuation assertion associated with inventory. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 118) Explain the importance of observing physical inventory during an audit. Answer: Inventory is typically a large account on the financial statements, especially for manufacturing and retail companies. Examining physical inventory primarily provides evidence that the inventory does exist, but it can also provide evidence for the rights and obligations and valuation assertions. It is also a generally accepted auditing procedure. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

119) You are auditing ZZ Top Inc., which has a December 31st year-end. On December 24th, the person responsible for processing receiving reports and recording the receipt of inventory became ill and was out of the office for a week. Due to the company's small staff and the holiday season, a number of the receiving reports were not processed on a timely basis. As an auditor, on which assertion would you place a high importance for this client and how would you test for it? Answer: The cutoff assertion would be very important in this situation. The risk of inventory transactions being recorded in the wrong period is very high. To test for misstatements, the auditor should trace a sample of receiving reports before and after year-end to ensure that the inventory was recorded in the proper period. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 120) For each of the following tests of details, state whether it is a test of details of account balances or whether it is a test of details of disclosures. 1. Inspect loan agreements under which an entity's inventories are pledged. 2. Review inventory compilation for proper classification among raw materials, work in process and finished goods. 3. Observe the count of physical inventory. 4. Trace test counts and tag control information to the inventory compilation. 5. Inquire of management about issues related to LIFO liquidations. 6. Review book-to-physical adjustments for possible misstatements. Answer: 1. Disclosures (Occurrence, Rights and obligations) 2. Disclosures (Classification and understandability) 3. Account balances (Existence) 4. Account balances (Completeness, Valuation and allocation) 5. Disclosures (Accuracy, Valuation) 6. Account balances (Valuation and allocation) Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: Decision Making

121) ________ formula can be used to find out the ratio of Return on common Shareholder's equity. A) Net income − preferred dividends/average common shareholders' equity B) Net income − preferred dividends/total fixed asset C) Net income/total sale D) Total income * total assets Answer: A Explanation: Net income − preferred dividends / average common shareholders' equity provides a measure of the rate of return generated on the common shareholders' investment. The auditor should understand the competitiveness factors that allow a company to obtain an unusually high return. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 122) A ________ reconciles not only the ending balance but also cash receipts transactions between the accounting records and the bank? A) proof of cash B) asset transaction C) year-end statement D) auditing year transaction Answer: A Explanation: A proof of cash reconciles not only the ending balance but also cash receipts transactions between the accounting records and the bank. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

123) ________ can be done if inventory is not recorded. A) Investigation of negative balances in inventory records B) Investigation of bank solution C) Writing-off bad debts D) Offering sales discounts Answer: A Explanation: If inventory is not recorded, auditors may investigate negative balances in inventory records. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

Auditing, 2e (Johnson) Chapter 14 Auditing Investing and Financing Activities 1) Financing activities include the purchase and sale of land, buildings, equipment, and other long-term assets not generally held for resale. Answer: FALSE Explanation: Investing activities include the purchase and sale of land, buildings, equipment, and other long-term assets not generally held for resale. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 2) Inherent risk for property, plant and equipment is always low. Answer: FALSE Explanation: Inherent risk for property, plant and equipment is not straight forward. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 3) The purpose of the auditor's test of repair and maintenance expenses is to determine the propriety and consistency of these charges. Answer: TRUE Explanation: The purpose of the auditor's test of repair and maintenance expenses is to determine the propriety and consistency of these charges. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

4) Investing activities include transactions and events whereby cash is obtained from or repaid to creditors (debt financing) or owners (equity financing). Answer: FALSE Explanation: Financing activities include transactions and events whereby cash is obtained from or repaid to creditors (debt financing) or owners (equity financing). Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 5) When an auditor finds that a client has engaged in significant new debt or equity transactions, the auditor should be prepared to study a significant volume of legal documents related to the financing transaction and determine the impact of any legal requirements (such as debt covenants) on the entity. Answer: TRUE Explanation: When an auditor finds that a client has engaged in significant new debt or equity transactions, the auditor should be prepared to study a significant volume of legal documents related to the financing transaction and determine the impact of any legal requirements (such as debt covenants) on the entity. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 6) While authorizing bonds and capital stock issuance, the board of directors usually authorizes financing transactions based on the entity's strategic plans and investing activities. Answer: TRUE Explanation: While authorizing bonds and capital stock issuances, the board of directors usually authorizes financing transactions based on the entity's strategic plans and investing activities. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

7) Controls over fixed asset balances often include ________. A) physical controls over fixed liabilities as well as the maintenance of a fixed asset inventory that is periodically checked against existing assets B) physical controls over current assets as well as the maintenance of a fixed asset inventory that is periodically checked against existing assets C) physical controls over fixed assets as well as the maintenance of a fixed asset inventory that is periodically checked against existing assets D) ensuring all assets are recorded at fair value, and not historical cost Answer: C Explanation: Controls over fixed asset balances often include physical controls over fixed assets as well as the maintenance of fixed asset inventory that is periodically checked against existing assets. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 8) Plant assets should be ________. A) classified as current assets if the intention is to sell them B) listed as a liability if the assets are financed C) relatively stable and grow at approximately the rate of sales growth D) relatively stable and grow at a higher rate than the rate of sales growth Answer: C Explanation: Plant assets should be relatively stable and grow at approximately the rate of sales growth. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

9) An entity acquires property, plant and equipment assets ________. A) because they support its operations and core processes B) to hold for resale at a higher price C) because they support its ancillary operations and processes D) as tax write-offs only Answer: A Explanation: An entity acquires property, plant and equipment assets because they support its operations and core processes. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 10) Most businesses will acquire new assets if ________. A) the rate of return generated by those assets is lower than the after-tax marginal cost of debt financing associated with acquiring additional assets B) the rate of return generated by those assets exceeds the after-tax marginal cost of debt financing associated with acquiring additional assets C) they have surplus amounts of cash which they need to spend D) their stockholders vote to do so Answer: B Explanation: As a rule of thumb, most businesses will acquire new assets if the rate of return generated by those assets exceeds the after-tax marginal cost of debt financing associated with acquiring additional assets. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

11) The first step in auditing investing activities ________. A) involves understanding the assets that are needed to support the entity's operations B) involves understanding the liabilities that will be matched with required assets C) involves understanding the assets that are needed to support the entity's compliance with debt covenants D) is to issue a preliminary audit opinion Answer: A Explanation: The first step in auditing investing activities involves understanding the assets that are needed to support the entity's operations. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 12) Usually the growth in fixed assets should ________. A) demonstrate a consistent relationship with the growth in revenues, accounting for some startup period B) demonstrate an inconsistent relationship with the growth in revenues, accounting for some startup period C) be unrelated to revenue D) be unrelated to expenses such as cost of goods sold Answer: A Explanation: Usually the growth in fixed assets should demonstrate a consistent relationship with the growth in revenues, accounting for some startup period. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Technology AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 13) Substantive tests of property, plant and equipment often focus on ________. A) agreeing the beginning balance in property, plant and equipment to the prior year's audit B) auditing the acquisition of new property, plant and equipment C) auditing the disposal of property, plant and equipment D) All of these answer choices are correct. Answer: D Explanation: Substantive tests of property, plant and equipment will typically focus on all of these things. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 5

14) When an auditor develops a business-based approach to auditing property, plant and equipment, ________. A) it is not necessary to understand how the long-term assets support the operations of the entity B) it is essential to understand how the long-term assets support the operations of the entity C) the auditor recommends which assets to sell and keep D) the auditor attempts to find competitors who are willing to buy certain of the client's assets Answer: B Explanation: When an auditor develops a business-based approach to auditing property, plant and equipment, it is essential to understand how the long-term assets support the operations of the entity. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 15) The auditor will often look at how the entity is growing in order to determine ________. A) the likelihood of being paid for the audit B) the assets needed to support that growth C) which assets the client should keep D) which assets the client should sell Answer: B Explanation: The auditor will often look at how the entity is growing and determine the assets needed to support that growth. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 16) It is important to develop a good understanding of the audit client in order to ________. A) develop expectations regarding the client's financial statements B) develop expectations regarding payment for fees earned by the auditor C) ensure the auditor will be employed in subsequent years by the client D) help ensure inherent risk is high Answer: A Explanation: It is important to develop a good understanding of the audit client in order to develop expectations regarding the client's financial statements. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 6

17) Analytical procedures are required ________. A) by management B) by the internal auditors C) as part of risk assessment D) in order to eliminate risk Answer: C Explanation: Analytical procedures are required as part of risk assessment. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 18) Which of the following include(s) the purchase and sale of land, buildings, equipment, and other long-term assets not generally held for resale? A) Investing activities B) Property ownership C) Real estate ownership D) Ownership activities Answer: A Explanation: Investing activities include the purchase and sale of land, buildings, equipment, and other long-term assets not generally held for resale. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 19) Which of the following is the purpose of the auditor's test of repair and maintenance expense to determine the propriety and consistency of these charges? A) Review Entries to Repairs and Maintenance Expense B) Vouch Plant Asset Disposals C) Year-end statement D) Auditing year transactions Answer: A Explanation: Inventory counts may be inflated: Regular independent comparison of perpetual records with actual inventory. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 7

20) Fixed assets and key locations are important for which of the following types of companies? A) Supermarkets and other grocery stores B) Hotels and motels C) Colleges, Universities and other professional schools D) All of the answer choices are correct Answer: D Explanation: Fixed assets and key locations are important for supermarkets and other grocery stores. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 21) Tom is sitting in his auditing class at a local state university, listening to the professor deliver a lecture on auditing a client's investing activities. At the end of the lecture, Tom approaches the professor and asks for clarification on what activities would be included in investing activities. Which of the following would be the correct response from the professor? A) A firm's investing activities typically include purchasing and selling of fixed assets such as equipment. B) A firm's investing activities typically include interest paid on loans taken out to purchase fixed assets. C) A firm's investing activities typically include the sale of financial instruments held for trading purposes. D) A firm's investing activities typically include the proceeds received from retirement of fixed assets as well as cash disbursements for interest expenses. Answer: A Explanation: A firm's investing activities typically include purchasing and selling of fixed assets such as equipment. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

22) As an auditor prepares to begin an audit of an attestation client, which of the following should the auditor consider doing to prepare for the audit? A) The auditor should consider obtaining written assurances from senior management pertaining to all higher risk areas of the audit. B) The auditor should consider obtaining a better understanding of the client, and the industry in which the client operates. C) The auditor should consider which areas of the client the auditor is willing to express an opinion on, and which the audit firm will disclaim an opinion on. D) The auditor should consider examining similar industries to that which the client operates in, and comparing key metrics and ratios. Answer: B Explanation: The auditor should consider obtaining a better understanding of the client, and the industry in which the client operates. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 23) Ramon is an audit staff associate who has been assigned to the audit of the property, plant and equipment accounts of Sterling, Inc. a supplier of luxury silverware across the United States. This is Ramon's first audit of this type of account, and so he consults his supervisor for assistance and an overview of what he might expect. Which of the following represents the most appropriate response by the supervisor? A) A client's property, plant and equipment accounts tend to be fairly voluminous with respect to transactions, so just aim to audit a sample of transactions. B) It's usually a good idea to start with the beginning balance for the accounts, and vouch them to last year's audit records. Any additions and deletions, of which there should be few, can then be audited. C) Perhaps the best way to approach the audit of these accounts is to recalculate the associated depreciation expenses first, and then trace the expenses back to the individual assets. D) None of these answer choices are correct. Answer: B Explanation: It's usually a good idea to start with the beginning balance for the accounts, and vouch them to last year's audit records. Any additions and deletions, of which there should be few, can then be audited. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

24) Celina is currently working on the audit of a client's property, plant and equipment accounts, and has turned her attention to asset retirements and disposals. Celina asks her supervisor what specifically she should look for in these areas. Which of the following represents the supervisor's most appropriate response? A) Pay attention to make sure that for each retirement and disposal, the appropriate asset and accumulated depreciation accounts have been debited and credited respectively. B) Make sure that for asset retirements and disposals, you check to make sure there is a proportionate decrease in interest expense related to long-term debt that was used to purchase these assets. C) Check to make sure that for assets that were sold, the appropriate gains and losses are recorded correctly on the client's balance sheet. D) For each asset retirement and disposal, you should check to ensure that asset and accumulated depreciation accounts have been closed properly. Answer: D Explanation: For each asset retirement and disposal, you should check to ensure that asset and accumulated depreciation accounts have been closed properly. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 25) Marjorie is working on the audit of the property, plant and equipment accounts for Jamboree Enterprises, a supplier of party supplies and equipment across the United States and Canada. As Marjorie wants to gain a better understanding of the client's industry, she has decided to investigate key ratios related to fixed assets and compare them with industry averages. Which of the following would represent key ratios that Marjorie should consider investigating? A) The debt to total assets ratio and the times interest earned ratio for the client and the industry. B) The net fixed assets as a percentage of total assets ratio and the sales divided by fixed assets ratio for the client and the industry. C) The sales divided by fixed assets ratio and the operating debt as a percentage of total equity ratio for the client and the industry. D) The financing debt as a percentage of total assets ratio and the price earnings ratio for the client and the industry. Answer: B Explanation: The net fixed assets as a percentage of total assets ratio and the sales divided by fixed assets ratio. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

26) David is working on the audit of a major client's property, plant and equipment accounts, and has been tasked by his supervisor to determine the client's fixed asset turnover ratio. David has started gathering the necessary information in order to calculate the ratio and approaches his supervisor to ask why his supervisor is requesting he do this. Which of the following is the most likely response from his supervisor? A) It is customary during any routine audit and attestation engagement that we calculate all key and pertinent ratios for our clients. B) If we determine that the ratio is lower than we expect it to be, it may indicate evidence of failure by the client to record certain fixed assets. C) If the ratio is higher than our expectation, it may provide evidence that the client is failing to capitalize certain assets on the balance sheet. D) None of these answer choices are correct. Answer: C Explanation: If the ratio is higher than our expectation, it may provide evidence that the client is failing to capitalize certain assets on the balance sheet. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 27) Clarissa is assisting with the audit of a client's property, plant and equipment accounts and has determined that the client's depreciation expense amounts for the past year are significantly higher than in previous periods. Which of the following offers the most plausible explanation for this increase? A) This increased depreciation expense is likely because the client has retired major assets during the last fiscal year. B) This increased depreciation expense is probably due to a client switching from straight-line depreciation to units of production method for low-usage assets. C) This increased depreciation expense may be because the client has acquired additional fixed assets during the most recent fiscal year. D) This increased depreciation expense may be because management is attempting to manipulate expenses by increasing the useful lives of the entity's fixed assets. Answer: C Explanation: This increased depreciation expense may be because the client has acquired additional fixed assets during the most recent fiscal year. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

28) Sandra is an audit intern working at McGoldrick CPA firm. As the CPA firm begins to audit the property, plant and equipment accounts of one of their large clients, Sandra asks her supervisor, Karen, to explain what inherent risks, if any, are associated with these types of fixed asset accounts. Which of the following would be Karen's most appropriate response to this question? A) Inherent risk for property, plant and equipment accounts is generally considered to be high. This is because of the difficulty in auditing the existence assertion. B) Inherent risk for property, plant and equipment accounts is generally considered to be higher. An example of a reason for this assessment is the opportunity to inappropriately capitalize or expense assets. C) Inherent risk for property, plant and equipment is generally considered to be low. This is because is it relatively straightforward for the auditor to audit the valuation and allocation assertions. D) None of these answer choices are correct. Answer: C Explanation: Inherent risk for property, plant and equipment accounts is generally considered to be higher. An example of a reason for this assessment is the opportunity to inappropriately capitalize or expense assets. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 29) KC CPAs have just completed testing of internal controls related to property, plant and equipment for Sunshine Corporation and have noted that these controls appear to be robust and effective. Based on this finding, which of the following is accurate with respect to the auditors' substantive testing of this area? A) As internal controls related to property, plant and equipment are strong, the auditors will most likely perform substantive testing at an interim date. B) As internal controls related to property, plant and equipment are strong, the auditors are likely to perform substantive testing closer to the firm's balance sheet date. C) As internal controls related to property, plant and equipment are strong, the auditors will most likely not perform substantive testing in this area, and will redirect audit hours to other areas of the audit. D) None of these answer choices are correct. Answer: A Explanation: As internal controls related to property, plant and equipment are strong, the auditors will most likely perform substantive testing at an interim date. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 12

30) Marissa is an audit intern working at Marshall CPA firm. Her supervisor at Marshall CPA firm has explained that the audit of property, plant and equipment and the related accounts ties in to management's expectations of the firm's earnings. Marissa is unclear as to how this relationship works and asks the supervisor to elaborate. Which of the following would be the most accurate response? A) The relationship is fairly straightforward. If the client's management is keen to show strong earnings to beat analysts' expectations, they may manipulate depreciation expenses to boost these earnings. B) The best way to think about this relationship is to think about how fixed assets are depreciated over time, and the incentive management has to shorten useful lives to decrease depreciation expenses. C) The relationship works on the premise that when property, plant and equipment is amortized, the firms earnings are boosted through the accelerated amortization of fixed assets. D) None of these answer choices are correct. Answer: A Explanation: The relationship is fairly straightforward. If the client's management is keen to show good earnings to beat analysts' expectations, they may manipulate depreciation expenses to boost these earnings. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 31) Kirby is an audit staff associate assigned to the attestation engagement of a major client. Kirby's supervisor has tasked her with auditing the client's financing activities, however before Kirby begins with the audit of this area, she wishes to understand more activities that would be included in this category. Which of the following represents areas Kirby would want to check? A) Kirby should consider examining the client's acquisition of major fixed assets and reconciling to the general ledger. B) Kirby should think about investigating a secondary stock offering that the client conducted within the last year. C) Kirby should think about examining interest payments on long-term bond issues to ensure accurate amounts are being paid to bondholders. D) None of these answer choices are correct. Answer: B Explanation: Kirby should think about investigating a secondary stock offering that the client conducted within the last year. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

32) Jan and Sharon are discussing the audit of the financing activities of one of their large attestation clients. Jan mentions to Sharon that she would like to know more about what to expect when auditing these types of accounts, and asks Sharon for advice. Which of the following is the most appropriate response from Sharon as to what Jan may expect to see? A) It is likely that you'll see only a few accounts, but each account is likely to have a large number of transactions, so plan to audit a sample. B) The best thing to do with these types of accounts is to use audit data analytic (ADA) to audit the entire population of accounts. C) What you'll most likely see is fewer numbers of transactions than other accounts, but the transactions are often for large dollar amounts. D) You'll likely see few transactions for bond related transactions and many transactions for equity related transactions. Answer: C Explanation: What you'll most likely see is fewer numbers of transactions than other accounts, but the transactions are often for large dollar amounts. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 33) Colin and Derek are meeting to discuss their upcoming audit of a client's financing cycle and activities. Colin mentions to Derek that there is often a correlation between the extent of a client's fixed assets and its level of financing activities. Derek is confused and asks Colin to explain further. Which of the following would be Colin's most appropriate response? A) There is a connection between a client's fixed assets and its level of financing, as firms often borrow money in order to fund expansion via increased fixed assets. B) There isn't really a defined relationship per se. We can think of it more in the sense that when a client's fixed assets increase, their level of investing activities decrease and vice-versa. C) The research literature indicates a strong correlation between a client's level of fixed assets and the number of financing activity transactions. This is because a client often needs to refinance loans in order to qualify for new asset purchases. D) None of these answer choices are correct. Answer: A Explanation: There is a connection between a client's fixed assets and its level of financing, as firms often borrow money in order to fund expansion via increased fixed assets. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

34) Tommy and Melissa are preparing to examine a client's financing cycle and associated activities. Melissa, a less experienced auditor, asks Tommy if there is anything the auditor should be mindful of that would go in tandem with the fixed assets audit. Which of the following is Tommy's most appropriate response to this question? A) Yes. When you audit the clients' financing activities, pay close attention to interest payments on outstanding loans and stock offerings. B) No, The main goal of the audit of the client's financing cycle is simply to ascertain that the assets exist and the revenue they helped generate actually occurred. C) Yes, as part of the audit of the client's financing activities, you should also consider what fixed assets were purchased with that particular financing activity. D) Not really. The main thing to focus on at this stage of the audit is ensuring all financing activities actually occurred and are valued appropriately on the income statement. Answer: C Explanation: Yes, as part of the audit of the client's financing activities, you should also consider what fixed assets were purchased with that particular financing activity. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 35) Janessa has just graduated from a local university and accepted a job with Hartke CPAs. During her first week on the job, and as the CPA firm is working on the audit of a client's financing cycle, Janessa asks her supervisor why the CPA firm needs to concern itself with this area, as surely inherent risk would be low. Which of the following represents the correct response by her supervisor to this question? A) You are correct. Inherent risk in this area is indeed low, however we can increase the number of billable audit hours so we perform testing in this area anyway. B) That is not the case. Inherent risk associated with a client's financing cycle is high because of the complexity of the associated interest and dividend transactions that accompany these activities. C) That is not the case. Inherent risk in this area is often assessed as higher by auditors because of the prior number of financial statement restatements that have emerged from activities in this area. D) None of these answer choices are correct. Answer: C Explanation: That is not the case. Inherent risk in this area is often assessed as higher by auditors because of the prior number of financial statement restatements that have emerged from activities in this area. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 15

36) Janiya and Carlie have been assigned to the audit the financing activities for Buckaroo Enterprises, LLC, a provider of horse riding equipment throughout the continental United States. Carlie has never audited a client's financing activities before, and asks Janiya where they should start? Which of the following represents an appropriate response by Carlie to this question? A) I would recommend we start with auditing the associated interest expense accounts for the client's equity offerings. B) I would recommend we start with testing a sample of dividend payments associated with the client's long-term bonds. C) I would recommend we review the minutes of board of directors meetings to check for appropriate authorizations of debt or equity transactions. D) I would recommend we solicit written assurances from senior management. If we can obtain those, we can go ahead and issue an audit opinion on this area. Answer: C Explanation: I would recommend we review the minutes of board of directors meetings to check for appropriate authorizations. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 37) Dennis has been tasked by his supervisor to audit the financing activities of Margram Enterprises, LLC; a large, national retailer of wooden and plastic furniture. As this will be Dennis' first audit of the client's equity accounts, he asks his supervisor if there are any areas he should be cognizant of as he completes this part of the audit? Which of the following represents his supervisors' most appropriate response to this question? A) The best thing to do is to approach this part of the audit in the exact same way as auditing bonds and long-term debt. Pay particular attention to interest expense accounts. B) Pay close attention to any instances of stock buybacks by the client, and consider checking for appropriate authorizations for these transactions. C) Pay attention to how much stock the client has issued relative to the prior year's audit, and make sure this number can be reconciled to asset acquisitions and retirements. D) None of these answer choices are correct. Answer: B Explanation: Pay close attention to any instances of stock buybacks by the client, and consider checking for appropriate authorizations for these transactions. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

38) Jasmine is working on the audit of a client's financing activities, and is beginning testing of long-term debt transactions. Jasmine approaches her colleague Max and asks him if he has any suggestions on areas to pay attention to during this part of the audit. Which of the following suggestions by Max would be most helpful to Jasmine? A) Pay close attention to dividend payments, and make sure they have been appropriately authorized by the client's board of directors. B) Spend some time scrutinizing the client's long-term loans and make sure that all loan covenants are renegotiated by the client to avoid loan defaults. C) Pay close attention to principal and interest payments made as part of loan repayment and check the mathematical accuracy of related amortization schedules to actual loan payments. D) Interview key management employees and board of directors to confirm loan balances contained in the financial statements are accurate. Answer: C Explanation: Pay close attention to principal and interest payments made as part of loan repayment and check the mathematical accuracy of related amortization schedules to actual loan payments. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 39) Juniper CPAs is auditing the financing cycle of Westover Corporation, a large, publiclytraded firm. Senior management of the firm has recently apprised the auditors of a major bond issue which the client has just conducted in order to raise capital to fund a major new expansion plan. If Juniper CPAs wish to confirm the details of the bond issue, which of the following would be an appropriate method by which to achieve this? A) Juniper CPAs should consider contacting the client's bond trustee, who can independently provide details of the bond issue. B) Juniper CPAs should consider preparing a separate amortization schedule related to principal and interest payments related to bond issue repayment. C) Juniper CPAs should consider requesting written details of the bond issue from senior management, which can then be compared against details of the bond issue contained in the board of directors' minutes. D) None of these answer choices are correct. Answer: A Explanation: Juniper CPAs should consider contacting the client's bond trustee, who can independently provide details of the bond issue. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

40) During the first year audit of Junebug Corporation, the auditors, Firefly CPAs are interested in independently assessing the entity's ability and viability as a going concern. Despite assurances by senior management related to this area, Firefly CPAs would like to confirm this independently of the firm's management. Which of the following would be a suitable way for Firefly CPAs to achieve this? A) Firefly CPAs should consider performing substantive testing on all internal controls related to the going concern assumption. B) Firefly CPAs should consider auditing the entire population associated with all financing activities to look for irregularities and anomalies which might indicate the client will face solvency problems in the near future. C) Firefly CPAs should consider assessing whether the client is able to generate sufficient cash flows from operations to cover current debts such as interest expenses and long-term expenses such as loan maturities. D) Firefly CPAs might decide to contact all third parties that the client owes money to, including vendors and creditors, and request a full repayment history. This can be used to assess Junebug's viability as a going concern. Answer: C Explanation: Firefly CPAs should consider assessing whether the client is able to generate sufficient cash flows from operations to cover current debts such as interest expenses and longterm expenses such as loan maturities. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 41) As part of the auditor's responsibilities with respect to evaluating whether an entity is a going concern, ________. A) the auditor will attempt to obtain written assurances from management to this effect B) substantive testing and procedures will likely be extended over common stock and additional paid-in capital accounts C) the auditor will evaluate the entity's ability to generate sufficient debt to meet commitments regarding interest expenses, debt maturities, and debt covenants D) the auditor will evaluate the entity's ability to generate sufficient cash flow to meet commitments regarding interest expenses, debt maturities, and debt covenants Answer: D Explanation: As part of the auditor's responsibilities with respect to evaluating whether an entity is a going concern the auditor will evaluate the entity's ability to generate sufficient cash flow to meet commitments regarding interest expenses, debt maturities, and debt covenants. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 18

42) Financing activities typically include ________. A) selling to customers B) acquisition and retirement of debt C) acquiring shares of stock in another company D) related party transactions between senior management and the company Answer: B Explanation: Financing activities would include acquiring debt, capital leases, issuing bonds, or issuing preferred or common stock. Financing activities would also include payments to retire debt, reacquiring stock (treasury stock), and the payment of dividends. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Technology AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 43) Financing activities typically include which of the following? A) Retirement of debt B) Selling to customers C) Acquisition of a building for resale D) Acquisition of a building to be used for core business operations Answer: A Explanation: Financing activities typically include retirement of debt. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 44) The population of debt and equity instruments ________. A) is typically large in terms of the number of instruments B) is typically small in terms of the number of instruments C) is usually of no concern to the auditor D) should all carry the same interest rates Answer: B Explanation: The population of debt and equity instruments is typically small in terms of the number of instruments. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

45) When an auditor performs risk assessment activities and develops a business-based approach to auditing financing activities, ________. A) the auditor should be prepared to make recommendations pertaining to which arrangements should be refinanced B) it is essential to understand how the entity chooses an investing strategy, and the types of financial instruments used by the entity C) it is essential to understand how the entity chooses a financing strategy, and the types of financial instruments used by the entity D) it is essential to understand how the entity chooses to finance an operating strategy, and the types of financial instruments used by the entity Answer: C Explanation: When an auditor performs risk assessment activities and develops a businessbased approach to auditing financing activities, it is essential to understand how the entity chooses a financing strategy, and the types of financial instruments used by the entity. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 46) With respect to financing activities, ________. A) there continues to be significant variation from industry to industry B) there continues to be little variation from industry to industry C) there should be no deviation between industries D) the auditor should attempt to confirm all financing activity transactions with the firm's stockholders Answer: A Explanation: With respect to financing activities there continues to be significant variation from industry to industry. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

47) With respect to financing activities, an auditor should understand ________. A) how a company plans to sell its long-term assets B) how a company plans to fund the acquisition of long-term assets C) that this area lacks inherent risk, thus can be ignored D) that this area is handled by the internal audit function, and thus should defer the audit procedures to them Answer: B Explanation: With respect to financing activities, an auditor should understand how a company plans to fund the acquisition of long-term assets. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 48) When an auditor finds that a client has engaged in significant new debt or equity transactions, the auditor should ________. A) be prepared to study a significant volume of legal documents related to the financing transaction in order to determine the impact of any legal requirements B) be prepared to study a small volume of legal documents related to the financing transaction in order to determine the impact of any legal requirements C) be prepared to study a significant volume of legal documents related to the operating transaction in order to determine the impact of any legal requirements D) attempt to obtain additional written representations from management to increase the assurance level Answer: A Explanation: When an auditor finds that a client has engaged in significant new debt or equity transactions, the auditor should be prepared to study a significant volume of legal documents related to the financing transaction in order to determine the impact of any legal requirements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

49) Which of the following functions and related control activities are associated with the financing process? A) Authorizing bonds and capital stock B) Paying bond interest and cash dividends C) Redeeming and reacquiring bonds and capital stock D) All of these answer choices are correct. Answer: D Explanation: All of these financing functions and related control activities are associated with the financing process. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 50) A bond trustee ________. A) is appointed by the auditor to sell the client's bonds B) is usually a commercial bank or a trust company that is given fiduciary powers by a bond issuer to enforce the terms of a bond indenture C) is usually a regular bank or a trust company that is given fiduciary powers by a bond issuer to enforce the terms of a bond indenture D) does not assist the client in selling its bonds under any circumstances Answer: B Explanation: A bond trustee is usually a commercial bank or a trust company that is given fiduciary powers by a bond issuer to enforce the terms of a bond indenture. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

51) A transfer agent is ________. A) a trust company, bank, or similar financial institution assigned by a corporation to maintain records of investors and account balances B) responsible for handling the client's foreign currency exchanges C) responsible for handling the client's banks foreign currency exchanges D) seldom used by a publicly traded client due to prohibitive costs Answer: A Explanation: A transfer agent is a trust company, bank, or similar financial institution assigned by a corporation to maintain records of investors and account balances. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 52) If an entity is a public company, the auditor will most likely ________. A) not feel the need to test the client's controls B) will test controls and follow a higher assessed level of control risk approach C) will test controls and follow a lower assessed level of control risk approach D) outsource the testing of controls to the internal audit function Answer: C Explanation: If the entity is a public company, the auditor will test controls and follow a lower assessed level of control risk approach. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 53) Which of the following activities include transactions and events whereby cash is obtained from or repaid to creditors or owners? A) Financing activities B) Investment activities C) Auditing activities D) Risk assessment activities Answer: A Explanation: Financing activities include transactions and events whereby cash is obtained from or repaid to creditors (debt financing) or owners (equity financing). Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 23

54) Which of the following formulas is used to calculate the ratio of interest-bearing debt to total assets? A) Interest bearing debt/total assets B) Interest bearing rate * total assets C) Interest bearing rate * debt D) Interest bearing rate/100 * total assets Answer: A Explanation: The ratio of interest-bearing debt to total assets equals interest bearing rate/total assets. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 55) Which of the following formulas is used to calculate the dividend payout rate? A) Cash dividends/net income B) Cash dividends * net income C) Cash dividends − net income D) Average total assets − total dividends Answer: A Explanation: The dividend payout rate equals cash dividends/net income. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 56) Controls over the disposition of assets should include specific ________ controls for the sale, or trade-in, of fixed assets Answer: authorization Explanation: Controls over the disposition of assets should include specific authorization. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

57) ________ is the formula applied to find out the ratio of total asset turnover. Answer: Net sales/average total assets Explanation: Net sales/average total assets is the formula applied to find out the ratio of total asset turnover. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 58) If the auditor knows changes that have occurred in ________ activities, changes in financing activities often are predictable. Answer: investing Explanation: Investing Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 59) A ________ is a trust company, bank, or similar financial institution assigned by a corporation to maintain records of investors and account balances. Answer: transfer agent Explanation: A transfer agent is a trust company, bank, or similar financial institution assigned by a corporation to maintain records of investors and account balances. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

60) Match the phrases below with their corresponding statements. A. Review Provisions for Depreciation B. Inspect Plant Assets C. Confirm if assets have been pledged as collateral for loans D. Impairment of Property, Plant and Equipment ____ It is possible that assets may be pledged even though invoices for the purchase of property, plant and equipment might be marked "paid." ____ Exists when the cost of a long-lived asset, or group of assets, exceeds its fair value and is not recoverable. ____ In this test, the auditor seeks evidence on the reasonableness, consistency, and accuracy of depreciation charges for the period. ____ Enables the auditor to obtain direct personal knowledge of the existence of plant assets. Answer: Review Provisions for Depreciation: In this test, the auditor seeks evidence on the reasonableness, consistency, and accuracy of depreciation charges for the period. Inspect Plant Assets: Enables the auditor to obtain direct personal knowledge of the existence of plant assets. Confirm if assets have been pledged as collateral for loans: It is possible that assets may be pledged even though invoices for the purchase of property, plant and equipment might be marked "paid." Impairment of Property, Plant and Equipment: Exists when the cost of a long-lived asset, or group of assets, exceeds its fair value and is not recoverable. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

61) Match the concepts below with their details. A. Financing activities B. Analytical procedures C. Significant inherent risks D. Initial procedures ____ They are applicable to long-term debt balances. ____ They involve proper accounting for interest rate swaps and classification of equity instruments that behave like debt. ____ They assist the auditor in evaluating the reasonableness of the financial statements. ____ They include acquiring debt, capital leases, issuing bonds,and issuing preferred or common stock. Answer: Financing activities include acquiring debt, capital leases, issuing bonds, and issuing preferred or common stock. Analytical procedures assist the auditor in evaluating the reasonableness of the financial statements. Significant inherent risks involve proper accounting for interest rate swaps and classification of equity instruments that behave like debt. Initial procedures are applicable to long-term debt balances. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

62) Which of the following procedures may be useful to the auditor in determining whether all retirements have been recorded? A) Analyzing the miscellaneous revenue accounts for proceeds from sales of plant assets. B) Investigating the disposition of facilities associated with discontinued product lines and operations. C) Reviewing insurance policies for termination or reductions of coverage. D) Making inquiry of investors about retirements. Answer: A, B, C Explanation: The following procedures may be useful to the auditor in determining whether all retirements have been recorded: 1. Analyzing the miscellaneous revenue accounts for proceeds from sales of plant assets. 2. Investigating the disposition of facilities associated with discontinued product lines and operations. 3. Reviewing insurance policies for termination or reductions of coverage. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 63) Rebecca and Juan are discussing the audit of property, plant and equipment for one of their largest audit clients one day over lunch. Rebecca tells Juan that she has been assigned to the audit of this area and has been tasked with examining the client's investing activities. Rebecca asks Juan what would be included in investing activities. Which of the following examples would be included in investing activities? Select all that apply. A) The audit client recently purchased a new factory building as part of a major expansion plan. B) The audit client recently issued bonds to help pay for the major expansion. C) The audit client recently purchased long-term bonds from a prominent, publicly-traded firm. D) The audit client recently declared and paid dividends to all stockholders of record as of the last day of their fiscal year. Answer: A, C Explanation: The audit client recently purchased a new factory building as part of a major expansion plan. The audit client recently purchased long-term bonds from a prominent, publiclytraded firm. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

64) Charlie and Ramona have been tasked by their supervisor with the audit of property, plant and equipment for Budget Enterprises, one of their largest attestation clients. Charlie mentions to Ramona that the volume of transactions in these accounts should be relatively low. Because of the nature of these accounts, which of the following procedures would be appropriate? Select all that apply. A) Charlie and Ramona should reconcile this year's beginning account balances with last year's audit to verify the accuracy of the amounts. B) Charlie and Ramona should examine fixed asset turnover ratios to make sure that the client is turning over fixed assets at a pace that roughly matches the industry. C) Charlie and Ramona should consider verifying any purchases and acquisitions in these accounts, as well as related depreciation entries. D) Charlie and Ramona should consider auditing the opening balances of these accounts and matching them to related interest expenses. Answer: A, B, C Explanation: Charlie and Ramona should reconcile this year's beginning account balances with last year's audit to verify the accuracy of the amounts. Charlie and Ramona should consider verifying any purchases and acquisitions in these accounts, as well as related depreciation entries. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 65) The audit partners of Bloom CPAs are meeting with the senior management of Custard Company to discuss their upcoming audit of the client's property, plant and equipment accounts. Senior management has mentioned that since the last audit, several new major asset purchases have been made. Which of the following represent items of audit interest to the auditors in this area? Select all that apply. A) The auditors may wish to determine how the fixed assets purchased were financed. B) The auditors may wish to determine if recently acquired fixed assets are appropriately capitalized. C) The auditors may wish to determine the rate of return being generated by the client's assets, including recently purchased assets. D) The auditors will likely wish to consider the after-tax cost of the assets, in order to ensure amortization expense amounts on the income statements are accurate. Answer: A, B Explanation: The auditors may wish to determine how the fixed assets purchased were financed. The auditors may wish to determine if recently acquired fixed assets are appropriately capitalized. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 29

66) Delagrange CPAs are preparing to begin the first-year audit of Kearns Company, a mediumsized firm and regional provider of security and protective services in the southeastern United States. The partners of the audit firm are meeting with the client's senior management to discuss the audit of the client's property, plant and equipment accounts, in the hopes of obtaining a better understanding of this area. Which of the following represent prudent questions the audit partners should ask during the meeting? Select all that apply. A) What fixed assets are required by the client in order to support the client's business operations? B) What method of amortization or depletion is the client using for its fixed assets? C) What is the desired rate of return that the company's senior management and board of directors expect to earn on these fixed assets? D) What percentage of the assets are owned by the firm as opposed to being leased to other entities? Answer: A, B, D Explanation: What fixed assets are required by the client in order to support the client's business operations? What method of amortization or depletion is the client using for its fixed assets? What percentage of the assets are owned by the firm as opposed to being leased to other entities? Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

67) Anna and Felice are two audit staff associates assigned to the audit of Thomas Co.'s property, plant and equipment accounts. Anna explains to Felice that before they start the audit, it would be a good idea to brainstorm a list of assertions that would apply to these accounts that they should check. Which of the following are assertions related to property, plant and equipment that Anna and Felice should consider checking? Select all that apply. A) The completeness assertion, as the pair will want to ensure that property, plant and equipment and related expense entries are recorded in the correct period. B) The rights and obligations assertion, as Anna and Felice will want to check to see if any assets are pledged as collateral for loans. C) The valuation and allocation assertion, as the pair will want to check to make sure that all property, plant and equipment is included on the client's balance sheet. D) The presentation and disclosure assertion, as the pair will want to ensure that fixed assets held by the client are appropriately displayed on the balance sheet. Answer: B, D Explanation: The rights and obligations assertion, as Anna and Felice will want to check to see if any assets are pledged as collateral for loans. The presentation and disclosure assertion, as the pair will want to ensure that fixed assets held by the client are appropriately displayed on the balance sheet. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

68) Debbie and Melinda have been tasked by their supervisor to audit a major client's financing activities. This is Debbie's first audit of this area, and so she asks Melinda what items would be included in the client's financing activities. Which of the following are correct responses to this question by Melinda? Select all that apply. A) The client recently completed a secondary stock offering, in order to raise capital for a planned major expansion. B) The client recently repurchased outstanding bonds in order to reduce interest expense and improve the times interest earned ratio. C) The client recently purchased land and has begun work on building a new factory on this land. D) The client's board of directors recently approved a dividend payment to all stockholders of record as of the last date of the company's fiscal year. Answer: A, B, D Explanation: The client recently completed a secondary stock offering, in order to raise capital for a planned major expansion. The client recently repurchased outstanding bonds in order to reduce interest expense and improve the times interest earned ratio. The client's board of directors recently approved a dividend payment to all stockholders of record as of the last date of the company's fiscal year. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 69) The partners of Flower CPAs have been asked to meet with the senior managers of Glass & Co., a national provider of blown glass and other glassware products to discuss a possible audit of the client's financial statements. During the meeting, the auditors are interested in learning more about the client's current outstanding debt. Which of the following represent viable items to increase their understanding in this area? Select all that apply. A) Understanding the client's average debt levels relative to the industry in which the client operates. B) Key leverage ratios, such as the debt-to-assets and debt-to-equity ratio, and how they compare to industry averages. C) Understanding the client's current stock price and earnings per share, as well as the current price-earnings ratio. D) Learning more about covenants that are related to the client's common and preferred stock offerings. Answer: A, B Explanation: Understanding the client's average debt levels relative to the industry in which the client operates. Key leverage ratios, such as the debt-to-assets and debt-to-equity ratio, and how they compare to industry averages. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 32

70) Dave and Maria are working on the audit of a major client's financing cycle and activities. Dave's supervisor has recently apprised him that he would like Dave to check the details and amounts surrounding a recent major bond issue by the client. Dave is unsure as to how to proceed, and asks Maria for advice. Which of the following would be helpful suggestions by Maria? Select all that apply. A) You should think about examining the minutes of previous board of directors meetings, as details of the approval should be contained in those minutes. B) You should plan to meet with the client's bondholders to confirm the existence of bond indentures and certificates. C) You should consider auditing related interest expense accounts, as a new bond issue would have increased these. D) The easiest thing to do would be to request written assurances from senior management pertaining to the bond issue. We can then include this document in our audit file. Answer: A, C Explanation: You should think about examining the minutes of previous board of directors meetings, as details of the approval should be contained in those minutes. The easiest thing to do would be to request written assurances from senior management pertaining to the bond issue. We can then include this document in our audit file. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

71) An audit staff associate is working on the audit of the financing cycle and activities of Greenfield Enterprises, LLC; a nationwide retailer of computer and other peripheral electronic equipment. The staff associates' supervisor recently mentioned that the first task will be to examine controls related to a recent stock issue the client conducted. Which of the following represents appropriate controls the audit staff associate should consider checking related to the secondary stock issue? Select all that apply. A) The audit staff associate should consider examining the minutes of board of directors meetings to ensure that the appropriate authorizations were obtained in order to conduct the stock issue. B) The audit staff associate should consider discussing the details of the stock issue with major investors and confirming appropriate interest payments have been received from the client. C) The audit staff associate should consider checking the client's dividend accounts to confirm the mathematical accuracy of dividend declarations and payments by computer systems. D) The audit staff associate should consider checking the cash accounts of the client to account for all funds received from the stock issue. Answer: A, C Explanation: The audit staff associate should consider examining the minutes of board of directors meetings to ensure that the appropriate authorizations were obtained in order to conduct the stock issue. The audit staff associate should consider checking the client's dividend accounts to compute the mathematical accuracy of dividend declarations and payments. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

72) Monica and Steve have been tasked by their supervisor with the audit of a client's financing cycle; specifically the audit of the client's long-term debt accounts. Monica has performed some preliminary testing of internal controls in this area, and found them to be effective and robust. Steve is now planning to conduct substantive procedures and asks Monica if she has any suggestions as to procedures that they should consider performing. Which of the following are appropriate substantive procedures in this area? Select all that apply. A) Steve could consider confirming key details of long-term debt issues with external entities such as banks and other creditors. B) Steve could consider recalculating interest expense amounts related to long-term debt issues, to ensure accuracy of accruals and expenses. C) Steve could consider key economic drivers that may have influenced the need for the client's long-term debt. D) Steve should consider recalculating dividend payments and reviewing minutes of board of directors meetings to ensure appropriate authorizations for dividend payments on long-term debt. Answer: A, B, C Explanation: Steve could consider confirming key details of long-term debt issues with external entities such as banks and other creditors. Steve could consider recalculating interest expense amounts related to long-term debt issues, to ensure accuracy of accruals and expenses. Steve could consider key economic drivers that may have influenced the need for the client's long-term debt. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 73) Which three of the following analytical procedures are commonly used to audit long term debt? A) Shareholders' equity to total assets B) Interest bearing debt to total assets C) Return on common equity D) Comparing return on assets with shareholders' equity Answer: A, B, C Explanation: Three analytical procedures commonly used to audit long term debt are as follows: 1. Shareholders' equity to total assets 2. Interest bearing debt to total assets 3. Return on common equity Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

74) Daniel and Micah are working on the audit of McGee Enterprises, LLC, a national provider of carpet and underlay products throughout the northeastern United States. The audit will be Daniel's first time working on a client's investing activities, and so Daniel has requested that Micah provide him with an overview of what types of items he may be auditing. Which of the following represents Micah's most appropriate response to this query? A) Investing activities is a pretty broad area. You will likely run into some stocks and bonds held by the client, as well as some trading securities. B) Investing activities can be best thought of as the category whereby the client lists all of their purchases and sales of equipment that they need to run the business. You'll probably also see some other long-term assets that the client is not trying to sell. C) Investing activities is usually populated with long-term stocks and bonds in other companies held by the client. You will typically also see the purchase and sale of the client's own debt and equity securities in this area. D) Investing activities is usually populated with investments that were not purchased for trading purposes. In addition, you'll probably also see equipment and buildings the client is attempting to resell, as well as land owned by the client. Answer: B Explanation: Investing activities can be best thought of as the category whereby the client lists all of their purchase and sale of equipment they need to run the business. You'll probably also see some other long-term assets that the client is not trying to sell. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

75) Jason and Maria have been tasked by their supervisor with the audit of a major attestation client's investing activities. Jason has clarified with the supervisor that they are to spend the forthcoming week auditing the clients' property, plant and equipment. Jason and Maria have decided to meet to discuss their approach to auditing this area, and what they expect to see. Which of the following is the most accurate description of this area and what they will likely see? A) The client's property, plant and equipment accounts are likely to contain large balances, with a large amount of transactions. Because of this, inherent risk is usually assessed as higher by the auditors. B) The client's property, plant and equipment accounts are likely to have high turnover ratios. Because of this, the auditors typically examine key ratios related to this such as the property, plant and equipment to total assets ratio. C) The client's property, plant and equipment accounts are typically high dollar amount, low volume accounts. The audits of these accounts typically focus on vouching fixed asset additions and disposals, retirements etc. D) None of these answer choices are correct. Answer: C Explanation: The client's property, plant and equipment accounts are typically high dollar amount, low volume accounts. The audits of these accounts typically focus on vouching fixed asset additions and disposals, retirements etc. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

76) Millie and Catherine have convened a meeting to discuss the upcoming audit of a client's property, plant and equipment accounts. The client is a large, decentralized entity, so the pair wants to make sure they are as thorough as possible during the audit of this area. Millie has recently joined the firm after graduating college, and asks Catherine to explain some factors and events that might cause the client's property, plant and equipment accounts to decrease. Which of the following is Catherine's best response to this question? A) There are various factors that may cause these accounts to decrease. For example, asset acquisitions and retirements are two such factors that would cause us to check to ensure these assets have been removed from the clients' general ledger. B) During the last year, the client may have decided to retire fixed assets, or perhaps just dispose of them. The client may have sold them to a third party, which would have implications for gain and loss accounts that we would also want to check. C) It is feasible that during this past year, the client has depreciated its property, plant and equipment at a higher rate than in prior years. If we ascertain that this is the case, then we need to propose correcting entries to adjust the accounts to their correct balances. D) It is possible that the client has retired certain fixed assets, but has not removed them from the general ledger. This is problematic because it causes a subsequent understatement of fixed assets and overstatement of depreciation expense. Answer: B Explanation: During the last year, the client may have decided to retire fixed assets, or perhaps just dispose of them. The client may have sold them to a third party, which would implications on gain and loss accounts that we would also want to check. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

77) Robert and Sarah have been tasked by their supervisor to complete the audit of the property, plant and equipment accounts of Robles, LLC, a large firm and purveyor of fine chocolates throughout the United States and Canada. Their supervisor has requested to meet with the pair to discuss the client's level of fixed assets. Which of the following is the supervisor likely to discuss with Robert and Sarah in the meeting? A) When you audit the property, plant and equipment accounts for this client, you'll want to make sure that the client is effectively using debt leverage. The client should be achieving this by purchasing as much fixed assets as possible while interest rates are low to take advantage of cheaper financing. B) As you work through the audit of the client's property, plant and equipment accounts, bear in mind that the client should be purchasing fixed assets only as replacements for other fixed assets that the client is retiring or disposing of. C) When you audit the client's property, plant and equipment accounts, it is worth checking to make sure that the client is maintaining an appropriate level of fixed assets to support its current level of operations, as well as any future planned growth. D) None of these answer choices are correct. Answer: C Explanation: When you audit the client's property, plant and equipment accounts, it is worth checking to make sure that the client is maintaining an appropriate level of fixed assets to support its current level of operations, as well as any future planned growth. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

78) Derek is currently sitting in his auditing class at a local state university, listening to the professor deliver a lecture on inherent risk and a client's property, plant and equipment accounts. Derek approaches the professor at the end of the lecture to ask for clarification on what exactly the relationship is between inherent risk and these accounts. Which of the following represents the most appropriate response by the professor to this question? A) There is a clearly defined relationship between inherent risk and the clients' property, plant and equipment accounts. The best way to think about it is that when the client purchases more fixed assets, the inherent risk associated with these accounts tends to decrease. B) The relationship between inherent risk and a client's property, plant and equipment accounts is best defined as a fluctuating one. For example, when a client completes major acquisitions of fixed assets via high-interest debt, inherent risk increases due to the client's increased risk of default. C) The best way to think about the relationship between inherent risk and a client's property, plant and equipment is as follows. If a client needs and uses a large amount of fixed assets to support its business operations, inherent risk is likely to be higher and vice-versa. D) The relationship between inherent risk and a client's property, plant and equipment accounts is a fairly straightforward one. The client determines the level of fixed assets it will need to purchase in order to support business operations, and then determines its subsequent level of inherent risk. Answer: C Explanation: The best way to think about the relationship between inherent risk and a client's property, plant and equipment is as follows. If a client needs and uses a large amount of fixed assets to support its business operations, inherent risk is likely to be higher and vice-versa. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

79) During a meeting of the audit team assigned to the attestation engagement for Jester Enterprises, the audit manager running the meeting has been asked to explain how the audit team should consider approaching the risk assessment phase of the audit of the client's property, plant and equipment accounts. Which of the following responses by the audit manager would best help the team understand more details about this risk assessment phase? A) Risk assessment procedures for the audit of a client's property, plant and equipment accounts are generally decided on a case-by-case basis. There's no specific advice I can give you; other than make sure all beginning and ending balances for the client's fixed asset accounts are accurate. B) Risk assessment procedures for the audit of a client's property, plant and equipment accounts are usually achieved via analytical procedures. For example, you could opt to perform ratio analysis related to fixed assets to see if any notable results arise that might warrant further investigation. C) Risk assessment procedures for auditing a client's property, plant and equipment accounts are set forth by generally accepted auditing standards. As this is a publicly-traded company, you should just plan to follow those. D) None of these answer choices are correct. Answer: B Explanation: Risk assessment procedures for the audit of a client's property, plant and equipment accounts are usually achieved via analytical procedures. For example, you could opt to perform ratio analysis related to fixed assets to see if any notable results arise that might warrant further investigation. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

80) In order to help the audit team assigned to the audit of a major client's property, plant and equipment accounts better understand the link between auditing assertions and this area of the audit, the audit manager with overall responsibility for this part of the audit has convened a meeting. Which of the choices below would be the supervisor's best response to help explain this relationship? A) The best way to understand the relationship between these two areas is to think that when we begin the audit of this area; we will take our list of all the audit assertions, and we will find ways to test those assertions and document the results. B) The easiest way to understand this relationship is to imagine taking our list of assertions, determining which ones apply to the client's property, plant and equipment accounts, and then finding ways to test the assertions we selected. For example, we might decide to test the completeness assertion by examining documents to see if the client's fixed assets are leased or owned. C) The easiest way to understand this relationship is to imagine taking our list of assertions, determining which ones apply to the client's property, plant and equipment accounts, and then finding ways to test the assertions we selected. For example, we might decide to test the valuation and allocation assertion by examining documents to see if the client has defaulted on any debt associated with these assets. D) The easiest way to understand this relationship is to imagine taking our list of assertions, determining which ones apply to the client's property, plant and equipment accounts, and then finding ways to test the assertions we selected. For example, we might decide to test the presentation and disclosure assertion by examining the client's financial statements and determining if fixed assets are presented correctly. Answer: D Explanation: The easiest way to understand this relationship is to imagine taking our list of assertions, determining which ones apply to the client's property, plant and equipment accounts, and then finding ways to test the assertions we selected. For example, we might decide to test the presentation and disclosure assertion by examining the client's financial statements and determining if fixed assets are presented correctly. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

81) Margo and Allen are discussing their audit of a client's fixed assets one day over lunch at the client's premises. Margo tells Allen that she has spent most of the week learning about and performing tests on the client's internal controls related to property, plant and equipment. She proceeds to tell Allen that her supervisor also mentioned the client's tone at the top as a key internal control, but doesn't understand what this means, or how it would be related to the client's fixed assets. How should Allen best respond to these questions? A) I would imagine the supervisor is probably talking about the relationship between management's acquisition strategies for fixed assets. Some clients are very aggressive when it comes to purchasing fixed assets, especially when interest rates on debt are lower. B) The tone at the top speaks to management's demonstrated desire to act ethically and to be seen doing the right thing. This can permeate through the organization, which may be manifested in accurate balances in property, plant and equipment accounts, as well as appropriate depreciation and related expense entries. C) I know that the tone at the top refers to whether or not management of the firm acts ethically, and also whether they hold others around them to the same standard. With respect to your question about fixed assets, that has to do with negotiating the original costs of those assets, and making sure that during asset acquisitions and retirements etc. everything is done as equitably and transparently as possible. D) None of these answer choices are correct. Answer: B Explanation: The tone at the top speaks to management's demonstrated desire to act ethically and to be seen doing the right thing. This can permeate through the organization, which may be manifested in accurate balances in property, plant and equipment accounts, as well as appropriate depreciation and related expense entries. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

82) Janice and Henry are meeting to discuss potential fraud risks associated with a new attestation client they are considering taking on. During the meeting, the conversation turns to the fraud risk associated with the client's property, plant and equipment accounts. Janice tells Henry that as fixed assets are typically large and hard to steal, she doesn't see any concerns in this area. Which of the following correctly represents Henry's most appropriate reply to this statement? A) You are correct. It would be extremely hard if not impossible for someone to steal a client's fixed assets without being noticed. Another issue would be transferring the title to someone else's name. I don't see anything to worry about here either. B) I partially agree with you. I think you are correct in saying that fixed assets would indeed be hard to steal. However, I also think that there is an opportunity for accounts that are related to fixed assets such as depreciation and dividends accounts to be manipulated. C) I partially agree with you. I would agree that it would seem difficult to steal or redirect fixed assets without the client finding out. With that being said, perhaps the fraud risk in this area is related to improper capitalization practices. D) I completely disagree. I think that anytime a client increases its fixed assets via acquisition of property, plant and equipment, inherent risk and fraud risk also increase. Despite being large, these assets are still prone to theft, embezzlement, and fraud. Answer: C Explanation: I partially agree with you. I would agree that it would seem difficult to steal or redirect fixed assets without the client finding out. With that being said, perhaps the fraud risk in this area is related to improper capitalization practices. Diff: 3 LO: 1 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

83) Theodore and Marvin are sitting at lunch one day discussing their audit of a client's property, plant and equipment accounts. Theodore mentions to Marvin that his supervisor has tasked him with creating a list detailing what could go wrong in these accounts. Marvin mentions he doesn't know where to begin, and requests Theodore's help in making the list. Which of the following represents the most helpful suggestions by Theodore to help Marvin make the list? A) When we think of a client's property, plant and equipment accounts, we are thinking of large, fixed assets. You should mention in your list that people might attempt to change the titles and deeds to these fixed assets to their own names as a fraud scheme. B) One thing you could consider mentioning on the list is checking entries related to repairs and maintenance expense associated with the client's fixed assets. I seem to remember my auditing professor in college saying this was an area that could fairly easily be manipulated. C) I would suggest adding to the list that the audit team should consider physical inspection of the client's fixed assets. This is because in many cases, the client's fixed assets are decentralized, and thus it would be easy for the client to overstate assets by claiming to own assets that didn't actually exist. D) None of these answer choices are correct. Answer: B Explanation: One thing you could consider mentioning on the list is checking entries related to repairs and maintenance expense associated with the client's fixed assets. I seem to remember my auditing professor in college saying this was an area that could fairly easily be manipulated. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

84) List three substantive tests of details of transactions that can be performed over Plant, Property, and Equipment (PP&E), and identify the relevant assertion for each test. Answer: Tests of Details of Transactions Relevant Assertion 1) Vouch plant asset additions to supporting documentation. Existence, Valuation 2) Vouch plant asset disposals to supporting documentation. Existence, Valuation 3) Vouch a sample of larger entries to repairs and maintenance expense. Completeness, Valuation 4) Vouch the recording of new capital lease and operating leases to underlying contracts. Existence, Completeness, Valuation 5) Evaluate the fair presentation of depreciation expense by evaluating the appropriateness of useful lives and estimated salvage values. Valuation and allocation Diff: 3 LO: 1 Bloom: Synthesis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 85) Artwork Gallery has current year total assets of $1,000,000 and prior year total assets of $800,000. Artwork Gallery has current year debt of $600,000, compared to $400,000 prior year. The industry debt to assets ratio is approximately 35%. Calculate the debt to assets ratio for the current year and prior year and explain the significance for the Artwork Gallery audit. Answer: Current year debt to assets = $600,000 / $1,000,000 = 60% Prior year debt to assets = $400,000 / $800,000 = 50% Debt to assets provides a reasonableness of the entity's proportion of debt that may be compared with prior years' experience or industry data. In this case, the debt to assets ratio is higher than the industry average of 35% and increased over the prior year. The auditors would need to investigate the reason for the increase to determine if there is a potential misstatement. Diff: 3 LO: 2 Bloom: Evaluation Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None

86) Explain how the audit strategy for financing activities would differ for a public company vs. a small private company with a limited number of debt and equity transactions. Answer: Audit strategy is often determined by the nature of the entity and the complexity of the entity's transactions. If the entity is a public company, the auditor will test controls and follow a lower assessed level of control risk approach. If the entity is not a public company, and debt and equity transactions are limited in number and straight forward, the auditor will often follow a primarily substantive approach after understanding the controls that the entity has placed in operation. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Communication AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 87) Jemma and Marcus have been assigned to the audit team which has been tasked with auditing the financing activities of one of the firm's major attestation clients. Jemma has only recently joined the firm after graduating from college, and asks Marcus to explain what they are likely to see as they audit this area. Which of the following represents Marcus' best response to this question? A) We are likely to see very similar items and characteristics that we noted before when we audited the client's current asset accounts. It tends to follow that all asset accounts follow a fairly similar auditing pattern. B) We are likely to see a large volume of transactions that pertain to asset acquisitions, disposals and retirements. The amounts of these transactions are typically very high, which carries a much higher audit and inherent risk. This is why we spend so much time in this area. C) We will focus on auditing any debt and equity accounts the client has. These accounts are associated with raising capital to help fund asset purchases etc. We typically see less transactions in these accounts, but higher balances in the accounts themselves. D) What we often see when we audit a client's financing activities is debt and equity transactions associated with the purchase of fixed assets. In many cases, clients will repurchase stock in order to raise capital to pay for large asset acquisitions. Answer: C Explanation: We will focus on auditing any debt and equity accounts the client has. These accounts are associated with raising capital to help fund asset purchases etc. We typically see less transactions in these accounts, but higher balances in the accounts themselves. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

88) As Jameson CPAs prepare to begin the current year audit of one of their long-time attestation clients, senior management apprise the auditors that in the past year, they have conducted a large secondary stock offering to raise capital for planned future expansion. As a result of this notification, which of the following is accurate with respect to the auditor's strategy? A) The auditors should pay close attention to the details of this secondary stock offering, and make note of key details. Full details of the offering should be furnished to the auditors, for inclusion in the permanent audit file. B) The auditors should consider how the amended capital structure of the client affects audit risk and inherent risk. The audit team should carefully study key details associated with the secondary offering and make a determination as to what other areas of the client's business this may affect. C) The auditors should consider performing increased substantive procedures on all of the client's debt and equity accounts as a result of this notification. This will help the auditors offer increased assurance that no misstatements are present in the clients' accounts. D) None of these answer choices are correct. Answer: B Explanation: The auditors should consider how the amended capital structure of the client affects audit risk and inherent risk. The audit team should carefully study key details associated with the secondary offering and make a determination as to what other areas of the client's business this may affect. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

89) Satvinder and Janiya have been assigned to the audit team responsible for auditing a major attestation client's financing activities. Janiya has performed audits in this area in the past; whereas this is Satvinder's first audit. Satvinder asks Janiya how they will go about checking the details of a new bond issue that the client conducted in the past year. Which of the following represents Janiya's most appropriate response to this question? A) What we typically do in these situations is request written assurances from senior management pertaining to the bond issue. We can use these written assurances to help indemnify the firm if any lawsuit is filed in the future. B) The easiest and most efficient way to audit this area is to contact the bondholders via positive confirmations, and request that each bondholder confirm the current balance owed on their bond. This will provide us with assurance that no irregularities or discrepancies exist. C) One of the first things we'll typically do is research the minutes of the board of directors' meetings. The reason we do this is to determine if appropriate authorizations were received from the client's board of directors to issue these bonds. D) In my experience, the easiest and most efficient way to audit this new bond issuance is to examine the associated interest and dividend accounts. If the bonds were never actually issued, then there will be no changes in these accounts. Answer: C Explanation: One of the first things we'll typically do is research the minutes of the board of directors' meetings. The reason we do this is to determine if appropriate authorizations were received from the client's board of directors to issue these bonds. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

90) During the audit of the financing cycle and activities for Luther Corporation, the audit team has determined that the client has taken out a number of large loans with different creditors around the same time. Senior management has advised the auditors that the infusion of new capital is to help the firm branch out into a new market abroad. As a result of this finding, which of the following statements is true with respect to inherent risk associated with financing activities? A) Inherent risk associated with financing activities has remained unchanged, and should not be increased by the auditor. If the auditing firm is concerned with the extra debt the client has taken on, then it should consider assessing control risk as higher. B) Inherent risk associated with financing activities is likely to have decreased. The reason for this decrease is because the audit client is using several different creditors for loans, which has helped to diversify this risk. C) Inherent risk associated with financing activities is likely to increase, as assessed by the auditing firm. The reason for this increase is because the client has taken on considerable amounts of new debt, which increases the risk of default. D) None of these answer choices are correct. Answer: C Explanation: Inherent risk associated with financing activities is likely to increase, as assessed by the auditing firm. The reason for this increase is because the client has taken on considerable amounts of new debt, which increases the risk of default. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

91) During the audit of the financing cycle and activities of McKinley Corporation, a provider of luxury jewelry in niche markets across the United States, the auditors, Jones CPAs, have noted that demand is decreasing. The auditors have attributed this decrease to a wider recession which is decreasing demand for luxury products. The auditors have also noted that McKinley Corporation also has large amounts of debt. Which of the following correctly encapsulates the concerns that the auditor may have in this scenario? A) The auditor is likely to be concerned that if demand continues to decrease for the client's products, future audits will have to be scaled back, which will result in a loss of revenue for the auditing firm. B) The auditing firm is likely to be concerned about McKinley Corporations' future ability to successfully service its debt payments. As demand decreases, McKinley's risk of default on its debt is likely to decrease. C) The auditors are likely to be concerned that if the recession continues, all firms in this industry will suffer from decreased demand. This will make it hard for the auditors to calculate benchmark metrics for the industry to compare the client to. D) The auditor's main concern in this scenario is likely to be that as demand for the client's goods decreases, key officers and executives may decide to leave. If this happens, the resultant management and experience gap may exacerbate McKinley's problems further. Answer: B Explanation: The auditing firm is likely to be concerned about McKinley Corporations' future ability to successfully service its debt payments. As demand decreases, McKinley's risk of default on its debt is likely to decrease. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

92) During the audit of the financing activities for Dalton Corporation, the external auditors are attempting to determine whether the client is paying installment payments owed to a creditor for a recent loan the client obtained. The audit team working on this are attempting to determine the best way to check this, and have approached you, the audit partner with overall responsibility for the engagement, for advice. Which of the following represents the most prudent suggestion to help the audit team check this? A) I would recommend obtaining written assurances from senior management pertaining to the currency of payments related to the loan. Once we obtain this assurance, we can use it for assurance in this area. B) The team may want to consider examining the minutes of prior board of directors meetings to ensure the appropriate authorizations were in place for the loan, and that the board of directors subsequently approved the amortization schedule for the loan. C) I would recommend examining the clients' cash disbursements journals to vouch the payments of the loan are occurring in a timely manner. You can also audit repayment of principal on loans by examining canceled checks and vouchers. D) None of these answer choices are correct. Answer: C Explanation: I would recommend examining the clients' cash disbursements journals to vouch the payments of the loan are occurring in a timely manner. You can also audit repayment of principal on loans by examining canceled checks and vouchers. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

93) During the audit of the financing activities and cycle of Newcombe Enterprises, Inc. one of the audit staff associates working on the audit has brought to attention a large debit entry in the client's stockholder's equity accounts. The same staff associate has also noted that around the same time as this journal entry was input into the system, there was a large cash disbursement. Which of the following scenarios is most likely to explain these occurrences? A) This scenario most likely involves a secondary offering of stock by the client. This would explain the journal entries and occurrences noted by the audit staff associate. B) This scenario is most likely to do with some of the client's stockholders possessing convertible stock. The entries are most likely to do with some of the stockholder's converting their stock to bonds. C) This scenario is most likely to do with the client repurchasing shares of its own outstanding stock. This would explain the entries and occurrences the audit staff associate noted. D) The entries that the staff associate uncovered are likely to do with callable stock and bonds which the client had previously issued. These journal entries describe a scenario whereby the client has called some its stocks and/or bonds. Answer: C Explanation: This scenario is most likely to do with the client repurchasing shares of its own outstanding stock. This would explain the entries and occurrences the audit staff associate noted. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

94) During the audit of Topsail Corporation, a large firm and manufacturer of luxury sailing boats throughout the United States and Canada, the audit team working on the audit of the client's financing cycle and activities has noted that a number of new executives have been hired since last year's audit, with a significant portion of their compensation being stock options. As a result of this finding, which strategy might the auditors choose to adopt? A) The auditors might decide to perform increased substantive testing on the client's stockholder's equity accounts; specifically examining equity and contra-equity accounts such as treasury stock for evidence of executives exercising options. B) The auditors may decide to audit financial statement disclosures relating to the stock option plans offered to the new executives to ensure that the firm is being fully transparent to its stockholders with respect to the stock option plans. C) The auditors may decide to investigate the par and market values of the client's stock to ascertain if any unexplained changes have occurred. Such discrepancies might point to fraud with respect to stock option plans. D) None of these answer choices are correct. Answer: B Explanation: The auditors may decide to audit financial statement disclosures relating to the stock option plans offered to the new executives to ensure that the firm is being fully transparent to its stockholders with respect to the stock option plans. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

95) Jeremy and his supervisor, Clara, are working on the audit of Maxim Industries, Inc. a large corporation and nationwide provider of industrial piping for building contractors. As the pair are about to begin the audit of the client's financing cycle and activities, Jeremy asks Clara to elaborate on why they need to spend time gaining an understanding of the client and its industry when the CPA firm has performed prior audits for the client. Which of the following is the most appropriate response by Clara to this question? A) The main reason that we like to spend time gaining an understanding of the client before starting the audit of the client's financing activities is because this helps us to decrease inherent risk associated with this area, and also helps to add more billable hours to the audit. B) The reason that we like to spend some time understanding more about the client and its industry is because the client's need for external financing may have changed since the last audit. C) The reason that we investigate more about the client's industry is because opportunities may have arisen since last year for the client to acquire competitors. If the client is able to do this, we will be able to increase the size of future audits. D) The reason we typically like to investigate the client and the industry in which the client operates is to gain a better understanding of typical financing activities and cycles in this industry and determine where the client may be able to refinance long-term debt and equity offerings. Answer: B Explanation: The reason that we like to spend some time understanding more about the client and its industry is because the client's need for external financing may have changed since the last audit. We may need to make recommendations to the client's senior management pertaining to adjusting levels of external financing. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

96) During the audit of Raintree Corporation, the auditors, Neall CPAs are working on the audit of the client's financing activities. The audit manager in charge of this part of the audit has tasked you with auditing the presentation and disclosure assertion. Which of the following procedures would be most appropriate in order to effectively audit this area? A) You should consider by examining the corporations charter to determine the number of shares authorized, issued, and outstanding. This can then be vouched back to subsequent dividend payments. B) You should consider reviewing the notes to the financial statements for relevant disclosures in this area, as well as examining the minutes of board of directors meetings to ascertain if any stock is restricted for any reason. C) You should consider meeting with the client's internal audit function. The head of this function should provide written details and assurances pertaining to the accurate presentation and disclosure of all financing related items. D) None of these answer choices are correct. Answer: B Explanation: You should consider reviewing the notes to the financial statements for relevant disclosures in this area, as well as examining the minutes of board of directors meetings to ascertain if any stock is restricted for any reason. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 97) In the ________ assertion, inherent risk is often high because assets are usually pledged as collateral for underlying debt. A) rights and obligations B) valuation and allocation C) completeness D) existence Answer: A Explanation: In the rights and obligations assertion, inherent risk is often high because assets are usually pledged as collateral for underlying debt. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

98) While ________, transactions are executed in accordance with board of director's authorizations and treasury stock certificates are physically safeguarded. A) redeeming and reacquiring bonds and capital stock B) authorizing bonds and capital stock C) issuing bonds and capital stock D) paying bond interest and cash dividends Answer: A Explanation: While redeeming and reacquiring bonds and capital stock financing function, transactions are executed in accordance with board of director's authorizations and treasury stock certificates are physically safeguarded. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

Auditing, 2e (Johnson) Chapter 15 Completing the Audit 1) The Financial Accounting Standards Board (FASB) defines a loss contingency as an existing condition or situation involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur. Answer: TRUE Explanation: FASB defines a loss contingency as an existing condition or situation involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None 2) If, in addition to external legal counsel, the client also has in-house legal counsel responsible for litigation, claims, and assessments, a legal letter would NOT be sent to the in-house legal counsel. Answer: FALSE Explanation: If, in addition to external legal counsel, the client also has in-house legal counsel responsible for litigation, claims, and assessments, a legal letter would be sent to both legal counsels. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 3) The likelihood of loss contingencies is considered reasonably possible when the future event is likely to occur. Answer: FALSE Explanation: The likelihood of loss contingencies is considered probable when the future event is likely to occur. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

4) For public companies, the SEC (Securities and Exchange Commission) has strict deadlines for the filing of Form 10-K, which is the document that contains the company's audited annual financial statements. Answer: TRUE Explanation: For public companies, the SEC has strict deadlines for the filing of Form 10-K, which is the document that contains the company's audited annual financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 5) An example of a Type II subsequent event would be the bankruptcy of a client's customer after year-end as a result of poor financial condition that existed as of the balance sheet date. Answer: FALSE Explanation: An example of a Type I subsequent event would be the bankruptcy of a client's customer after year-end as a result of poor financial condition that existed as of the balance sheet date. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 6) A Type I subsequent event requires an adjustment to the financial statements. Answer: TRUE Explanation: A Type I subsequent event requires an adjustment to the financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 7) Analytical procedures may include ratio analysis, trend analysis, and other procedures. Answer: TRUE Explanation: Analytical procedures may include ratio analysis, trend analysis, and other analytical procedures. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None 2

8) At the conclusion of the audit, auditors revisit the materiality level determined at the beginning of the audit to ensure it is still appropriate based on the results of audit procedures. Answer: TRUE Explanation: At the conclusion of the audit, auditors revisit the materiality level determined at the beginning of the audit to ensure it is still appropriate based on the results of audit procedures. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 9) As the audit is being performed, the engagement partner should conduct timely reviews of work completed on accounts, transactions, or disclosures that require extensive judgment or involve significant risks. Answer: TRUE Explanation: As the audit is being performed, the engagement partner should conduct timely reviews of work completed on accounts, transactions, or disclosures that require extensive judgment or involve significant risks. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 10) Analytical procedures during risk assessment may identify negative trends such as working capital deficiencies, adverse key financial ratios, and decreasing cash flow from operations. Answer: TRUE Explanation: Analytical procedures during risk assessment may identify negative trends such as working capital deficiencies, adverse key financial ratios, and decreasing cash flow from operations. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

11) If auditors determine there is substantial doubt about the entity continuing as a going concern, the next step is to obtain information about management's plans to mitigate or minimize the adverse effects of the situation. Answer: TRUE Explanation: If auditors determine there is substantial doubt about the entity continuing as a going concern, the next step is to obtain information about management's plans to mitigate or minimize the adverse effects of the situation. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 12) A legal representation is a written statement by management provided to the auditor to confirm certain matters or to support other audit evidence. Answer: FALSE Explanation: A written representation is a written statement by management provided to the auditor to confirm certain matters or to support other audit evidence. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 13) AS 1301 specifies that only critical accounting policies and practices must be communicated to the audit committee. Answer: FALSE Explanation: AS 1301 specifies that critical accounting policies and practices, and critical accounting estimates must be communicated to the audit committee. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

14) Estimating the amount of a loss contingency from a material litigation situation is not a critical accounting estimate. Answer: FALSE Explanation: Estimating the amount of a loss contingency from a material litigation situation is a critical accounting estimate. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 15) The Financial Accounting Standards Board (FASB) defines a loss contingency as ________. A) an existing condition or situation involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur B) an existing condition or situation involving certainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur C) an existing condition or situation involving uncertainty as to possible loss that will ultimately be resolved when one or more future events fail to occur D) an existing condition or situation involving uncertainty as to possible gain that will ultimately be resolved when one or more future events occur or fail to occur Answer: A Explanation: A loss contingency is an existing condition or situation involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 16) FASB ASC Topic 450, Contingencies, provides accounting guidance for ________. A) the accounting treatment for intangible assets B) depreciable methods for property, plant and equipment C) events, or potential events, that create uncertainty for a company D) business combinations Answer: C Explanation: FASB ASC Topic 450, Contingencies, provides accounting guidance for events, or potential events, that create uncertainty for a company. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 5

17) An example of a loss contingency includes ________. A) guarantees of debt of others B) collection of accounts receivable C) payment of accounts payable D) repurchasing outstanding shares Answer: A Explanation: An example of a loss contingency includes guarantees of debt of others. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 18) A legal letter refers to a letter ________. A) of inquiry sent to the client's legal counsel B) of inquiry sent to the prior auditor C) sent to the Securities and Exchange Commission to advise of questionable accounting practices D) sent to the client's internal audit function, questioning certain legal practices employed by the client Answer: A Explanation: A legal letter refers to a letter of inquiry sent to the client's legal counsel. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 19) Attorneys and their clients have a ________. A) confidential relationship B) fiduciary relationship C) privileged relationship D) legal relationship Answer: C Explanation: Attorneys and their clients have a privileged relationship. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

20) Large publicly traded companies are under great scrutiny ________. A) from the SEC only B) from both the public and the SEC C) from the public only D) from the internal audit function Answer: B Explanation: Large publicly traded companies are under great scrutiny from both the public and the SEC. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 21) Which of the following is NOT an example of a loss contingency? A) Payment of income taxes B) Income tax disputes C) Guarantees of debt of others D) Threat of expropriation of assets Answer: A Explanation: Payment of income taxes is not an example of a loss contingency, but simply a payment of taxes. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 22) Determining the likelihood of a loss contingency occurring and trying to estimate a reasonable amount for a future loss ________. A) should be determined solely by the client's legal counsel B) should be determined solely by the external auditor C) should be determined solely by the internal auditor D) involves significant judgment by management Answer: D Explanation: Determining the likelihood of a loss contingency occurring and trying to estimate a reasonable amount for a future loss involves significant judgment by management. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

23) Auditors should carefully consider which of the following assertions for loss contingencies? A) Existence B) Presentation and disclosure C) Completeness D) Rights and obligations Answer: C Explanation: Auditors should carefully consider the completeness assertion for loss contingencies. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 24) If management determines the loss contingency is probable and an amount can be reasonably estimated, then the company ________. A) must record a liability and a related expense or loss, and disclose the relevant details of the event in the notes to the financial statements B) must record an asset and a related expense or loss, and disclose the relevant details of the event in the notes to the financial statements C) must record a liability and a related depreciation expense or loss, and disclose the relevant details of the event in the notes to the financial statements D) should include a note in the notes to the financial statements but need not record an entry in accounting journals Answer: A Explanation: If management determines the loss contingency is probable and an amount can be reasonably estimated, then the company must record a liability and a related expense or loss, and disclose the relevant details of the event in the notes to the financial statements. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

25) If a loss contingency is reasonably possible or the amount cannot be reasonably estimated, ________. A) disclosure should occur in both the financial statements and the notes to the financial statements B) disclosure should occur in the financial statements only C) only a disclosure in the notes is required D) then no disclosure is required Answer: C Explanation: If the loss contingency is reasonably possible or the amount cannot be reasonably estimated, then only a disclosure in the notes is required. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 26) What is loss contingency? A) An existing condition or situation involving uncertainty to possible loss that will ultimately be resolved when one or more future events occur or fail to occur. B) An opinion expressed by the auditor when the auditor concludes that the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework. C) Lack of confidence in the audit process that intended users place in the financial statements. D) A statement in the auditor's report that is required by generally accepted auditing standards. Answer: A Explanation: A loss contingency is an existing condition or situation involving uncertainty to possible loss that will ultimately be resolved when one or more future events occur or fail to occur. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

27) Attorneys and their clients have a ________, which means attorneys cannot talk about their client's cases to anyone without permission from the client. A) privileged relationship B) no permission agreement C) confidential rapport D) legal right Answer: A Explanation: Attorneys and their clients have a privileged relationship. That means attorneys cannot talk about their client's cases to anyone without permission from the client. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 28) Which of the following defines a legal letter? A) An audit inquiry sent to a client's external and in-house legal counsel to obtain information about litigation, assessments, and claims. B) A letter comprising the auditor's report that is required by generally accepted auditing standards or is included at the auditor's discretion. C) A statement in which a CPA orders inquiry and analytical procedures to provide limited assurance that no material modifications should be made to the financial statements. D) An engagement in which a CPA applies accounting and financial expertise to assist management in the presentation of financial statements. Answer: A Explanation: A legal letter is an audit inquiry sent to a client's external and in-house legal counsel to obtain information about litigation, assessments, and claims. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

29) FASB ASC Topic 450, Contingencies provides auditors and other practitioners with guidance for events that a firm (company) may experience which create financial uncertainty for a firm. Which of the following most accurately describes a loss contingency? A) A loss contingency is best defined as a loss that a firm experiences, which is then contingent upon future losses. B) A loss contingency is a situation where a firm may be the defendant or plaintiff in a future lawsuit, but the suit is yet to be filed by either party. C) A loss contingency involves a situation of uncertainty that is typically resolved when one or more future events occur or fail to occur. D) A loss contingency involves the accounting procedures required when a firm hires external legal counsel and pays a retainer fee. Answer: C Explanation: A loss contingency involves a situation of uncertainty that is typically resolved when one or more future events occur or fail to occur. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 30) In order for a loss contingency to be recognized in a firm's financial statements, certain requirements as defined by the FASB must be met. Which of the following most accurately describes these requirements? A) The amount of the loss must be known beforehand by the firm (company), in order to list a dollar amount in the balance sheet. B) The likelihood of the loss occurring should be considered reasonably possible, and firm management should be able to estimate the amount. C) The amount of the contingent loss should be able to be estimated by management, and the likelihood of the event occurring should be considered probable. D) None of these answer choices are correct. Answer: C Explanation: The amount of the contingent loss should be able to be estimated by management, and the likelihood of the event occurring should be considered probable. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

31) During the audit of Newglow Company, the auditors, Chatmon CPAs have been apprised by management of a loss contingency that has been disclosed in the financial statements. Which of the following best describes the auditor's responsibilities upon receipt of this notification? A) The auditors should examine the client's financial statements to ensure that the information divulged by management is correctly reported and classified. B) The auditors should seek written assurances and representations from management to indemnify the audit firm from the lawsuit. C) The auditors should ensure that the associated liabilities are recorded accurately, and that management's assessments and disclosures are complete. D) None of these answer choices are correct. Answer: C Explanation: The auditors should ensure that the associated liabilities are recorded accurately, and that management's assessments and disclosures are complete. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 32) During the audit of Smithfield Corporation, the auditors, Deerfield CPAs are preparing to draft and send a legal letter as part of the audit process. Which of the following most accurately describes the purpose and recipient of the letter? A) The auditors typically send the legal letter to the client's internal audit function, who then return the letter with all pertinent details of pending lawsuits. B) The auditors generally send the legal letter to the client's in-house and/or external counsel, to obtain information about litigation affecting the client. C) The auditors often send the legal letter to the client's management, who then forward the letter on to the appropriate counsel. D) Because the client and the client's counsel have a privileged relationship, the auditor is not allowed to request details of pending cases, only litigated cases. Answer: B Explanation: The auditors generally send the legal letter to the client's in-house and/or external counsel, to obtain information about litigation affecting the client. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

33) Two audit staff associates are discussing subsequent events one day at a client's location. The pair is examining drafts of the client's financial statements. Which of the following is accurate with respect to the financial statements? A) Auditing clients typically prepare financial statements as of the last day of their fiscal year end. B) Auditing clients typically prepare financial statements with the effects of next period's accruals and deferrals included. C) Auditing clients typically prepare interim financial statements at the beginning of the 4th quarter which is what the auditors use for the attest engagement. D) None of these answer choices are correct. Answer: A Explanation: Auditing clients typically prepare financial statements as of the last day of their fiscal year end. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 34) Phil and Jennifer are working on the audit of Smith Enterprises and are discussing subsequent events. Phil asks Jennifer to elaborate on the meaning of this term as he hasn't heard about it since college. Which of the following represents Jennifer's most appropriate response to this request? A) Subsequent events can be best thought of as events that occur after the audit report has been issued, which will need to be examined during next year's audit. B) Subsequent events are defined as events that occur after the client's fiscal year-end, and always require inclusion in the financial statements. C) A type II subsequent event occurs after the client's financial statement date, and usually causes the auditor to issue a qualified opinion on the area related to the subsequent event. D) Subsequent events refer to events that occur between the date of the financial statements and the date of the audit report. Answer: D Explanation: Subsequent events refer to events that occur between the date of the financial statements and the date of the audit report. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

35) Stephen, an audit partner assigned to the audit of Rayglow Corporation is discussing subsequent events with an audit staff associate, Kendra. Kendra proceeds to ask Stephen how the audit firm would evaluate subsequent events that may require disclosure by the client. Which of the following is Stephen's best response to this? A) We typically rely on management to apprise us of any subsequent events. If we are not apprised of any, we can assume none have occurred. B) The firm typically performs procedures to identify subsequent events such as reading the minutes of post-year-end board of directors meetings. C) The audit firm will often perform substantive procedures on the client's system of internal control to specifically search for subsequent events. D) None of these answer choices are correct. Answer: B Explanation: The firm typically performs procedures to identify subsequent events such as reading the minutes of board of directors meetings. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 36) Charlie and Keona are discussing the upcoming review of a client's subsequent events by their firm one day over lunch. Charlie, a recent hire, asks Keona to explain how this is typically handled by the audit firm. Which of the following is the most appropriate response to this question by Keona? A) Our firm generally requests an official written document from senior management containing assurances that no subsequent events have occurred. B) We typically perform substantive and analytical procedures on all the client's accounts as part of the audit, thus if any subsequent events existed, we would already be aware of them. C) The determination of how to audit and review a client's subsequent events is a subjective one. The auditor often considers what they have learned about the client during risk assessment. D) The subsequent events review is typically handled by the internal audit function. This is because the staff working in this function know the client better than we do. Answer: C Explanation: The determination of how to audit and review a client's subsequent events is a subjective one. The auditor often considers what they have learned about the client during risk assessment. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

37) The financial statements are prepared by client management ________. A) based on beginning of year financial conditions B) for formal review and issuance of an audit opinion by the internal auditors C) on the basis of conditions existing at year-end, which would be December 31 for a calendar year entity D) on the basis of conditions existing at year-end, which should always be December 31 Answer: C Explanation: Financial statements are prepared on the basis of conditions existing at year-end, which would be December 31 for a calendar year entity. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 38) Auditors should be alert to subsequent events ________. A) that may occur between the date of the financial statements and the date of the auditor's report B) that may occur between the date of the auditor's report and the next balance sheet date C) and report all immaterial findings to the Securities and Exchange Commission D) as they are particularly important to the year-end closing process Answer: A Explanation: Auditors should be alert to subsequent events that may occur between the date of the financial statements and the date of the auditor's report. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

39) Which statement defines a Type 1 subsequent event? A) An event that provides evidence of conditions that arose after the date of the financial statements B) An event that provides evidence of unreported earnings that arose after the date of the financial statements. C) An event that provides evidence of conditions that existed at the date of the financial statements. A Type I event requires an adjustment to the financial statements. D) An event that provides evidence of conditions that did not exist at the date of the financial statements. A Type I event requires an adjustment to the financial statements. Answer: C Explanation: A subsequent event is an event that provides evidence of conditions that existed at the date of the financial statements. A Type I event requires an adjustment to the financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None 40) A Type II subsequent event ________. A) provides evidence of conditions that arose after the date of the financial statements B) provides evidence of conditions that arose before the date of the financial statements C) provides evidence of conditions that arose after the date of the auditor's report D) provides evidence of conditions that arose before the date of the auditor's report Answer: A Explanation: A Type II subsequent event provides evidence of conditions that arose after the date of the financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None

41) The financial statements are prepared by client management ________. A) on the basis of conditions existing at year-end B) on the basis of conditions that existed at the beginning of the year C) on the basis of conditions existing throughout the year D) and sent to the Securities and Exchange Commission (SEC) for approval Answer: A Explanation: The financial statements are prepared by client management on the basis of conditions existing at year-end. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 42) A form 10-K refers to ________. A) A form filed with the Securities and Exchange Commission (SEC) relating to changing of senior management B) a firm's audited financial statements, filed with the SEC C) a firm only filed with the SEC by privately traded companies D) certain required income statement disclosures Answer: B Explanation: A form 10-K is the firm's audited financial statements, filed with the SEC. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 43) The most common user of a private company's financial statements ________. A) is a bank or other lender B) are regulatory agencies such as the Internal Revenue Service (IRS) C) are competing companies D) are employees of the company Answer: A Explanation: Banks or other lenders are the most common users of a private company's financial statements. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

44) A Type I subsequent event refers to ________. A) an event that occurred after the date of the financial statements B) an event that most likely occurred before the date of the financial statements C) a contingent event, that may or may not occur D) an event that is typified by debit entries to contra-revenue accounts Answer: B Explanation: A Type I subsequent event refers to an event that most likely occurred before the date of the financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 45) Type II subsequent events are those events that ________. A) likely occurred before the financial statement date B) likely occurred after the financial statement date C) are unlikely to require adjustment to the financial statements D) should be reported to the Securities and Exchange Commission (SEC) Answer: B Explanation: Type II subsequent events are those events that likely occurred after the financial statement date. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 46) A Type I subsequent event should ________. A) not require an adjustment to the financial statements B) always require an adjustment to the financial statements C) be disclosed in the notes to the financial statements only D) should be referred to management to determine disclosure requirements Answer: B Explanation: A type I event should always require an adjustment to the financial statements Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

47) Subsequent events refer to ________. A) events occurring between the date of the financial statements and the date of the auditor's report B) events occurring before the financial statement date C) events occurring after the financial statement date D) events occurring after completion of the audit and issuance of the audit report Answer: A Explanation: Subsequent events are events that occurred between the date of the financial statements and the date of the auditor's report. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 48) An example of a Type I subsequent event would be ________. A) a sudden change in senior management after the financial statement date B) a filing with the Securities and Exchange Commission (SEC) of an amended form 10K after the financial statement date C) the bankruptcy of a client's customer after year-end as a result of poor financial condition that existed as of the balance sheet date D) the bankruptcy of a client's customer after year-end as a result of poor financial condition that existed after the balance sheet date Answer: C Explanation: An example of a type I event would be the bankruptcy of a client's customer after year-end as a result of poor financial condition that existed as of the balance sheet date. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

49) Audit standards require auditors to ________. A) conduct specific audit procedures to identify subsequent events that may occur up through the date of the auditor's report B) conduct specific audit procedures to identify subsequent events that may occur after the date of the auditor's report. C) apply optional use of analytical procedures to increase assurance levels related to subsequent events D) delegate auditing of subsequent events to the internal audit function Answer: A Explanation: Audit standards require auditors to conduct specific audit procedures to identify subsequent events that may occur up through the date of the auditor's report. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 50) Specific audit procedures used to identify subsequent events include ________. A) obtaining an understanding of how management identifies subsequent events B) reading the client's subsequent interim financial statements, if available, and other data such as budgets and cash flow forecasts C) inquiring of the client's legal counsel regarding litigation, claims, and assessments D) All of these answer choices are correct. Answer: D Explanation: Specific audit procedures to identify subsequent events include obtaining an understanding of how management identifies subsequent events; reading the client's subsequent interim financial statements, if available, and other data such as budgets and cash flow forecasts; and, inquiring of the client's legal counsel regarding litigation, claims, and assessments. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

51) The nature of the specific procedures performed for the subsequent events review ________. A) will depend on the individual circumstances of each client B) should be uniform across all clients, to increase consistency C) should be agreed with management, with respect to areas to focus audit resources and effort D) will be determined and handled by the internal audit function Answer: A Explanation: The nature of the specific procedures performed for the subsequent events review will depend on the individual circumstances of each client. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 52) Define subsequent events. A) Events occurring between the date of the financial statements and the date of the auditor's report. B) Events that provide evidence of conditions that arose after the date of the auditor's report. C) Events that provide evidence of conditions that arose after the date of the financial statements. D) Events that never require an adjustment to the financial statements but may require disclosure in the notes to the financial statements. Answer: A Explanation: Subsequent events are events occurring between the date of the financial statements and the date of the auditor's report. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

53) What is Type I subsequent event? A) An event that provides evidence of conditions that existed at the date of the financial statements. B) An event occurring between the date of the financial statements and the date of the auditor's report. C) An event that provides evidence of conditions that arose after the date of the financial statements. D) An event that does not require an adjustment to the financial statements but may require disclosure in the notes to the financial statements. Answer: A Explanation: A Type I subsequent event is an event that provides evidence of conditions that existed at the date of the financial statements and requires an adjustment to the financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 54) Type II subsequent events provide evidence of conditions that arose ________. A) after the date of the financial statements B) between the date of the financial statements and the date of the auditor's report C) at the date of the financial statements D) none of the above are correct Answer: A Explanation: Type II subsequent events provide evidence of conditions that arose after the date of the financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

55) Final analytical procedures are intended ________. A) to corroborate audit evidence obtained during the audit only B) to corroborate audit evidence obtained during the audit, and to confirm the financial statements are consistent with the auditor's revised expectations based on evidence evaluated during the audit C) to refute audit evidence obtained during the audit, and to confirm the financial statements are consistent with the auditor's revised expectations based on evidence evaluated during the audit D) to corroborate audit evidence obtained during the audit, and to confirm the financial statements are inconsistent with the auditor's revised expectations based on evidence evaluated during the audit Answer: B Explanation: Final analytical procedures are intended to corroborate audit evidence obtained during the audit, and to confirm the financial statements are consistent with the auditor's revised expectations based on evidence evaluated during the audit. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None 56) An engagement quality control reviewer ________. A) will review selected areas of working papers prior to the issuance of the audit report B) will review all areas of working papers prior to the issuance of the audit report C) is typically a person with minimal audit expertise and experience D) should be appointed by the client Answer: A Explanation: An engagement quality control reviewer will review selected areas of working papers prior to the issuance of the audit report. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None

57) During the risk response phase, ________. A) all analytical procedures have been conducted B) analytical procedures can be used, but are not required, as a substantive test to gather audit evidence C) analytical procedures are required, as a substantive test to gather audit evidence D) the auditor should begin testing internal control Answer: B Explanation: During the risk response phase, analytical procedures can be used, but are not required, as a substantive test to gather audit evidence. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 58) The actual analytical procedures performed at the end of an audit ________. A) should always be the same for every client in order to increase uniformity of audits B) will depend on senior management's preferences C) will depend on auditor judgment and may vary by client D) will depend on auditor judgment but should be the same for each client Answer: C Explanation: The actual analytical procedures performed at the end of the audit will depend on auditor judgment and may vary by client. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 59) At the conclusion of the audit, ________. A) auditors typically revaluate materiality decisions made during the audit to ensure it is still appropriate based on the results of audit procedures B) auditors typically attempt to contact the prior auditor C) auditors may attempt to contact the client's legal counsel D) auditors ask management for recommendations on any needed adjustments to the accounts Answer: A Explanation: At the conclusion of the audit, auditors revisit the materiality level determined at the beginning of the audit in order to ensure it is still appropriate based on the results of audit procedures. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 24

60) When the results of substantive procedures identify misstatements, ________. A) the auditors refer the misstatements to the prior auditor for correction B) auditors consider whether the misstatements may be indicative of the need to re-evaluate inherent risk, control risk or fraud risk C) auditors consider whether the misstatements may be indicative of the need to re-evaluate inherent risk only D) auditors consider whether the misstatements may be indicative of the need to re-evaluate control risk only Answer: B Explanation: When the results of substantive procedures identify misstatements, auditors consider whether the misstatements may be indicative of the need to re-evaluate inherent risk, control risk or fraud risk. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 61) If controls are weak, ________. A) auditors will perform less substantive testing as a result B) auditors will increase the control risk assessment and perform additional substantive tests to detect material misstatements C) auditors will decrease the control risk assessment and perform additional substantive tests to detect material misstatements D) auditors will increase the control risk assessment and perform fewer substantive tests to detect material misstatements Answer: B Explanation: If controls are weak, auditors will increase the control risk assessment and perform additional substantive tests to detect material misstatements. Diff: 1 LO: 3 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

62) When fraud is discovered, ________. A) auditors should immediately contact the Securities and Exchange Commission (SEC) B) auditors should determine the amounts involved, and then decide whether to report the fraud to management C) auditors gather sufficient appropriate evidence to support their conclusion D) the matter should immediately be referred to the internal audit function Answer: C Explanation: When fraud is discovered, auditors gather sufficient appropriate evidence to support their conclusion. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 63) Auditors report fraud ________. A) to the Securities and Exchange Commission (SEC) within 72 hours B) to a level of management at least one level above the level where the fraud occurred C) directly to the manager that is suspected of involvement in the fraud D) to the level below where the auditor suspects the fraud is occurring Answer: B Explanation: Auditors report fraud to a level of management at least one level above the level where the fraud occurred. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

64) If the auditors withdraw from an engagement, ________. A) they will inform the appropriate level of management or those charged with governance and provide reasons for the withdrawal B) they will inform the appropriate level of management only and will provide reasons for the withdrawal C) the auditor should immediately cease communication with the client, and refer them to another auditor D) they are not entitled to receive compensation for services performed Answer: A Explanation: If the auditors withdraw, they will inform the appropriate level of management or those charged with governance and provide reasons for the withdrawal. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 65) A form 8-K is used ________. A) to file a company's audited financial statements B) for management to report a change of auditors, and the reason for the change C) for management to report a change of internal auditors, and the reason for the change D) to disclose fraudulent transactions that have occurred within a company to the Securities and Exchange Commission (SEC) Answer: B Explanation: A form 8-K is used for management to report significant events to investors and the SEC. These events include a change of auditors, and the reason for the change. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

66) When evaluating the effect of uncorrected misstatements, ________. A) only quantitative factors are considered B) only qualitative factors are considered C) both quantitative and qualitative factors are considered D) neither quantitative and qualitative factors are considered Answer: C Explanation: When evaluating the effect of uncorrected misstatements, both quantitative and qualitative factors are considered. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 67) The individual responsible for the audit engagement, its performance, and for the auditor's report that is issued on behalf the firm is ________. A) the senior audit manager B) the audit partner C) the Chief Executive Officer (CEO) of the client firm D) the Chief Financial Officer (CFO) of the client firm Answer: B Explanation: The engagement partner is responsible for the audit engagement, its performance, and for the auditor's report that is issued on behalf of the firm. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 68) An engagement quality control reviewer ________. A) will review selected areas of working papers prior to the issuance of the audit report B) will review all areas of working papers prior to the issuance of the audit report C) should be impartial and chosen by the client's senior management D) should be chosen from a different audit firm Answer: A Explanation: An engagement quality control reviewer will review selected areas of working papers prior to the issuance of the audit report. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

69) Who considers whether work has been performed in accordance with appropriate audit standards? A) Working paper reviewer B) Engagement partner C) Quality control reviewer D) Audit partner Answer: A Explanation: It is the job of a working paper reviewer to consider whether work has been performed in accordance with appropriate audit standards. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 70) ________ are used near the end of the audit to assist the auditor in forming an overall conclusion about whether the financial statements are consistent with the auditor's understanding of the entity. A) Analytical procedures B) Engagement procedures C) Quality control procedures D) Audit standards Answer: A Explanation: Analytical procedures are used near the end of the audit to assist the auditor in forming an overall conclusion about whether the financial statements are consistent with the auditor's understanding of the entity. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

71) At the end of the audit, which of the following is NOT reevaluated by the auditors? A) Misstatements found during the audit B) Materiality decisions made during the audit C) Inherent risk based on audit findings D) Fraud risk based on audit findings Answer: A Explanation: At the end of the audit, auditors revaluate materiality decisions, inherent risk, control risk, and fraud risk based on audit findings. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 72) As the audit of Barrow Enterprises draws to its conclusion, one of the audit staff associates, Carrie asks her supervisor Dave why the firm is preparing to perform further analytical procedures. Which of the following responses by Dave is most appropriate to answer this question? A) We perform final analytical procedures at the end of the audit to confirm our findings throughout the audit. B) The firm performs analytical procedures at the end of the audit to help indemnify the auditors against future litigation involving the client. C) We are required to perform analytical procedures at conclusion of the audit per generally accepted auditing standards. This requirement applies to all public and private companies. D) None of these answer choices are correct. Answer: A Explanation: We perform final analytical procedures at the end of the audit to confirm our findings throughout the audit. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

73) Charlene and Jason are completing their audit of Newsome Enterprises, LLC. Charlene mentions to Jason that he should evaluate materiality again as the audit is now pretty much complete. What should Jason do at this juncture with respect to materiality? A) Jason should examine beginning materiality and make the adjustments necessary to ensure the auditors are still under this materiality threshold. B) Jason should request management confirm and agree that the beginning materiality as set by the audit firm is still appropriate. C) Jason should reexamine materiality determined at the beginning of the audit to confirm its appropriateness. D) None of these answer choices are correct. Answer: C Explanation: Jason should reexamine materiality determined at the beginning of the audit to confirm its appropriateness. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 74) During the audit of Green Corporation, the auditors have completed substantive testing and noted numerous misstatements present in the client's financial statements. Based on this finding, which of the following courses of action may the auditors decide to take? A) The auditors are likely to disclaim an opinion on the client's financial statements, in order to preserve the reputation of the firm. B) The auditors are likely to increase their levels of substantive testing to the populations of the client's accounts to increase the level of assurance they can offer. C) The auditors are likely to consider reevaluating fraud risk related to the audit, as well as inherent risk. D) Generally accepted auditing standards require the auditors to notify the client's internal audit function, so follow-up procedures can be performed at a later date. Answer: C Explanation: The auditors are likely to consider reevaluating fraud risk related to the audit, as well as inherent risk. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

75) During the audit of Summerbee Enterprises, the auditors have noted and documented a large number of misstatements. Which of the following correctly describes the auditor's responsibility with respect to the documented misstatements? A) The audit firm should gather and document all noted misstatements and present them as an addendum to the official audit report. B) The audit firm should notify management of the misstatements in a timely manner, and perform procedures to ensure the material misstatements have been corrected. C) The audit firm should notify management of all misstatements noted during the audit, and request official confirmation that all material misstatements have been corrected by the date of the audit report. D) None of these answer choices are correct. Answer: B Explanation: The auditing firm should notify management of the misstatements in a timely manner, and perform procedures to ensure the misstatements have been corrected. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 76) Melissa and Alan are working on the audit of TJ Enterprises, a distributor of clothing items in the southwestern United States. Melissa mentions to Alan that she recently heard discussion among the audit partners about TJ Enterprises' ability to remain as a going concern, and asks Alan to explain what this means. Which of the following represent Alan's best response to this question? A) The best way to think about the term 'going concern' is whether or not the company is likely to be acquired by another firm in the near future. B) The term going concern deals with the entity's ability to continue operating for the foreseeable future. C) The 'going concern' term is most frequently associated with firms who have refinanced maturing loans out of current liabilities to improve key liquidity ratios. D) None of these answer choices are correct. Answer: B Explanation: The term going concern deals with the entity's ability to continue operating for the foreseeable future. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

77) Max and Sandra have been tasked by their supervisor with auditing the going concern assumption of one of their largest audit clients. As this is the pairs first time auditing this assumption, they approach you for some suggestions on ways to audit this assumption. Which of the following represents a viable way the pair could audit this assumption? A) The pair could consider looking at key liquidity and solvency ratios as well as review minutes of board of directors meetings for any evidence that a going concern issue may be present. B) Max and Sandra could consider requesting written confirmations and assurances from senior management, to include in the current year's audit file. C) Max and Sandra should think about contacting the client's legal counsel independently of the client and requesting any and all information that would pertain to this assumption. D) None of these answer choices are correct. Answer: A Explanation: The pair could consider looking at key liquidity and solvency ratios as well as review minutes of board of directors meetings for any evidence that a going concern issue may be present. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 78) Sharon and Jan are two audit staff associates working on the audit of Parrish Enterprises, a medium size firm and supplier of concrete and other building materials across the United States and Canada. Sharon is currently working on her first audit, and asks Jan to explain where responsibility for the going concern assumption and auditing this assumption rests. Which of the following represent Jan's most appropriate response to this question? A) The responsibility for a client's going concern assumption rests with the auditor for publiclytraded firms; hence why the auditor is responsible for testing this assumption. B) The responsibility for a client's going concern assumption rests with the firm's management. The auditors are responsible for evaluating this assumption. C) The responsibility for a client's going concern assumption is the responsibility of the client's legal counsel. The client's internal audit function is responsible for testing this assumption. D) The responsibility for the client's going concern assumption rests with the external auditing firm. Senior management are responsible for approving the auditors opinion on this assumption. Answer: B Explanation: The responsibility for a client's going concern assumption rests with the firm's management. The auditors are responsible for evaluating this assumption. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

79) As the audit of Drew Corporation draws to a close, the audit firm, McKay CPAs is concerned about the client's ability to continue as a going concern. As a result of this, which of the following courses of action should the auditors take? A) The auditors should request written disclosures and assurances from senior management pertaining to the entity's ability to continue as a going concern, for inclusion in the audit file. B) The auditors should ensure that management, via appropriate disclosures in the financial statements, is transparent with its stakeholders as to this issue. C) The auditors should not request that management disclose this in the financial statements, due to the potentially negative repercussions. D) None of these answer choices are correct. Answer: B Explanation: The auditors should ensure that management, via appropriate disclosures in the financial statements, is transparent with its stakeholders as to this issue. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 80) The going concern assumption ________. A) is not the responsibility of the auditor, and should be left to management to determine B) is a fundamental principle in the preparation of the financial statements C) is the legal responsibility of the auditor D) relates to the comparability and verifiability of a firm's financial statements Answer: B Explanation: The going concern assumption is a fundamental principle in the preparation of the financial statements. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None

81) With respect to the going concern assumption, auditors also draw their own conclusions ________. A) about whether there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time B) about whether there is substantial doubt about the entity's ability to continue as a going concern for an indefinite period of time C) as to whether the client is likely to be a target for an acquisition by another company in the near future D) as to whether the client is likely to attempt to acquire another company in the near future Answer: A Explanation: With respect to the going concern assumption, auditors also draw their own conclusions about whether there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 82) If auditors determine there is substantial doubt about the entity continuing as a going concern, ________. A) the next step is to obtain information about management's plans to mitigate or minimize the adverse effects of the situation B) the next step is to obtain information about the auditor's plans to mitigate or minimize the adverse effects of the situation C) they should immediately issue an adverse opinion and withdraw from the engagement D) the auditors should immediately invoice the client for the cost of the audit and request payment within 30 days Answer: A Explanation: If auditors determine there is substantial doubt about the entity continuing as a going concern, the next step is to obtain information about management's plans to mitigate or minimize the adverse effects of the situation. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

83) The assumption that relates to the entity continuing in business for the foreseeable future is called ________. A) the entity assumption B) the going concern assumption C) the solvency assumption D) the liquidity assumption Answer: B Explanation: The assumption that relates to the entity continuing in business for the foreseeable future is called the going concern assumption. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None 84) Responsibility for evaluating the going concern assumption in accordance with the applicable financial reporting framework rests with ________. A) the auditor B) management C) the internal audit function D) the clients legal counsel Answer: B Explanation: Responsibility for evaluating the going concern assumption in accordance with the applicable financial reporting framework rests with management. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

85) If management determines there is substantial doubt about continuing as a going concern, ________. A) then management must make a note disclosure about the circumstances, including any plans management may have to mitigate the situation B) then management must make list an estimated loss contingency in the financial statements about the circumstances, including any plans management may have to mitigate the situation C) nothing should be disclosed in the notes to the financial statements until management is reasonably certain it will be an issue D) then future debt issues will likely enjoy lower interest rates Answer: A Explanation: If management determines there is substantial doubt about continuing as a going concern, then management must make a note disclosure about the circumstances, including any plans management may have to mitigate the situation. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 86) With respect to the going concern assumption, under Generally Accepted Accounting Principles (GAAP), a reasonable period of time is ________. A) considered to be 90 days B) considered to be 180 days C) one year from the date the client issues financial statements D) two years from the date the client issues financial statements Answer: C Explanation: Under GAAP, a reasonable period of time is one year from the date the client issues financial statements. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

87) Analytical procedures during risk assessment of a going concern ________. A) May identify negative trends such as working capital deficiencies, adverse key financial ratios, and decreasing cash flow from operations B) May identify positive trends such as working capital deficiencies, adverse key financial ratios, and decreasing cash flow from operations C) May identify only external matters that have occurred such as loss of a key franchise, loss of a principal customer, or work stoppages due to natural disaster D) May identify internal matters that have occurred such as legal proceedings Answer: A Explanation: Analytical procedures during risk assessment of a going concern may identify negative trends such as working capital deficiencies, adverse key financial ratios, and decreasing cash flow from operations. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 88) If auditors determine there is substantial doubt about the entity continuing as a going concern, ________. A) then the auditor should immediately notify the Securities and Exchange Commission (SEC) B) the next step is to obtain information about management's plans to mitigate or minimize the adverse effects of the situation C) the next step is to obtain information about the auditor's plans to mitigate or minimize the adverse effects of the situation D) the next step is to ensure the client is immediately billed for all services performed, to ensure payment Answer: B Explanation: If auditors determine there is substantial doubt about the entity continuing as a going concern the next step is to obtain information about management's plans to mitigate or minimize the adverse effects of the situation. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

89) After considering management's plans, if auditors determine there is substantial doubt about the entity's ability to continue as a going concern, ________. A) the auditor should consider withdrawing from the engagement B) the next steps are to consider the possible effects on the financial statements and on the auditor's report C) the next steps are to consider the possible effects on the financial statements and on the internal auditor's report D) the auditor should attempt to locate alternative lines of debt and equity capital for the client Answer: B Explanation: After considering management's plans, if auditors determine there is substantial doubt about the entity's ability to continue as a going concern, the next steps are to consider the possible effects on the financial statements and on the auditor's report. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 90) The final step for the auditor to perform with respect to doubts about an entity's ability to remain a going concern is to communicate ________. A) all relevant findings to the internal audit function B) all relevant findings to common stockholders C) with those charged with governance D) with all preferred stockholders Answer: C Explanation: The final step for the auditor to perform with respect to doubts about an entity's ability to remain a going concern is to communicate with those charged with governance. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

91) If the auditors decide to issue a modified auditor's report due to doubt about an entity's ability to continue as a going concern ________. A) the report should always be adverse B) the report should always be a disclaimer of opinion C) the matter should be communicated with those charged with governance D) the should be communicated to the client's legal counsel for disclosure to senior management Answer: C Explanation: If the auditors decide to issue a modified auditor's report due to doubt about an entity's ability to continue as a going concern, the matter should be communicated to those charged with governance. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 92) An example of a factor that mitigates doubts about an entity's ability to continue as a going concern would be ________. A) a letter of guarantee from a parent company B) the ability to raise additional funds through the issuance of more stock C) the ability to sell an unprofitable segment of the business D) All of these examples are mitigating factors Answer: D Explanation: All of these would be considered mitigating factors with respect to an auditor's concern about a client's ability to continue as a going concern. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 93) What is the going concern assumption? A) The viability of an entity to remain in business for the foreseeable future B) The period of time required by the applicable financial reporting framework C) The responsibility to perform any audit procedures D) An overall conclusion on the audit drawn by auditors Answer: A Explanation: The going concern assumption is the viability of an entity to remain in business for the foreseeable future. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 40

94) According to Generally Accepted Accounting Principles (GAAP), to meet the "goingconcern" standard an entity must be viewed as capable of staying in business for ________ after the date of the financial statements. A) a reasonable period of time B) six months C) nine months D) two years Answer: A Explanation: According to Generally Accepted Accounting Principles (GAAP), to meet the "going-concern" standard an entity must be viewed as capable of staying in business for a reasonable period of time after the date of the financial statements. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 95) Jerry and Stella are working on the audit of Packham Enterprises, which is drawing to a close. Their supervisor has mentioned to them that it will soon be time for the management representation letter associated with the audit. Which of the following statements best describes the reason for the management representation letter? A) The management representation letter is designed to ensure that the auditing firm and client management's records match in all key areas. B) The management representation letter is designed to ensure management confirms certain matters and/or supports other audit evidence. C) The management representation letter is used by the auditing firm to indemnify itself against any future litigation involving the client. D) The management representation letter is typically drafted by the auditor and approved and subsequently signed by client management. Once signed by management, the letter can substitute for other audit procedures. Answer: B Explanation: The management representation letter is designed to ensure management confirms certain matters and/or supports other audit evidence. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

96) Joey and Steve have been tasked by their supervisor to draft the management representation letter for one of their large audit clients. Joey and Steve are not sure where to begin, and ask their supervisor for advice and assistance in getting started. Which of the following represents prudent advice from the supervisor? A) All you need to do is go pull a management representation letter from another client's file, and change the personal details. The form and content of the letters are identical. B) You should consider requesting management draft and then finalize/sign the letter, and send it to you. C) You should consider consulting auditing standards for examples of management representation letters that could help you both draft one. D) None of these answer choices are correct. Answer: C Explanation: You should consider consulting auditing standards for examples of management letters that could help you both draft one. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 97) During the most recent year's audit of Pillco Corporation, the auditors have once again noted that inventory turnover is considerably slower than the industry average. Which of the following should the auditors consider doing to address this issue? A) The auditors should consider issuing a qualified opinion on the client's inventory accounts in order to draw attention to this issue. B) The auditors should consider making reference to this in the management representation letter, to ensure client management is appropriately aware of this issue. C) The auditors should consider requesting the client formulate note disclosure in the financial statements, specifically addressing this issue. D) None of these answer choices are correct. Answer: B Explanation: The auditors should consider making reference to this in the management representation letter, to ensure client management is appropriately aware of this issue. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

98) Joan and Colin are sitting in auditing class listening to the professor lecture about communications with those charged with governance as part of an attestation engagement. Which of the following statements surrounding these communications is accurate? A) The auditors typically begin the audit with a management letter which outlines the auditor's responsibilities and plan for the forthcoming audit. B) The auditors typically end the audit with a representation letter which details the results of substantive procedures the auditors have performed throughout the course of the audit. C) The auditors generally provide detailed plans relating to the nature, timing, and extent of planned audit procedures at the beginning of the audit. D) The auditors are required to communicate their responsibility for forming and expressing an opinion on the client's financial statements. Answer: D Explanation: The auditors are required to communicate their responsibility for forming and expressing an opinion on the client's financial statements. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 99) The management representation letter ________. A) can sometimes serve as a substitute for certain audit procedures that were not able to be performed B) is a letter from management to the auditor acknowledging management's responsibility for the preparation of the financial statements C) is a letter from the auditor to management acknowledging management's responsibility for the preparation of the financial statements D) should only be sent to the client's legal counsel; not directly to the client Answer: B Explanation: The management representation letter is a letter from management to the auditor acknowledging management's responsibility for the preparation of the financial statements. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

100) The written representation from management ________. A) supplements the inquiries made of management regarding subsequent events and the evidence gathered from audit procedures B) supplements the inquiries made of the auditor regarding subsequent events and the evidence gathered from audit procedures C) can be drafted by the auditor and signed by the internal audit function on behalf of management D) transfers legal liability for any financial statement errors to the auditor Answer: A Explanation: The written representation from management supplements the inquiries made of management regarding subsequent events and the evidence gathered from audit procedures. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 101) A written representation is ________. A) a written statement by management provided to the auditor to confirm certain matters or to support other audit evidence B) a written statement drafted by the internal audit function, and provided to the auditor to confirm certain matters or to support other audit evidence C) should be filed as part of court filings by the client, to confirm the details of the representing attorney D) a statement from the prior auditor, confirming there were no material misstatements found in prior audits Answer: A Explanation: A written representation is a written statement by management provided to the auditor to confirm certain matters or to support other audit evidence (AU-C 580.07). Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

102) Generally, a written representation ________. A) is sufficient evidence to issue an unmodified audit report B) complements other audit procedures that were performed and generally does not provide sufficient appropriate audit evidence on its own C) replaces other audit procedures that were performed and generally does provide sufficient appropriate audit evidence on its own D) should be drafted by the client's legal counsel and signed with the auditor Answer: B Explanation: Generally, a written representation complements other audit procedures that were performed and generally does not provide sufficient appropriate audit evidence on its own. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 103) The responses to the inquiries that auditors have made of management throughout the course of the audit ________. A) are recorded in the client's permanent file B) are confidential and not shared with senior management C) are documented in the auditor's working papers D) are sent to the prior auditor to be checked for prior year consistency Answer: C Explanation: The responses to the inquiries that auditors have made of management throughout the course of the audit are documented in the auditor's working papers. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

104) A management representation letter is a letter ________. A) that is sent from the auditor to management, and then signed off on by the client's legal counsel B) that is sent from management to the auditor, and then signed off on by the client's legal counsel C) from management to the auditor acknowledging management's responsibility for the preparation of the financial statements D) from the auditor to management acknowledging management's responsibility for the preparation of the financial statements Answer: C Explanation: A management representation letter is a letter from management to the auditor acknowledging management's responsibility for the preparation of the financial statements and details of any verbal representations made by management during the course of the audit. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 105) The management representation letter ________. A) can sometimes be used as a substitute for the gathering of audit evidence B) is not a substitute for obtaining sufficient, appropriate evidence regarding the financial statements through other audit procedures C) can replace analytical procedures conducted as part of the audit, but cannot replace the audit of internal control D) can replace the audit of internal control conducted as part of the audit, but cannot replace the analytical procedures Answer: B Explanation: The management representation letter is not a substitute for obtaining sufficient, appropriate evidence regarding the financial statements through other audit procedures. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

106) Governance structures will ________. A) typically be the same for each client B) typically be the same within an industry C) typically vary by client D) be determined by auditor recommendations Answer: C Explanation: Governance structures will typically vary by client. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 107) Auditors communicate significant findings or issues from the audit to those charged with governance ________. A) typically at the beginning of the audit B) typically during the audit C) typically towards the end of the audit D) via the client's legal counsel Answer: C Explanation: Auditors communicate significant findings or issues from the audit to those charged with governance typically towards the end of the audit. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 108) AS 1301 specifies that ________. A) critical accounting policies and practices and critical accounting estimates must be communicated to the audit committee B) significant and immaterial accounting policies and practices and critical accounting estimates must be communicated to the audit committee C) the auditor should bill audit clients at distinct phases of the audit process D) auditors should always consult with their own legal counsel before issuing an unmodified opinion Answer: A Explanation: AS 1301 specifies that critical accounting policies and practices and critical accounting estimates must be communicated to the audit committee. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None 47

109) Which of the following characteristics exist in critical accounting communications? A) the nature of the estimate is material due to the levels of subjectivity B) judgment is necessary to account for highly uncertain matters or the susceptibility of such matters to change C) the impact of the estimate on financial condition or operating performance is material D) All of these answer choices are correct. Answer: D Explanation: Critical accounting estimates are accounting estimates that possess the following two characteristics: (1) the nature of the estimate is material due to the levels of subjectivity, (2) judgment is necessary to account for highly uncertain matters or the susceptibility of such matters to change, and (3) the impact of the estimate on financial condition or operating performance is material. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 110) The outcome of litigation ________. A) is usually decided relatively quickly B) does not affect the auditor C) may be highly uncertain, and the circumstances may change over the course of a long court battle that spans several years D) may be highly certain, and the circumstances may change over the course of a long court battle that spans several years Answer: C Explanation: The outcome of litigation may be highly uncertain, and the circumstances may change over the course of a long court battle that spans several years. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

111) What is a written representation? A) A written statement by management provided to the auditor to confirm certain matters or to support other audit evidence. B) A letter from management to the auditor acknowledging management's responsibility for the preparation of the financial statements. C) A written statement containing details of any verbal representations made by management during the course of the audit. D) A letter from auditor to the management informing their concerns. Answer: A Explanation: A written representation is a written statement by management provided to the auditor to confirm certain matters or to support other audit evidence. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 112) Define a management representation letter. A) A letter from management to the auditor acknowledging management's responsibility for the preparation of the financial statements and details of any verbal representations made by management during the course of the audit. B) A written statement by management provided to the auditor to confirm certain matters or to support other audit evidence. C) A letter from auditor informing management about concerns. D) A written statement containing details of any verbal representations made by management during the course of the audit. Answer: A Explanation: A management representation letter is a letter from management to the auditor acknowledging management's responsibility for the preparation of the financial statements and details of any verbal representations made by management during the course of the audit. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

113) Which of the following refer(s) to accounting policies and practices that are most important to the portrayal of the company's financial condition and results and that require management's most difficult, subjective, or complex judgments? A) Critical accounting policies and practices B) Critical accounting estimates C) Critical accounting projections D) A disclosure agreement Answer: A Explanation: Critical accounting policies and practices are accounting policies and practices that are most important to the portrayal of the company's financial condition and results. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 114) A ________ is an existing condition or situation involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur. Answer: loss contingency Explanation: A loss contingency is an existing condition or situation involving uncertainty as to possible loss that will ultimately be resolved when one or more future events occur or fail to occur. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 115) A/an ________ is an audit inquiry sent to a firm's in-house legal counsel to obtain information about litigation, assessments, and claims. Answer: legal letter Explanation: A legal letter is an audit inquiry sent to a client's external and in-house legal counsel to obtain information about litigation, assessments, and claims. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

116) Type ________ subsequent events are those that provide evidence about conditions that developed subsequent to year-end. Answer: two or 2 Explanation: Type 2 subsequent events are those that provide evidence about conditions that developed subsequent to year-end. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 117) An example of a ________ would be the bankruptcy of a client's customer after year-end as a result of poor financial condition that existed as of the balance sheet date. Answer: Type I subsequent event Explanation: An example of a Type I subsequent event would be the bankruptcy of a client's customer after year-end as a result of poor financial condition that existed as of the balance sheet date. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 118) A/an ________ is responsible for the audit engagement, its performance, and for the auditor's report that is issued on behalf of the firm. Answer: engagement partner Explanation: An engagement partner is a partner or other person in the firm who is responsible for the audit engagement, its performance, and for the auditor's report that is issued on behalf of the firm. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

119) Under the ________, an entity is viewed as continuing in business for the foreseeable future with neither the intention nor the need for liquidation. Answer: going concern assumption Explanation: Under the going concern assumption, an entity is viewed as continuing in business for the foreseeable future with neither the intention nor the need for liquidation. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 120) A ________ is a letter from management to the auditor acknowledging management's responsibility for the preparation of the financial statements and details of any verbal representations made by management during the course of the audit. Answer: management representation letter Explanation: A management representation letter is a letter from management to the auditor acknowledging management's responsibility for the preparation of the financial statements and details of any verbal representations made by management during the course of the audit. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 121) The nature of the critical accounting estimates is ________ due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change. Answer: material Explanation: The nature of the critical accounting estimates is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

122) Match the sections of a legal letter with their corresponding explanations. A. The legal letter is prepared on the client's letterhead B. Date of the letter C. Name and address of attorneys D. Request for information ____ The letter is sent about mid-way through the completion of year-end fieldwork. ____ The client must grant permission for the attorneys to respond. ____ This paragraph identifies the financial statements under audit and states a request to supply information directly to the auditors. ____ A legal letter should be sent to all attorneys the client hired during the year for legal services, as well as in-house counsel. Answer: The legal letter is prepared on the client's letterhead: The client must grant permission for the attorneys to respond. Date of the letter: The letter is sent about mid-way through the completion of year-end fieldwork. Name and address of attorneys: A legal letter should be sent to all attorneys the client hired during the year for legal services, as well as in-house counsel. Request for information: This paragraph identifies the financial statements under audit and states a request to supply information directly to the auditors. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

123) Match the audit procedures with their descriptions. A. Confirmation with related parties and third parties of the details of arrangements to provide or maintain financial support B. Reading of minutes of meetings with stockholders, board of directors, and other important committees of the board C. Review of compliance with terms of debt and loan agreements D. Inquiry of client's legal counsel ____ May identify external matters that have occurred such as legal proceedings that might jeopardize the client's ability to operate ____ May identify possible financial difficulties such as restructuring of debt, default on loan or similar agreements, and need to dispose of substantial assets ____ May identify internal or external matters that have occurred such as labor difficulties, arrearages in dividends, and substantial dependence on the success of a particular project ____ May identify possible financial difficulties such as default on financing arrangements, restructuring of financing agreements, and need to seek new sources or methods of financing Answer: Confirmation with related parties and third parties of the details of arrangements to provide or maintain financial support may identify possible financial difficulties such as default on financing arrangements, restructuring of financing agreements, and need to seek new sources or methods of financing. Reading of minutes of meetings with stockholders, board of directors, and other important committees of the board may identify internal or external matters that have occurred such as labor difficulties, arrearages in dividends, and substantial dependence on the success of a particular project. Review of compliance with terms of debt and loan agreements may identify possible financial difficulties such as restructuring of debt, default on loan or similar agreements, or need to dispose of substantial assets. Inquiry of client's legal counsel may identify external matters that have occurred such as legal proceedings that might jeopardize the client's ability to operate. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

124) Match the significant findings or issues with their explanations. A. Corrected misstatements B. Written representation C. Business conditions affecting the entity D. Consultations with other accountants ____ Auditors should provide those charged with governance with a copy of the management representation letter. ____ Misstatements that were brought to management's attention and corrected during the audit. ____ If there are industry, economic, or other uncertainties that could affect the entity's ability to continue as a going concern, these matters should be communicated to those charged with governance. ____ If auditors and management disagree on an issue, management may contact other outside accountants to see if they may agree with management's views. If auditors are aware that management has consulted with other accountants, then it should be brought to the attention of those charged with governance. Auditors should communicate their own views on the issue and how they differ from management's views. Answer: Corrected misstatements: Misstatements that were brought to management's attention and corrected during the audit. Written representation: Auditors should provide those charged with governance with a copy of the management representation letter. Business conditions affecting the entity: If there are industry, economic, or other uncertainties that could affect the entity's ability to continue as a going concern, these matters should be communicated to those charged with governance. Consultations with other accountants: If auditors and management disagree on an issue, management may contact other outside accountants to see if they may agree with management's views. If auditors are aware that management has consulted with other accountants, then it should be brought to the attention of those charged with governance. Auditors should communicate their own views on the issue and how they differ from management's views. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

125) Identify three risk assessment and risk response procedures that may identify loss contingencies. A) Inquiring of management regarding the completeness of recorded liabilities B) Inspecting tax returns and correspondence with the IRS (Internal Revenue Service) C) Confirming with financial institutions, including guarantees of debt D) Threat of expropriation of assets Answer: A, B, C Explanation: Some risk assessment and risk response procedures that may identify loss contingencies are as follows: 1) inquiring of management regarding the completeness of recorded liabilities; 2) inquiring of management regarding the completeness of recorded liabilities; and 3) inspecting tax returns and correspondence with the IRS. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 126) Derek and Samantha are discussing loss contingencies one day while at lunch on the premises of a major audit client. The topic came up in a recent meeting, as the client has advised the audit firm that their legal counsel has advised them they may become the defendant in a class action lawsuit, and to check with the auditors as to whether or not this should be disclosed in the financial statements. Which of the following is true regarding a loss contingency that will be recorded in the financial statements? Select all that apply. A) The client must have been served paperwork and/or notification that a lawsuit has been filed, and the firm has now entered the allowed period in which to respond. B) The client and/or the client's legal counsel have determined that the likelihood of litigation is probable. C) The client's management and legal counsel has determined that a lawsuit will only proceed against them when a future event fails to occur. D) The amount of the contingent loss can be reasonably estimated. Answer: B, D Explanation: The client and/or the client's legal counsel have determined that the likelihood of litigation is probable. The amount of the contingent loss can be reasonably estimated. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

127) During their initial audit of Price Industries, LLC, the auditors, Jones CPAs would like to determine if there are any loss contingencies that the client may need to disclose in the financial statements. Which of the following are methods the auditors could use to determine if any loss contingencies exist? Select all that apply. A) The auditors should request written assurances and/or confirmations from management that loss contingencies do not exist. This can be added to the current year's audit file and used as evidence. B) The auditors should consider reviewing the minutes of board of directors meetings for any evidence of loss contingencies. C) The auditors should consider contacting the client's legal counsel and formally requesting notification of any loss contingencies. D) The auditors should consider contacting key customers and vendors of the client to determine if the client has been subject to any prior lawsuits. Answer: B, C Explanation: The auditors should consider reviewing the minutes of board of directors meetings for any evidence of loss contingencies. The auditors should consider contacting the client's legal counsel and formally requesting notification of any loss contingencies. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

128) Mayday Industries, a private firm and supplier of fine jewelry throughout the northwestern United States has contacted Norton CPAs and requested an audit. Mayday Industries has advised the CPA firm that the reason for the audit is to help them obtain a large bank loan and line of credit. Which of the following are factors that would determine the timeline for audit completion? Select all that apply. A) Norton CPAs are required, per generally accepted auditing standards, to adhere to strict deadlines for the audit of this type of company. B) Norton CPAs may need to ask the client if the creditors who are considering extending them credit have specified a deadline for the audit to be completed. C) Norton CPAs may wish to inquire of management if they have a deadline that they would like the audit to be completed by. D) Norton CPAs should set a deadline that the audit opinion will be delivered no later than six months after completion of the audit. Answer: B, C Explanation: Norton CPAs may need to ask the client if the creditors who are considering extending them credit have specified a deadline for the audit to be completed. Norton CPAs may wish to inquire of management if they have a deadline that they would like the audit to be completed by. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 129) Janice and Ray are working on the audit of Bloom LLC, and have heard the term 'subsequent events' mentioned in a recent meeting. At lunch one day, Janice asks Ray if he understands what subsequent events are, and why the auditors pay attention to them? Which of the following are correct responses by Ray to this question? Select all that apply. A) Subsequent events are best described as events that occurred between the date of the financial statements and the auditor's report. B) Subsequent events are classified as Type I and Type II events. Type II events always require disclosure in the financial statements. C) Type I subsequent events are events that existed at the balance sheet date, and require the financial statements to be adjusted. D) Type II subsequent events typically occur after the date of the financial statements, and require the auditors to disclaim an opinion on the financial statements. Answer: A, C Explanation: Subsequent events are best described as events that occurred between the date of the financial statements and the auditor's report. Type I subsequent events are events that existed at the balance sheet date, and require the financial statements to be adjusted. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 58

130) Examples of inquiries of management regarding subsequent events include which three of the following? A) Has the company entered into new commitments, borrowings, or guarantees? B) Have sales occurred or are planned that may affect the carrying value or classification of assets? C) Are there any plans to issue new shares or debt instruments (debentures)? D) Have competitors diversified their portfolio? Answer: A, B, C Explanation: Examples of inquiries of management regarding subsequent events include the following: 1) Has the company entered into new commitments, borrowings, or guarantees? 2) Have sales occurred or are planned that may affect the carrying value or classification of assets? 3) Are there any plans to issue new shares or debt instruments (debentures)? Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 131) Which three of the following are items to consider when reviewing working papers? A) Work has been performed in accordance with appropriate audit standards. B) Significant findings or issues have been raised for further consideration or audit testing. C) Consultations among team members and others within or outside of the audit firm, have taken place, as needed, and the resulting conclusions have been documented. D) Competitors have changed their business plans. Answer: A, B, C Explanation: The following are items to consider when reviewing working papers: 1) Work has been performed in accordance with appropriate audit standards; 2) Significant findings or issues have been raised for further consideration or audit testing; and 3) Consultations among team members, others within or outside of the audit firm, have taken place, as needed, and the resulting conclusions have been documented. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

132) Maurice and Janice are discussing final analytical procedures that are conducted toward the end of an audit. Maurice has recently joined the firm and is working on his first audit. He asks Janice to explain in a little more depth about analytical procedures performed at the end of the audit. Which of the following statements by Janice are accurate? Select all that apply. A) Analytical procedures are required by generally accepted auditing standards to be conducted at the beginning of the audit only as part of risk assessment. B) Analytical procedures are used at the end of an audit to help the auditor confirm his or her understanding of the audit findings. C) The exact analytical procedures performed are determined subjectively by the auditors, based on his or her experience with the industry and the client. D) The nature, timing, and extent of final analytical procedures are determined jointly during the audit by the auditors and senior management. Answer: B, C Explanation: Analytical procedures are used at the end of an audit to help the auditor confirm his or her understanding of the audit findings. The exact analytical procedures performed are determined subjectively by the auditors, based on his or her experience with the industry and the client. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 133) During the audit of the accounts receivable accounts of Solace Enterprises, a provider of car batteries in the southeastern United States, the auditors have received an abnormally high amount of receivable confirmations back from the client's customers indicating much lower balances owed to the client. As a result of this finding, which of the following are accurate? Select all that apply. A) The auditor will need to have the client adjust their records to match their customers receivable balances listed on confirmations. B) The auditor may wish to confirm that the correct controls were tested as part of the audit of this area. C) The auditor may wish to perform procedures to determine if the selected sample was representative of the population of receivables accounts. D) The auditor should resend the confirmations to the clients customers, requesting that they perform a reconciliation of the clients stated balance to the balance listed on the confirmation. Answer: B, C Explanation: The auditor may wish to confirm that the correct controls were tested as part of the audit of this area. The auditor may wish to perform procedures to determine if the selected sample was representative of the population of receivables accounts. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 60

134) Dave and Charlie are sitting at lunch one day on the premises of one of their large audit clients when the topic of going concern comes up. Dave mentions to Charlie that he vaguely recalls hearing this term in his accounting classes back in college, but doesn't remember what this means or why it is part of the audit. Which of the following responses by Charlie would help Dave to understand this? Select all that apply. A) Going concern really speaks to the client firm's ability to pay its short-term liabilities when they come due, and whether the firm will need to refinance maturing loans to conserve cash. B) Going concern deals with the entity's ability to continue operating as an enterprise, and is an important assumption that the auditor should evaluate. C) The going concern assumption is required to be evaluated by management each year for the forthcoming year. D) The going concern assumption is tested by evaluating management's breach of loan and debt covenants over the past three years. Answer: B, C Explanation: Going concern deals with the entity's ability to continue operating as an enterprise, and is an important assumption that the auditor should evaluate. The going concern assumption is required to be evaluated by management each year for the forthcoming year. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 135) Smithson Company, a subsidiary of Gladco Corporation, is currently being audited by Greenleaf CPAs. Senior management of Smithson has recently apprised the auditors that there may be a going concern issue with the firm. Which of the following should the auditors consider to determine the severity of this issue? Select all that apply. A) Whether Smithson Company's parent firm, Gladco Corporation will provide liquidity if the need arises. B) Whether Smithson is in a position to raise extra capital in the equities and credit markets, should the need arise. C) How quickly Smithson can liquidate property, plant and equipment to settle short-term liabilities, should the need arise. D) What the likelihood of receiving payment for audit services rendered is likely to be. Answer: A, B Explanation: Whether Smithson Company's parent firm, Gladco Corporation will provide liquidity if the need arises. Whether Smithson is in a position to raise extra capital in the equities and credit markets, should the need arise. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None 61

136) Identify two examples of mitigating factors that could offset going concern issues. A) Reduction of expenditures B) Ability to sell assets without interrupting the entity's operating capacity C) Inability to sell an unprofitable segment of the business D) Increase in expenditures Answer: A, B Explanation: Examples of mitigating factors include reduction in expenditures and the ability to sell assets without interrupting the entity's operating capacity. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 137) Which three of the following are matters to be communicated with those charged with governance? A) Appropriateness of significant accounting policies B) Difficulties encountered during the audit C) Process used by management in developing sensitive accounting estimates D) Agreements with management Answer: A, B, C Explanation: Matters to be communicated with those charged with governance include appropriateness of significant accounting policies, difficulties encountered during the audit, and the process used by management in developing sensitive accounting estimates. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

138) As the audit of Faircloth Industries reaches its conclusion, Arthur, the audit partner with overall responsibility for the engagement is discussing the management representation letter with one of his audit staff associates. The audit staff associate asks Arthur to explain a little more about the purpose and content of this letter. Which of the following statements by Arthur are correct? Select all that apply. A) The purpose of the management representation letter is to help the audit firm perform fewer procedures, as the firm can instead rely on the letter. B) The letter is delivered to the client's management by the audit firm, and draws attention to all deficiencies noted in the audit. C) The letter is typically drafted by the auditors and should confirm matters related to the audit. D) The letter does not absolve the auditor from his or her responsibility for identifying subsequent events. Answer: C, D Explanation: The letter is typically drafted by the auditors and should confirm matters related to the audit. The management representation letter does not absolve the auditor from his or her responsibility for identifying subsequent events. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 139) As the audit of Halley Enterprises draws to its conclusion, the auditors, Edmund CPAs are discussing and preparing a document to deliver significant audit findings to the firm's senior management. Which of the following are potential findings that an auditor may include in such a communication? A) The types of substantive and analytical procedures as part of the audit, for management's records. B) The auditors' assessment of the appropriateness of significant accounting policies currently being used by management and the firm. C) A record of significant findings or issues that the auditors noted during the course of the audit. D) A list of all misstatements that the client corrected, having been alerted to them by the auditors. Answer: B, D Explanation: The auditors' assessment of the appropriateness of significant accounting policies currently being used by management and the firm. A list of all misstatements that the client corrected, having been alerted to them by the auditors. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

140) A/an ________ is an audit inquiry sent to a client's external and in-house legal counsel to obtain information about litigation, assessments, and claims. A) legal letter B) loss contingency C) working papers D) audit evidence Answer: A Explanation: A legal letter is an audit inquiry sent to a client's external and in-house legal counsel to obtain information about litigation, assessments, and claims. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 141) ________ events provide evidence of conditions that existed at the date of the financial statements and require adjustment to the financial statements. A) Type I B) Type II C) Type III D) Subsequent Answer: A Explanation: Type I subsequent events provide evidence of conditions that existed at the date of the financial statements and require adjustment to the financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 142) The audit file ________ deadline is seven years from the audit report release date. A) retention B) assembly C) review D) litigation Answer: A Explanation: The audit file retention deadline is seven years from the audit report release date. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

143) ________ are accounting estimates whose nature and impact on the financial statements are material because of the high levels of subjectivity and judgment necessary to account for highly uncertain matters. A) Critical accounting estimates B) Critical accounting policies and practices C) Critical accounting projections D) Management representation practices Answer: A Explanation: Critical accounting estimates are accounting estimates whose nature and impact on the financial statements are material because of the high levels of subjectivity and judgment necessary to account for highly uncertain matters. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 144) Devon and Bernice are working on the audit of Summer Enterprises, LLC, a large firm and supplier of cotton candy and other confectionary products throughout the United States. Devon tells Bernice that his supervisor has tasked him with examining loss contingencies, but that he doesn't understand exactly what these are. Which of the following represents Bernice's most accurate response to this question? A) Loss contingencies can best be thought of as instances whereby the company is going to lose money. The cause of this monetary loss is usually due to the actions of third parties that the firm has no control over. B) Loss contingencies are caused when the company's debt to equity ratio reaches a certain threshold. At this point, generally accepted auditing standards require the firm to record a loss contingency associated with the increased default risk. C) Loss contingencies are typically recorded when a company may face a future monetary loss. In order for the company to record the loss in the financial statements, the amount has to be estimable by the firm and the likelihood of the loss occurring be considered probable. D) Loss contingencies are best thought of as accruals that the firm makes on its balance sheet associated with bad debt expense. An example of such an accrual would be bad debt expense associated with receivables. Answer: C Explanation: Loss contingencies are typically recorded when a company may face a future monetary loss. In order for the company to record the loss, the amount has to be estimable by the firm and the likelihood of the loss occurring be considered probable. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

145) Micah and Sarah are working on the audit of Peabody Corporation and are sitting in a meeting to discuss the upcoming audit of the client's loss contingencies. As this is Micah's first audit, he asks Sarah how a client determines the amount of a loss contingency. Which of the following responses by Sarah would be most appropriate to answer this question? A) Auditing loss contingencies is achieved by following strict rules and standards as promulgated by generally accepted auditing standards. These standards ensure uniformity and consistency in related loss calculations. B) Auditing loss contingencies is a subjective process. This process involves considerable judgment on the part of the audit firm, and each loss contingency should be assessed on a caseby-case basis. C) Auditing loss contingencies is a fairly routine and standardized process. The auditors really just have to make sure that appropriate adjustments to stockholders' equity accounts have been recorded correctly. D) None of these answer choices are correct. Answer: B Explanation: Auditing loss contingencies is a subjective process. This process involves considerable judgment on the part of the audit firm, and each loss contingency should be assessed on a case-by-case basis. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

146) During the audit of Rainbow Enterprises, a nationwide distributor of building materials and other supplies, the audit firm has learned through consultation with the client's external legal counsel that the client firm may soon be the defendant in a class action lawsuit. As a result of this notification, which of the following represents the most appropriate response by the audit firm? A) The audit firm, upon receipt of this news, should either immediately disclaim an opinion, or consider issuing a qualified opinion on the client's financial statements. This will help preserve the reputation of the firm. B) The audit firm should consider discussing this issue with client management. The auditors will want to determine if the likelihood of litigation is considered probable, and if the amount that may be disbursed is estimable. C) The audit firm should formally request that the client's internal audit function conduct a full investigation and audit into this area. If it is determined that the lawsuit is likely to proceed, the internal auditors should determine the amounts to be recorded in the balance sheet. D) The audit firm should consider issuing a further letter to both the client's external legal counsel and client's senior management. The letter should confirm the auditors lack of liability should a lawsuit proceed, and should be signed by all parties. Answer: B Explanation: The audit firm should consider discussing this issue with client management. The auditors will want to determine if the likelihood of litigation is considered probable, and if the amount that may be disbursed is estimable. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

147) Janice and Peter are working on the audit of Fairtree Industries, and have been requested by their supervisor to draft a legal letter to be sent to the client's external and in-house legal counsel. Which of the following most accurately represents issues that may be addressed in this communication? A) The legal letter is likely to include a history of all legal instances whereby the client has ever been a plaintiff, defendant or witness in any type of civil lawsuit. This letter will then be used to assess the client's riskiness and whether the auditor wishes to proceed with the engagement. B) The legal letter is used by the audit firm to gather key information pertaining to ongoing and potential lawsuits that the client firm may be named as a defendant in. Upon receipt of this information, the auditor will immediately make the appropriate accruals in the client's financial statements. C) The legal letter is used by the audit firm to determine any ongoing or likely litigation that may involve the client. An example of an issue raised in the legal letter may be the estimated monetary amount of any losses the client may incur. D) None of these answer choices are correct. Answer: C Explanation: The legal letter is used by the audit firm to determine any ongoing or likely litigation that may involve the client. An example of an issue raised in the legal letter may be the estimated monetary amount of any losses the client may incur. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

148) Eric and Donna are discussing the issue of subsequent events while working on the audit of Peachtree Enterprises, LLC. Eric mentions to Donna that he has heard that there is some type of relationship between inherent risk and the timing of substantive procedures. Eric asks Donna to explain her understanding of this relationship. Which of the following is the most appropriate response from Donna to help Eric understand this? A) The best way to think about the relationship between inherent risk and the timing of substantive procedures is to understand that accounts and assertions that are considered more risky by the auditor are typically audited during interim periods. B) The easiest way to explain this relationship is that for accounts and assertions that carry increased inherent risk, the auditor will typically audit these closer to the end of the audit. C) The relationship between inherent risk and the timing of substantive procedures is best defined as an inverse one. This is because as inherent risk increases, the timing of substantive procedures is less important and vice-versa. D) None of these answer choices are correct. Answer: B Explanation: The easiest way to explain this relationship is that for accounts and assertions that carry increased inherent risk, the auditor will typically audit these closer to the end of the audit. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

149) Alan and Millie are two audit staff associates working on the audit of Blossom Enterprises, a national retailer of horticultural products. Alan mentions to Millie that he recently heard his supervisor discussing Type I events with a colleague, and is not sure what that means. Which of the following describes Millie's most appropriate response to this query? A) Type I events are fairly straightforward. If the auditor discovers a misstatement in the client's financial statements, the auditor reports it to the client's management on the firm's balance sheet date. B) Type I events can be distinguished from Type II events as follows: Type I events typically occur between the client's year-end date and the date of the audit reports, whereas Type II events usually occur before the client's year-end. C) Type I events are categorized as events that occurred before the client's year-end. This can be compared to Type II events that occurred after the client's financial statement date. D) Type I events are events that always require adjustments to the client's financial statements. On the other hand, Type II events are events that the client should be made aware of, but do not require disclosure. Answer: C Explanation: Type I events are categorized as events that occurred before the client's year-end. This can be compared to Type II events that occurred after the client's financial statement date. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

150) As the audit of Greenfield Corporation draws to a close shortly before issuance of the audit report, the audit firm, Slater CPAs has just learned that the client has a large, undisclosed loan outstanding which significantly affects the client's debt to equity ratio was taken out approximately one week ago. Which of the following statements is most accurate regarding this finding? A) Upon receipt of this notification, the audit firm should immediately either issue a qualified opinion on this area of the financial statements, or consider issuing a disclaimer of opinion. B) Upon receipt of this notification, the audit firm should classify this as a Type II subsequent event and consider any related adjustments or disclosures that need to be made by the client related to this. C) Upon receipt of this notification, the audit firm should classify this as a Type I event and ensure that senior management adjust the financial statements and ensure all pertinent details are appropriately disclosed in the financial statements. D) None of these answer choices are correct. Answer: B Explanation: Upon receipt of this notification, the audit firm should classify this as a Type II subsequent event and consider any related adjustments or disclosures that need to be made by the client related to this. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

151) While working on the audit of Figtree Corporation, the audit firm, Jones CPAs has learned that per the details of a loan covenant associated with a significant loan the client has outstanding, the client is expected to maintain a minimum current ratio of 2:1. The client's current ratio is 1.7:1 at present. As a result of this finding, which of the following represents the auditor's most appropriate course of action? A) The auditors should proceed with issuing either a qualified opinion on this area of the client's financial statements, or consider issuing a disclaimer of opinion to preserve the reputation of the firm. B) The auditors should consider categorizing this as a Type I subsequent event. At this juncture, the auditors should request the client's management make all necessary and pertinent disclosures in the financial statements. C) The auditors should consider categorizing this as a Type II subsequent event. The auditors should request the client's management make all necessary adjustments and disclosures in the financial statements. D) The auditors should consider categorizing this as a Type I subsequent event. Once this determination has been made, the auditors should request management make all necessary changes to the financial statements and should notify the SEC per generally accepted auditing standards. Answer: B Explanation: The auditors should consider categorizing this as a Type I subsequent event. At this juncture, the auditors should request the client's management make all necessary and pertinent disclosures in the financial statements. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 152) Explain briefly auditors' responsibility for subsequent discovery of facts existing at the date of the auditors' reports. Answer: If auditors become aware of facts that existed at the date of the reports, auditors should require the client to disclose the facts and their impact on the financial statements to persons relying on the financial statements if the following conditions exist: 1. The facts are reliable and existed at the report date. 2. The facts affect the financial statements and auditors' reports. 3. Persons are continuing to rely on the financial statements and auditors' reports. If the client refuses to make the appropriate disclosures (as discussed above), auditors should notify each member of the board of directors that they will be notifying regulatory agencies having jurisdiction over the client (such as the Securities and Exchange Commission) as well as other persons who are currently relying on the reports. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 72

153) Define what is meant by the term "subsequent event". In addition, identify the two types of subsequent events and indicate how auditors should modify the engagement for the discovery of subsequent events. Answer: A subsequent event is an event that occurs between the balance sheet date and audit report release date that may affect the presentation and disclosure in the client's financial statements. A Type I subsequent event provides new information regarding a condition that existed at the balance sheet date (such as a loss on uncollectible accounts receivable or settlement of litigation for an amount different than estimated). A Type II subsequent event involves a matter that occurs after the balance sheet date, such as a bond sale, capital stock issuance, or loss of plant or inventories as a result of fire or flood. Because the related matters existed at the balance sheet date, Type I subsequent events require adjustment of reported amounts in the financial statements. In contrast, Type II subsequent events will require disclosure. In some cases, the effect(s) of the events may be of such a magnitude that pro forma financial statements are prepared. In cases where the events are discovered after the audit completion date but prior to the audit report release date, auditors would recommend adjustment or disclosure in the financial statements and dual date the reports. If the events are discovered after the audit report release date, auditors should recommend client disclosure of the event to persons relying on the financial statements if (1) the facts are reliable and existed at the report date, (2) the facts affect the financial statements and auditors' reports, and (3) persons are continuing to rely on the financial statements and auditors' reports. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

154) Tinley Corporation is being audited for the calendar year 2024. Among other items related to the audit, Tinley Corporation was being sued for personal injury resulting from the malfunction of one of their products. The lawsuit was initiated by Mr. John Jones in September 2024. Tinley's senior management and their outside legal counsel estimated the loss from the suit to be approximately $200,000. This amount is accrued and properly disclosed in the footnotes of the financial statements. The auditors have no reason to believe that the estimate is inaccurate. The audit is completed, and the report is dated February 1, 2025. The financial statements were issued on February 14, 2025. On March 30, 2025, the auditor reads an article in a trade journal about the Tinley Corporation and the recent jury award to Mr. John Jones for $1.5 million his personal injury lawsuit. Discuss the nature of these events and what responsibility, if any, does the auditor have regarding the news of the jury award on March 30, 2025. Answer: The outcome of the lawsuit would ordinarily be considered a Type I event. It is a subsequent event that provides new information regarding a financial condition that existed at the date of the balance sheet. However, auditors have no responsibility with regard to the March 30 outcome because it occurred after the audit completion date and audit report release date. Since the best estimate had been properly recorded and disclosed in the financial statements issued, auditors have no additional responsibility in this situation. Diff: 3 LO: 2 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Measurement; PC: None 155) Ms. Wood accepted an engagement to audit the 2024 financial statements of XYZ Company. XYZ completed the preparation of the 2024 financial statements on February 5, 2025, and Ms. Wood began the field work on February 20, 2025. Ms. Wood completed gathering sufficient appropriate evidence on March 25, 2025 and issued the report on March 31, 2025. When should management representations be dated and why? Answer: Management representations should be dated March 25, 2025, as that was the date on which sufficient evidence had been gathered. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Research; PC: None

156) Marty and Claire are working on the audit of Winter Corporation and are discussing the audit of this client one day over lunch. Marty tells Claire that he believes the audit is wrapping up and that he heard his supervisor talking about some final procedures that are typically performed at the end of the audit. Which of the following is the best example of procedures that may be performed as the audit wraps up? A) As the audit nears its conclusion, it is customary and typical for the auditors to perform substantive procedures. These procedures are generally used to test internal control at this stage. B) As the audit wraps up, the audit firm will often perform analytical procedures on the client's system of internal control. These procedures are designed to ensure the client's controls are operating effectively. C) As the audit draws near to its conclusion, the audit firm is required to perform analytical procedures to in essence verify the auditors understanding of the entity is consistent with the financial statements of that entity. D) None of these answer choices are correct. Answer: C Explanation: As the audit draws near to its conclusion, the audit firm is required to perform analytical procedures to in essence verify the auditors understanding of the entity is consistent with the financial statements of that entity. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

157) Maurice and Satvinder are currently working on the audit of Spring Corporation; which is drawing to its conclusion. Maurice mentions to Satvinder that he doesn't understand why the audit firm is performing analytical procedures again at the end of the audit, as this seems redundant. Which of the following represents Satvinder's best response to this observation? A) It's always a good idea to perform analytical procedures again towards the end of the audit. The reason we do this is to compare the results of the final analytical procedures to prior results of these same procedures, and determine where variances and thus fraud and errors may exist. B) I can see why you might at first think this was a duplication of effort. With that being said, when initial analytical procedures reveal changes that we request the client to make, the final analytical procedures help us determine if the client has made the changes appropriately or not. C) The main reason we repeat the analytical procedures towards the end of the audit is to help us increase the level of assurance we can offer on the client's financial statements, as well as help us increase the number of billable audit hours. D) I can see why you might think that. With that being said, by repeating selected analytical procedures, we are able to determine where areas of lower and higher inherent risk may be. This helps us tailor the audit and direct audit resources to the appropriate areas. Answer: B Explanation: I can see why you might at first think this was a duplication of effort. With that being said, when initial analytical procedures reveal changes that we request the client to make, the final analytical procedures help us determine if the client has made the changes appropriately or not. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

158) Bernard and Edna are two audit staff associates working on the audit of Autumn Enterprises, LLC, a regional distributor of commercial piping and other similar products. The pair are examining the results of substantive tests they recently performed and have identified numerous misstatements. Which of the following represents the pair's most prudent strategy at this juncture? A) The pair should write up and document their findings with respect to the misstatements, and then request that the audit firm consider issuing a qualified or adverse opinion on all affected accounts and areas of the financial statements. B) The pair should consider performing further substantive testing on the population of all accounts where misstatements were found, to see if the same conclusions hold. If this is the case, the auditors should consider increasing inherent risk accordingly. C) The pair should consider whether their initial assessments of fraud risk and inherent risk are appropriate, and further consider whether any revisions should be made accordingly. D) None of these answer choices are correct. Answer: C Explanation: The pair should consider whether their initial assessments of fraud risk and inherent risk are appropriate, and further consider whether any revisions should be made accordingly. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

159) During the audit of Fall Corporation, the auditors, Bayside CPAs have determined that an accounting clerk inadvertently recorded depreciation entries for a certain class of equipment using an incorrect depreciation method. As a result, depreciation expense on the income statement is understated. Based on this finding, which of the following represents the auditor's most appropriate response? A) The auditors should confirm with the accounting clerk that there was a logical theoretical rationale for the different depreciation entries, and record the responses for inclusion in the current year's audit file. B) The auditors should classify this as a factual misstatement on the basis that the accounting clerk inadvertently used an incorrect depreciation method, and subsequently recorded incorrect entry amounts. C) The auditors should classify this as a judgmental mistake on the grounds that selection of depreciation methods is subjective and requires judgment on the part of the client's accountants. D) The auditors should classify this as a projected misstatement on the grounds that the client's financial statements are yet to be released to the general public. If the client accepts the auditor's adjusting entries, then no disclosures relating to this should be made in the client's financial statements. Answer: B Explanation: The auditors should classify this as a factual misstatement on the basis that the accounting clerk inadvertently used an incorrect depreciation method, and subsequently recorded incorrect entry amounts. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

160) During the audit of BestSupply Enterprises, LLC, the auditors, Smithfield CPAs have noted that the client has sold a sizeable amount of productive long-term assets over the last year in attempts to maintain key liquidity ratios required by its creditors. As a result of this finding, which of the following courses of action might the auditors proceed with? A) The auditors are likely to consider disclaiming an opinion on the client's financial statements. This is because an audit firm does not want to be associated with failing clients. B) The auditors are most likely to request that the client consider refinancing any significant long-term loans that will mature in the next year. This will help the client maintain a stronger liquidity position. C) The auditors are likely to explain to client management that they have concerns related to the going concern assumption. The auditors may request management make appropriate related disclosures in the financial statements. D) None of these answer choices are correct. Answer: C Explanation: The auditors are likely to explain to client management that they have concerns related to the going concern assumption. The auditors may request management make appropriate related disclosures in the financial statements. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

161) Janet and Mike are eating lunch one day in the cafeteria of one of their major audit clients, and are discussing the topic of going concern. Janet was not familiar with this term, and so Mike explained its meaning to her. Janet proceeds to ask Mike why this would be the auditors responsibility to examine, as it would seem like management should take care of this. Which of the following is Mike's best response to this statement? A) Generally accepted auditing standards require that the audit firm, as part of an attestation engagement, take responsibility for and audit the client's going concern assumption. B) It is true that the auditors are not technically responsible for ensuring the client firm can viably continue as a going concern. However, if the client has liquidity or solvency problems, this could affect the client's ability to pay us in the future. C) While it's fair to say that overall responsibility for the client's ability to remain as a going concern rests with management, this is still something we examine. As an independent, impartial auditor, we owe a duty of care to the client's stockholders, and thus we have to evaluate this. D) While the auditing firm is not required to audit a client's ability to operate as a going concern, we typically audit this anyway because if the client can prove it holds a strong liquidity position; this will help increase the cost of capital associated with future equity offerings. Answer: C Explanation: While it's fair to say that overall responsibility for the client's ability to remain as a going concern rests with management, this is still something we evaluate. As an independent, impartial auditor, we owe a duty of care to the client's stockholders, and thus we have to evaluate this. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

162) As part of the audit of Bloomtree Corporation, the audit firm, Neall CPAs have determined that the client's receivables turnover ratios are drastically lower than industry averages, and have continued to decrease over the past three years. The auditors predict that if this trend continues, the client's liquidity position will soon fall in breach of debt covenants associated with significant outstanding loans. Which of the following represents the auditor's most appropriate response to this? A) The auditors should attempt to convene a meeting with the client's senior management. In this meeting, the auditors should recommend refinancing of any currently maturing long-term debt to help improve the client's liquidity position. B) The auditors should consider discussing the client's ability to continue as a going concern with the client's senior management. If concern over this assumption remains after the meeting, the auditors should consider recommending management insert appropriate disclosures in the financial statements. C) The auditors should consider requesting the client immediately outsource the receivables function to a third party. If the client can find a firm that specializes in collection, it will be able to improve its liquidity position. D) None of these answer choices are correct. Answer: B Explanation: The auditors should consider discussing the client's ability to continue as a going concern with the client's senior management. If concern over this assumption remains after the meeting, the auditors should consider recommending management insert appropriate disclosures in the financial statements. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

163) During the audit of Apple Company, the auditors, Orange CPAs are concerned about the client's ability to continue operating as a going concern. As a result, a meeting is convened with senior management who advise the auditors that while they are aware of recent liquidity problems, a new line of credit has just been secured with a large bank, which will help the client with the seasonal nature of its business. Official documents received by the bank confirm the existence of this new line of credit. As a result of this, which of the following courses of action is most prudent for the audit firm? A) The auditors should consider requesting senior management record a contingent liability in the financial statements for any projected liquidity shortages, in order that the accounting principle of conservatism is adhered to. B) The auditors should consider requesting senior management make appropriate disclosures in the financial statements pertaining to the new line of credit, including reasons why the line of credit was obtained. C) The auditors should consider contacting the bank that has agreed to provide the line of credit and perform appropriate substantive and analytical procedures to ensure that the bank's liquidity position is strong enough to provide necessary funds to the client. D) The auditors should consider requesting the client's internal audit function perform quarterly audits on the clients liquidity and solvency positions respectively, and ensure any appropriate accruals and deferrals are made accordingly. Answer: B Explanation: The auditors should consider requesting senior management make appropriate disclosures in the financial statements pertaining to the new line of credit, including reasons why the line of credit was obtained. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

164) Jeremiah and Daniel are currently working on the audit of Sage Enterprises, LLC, a medium-sized firm and distributor of cleaning products throughout the southeastern United States. The pair is discussing subsequent events, at which point Jeremiah asks Daniel how the auditing firm can try to decrease its liability in this area. Which of the following responses by Daniel represents the most appropriate suggestion? A) The easiest and quickest way for the audit firm to lower our exposure and liability in this area is to send a formal written communication to the client's management, advising that the auditors do not take or accept responsibility for any type of subsequent events. B) One of the most prudent courses of action the auditing firm can take associated with decreasing its liability in this area is to request client management make reference to any subsequent events they are aware of in the management representation letter. C) The most efficient way for the auditing firm to decrease its liability in the area of subsequent events is for the audit firm to formally advise client management in writing that the period covered by the audit report and opinion only extends to the client's fiscal year-end and not thereafter. D) None of these answer choices are correct. Answer: B Explanation: One of the most prudent courses of action the audit firm can take associated with decreasing its liability in this area is to request client management make reference to any subsequent events they are aware of in the management representation letter. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic, Data Analytics AICPA: BC: None; AC: Reporting; PC: None

165) After his auditing class at a local state university, James stops by to see the professor during his office hours. James asks the professor to elaborate a little more on and provide an overview of the management representation letter. Which of the following is the professors' best response to this query? A) The easiest way to think about the management representation letter is to think of it as a mechanism by which the audit firm can absolve itself of any liability associated with the audit. B) The best way to understand the management representation letter is to think of it as management's communication to the auditors acknowledging responsibility for the financial statements. C) Perhaps the best way to conceptualize the management representation letter and the purpose behind sending it is to ensure that management makes the auditors fully aware of any and all issue that may cause future litigation for the client and/or the auditor. The audit firm cannot be held liable if this letter is not sent. D) The management representation letter is typically sent to the client's management by the auditing firm towards the end of the attestation engagement. It details all recommendations the audit firm to amend the financial statements and thus decrease liability. Answer: B Explanation: The best way to understand the management representation letter is to think of it as management's communication to the auditors acknowledging responsibility for the financial statements. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

166) Tommy and Melissa are working on the audit of High Point Enterprises, a national supplier of lawn irrigation systems. This audit is Tommy's first audit, and he has asked Melissa to explain how auditors typically communicate with the client's management. Which of the following represents Melissa's most appropriate response? A) It is generally customary for the auditors to communicate with the client's management toward the end of the audit. At this point, we're usually in a position to communicate the audit findings and what opinion we expect to give on the client's financial statements. B) The auditors routinely communicate with the client's senior management at various points throughout the audit. Most of the communication occurs at the beginning of the audit, as the audit partners and senior management agree on the nature, timing and extent of audit procedures. C) The auditors communicate with the client's management at different points of the audit. For example, the auditors will likely send an engagement letter at the beginning of the audit, and will communicate audit findings to management during the audit itself. D) None of these answer choices are correct. Answer: C Explanation: The auditors communicate with the client's management at different points of the audit. For example, the auditors will likely send an engagement letter at the beginning of the audit, and will communicate audit findings to management during the audit itself. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

167) Rayma and Brian are currently working on the audit of Drexel Enterprises, LLC, and are discussing communications with the client's management one day over lunch. Rayma has recently graduated from college, and is working on her first audit, and so asks Brian to provide her with examples of situations and/or issues that the auditor would likely wish to communicate to management. Which of the following represents Brian's most appropriate response to this query? A) Because we are external auditors, we typically communicate all misstatements immediately to management, and then allow them a prespecified period of time to address and fix these misstatements before we render an audit opinion. B) Some examples of issue that we may decide to communicate to the client's management could be noncompliance with laws and regulations, and an identification of fraud or significant errors. C) There are various issues that are required to be reported to the client's management, per generally accepted auditing standards. An example of such an issue would be any misstatements noted in the client's cash account. D) There are a whole host of issues that we typically communicate to the client's management. We generally communicate these issues in a representation letter and then follow up with them via an engagement letter. Answer: B Explanation: Some examples of issue that we may decide to communicate to the client's management could be noncompliance with laws and regulations, and an identification of fraud or significant errors. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

168) Marcella Good is the audit manager on the Green Tree Landscaping audit. Management has refused to sign the management representation letter. Draft a short letter to the Green Tree management explaining the purpose of the management representation letter and the ramifications of refusing to sign the letter. Answer: Student answers will vary but should cover: A management representation letter is a letter from management to the auditor acknowledging management's responsibility for the preparation of the financial statements and details of any verbal representations made by management during the course of the audit. However, the management representation letter is not a substitute for obtaining sufficient, appropriate evidence regarding the financial statements through other audit procedures. If management refuses to sign a management representation letter, that would cause the auditors to question management's integrity, competence, and ethical values. And, it could have serious ramifications for the audit. Auditors would be especially concerned about the reliability of audit evidence obtained through inquiry of management. The refusal by management to sign the representation letter would be considered a scope limitation and could affect the auditor's opinion on the financial statements or the ability to provide an opinion on the financial statements. Diff: 3 LO: 5 Bloom: Synthesis Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

169) Explain briefly (a) management representations, (b) internal control communications, and (c) management letters. In your answer, include the general content of the communication, the parties involved with the communication, the required form of the communication, and whether the communication is required under generally accepted auditing standards. Answer: A. Management representations normally take the form of a letter on the client's letterhead, addressed to auditors, and signed by a responsible officer of the client. The purpose of this letter is to impress upon management its responsibility for the financial statements. Included in the letter are statements on (1) management's responsibility for financial statements, (2) the availability of all financial records and related data, (3) management's responsibility for design and implementation of programs and controls to prevent and detect fraud, (4) disclosure of all significant deficiencies in internal control, and (5) information concerning fraud involving management, employees who have significant roles in internal control, or cases where the fraud could have a material effect on the financial statements. This communication is required by generally accepted auditing standards and must be in writing. B. An internal control communication is normally made by auditors to the client or client's audit committee (those charged with governance). It involves the communication of deficiencies in the client's internal control. This communication is required by generally accepted auditing standards and should be made in writing. C. The management letter is sent by auditors to the client after the completion of the audit. The letter can include recommendations for improvement and suggestions for other possible auditors' services. Management letters are not required by generally accepted auditing standards; while they are typically prepared in writing, the related communication can be made orally. Diff: 1 LO: 5 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; AC: Research; PC: None

Auditing, 2e (Johnson) Chapter 16 Reporting on the Audit 1) The auditor's report can be in writing or it can be expressed orally. Answer: FALSE Explanation: The auditor's report must be in writing, in either hard copy or electronic form. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Research; PC: None 2) An emphasis of matter paragraph is mandatory for all audit reports. Answer: FALSE Explanation: An emphasis of matter paragraph is optional, and can be used by the auditor to draw attention to important information that is already presented or disclosed in the financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 3) Companies typically present their financial statements in comparative form, which means showing two consecutive years of balance sheets and three consecutive years of the income statement, statement of cash flows, and statement of stockholders' equity. Answer: TRUE Explanation: Companies typically present their financial statements in comparative form, which means showing two consecutive years of balance sheets and three consecutive years of the income statement, statement of cash flows, and statement of stockholders' equity. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

4) If the client has a going concern issue, then management must make a note disclosure about the circumstances, including any plans management may have to mitigate the situation. Answer: TRUE Explanation: If the client has a going concern issue, then management must make a note disclosure about circumstances, including any plans management may have to mitigate the situation. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 5) A component auditor, which is a different accounting firm, may audit a component or subsidiary of the parent company. Answer: TRUE Explanation: A component auditor, which is a different accounting firm, may audit a component or subsidiary of the parent company. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 6) If the subsidiary 's financial statements audited by the component auditor is a material amount of the group financial statements, the group engagement partner typically decides to reference the work completed by the component auditor in the audit report. Answer: TRUE Explanation: If the subsidiary audited by the component auditor is a material amount of the group financial statements, the group engagement partner typically decides to reference the work completed by the component auditor in the audit report. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

7) Characteristics of a pervasive misstatement or scope limitation include that is it not confined to specific elements, accounts, or items of the financial statements. Answer: TRUE Explanation: Characteristics of a pervasive misstatement or scope limitation include that is it not confined to specific elements, accounts, or items of the financial statements. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 8) An unmodified opinion is expressed by the auditor when the auditor concludes the financial statements are presented fairly, in all material respects. Answer: TRUE Explanation: An unmodified opinion is expressed by the auditor when the auditor concludes the financial statements are presented fairly, in all material respects. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 9) An immaterial misstatement occurs when the client departs from the applicable financial reporting framework. Answer: FALSE Explanation: A material misstatement occurs when the client departs from the applicable financial reporting framework. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 10) A scope limitation occurs when auditors are able to perform planned audit procedures to gather sufficient appropriate evidence. Answer: FALSE Explanation: A scope limitation occurs when auditors cannot perform planned audit procedures to gather sufficient appropriate evidence. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 3

11) Whether auditors choose to dual date or extend the end of fieldwork, they must request written representation from management as of the new date of the auditor's report. Answer: TRUE Explanation: Whether auditors choose to dual date or extend the end of fieldwork, they must request written representation from management as of the new date of the auditor's report. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 12) The concept of materiality is NOT an important factor in determining which type of modified report to issue. Answer: FALSE Explanation: The concept of materiality is a key factor in determining which type of modified report to issue. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 13) An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. Answer: TRUE Explanation: An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

14) The auditor should consider modifying the opinion if the management refuses to sign the updated representation letter. Answer: TRUE Explanation: The auditor should consider modifying the opinion if the management refuses to sign the updated representation letter. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 15) Auditors of public companies can perform an integrated audit, which means performing the financial statement audit and the audit of the effectiveness of the internal control over financial reporting (ICFR) at the same time. Answer: FALSE Explanation: Auditors of public companies must perform an integrated audit, which means performing the financial statement audit and the audit of the effectiveness of internal control over financial reporting (ICFR) at the same time. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 16) Adverse opinions on the effectiveness of internal control over financial reporting (ICFR) are frequently issued for large, well-established companies. Answer: FALSE Explanation: Adverse opinions on the effectiveness of ICFR are rare for large, well-established companies. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

17) In a compilation engagement, the CPA will assist management in the presentation of financial statements and will provide assurance as to whether the financial statements are presented fairly in accordance with the applicable financial reporting framework. Answer: FALSE Explanation: In a compilation engagement, the CPA will assist management in the presentation of financial statements but will not provide assurance as to whether the financial statements are presented fairly in accordance with the applicable financial reporting framework. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 18) To provide limited assurance, the CPA must perform procedures to gather evidence that no material modifications are needed for the financial statements to be in accordance with the financial reporting framework. Answer: TRUE Explanation: To provide limited assurance, the CPA must perform procedures to gather evidence that no material modifications are needed for the financial statements to be in accordance with the financial reporting framework. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 19) An unmodified opinion is expressed by ________. A) the internal audit function upon concluding the financial statements are fairly represented B) the external auditor when the auditor concludes the financial statements are presented fairly, in all material respects C) the external auditor when the auditor concludes the financial statements are presented fairly, in all material and immaterial respects D) management when the auditor concludes the financial statements are presented fairly, in all material respects Answer: B Explanation: An unmodified opinion is expressed by the auditor when the auditor concludes the financial statements are presented fairly, in all material respects. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

20) The responsibility for the financial statements rests ________. A) jointly with the auditor and management B) solely with management C) with the internal audit function D) solely with the external auditor Answer: B Explanation: The responsibility for the financial statements rests solely with management. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 21) The purpose of an audit is to ________. A) provide financial statement users with an opinion by an independent auditor on whether the financial statements are presented fairly in accordance with an applicable financial reporting framework B) provide internal auditors with an opinion by the external auditor on whether the financial statements are presented fairly in accordance with an applicable financial reporting framework C) provide absolute assurance that the financial statements conform to Generally Accepted Accounting Principles (GAAP) D) help management ensure yearly bonuses will be received Answer: A Explanation: The purpose of an audit is to provide financial statement users with an opinion by an independent auditor on whether the financial statements are presented fairly in accordance with an applicable financial reporting framework. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

22) The purpose of an audit is to provide ________. A) financial statement users with an opinion by an independent auditor on whether the financial statements are presented fairly in accordance with an applicable financial reporting framework B) internal auditors with an opinion by the independent auditor on whether the financial statements are presented fairly in accordance with an applicable financial reporting framework C) management with assurance that they will be able to maximize profit and bonuses D) absolute assurance that the financial statement conform to GAAP Answer: A Explanation: The purpose of an audit is to provide financial statement users with an opinion by an independent auditor on whether the financial statements are presented fairly in accordance with an applicable financial reporting framework. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 23) The audit process ________. A) can typically take up to a year B) is aimed primarily at creditors C) enhances the degree of confidence that intended users place in the financial statements D) decreases the degree of confidence that intended users place in the financial statements Answer: C Explanation: The audit process enhances the degree of confidence that intended users place in the financial statements. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

24) Once auditors have gathered sufficient appropriate audit evidence, evaluated uncorrected misstatements, and completed the required communications with those charged with governance ________. A) the final step is to prepare and issue the independent auditor's report B) the final step is to confer with the client's legal counsel C) the audit report should be sent to the internal audit function for review D) the report should be sent to the SEC for modification and approval Answer: A Explanation: Once auditors have gathered sufficient appropriate audit evidence, evaluated uncorrected misstatements, and completed the required communications with those charged with governance, the final step is to prepare and issue the independent auditor's report. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 25) AU-C 700 Forming an Opinion and Reporting on Financial Statements defines an unmodified opinion as the opinion expressed by the ________. A) internal auditor when the auditor concludes the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework B) external auditor when the auditor concludes the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework C) external auditor when the auditor concludes the financial statements are presented fairly, in all material and immaterial respects, in accordance with the applicable financial reporting framework D) external auditor when the auditor concludes the financial statements are presented fairly, in all material respects, in accordance with the international financial reporting standards Answer: B Explanation: AU-C 700 Forming an Opinion and Reporting on Financial Statements defines an unmodified opinion as the opinion expressed by the external auditor when the auditor concludes the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

26) The audit process ________. A) enhances the degree of confidence that intended users place in the financial statements B) has no effect on the degree of confidence that intended users place in the financial statements C) decreases the degree of confidence that intended users place in the financial statements D) is unrelated to the degree of confidence that intended users place in the financial statements Answer: A Explanation: The audit process enhances the degree of confidence that intended users place in the financial statements. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 27) The audit report represents the ________. A) beginning of the audit process B) "end product" of the financial statement audit C) "end product" of the internal audit review and audit D) opinion of management with respect to the fairness and accuracy of the financial statements Answer: B Explanation: The audit report is the "end product" of the financial statement audit. Diff: 1 LO: 1 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 28) Audit reports tend to be ________. A) very different, depending on the company being audited B) fairly standard with respect to wording and paragraphs C) standard for companies within an industry, but varying between industries D) very different,with respect to wording and paragraphs Answer: B Explanation: Audit reports tend to be fairly standard with respect to wording and paragraphs. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

29) The auditor's responsibility, as expressly stated in the audit report, is to ________. A) express an opinion on the financial statements B) take responsibility for the financial statements C) make it clear that responsibility for the financial statements rests with the internal audit function D) make it clear that responsibility for the financial statements rests with the client's legal counsel Answer: A Explanation: The auditor's responsibility, as expressly stated in the audit report, is to express an opinion on the financial statements. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 30) In the audit report, the auditor states that another party is responsible for the preparation of the financial statements. This party is ________. A) the internal auditor B) the client's legal counsel C) management D) the SEC Answer: C Explanation: In the audit report, the auditor states that another party is responsible for the preparation of the financial statements. This party is management. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

31) A/an ________ is presented by the auditor to indicate that the financial statements are in accordance with the applicable financial reporting framework. A) unmodified opinion B) modified opinion C) unqualified opinion D) audit opinion Answer: A Explanation: An unmodified opinion is presented by the auditor to indicate that the financial statements are in accordance with the applicable financial reporting framework. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 32) Which of the following is NOT a component of unmodified opinion for a private company audit? A) Auditor tenure B) Title C) Opinion paragraph D) Introductory paragraph Answer: A Explanation: Some components of unmodified opinion for a private company audit include title, opinion paragraph, and introductory paragraph. Audit tenure is only required for audits of public companies. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

33) During auditing class, Janine asks her auditing professor why companies need audits in the first place, as she doesn't understand why they would expend resources on this. Which of the following responses by the professor would be most appropriate? A) Firms, especially publicly-traded firms, need audits because they are required to be audited by the Financial Accounting Standards Board. B) Audits lend assurance to the client's financial statements and disclosures and help them raise money in the debt and equity markets. C) Audits help companies increase investor confidence in their firm. When investor confidence is higher, firms can usually negotiate lower dividends. D) None of these answer choices are correct. Answer: B Explanation: Audits lend assurance to the client's financial statements and disclosures and help them raise money in the credit markets. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 34) Upon conclusion of the audit of Spear Corporation, the audit firm, Jones CPAs has not found any material misstatements, and is ready to proceed with issuance of an audit opinion. Which of the following is the most appropriate audit opinion in this scenario? A) Jones CPAs should issue an unmodified opinion as the client's financial statements do not contain any material misstatements. B) Jones CPAs should issue a qualified opinion, and draw attention to the fact that no misstatements were found. C) Jones CPAs should consider issuing a disclaimer of opinion, as it is highly unlikely that there are actually no misstatements. D) Jones CPAs should consider issuing an opinion on internal control rather than the financial statements, as this helps protect the auditor in instances of litigation. Answer: A Explanation: Jones CPAs should issue an unmodified opinion as the client's financial statements do not contain any material misstatements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

35) Suzy and Dan are working on the audit of a major publicly traded audit client, and are discussing the audit report that will soon be released. Suzy asks Dan why the audit report is really necessary. Which of the following responses by Dan would be most appropriate? A) The audit report is necessary because if our firm doesn't issue it, we can still be dragged into lawsuits involving the client. B) The audit report presents our findings and recommendations and liability indemnification in a formal report. C) The audit report presents our findings and opinion on the client's financial statements and internal control, and helps delineate responsibility. D) None of these answer choices are correct. Answer: C Explanation: The audit report presents our findings and opinion on the client's financial statements and internal control, and helps delineate responsibility. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 36) Geoff and Heather are discussing the audit report that their firm recently released on a major client. Geoff notes that he wonders if their firm's finding that the client had unexplainably switched depreciation methods which had caused various depreciation expenses to be understated on the income statement would be noted in the report. Which of the following is Heather's best response to this? A) An issue like this is really between the client's accountants and firm management, so it's unlikely to be in the audit report. B) It is likely that they included it in the audit report in the opinion paragraph so as to draw attention to it. C) Yes, it's probably been included and would be categorized as a critical audit matter. D) They will have definitely included it in the audit report. It is most likely in the basis for opinion section. Answer: C Explanation: Yes, it's probably been included and would be categorized as a critical audit matter. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

37) Alan and Toni have been working on the audit of Sundraw Corporation and have expressed concerns about the client's ability to continue as a going concern. What recommendation should the pair make to firm management with respect to the financial statements? A) The pair should advise client management that they should not inform stakeholders of this concern, as it could affect the share price negatively. B) The pair should advise firm management that this should be listed as a note disclosure, in order to maintain transparency. C) The pair should advise firm management that a contingent liability should be recorded for the estimated amount of the liquidity or solvency shortfall. D) None of these answer choices are correct. Answer: B Explanation: The pair should advise firm management that this should be listed as a note disclosure, in order to maintain transparency. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 38) Smith CPAs have requested that an audit client add a note disclosure to the financial statements related to their ability to operate as a going concern. The client has refused to do so; citing differences in opinion on some key loans that they believe will be refinanced. What should the auditors do at this point? A) The auditors should consider disclaiming an opinion on the financial statements to preserve the reputation of the firm. B) The auditors should consider issuing a scope limitation, on the basis that management is not willing to make the necessary amendment. C) The auditors should consider modifying the opinion for a material departure. D) The auditors should request a meeting with the client's board of directors, and discuss the issue with them. Answer: C Explanation: The auditors should consider modifying the opinion for a material departure. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

39) At the conclusion of the audit of Sparrow Corporation, the external auditors determined that one of the client's warehouses had been destroyed due to a freak weather event, resulting in the loss of millions of dollars of inventory. What might the auditors decide to do as a result of this? A) The auditors may decide to disclaim an opinion on the client's inventory accounts. B) The auditors may decide to add an emphasis-of-matter paragraph, to draw attention to this. C) The auditors may decide to request the client replace all lost inventory, so the inventory accounts can be audited again before issuing an opinion on this area. D) None of these answer choices are correct. Answer: B Explanation: The auditors may decide to add an emphasis-of-matter paragraph, to draw attention to this. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 40) During the audit of Jack Corporation, the auditors noted that the client switched from the LIFO inventory costing method to the FIFO method. As a result of this finding, what should the auditors request? A) The auditors should ensure all reconciliations between the two methods are correct. B) The auditors should file appropriate paperwork with the SEC to notify them of the change, per generally accepted auditing standards. C) The auditors should request management add pertinent note disclosures to the financial statements, drawing attention to this change. D) The auditors should consider including a copy of all reconciliation calculations as an addendum to the financial statements, in the interests of transparency. Answer: C Explanation: The auditors should request management add pertinent note disclosures to the financial statements, drawing attention to this change. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

41) An emphasis-of-matter paragraph refers to when an auditor ________. A) issues an unmodified opinion but may include an additional paragraph in the report to draw attention to important information B) issues a disclaimer of opinion due to a scope limitation C) makes inquiries of the prior auditor relating to prior audit opinions issues D) makes inquiries of the legal auditor relating to prior audit opinions issues Answer: A Explanation: An emphasis-of-matter paragraph refers to when an auditor issues an unmodified opinion but may include an additional paragraph in the report to draw attention to important information. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None 42) If an auditor wishes to draw attention to important information that is already presented or disclosed in the financial statements, the auditor would include a ________. A) qualified opinion B) disclaimer of opinion C) emphasis-of-matter paragraph D) scope limitation paragraph Answer: C Explanation: There are certain situations in which the auditor issues an unmodified opinion but may include an additional paragraph in the report to draw attention to important information that is already presented or disclosed in the financial statements. This additional paragraph is called an emphasis-of-matter paragraph. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

43) The emphasis-of-matter paragraph is ________. A) placed after the opinion paragraph in the standard unmodified report B) placed before the opinion paragraph in the standard unmodified report C) placed with the opinion paragraph in the standard unmodified report D) referred to in a separate report Answer: A Explanation: The emphasis-of-matter paragraph is placed after the opinion paragraph in the standard unmodified report. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 44) If the client has a going concern issue, ________. A) then management must make a note disclosure about the circumstances, including any plans management may have to mitigate the situation B) then the internal auditors must make a note disclosure about the circumstances, including any plans management may have to mitigate the situation C) then the external auditors must make a note disclosure about the circumstances, including any plans management may have to mitigate the situation D) the auditor should recommend that management begin the liquidation process to dissolve the firm Answer: A Explanation: If the client has a going concern issue, then management must make a note disclosure about the circumstances, including any plans management may have to mitigate the situation. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

45) With respect to management's disclosure required for going concern issues, ________. A) if management determines that the disclosure is fairly presented in accordance with the applicable financial reporting framework, then an unmodified auditor's report can still be issued B) if auditors determine that the disclosure is fairly presented in accordance with the applicable financial reporting framework, then an unmodified auditor's report can still be issued C) the auditor should advise management that they are now unable to issue an unmodified audit opinion D) the auditor should advise management that they are now unable to issue a modified audit opinion Answer: B Explanation: With respect to management's disclosure required for going concern issues, if auditors determine that the disclosure is fairly presented in accordance with the applicable financial reporting framework, then an unmodified auditor's report can still be issued. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 46) An unmodified auditor's report is ________. A) an indication that a firm is financially successful B) an indicator that the firm's stock price may be about to drop C) not an indication the company is successful financially, but rather an indication the company has followed accounting standards as dictated by the applicable financial reporting framework D) an indication the company is successful financially, but not an indication the company has followed accounting standards as dictated by the applicable financial reporting framework Answer: C Explanation: An unmodified auditor's report is not an indication the company is successful financially, but rather an indication the company has followed accounting standards as dictated by the applicable financial reporting framework. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

47) When a client has a going concern issue, ________. A) AU-C 570 The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern requires an emphasis-of-matter paragraph be added to the unmodified report, after the opinion paragraph B) AU-C 570 The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern requires an emphasis-of-matter paragraph be added to the unmodified report, before the opinion paragraph C) the auditor must notify the Securities and Exchange Commission (SEC) within ten business days D) the auditor should recommend a potential acquirer Answer: A Explanation: When a client has a going concern issue, AU-C 570 The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern, requires an emphasis-of-matter paragraph be added to the unmodified report, after the opinion paragraph. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 48) Companies typically present their financial statements ________. A) to show the most recent year only B) in comparative form, which means showing two consecutive years of balance sheets and three consecutive years of the income statement, statement of cash flows, and statement of stockholders' equity C) in standard form, which means showing three consecutive years of balance sheets and three consecutive years of the income statement, statement of cash flows, and statement of stockholders' equity D) only to those entities who have expressed an interest in scrutinizing them Answer: B Explanation: Companies typically present their financial statements in comparative form, which means showing two consecutive years of balance sheets and three consecutive years of the income statement, statement of cash flows, and statement of stockholders' equity. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

49) Showing comparative financial statements helps users ________. A) to calculate a definite future stock price B) to analyze the company's financial condition and profitability C) spot potential problems in the most recent years note disclosures D) understand the difference between basic and diluted earnings per share Answer: B Explanation: Showing comparative financial statements helps users to analyze the company's financial condition and profitability. Diff: 1 LO: 2 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 50) Which of the following paragraphs is placed after the opinion paragraph in the standard unmodified report, when applicable? A) Emphasis-of-matter paragraph B) Scope paragraph C) Opinion paragraph D) Auditor's responsibility paragraph Answer: A Explanation: The emphasis-of-matter paragraph is placed after the opinion paragraph in the standard unmodified report. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

51) Define the emphasis of matter paragraph. A) A paragraph included in the auditor's report that is required by generally accepted auditing standards or is included at the auditor's discretion. B) A paragraph that identifies the statements being audited and states the auditor's opinion. C) A paragraph that states responsibilities and references registration with the Public Company Accounting Oversight Board (PCAOB). D) A paragraph that briefly explains the process of conducting an audit and that the PCAOB standards were followed. Answer: A Explanation: The emphasis-of-matter paragraph is a paragraph included in the auditor's report that is required by generally accepted auditing standards, or is included at the auditor's discretion, and that refers to a matter appropriately presented or disclosed in the financial statements. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 52) Which of the following is NOT a situation in which the auditor wants to draw users' attention to a material matter that is already presented and/or disclosed in the client's financial statements? A) A major disaster that may not have a significant impact on the company's financial situation B) Uncertainties relating to the future outcome of litigation C) Significant subsequent events D) Material transactions with related parties Answer: A Explanation: Examples of situations in which the auditor wants to draw users' attention to a material matter that is already presented and/or disclosed in the client's financial statements are as follows: uncertainties relating to the future outcome of litigation; significant subsequent events; and material transactions with related parties. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

53) The group engagement partner typically decides to reference the work completed by the component auditor in the audit report ________. A) when management requests that the audit firm do so B) when the subsidiary audited by the component auditor is a material amount of the group financial statements C) when the subsidiary audited by the component auditor is an immaterial amount of the group financial statements D) when the group auditor requests the inclusion of their firm on the audit report Answer: B Explanation: The group engagement partner typically decides to reference the work completed by the component auditor in the audit report when the subsidiary audited by the component auditor is a material amount of the group financial statements. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None 54) The group engagement team ________. A) audits the parent company and is responsible for the overall audit strategy for all of the components B) audits the subsidiary company and is responsible for the overall audit strategy for all of the components C) has no responsibility for issuing an audit opinion D) is responsible for the fairness of the financial statements Answer: A Explanation: The group engagement team audits the parent company and is responsible for the overall audit strategy for all of the components. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

55) A component auditor is typically ________. A) another audit partner in the same office B) a different partner at a different office of the same firm C) a different accounting firm that audits a component or subsidiary of the parent company D) a different accounting firm that audits a component of the subsidiary company Answer: C Explanation: A component auditor is typically a different accounting firm that audits a component or subsidiary of the parent company. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 56) It is the responsibility of the group engagement partner to ________. A) ensure the work completed by a component auditor meets the group engagement partner's requirements and standards B) ensure the financial statements are free from error C) ensure the work completed by a prior auditor meets the group engagement partner's requirements and standards D) notify the appropriate supervisor of fraud being committed at the next level of management up from the individual Answer: A Explanation: It is the responsibility of the group engagement partner to ensure the work completed by a component auditor meets the group engagement partner's requirements and standards. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

57) The group engagement partner ________. A) shares joint responsibility with management for the fairness and accuracy of the financial statements B) has sole responsibility for the fairness and accuracy of the financial statements C) must decide whether to refer to the audit of a component auditor in the auditor's report on the group financial statements D) must decide whether to refer to the audit of a prior auditor in the auditor's report on the group financial statements Answer: C Explanation: The group engagement partner must decide whether to refer to the audit of a component auditor in the auditor's report on the group financial statements. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 58) When reference is made to a component auditor, ________. A) the auditor's responsibility paragraph is modified to indicate the portion of the group financial statements that were audited by the component auditor B) the auditor's responsibility paragraph is removed, and reference is made to the group financial statements that were audited by the component auditor C) liability for the fairness of the financial statements is transferred accordingly D) inherent risk will decrease accordingly Answer: A Explanation: When reference is made to a component auditor, the auditor's responsibility paragraph is modified to indicate the portion of the group financial statements that were audited by the component auditor. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

59) The portion of the consolidated financial statements audited by the component auditor ________. A) is expressed in dollar amounts only B) must be expressed in terms of percentages of total assets only C) can be expressed in dollar amounts or percentages of total assets, total revenues, or other appropriate criteria D) should not be relied on to the same extent as the group auditor Answer: C Explanation: The portion of the consolidated financial statements audited by the component auditor can be expressed in dollar amounts or percentages of total assets, total revenues, or other appropriate criteria (AU-C 600.A58). Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 60) If more than one component auditor was used to audit multiple subsidiaries, ________. A) then the audit report should not be relied upon B) then the portion of the client audited by all component auditors can be aggregated together and expressed as one-dollar amount or percentage C) then the portion of the client audited by all prior auditors can be aggregated together and expressed as one-dollar amount or percentage D) control risk will increase accordingly Answer: B Explanation: If more than one component auditor was used to audit multiple subsidiaries, then the portion of the client audited by all component auditors can be aggregated together and expressed as one-dollar amount or percentage. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

61) If the group engagement partner wants to name the component audit firm, then ________. A) he/she must receive permission from the component auditor, and the component auditor's report on the subsidiary must be presented together with the auditor's report on the group financial statements B) he/she must receive permission from the component auditor, and the prior auditor's report on the subsidiary must be presented together with the auditor's report on the group financial statements C) he or she is free to do so D) management must provide permission accordingly Answer: A Explanation: If the group engagement partner wants to name the component audit firm, then he/she must receive permission from the component auditor, and the component auditor's report on the subsidiary must be presented together with the auditor's report on the group financial statements. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 62) When is a disclaimer of opinion issued? A) When a scope limitation is material and pervasive B) When a scope limitation is material but not pervasive C) When a misstatement is material and pervasive D) When scope limitation is eliminated by alternative procedures Answer: A Explanation: A disclaimer of opinion is issued when scope limitation is imposed by management and that scope limitation is material and pervasive to the financial statements. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

63) Which of the following types of auditors perform audits of a component or subsidiary of the parent company? A) Component auditor B) Subsidiary auditor C) Individual auditor D) Auditing firm Answer: A Explanation: A component auditor audits a component or subsidiary of the parent company. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 64) When reference is made to a component auditor, which of the following paragraphs is modified to include the portion of the group financial statements that were audited by the component auditor? A) Auditor's responsibility paragraph B) Scope paragraph C) Going concern paragraph D) Emphasis-of-the-matter paragraph Answer: A Explanation: When reference is made to a component auditor, the auditor's responsibility paragraph is modified to include the portion of the group financial statements that were audited by the component auditor. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 65) Engagement of a component auditor requires an emphasis-of-a-matter paragraph. Answer: FALSE Explanation: No emphasis-of-matter paragraph is required when there is a reference to a component auditor. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

66) Millie and Steve are discussing the work of component auditors one day after audit class. Millie mentions to Steve that she doesn't really understand when the group engagement partner would decide to make reference to the component auditor. Which of the following represents Steve's best response to this query? A) Generally accepted auditing standards require the group engagement partner to always reference the work of the component auditor in an audit report. B) The decision as to whether or not to reference a component auditor's work generally depends on whether the component audit would be considered material or not. C) It is really a subjective decision on the part of the group engagement partner as to whether or not to include this. Most times they don't draw attention to it for reasons of liability. D) None of these answer choices are correct. Answer: B Explanation: The decision as to whether or not to reference a component auditor's work generally depends on whether the component audit would be considered material or not. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 67) Upon conclusion of the audit of Marrow Enterprises, the audit firm noted that they have been unable to audit a significant portion of the client's inventory, despite their best efforts. As a result of this, what might the auditors decide to do? A) The auditors will most likely issue a disclaimer of opinion on the client's financial statements. B) The auditors will likely proceed with issuance of a scope limitation, related to the inventory that they were unable to audit. C) The auditors will likely consider issuing a qualified opinion related to the inventory accounts, in order to draw stakeholder attention to this area. D) The auditors will likely issue an adverse opinion on the financial statements, on the presumption that the client is attempting to conceal fraud. Answer: A Explanation: The auditors will most likely issue a disclaimer of opinion on the client's financial statements. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

68) At the end of the audit of Ironsides Corporation, the audit firm has noted a large amount of misstatements that are all considered to be immaterial by the auditors. Based on this information, what type of audit opinion is the audit firm likely to issue? A) The audit firm will likely issue an unmodified opinion on the client's financial statements. B) The audit firm will likely proceed with issuance of a qualified opinion; drawing investors' attention to these misstatements. C) The audit firm will likely proceed with issuance of a scope limitation, on the grounds that the audit sampling must have been too limited. D) None of these answer choices are correct. Answer: A Explanation: The audit firm will likely issue an unmodified opinion on the client's financial statements. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 69) Upon conclusion of the audit of Jackson Corporation, the auditors noted material misstatements related to depreciation expense for many of the client's property, plant and equipment accounts. The auditors are concerned that these misstatements have affected other accounts such as accumulated depreciation. As a result of this information, which of the following should the auditors do? A) The auditors should consider issuing a qualified opinion on all of the client's fixed asset accounts. B) The auditors should consider issuing a qualified opinion, but only on the client's income statement accounts such as depreciation expense. C) The auditors should consider issuing an adverse opinion on the client's financial statements, on the grounds that the misstatement could be considered both material and pervasive. D) The auditors should consider issuing a scope limitation on the client's fixed asset accounts, as further audit testing may have eliminated this issue. Answer: C Explanation: The auditors should consider issuing an adverse opinion on the client's financial statements, on the grounds that the misstatement could be considered both material and pervasive. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

70) When a client has a going concern issue, AU-C 570 The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern requires an ________. A) emphasis-of-matter paragraph be added to the unmodified report, before the opinion paragraph B) an emphasis-of-matter paragraph be added to the unmodified report, after the opinion paragraph C) an explanatory paragraph be added to the unmodified report, after the opinion paragraph D) an explanatory paragraph be added to the unmodified report, before the opinion paragraph Answer: B Explanation: AU-C 570 The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern requires an emphasis-of-matter paragraph be added to the unmodified report, after the opinion paragraph. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 71) Companies typically present their financial statements in comparative form, which means showing ________. A) three consecutive years of balance sheets and four consecutive years of the income statement, statement of cash flows, and statement of stockholders' equity B) two consecutive years of balance sheets and two consecutive years of the income statement, statement of cash flows, and statement of stockholders' equity C) the last fiscal year's balance sheet income statement, statement of cash flows, and statement of stockholders' equity D) two consecutive years of balance sheets and three consecutive years of the income statement, statement of cash flows, and statement of stockholders' equity Answer: D Explanation: Companies typically present their financial statements in comparative form, which means showing two consecutive years of balance sheets and three consecutive years of the income statement, statement of cash flows, and statement of stockholders' equity. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

72) An auditor issues a modified audit opinion when the auditor ________. A) concludes the financial statements are not presented fairly in accordance with the applicable financial reporting framework because of one or more material misstatements B) concludes the financial statements are not presented fairly in accordance with the applicable financial reporting framework because of one or more immaterial misstatements C) is able to gather sufficient appropriate audit evidence to draw a conclusion as to the fair presentation of the financial statements D) is not able to gather sufficient appropriate audit evidence to draw a conclusion about the unfair presentation of the financial statements Answer: A Explanation: An auditor issues a modified audit opinion when the auditor concludes the financial statements are not presented fairly in accordance with the applicable financial reporting framework because of one or more material misstatements. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 73) Akey factor in determining which type of modified report to issue is ________. A) objectivity B) independence C) materiality D) existence Answer: C Explanation: Materiality is akey factor in determining which type of modified report to issue. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

74) In regard to subsequent facts, the auditor ________. A) has no responsibility B) is responsible for making reasonable efforts to detect any material subsequent facts C) is responsible for making reasonable efforts to detect any immaterial subsequent facts D) is only responsible for material events occurring before the balance sheet date Answer: B Explanation: In regard to subsequent facts, the auditor is responsible for making reasonable efforts to detect any material subsequent facts. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 75) If a misstatement is considered material, ________. A) it should have no bearing on financial statement users and their decisions B) it could affect decisions that users make if the users are made aware of the misstatement C) it should not affect decisions that users make if the users are made aware of the misstatement D) an auditor should immediately issue an adverse opinion Answer: B Explanation: If a misstatement is considered material, it could affect decisions that users make if the users are made aware of the misstatement. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 76) If a scope limitation is material, ________. A) auditors cannot state a conclusion without evidence to support the conclusion B) auditors should state a conclusion even without evidence to support the conclusion C) it is of no relevance to the financial statements and their users D) the auditor should immediately withdraw from the engagement Answer: A Explanation: If a scope limitation is material, auditors cannot state a conclusion without evidence to support the conclusion. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

77) Which of the following are characteristics of a pervasive misstatement or scope limitation? A) It is not confined to specific elements, accounts, or items of the financial statements B) If it is confined, it represents or could represent a substantial portion of the financial statements C) In the context of disclosures, it is fundamental to users' understanding of the financial statements D) All of these answer choices are correct Answer: D Explanation: Characteristics of a pervasive misstatement or scope limitation are as follows: o It is not confined to specific elements, accounts, or items of the financial statements. o If it is confined, it represents or could represent a substantial portion of the financial statements. o In the context of disclosures, it is fundamental to users' understanding of the financial statements (AU-C 705.06). Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 78) Auditors must use their professional judgment ________. A) to distinguish if a misstatement or scope limitation is just material or pervasively material B) to distinguish if a misstatement or scope limitation is just immaterial or pervasively material C) to determine if the firm has the ability to pay the auditor for services rendered D) in selecting the client's audit committee Answer: A Explanation: Auditors must use their professional judgment to distinguish if a misstatement or scope limitation is just material or pervasively material. Diff: 1 LO: 4 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

79) With respect to the issuance of an audit report, the level of materiality will determine ________. A) how much the auditor charges for services rendered B) which modified opinion should be issued, if any C) which unmodified opinion should be issued D) which type of adverse opinion should be issued Answer: B Explanation: With respect to the issuance of an audit report, the level of materiality will determine which modified opinion should be issued, if any. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 80) Material misstatements discovered during the audit ________. A) are a basis for the auditor to immediately issue a scope limitation B) are discussed with the client's legal counsel only, and usually they make the recommended adjustment to correct the misstatement C) are discussed with management, and usually management makes the recommended adjustment to correct the misstatement D) require a note disclosure in the financial statements Answer: C Explanation: Material misstatements discovered during the audit are discussed with management, and usually management makes the recommended adjustment to correct the misstatement. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

81) A material misstatement occurs when ________. A) management incorrectly calculate profitability ratios B) the client departs from the applicable financial reporting framework C) the client abides with the applicable financial reporting framework D) the auditor does not receive the agreed upon compensation from the firm Answer: B Explanation: A material misstatement occurs when the client departs from the applicable financial reporting framework. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 82) The date of the auditor's report should be the ________. A) same date as the financial statement date B) date of the completion of fieldwork C) date the audit report is sent to the SEC for approval D) date the auditor receives the audit report from the internal auditors Answer: B Explanation: The date of the auditor's report is the date of the completion of fieldwork. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

83) AU-C 560 and AS 2905 state the first step when responding to subsequently discovered facts is to ________. A) discuss the matter with the appropriate level of management and, if appropriate, those charged with governance B) discuss the matter with the appropriate level of management rather than those charged with governance C) issue a disclaimer of opinion, to avoid liability D) immediately notify the board of directors, and request the internal audit function investigate accordingly Answer: A Explanation: AU-C 560 and AS 2905 state the first step when responding to subsequently discovered facts is to discuss the matter with the appropriate level of management and, if appropriate, those charged with governance. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 84) If management revises the financial statements due to subsequently discovered facts, auditors should ________. A) perform no further audit procedures on the changes made by management B) perform audit procedures on the changes made by management C) always issue a qualified opinion with respect to the changes D) issue a scope limitation, even if they are able to audit the changes Answer: B Explanation: If management revises the financial statements due to subsequently discovered facts, auditors should perform audit procedures on the changes made by management. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

85) Performing audit procedures after the end of fieldwork ________. A) has no impact on the date of the audit report B) automatically extends the date of the audit report by 90 days C) automatically extends the date of the audit report by 30 days D) impacts the dating of the audit report Answer: D Explanation: Performing audit procedures after the end of fieldwork impacts the dating of the audit report. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 86) Dual dating refers to when the auditor ________. A) shows two dates on the same audit report B) shows two dates on two different audit reports C) references last year's audit report concurrently with the current year report D) also includes the date that the internal control function issued their audit opinion Answer: A Explanation: Dual dating refers to when the auditor shows two dates on the same audit report. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 87) Whether auditors choose to dual date the audit report, or extend the end of fieldwork, ________. A) their liability with respect to the financial statements remains the same B) they must request written representation from management as of the new date of the auditor's report C) they must request written representation from the internal auditors as of the new date of the auditor's report D) no further representations should be requested of management Answer: B Explanation: Whether auditors choose to dual date the audit report, or extend the end of fieldwork, they must request written representation from management as of the new date of the auditor's report. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 38

88) If the auditor's opinion on the revised financial statements is different from the previously issued audit report, ________. A) a disclaimer of opinion should be issued B) a scope limitation should be issued C) then an emphasis-of-matter paragraph should be added to the revised audit report after the opinion paragraph. D) then a management opinion paragraph should be added to the revised audit report after the opinion paragraph Answer: C Explanation: If the auditor's opinion on the revised financial statements is different from the previously issued audit report, then an emphasis-of-matter paragraph should be added to the revised audit report after the opinion paragraph. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 89) An emphasis-of-matter paragraph in regard to revised financial statements should include ________. A) the date of the auditor's previous report B) the type of opinion previously expressed C) the key reasons for a different opinion, if there are two different opinions D) all of these answer choices are correct Answer: D Explanation: The emphasis-of-matter paragraph in regard to revised financial statements would include the date of the auditor's previous report, the type of opinion previously expressed, a statement that the opinion on the revised financial statements is different from the previous opinion, and the key reasons for the different opinion. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

90) An example of a scenario which would cause the auditors to modify the opinion on internal control would be ________. A) hiring of a new Chief Operating Officer B) there is a restriction on the scope of the auditor's work C) there is a restriction on the scope of the prior auditor's work D) certain analytical procedures conducted yield expected results Answer: B Explanation: There are two scenarios that would cause auditors to modify the opinion on internal controls over financial reporting (ICFR): (1) One or more material weaknesses in ICFR is/are identified, or (2) There is a restriction on the scope of the auditor's work. Diff: 1 LO: 5 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 91) A/an ________ is an event that occurs between the date of the financial statements and the date of the auditor's report. A) subsequent event B) dual event date C) auditor's report event D) financial event Answer: A Explanation: A subsequent event is an event that occurs between the date of the financial statements and the date of the auditor's report. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

92) Whether auditors choose to dual date or extend the end of fieldwork, they must obtain a/an ________ from management. A) written representation letter B) management representation letter C) auditing representation letter D) auditor's report date letter Answer: A Explanation: Whether auditors choose to dual date or extend the end of fieldwork, they must obtain a written representation letter from management. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 93) If the auditor's opinion on the revised financial statements is different from the previously issued audit report, then a/an ________ should be added to the revised audit report. A) emphasis-of-matter paragraph B) going concern paragraph C) auditor's responsibility paragraph D) opinion paragraph Answer: A Explanation: If the auditor's opinion on the revised financial statements is different from the previously issued audit report, then an emphasis-of-matter paragraph should be added to the revised audit report. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

94) Eric's CPAs have recently completed the audit of Sunglow Corporation. Since the date of the audit report, it has come to light that significant related party transactions had occurred in the past year. As a result of this finding, what should the audit firm do? A) The audit firm should advise client management that because this information did not come to light until after the date of the audit report, they have no responsibility for this new information. B) The audit firm should extend audit procedures to effectively audit this new information, and consider amending the audit opinion if necessary. C) The audit firm should audit the areas affected by this new disclosure, but make it clear in the audit report that the date of the report is not being extended. D) None of these answer choices are correct. Answer: B Explanation: The audit firm should extend audit procedures to effectively audit this new information, and consider amending the audit opinion if necessary. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 95) Right before the audit report release date for Hewitt Corporation, the audit firm, Jackson CPAs, learn that a major planned secondary stock offering has fallen through. Based on this information, which of the following courses of action should the auditors take? A) The auditors should formally communicate to client management that the audit is over, and they have no legal liability for any litigation related to this failed stock offering. B) The auditors should consider discussing the issue with management, and consider recommending note disclosures in the financial statements related to this. C) The auditors should consider auditing all of the client's stockholder's equity accounts again, in order to be able to provide the same level of assurance. D) The auditors should consider disclaiming an opinion on the client's stockholders' equity accounts, in order to avoid future litigation related to this area. Answer: B Explanation: The auditors should consider discussing the issue with management, and consider recommending note disclosures in the financial statements related to this. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

96) Tyffany and Troy are discussing the topic of integrated audits one day right after their auditing class. Tyffany mentions to Troy that she is unsure as to what exactly an integrated audit is, and asks Troy to provide an overview. Which of the following represents Troy's best response to this query? A) An integrated audit deals with the fact that both the external and internal auditors are usually involved in the audit, i.e. their work is integrated. B) An integrated audit gets its name from the fact that we audit both the client's internal controls over financial reporting, as well as its financial statements. C) An integrated audit is basically an audit of a client's financial statements and note disclosures. We are integrating both the quantitative and qualitative aspects of the audit. D) None of these answer choices are correct. Answer: B Explanation: An integrated audit gets its name from the fact that we audit both the client's internal control as well as its financial statements. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 97) Upon conclusion of the audit of Fenton Corporation, the external auditors have determined that a material weakness exists in the client's system of internal control. As a result of this finding, which of the following are the auditors most likely to do? A) The auditors are likely to issue a qualified opinion on internal control, and an unmodified opinion on the financial statements. B) The auditors are likely to issue an unmodified opinion on the financial statements, and a qualified opinion on internal control. C) The auditors are likely to issue an adverse opinion on internal control, with details of the material weakness provided in a separate paragraph. D) The auditors are likely to disclaim an opinion on both the client's system of internal control and financial statements, in order to preserve the reputation of the firm. Answer: C Explanation: The auditors are likely to issue an adverse opinion on internal control, with details of the material weakness provided in a separate paragraph. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

98) At the conclusion of the audit of Gatsby Enterprises, the audit firm, Dane CPAs, has been unable to evaluate the details of a significant recent equity issuance performed by the client prior to year-end. As a result of this, which of the following are the auditors likely to do? A) The auditors will likely consider this a scope limitation, and proceed with issuance of a disclaimer of opinion. B) The auditors will likely issue an adverse opinion, due to the materiality associated with stockholder's equity accounts. C) The auditors will typically consider this to be a scope limitation, and proceed with issuance of a scope limitation opinion on the financial statements. D) None of these answer choices are correct. Answer: A Explanation: The auditors will likely consider this a scope limitation, and proceed with issuance of a disclaimer of opinion. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 99) An integrated audit is defined as ________. A) an audit of a client's financial statements B) an audit of a client's system of internal control C) performing the financial statement audit and the audit of the effectiveness of internal control over financial reporting (ICFR) at the same time D) both the external and internal auditors performing the financial statement audit Answer: C Explanation: An integrated audit is defined as performing the financial statement audit and the audit of the effectiveness of ICFR at the same time. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

100) According to PCAOB AS 2201, ________. A) publicly traded companies are required to have an audit of the effectiveness of internal control over financial reporting (ICFR) B) privately traded companies are required to have an audit of the effectiveness of internal control over financial reporting (ICFR) C) companies should provide clear note disclosures for any change in inventory method D) companies should clearly disclose which financial investments are being accounted for at fair value Answer: A Explanation: According to PCAOB AS 2201, publicly traded companies are required to have an audit of the effectiveness of internal controls over financial reporting (ICFR). Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None 101) An integrated audit refers to ________. A) integrating the opinion of the prior auditor into the current year audit B) allowing the firm's legal counsel to amend the audit report as they see fit C) performing the financial statement audit and the audit of the effectiveness of internal control over financial reporting (ICFR) at the same time D) only auditing the financial statements, with no procedures extended to the system of internal control Answer: C Explanation: Auditors of public companies can perform an integrated audit, which means performing the financial statement audit and the audit of the effectiveness of ICFR at the same time. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

102) If an internal control exception is identified, the auditor ________. A) must use their professional judgment to determine if the exception is a control deficiency, a significant deficiency, or a material weakness B) must use published frameworks to determine if the exception is a control deficiency, a significant deficiency, or a material weakness C) should notify the Securities and Exchange Commission (SEC) within 14 days D) should consider withdrawing from the engagement Answer: A Explanation: If an internal control exception is identified, auditors must use their professional judgment to determine if the exception is a control deficiency, a significant deficiency, or a material weakness. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 103) When a material weakness is identified, the auditor should ________. A) presume that a material misstatement exists in the financial statements B) not presume that a material misstatement occurred in the financial statements C) immediately request the internal audit function conduct a full review of the control issue D) proceed with issuing an unmodified opinion Answer: B Explanation: When a material weakness is identified, the auditor should NOT presume that a material misstatement occurred in the financial statements. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 104) Adverse opinions on the effectiveness of internal control are ________. A) commonplace among larger companies B) rare for large, well-established companies C) never seen in practice D) routinely seen in practice Answer: B Explanation: In practice, adverse opinions on the effectiveness of ICFR are rare for large, wellestablished companies. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 46

105) When an adverse opinion is issued regarding internal control over financial reporting (ICFR), the auditor ________. A) opines that the company has fairly reported its financial statements in accordance with Generally Accepted Accounting Principles (GAAP) B) makes a clear statement that the company has not maintained effective internal control for the period under audit C) makes a clear statement that the company has maintained effective internal control for the period under audit D) is not entitled to receive full compensation for services rendered during the audit Answer: B Explanation: When an adverse opinion is issued regarding internal control over financial reporting (ICFR), the auditor makes a clear statement that the company has not maintained effective internal control for the period under audit. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 106) A material weakness in internal control over financial reporting (ICFR) is defined as ________. A) a deficiency, or a combination of deficiencies, in internal control over financial reporting B) a single deficiency in internal control over financial reporting C) multiple deficiencies in internal control over financial reporting D) any account balance that the auditor has concluded is incorrect by more than a predetermined percentage Answer: A Explanation: A material weakness in ICFR is defined as a deficiency, or a combination of deficiencies in internal control over financial reporting. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

107) A scope limitation in regard to and audit of internal control over financial reporting (ICFR) occurs when the auditors ________. A) are able to audit all of a client's accounts without issue B) cannot perform planned procedures to gather sufficient appropriate evidence regarding the design and effectiveness of a client's internal controls C) cannot perform planned procedures to gather sufficient appropriate evidence regarding the design and effectiveness of a client's financial statements D) have not been prepaid for audit services, and is unable to collect the associated receivable Answer: B Explanation: A scope limitation in regard to an audit of internal control over financial reporting (ICFR) occurs when auditors cannot perform planned procedures to gather sufficient appropriate evidence regarding the design and effectiveness of a client's internal controls. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 108) Auditors of public companies can perform a/an ________, which means performing the financial statement audit and the audit of the effectiveness of internal control over financial reporting (ICFR) at the same time. A) integrated audit B) internal audit C) compliance audit D) investigative audit Answer: A Explanation: Auditors of public companies can perform an integrated audit, which means performing the financial statement audit and the audit of the effectiveness of ICFR at the same time. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

109) Which component of an unqualified opinion defines the concept of internal control over financial reporting (ICFR) and states inherent limitations of ICFR? A) Definition and inherent limitations paragraph B) Paragraph referencing the financial statement audit C) Scope paragraph D) Basis for opinion paragraph Answer: A Explanation: The definition and inherent limitations paragraph defines the concept of ICFR and states inherent limitations of ICFR. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 110) When an adverse opinion is issued regarding internal control over financial reporting (ICFR), the auditor ________. A) maintains that the company has fairly reported its financial statements in accordance with Generally Accepted Accounting Principles (GAAP) B) makes a clear statement that the company has not maintained effective internal control for the period under audit C) makes a clear statement that the company has maintained effective internal control for the period under audit D) is not entitled to receive full compensation for services rendered during the audit Answer: B Explanation: When an adverse opinion is issued regarding internal control over financial reporting, the auditor makes a clear statement that the company has not maintained effective internal control for the period under audit. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

111) A compilation engagement is ________. A) an audit of the financial statements, whereby an auditor expresses an opinion on the financial statements B) an audit of the system of internal control, whereby an auditor expresses an opinion on the system of internal control C) when an accounting firm assists management in the presentation of financial statements but does not audit, review, nor provide assurance as to whether the financial statements are presented fairly D) when an audit firm assists management in the presentation of financial statements and attempts to provide assurance as to whether the financial statements are presented fairly Answer: C Explanation: In a compilation engagement, an accounting firm assists management in the presentation of financial statements but will not audit, review, nor provide assurance as to whether the financial statements are presented fairly. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 112) In a compilation engagement, ________. A) an internal auditor reviews the client firm's filings with the Securities and Exchange Commission (SEC) for compliance and accuracy B) the CPA will assist management in the presentation of financial statements and will provide assurance as to whether the financial statements are presented fairly in accordance with the applicable financial reporting framework C) the CPA will assist management in the presentation of financial statements but will not provide assurance as to whether the financial statements are presented fairly in accordance with the applicable financial reporting framework D) the current and prior auditors will jointly determine the fairness and conformity of a client's financial statements Answer: C Explanation: In a compilation engagement, the CPA will assist management in the presentation of financial statements but will not provide assurance as to whether the financial statements are presented fairly in accordance with the applicable financial reporting framework. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

113) Holder Enterprises, a small firm operating in the southern United States has approached Howard CPAs and requested assistance with its financial statements. Holder Enterprises' accountant recently left the firm for a better position elsewhere, and no-one else at the firm has the expertise to do this. Which of the following types of engagements would this represent? A) This would represent an attestation engagement, as any time a CPA firm helps with financial statements, it is legally liable for them. B) This would represent a preparation of financial statements engagement, as the CPA firm is merely engaged in the practice of preparing the financial statements. C) This would represent a compilation engagement, as in preparing the financial statements, the CPA firm is having to compile information. D) This would represent an auditing engagement, as if the CPA firm discovers misstatements, they are liable for them. Answer: B Explanation: This would represent a preparation of financial statements engagement, as the CPA firm is merely engaged in the practice of preparing. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 114) A CPA firm has been approached by a local small business and has been requested to assist management in preparation of the financial statements. Which of the following correctly represents the type of engagement this would be classified as? A) This would be classified as an attestation engagement, as the CPA firm can still be held legally liable for misstatements. B) This would be classified as a compilation engagement, as the CPA firm is simply assisting management with financial statement preparation. C) This would be classified as a review engagement, as the CPA firm will undoubtedly review the information before signing any documents related to the engagement. D) None of these answer choices are correct. Answer: B Explanation: This would be classified as a compilation engagement, as the CPA firm is simply assisting management with financial statement preparation. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

115) Dixon CPAs has been hired by a local firm to perform a review of its financial statements. The partners of Dixon are meeting with the client's management to discuss the engagement and the CPA firm's liability. Which of the following most accurately describes this? A) The auditor's liability in this scenario is the same as a full attestation engagement, as the auditor is expressing assurance. B) The auditor's liability in this scenario is confined to limited assurance, which is less than the level of assurance offered as part of a regular audit. C) The auditor's liability in this scenario is extended to full assurance, which is a level of assurance higher than the reasonable assurance offered as part of an attestation engagement. D) As part of the engagement, the auditor must agree that it has responsibility for fair presentation of the financial statements in accordance with the applicable framework. Answer: B Explanation: The auditor's liability in this scenario is confined to limited assurance, which is less than the level of assurance offered as part of a regular audit. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 116) A compilation engagement would be described as ________. A) a non-attest service B) an attest service C) an audit engagement D) an assurance service Answer: B Explanation: A compilation is considered an attest engagement because the CPA issues a report at the end of a compilation engagement. Diff: 1 LO: 7 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Measurement Analysis and Interpretation; PC: None

117) AR-C 80, Compilation Engagements ________. A) provides guidance on materiality thresholds B) assists the auditor with respect to fee arrangements C) provides guidance for the performance of a compilation engagement D) provides guidance for the performance of an audit engagement Answer: C Explanation: AR-C 80, Compilation Engagements, provides guidance for the performance of a compilation engagement. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 118) At the conclusion of a compilation engagement, ________. A) the auditor provides a verbal report to management only B) the auditor attests to the accuracy and fairness of the financial statements C) the CPA provides a written compilation report to the client D) the auditor uses the compilation report to assist the client in raising funds in capital markets Answer: C Explanation: At the conclusion of a compilation engagement the CPA provides a written compilation report to the client. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 119) A review engagement ________. A) comes under the umbrella of non-attest services B) comes under the umbrella of assurance services C) is an attest engagement performed on the financial statements of a private company client D) is virtually identical to an audit of a client's financial statements Answer: C Explanation: A review engagement is an attest engagement performed on the financial statements of a private company client. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None

120) In which of the following engagements does the CPA provides limited assurance that no material modifications should be made to the financial statements for them to be in accordance with the applicable financial reporting framework? A) Review engagement B) Compilation engagement C) Audit engagement D) Material engagement Answer: A Explanation: In a review engagement, the CPA provides limited assurance that no material modifications should be made to the financial statements for them to be in accordance with the applicable financial reporting framework. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 121) In a financial statement audit, which level of assurance provides that no material modifications should be made to the financial statements for them to be in accordance with the applicable financial reporting framework? A) Reasonable assurance B) Limited assurance C) No assurance D) None of the answers are correct. Answer: A Explanation: A financial statement audit provides reasonable assurance that no material modifications should be made to the financial statements for them to be in accordance with the applicable financial reporting framework. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 122) An audit involves performing ________ to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. Answer: procedures Explanation: An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Risk Assessment, Analysis and Management; PC: None 54

123) The purpose of a/an ________ is to provide financial statement users with an opinion by an independent auditor on whether the financial statements are presented fairly in accordance with an applicable financial reporting framework. Answer: audit Explanation: The purpose of an audit is to provide financial statement users with an opinion by an independent auditor on whether the financial statements are presented fairly in accordance with an applicable financial reporting framework. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 124) If a change in accounting principle has a material effect on the comparability of the financial statements, then AU-C 708 requires auditors to add an ________ paragraph to the auditor's report. Answer: emphasis-of-matter Explanation: If a change in accounting principle has a material effect on the comparability of the financial statements, then AU-C 708 requires auditors to add an emphasis-of-matter paragraph to the auditor's report. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 125) It is the responsibility of the ________ to ensure that the work completed by a component auditor meets the auditing requirements and standards. Answer: group engagement partner Explanation: It is the responsibility of the group engagement partner to ensure that the work completed by a component auditor meets the auditing requirements and standards. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

126) When the auditor cannot complete some portion of the planned audit procedures, this is referred to as ________. Answer: scope limitation Explanation: When the auditor cannot complete some portion of the planned audit procedures, this is referred to as scope limitation. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 127) A company's internal control over financial reporting is a ________ designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes. Answer: process Explanation: A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes. Diff: 1 LO: 6 Bloom: Comprehension Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 128) If auditors determine that one or more material weaknesses exist in an audit of internal control over financial reporting (ICFR) they must issue a/an ________ on the effectiveness of ICFR. Answer: adverse opinion Explanation: If auditors determine that one or more material weaknesses exist, they must issue an adverse opinion on the effectiveness of ICFR. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

129) Match the terms related to an audit report with their details. A. Title of an unmodified opinion B. Opinion paragraph of an unmodified opinion C. Scope paragraph of an unmodified opinion D. Audit ____ It involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. ____ It briefly explains the process of conducting an audit and that the Public Company Accounting Oversight Board (PCAOB) standards were followed. ____ It identifies the statements being audited and states the auditor's opinion. ____ It must include the terms "registered" and "independent." Answer: The title of an unmodified opinion must include the terms "registered" and "independent." The opinion paragraph of an unmodified opinion identifies the statements being audited and states the auditor's opinion. The scope paragraph of an unmodified opinion briefly explains the process of conducting an audit and that the PCAOB standards were followed. Audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial reports. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

130) Match the concepts related to an audit report with their details. A. Emphasis-of-matter paragraph B. Reporting standards C. Going concern issue with a client D. Core concept in accounting ____ They are quite similar for private and public company audits. ____ It requires accounting principles to be applied consistently from one accounting period to the next. ____ It requires emphasis-of-matter paragraph to be added to the unmodified report, after the opinion paragraph. ____ It is of such importance that it is fundamental to users’ understanding of the financial statements. Answer: The emphasis-of-matter paragraph is of such importance that it is fundamental to users' understanding of the financial statements. Reporting standards are quite similar for private and public company audits. A going concern issue with a client requires emphasis-of-matter paragraph to be added to the unmodified report, after the opinion paragraph. A core concept in accounting requires accounting principles to be applied consistently from one accounting period to the next. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

131) Match the concepts related to the audit report with their details. A. Not referencing the component auditor in the audit report B. Principal auditor C. Group engagement team D. Audit ____ It is responsible for the overall audit strategy for all of the components. ____ It refers to the firm of the group engagement team. ____ It means the group engagement partner is assuming responsibility for the work of the component auditor. ____ It involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. Answer: Not referencing the component auditor in the audit report means the group engagement partner is assuming responsibility for the work of the component auditor. A principal auditor refers to the firm of the group engagement team. A group engagement team is responsible for the overall audit strategy for all of the components. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

132) Match the terms related to audit opinion with their details. A. Pervasive B. Qualified opinion C. Adverse opinion D. Disclaimer of opinion ____ It is issued if a scope limitation is material and pervasive. ____ It is a description of the impact or possible impact of a material misstatement or material scope limitation on the financial statements as a whole. ____ It is issued if a misstatement is material but not pervasive. ____ It is issued when the auditors state the financial statements are not fairly presented due to a pervasively material departure from the applicable financial reporting framework. Answer: Pervasive is a description of the impact or possible impact of a material misstatement or material scope limitation on the financial statements as a whole. A qualified opinion is issued if a misstatement is material, but not pervasive. An adverse opinion is issued when the auditors state the financial statements are not fairly presented due to a pervasively material departure from the applicable financial reporting framework. A disclaimer of opinion is issued if a scope limitation is material and pervasive. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

133) Match the concepts related to the auditor's report with their details. A. Subsequently discovered fact B. Date of auditor's report C. Dual dating D. Written representation letter ____ It shows two dates on an audit report; one date is the end of fieldwork and the other is the date of a revision to the financial statements that occurred after the end of fieldwork. ____ It must be obtained when auditors choose to extend the end of fieldwork. ____ It is the date of the completion of fieldwork. ____ It is a fact that becomes known to the auditor after the date of the auditor's report. Answer: A subsequently discovered fact is a fact that becomes known to the auditor after the date of the auditor's report. The date of auditor's report is the date of the completion of fieldwork. Dual dating shows two dates on an audit report; one date is the end of fieldwork and the other is the date of a revision to the financial statements that occurred after the end of fieldwork. A written representation letter must be obtained when auditors choose to extend the end of fieldwork. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

134) Match the concepts related to the auditor's report with their details. A. A company's internal control over financial reporting (ICFR) B. Material weakness C. Scope limitation D. Disclaimer of opinion ____ It occurs when auditors cannot perform planned procedures to gather sufficient appropriate evidence regarding the design and effectiveness of a client's internal controls. ____ It states that the auditor does not express an opinion on the effectiveness of ICFR. ____ It is a deficiency, or a combination of deficiencies, in internal control over financial reporting. ____ It is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes. Answer: A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting. A scope limitation occurs when auditors cannot perform planned procedures to gather sufficient appropriate evidence regarding the design and effectiveness of a client's internal controls. A disclaimer of opinion states that the auditor does not express an opinion on the effectiveness of ICFR. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

135) Match the terms related to the auditor's report with their details. A. Review engagement B. Inquiry and analytical procedures C. Limited assurance D. Reasonable assurance ____ Designed to focus on areas the CPA believes to have increased risks of material misstatements. ____ Provided by the CPA in a review engagement. ____ A CPA uses inquiry and analytical procedures to provide limited assurance that no material modifications should be made to the financial statements for them to be in accordance with the applicable financial reporting framework. ____ Provided by the CPA in an audit engagement. Answer: A review engagement is an engagement in which a CPA uses inquiry and analytical procedures to provide limited assurance that no material modifications should be made to the financial statements for them to be in accordance with the applicable financial reporting framework. Inquiry and analytical procedures are designed to focus on areas the CPA believes to have increased risks of material misstatements. Limited assurance is provided by the CPA in a review engagement. Reasonable assurance is provided by the CPA in an audit engagement. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

136) Jethro CPAs have just completed the audit of Bloom Corporation, and are preparing to issue an audit opinion and report on the corporation's financial statements. The results of the audit report noted two material misstatements which were corrected by the client before the conclusion of the audit. Based on this information, which of the following is correct? Select all that apply. A) The auditors will most likely proceed with issuing an unmodified audit opinion on the client's financial statements. B) The auditors will issue a qualified opinion based on the two areas that the misstatements were located. C) The auditors are likely to conclude that the financial statements are presented fairly, in all material respects. D) The auditors will likely conclude that the entity has appropriately used generally accepted auditing standards as the applicable financial reporting framework. Answer: A, C Explanation: The auditors will most likely proceed with issuing an unmodified audit opinion on the client's financial statements. The auditors are likely to conclude that the financial statements are presented fairly, in all material respects. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 137) At the conclusion of the audit of Newberry Enterprises, LLC, the auditors, Parker CPAs are reviewing the work and audit procedures carried out. One of the audit managers notes that the client had performed some extremely complex calculations in order to arrive at what they believed was an accurate value for a recently acquired subsidiary. Based on this information, what might the auditors decide to do? Select all that apply. A) The auditors may decide to classify this as a critical audit matter, and request the client disclose this information in the financial statements. B) The auditors may decide to disclaim an opinion on this area of the financial statements, in order to preserve the reputation of the firm. C) The auditors may classify this as a critical audit matter due to its complexity and subjective nature. D) The auditors may perform their own calculations for goodwill and propose adjusting entries to the client accordingly. Answer: A, C Explanation: The auditors may decide to classify this as a critical audit matter, and request the client disclose this information in the financial statements. The auditors may classify this as a critical audit matter due to its complexity and subjective nature. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 64

138) Upon the conclusion of audit fieldwork for the audit of Blossom Corporation, the auditors are preparing to issue the audit report. A major concern for the auditors during this year's audit was the client's going concern assumption. The client's senior management has agreed to add a note disclosure to the financial statements explaining their plan to alleviate this problem. As a result of this, which courses of action should the auditors take? Select all that apply? A) The auditors should plan to issue an unmodified opinion on the client's financial statements if they agree with management's assessment of the situation and plan to remedy it. B) The auditors should consider either disclaiming an opinion or at minimum issuing a qualified opinion on the financial statements if management's disclosure are not adequate. C) The auditors should consider adding their own wording to the client's financial statement disclosures to ensure full transparency to firm stakeholders. D) The auditors should consider making this the last audit, as being associated with a client with going concern issues may damage the auditors' reputation. Answer: A Explanation: The auditors should plan to issue an unmodified opinion on the client's financial statements if they agree with management's assessment of the situation and plan to remedy it. The auditors should consider either disclaiming an opinion or at minimum issuing a qualified opinion on the financial statements if management's disclosure are not adequate. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

139) At the conclusion of the audit of Maxim Corporation, the auditors, Jasmine CPAs are preparing to issue their audit report on the client's financial statements. The auditors are concerned about a contingent liability the client has recorded related to potential litigation it may face in the future. As a result of this, which courses of action are the auditors likely to take? Select all that apply. A) The auditors are likely to proceed with disclaiming an audit opinion on the financial statements. B) The auditors may decide to add an emphasis-of-matter paragraph to draw attention to this matter. C) The auditors will likely draw on their experience and professional judgment to determine if an emphasis-of-matter paragraph is required or appropriate. D) The auditors will likely add an addendum to the audit report to indemnify the audit firm of any litigation associated with this contingent liability. Answer: B, C Explanation: The auditors may decide to add an emphasis-of-matter paragraph to draw attention to this matter. The auditors will likely draw on their experience and professional judgment to determine if an emphasis-of-matter paragraph is required or appropriate. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 140) Which three of the following situations are considered a change in accounting principle? A) Changing from one acceptable accounting principle to another acceptable accounting principle B) Changing from one acceptable accounting principle to a newly adopted accounting principle C) Changing the method of applying an acceptable accounting principle D) Changing from one acceptable accounting principal to another accounting principle that is not yet accepted Answer: A, B, C Explanation: The following situations are considered a change in accounting principle: 1. Changing from one acceptable accounting principle to another acceptable accounting principle, 2. Changing from one acceptable accounting principle to a newly adopted accounting principle, 3. Changing the method of applying an acceptable accounting principle. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

141) The portion of the consolidated financial statements audited by the component auditor can be expressed in which of the following three forms? A) Dollar amounts B) Percentages of total assets C) Total revenues D) Account payables Answer: A, B, C Explanation: The portion of the consolidated financial statements audited by the component auditor can be expressed in dollar amounts, percentages of total assets, or total revenues. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 142) Adams CPAs have just completed the audit of Bridge Corporation. During the audit, it was determined that Bridge Corporation had recently purchased a subsidiary and so a component auditor was hired to audit the subsidiary. Which of the following statements is true related to this scenario? Select all that apply. A) The partners at Adams CPAs are responsible for the overall audit strategy. B) It is the responsibility of the auditor auditing the subsidiary to ensure the work meets all requirements and standards of the parent company's auditor. C) The audit opinion issued by the audit firm auditing the subsidiary must match the parent auditors audit opinion, per generally accepted auditing standards. D) The audit firm auditing the parent company must ensure that all work completed by the subsidiary auditor meets their requirements and standards. Answer: A, D Explanation: The partners at Adams CPAs are responsible for the overall audit strategy. The audit firm auditing the parent company must ensure that all work completed by the subsidiary auditor meets their requirements and standards. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

143) At the completion of the audit of Zenith Enterprises, LLC, the auditors have made several requests of the client firm to correct two material misstatements related to allowances for doubtful accounts. The client has advised the audit firm that they will not be correcting the misstatements. As a result of this information, which of the following courses of action might the audit firm decide to take? Select all that apply. A) The auditors will request written assurances from management indemnifying them from any litigation in this area, and will proceed with issuance of an unmodified opinion. B) The auditors will likely be forced to issue a modified opinion, such as a qualified opinion. C) The auditors will likely have to issue a modified opinion. Examples of these would be a disclaimer of opinion or a clean opinion. D) In this situation, the auditors are unlikely to issue a clean audit opinion, as management refused to correct the misstatements. Answer: B, D Explanation: The auditors will likely be forced to issue a modified opinion, such as a qualified opinion or a disclaimer of opinion. In this situation, the auditors are unlikely to issue a clean audit opinion, as management refused to correct the misstatements. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 144) At the conclusion of the audit of Hornet Corporation, a national provider of bug spray and repellant, the auditors, McKee CPAs have noted a major misstatement in the client's financial statements which the client disagrees with the auditor on. Which of the following courses of action are open to the auditor at this point? Select all that apply. A) If the auditor determines that the misstatement could be considered pervasive, the audit firm could issue an adverse opinion on the client's financial statements. B) If the client agrees to correct the material misstatement before issuance of the audit report, it may still be possible for the auditor to issue an unmodified opinion on the financial statements. C) The auditor will likely consider if the misstatement is not just material, but also pervasive. In this context, pervasive would indicate that the misstatement is localized to that account. D) The auditor would likely request extra written assurances from senior management pertaining to the misstatement. Such written assurances would be placed in the current year's audit file. Answer: A, B Explanation: If the auditor determines that the misstatement could be considered pervasive, the audit firm could issue an adverse opinion on the client's financial statements. If the client agrees to correct the material misstatement before issuance of the audit report, it may still be possible for the auditor to issue an unmodified opinion on the financial statements. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 68

145) Which three of the following are scenarios that may cause a material scope limitation? A) Circumstances beyond the control of the entity B) Circumstances relating to the nature or timing of the auditor's work C) Scope limitation imposed by management D) Scope limitation imposed by component auditor Answer: A, B, C Explanation: AU-C 705.A3 lists three scenarios that may cause a material scope limitation: 1. Circumstances beyond the control of the entity, 2. Circumstances relating to the nature or timing of the auditor's work, 3. Scope limitation imposed by management. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 146) What three steps are followed if new information is discovered during the period between the date of the auditor's report and the report release date? A) Discussing the matter with the appropriate level of management B) Determining whether the financial statements need to be revised C) Inquiring of management as to how it will address the situation in the financial statements D) Not altering the opinion if management refuses to sign the updated representation letter or refuses to revise the financial statements Answer: A, B, C Explanation: The following three steps are followed if new information is discovered during the period between the date of the auditor's report and the report release date: 1) Discussing the matter with the appropriate level of management, 2) Determining whether the financial statements need to be revised, 3) Inquiring management as to how it will address the situation in the financial statements. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

147) McGoldrick CPAs have completed the audit for Stones Corporation and issued the audit opinion on the client's financial statements. The firm is yet to release the audited financial statements to the public. Before the report is released, the CPA firm learns that a major loan refinance the client had been working on has been denied by the creditor. As a result of this, which of the following might the auditor decide to do? Select all that apply. A) The auditor may contact the client's senior management and advise that they will be issuing an amended audit opinion. In this case, it will be an adverse opinion. B) The audit firm may decide to perform additional audit procedures and dual date the audit report. C) The audit firm may elect to issue a written notice to the client's management, advising that the audit firm is not legally liable for any litigation arising from the refinance denial. D) The audit firm may elect to perform additional audit procedures and amend the date of the audit report to the date of the subsequently discovered fact. Answer: B, D Explanation: The audit firm may decide to perform additional audit procedures and dual date the audit report. The audit firm may elect to perform additional audit procedures and amend the date of the audit report to the date of the subsequently discovered fact. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

148) Johnny and Sandra are working on the audit of Margate Enterprises, a publicly-traded firm and supplier of cotton products throughout the United States and Canada. Johnny mentions to Sandra that he heard the term 'integrated audit' mentioned in a meeting earlier in the day, and is not sure what exactly this is. Which of the following responses by Sandra would be most helpful? Select all that apply? A) The term integrated audit is actually fairly easy to understand. It just deals with auditing both a parent and subsidiary company. B) An integrated audit gets its name from the fact that for publicly-traded firms, we are required to audit both the client's system of internal control and the financial statements. C) An integrated audit is only required for private firms, and entails auditing both the financial statements and work performed by the internal audit function. D) An integrated audit sees the audit firm evaluating the client's financial statements as well as the effectiveness of internal control. Answer: B, D Explanation: An integrated audit gets its name from the fact that for publicly-traded firms, we are required to audit both the client's system of internal control and the financial statements. An integrated audit sees the audit firm evaluating the client's financial statements as well as the effectiveness of internal control. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 149) Which three of the following are components of unqualified opinion on the effectiveness of internal control over financial reporting (ICFR) for public companies? A) Opinion paragraph B) Scope paragraph C) Basis for opinion paragraph D) Auditory paragraph Answer: A, B, C Explanation: The following three are components of unqualified opinion on the effectiveness of ICFR for public companies: 1. opinion paragraph; 2. scope paragraph; and 3. basis for opinion paragraph. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

150) Which three conditions must be met when a CPA is considering whether to accept a review engagement? A) Management must agree to provide a representation letter at the conclusion of the review engagement. B) The CPA must obtain an agreement from management that it acknowledges its responsibility for the preparation and fair presentation of the financial statements. C) The financial reporting framework selected by management must be acceptable. D) The CPA may not always be independent of the client. Answer: A, B, C Explanation: Three conditions that must be met when a CPA is considering whether to accept a review engagement are as follows: 1. Management must agree to provide a representation letter at the conclusion of the review engagement, 2. The CPA must obtain an agreement from management that it acknowledges its responsibility for the preparation and fair presentation of the financial statements, 3. The financial reporting framework selected by management must be acceptable. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 151) In addition to the attestation engagements that CPA firms routinely perform, other services are typically offered also. Which of the following correctly lists and describes other service that CPA firms may also perform for clients? Select all that apply. A) CPA firms may also provide services related to preparation of financial statements. This service does not provide an opinion on the fairness of the financial statements. B) CPA firms may provide attestation services such as reviewing client's financial statements as a subject matter expert but not expressing an opinion on them. C) CPA firms may provide services related to compilations of financial statements, whereby the firm assists management in preparing and presenting financial statements. D) CPA firms may provide financial statement review services, whereby the CPA firm reviews the opinion expressed on the financial statements by the internal audit function. Answer: B, D Explanation: CPA firms may provide attestation services such as reviewing client's financial statements as a subject matter expert but not expressing an opinion on them. CPA firms may provide financial statement review services, whereby the CPA firm reviews the opinion expressed on the financial statements by the internal audit function. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

152) During the compilation engagement for Cozy Couches Company, CPA Jim Bryce becomes aware that the accounting records and other information provided by management are incomplete and inaccurate. What should Jim Bryce do in this situation? Answer: During a compilation engagement, if the CPA becomes aware that accounting records or other information provided by management are incomplete or inaccurate, the CPA should notify management and ask for additional or corrected information. If the CPA determines that adjustments to the financial statements are necessary for them to be in accordance with the applicable financial reporting framework, the CPA should recommend the adjustments be made by management. If management is unwilling or unable to provide all necessary documentation or is unwilling to make recommended adjustments to the financial statements or disclose that adjustments are needed, the CPA should consider withdrawing from the compilation engagement. Diff: 3 LO: 1 Bloom: Evaluation Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 153) The auditors of BZ Manufacturing completed their fieldwork on February 15, 2022. However, they became aware of a subsequently discovered fact requiring revision on February 20, 2022. Compare and contrast the two options auditors have for dating the audit report in relation to performing audit procedures on subsequently discovered facts that become known before the report release date. Answer: Since additional procedures have been performed after the end of fieldwork, auditors have two options for how to date the audit report. The first option is to date the audit report as of the date of the subsequently discovered fact, which is February 20, 2022. Effectively, auditors are extending fieldwork by five additional days and extending their responsibility period for subsequent events. The second option is to show two dates on the report, which is called dual dating. The report would show the original end of fieldwork date, February 15, 2022, and a reference to a note that is dated February 20, 2022. The date at the bottom of the auditor's report would look like this: February 15, 2022, except as to note X, which is as of February 20, 2022 The dual dating conveys that sufficient appropriate evidence was obtained by February 15, and the auditor's responsibility after that date is limited to the subsequent note disclosure that is dated as of February 20, 2022. The auditor is not taking responsibility for any other events after February 15. Diff: 3 LO: 1 Bloom: Evaluation Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

154) Briefly discuss the conditions that would prohibit an auditor from issuing an unqualified opinion. Answer: Conditions that may require a departure from an unqualified audit report: 1. Scope limitation. A scope limitation results from an inability to collect sufficient appropriate evidence, such as when management prevents the auditor from conducting an audit procedure considered necessary. 2. Departure from Generally Accepted Accounting Procedures (GAAP). The financial statements are affected by a departure from GAAP. 3. Lack of auditor independence. The auditor must comply with the second general standard and the Code of Professional Conduct in order to issue an unqualified opinion. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 155) What type of reports can an auditor issue if they cannot provide an unqualified audit report? Answer: The three types of reports other than unqualified are: 1. Qualified. The auditor's opinion is qualified because of either a scope limitation or a nonpervasive departure from Generally Accepted Accounting Principles (GAAP), but overall the financial statements were presented fairly. 2. Disclaimer. The auditor disclaims an opinion on the financial statements either because there is insufficient appropriate evidence to form an opinion on the overall financial statements or because there is a lack of independence. 3. Adverse. The auditor's opinion states that the financial statements are not presented fairly in conformity with GAAP because the departure materially affects the overall financial statements. Diff: 2 LO: 1 Bloom: Application Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

156) After auditing class, Samantha approaches the professor and explains that while she enjoyed the lecture, she isn't exactly sure why companies need audits from independent firms. Samantha asks the professor to elaborate a little more on this topic. Which of the following is the correct response from the professor to this question? A) It's not that companies really need audit firms to audit their financial statements. It just helps them increase their stock price and lower costs of capital associated with borrowing. B) Companies routinely employ audit firms to audit their financial statements, as it helps to increase investor confidence if an independent third party has scrutinized the firm's financial statements and confirmed that they are accurate and not misleading. C) All companies, whether public or private are required by the Securities and Exchange Commission to have their financial statements and associated disclosures audited once a year. This helps decrease the enforcement efforts that the commission has to make. D) None of these answer choices are correct. Answer: B Explanation: Companies routinely employ audit firms to audit their financial statements, as it helps to increase investor confidence if an independent third party has scrutinized the firm's financial statements and confirmed that they are accurate and not misleading. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

157) Tommy and Melissa have just completed the audit fieldwork for Lucky Enterprises, LLC, and are attempting to determine the appropriate audit opinion for this client. Tommy notes that during the audit, no material misstatements were found, and everything appeared to be in order with respect to the client's financial statements. Based on this information, which of the following is correct? A) Tommy and Melissa should likely proceed with issuance of an unmodified opinion on the grounds that no material misstatements were noted in the client's financial statements. B) Tommy and Melissa should consider issuing a qualified opinion on the client's financial statements. This is because although no misstatements were found, only a sample was examined, not the entire population. C) Tommy and Melissa should consider issuing an adverse opinion on the client's financial statements. The pair should further advise management that when they are able to examine the population of each account, an unmodified opinion can be issued. D) Tommy and Melissa should consider issuing a scope limitation, resulting in a disclaimer of opinion. This is appropriate because they were only able to audit a sample, not the entire population. Answer: A Explanation: Tommy and Melissa should likely proceed with issuance of an unmodified opinion on the grounds that no material misstatements were noted in the client's financial statements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

158) At the conclusion of the audit of Peabody Corporation, the audit firm Herman CPAs notes that a difference of opinion exists between the auditors and management on the allowance for doubtful accounts and associated bad debt expense. The auditors have proposed adjusting entries increasing the allowance and expense but management have refused to record the adjustment. Based on this information, which of the following might the auditors decide to do? A) The auditors are likely to issue an adverse opinion on the client's financial statements. If the client agrees to record the audit firms' proposed adjusting entry in the future, the auditors can always go back and modify the audit opinion. B) The auditors are likely to consider adding a critical audit matter paragraph to the audit report. This may be added on the grounds that the difference in opinion is considered material to the financial statements. C) The auditors will likely issue a scope limitation surrounding the audit of accounts receivable and the related allowance accounts. This will ultimately lead to a disclaimer of opinion. D) None of these answer choices are correct. Answer: B Explanation: The auditors are likely to consider adding a critical audit matter paragraph to the audit report. This may be added on the grounds that the difference in opinion is considered material to the financial statements. Diff: 2 LO: 1 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

159) After completing the audit of Fairman Corporation, the auditors, Hitchcock CPAs has concluded that an unmodified opinion is the appropriate audit opinion to issue. One issue that did come to light during the audit was the forthcoming maturity of a previous large bond issue by the client, and concern over the lack of funds in the sinking fund to cover the large maturity repayment. Based on this information, which of the following might the auditors decide to do? A) The auditors may decide to disclaim an opinion on the client's financial statements. If the bond maturity ends up bankrupting the client, it is better for the audit firm to not be associated with them. B) The auditors may decide to add a note disclosure in the financial statements, alerting firm stakeholders to this upcoming event and disclaiming any liability associated with it. C) The auditors may decide to request firm management add a note disclosure to the financial statements in the interests of transparency. This will allow firm stakeholders to be fully aware of the upcoming maturity. D) The auditors may decide to issue a qualified opinion on the client's financial statements. The qualified opinion would cover everything except the bonds payable account, for which the auditors will disclaim liability. Answer: C Explanation: The auditors may decide to request firm management add a note disclosure to the financial statements in the interests of transparency. This will allow firm stakeholders to be fully aware of the upcoming maturity. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

160) At the conclusion of the audit of Faircloth Corporation, the auditors have determined that no material misstatements exist in the client's financial statements. In a meeting of the audit partners convened to discuss the appropriate audit opinion to render, one of the partners mentions that in the last year, the client has switched from the LIFO to the FIFO method of inventory costing. Based on this information, which of the following might the auditors decide to do? A) The auditors will likely request that senior management add additional note disclosures in the financial statements. These note disclosures should provide reconciliations between the two methods for purposes of conservatism. B) The auditors should consider disclaiming an opinion on all inventory and cost of goods sold accounts to ensure that they minimize any potential liability for the firm. C) The auditors should consider adding an emphasis-of-matter paragraph. This paragraph does not indicate a problem on the part of the client, but rather emphasizes the auditors desire to draw stakeholder's attention to a particular area of the financial statements. D) None of these answer choices are correct. Answer: C Explanation: The auditors should consider adding an emphasis-of-matter paragraph. This paragraph does not indicate a problem on the part of the client, but rather emphasizes the auditors desire to draw stakeholder's attention to a particular area of the financial statements. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

161) Jackie and Douglas are walking across campus one day after their auditing class. Jackie mentions to Douglas that if financial statements are required to be presented according to generally accepted accounting principles, she doesn't really follow why consistency is a big deal. Which of the following represents Douglas' most appropriate response to this comment? A) You're right. Generally accepted accounting principles surely provide all the consistency that users of financial statements need, as it ensures everyone is using the same framework. B) It is important that the financial statements are consistent, especially from one period to the next, as otherwise financial statement users might misinterpret the numbers contained in those statements. C) Financial statements are required per generally accepted auditing standards to be presented in a precise format. Companies that don't follow this precise format are usually the ones who receive qualified or adverse audit opinions. D) It is extremely important that financial statements be prepared in a consistent and comparable way. When financial statements are not prepared according to the applicable reporting framework, auditors usually have to disclaim an opinion on them. Answer: B Explanation: It is important that the financial statements are consistent, especially from one period to the next, as otherwise financial statement users might misinterpret the numbers contained in those statements. Diff: 2 LO: 2 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

162) Sally Jones is a staff accountant and has been assigned to the audit of Pipeline Services, Inc. Subsequent to the completion of fieldwork Sally was assigned to draft the audit report. The content of one of the paragraphs she has drafted reads as follows: As explained in Note 2 to the financial statements, Pipeline has charged goodwill and certain other intangible assets acquired in two separate acquisitions directly to shareholders' equity. Under generally accepted accounting principles, these intangibles should have been recorded as assets and amortized to income over future periods. Had these intangibles been capitalized, total assets would have increased by $500,000 as of December 31, 2025 and net income and earnings per share would be increased by $250,000 and $2.25, respectively (assuming a 20-year amortization period). A. Based on the contents of the paragraph above, which condition requiring a departure from a standard unqualified opinion exists in the engagement? B. Assuming that the engagement partner agrees with the paragraph Sally has drafted, where in the auditor's report should the paragraph be placed? C. How would the materiality of the condition above affect the final choice of opinion? Answer: A. The paragraph indicates a departure from Generally Accepted Accounting Principles (GAAP), which would require a departure from a standard unqualified opinion—either qualified or adverse, depending on the materiality of the issue. B. If a qualified or an adverse report is issued, the paragraph should be placed before the opinion paragraph. C. A material misstatement would require a qualified opinion. A pervasive material misstatement would require an adverse opinion. Diff: 2 LO: 2 Bloom: Application Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

163) Marcus and Matthew are discussing the use of component auditors one day after their auditing class. Marcus asks Matthew if he can explain the role of a component auditor with more clarity, as he wasn't sure he understood what the professor said about this. Which of the following represents Matthew's best response to this query? A) The best way to think about component auditors is the auditing team that we select from within the company to go audit a subsidiary of the client, or perhaps another division in a different location. B) The main role of a component auditor is to ensure that the subsidiary or components financial statements match the parents' financial statements and disclosures. C) The component auditor is usually a different audit firm which is tasked with auditing the financial statements of a subsidiary firm. The parent company auditor still retains overall responsibility for the audit. D) None of these answer choices are correct. Answer: C Explanation: The component auditor is usually a different audit firm which is tasked with auditing the financial statements of a subsidiary firm. The parent company auditor still retains overall responsibility for the audit. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

164) Janine and Cristin are discussing the work of component auditors one day while sitting in the campus cafeteria. Janine mentions to Cristin that she is not sure to what extent the component auditor's shares responsibility for the audit report. Which of the following represents Cristin's most appropriate response? A) The component auditor has no responsibility for the audit report under any circumstances. The component auditor is simply engaged to report on the financial condition of the subsidiary. B) The component auditor shares full responsibility for the audit report issued by the parent company's auditor. This is because the financial statements of the parent company include the subsidiary. C) If the parent company auditors elect not to reference the component auditor in the audit report, then the parent company audit firm assumes full responsibility for the contents of the audit report. D) The parent company auditors and the component company auditors typically preemptively determine a percentage of responsibility and subsequent liability in the event of future litigation. Answer: C Explanation: If the parent company auditors elect not to reference the component auditor in the audit report, then the parent company audit firm assumes full responsibility for the contents of the audit report. Diff: 2 LO: 3 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 165) Upon conclusion of the audit of Saxby Enterprises, LLC, the external auditors have determined that during the most recent fiscal year, the client has switched from the FIFO to the LIFO method for inventory costing method, and has not provided a satisfactory reason for the switch. As a result of this finding, what might the auditors decide to do? A) The auditors may decide to insist that management adjust the inventory costing method back to FIFO. Until this is done, the auditors will refuse to issue an audit report. B) The auditors may decide to modify the audit opinion from the standard, unmodified opinion. In this situation, they may decide to qualify the audit opinion with respect to this switch. C) The auditors may decide to propose adjustments to the inventory account to provide reconciliations from the LIFO method back to the FIFO method and request management include these in accompanying note disclosures. D) None of these answer choices are correct. Answer: B Explanation: The auditors may decide to modify the audit opinion from the standard, unmodified opinion. In this situation, they may decide to qualify the audit opinion with respect to this switch. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 83

166) During the audit of Newsome Corporation, the external auditors have repeatedly requested and been denied access to the full physical inventory and records for the client. Inventory as a percentage of the client's total assets is relatively high in this industry. As a result of this situation, which of the following courses of action might the auditor decide to take? A) The auditors will likely disclaim an opinion on the financial statements, on the basis that because inventory is relatively large percentage of total assets, it would be too risky to offer an opinion. B) The auditors are likely to consider this constraint as a scope limitation. As a result of this the auditors may choose to disclaim an opinion or withdraw from the engagement. C) The auditors are most likely to issue a qualified opinion on this area of the client's financial statements. A qualified opinion would be appropriate because the inventory is a large percentage of total assets. D) The auditors will most likely issue an unmodified opinion on the client's financial statements, with a note to examine the inventory accounts more thoroughly during next year's audit. Answer: B Explanation: The auditors are likely to consider this constraint as a scope limitation. As a result of this the auditors may choose to disclaim an opinion or withdraw from the engagement. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

167) During the audit of Millennium Corporation, the audit firm, Tyson CPAs has advised firm management that they plan to confirm a sample of accounts receivable balances with a randomly selected pool of the client's customers. The client has refused permission for the auditors to undertake this procedure, citing customer privacy over balances owed to the firm. At this juncture, what might the auditors decide to do? A) The auditors are most likely to consider withdrawing from the engagement. If management is uncooperative, it is probably because they are hiding fraud or other material errors. B) The auditors are likely to proceed with contacting a sample of accounts receivable customers anyway. As these customers represent third parties, the auditor does not need the client's expressed permission to contact them. C) The auditors may attempt perform alternative audit procedures. If they are able to do this, they may be able to offer the same level of assurance in this area. D) None of these answer choices are correct. Answer: C Explanation: The auditors may attempt perform alternative audit procedures. If they are able to do this, they may be able to offer the same level of assurance in this area. Diff: 2 LO: 4 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 168) Compare the two scenarios that would cause auditors to modify the audit opinion and provide an example of each. Answer: Student answers will vary but should cover the following: Two scenarios that would cause auditors to modify the opinion for both private and public company clients: (1) The auditor concludes the financial statements are not presented fairly in accordance with the applicable financial reporting framework because of one or more material misstatements. Essentially, the client has departed from accounting standards and will not or cannot correct the departure. (2) The auditor is not able to gather sufficient appropriate audit evidence to draw a conclusion about the fair presentation of the financial statements. In other words, the auditor cannot complete some portion of the planned audit procedures. This is referred to as a scope limitation. Diff: 2 LO: 4 Bloom: Evaluation Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

169) The following four situations require a modification to the standard unqualified audit report. Identify the modification required for each. I. Opinion based in part on the report of another auditor II. Going concern III. Lack of consistency IV. Subsequent event Answer: I. This situation results in a modification of the wording for the three paragraphs included in the standard report II. This situation results in an explanatory paragraph found after the opinion paragraph III. This situation results in an explanatory paragraph found after the opinion paragraph IV. This situation results in an explanatory paragraph found after the opinion paragraph Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 170) Pen and Jones, CPAs, were engaged to perform an audit of the financial statements of AZG, Inc. AZG 's management would not allow Pen and Jones to confirm any of the accounts receivable. All other auditing procedures were performed as considered necessary by Pen and Jones, and no problems were found. However, Pen and Jones, were unable to satisfy themselves with regard to the balance in accounts receivable. - State what type of opinion should be issued on the company's financial statements. - Briefly explain your rationale. - Indicate which paragraphs, if any, of the standard report would be modified. Answer: AZG Inc has imposed a scope limitation on Pen and Jones, CPAs. Although it is possible to issue a qualified opinion for a less material scope limitation, auditing standards state that disclaimers of opinion are more appropriately issued for client-imposed scope limitations than for circumstance-imposed scope limitations. For the disclaimer of opinion: (1) the introductory paragraph would be modified to state that auditors were engaged to audit the financial statements and delete the sentence referring to the auditors' responsibility for the financial statements; (2) the scope paragraph would be omitted; (3) an explanatory paragraph would be added to describe the scope limitation; and, (4) the opinion paragraph would be modified to express a disclaimer of opinion. Diff: 3 LO: 4 Bloom: Synthesis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

171) For each of the following situations, indicate what type of audit report is most appropriate: I. The auditor lacks independence in fact, but not necessarily in appearance. II. There is a scope limitation and it is material, but the overall financial statements are still presented fairly. III. The uncorrected misstatements are immaterial. IV. There is a departure from Generally Accepted Accounting Principles (GAAP), and it is pervasively material. Answer: I. Disclaimer II. Qualified III. Unqualified IV. Adverse Diff: 2 LO: 4 Bloom: Application Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 172) Assume you completed your fieldwork on the XYZ Company audit of the December 31, 2025 financial statements on February 11, 2026. On February 13, 2026, you discovered that XYZ's largest customer filed for bankruptcy. XYZ has not yet released the financial statements. What is your responsibility as an auditor and what steps should be taken, if any? Answer: Auditors are responsible for subsequently discovered facts that become known before the report release date. AU-C 560 and AS 2905 state the first step is to discuss the matter with the appropriate level of management and, if appropriate, those charged with governance. Auditors must determine if the new information is reliable, material, and if it existed at the date of the auditor's report. If so, the next step is to determine whether the financial statements need to be revised. If revision is necessary, auditors should inquire of management as to how management will address the situation in the financial statements, either through adjustment and disclosure or only disclosure. If management revises the financial statements, auditors should perform audit procedures on the changes made by management. The types of audit procedures performed will depend on the circumstances and type of revision made to the financial statements. Performing audit procedures after the end of fieldwork impacts the dating of the audit report. Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

173) Assume you completed your fieldwork on the XYZ Company audit of the December 31, 2025 financial statements on February 15, 2026. The financial statements were released on February 28, 2026. On March 16, 2026, you discovered that XYZ's largest customer filed for bankruptcy, which you believe could have caused you to change the audit report. How is your responsibility as an auditor, and the steps that should be taken, different than if you had been made aware of the subsequently discovered fact before February 28, 2026? Answer: Auditors would follow the same initial steps whether they discovered the information before or after the report release date. First, they would discuss the matter with an appropriate level of management and, if appropriate, those charged with governance. Then they would determine if the new information is reliable, material, and if it would have impacted the financial statements and auditor's report had the information been known at the date of the auditor's report. If so, they would determine whether the financial statements need revision and inquire as to how management plans to address the situation in the financial statements. The auditors would perform audit procedures on the revisions made by management and then reissue the auditor's report along with the revised financial statements. The revised auditor's report would have a new date or follow the dual dating procedure. Diff: 3 LO: 5 Bloom: Evaluation Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None 174) Upon completion of the audit of Burrow Enterprises, the audit firm has recently completed its audit report which has been released, along with the financial statements, to the public. In the last few days, the auditors have learned that due to a new competing product coming out in the marketplace, the value of the client's inventory may be significantly less. As a result of this finding, what might the auditors need to do? A) The auditors have no responsibility in relation to this new information, as this information was not available during the audit. It can be safely ignored. B) The auditors may need to consider extending further audit procedures in this area, attempting to evaluate the value of the client's inventory accounts. C) The auditors should simply add an emphasis-of-matter paragraph to the audit report. This should be done in lieu of any further audit procedures related to inventory. D) The auditors should consider issuing a disclaimer of opinion on the client's inventory and cost of goods sold accounts. All other accounts and financial statements will continue to be covered by the unmodified opinion. Answer: B Explanation: The auditors may need to consider extending further audit procedures in this area, attempting to evaluate the value of the client's inventory accounts. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 88

175) After the audit report and financial statements of Publix Corporation had been released to the public, the auditors learned of a potentially significant misstatement relating to the clients interest expense accounts. After an investigation, the auditors concluded that the previously issued audit opinion should remain unchanged. As a result of this, which of the following is likely to happen? A) The auditors will do nothing, as there is no new or amended information to convey to the firm's stakeholders. B) The auditors may decide to extend the date of fieldwork through the date that investigative procedures were performed in the area of interest expense. This also extends the auditors responsibility through this date. C) The auditors are likely to issue an updated opinion. In this case, the most appropriate opinion to issue would be either an adverse opinion or disclaimer of opinion on the basis that there may be other areas the auditor is unaware of. D) None of these answer choices are correct. Answer: B Explanation: The auditors may decide to extend the date of fieldwork through the date that investigative procedures were performed in the area of interest expense. This also extends the auditors responsibility through this date. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

176) While walking across campus one day after auditing class, Jeremiah and Sandy are discussing the topic of that day's lecture; dual dating. Jeremiah asks Sandy if she can explain exactly how this works, as he wasn't sure he fully understood the way the professor explained it. Which of the following represents Sandy's most appropriate response to this? A) The easiest and best way to explain dual dating is as follows: the audit report contains two dates. The first date is for the audit of internal control, and the second date is for the audit of the financial statements. B) Dual dating can be best thought of as the audit report itself having two dates. The first date is the date that the auditor finished fieldwork and related procedures, and the second date is the date the report was actually made public by the audit client. C) Dual dating is best thought of as follows: There are two dates shown on the audit report. The first date relates to the end of fieldwork, whereas the second date relates to a revision to the financial statements that occurred after the original fieldwork end date. D) Dual dating can get a little complicated. The first date pertains to the date that the auditor amended the original financial statements, and the second date pertains to the end date of the auditor's liability for those financial statements. Answer: C Explanation: Dual dating is best thought of as follows: There are two dates shown on the audit report. The first date relates to the end of fieldwork, whereas the second date relates to a revision to the financial statements that occurred after the original fieldwork end date. Diff: 2 LO: 5 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

177) Micah and Sally are two audit staff associates working on the audit of Summertime Enterprises, a publicly-traded firm and provider of beach goods on the eastern coast of the United States. Micah mentions to Sally that he remembers hearing about an integrated audit back in college during an accounting class, but doesn't recall exactly what this is. How should Sally best respond to this? A) It's actually fairly easy to understand. When we think of an integrated audit, we basically combine the audit of the financial statements with the audit of internal control, and do them both at the same time with the same tests. B) The term 'integrated audit' is used because, for publicly-traded firms, we are required to audit both the client's system of internal control as well as the financial statements. C) We use the term 'integrated audit' to refer to how we integrate the testing of populations and samples. Some larger accounts are only sampled, whereas with smaller accounts we can audit populations. D) None of these answers are correct. Answer: B Explanation: The term 'integrated audit' is used because, for publicly-traded firms, we are required to audit both the client's system of internal control as well as the financial statements. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

178) Two audit staff associates are discussing the audit of a client's system of internal control one day over lunch. One of the associates mentions that in the audit of a recent client, it was determined that the internal controls related to receivables were ineffective. As a result of this finding, which of the following is most accurate? A) If the client's internal controls are found to be ineffective, then the audit firm will usually issue a disclaimer of opinion. This helps protect the reputation of the firm. B) If it is determined by the auditors that a client's system of internal control contains material weaknesses, the auditors will proceed with issuance of an adverse opinion on internal control. C) If the auditors determine that the client's system of internal control contains material weaknesses, it is safe to assume there are errors in the financial statements, and so the auditors issue an adverse opinion on both the client's system of internal control and the financial statements. D) If internal control is determined to be ineffective by the audit firm, then the auditors will typically disclaim an opinion on the effectiveness of internal control and concentrate on the financial statements instead. Answer: B Explanation: If it is determined by the auditors that a client's system of internal control contains material weaknesses, the auditors will proceed with issuance of an adverse opinion on internal control. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

179) Oliver and Millie are discussing the topic of integrated audits for public company clients in the cafeteria one day. Oliver tells Millie that he has heard that an audit firm's opinion on the effectiveness of a client's system of internal control must always match the opinion on the financial statements. How should Millie respond to this? A) That is absolutely true. It would be counterintuitive and illogical for an audit firm to issue a clean, unmodified opinion on a client's financial statements and not on its system of internal control. B) That is not the case. It is possible that an auditor could issue an adverse opinion on internal control, but that doesn't guarantee that there are errors or fraud contained in the financial statements, so the financial statements may still be subject to an unmodified audit opinion. C) I don't believe that's the case. For example, auditors routinely issue an adverse opinion on the client's financial statements and an unmodified opinion on the client's system of internal control. D) None of these answer choices are correct. Answer: B Explanation: That is not the case. It is possible that an auditor could issue an adverse opinion on internal control, but that doesn't guarantee that there are errors or fraud contained in the financial statements, so the financial statements may still be subject to an unmodified audit opinion. Diff: 2 LO: 6 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

180) In the paragraph below, there are three errors in the basis for opinion paragraph of the unqualified opinion on the effectiveness of ICFR for public companies. Rewrite the paragraph to correct the errors. Basis for Opinion The auditor is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express a certification on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the AICPA. Answer: The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. Diff: 3 LO: 6 Bloom: Evaluation Min: 1 AACSB: Communication AICPA: BC: None; AC: Reporting; PC: None

181) Small Town Bank would like to gain a degree of comfort regarding the financial statements of Home Town Builders, Inc., a company for which Small Town Bank provides a line of credit. The cost of an audit would be prohibitive for Home Town Builders. Compare two other types of services that accounting firms can provide to Home Town Builders that may be acceptable to Small Town Bank. Answer: There are other services that accounting firms can provide for private company clients that are less in scope than an audit, but are often accepted by lenders to small businesses. Two services that are discussed in this text are a compilation of financial statements and review of financial statements. In a compilation engagement, the CPA will assist management in the presentation of financial statements but will not provide assurance as to whether the financial statements are presented fairly in accordance with the applicable financial reporting framework. A review engagement is an attest engagement performed on the financial statements of a private company client. In a review engagement, management prepares the financial statements. The CPA is engaged to perform analytical procedures and inquiries sufficient to provide limited assurance that no material modifications should be made to the financial statements for them to be in accordance with the applicable financial reporting framework. In contrast to a compilation engagement, in which the CPA provides no assurance, the CPA provides limited assurance in a review engagement. Diff: 3 LO: 7 Bloom: Synthesis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

182) Tyffany and Phil are discussing the various types of engagements a CPA firm might take on one day over coffee. Which of the following statements by Phil is the most accurate with respect to the different services a CPA firm could undertake on behalf of clients? A) The most complex type of engagement is an attestation engagement. This type of engagement also offers the highest level of assurance. B) When a client's senior management needs assistance in preparing their financial statements, they will usually request an audit engagement. This type of engagement only offers limited assurance on the financial statements. C) The most complex type of engagement for a CPA firm would be a preparation engagement. This is highly lucrative for the audit firm, but also requires the audit firm to offer the highest level of assurance. D) The most routine type of engagement for a CPA firm would be a compilation engagement. This type of engagement sees the auditors gathering the client's financial information and separately preparing financial statements. Answer: A Explanation: The most complex type of engagement is an attestation engagement. This type of engagement also offers the highest level of assurance. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 183) Harper CPAs have been approached by Drexel Corporation to assist management in preparing financial statements in order to qualify for a large loan the firm is looking to obtain. Which of the following most accurately describes this type of engagement? A) This type of engagement would most likely be classified as a review engagement. The auditors offer limited assurance to users of the financial statements in this setting. B) This type of engagement would most likely be classified as a compilation engagement on the grounds that the CPA firm will be assisting management in preparing the financial statements and will issue a report upon conclusion of the engagement. C) This type of engagement is most likely to be classified as an attestation engagement. This is because anytime a CPA firm prepares financial statements or helps others prepare financial statements, the firm is automatically considered to be offering assurance. D) None of these answer choices are correct. Answer: B Explanation: This type of engagement would most likely be classified as a compilation engagement on the grounds that the CPA firm will be assisting management in preparing the financial statements and will issue a report upon conclusion of the engagement. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 96

184) Darren and Michaela are discussing a current review engagement that the audit firm they work for is close to completing. Darren asks Michaela to give him some examples of items that might be included in the auditor's official report. Which of the following most accurately describes items that would likely be included in the review report? A) The audit firm is likely to include that the financial statements are the responsibility of management, and will likely list the financial statements that the auditors reviewed. B) The audit firm will likely mention that they are only offering limited assurance on the fairness and accuracy of the financial statements. These items are management's responsibility overall. C) The audit firm will likely make reference to the fact that the engagement was completed in accordance with generally accepted accounting principles, per the relevant standards. D) The audit firm will likely include a paragraph stating that the financial statement review is greater in scope than a compilation or audit. Answer: A Explanation: The audit firm is likely to include that the financial statements are the responsibility of management, and will likely list the financial statements that the auditors reviewed. Diff: 2 LO: 7 Bloom: Analysis Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 185) The ________ states the auditor's opinion that the financial statements are fairly presented, in all material respects, in accordance with the applicable financial reporting framework. A) opinion paragraph B) management's responsibility paragraph C) scope paragraph D) paragraph referencing the audit of internal control Answer: A Explanation: The opinion paragraph clearly states the auditor's opinion that the financial statements are fairly presented, in all material respects, in accordance with the applicable financial reporting framework. Diff: 1 LO: 1 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

186) Audit standards require an emphasis-of-matter paragraph for ________ and consistency issues. A) going concern B) scope concern C) audit evidence D) audit failure Answer: A Explanation: Audit standards require an emphasis-of-matter paragraph for going concern and consistency issues. Diff: 1 LO: 2 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 187) A/an ________ is responsible for issuing the audit report on the group financial statements. A) group engagement partner B) component auditor C) auditing firm D) accounting firm Answer: A Explanation: A group engagement partner is responsible for issuing the audit report on the group financial statements. Diff: 1 LO: 3 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 188) ________ is not confined to specific elements, accounts, or items of the financial statements. A) Pervasive misstatement B) Material misstatement C) Material scope limitation D) Adverse opinion Answer: A Explanation: Pervasive misstatement is not confined to specific elements, accounts, or items of the financial statements. Diff: 1 LO: 4 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 98

189) ________ shows two dates on an audit report; one date is the end of fieldwork and the other is the date of a revision to the financial statements. A) Dual dating B) Date of audit C) Completion date D) Dual revision date Answer: A Explanation: Dual dating shows two dates on an audit report, one date is the end of fieldwork and the other is the date of a revision to the financial statements that occurred after the end of fieldwork. Diff: 1 LO: 5 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None 190) When one or more material weaknesses in internal control over financial reporting (ICFR) are identified, it would cause auditors to ________. A) modify the opinion on ICFR B) retain the same opinion on ICFR C) create restriction on the scope of auditor's work D) issue an unqualified opinion on the effectiveness of ICFR Answer: A Explanation: When one or more material weaknesses in ICFR are identified, it would cause auditors to modify the opinion on ICFR. Diff: 1 LO: 6 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None

191) A/an ________ is an attest engagement performed on the financial statements of a private company client. A) review engagement B) audit engagement C) compilation engagement D) financial review engagement Answer: A Explanation: A review engagement is an attest engagement performed on the financial statements of a private company client. Diff: 1 LO: 7 Bloom: Knowledge Min: 1 AACSB: Analytic AICPA: BC: None; AC: Reporting; PC: None