For Order This And Any Other Test Banks And Solutions Manuals, Course, Assignments, Discussions, Quizzes, Exams, Contact us At: johnmate1122@gmail.com Test Bank Audting and Assurance Services An Integrated Approach 15th Edition Auditing and Assurance Services, 15e Chapter 1 The Demand for Audit and Other Assurance Services Learning Objective 1-1 1) The Sarbanes-Oxley Act applies to which of the following companies? A) All companies B) Privately held companies C) Public companies D) All public companies and privately held companies with assets greater than $500 million Answer: C Terms: Sarbanes-Oxley Act Diff: Easy Objective: LO 1-1 AACSB: Reflective thinking skills Topic: SOX
2) Which of the following is considered audit evidence? A) Oral statements Written Auditor made by management Communications Observation Y N N B) Oral statements made by management N
Written Communications Y
Auditor Observation Y
C) Oral statements made by management Y
Written Communications Y
Auditor Observation Y
Written Communications N
Auditor Observation Y
D) Oral statements made by management N Answer: C
Terms: Audit evidence Diff: Moderate Objective: LO 1-1 AACSB: Reflective thinking skills
3) Evidence is paramount to audit and attestation engagements. List the four basic types of audit evidence. Answer: The four types of audit and attestation evidence include: 1. Electronic and documentary data about transactions 2. Written and electronic communications with outsiders 3. Observations by the auditor 4. Oral testimony of the auditee (client) Terms: Basic types of audit evidence Diff: Easy Objective: LO 1-1 AACSB: Reflective thinking skills
4) The criteria by which an auditor evaluates the information under audit may vary with the information being audited. Answer: TRUE Terms: Criteria which an auditor evaluates information Diff: Easy Objective: LO 1-1 AACSB: Reflective thinking skills
5) The criteria used by an external auditor to evaluate published financial statements are known as generally accepted auditing standards. Answer: FALSE Terms: Criteria used by external auditor to evaluate published financial statements Diff: Easy Objective: LO 1-1 AACSB: Reflective thinking skills
6) The Sarbanes-Oxley Act establishes standards related to the audits of privately held companies. Answer: FALSE Terms: Sarbanes-Oxley Act Diff: Easy Objective: LO 1-1 AACSB: Reflective thinking skills Topic: SOX
7) The Sarbanes-Oxley Act is widely viewed as having ushered in sweeping changes to auditing and financial reporting. Answer: TRUE Terms: Sarbanes-Oxley Act Diff: Easy Objective: LO 1-1 AACSB: Reflective thinking skills Topic: SOX
8) An auditor must be competent and have an independent mental attitude. Answer: TRUE Terms: Competence and independent mental attitude Diff: Easy Objective: LO 1-1 AACSB: Reflective thinking skills
Learning Objective 1-2 1) Recording, classifying, and summarizing economic events in a logical manner for the purpose of providing financial information for decision making is commonly called: A) finance. B) auditing. C) accounting. D) economics. Answer: C Terms: Recording, classifying, and summarizing economic events Diff: Easy Objective: LO 1-2 AACSB: Reflective thinking skills
2) An accountant: A) must possess expertise in the accumulation of audit evidence. B) must decide the number and types of items to test. C) must have an understanding of the principles and rules that provide the basis for preparing the accounting information. D) must be a CPA. Answer: C Terms: Distinguishes auditors from accountants Diff: Moderate Objective: LO 1-2 AACSB: Reflective thinking skills
3) In "auditing" financial accounting data, the primary concern is with: A) determining whether recorded information properly reflects the economic events that occurred during the accounting period. B) determining if fraud has occurred. C) determining if taxable income has been calculated correctly. D) analyzing the financial information to be sure that it complies with government requirements. Answer: A Terms: Auditing financial accounting data primary concern Diff: Moderate Objective: LO 1-2 AACSB: Reflective thinking skills
4) The trait that distinguishes auditors from accountants is the: A) auditor's ability to interpret accounting principles generally accepted in the United States. B) auditor's education beyond the Bachelor's degree. C) auditor's ability to interpret FASB Statements. D) auditor's accumulation and interpretation of evidence related to a company's financial statements. Answer: D Terms: Distinguishes auditors from accountants Diff: Challenging Objective: LO 1-2 AACSB: Reflective thinking skills
5) Discuss the differences and similarities between the roles of accountants and auditors. What additional expertise must an auditor possess beyond that of an accountant? Answer: The role of accountants is to record, classify, and summarize economic events in a logical manner for the purpose of providing financial information for decision making. To provide relevant information, accountants must have a thorough understanding of the principles and rules that provide the basis for preparing the accounting information. In addition, accountants must develop a system to ensure that the entity's economic events are properly recorded on a timely basis and at a reasonable cost. The role of auditors is to determine whether the recorded information prepared by accountants properly reflects the economic events that occurred during the accounting period. Because U.S. or international standards provide the criteria for evaluating whether financial information is properly recorded, auditors must thoroughly understand those accounting standards. In addition to understanding accounting, the auditor must possess expertise in the accumulation and interpretation of audit evidence. It is this expertise that distinguishes auditors from accountants. Determining the proper audit procedures, deciding the number and types of items to test, and evaluating the results are unique to the auditor. Terms: Roles of accountants and auditors Diff: Moderate Objective: LO 1-2 AACSB: Reflective thinking skills
Learning Objective 1-3 1) ________ risk reflects the possibility that the information upon which the business decision was made was inaccurate. A) Client acceptance B) Information C) Business D) Control Answer: B Terms: Risk that reflects the possibility that information upon which business risk decision was made Diff: Moderate Objective: LO 1-3 AACSB: Reflective thinking skills
Learning Objective 1-4 1) A correct relationship among the auditor, the client, and the external users is: A) management of a public company hires the independent auditor. B) the audit committee of a private company hires the independent auditor. C) the client provides capital to the external users. D) the external users can rely upon the auditor's report to reduce information risk. Answer: D Terms: Relationships among auditor, client, and external users Diff: Moderate Objective: LO 1-4 AACSB: Reflective thinking skills
2) The most common way for users to obtain reliable information is to: A) have an internal audit. B) have an independent audit. C) verify all information individually. D) verify the information with management. Answer: B Terms: Reducing information risk Diff: Moderate Objective: LO 1-4 AACSB: Reflective thinking skills
3) Explain what is meant by information risk, and list the four causes of this risk. Answer: Information risk reflects the possibility that the information upon which the business risk decision was made was inaccurate. Four causes of information risk are: • remoteness of information, • biases and motives of the provider, • voluminous data, and • complex exchange transactions. Terms: Information risk definition and causes Diff: Easy Objective: LO 1-3 and LO 1-4 AACSB: Reflective thinking skills
Learning Objective 1-5 1) In the audit of historical financial statements, what accounting criteria is most common? A) Regulatory accounting principles B) Applicable international accounting standards C) Applicable U.S. accounting standards D) B and C E) All of the above Answer: D Terms: Most common accounting criteria Diff: Easy Objective: LO 1-5 AACSB: Reflective thinking skills
2) Any service that requires a CPA firm to issue a report about the reliability of an assertion that is made by another party is a(n): A) accounting and bookkeeping service. B) attestation service. C) assurance service. D) tax service. Answer: B Terms: Strengthen internal controls over accounting for materials used in production Diff: Easy Objective: LO 1-5 AACSB: Reflective thinking skills
3) Three common types of attestation services are: A) audits of historical financial statements, reviews of historical financial statements, and audits of internal control over financial reporting. B) audits of historical financial information, verifications of historical financial information, and attestations regarding internal controls. C) reviews of historical financial information, verifications of future financial information, and attestations regarding internal controls. D) audits of historical financial information, reviews of controls related to investments, and verifications of historical financial information. Answer: A Terms: Types of attestation services Diff: Easy Objective: LO 1-5 AACSB: Reflective thinking skills
4) Which of the following services provides the lowest level of assurance on a financial statement? A) A review B) An audit C) Neither service provides assurance on financial statements. D) Each service provides the same level of assurance on financial statements. Answer: A Terms: Service provides lowest level of assurance on a financial statement Diff: Moderate Objective: LO 1-5 AACSB: Reflective thinking skills
5) Which of the following is not a SysTrust Services principle as defined by the AICPA? A) Online privacy B) Availability C) Processing integrity D) Operational integrity Answer: D Terms: SysTrust Services principles defined by AICPA Diff: Moderate Objective: LO 1-5 AACSB: Reflective thinking skills
6) The Sarbanes-Oxley Act prohibits a CPA firm that audits a public company from providing which of the following types of services to that company? A) Reviews of quarterly financial statements B) Preparation of corporate tax returns C) Most consulting services D) Tax services Answer: C Terms: Sarbanes-Oxley Act Diff: Challenging Objective: LO 1-5 AACSB: Reflective thinking skills Topic: SOX
7) Attestation services on information technology include WebTrust services and SysTrust services. Which
of the following statements most accurately describes SysTrust services? A) SysTrust services provide assurance on business processes, transaction integrity and information processes. B) SysTrust services provide assurance on system reliability in critical areas such as security and data integrity. C) SysTrust services provide assurance on internal control over financial reporting. D) SysTrust services provide assurance as to whether accounting personnel are following procedures prescribed by the company controller. Answer: B Terms: Attestation services on information technology; WebTrust and Systrust services Diff: Challenging Objective: LO 1-5 AACSB: Reflective thinking skills
8) Two types of attestation services provided by CPA firms are audits and reviews. Discuss the similarities and differences between these two types of attestation services. Which type provides the least assurance? Answer: In both the review and audit of the historical financial statements, management asserts that the statements are fairly stated in accordance with accounting standards. The CPA provides a lower level of assurance for reviews of financial statements compared to the high level for audits, therefore less evidence is needed. A review is often adequate to meet financial statement users' needs. It can be provided by a CPA firm at a much lower fee than an audit because less evidence is needed. An audit is the most common assurance service provided by CPA firms. Publicly traded companies in the U.S. are required to have audits under the federal securities acts. Many nonpublic companies have a review to limit auditor fees. Terms: Attestation services; Audits and reviews of historical financial statements Diff: Moderate Objective: LO 1-5 AACSB: Reflective thinking skills
9) What is an engagement to attest on internal control over financial reporting? Answer: For an audit of internal control over financial reporting, management asserts that internal controls have been developed and implemented following well established criteria. Section 404 of the Sarbanes-Oxley Act requires public companies to report management's assessment of the effectiveness of internal control over financial reporting. The Act also requires auditors for larger public companies to attest to the effectiveness of internal control over financial reporting. This evaluation, which is integrated with the audit of financial statements, increases user confidence about future financial reporting, because effective internal controls reduce the likelihood of future misstatements in the financial statements. Terms: Engagement to attest on internal control over financial reporting Diff: Moderate Objective: LO 1-5 AACSB: Reflective thinking skills Topic: SOX
10) What are the five categories of attestation services? Answer: The five categories of attestation services include: • Audit of historical financial statements • Audit of internal control over financial reporting • Review of historical financial statements • Attestation services on information technology • Other attestation services that may be applied to a broad range of subject matter Terms: Categories of attestation services Diff: Moderate Objective: LO 1-5 AACSB: Reflective thinking skills
11) What is a WebTrust engagement? What is a SysTrust engagement? How do they differ? Answer: WebTrust is a service provided by a CPA where the CPA provides assurance that the Web Site owner has met established criteria related to business practices, transaction integrity, and information processes. SysTrust is a service provided by a CPA to evaluate and test a system reliability in areas such as security and data integrity. There are five principles that must be addressed on a SysTrust engagement: security, availability, processing integrity, online privacy, and confidentiality. WebTrust is primarily designed to provide assurance to third party users of a Web site. SysTrust provides assurance to management, the board of directors or third parties about the reliability of information systems used to generate real-time information. Terms: WebTrust and SysTrust engagements Diff: Challenging Objective: LO 1-5 AACSB: Reflective thinking skills
12) CPA firms are never allowed to provide bookkeeping services for clients. Answer: FALSE Terms: CPA services provided to clients Diff: Moderate Objective: LO 1-5 AACSB: Reflective thinking skills
13) Section 404 of the Sarbanes-Oxley Act requires public companies to have an external auditor attest to their internal control over financial reporting. Answer: TRUE Terms: Section 404 of the Sarbanes-Oxley Act Diff: Moderate Objective: LO 1-5 AACSB: Reflective thinking skills Topic: SOX
14) Most public companies' audited financial statements are available on the SEC's EDGAR database. Answer: TRUE Terms: Public companies' audited financial statements: SEC's EDGAR database Diff: Challenging Objective: LO 1-5 AACSB: Reflective thinking skills
Learning Objective 1-6 1) One objective of an operational audit is to: A) determine whether the financial statements fairly present the entity's operations. B) determine if the auditee is in compliance with GAAP. C) make recommendations for improving performance. D) report on the entity's relative success in attaining profit maximization. Answer: C Terms: Objective of operational audit Diff: Moderate Objective: LO 1-6 AACSB: Reflective thinking skills
2) An examination of part of an organization's procedures and methods for the purpose of evaluating efficiency and effectiveness is what type of audit? A) Operational audit B) Compliance audit C) Financial statement audit D) Production audit Answer: A Terms: Examination of part of an organization's procedures and method to evaluate efficiency and effectiveness Diff: Moderate Objective: LO 1-6 AACSB: Reflective thinking skills
3) An audit to determine whether an entity is following specific procedures or rules set down by some higher authority is classified as a(n): A) audit of financial statements. B) compliance audit. C) operational audit. D) production audit. Answer: B Terms: Audit to determine whether entity followed specific procedures or rules Diff: Moderate Objective: LO 1-6 AACSB: Reflective thinking skills
4) Which one of the following is more difficult to evaluate objectively? A) Presentation of financial statements in accordance with generally accepted accounting principles B) Compliance with government regulations C) Efficiency and effectiveness of operations D) All three of the above are equally difficult. Answer: C Terms: Most difficult to evaluate objectively Diff: Challenging Objective: LO 1-6 AACSB: Reflective thinking skills
5) Which of the following audits can be regarded as generally being a compliance audit? A) IRS agents' examinations of taxpayer returns B) GAO auditor's evaluation of the computer operations of governmental units C) An internal auditor's review of a company's payroll authorization procedures D) A CPA firm's audit of a public company Answer: A Terms: Compliance audit Diff: Challenging Objective: LO 1-6 AACSB: Reflective thinking skills
6) Which of the following are required to have a written report regarding the assertion of another party? A) Financial Operational Compliance Attestation Assurance Statement Audit Audit Audit Engagement Engagement Y Y Y Y Y B) Financial Operational Statement Audit Audit Y Y
Compliance Audit Y
Attestation Engagement Y
Assurance Engagement N
Compliance Audit Y
Attestation Engagement N
Assurance Engagement N
Compliance Audit N
Attestation Engagement Y
Assurance Engagement Y
C) Financial Operational Statement Audit Audit Y Y D) Financial Operational Statement Audit Audit N N Answer: B Terms: Required to have a written report Diff: Challenging Objective: LO 1-6 AACSB: Reflective thinking skills
7) Discuss the similarities and differences between financial statement audits, operational audits, and compliance audits. Give an example of each type. Answer: Financial statement audits, operational audits, and compliance audits are similar in that each type of audit involves accumulating and evaluating evidence about information to ascertain and report on the degree of correspondence between the information and established criteria and/or procedures, rules, or regulations. The differences between each type of audit are the information being examined and the criteria used to evaluate the information. An operational audit evaluates the efficiency and effectiveness of any part of an organization's operating procedures and methods. At completion of an operational audit, management normally expects recommendations for improving operations. In operational auditing, the reviews are not limited to accounting. It is more difficult to objectively evaluate whether the efficiency and effectiveness of operations meets established criteria than it is for compliance and financial statement audits. Also, establishing criteria for evaluating the information in an operational audit is extremely subjective. Thus, operational auditing is more like management consulting than what is usually considered auditing. A compliance audit is conducted to determine whether the auditee is following specific procedures, rules, or regulations set by some higher authority. Results of compliance audits are typically reported to management, like in the operational audits, rather than to outside users as is done with financial statement audits. A financial statement audit is conducted to determine whether financial statements are stated in accordance with specified criteria, normally the U.S. or international standards. Auditors not only focus on accounting transactions, but also focus on an integrated approach in which both the risk of misstatements and the operating controls are considered. The auditor must have a thorough understanding of the entity and its environment. An example of a financial statement audit would be the annual audit of IBM Corporation, in which the external auditors examine IBM's financial statements to determine the degree of correspondence between those financial statements and generally accepted accounting principles. An example of an operational audit would be an internal auditor's evaluation of whether the company's computerized payrollprocessing system is operating efficiently and effectively. An example of a compliance audit would be an IRS auditor's examination of an entity's federal tax return to determine the degree of compliance with the Internal Revenue Code. Terms: Financial statement audits, operational audits and compliance audits Diff: Challenging Objective: LO 1-6 AACSB: Analytic skills
8) To perform an audit, it is necessary for the information to be in a verifiable form and there must be some criteria by which the auditor can evaluate the information. Detail the information and criteria that would be used when: (A) an independent CPA firm audits a company's historical financial statements. (B) an Internal Revenue Service auditor audits that same company's tax return. (C) an internal auditor performs an operational audit to evaluate whether the company's computerized payroll processing system is operating efficiently and effectively. Answer: (A) The information used by a CPA firm in a financial statement audit is the financial information in the company's financial statements. The most commonly used criteria are applicable U.S. generally accepted accounting standards or International Financial Reporting Standards (IFRS). (B) The information used by an IRS auditor is the financial information in the company's federal tax return. The criteria used are the internal revenue code and interpretations. (C) The information used by an internal auditor when performing an operational audit of the payroll system could include various items such as the number of errors made, costs incurred by the payroll department, and number of payroll records processed each month. The criteria would consist of company standards for departmental efficiency and effectiveness. Terms: Information and criteria used by CPA firm, Internal Revenue Service auditor, and internal auditor Diff: Easy Objective: LO 1-1 and LO 1-6 AACSB: Reflective thinking skills
9) The primary purpose of a compliance audit is to determine whether the financial statements are prepared in compliance with generally accepted accounting principles. Answer: FALSE Terms: Compliance audit Diff: Moderate Objective: LO 1-6 AACSB: Reflective thinking skills
10) Results of compliance audits are typically reported to the company's management rather than to a broad spectrum of outside users. Answer: TRUE Terms: Compliance audit Diff: Moderate Objective: LO 1-6 AACSB: Reflective thinking skills
Learning Objective 1-7 1) Match the engagement described to the (A) type of audit and (B) auditor that would perform the engagement. Each engagement will have an answer from List-A and List-B. An answer can be used once, more than once, or not at all. List A - Type of Audit: a. Financial Statement b. Compliance c. Operational
List B - Type of Auditor: d. Internal e. External f. Government g. IRS
Engagement: 1. Evaluate a company's payroll processing for economy. 2. Evaluate/determine if bank covenants are being met. 3. Evaluate financial statements that are to be submitted to a bank. 4. Evaluate the promptness of materials inspection in a manufacturer's receiving department. 5. Determine if Medicare reimbursements are in accordance with the Healthcare Financing Administration (HCFA). 6. Determine if the tax return of a multinational corporation is in accordance with the tax code. 7. Determine if a public school is properly applying their reimbursement for the payment-in-kind program. 8. Determine the effectiveness of a Department of Defense project. Answer: 1. c, d 2. b, d 3. a, e 4. c, d 5. b, f 6. b, g 7. b, e 8. c, f Terms: Financial statement audit; Compliance audit; Operational audit; Types of auditors Diff: Challenging Objective: LO 1-6 and LO 1-7 AACSB: Analytic skills
2) Discuss the similarities and differences between the roles of independent auditors, GAO auditors, internal revenue agents, and internal auditors. Answer: The roles of all four types of auditors are similar in that they involve the accumulation and evaluation of evidence about information to ascertain and report on the degree of correspondence between the information and established criteria. The differences in their roles center around the information audited and the criteria used to evaluate that information. Independent auditors primarily audit companies' financial statements. GAO auditors' primary responsibility is to perform the audit function for Congress. IRS auditors are responsible for the enforcement of federal tax laws. Internal auditors primarily perform operational and compliance audits for their employing company. Terms: Roles of independent auditors, GAO auditors, internal revenue agents and internal auditors Diff: Moderate Objective: LO 1-7 AACSB: Reflective thinking skills
3) The primary role of the United States General Accounting Office is the enforcement of the federal tax laws as defined by Congress and interpreted by the courts. Answer: FALSE Terms: Primary role of United States General Accounting Office Diff: Moderate Objective: LO 1-7 AACSB: Reflective thinking skills
Learning Objective 1-8 1) The three requirements for becoming a CPA include all but which of the following? A) Uniform CPA examination requirement B) Educational requirements C) Character requirements D) Experience requirement Answer: C Terms: Requirements for becoming a CPA Diff: Moderate Objective: LO 1-8 AACSB: Reflective thinking skills
2) The use of the Certified Public Accountant title is regulated by: A) the federal government. B) state law through a licensing department or agency of each state. C) the American Institute of Certified Public Accountants through the licensing departments of the tax and auditing committees. D) the Securities and Exchange Commission. Answer: B Terms: Certified Public Accountant title Diff: Moderate Objective: LO 1-8 AACSB: Reflective thinking skills
3) List and discuss the three primary requirements to become a CPA. Answer: The three primary requirements for becoming a CPA are: • Educational requirement. An undergraduate degree or a graduate degree with a major in accounting is required. Most states now require 150 semester hours for licensure and some states require 150 semester hours before taking the CPA exam. • Uniform CPA examination requirement. This is a four-part, computer-based examination with components on auditing and attestation, financial accounting and reporting, regulation, and business environment and concepts. Some states also require a separate ethics requirement. • Experience requirement. The experience requirement varies from state to state with some states requiring no experience, while other states require up to two years of audit experience. Terms: Primary requirements to become CPA Diff: Easy Objective: LO 1-8 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e Chapter 2 The CPA Profession
Learning Objective 2-1 1) The legal right to perform audits is granted to a CPA firm by regulation of: A) each state. B) the Financial Accounting Standards Board (FASB). C) the American Institute of Certified Public Accountants (AICPA). D) the Audit Standards Board. Answer: A Terms: Legal rights to perform audits Diff: Moderate Objective: LO 2-1 AACSB: Reflective thinking skills
2) The four categories for describing the size of audit firms include: the Big Four international firms; national firms; regional and local firms; and small firms. Which of the following is not a characteristic of a small firm? A) Most have fewer than 25 professionals. B) They perform audits on small and not-for-profit businesses. C) Tax services are more important to their practice than auditing. D) They do not audit publicly traded companies. Answer: D Terms: Four categories for describing size of audit firms Diff: Moderate Objective: LO 2-1 AACSB: Reflective thinking skills
3) Sarbanes-Oxley and the Securities Exchange Commission restrict auditors from providing many consulting services to their publicly traded audit clients. Which of the following is true for auditors of publicly traded companies? I. They are restricted from providing consulting services to privately held companies. II. There is no restriction on providing consulting services to non-audit clients. A) I only B) II only C) I and II D) Neither I or II Answer: B Terms: Sarbanes-Oxley and Securities Exchange Commission restrictions Diff: Moderate Objective: LO 2-1 AACSB: Reflective thinking skills Topic: SOX
4) Which of the following statements is true as it relates to limited liability partnerships? A) Only senior partners are liable for the partnership's debts. B) Partners have no liability in a limited liability partnership arrangement. C) Partners are personally liable for the acts of those under their supervision. D) All partners must be AICPA members. Answer: C Terms: Limited liability partnerships Diff: Challenging Objective: LO 2-1 AACSB: Reflective thinking skills
5) List and describe the three factors that influence the organizational structure of all CPA firms. What are the most common forms of CPA firm organization? Answer: The three factors that influence the organization of a CPA firm include: 1. Independence from clients. Independence is important as it allows the auditors to remain unbiased in drawing conclusions on client financial statements. 2. Auditor Competency. Competency allows auditors to conduct audits and perform services effectively and efficiently. 3. Litigation. The increased litigation risk faced by auditors increases audit firm business risk. Certain organizational structures allow a degree of personal protection to individual firm members. Common forms of audit firm organization include: • Limited Liability Partnerships • Limited Liability Companies • Professional Corporations • General Corporations • General Partnerships • Sole Proprietorship Terms: Factors that influence that influence the organizational structure of CPA firms Diff: Moderate Objective: LO 2-1 AACSB: Reflective thinking skills
6) List and describe the six organizational structures available to CPA firms. Answer: CPA firms can take one of six organizational forms: • Proprietorship. This form is limited to firms with only one owner. • General partnership. This form is similar to a proprietorship, except that it applies to multiple owners. • General corporation. Unlike a general partnership, shareholders in a general corporation are liable only to the extent of their investment in the corporation. Many states prohibit CPA firms from organizing as a general corporation. • Professional corporation. Professional corporations can have one or more shareholders. Personal liability protection for shareholders in professional corporations varies widely from state to state. • Limited liability company. This form combines the most favorable attributes of a general corporation and a general partnership. LLCs are taxed like a general partnership, but its owners have limited personal liability similar to that of a general corporation. • Limited liability partnership. An LLP is structured and taxed like a general partnership. However, the personal liability protection of an LLP is less than that of a general corporation or an LLC, but it is greater than a general partnership. Many accounting firms now operate as LLPs. Terms: Organizational structures available to CPA firms Diff: Moderate Objective: LO 2-1 AACSB: Reflective thinking skills
7) Many small, local accounting firms do not perform audits as their primary services to their clients include accounting and tax. Answer: TRUE Terms: Small accounting firms do not perform audits Diff: Easy Objective: LO 2-1 AACSB: Reflective thinking skills
8) All of the Big Four accounting firms and many of the smaller CPA firms now operate as Limited Liability Partnerships. Answer: TRUE Terms: Limited liability partnerships Diff: Easy Objective: LO 2-1 AACSB: Reflective thinking skills
9) Sarbanes-Oxley and the Securities Exchange Commission restrict auditors from providing many consulting services to their publicly traded audit clients. Answer: TRUE Terms: Sarbanes-Oxley and Securities Exchange Commission restrict auditors Diff: Easy Objective: LO 2-1 AACSB: Reflective thinking skills Topic: SOX
10) Limited liability companies are structured and taxed like a general partnership, but their owners have limited personal liability similar to that of a general corporation. Answer: TRUE Terms: Limited liability companies Diff: Moderate Objective: LO 2-1 AACSB: Reflective thinking skills
Learning Objective 2-2 1) The organization that is responsible for providing oversight for auditors of public companies is called the ________. A) Auditing Standards Board B) American Institute of Certified Public Accountants C) Public Oversight Board D) Public Company Accounting Oversight Board Answer: D Terms: Organization responsible for providing oversight for auditors of public companies Diff: Easy Objective: LO 2-2 AACSB: Reflective thinking skills Topic: SOX
2) Members of the Public Company Accounting Oversight Board are appointed and overseen by: A) the U.S. Congress. B) the American Institute of Certified Public Accountants. C) the Auditing Standards Board. D) the Securities and Exchange Commission. Answer: D Terms: Members of Public Company Accounting Oversight Board Diff: Easy Objective: LO 2-2 AACSB: Reflective thinking skills Topic: SOX
3) The Public Company Accounting Oversight Board: A) performs inspections of the quality controls of audit firms that audit public companies. B) establishes auditing standards that must be followed by CPAs on all audits. C) oversees auditors of private companies. D) performs any of the above functions. Answer: A Terms: Public Company Accounting Oversight Board Diff: Moderate Objective: LO 2-2 AACSB: Reflective thinking skills Topic: SOX
4) Assume the Public Company Accounting Oversight Board (PCAOB) identifies a violation during its inspection of a registered accounting firm. The PCAOB: A) can enforce disciplinary report the matter to the suspend the license to action against the Securities and Exchange practice of the CPA accounting firm Commission guilty of the violation Yes Yes Yes B) can enforce disciplinary report the matter to the suspend the license to action against the Securities and Exchange practice of the CPA accounting firm Commission guilty of the violation Yes Yes No C) can enforce disciplinary report the matter to the suspend the license to action against the Securities and Exchange practice of the CPA accounting firm Commission guilty of the violation Yes No No D) can enforce disciplinary report the matter to the suspend the license to action against the Securities and Exchange practice of the CPA accounting firm Commission guilty of the violation No No No Answer: B
Terms: Public Company Accounting Oversight Board inspection violations Diff: Moderate Objective: LO 2-2 AACSB: Reflective thinking skills Topic: SOX
5) The Sarbanes-Oxley Act established the Public Company Accounting Oversight Board (PCAOB). What are the PCAOB's primary functions? Answer: The PCAOB has responsibility for providing oversight to auditors of public companies, establishing auditing and quality control standards for public company audits and performing inspections of the quality controls at audit firms performing those audits. Terms: Sarbanes-Oxley Act; Public Company Accounting Oversight Board primary functions Diff: Moderate Objective: LO 2-2 AACSB: Reflective thinking skills Topic: SOX
6) The Public Company Accounting Oversight Board (PCAOB) provides oversight to auditors of publicly traded and private companies. Answer: FALSE Terms: Public Company Accounting Oversight Board Diff: Easy Objective: LO 2-2 AACSB: Reflective thinking skills
7) All CPA firms registered with the PCAOB are required to undergo a peer review annually. Answer: FALSE Terms: PCAOB requirement for peer review Diff: Moderate Objective: LO 2-2 AACSB: Reflective thinking skills Topic: SOX
Learning Objective 2-3 1) The form that must be completed and filed with the Securities and Exchange Commission whenever a company experiences a significant event that is of interest to public investors is the: A) Form S-1. B) Form 8-K. C) Form 10-K. D) Form 10-Q. Answer: B Terms: Sec form 8-k, reporting significant events Diff: Moderate Objective: LO 2-3 AACSB: Reflective thinking skills
2) The form that must be filed with the Securities and Exchange Commission whenever a company plans to issue new securities to the public is the: A) Form S-1. B) Form 8-K. C) Form 10-K. D) Form 10-Q. Answer: A Terms: Form must be completed and filed with Securities and Exchange Commission when company plans to issue new securities Diff: Moderate Objective: LO 2-3 AACSB: Reflective thinking skills
3) The AICPA has authority to establish standards and rules in all but which of the following areas? A) Auditing standards applicable to financial statements of private companies B) Compilation and review standards C) Professional conduct D) Auditing standards applicable to financial statements of private and public companies Answer: D Terms: AICPA has authority to establish standards and rules Diff: Challenging Objective: LO 2-3 AACSB: Reflective thinking skills
4) Discuss the purpose of the Securities and Exchange Commission and its influence on setting generally accepted accounting principles. Answer: The SEC, an agency of the federal government , assists in providing investors with reliable information upon which to make investment decisions. The SEC has considerable influence in setting generally accepted accounting principles and disclosure requirements for financial statements as a result of its authority for specifying reporting requirements considered necessary for fair disclosure to investors. The SEC has power to establish rules for any CPA associated with audited financial statements submitted to the commission. The SEC's attitude is generally considered in any major change proposed by the FASB, the independent organization that establishes U.S. GAAP. Terms: Securities and Exchange Commission influence on setting generally accepted accounting principles Diff: Moderate Objective: LO 2-3 AACSB: Reflective thinking skills
5) The difference between the Securities Act of 1933 and the Securities Act of 1934 is that only the 1934 act requires audited financial statements. Answer: FALSE Terms: Securities Acts of 1933 and 1934 Diff: Easy Objective: LO 2-3 AACSB: Reflective thinking skills
6) Form 10-K must be filed with the SEC whenever a public company experiences a significant event. Answer: FALSE Terms: Form 10-K; SEC Diff: Moderate Objective: LO 2-3 AACSB: Reflective thinking skills
7) The overall purpose of the Securities and Exchange Commission is to assist in providing investors with reliable information upon which to make investment decisions. Answer: TRUE Terms: Securities and Exchange Commission Diff: Moderate Objective: LO 2-3 AACSB: Reflective thinking skills
Learning Objective 2-4 1) Statements on Standards for Accounting and Review Services are issued by the: A) Accounting and Review Services Committee. B) Professional Ethics Executive Committee. C) Securities and Exchange Commission. D) Financial Accounting Standards Board. Answer: A Terms: Statements on Standards for Accounting and Review Services (SSARS) Diff: Moderate Objective: LO 2-4 AACSB: Reflective thinking skills
2) What are the major functions of the AICPA? Answer: Major functions of the AICPA include: • Establishing standards and rules that practicing CPAs must follow. These standards consist of auditing standards for auditors of private companies, compilation and review standards, other attestation standards, and the Code of Professional Conduct. • Research and publication on many different subjects related to accounting, auditing, attestation and assurance services, management consulting services, and taxes. AICPA publications include the Journal of Accountancy, industry audit guides, periodic updates of the Codification of Statements on Auditing Standards, and the Code of Professional Conduct. • Promoting the accounting profession through organizing national advertising campaigns. • Developing specialist certifications to help market and ensure the quality of services in specialized practice areas. • Writing and grading the uniform CPA examination. • Providing continuing education seminars for its members. Terms: Major functions of AICPA Diff: Moderate Objective: LO 2-4 AACSB: Reflective thinking skills
3) Membership in the AICPA is restricted to CPAs who are currently practicing as independent auditors. Answer: FALSE Terms: Membership in AICPA Diff: Easy Objective: LO 2-4 AACSB: Reflective thinking skills
4) Membership in the AICPA is mandatory for all licensed practicing CPAs. Answer: FALSE Terms: Membership in AICPA Diff: Easy Objective: LO 2-4 AACSB: Reflective thinking skills
5) Any public accounting firm can be a member of the AICPA if the firm meets the membership requirements. Answer: TRUE Terms: Membership in AICPA Diff: Easy Objective: LO 2-4 AACSB: Reflective thinking skills
Learning Objective 2-5 1) Which of the following are audit standards used in professional practice by audit firms? A) International PCAOB Auditing Standards U.S. Generally Accepted Standards on Auditing Auditing Standards Yes No No B) International Standards on Auditing Yes
U.S. Generally Accepted Auditing Standards Yes
International Standards on Auditing Yes
U.S. Generally Accepted Auditing Standards Yes
International Standards on Auditing No
U.S. Generally Accepted Auditing Standards Yes
PCAOB Auditing Standards No
C) PCAOB Auditing Standards Yes
D)
Answer: C
Terms: Standards used in professional practice Diff: Easy Objective: LO 2-5 AACSB: Reflective thinking skills
PCAOB Auditing Standards Yes
2) For privately held companies who is responsible for establishing auditing standards? A) Securities and Exchange Commission B) Public Company Accounting Oversight Board C) Auditing Standards Board D) National Association of Accounting Answer: C Terms: Establishing auditing standards for privately held companies Diff: Easy Objective: LO 2-5 AACSB: Reflective thinking skills
3) Standards issued by the Public Company Accounting Oversight Board must be followed by CPAs who audit: A) both private and public companies. B) public companies only. C) private companies, public companies, and nonprofit entities. D) private companies only. Answer: B Terms: Public Company Accounting Oversight Board Standards Diff: Moderate Objective: LO 2-5 AACSB: Reflective thinking skills Topic: SOX
4) The International Standards on Auditing (ISAs): A) are issued by the AICPA. B) override a country's regulations governing the audit of a company. C) has many of the same standards as the Auditing Standards Board (ASB). D) must be followed by companies whose stock is traded in the U.S. Answer: C
Terms: International Standards on Auditing; International Auditing and Assurance Standards Board Diff: Moderate Objective: LO 2-5 AACSB: Reflective thinking skills
5) If an auditor of a public company cannot find guidance issued by the PCAOB on a particular audit matter, the auditor should generally seek guidance from which of the following sources? A) Statements on Auditing Standards B) Statements on Standards for Accounting and Review Services C) Regulations issued by the Securities and Exchange Commission D) The AICPA Code of Professional Conduct Answer: A Terms: Guidance issued by PCAOB Diff: Challenging Objective: LO 2-5 AACSB: Reflective thinking skills Topic: SOX
6) Which of the following is a true statement regarding auditing standards? A) Prior to the passage of Sarbanes-Oxley, the FASB established auditing principles for U.S. public companies. B) PCAOB auditing standards are applicable to entities outside the U.S. C) There are no similarities between PCAOB standards and International Standards on Auditing. D) The Auditing Standards Board has revised most of its standards to converge with the international standards. Answer: D Terms: Auditing standards of United States and International Standards of Auditing Diff: Easy Objective: LO 2-5 AACSB: Reflective thinking skills
7) The PCAOB considers International Standards on Auditing (ISAs) when developing its standards. Answer: TRUE Terms: Public Company Accounting Oversight Board Standards Diff: Easy Objective: LO 2-5 AACSB: Reflective thinking skills Topic: SOX
8) International Standards on Auditing are issued by the International Auditing and Assurance Standards Board. Answer: TRUE Terms: International Standards on Auditing; International Auditing and Assurance Standards Board Diff: Easy Objective: LO 2-5 AACSB: Reflective thinking skills
Learning Objective 2-6 1) Historically auditing standards have been organized into three categories, including: A) Standards of field work. B) Purpose of an audit. C) Responsibilities of the auditor. D) Proper planning and supervision. Answer: A Terms: GAAS, general standards Diff: Easy Objective: LO 2-6 AACSB: Reflective thinking skills
2) The "Principles Underlying an Audit in Accordance with Generally Accepted Auditing Principles" provides a framework to help auditors: A) understand the ten GAAS standards. B) obtain complete assurance that the financial statements are free from any error. C) report on the financial statements. D) prevent fraud. Answer: C Terms: GAAS; New principles underlying GAAS Diff: Easy Objective: LO 2-6 AACSB: Reflective thinking skills
3) Which of the following is not one of the responsibilities of an auditor under the principles underlying an audit? A) Possess appropriate competence and capabilities B) Comply with ethical requirements C) Plan work and supervise assistants D) Maintain professional skepticism and exercise professional judgment Answer: C Terms: New principles underlying an audit Diff: Easy Objective: LO 2-6 AACSB: Reflective thinking skills
4) To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, the auditor must fulfill several performance responsibilities, including: A) verifying that all audit work is performed by a CPA with a minimum of three years experience. B) obtaining sufficient, appropriate audit evidence. C) exercising professional judgment. D) providing an opinion on the financial statements. Answer: B Terms: GAAS- New principles underlying GAAS; Purpose of an audit Diff: Easy Objective: LO 2-6 AACSB: Reflective thinking skills
5) The Statements on Auditing Standards issued by the Auditing Standards Board: A) are regarded as authoritative literature. B) are the equivalent of laws for audit practitioners. C) must be followed in all situations. D) are optional guidelines which an auditor may choose to follow or not follow when conducting an audit. Answer: A Terms: General accepted auditing standards; Performance Diff: Moderate Objective: LO 2-6 AACSB: Reflective thinking skills
6) An auditor need not abide by a particular auditing standard if the auditor believes that: A) the issue in question is immaterial in amount. B) more expertise is needed to fulfill the requirement. C) the requirement of the standard has not been addressed by the PCAOB. D) any of the above three are correct. Answer: A Terms: Auditor need not abide by a particular auditing standard Diff: Moderate Objective: LO 2-6 AACSB: Reflective thinking skills
7) When assessing the risk of material misstatements in the financial statements, A) inadequate internal control procedures will mitigate client business risk. B) GAAS specifies in detail how much and what types of evidence the auditor needs to obtain. C) company management is responsible for determining materiality levels. D) the auditor must have an understanding of the client's business and industry. Answer: D Terms: General accepted auditing standards; Performance Diff: Moderate Objective: LO 2-6 AACSB: Reflective thinking skills
8) In order to properly plan and perform an audit, an important fact for both the auditor and the client to understand is that: A) the internal control policies and procedures are developed by the auditors. B) the purpose of an audit is to prevent fraud. C) management is responsible for the preparation of the financial statements. D) management can restrict the auditor's access to important information relevant to the financial statements. Answer: C Terms: GAAS- New principles underlying GAAS; Purpose of an audit Diff: Moderate Objective: LO 2-6 AACSB: Reflective thinking skills
9) Which of the following statements best describes the primary purpose of Statements on Auditing Standards? A) They are guides intended to set forth auditing procedures that are applicable to a variety of situations. B) They are procedural outlines that are intended to narrow the areas of inconsistency and divergence of auditor opinion. C) They are authoritative statements, enforced through the Code of Professional Conduct, and are intended to limit the degree of auditor judgment. D) They are interpretations that are intended to clarify the meaning of "generally accepted auditing standards." Answer: D Terms: Purpose of Statements on Auditing Standards Diff: Moderate Objective: LO 2-6 AACSB: Reflective thinking skills
10) Hansen Corporation's stock is listed on a national stock exchange and registered with the Securities
and Exchange Commission. Hansen's management hires a CPA to perform an independent audit of Hansen's financial statements. The primary objective of this audit is to provide assurance to the: A) investors in Hansen Corporation's stock. B) stock exchange. C) Securities and Exchange Commission. D) management of Hansen Corporation. Answer: A Terms: Primary objective of audit to provide assurance Diff: Moderate Objective: LO 2-6 AACSB: Reflective thinking skills
11) Which of the following statements about Generally Accepted Audit Standards are true? I. They serve as broad guidelines to auditors for conducting an audit engagement. II. They are sufficiently specific to provide any meaningful guide to practitioners. III. They represent a framework upon which the AICPA can provide interpretations.. A) I and II B) I and III C) II and III D) I, II and III Answer: B Terms: Generally Accepted Audit Standards Diff: Challenging Objective: LO 2-6 AACSB: Reflective thinking skills
12) Generally Accepted Auditing Standards (GAAS) and Statements on Auditing Standards (SAS) should be looked upon by practitioners as: A) ideals to work towards, but which are not achievable. B) maximum standards that denote excellent work. C) minimum standards of performance that must be achieved on each audit engagement. D) benchmarks to be used on all audits, reviews, and compilations. Answer: C Terms: Generally Accepted Auditing Standards (GAAS) and Statements on Auditing Standards (SAS) Diff: Challenging Objective: LO 2-6 AACSB: Reflective thinking skills
13) Statements on Auditing Standards issued by the AICPA's Auditing Standards Board are: A) part of the generally accepted auditing standards under the AICPA Code of Professional Conduct. B) interpretations of generally accepted auditing standards and departures from such statements must be justified. C) interpretations of generally accepted auditing standards and such standards must be followed in every engagement. D) generally accepted auditing procedures that are not covered by the AICPA Code of Professional Conduct. Answer: B Terms: Statements on Auditing Standards Diff: Moderate Objective: LO 2-6 AACSB: Reflective thinking skills
14) List the four principles underlying an audit. Answer: • Purpose of an audit • Responsibilities • Performance • Reporting Terms: GAAS; New principles underlying GAAS Diff: Easy Objective: LO 2-6 AACSB: Reflective thinking skills
15) Distinguish between generally accepted auditing standards (GAAS) and generally accepted accounting principles (GAAP). What professional organization establishes GAAS? What professional organization establishes GAAP? Answer: Generally accepted auditing standards are general guidelines to help auditors meet their professional responsibilities in the audit of historical financial statements. The general standards stress the important personal qualities that the auditor should possess. The standards of field work concern evidence accumulation and other activities during the actual conduct of the audit. The reporting standards require the auditor to prepare a report on the financial statements taken as a whole, stating whether the statements are prepared in accordance with Generally Accepted Accounting Principles (GAAP). They are considered to be the minimum standards of performance for auditors to follow and are established by the Auditing Standards Board of the American Institute of Certified Public Accountants for private companies and by the Public Company Accounting Oversight Board for public companies. Generally accepted accounting principles are the guidelines which an entity's management normally follows when preparing historical financial statements. GAAP is established by the Financial Accounting Standards Board. Terms: Generally Accepted Auditing Standards Diff: Easy Objective: LO 2-5 and LO 2-6 AACSB: Reflective thinking skills
16) Professional skepticism must be maintained only if the auditor suspects fraud. Answer: FALSE Terms: Generally Accepted Auditing Standards; Responsibilities Diff: Easy Objective: LO 2-6 AACSB: Reflective thinking skills
17) Statements on Auditing Standards (SASs) are issued by the Public Company Accounting Oversight Board. Answer: FALSE Terms: Statements on Auditing Standards (SAS); Public Company Accounting Oversight Board Diff: Easy Objective: LO 2-6 AACSB: Reflective thinking skills
18) The SAS number identifies the order in which it was issued in relation to all other SASs. Answer: TRUE Terms: Statements on Auditing Standards (SAS); Generally accepted auditing standards Diff: Moderate Objective: LO 2-6 AACSB: Reflective thinking skills
Learning Objective 2-7 1) Which of the following is not true for audit firms who audit publicly traded companies? A) They must undergo a PCAOB inspection on an annual basis if they audit more than 100 issuers. B) They must have an AICPA peer review on all audit clients. C) They must have an AICPA peer review on all non-publicly traded clients. D) The audit firm can choose which CPA firm they wish to conduct their AICPA peer review. Answer: B Terms: Audit firms who audit publicly traded companies Diff: Moderate Objective: LO 2-7 AACSB: Reflective thinking skills
2) The methods used by a CPA firm to ensure that the firm meets is professional responsibilities to clients and others is: A) continuing professional education. B) compliance with generally accepted reporting standards. C) quality control. D) peer review. Answer: C Terms: Quality control policies and procedures Diff: Moderate Objective: LO 2-7 AACSB: Reflective thinking skills
3) Within the context of quality control, the primary purpose of continuing professional education and training activities is to enable a CPA firm to provide its personnel with: A) technical training that assures proficiency as a valuation expert. B) professional education that is required in order to perform with due professional care. C) knowledge required to fulfill assigned responsibilities. D) knowledge required to perform a peer review. Answer: C Terms: Quality control; Continuing professional education and training activities Diff: Moderate Objective: LO 2-7 AACSB: Reflective thinking skills
4) The purpose of establishing quality control policies and procedures to accept or continue a client relationship is to: A) provide reasonable assurance that personnel are adequately trained to fulfill their responsibilities. B) monitor the risk factors concerning misstatements that arise from the misappropriation of assets. C) document objective criteria for the CPA firm's peer review. D) minimize the likelihood of associating with a client whose management may lack integrity. Answer: D Terms: Purpose of quality control policies and procedures to accept or continue client relationship Diff: Moderate Objective: LO 2-7 AACSB: Reflective thinking skills
5) Which of the following is an element of the CPA's quality control system that should be considered in establishing its quality control policies and procedures? A) Considering audit risk and materiality B) Using statistical sampling techniques C) Assigning personnel to engagements D) Complying with laws and regulations Answer: C Terms: Quality control policies and procedures Diff: Moderate Objective: LO 2-7 AACSB: Reflective thinking skills
6) Which of the following is not an essential component of quality control? A) Policies and procedures to ensure that firm personnel are actively engaged in marketing strategies B) Policies and procedures to ensure that the work performed by firm personnel meet applicable professional standards C) Policies to ensure that personnel maintain their independence in fact and in appearance D) Policies that ensure that monitoring activities are effectively applied Answer: A Terms: Component of quality control Diff: Moderate Objective: LO 2-7 AACSB: Reflective thinking skills
7) Which one of the following is not true regarding the American Institute of Certified Public Accountants peer review requirement? A) A CPA firm must develop and adhere to quality control standards. B) Peer reviews are mandatory. C) A CPA firm will lose AICPA eligibility if a peer review is not performed. D) Firms required to be registered with and inspected by the PCAOB are exempt. Answer: D Terms: AICPA peer review Diff: Challenging Objective: LO 2-7 AACSB: Reflective thinking skills
8) Discuss the relationship between quality control and generally accepted auditing standards. Answer: For a CPA firm, quality control encompasses the methods used to make sure that the firm meets its professional responsibilities to clients. Quality control is closely related to, but distinct from, GAAS. The standards recognize that a quality control system can provide only reasonable assurance, not a guarantee that auditing standards are followed. A CPA firm must make sure that GAAS are followed on every audit. Quality controls are the procedures used by the entire CPA firm that help it meet requirements demanded by GAAS on every engagement in a consistent manner. Terms: Relationship between quality control and generally accepted auditing standards Diff: Easy Objective: LO 2-7 AACSB: Reflective thinking skills
9) List and describe the six elements of quality control. Who establishes the standards for quality control? Answer: • Leadership responsibilities for quality within the firm - Firm should promote a culture that quality is essential in performing engagements and should establish policies and procedures that support that culture. • Relevant ethical requirements - Personnel on engagements should maintain independence in fact and in appearance, perform all professional responsibilities with integrity and maintain objectivity in performing their professional responsibilities. • Human Resources - Policies and procedures should be established to provide the firm with reasonable assurance that all new personnel are qualified to perform their work, work is assigned to personnel who have adequate training, and personnel should participate in continuing professional education. • Acceptance and continuation of clients and engagements - Policies and procedures should be established for deciding whether to accept or continue a client relationship. These policies should minimize the risk of associating with a client whose management lacks integrity. • Engagement performance - Policies and procedures should exist to ensure that engagement personnel perform work that meets applicable professional standards and the firm's standards of quality. • Monitoring - Policies and procedures should exist to ensure that the other quality control elements are being effectively applied. Quality control standards are established by the Auditing Standards Board for auditors of private companies and by the Public Company Accounting Oversight Board for auditors of public companies. Terms: Elements of quality controls Diff: Moderate Objective: LO 2-7 AACSB: Reflective thinking skills
10) Listed below are policies or procedures that the Crystal Cove audit firm has in place. For each
identified policy or procedure state if it is a Generally Accepted Audit Standard (GAAS) or a Quality Control Standard. Audit firm Policy or Procedure 1. Determination on whether to accept or reject a Standards Category new client. a. GAAS 2. A client evaluation form. b. Quality Control 3. All personnel participate in continuing professional education. 4. Conducting the audit with professional skepticism. 5. Answering an independence questionnaire. 6. Determine and apply materiality levels. 7. Audit staff workpapers are reviewed by audit seniors, then managers. 8. Plan work and supervise assistants. Answer: 1. a 2. b 3. b 4. a 5. b 6. a 7. b 8. a
Terms: Generally Accepted Audit Standards (GAAS) and Quality Control Standards Diff: Moderate Objective: LO 2-6 and LO 2-7 AACSB: Reflective thinking skills
11) The following are definitions of terms that are listed on the right. Match the definition with its associated term. Each term can be used once, more than once or not at all. Definition 1. An organizational structure where professional services are provided by one or more shareholders. 2. The grantor of the right to practice public accounting. 3. A report filed to indicate a significant event. Audit Term 4. Sets professional standards and rules for auditors. a. AICPA 5. Oversees accounting firms who audit public b. PCAOB companies. c. Securities Exchange Commission 6. An organizational structure where the owners are d. Form 10-k taxed like a partnership and have limited personal e. IAASB liability. f. Form S-1 7. A report that is filed when a company wishes to issue g. Due professional care new securities. h. Limited Liability Partnership 8. The methods used to ensure the firm meets its i. Professional Corporation professional responsibilities to clients and others. j. Limited Liability Company 9. Assists in providing investors with reliable k. Peer review information. l. 1933 Securities Act 10. Requires annual inspections of accounting firms m. 1934 Securities Act auditing > 100 issuers. n. Form 8-k 11. Practice monitoring by a CPA firm for another CPA o. State Regulation firm. p. Code of Professional Conduct 12. Fulfilling duties diligently and carefully. q. Quality Control Standards 13. Requires a registration statement. r. GAAS Standards Answer: 1. i 2. o 3. n 4. a 5. b 6. j 7. f 8. q 9. c 10. b 11. k 12. g 13. l
Terms: AICPA; PCAOB; Securities Exchange Commission; Form S-1; Form 8-K; Due professional care; Professional Corporation; Limited Liability Company; Peer review; 1933 Securities Act; State Regulation; Quality Control Standards Diff: Moderate Objective: LO 2-1, LO 2-2, LO 2-3, LO 2-6, and LO 2-7 AACSB: Reflective thinking skills
12) Quality controls are established for the entire CPA firm whereas GAAS are applicable to the individual engagement. Answer: TRUE Terms: Quality controls and GAAS Diff: Moderate Objective: LO 2-7 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e Chapter 3 Audit Reports Learning Objective 3-1 1) An audit of historical financial statements most commonly includes the: A) balance sheet, statement of retained earnings, and the statement of cash flows. B) income statement, the statement of cash flows, and the statement of net working capital. C) statement of cash flows, balance sheet, and the statement of retained earnings. D) balance sheet, income statement, statement of cash flows, and the statement of changes in stockholders' equity. Answer: D Terms: Audit of historical financial statements Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills
2) Auditing standards require that the audit report must be titled and that the title must: A) include the word "independent." B) indicate if the auditor is a CPA. C) indicate if the auditor is a proprietorship, partnership, or corporation. D) indicate the type of audit opinion issued. Answer: A Terms: Auditing standards require audit report title Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
3) To emphasize the fact that the auditor is independent, a typical addressee of the audit report could be: A) Company Controller Shareholders Board of Directors No Yes Yes B) Company Controller No
Shareholders No
Board of Directors Yes
C) Company Controller Yes
Shareholders Yes
Board of Directors No
D) Company Controller Yes
Shareholders No
Board of Directors No
Answer: A
Terms: Audit report addressee Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
4) The auditor's responsibility section of the standard unqualified audit report states that the audit is designed to: A) discover all errors and/or irregularities. B) discover material errors and/or irregularities. C) conform to generally accepted accounting principles. D) obtain reasonable assurance whether the statements are free of material misstatement. Answer: D Terms: Scope paragraph of standard unqualified audit report states Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
5) The audit report date on a standard unqualified report indicates: A) the last day of the fiscal period. B) the date on which the financial statements were filed with the Securities and Exchange Commission. C) the last date on which users may institute a lawsuit against either client or auditor. D) the last day of the auditor's responsibility for the review of significant events that occurred after the date of the financial statements. Answer: D Terms: Audit report date on standard unqualified report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
6) The standard audit report for non-public entities refers to GAAS and GAAP in which sections? A) GAAS GAAP Auditor's responsibility Auditor's responsibility B) GAAS Auditor's responsibility
GAAP Introductory paragraph
GAAS Management's responsibility and Opinion paragraph
GAAP Management's responsibility and Introductory paragraph
C)
D) GAAS Auditor's responsibility
GAAP Management's responsibility and Opinion paragraph
Answer: D
Terms: Standard unqualified audit report for non-public entities; GAAS and GAAP Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills
7) Which of the following is not explicitly stated in the standard unqualified audit report? A) The financial statements are the responsibility of management. B) The audit was conducted in accordance with generally accepted accounting principles. C) The auditors believe that the audit evidence provides a reasonable basis for their opinion. D) An audit includes assessing the accounting estimates used. Answer: B Terms: Standard unqualified audit report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
8) The standard unqualified audit report for a non-public entity must: A) have a report title that includes the word "CPA." B) be addressed to the company's stockholders and creditors. C) be dated. D) include an explanatory paragraph. Answer: C Terms: Standard unqualified audit report for a non-public entity; eight parts of the report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills Topic: Public
9) The management's responsibility section of the standard audit report for a non-public company states that the financial statements are: A) the responsibility of the auditor. B) the responsibility of management. C) the joint responsibility of management and the auditor. D) none of the above. Answer: B Terms: Standard unqualified audit report for a non-public entity; eight parts of the report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
10) The introductory paragraph of the standard audit report for a non-public company performs which functions? I. It states the CPA has performed an audit. II. It lists the financial statements being audited. III. It states the financial statements are the responsibility of the auditor. A) I and II B) I and III C) II and III D) I, II and III Answer: A Terms: Introductory paragraph of standard audit report Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills
11) Which of the following statements are true for the audit report of a non-public entity? I. The introductory paragraph states that management is responsible for the preparation and content of the financial statements. II. The scope paragraph states that the auditor evaluates the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management. A) I only B) II only C) I and II D) Neither I nor II Answer: B Terms: Introductory paragraph and scope paragraph Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills
12) The auditor's responsibility section of the standard audit report states that the auditor is: A) responsible for the financial statements and the opinion on them. B) responsible for the financial statements. C) responsible for the opinion on the financial statements. D) jointly responsible for the financial statements with management. Answer: C Terms: Standard unqualified audit report for a non-public entity; eight parts of the report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
13) If the balance sheet of a private company is dated December 31, 2011, the audit report is dated February 8, 2012, and both are released on February 15, 2012, this indicates that the auditor has searched for subsequent events that occurred up to: A) December 31, 2011. B) January 1, 2012. C) February 8, 2012. D) February 15, 2012. Answer: C Terms: Audit report subsequent event dating Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills
14) The appropriate audit report date for a standard nonqualified audit report for a non-public entity should be the: A) date the financial statements are given to the Board of Directors. B) date of the financial statements. C) date the auditor completed the auditing procedures in the field. D) 60 days after the date of the financial statements as required by the SEC. Answer: C Terms: Standard unqualified audit report for a non-public entity; eight parts of the report Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills
15) Most auditors believe that financial statements are "presented fairly" when the statements are in accordance with GAAP, and that it is also necessary to: A) determine that they are not in violation of FASB statements. B) examine the substance of transactions and balances for possible misinformation. C) review the statements using the accounting principles promulgated by the SEC. D) assure investors that net income reported this year will be exceeded in the future. Answer: B Terms: Financial statements are presented fairly in accordance with GAAP Diff: Challenging Objective: LO 3-1 AACSB: Reflective thinking skills
16) An audit report prepared by Garrett and Brown, CPAs, is provided below. The audit for the year ended December 31, 2012 was completed on March 1, 2013, and the report was issued to Javlin Corporation, a private company, on March 13, 2013. List any deficiencies in this report. Do not rewrite the report. We have examined the accompanying financial statements of Dalton Corporation as of December 31, 2012. These financial statements are the responsibility of the company's management. Management's Responsibility for the Financial Statements: Management is responsible for the preparation and fair presentation of the financial statements in accordance with generally accepted auditing standards; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from all misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to give an opinion on these financial statements based on our audit. We conducted our audits in accordance with auditing standards generally accepted throughout the world.Those standards require that we plan and perform the audit to obtain absolute assurance about whether the financial statements are free of misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on management's judgment, including the assessment of the risks of material misstatement of the income statement, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the auditor'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. An audit also includes evaluating the appropriateness of accounting policies and the accuracy of 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. Opinion In our opinion, the financial statements referred to above present accurately the financial position of Javlin Corporation as of December 31, 2012, in conformity with accounting principles generally accepted in the United States of America. Garrett and Brown, CPAs March, 2013
Answer: The audit report contains the following deficiencies: • The report title is missing. The title must include the word independent. • The audit report address is missing.The report should be addressed to shareholders and the board of directors. • The introductory paragraph should refer to an "audit," not an "examination." • The introductory paragraph should list the financial statements that were audited. • The introductory paragraph refers to the wrong company. • The introductory paragraph should not state that the financial statements are the responsibility of management. This belongs in the next section- management's responsibility. • The management's responsibility section should state that the financial statements are in accordance with "accounting principles generally accepted in the Unites States of America" not in accordance with generally accepted auditing standards." • The auditor's responsibility section should state that our responsibility is to "express" an opinion, not "give" an opinion. • The auditor's responsibility section should state the audit was conducted in accordance with "auditing standards generally accepted in the United States of America", not "throughout the world." • The auditor's responsibility section should state that the audit was planned and performed to obtain "reasonable" assurance, not "absolute "assurance. • The auditor's responsibility section should state that the financial statements are free of "material misstatements," not simply "misstatement." • The scope paragraph of the auditor's responsibility section should state that the procedures selected depend on the "auditor's" judgment, not "management's" judgment. • The scope paragraph of the auditor's responsibility section should state risk of material misstatement in the "financial statements," not the "income statement." • The scope paragraph of the auditor's responsibility section should state the auditor considers internal control relevant to management's preparation , not the entity's preparation. • The scope paragraph of the auditor's responsibility section is missing the sentence "Accordingly, we express no such opinion." This should be placed right after the second sentence. • The scope paragraph of the auditor's responsibility section should state " reasonableness" of significant accounting estimates," not "accurate." • The scope paragraph should contain the following phrase: "An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation." • The auditor's opinion section should state that the financial statements present "fairly, in all material respects," not present accurately. • The auditor's opinion section should include "and the results of their operations and cash flows for the year then ended." • The audit report should be dated March 1, 2013. Terms: Audit report deficiencies Diff: Challenging Objective: LO 3-1 AACSB: Analytic skills
17) Describe the standard unqualified report to be issued for an audit of a private company. Begin by specifying the eight parts of the report, and then discuss the contents of each part. Answer: The parts of the standard unqualified report are as follows: • Report title. The title must include the word "independent." Examples of appropriate titles are "independent auditor's report," or "report of independent accountant." • Report address. The report is usually addressed to the company's stockholders or board of directors. It should not be addressed to company management. • Introductory paragraph. This paragraph states that an audit was performed to distinguish the report from a compilation or review report. It also lists the financial statements that were audited, including the notes to the financial statements as well as the balance sheet dates and the accounting periods for the income statement and statement of cash flows. The wording of the financial statements in the report should be identical to those used by management on the financial statements. • Management's Responsibility section. This section states that the statements are the responsibility of management. This responsibility includes selecting the appropriate accounting principles and maintaining internal control over financial reporting sufficient for preparation of financial statements that are free of material misstatements due to fraud or error. •
Auditor's Responsibility section. This section contains three paragraphs:
The first paragraph states that (1) the audit was conducted in accordance with auditing standards generally accepted in the United States of America, (2) the audit is designed to obtain reasonable assurance about whether the statements are free of material misstatement. The second paragraph is called the scope paragraph and describes the scope of the audit and the evidence accumulated. This paragraph indicates that the procedures depend on the auditor's judgment and includes an assessment of the risk of material misstatements in the financial statements. It also indicates that the auditor considers internal control relevant to the preparation and fair presentation of the financial statements in designing the audit procedures performed, but this assessment of internal control is not for the purpose and is not sufficient to express an opinion on the effectiveness of the entity's internal control. The last sentence of the paragraph indicates that the audit includes evaluating the accounting policies selected, the reasonableness of accounting estimates, and the overall financial statement presentation.
The third paragraph indicates the auditor believes that sufficient appropriate evidence has been obtained to support the auditor's opinion. • Opinion paragraph. This paragraph states the auditor's conclusions based on the results of the audit. It states that in the auditor's opinion the financial statements present fairly, in all material respects, the financial position of the company as of a certain date, and the results of their operations and cash flows for the the year(s) then ended, in accordance with accounting principles generally accepted in the United States of America. • Name of CPA firm. Typically, the name of the CPA firm, and not the name of an individual auditor, is used. •
Audit report date. The audit report is normally dated as of the last day of fieldwork.
Terms: Standard unqualified audit report for a non-public entity; eight parts of the report Diff: Challenging Objective: LO 3-1 AACSB: Reflective thinking skills
18) EPM, Inc., is a private manufacturing company with a calendar year-end. Their financial statements include a balance sheet, a statement of income, statement of cash flows, and statement of stockholders' equity. For the most recent audit, Harrington and Perry, LLP, audited the 2011 and 2012 financial statements. The auditors completed all significant fieldwork on March 5, 2013 and issued the audit report on March 16, 2013. Required: Consider all the facts given and write the standard unqualified auditor's report, including all eight sections of the report. Answer: Independent Auditor's Report To the Board of Directors and Shareholders of EPM, Inc. We have audited the accompanying balance sheets of EPM, Inc., as of December 31, 2012 and 2011, and the related statements of income, changes in stockholders' equity, and cash flows for the years then ended, and the related notes to the financial statements. Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of the financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of 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.
Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of EPM, Inc., as of December 31, 2012 and 2011, and the results of their operations and cash flows for the years then ended, in accordance with accounting principles generally accepted in the United States of America. Harrington and Perry, LLP March 5, 2013
Terms: Audit report format for private company Diff: Challenging Objective: LO 3-1 AACSB: Analytic skills
19) An audit provides a high level of assurance, but is not a guarantee that a material misstatement will exist in the financial statements. Answer: TRUE Terms: Audit and reasonable assurance Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills
20) AICPA auditing standards provide uniform wording for the auditor's report to enable users of the financial statements to understand the audit report. Answer: TRUE Terms: Uniform wording for auditor's report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
21) Users of the financial statements rely on the auditor's report because of the absolute assurance the report provides. Answer: FALSE Terms: Users of financial statements rely on auditor's report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
22) The introductory paragraph of the auditor's report states that the auditor is responsible for the preparation, presentation and opinion on financial statements. Answer: FALSE Terms: Introductory paragraph of auditor's report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
23) The audit report date is the date the auditor completed audit procedures in the field. Answer: TRUE Terms: Audit report date Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
24) The scope paragraph of the auditor's responsibility section of the audit report issued for financial statements of a non-public company should refer to generally accepted auditing standards . Answer: TRUE Terms: Audit reports issued for financial statements of private company; Scope paragraph; Generally accepted auditing standards Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills Topic: Public
25) In the scope paragraph of the audit report issued for financial statements of a non-public company, the auditor expresses an opinion about the internal controls of the company. Answer: FALSE Terms: Audit reports issued for financial statements of private company; Scope paragraph; Generally accepted auditing standards Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
26) The audit report is normally addressed to the company's president or chief executive officer. Answer: FALSE Terms: Audit report normally addressed Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
27) The phrase "generally accepted accounting principles" can be found in the opinion paragraph of a standard unqualified report. Answer: TRUE Terms: Generally accepted accounting principles; Opinion paragraph of standard unqualified report Diff: Easy Objective: LO 3-1 AACSB: Reflective thinking skills
28) The date of the auditor's report is indicative of the last day of the auditor's responsibility for the review of significant events occurring after the balance sheet date. Answer: TRUE Terms: Date of auditor's report indicates auditor's responsibility Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills
29) The phrase "auditing standards generally accepted in the United States of America" can be found in the opinion paragraph of a standard, unqualified audit report for a non-public company. Answer: FALSE Terms: Auditing standards generally accepted in the United States; Opinion paragraph in standard unqualified report for public company Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills Topic: Public
30) The phrase "Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material error" is included in the auditor's opinion section of an audit report. Answer: FALSE Terms: Standard unqualified audit report for a non-public entity; eight parts of the report Diff: Moderate Objective: LO 3-1 AACSB: Reflective thinking skills
Learning Objective 3-2 1) In which of the following situations would the auditor most likely issue an unqualified report? A) The client valued ending inventory by using the replacement cost method. B) The client valued ending inventory by using the Next-In-First-Out (NIFO) method. C) The client valued ending inventory at selling price rather than historical cost. D) The client valued ending inventory by using the First-In-First-Out (FIFO) method, but showed the replacement cost of inventory in the Notes to the Financial Statements. Answer: D Terms: Issued audit report; further audit tests or inquiries Diff: Challenging Objective: LO 3-2 AACSB: Reflective thinking skills
2) The standard unqualified audit report: A) is sometimes called a clean opinion. B) can be issued only with an explanatory paragraph. C) can be issued if only a balance sheet and income statement are included in the financial statements. D) is sometimes called a disclaimer report. Answer: A Terms: Conditions for standard unqualified audit report Diff: Easy Objective: LO 3-2 AACSB: Reflective thinking skills
3) There are four conditions that must be met before an auditor can issue a standard unqualified report for the audit of a private company. Please discuss each of these five conditions. Answer: The four conditions that justify issuing a standard unqualified report are: • All statements–balance sheet, income statement, statement of changes in stockholder's equity, and statement of cash flows–are included in the financial statements. • Sufficient appropriate evidence has been accumulated, and the auditor has conducted the engagement in a manner that enables him or her to conclude that the audit was performed in accordance with auditing standards. • The financial statements are presented in accordance with U.S. generally accepted accounting principles or other appropriate accounting framework. This also means that adequate disclosures have been included in the footnotes and other parts of the financial statements. • There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report. Terms: Conditions for standard unqualified report for audit of private company Diff: Moderate Objective: LO 3-2 AACSB: Reflective thinking skills
Learning Objective 3-3 1) Whenever an auditor issues an audit report for a public company, the auditor can choose to issue a report in which of the following forms? I. A combined report on financial statements and internal control over financial reporting II. Separate reports on financial statements and internal control over financial reporting A) I only B) II only C) Either I or II. D) Neither I nor II. Answer: C Terms: Combined report on financial statements and internal control over financial reporting Diff: Easy Objective: LO 3-3 AACSB: Reflective thinking skills Topic: Public
2) The standard unqualified audit report for public entities includes the following three paragraphs: A) introductory, scope and management's responsibility. B) materiality, scope and report. C) introductory, scope and opinion. D) scope, fieldwork and conclusion. Answer: C Terms: Standard unqualified audit report for public entities Diff: Easy Objective: LO 3-3 AACSB: Reflective thinking skills Topic: Public
3) Auditing standards for public companies are established by the: A) SEC. B) FASB. C) PCAOB. D) IRS. Answer: C Terms: Audit standards for public companies; PCAOB Diff: Easy Objective: LO 3-3 AACSB: Reflective thinking skills Topic: Public
4) Section 404(b) of the Sarbanes Oxley Act requires that the auditor of a public company attest to management's report on the efficiency of internal controls over financial reporting. Answer: FALSE Terms: Section 404(b) of Sarbanes-Oxley Act; Internal controls over financial reporting Diff: Moderate Objective: LO 3-3 AACSB: Reflective thinking skills Topic: Public
5) Auditors of public company financial statements must issue separate reports on internal control over financial reporting. Answer: FALSE Terms: Auditors issue separate reports on internal control Diff: Moderate Objective: LO 3-3 AACSB: Reflective thinking skills Topic: Public
Learning Objective 3-4 1) Examples of unqualified opinions which contain modified wording (without adding an explanatory paragraph) include: A) the use of other auditors. B) material uncertainties. C) substantial doubt about the audited company (or the entity) continuing as a going concern. D) lack of consistent application of GAAP. Answer: A Terms: Modified unqualified opinion Diff: Easy Objective: LO 3-4 AACSB: Reflective thinking skills
2) A CPA may wish to emphasize specific matters regarding the financial statements even though an unqualified opinion will be issued. Normally, such explanatory information is: A) included in the scope paragraph. B) included in the opinion paragraph. C) included in a separate paragraph in the report. D) included in the introductory paragraph. Answer: C Terms: Unqualified opinion with emphasis on specific matters regarding the financial statements Diff: Easy Objective: LO 3-4 AACSB: Reflective thinking skills
3) All of the following are causes for the addition of an explanatory paragraph under both AICPA and PCAOB standards except for: A) emphasis of a matter. B) reports involving other auditors. C) lack of consistent application of generally accepted accounting principles. D) auditor agrees with a departure from promulgated accounting principles.. Answer: B Terms: Unqualified opinion with modified wording Diff: Easy Objective: LO 3-4 AACSB: Reflective thinking skills
4) The term "explanatory paragraph" was replaced in the AICPA auditing standards with: A) going concern paragraph. B) emphasis-of-matter paragraph. C) departure from principles paragraph. D) consistency paragraph. Answer: B Terms: Unqualified opinion with modified wording Diff: Easy Objective: LO 3-4 AACSB: Reflective thinking skills
5) Which of the following are changes that affect the comparability of financial statements but not the consistency and therefore, do not have to be included in the auditor's report? A) Error corrections not involving principles B) Changes in accounting estimates C) Variations in the format and presentation of financial information D) All of the above Answer: D Terms: Changes that affect the comparability of financial statements Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
6) Which of the following is least likely to cause uncertainty about the ability of an entity to continue as a going concern? A) The entity is suing a competitor for a minor patent infringement. B) The entity has lost a major customer. C) The entity has significant recurring operating losses. D) The entity has working capital deficiencies. Answer: A Terms: Going concern Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
7) When there is uncertainty about a company's ability to continue as a going concern, the auditor's concern is the possibility that the client may not be able to continue its operations or meet its obligations for a "reasonable period of time." For this purpose, a reasonable period of time is considered not to exceed: A) six months from the date of the financial statements. B) one year from the date of the financial statements. C) six months from the date of the audit report. D) one year from the date of the audit report. Answer: B Terms: Going concern ; time period Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
8) When the auditor concludes that there is substantial doubt about the entity's ability to continue as a going concern, the appropriate audit report could be: I. an unqualified opinion with an explanatory paragraph. II. a disclaimer of opinion. A) I only B) II only C) I or II D) Neither I nor II Answer: C Terms: Auditor concludes substantial doubt about entity's ability to continue as going concern Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
9) When a company's financial statements contain a departure from GAAP with which the auditor concurs, the departure should be explained in: A) the scope paragraph. B) an explanatory paragraph that appears before the opinion paragraph. C) the opinion paragraph. D) an explanatory paragraph after the opinion paragraph. Answer: D Terms: Justified Departure Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
10) William Gregory, CPA, is the principal auditor for a multi-national corporation. Another CPA has examined and reported on the financial statements of a significant subsidiary of the corporation. Gregory is satisfied with the independence and professional reputation of the other auditor, as well as the quality of the other auditor's examination. With respect to his report on the consolidated financial statements, taken as a whole, Gregory: A) must not refer to the examination of the other auditor. B) must refer to the examination of the other auditor. C) may refer to the examination of the other auditor. D) must refer to the examination of the other auditors along with the percentage off consolidated assets and revenue that they audited. Answer: C Terms: Reports involving other auditors Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
11) A company has changed its method of inventory valuation from an unacceptable one to one in conformity with generally accepted accounting principles. The auditor's report on the financial statements of the year of the change should include: A) no reference to consistency. B) a reference to a prior period adjustment in the opinion paragraph. C) an explanatory paragraph that justifies the change and explains the impact of the change on reported net income. D) an explanatory paragraph explaining the change. Answer: D Terms: Consistency modifications Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
12) Which of the following modifications of the auditor's report does not include an explanatory paragraph? A) A qualified report is due to a GAAP departure. B) The report includes an emphasis of a matter. C) There is a very material scope limitation. D) A principal auditor accepts the work of an other auditor. Answer: D Terms: Shared opinions Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
13) No reference is made in the auditor's report to other auditors who perform a portion of the audit when: I. The other auditor audited an immaterial portion of the audit. II. The other auditor is well known or closely supervised by the principle auditor. III. The principle auditor has thoroughly reviewed the work of the other auditor. A) I and II B) I and III C) II and III D) I, II and III Answer: D Terms: Shared opinions Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
14) When an auditor is trying to determine how changes can affect consistency and and/or comparability, he should keep in mind that: A) changes that affect comparability but not consistency require an explanatory paragraph. B) items that materially affect the comparability of financial statements requires a disclaimer of opinion. C) changes that affect consistency require an explanatory paragraph if they are material. D) changes that involve either comparability or consistency only need to be mentioned in the footnotes. Answer: C Terms: Standard audit report; explanatory paragraph; consistency and comparability Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
15) All of the following would require an emphasis of matter paragraph except for: A) the existence of material related party transactions. B) the lack of auditor independence. C) important events occurring subsequent to the balance sheet date. D) material uncertainties disclosed in the footnotes. Answer: B Terms: Unqualified opinion with emphasis on specific matters regarding the financial statements Diff: Easy Objective: LO 3-4 AACSB: Analytic skills
16) Under AICPA auditing standards, the primary auditor issuing the opinion on the financial statements is called the: A) component auditor. B) principal auditor. C) group engagement partner. D) majority auditor. Answer: C Terms: Reports involving other auditors Diff: Easy Objective: LO 3-4 AACSB: Reflective thinking skills
17) Which of the following is false concerning the principal CPA firm's alternatives when issuing a report when another CPA firm performs part of the audit? A) Issue a joint report signed by both CPA firms. B) Make no reference to the other CPA firm in the audit report, and issue the standard unqualified opinion. C) Make reference to the other auditor in the report by using modified wording (a shared opinion or report). D) A qualified opinion or disclaimer, depending on materiality, is required if the principal auditor is not willing to assume any responsibility for the work of the other auditor. Answer: A Terms: Shared opinions Diff: Challenging Objective: LO 3-4 AACSB: Reflective thinking skills
18) Which of the following requires recognition in the auditor's opinion as to consistency?
A) The correction of an error in the prior year's financial statements resulting from a mathematical mistake in capitalizing interest. B) A change in the estimate of provisions for warranty costs. C) The change from the cost method to the equity method of accounting for investments in common stock. D) A change in depreciation method which has no effect on current year's financial statements but is certain to affect future years. Answer: C Terms: Consistency Diff: Challenging Objective: LO 3-4 AACSB: Reflective thinking skills
19) Indicate which changes would require an explanatory paragraph in the audit report. A) Correction of an error by changing from an accounting principle that is not generally acceptable to one that is generally acceptable Change from LIFO to FIFO Yes Yes B) Correction of an error by changing from an accounting principle that is not generally acceptable to one that is generally acceptable No
Change from LIFO to FIFO No
C) Correction of an error by changing from an accounting principle that is not generally acceptable to one that is generally acceptable Yes
Change from LIFO to FIFO No
D) Correction of an error by changing from an accounting principle that is not generally acceptable to one that is generally acceptable No
Change from LIFO to FIFO Yes
Answer: A
Terms: Changes that require explanatory paragraph in audit report Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
20) Indicate which changes would require an explanatory paragraph in the audit report. A) Change in the estimated life of Variation in the format of the an asset financial statements Yes Yes B) Change in the estimated life of an asset No
Variation in the format of the financial statements No
C) Change in the estimated life of an asset Yes
Variation in the format of the financial statements No
D) Change in the estimated life of an asset No
Variation in the format of the financial statements Yes
Answer: B
Terms: Changes that require explanatory paragraph in audit report Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
21) Indicate which changes would require an explanatory paragraph in the audit report. A) The CPA concludes there is substantial doubt about the entity's ability to continue as a going concern Change from FIFO to LIFO Yes Yes B) The CPA concludes there is substantial doubt about the entity's ability to continue as a going concern No
Change from FIFO to LIFO No
C) The CPA concludes there is substantial doubt about the entity's ability to continue as a going concern Yes
Change from FIFO to LIFO No
D) The CPA concludes there is substantial doubt about the entity's ability to continue as a going concern No Answer: A
Change from FIFO to LIFO Yes
Terms: Changes that would require an explanatory paragraph in audit report Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
22) Indicate which changes would require an explanatory paragraph in the audit report. A) A departure from GAAP which, The CPA makes reference to the due to unusual circumstances, work of another auditor to does not require a qualified or indicate shared responsibility in adverse opinion. an unqualified opinion. Yes Yes B) A departure from GAAP which, The CPA makes reference to the due to unusual circumstances, work of another auditor to does not require a qualified or indicate shared responsibility in adverse opinion. an unqualified opinion. No No C) A departure from GAAP which, The CPA makes reference to the due to unusual circumstances, work of another auditor to does not require a qualified or indicate shared responsibility in adverse opinion. an unqualified opinion. Yes No D) A departure from GAAP which, The CPA makes reference to the due to unusual circumstances, work of another auditor to does not require a qualified or indicate shared responsibility in adverse opinion. an unqualified opinion. No Yes Answer: C
Terms: Changes that would require an explanatory paragraph in audit report Diff: Challenging Objective: LO 3-4 AACSB: Reflective thinking skills
23) Discuss each of the five circumstances when an auditor would issue an unqualified audit report with an explanatory paragraph or modified wording. Answer: An unqualified report with an explanatory paragraph or modified wording is appropriate in the following circumstances: • Lack of consistent application of GAAP. When the client has not followed generally accepted accounting principles consistently in the current period in relation to the preceding period, an unqualified opinion with an explanatory paragraph following the opinion paragraph is appropriate. • Substantial doubt about continuing as a going concern. When an auditor concludes there is substantial doubt about the client's ability to continue as a going concern, an unqualified opinion with an explanatory paragraph following the opinion paragraph is appropriate. The auditor also has the option of issuing a disclaimer of opinion. • A departure from GAAP with which the auditor concurs. If adherence to GAAP would result in misleading financial statements, an unqualified opinion with an explanatory paragraph is appropriate. • Emphasis of a matter. If the auditor wants to emphasize specific matters in the audit report, an explanatory paragraph discussing those matters may be added to an unqualified report. • Reports involving other auditors. When an auditor relies upon a different CPA firm to perform part of the audit, the auditor can indicate that responsibility for the audit is shared with another CPA firm by modifying the wording of an unqualified report. Terms: Circumstances where an auditor will issue modified unqualified report with explanatory paragraph or modified wording Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
24) A modified unqualified audit report arises when the auditor believes the financials are fairly stated but also believes additional information should be provided. Answer: TRUE Terms: Modified unqualified audit report Diff: Easy Objective: LO 3-4 AACSB: Reflective thinking skills
25) Changes in accounting estimates requires the auditor to issue a modified unqualified audit report with a consistency paragraph inserted after the opinion paragraph. Answer: FALSE Terms: Changes of accounting estimates; Modified unqualified audit report Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
26) The only modified unqualified opinion that does not include an explanatory paragraph is when other auditors are involved. In this case only the introductory paragraph is modified. Answer: FALSE Terms: Modified unqualified opinion Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
27) Items that materially affect the comparability of the financial statements generally require disclosure in the footnotes. Answer: TRUE Terms: Items that materially affect comparability of financial statements Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
28) Changes in an estimate, such as a change in the estimated useful life of an asset for depreciation purposes, affect consistency but not comparability, and therefore require an explanatory paragraph in the audit report. Answer: FALSE Terms: Comparability vs. consistency Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
29) Changes in reporting entities, such as the inclusion of an additional company in combined financial statements, affect comparability but not consistency, and therefore do not require an explanatory paragraph in the audit report. Answer: FALSE Terms: Comparability and consistency Diff: Challenging Objective: LO 3-4 AACSB: Reflective thinking skills
30) When an auditor relies upon a different CPA firm to perform part of the audit and chooses to issue a shared opinion, only the auditor's responsibility paragraph should be modified. Answer: FALSE Terms: Auditor reliance on different CPA firm to perform part of audit; Shared opinion Diff: Moderate Objective: LO 3-4 AACSB: Reflective thinking skills
31) When other auditors are involved in the audit and they qualify their portion of the audit, the principal auditor must decide if the amount in question is material to the financial statements as a whole. Answer: TRUE Terms: Shared responsibility Diff: Challenging Objective: LO 3-4 AACSB: Reflective thinking skills
Learning Objective 3-5 1) As a result of management's refusal to permit the auditor to physically examine inventory, the auditor must depart from the unqualified audit report because: A) the financial statements have not been prepared in accordance with GAAP. B) the scope of the audit has been restricted by circumstances beyond either the client's or auditor's control. C) the financial statements have not been audited in accordance with GAAS. D) the scope of the audit has been restricted. Answer: D Terms: Auditor must depart from unqualified audit report; Management refusal to permit the auditor to physically examine inventory Diff: Easy Objective: LO 3-5 AACSB: Reflective thinking skills
2) An adverse opinion is issued when the auditor believes: A) some parts of the financial statements are materially misstated or misleading. B) the financial statements would be found to be materially misstated if an investigation were performed. C) the auditor is not independent. D) the overall financial statements are so materially misstated that they do not present fairly the financial position or results of operations and cash flows in conformity with GAAP. Answer: D Terms: Adverse opinion Diff: Easy Objective: LO 3-5 AACSB: Reflective thinking skills
3) An auditor can express a qualified opinion due to a: A) Lack of Sufficient Departure from GAAP Lack of Consistency Evidence Yes No No B) Departure from GAAP No
Lack of Consistency Yes
Lack of Sufficient Evidence No
Lack of Consistency No
Lack of Sufficient Evidence Yes
Lack of Consistency Yes
Lack of Sufficient Evidence Yes
C) Departure from GAAP Yes D) Departure from GAAP Yes Answer: C
Terms: Qualified opinions Diff: Easy Objective: LO 3-5 AACSB: Reflective thinking skills
4) An auditor determines the financial statements include at least a material departure from GAAP. Which type of opinion may be issued? A) Disclaimer Qualified Adverse Yes No No B) Disclaimer No
Qualified Yes
Adverse No
Disclaimer Yes
Qualified No
Adverse Yes
Disclaimer No
Qualified Yes
Adverse Yes
C)
D)
Answer: D
Terms: Opinion , GAAP departure Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
5) A qualified opinion can be issued for which of the following? I. When a limitation on the scope of the audit has occurred II. When the auditor lacks independence III. When generally accepted accounting principles have not been used A) I and II B) I and III C) II and III D) I, II and III Answer: B Terms: Qualified opinion Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
6) In which situation would the auditor be choosing between "except for" qualified opinion and an adverse opinion? A) The auditor lacks independence. B) A client-imposed scope limitation C) A circumstance imposed scope limitation D) Lack of full disclosure within the footnotes Answer: D Terms: Qualified opinion and adverse opinion Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
7) When the auditor determines that the financial statements are fairly stated, but there is a nonindependent relationship between the auditor and the client, the auditor should issue: A) an adverse opinion. B) a disclaimer of opinion. C) either a qualified opinion or an adverse opinion. D) either a qualified opinion or an unqualified opinion with modified wording. Answer: B Terms: Audit report when auditor not independent Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
8) If the auditor lacks independence, a disclaimer of opinion must be issued: A) if the client requests it. B) only if it is highly material. C) only if it is material but not pervasive. D) in all cases. Answer: D Terms: Disclaimer when auditor lacks independence Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
9) If the phrase "except for" is present in the opinion paragraph of the audit report, the auditor has issued a(n): A) adverse opinion. B) disclaimer of opinion. C) unqualified opinion. D) qualified opinion. Answer: D Terms: Departure from unqualified audit report Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
10) A client has changed their method of valuing inventory from FIFO to LIFO and the change has a material effect on the financial statements. If the auditor does not concur with the appropriateness of the change, the auditor should issue a(n): A) disclaimer. B) adverse opinion. C) unqualified opinion. D) qualified opinion. Answer: D Terms: Change in valuing inventory and auditor does not concur with change Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
11) Items that materially affect the comparability of financial statements generally require disclosure in the footnotes. If the client refuses to properly disclose the item, the auditor will most likely issue: A) a disclaimer. B) an unqualified opinion. C) a qualified opinion. D) an adverse opinion. Answer: C Terms: Disclosure and comparability Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
12) Which of the following scenarios does not result in a qualified opinion? A) A scope limitation prevents the auditor from completing an important audit procedure. B) Circumstances exist that prevent the auditor from conducting a complete audit. C) The auditor lacks independence with respect to the audited entity. D) An accounting principle at variance with GAAP is used. Answer: C Terms: Qualified opinion Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
13) Whenever the client imposes restrictions on the scope of the audit, the auditor should be concerned that management may be trying to prevent discovery of misstatements. In such cases, the auditor will likely issue a: A) disclaimer of opinion in all cases. B) qualification of both scope and opinion in all cases. C) disclaimer of opinion whenever materiality is in question. D) qualification of both scope and opinion whenever materiality is in question. Answer: C Terms: Client imposed restrictions on scope of audit Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
14) In which of the following circumstances would an auditor most likely express an adverse opinion? A) The CEO refuses to let the auditor have access to the board of director meeting minutes. B) The financial statements are not in conformity with the FASB statement on loss contingencies. C) Information comes to the auditor's attention that raises substantial doubt about the ability for the client to continue as a going concern. D) Tests of controls show that the internal control structure is so poor that the auditor has to assess control risk at the maximum. Answer: B Terms: Adverse opinion circumstances Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
15) Which of the following statements is true? I. The auditor is required to issue a disclaimer of opinion in the event of a material uncertainty. II. The auditor is required to issue a disclaimer of opinion in the event of a going concern problem. A) I only B) II only C) I and II D) Neither I nor II Answer: D Terms: Disclaimer of opinion Diff: Challenging Objective: LO 3-5 AACSB: Reflective thinking skills
16) The most common case in which conditions beyond the client's and auditor's control cause a scope restriction in an engagement is when the: A) auditor is not appointed until after the client's year-end. B) client won't allow the auditor to confirm receivables for fear of offending its customers. C) auditor doesn't have enough staff to satisfactorily audit all of the client's foreign subsidiaries. D) client is going through Chapter 11 bankruptcy. Answer: A Terms: Scope restriction beyond client and auditor control Diff: Challenging Objective: LO 3-5 AACSB: Reflective thinking skills
17) When the client fails to make adequate disclosure in the body of the statements or in the related footnotes, it is the responsibility of the auditor to: A) inform the reader that disclosure is not adequate, and to issue an adverse opinion. B) inform the reader that disclosure is not adequate, and to issue a qualified opinion. C) present the information in the audit report and issue an unqualified or qualified opinion. D) present the information in the audit report and to issue a qualified or an adverse opinion. Answer: D Terms: Inadequate disclosure Diff: Challenging Objective: LO 3-5 AACSB: Reflective thinking skills
18) There are three conditions necessitating a departure from an unqualified audit report. Name, discuss and state the appropriate audit report for each of these three conditions. Answer: The three conditions requiring a departure from an unqualified report are: • Scope Restrictions. A scope restriction can be imposed by the client or due to circumstances beyond the auditor's or client's control. In either case the scope restriction prevents the auditor from accumulating sufficient evidence to reach a conclusion regarding whether financial statements are stated in accordance with GAAP. The type of opinion, depending upon materiality, would be either a qualified or a disclaimer of opinion report. • GAAP Departures. In this situation the financial statements are not prepared in accordance with GAAP. Accordingly, the auditor would issue a qualified opinion if the GAAP violation were moderately material, or an adverse opinion if the GAAP violation were highly material. • Auditor lacks independence. Independence is ordinarily determined by Rule 101 of the rules of the Code of Professional Conduct. When the auditor is not independent, the only report the auditor can issue is a disclaimer of opinion. Terms: Conditions necessitating a departure from an unqualified audit report Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
19) A qualified audit report is issued when all auditing conditions have been met, no significant misstatements have been discovered, and it is the auditor's opinion that the financial statements are fairly stated in accordance with GAAP. Answer: FALSE Terms: Qualified report Diff: Easy Objective: LO 3-5 AACSB: Reflective thinking skills
20) Auditors should issue a disclaimer of opinion when there is a highly material client-imposed scope restriction. Answer: TRUE Terms: Disclaimer of opinion; Client-imposed scope restriction Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
21) Whenever an auditor issues a qualified report, he or she must use the term "except for " in the opinion paragraph. Answer: TRUE Terms: Qualified report; Except for in opinion paragraph Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
22) A qualified report can take the form of a qualification of both the scope and the opinion or of the opinion alone. Answer: TRUE Terms: Qualified report; Scope limitation Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
23) When an auditor discovers a highly material GAAP violation in the financial statements and the client refuses to correct it, the auditor should issue a disclaimer of opinion. Answer: FALSE Terms: Disclaimer of opinion; Highly material GAAP violation in the financial statements and client refuses to correct it Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
24) Client imposed restrictions on the audit always require a disclaimer of opinion. Answer: FALSE Terms: Disclaimer of opinion; Client imposed restrictions on audit Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
25) An auditor should issue a qualified opinion with an explanatory paragraph whenever there is a material uncertainty affecting the financial statements. Answer: FALSE Terms: Qualified opinion with explanatory paragraph Diff: Moderate Objective: LO 3-5 AACSB: Reflective thinking skills
Learning Objective 3-6 1) A misstatement in the financial statements can be considered material if knowledge of the misstatement will affect a decision of: A) the PCAOB. B) a reasonable user of the financial statements. C) an accountant. D) the SEC. Answer: B Terms: Materiality Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills
2) Misstatements must be compared with some measurement base before a decision can be made about materiality. A commonly accepted measurement base includes: A) net income. B) total assets. C) working capital. D) all of the above. Answer: D Terms: Misstatements and materiality Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills
3) When comparing misstatements with a measurement base, the auditor must consider the pervasiveness of the misstatement. Of the following examples, the most pervasive misstatement is a(n): A) understatement of inventory. B) understatement of retained earnings caused by a miscalculation of dividends payable. C) misclassification of notes payable as a long-term liability when it should be current. D) misclassification of salary expense as a selling expense. Answer: A Terms: Pervasive misstatements Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills
4) The dollar amount of some misstatements cannot be accurately measured. For example, if the client were unwilling to disclose an existing lawsuit, the auditor must estimate the likely effect on: A) net income. B) users of the financial statements. C) the auditor's exposure to lawsuits. D) management's future decisions. Answer: B Terms: Misstatements accurately measured Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills
5) If most or all users' decisions that are based on the financial statements are likely to be significantly
affected, the materiality level is: A) unrestricted. B) material. C) pervasive. D) risky. Answer: C Terms: Materiality qualifications Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills
6) When a client fails to follow GAAP, the audit report can be unqualified, qualified, or adverse depending on the materiality. What factors affect materiality that an auditor should consider? A) The dollar amount in comparison to a base B) If the misstatement can be measured C) The nature of the item D) All the above are factors an auditor should consider regarding materiality. Answer: D Terms: Client fails to follow GAAP; Materiality Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills
7) Which of the following is a correct statement regarding materiality? A) There are well-defined guidelines that enable auditors to determine if something is material. B) Misstatements must be compared with some benchmark before a decision can be made about the materiality level of the failure of a company to follow GAAP. C) Pervasiveness is not considered when comparing potential misstatements with a base or benchmark. D) To evaluate overall materiality, the auditor does not combine all unadjusted misstatements. Answer: B Terms: Materiality Diff: Moderate Objective: LO 3-6 AACSB: Reflective thinking skills
8) Discuss how materiality affects audit reporting decisions. Answer: When determining the appropriate audit report to issue, the auditor considers three levels of materiality for a given condition. These three levels are (1) immaterial, (2) material without overshadowing the financial statements as a whole, and (3) so material and so pervasive that overall fairness of the statements is in question. For conditions involving a GAAP violation, the materiality level of the violation influences whether an unqualified, qualified, or adverse opinion is issued. For conditions involving a scope restriction, the materiality of the restriction influences whether an unqualified report, a qualified scope and opinion report, or a disclaimer of opinion is issued. Terms: Materiality affect on audit reporting decisions Diff: Easy Objective: LO 3-6 AACSB: Reflective thinking skills
9) Materiality is essential when an auditor considers his/her determination of the appropriate report for a given set of circumstances. Answer: TRUE Terms: Materiality; Appropriate report Diff: Easy Objective: LO 3-6 AACSB: Reflective thinking skills
10) A pervasive exception is one that affects different parts of the financial statements. Answer: TRUE Terms: Pervasive exception Diff: Easy Objective: LO 3-6 AACSB: Reflective thinking skills
11) An item with a "psychic" effect (e.g., where the item maintains an increasing earnings trend) is a qualitative factor that may affect the auditors decision regarding materiality. Answer: TRUE Terms: Psychic effect; Materiality Diff: Challenging Objective: LO 3-6 AACSB: Reflective thinking skills
Learning Objective 3-7 1) The explanatory paragraph for a qualified opinion would: A) precede the scope paragraph. B) follow the scope paragraph. C) follow the opinion paragraph. D) either precede or follow the opinion paragraph depending on the materiality. Answer: B Terms: Explanatory paragraph for qualified opinion Diff: Easy Objective: LO 3-7 AACSB: Reflective thinking skills
2) An auditor who issues a qualified opinion because sufficient appropriate evidence was not obtained should describe the limitations in an explanatory paragraph. The auditor should also modify the: A) Notes to the financial Scope paragraph Opinion paragraph statements Yes No Yes B) Scope paragraph No
Opinion paragraph Yes
Notes to the financial statements Yes
Scope paragraph No
Opinion paragraph Yes
Notes to the financial statements No
Opinion paragraph Yes
Notes to the financial statements No
C)
D) Scope paragraph Yes Answer: D
Terms: Qualified opinion insufficient evidence Diff: Challenging Objective: LO 3-7 AACSB: Reflective thinking skills
3) When an auditor issues a qualified report due to a scope limitation an explanatory paragraph is normally added. Which, if any, of the following paragraphs are also modified? A) Introductory Scope Opinion Yes Yes Yes B) Introductory Yes
Scope Yes
Opinion No
Introductory No
Scope Yes
Opinion No
Introductory No
Scope Yes
Opinion Yes
C)
D)
Answer: D
Terms: Qualified report due to scope restriction; Paragraphs modified Diff: Moderate Objective: LO 3-7 AACSB: Reflective thinking skills
4) When a qualified or adverse opinion is issued, the qualifying paragraph is inserted: A) between the introductory and scope paragraphs. B) between the scope and opinion paragraphs. C) after the opinion paragraph, as a fourth paragraph. D) immediately after the address, as the first paragraph. Answer: B Terms: Qualified or adverse opinion paragraph placement Diff: Moderate Objective: LO 3-7 AACSB: Reflective thinking skills
5) The independent auditor must issue a qualified opinion when which of the financial(s) are missing? I. Balance Sheet II. Income Statement III. Statement of Cash Flows A) I only B) II only C) III only D) I, II, and III Answer: C Terms: Qualified opinion issued when which financial statement is missing Diff: Moderate Objective: LO 3-7 AACSB: Reflective thinking skills
6) If the financial statements include an income statement and a balance sheet but exclude the statement
of cash flows, the auditors: A) can issue an unqualified report. B) should issue a qualified opinion due to the departure from GAAP. C) should issue a qualified opinion because the missing statement of cash flows constitutes a scope limitation. D) should include the statement of cash flows, modify the report and issue an unqualified opinion. Answer: B Terms: Report when financial statements exclude statement of cash flows Diff: Challenging Objective: LO 3-7 AACSB: Reflective thinking skills
7) Which of the following is incorrect concerning scope limitations? A) If client imposed, the auditor should be concerned about the client trying to prevent discovery of a material misstatement. B) An unqualified opinion can result if auditors can perform alternative procedures and are satisfied that the information is fairly stated. C) The most common circumstance imposed scope restriction is due to the client changing their auditors. D) The most common circumstance imposed scope limitation is when the auditor is appointed after the balance sheet date. Answer: C Terms: Scope limitation Diff: Moderate Objective: LO 3-7 AACSB: Reflective thinking skills
8) When dealing with materiality and scope limitation conditions: A) a disclaimer of opinion must be issued. B) it is easier to evaluate the materiality of potential misstatements resulting from a scope limitation than for failure to follow GAAP. C) scope limitations imposed by the client are always considered material. D) a unqualified opinion may still be issued depending on the materiality of the scope limitation. Answer: D Terms: Scope limitation Diff: Moderate Objective: LO 3-7 AACSB: Reflective thinking skills
9) When a pervasive scope limitation exists: A) a disclaimer of opinion rather than a qualified opinion is generally required. B) the auditor's responsibility paragraph is modified to indicate that the auditor was not able to obtain sufficient appropriate evidence to express an audit opinion. C) sections of the auditor's responsibility paragraph are eliminated to avoid stating anything that might lead readers to believe that other parts of the financial statements might be fairly stated. D) all of the above. Answer: D Terms: Pervasive scope limitation Diff: Moderate Objective: LO 3-7 AACSB: Reflective thinking skills
10) When there is a scope restriction, what type of audit report can be issued? A) Unqualified opinion B) Qualification of scope and opinion C) Disclaimer of opinion D) Any of the above Answer: D Terms: Audit reports in various situations Diff: Moderate Objective: LO 3-7 AACSB: Reflective thinking skills
11) Subsequent to the close of Spacely Sprockets fiscal year ending October 31, 2012, a major debtor has declared bankruptcy due to a series of events. The receivable is significantly material in relation to the financial statements, and recovery is doubtful. The debtor had confirmed the full amount due to Spacely Sprocket at the balance sheet date. Because the account was confirmed at the balance sheet date, Spacely refuses to disclose any information in relation to this subsequent event. The CPA believes that all other accounts were stated fairly at the balance sheet date. In addition, Spacely changed their method of inventory valuation from FIFO to LIFO. This change was disclosed in Note X to the financial statements. Accordingly, what type of opinion should be expressed? A) Unqualified with an explanatory paragraph. B) Qualified due to a GAAP departure. C) Qualified due to a scope limitation. D) A combination of B and C. Answer: B Terms: Audit report when client has subsequent event and change in inventory valuation Diff: Challenging Objective: LO 3-7 AACSB: Reflective thinking skills
12) For the report containing a disclaimer for lack of independence, the disclaimer is in the: A) second or scope paragraph. B) third or opinion paragraph. C) first and only paragraph. D) fourth or explanatory paragraph. Answer: C Terms: Disclaimer in which report paragraph Diff: Challenging Objective: LO 3-7 AACSB: Reflective thinking skills
13) When an adverse opinion is issued, a scope paragraph would be: A) qualified. B) unchanged. C) deleted. D) expanded to identify the additional procedures which the auditor performed. Answer: B Terms: Adverse opinion and scope paragraph Diff: Challenging Objective: LO 3-7 AACSB: Reflective thinking skills
14) After the balance sheet date but prior to issuance of the auditor's report the auditor learns that the client's facility in a foreign country has been expropriated. Management refuses to disclose this information in a financial statement footnote or present pro-forma data as to the effect of the event. The auditor should: A) add a footnote to the financial statements. B) disclaim an opinion due to the client imposed scope limitation. C) provide the information in the report and modify the opinion. D) issue an unqualified opinion but provide the information in the auditor report. Answer: C Terms: Material subsequent event management refusal to disclose Diff: Challenging Objective: LO 3-1 and LO 3-7 AACSB: Reflective thinking skills
15) The following is a portion of an adverse audit report issued for a public company. (Note: A separate report was issued on the effectiveness of internal control over financial reporting.) Independent Auditor's Report To the shareholders of Wallace Corporation We have audited the accompanying balance sheet of Wallace Corporation as of December 31, 2012, and the related statements of income, retained earnings, and cash flows for the year then ended. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. The company has excluded from property and debt in the accompanying balance sheet certain lease obligations that, in our opinion, should be capitalized in order to conform with generally accepted accounting principles. If these lease obligations were capitalized, property would be increased by $14,500,000, long-term debt by $13,200,000, and retained earnings by $1,300,000 as of December 31, 2012, and net income and earnings per share would be increased by $1,300,000 and $2.25, respectively, for the year then ended. Required: Complete the above adverse audit report by preparing the opinion paragraph. Do not date or sign the report. Answer: In our opinion, because of the significance of the matter discussed in the preceding paragraph, the financial statements referred to above do not present fairly the financial position of Wallace Corporation as of December 31, 2012, or the results of its operations and its cash flows for the year then ended. Terms: Adverse audit report Diff: Challenging Objective: LO 3-7 AACSB: Analytic skills Topic: Public
16) The following is the introductory paragraph, and the Basis for Qualified Opinion paragraph for Fast Times Corporation, a non-public company. Independent Auditor's Report To the shareholders of Fast Times Corporation We have audited the accompanying balance sheet of Fast Times Corporation as of September 30, 2012, and the related statements of income, retained earnings, and cash flows for the year then ended, and the related notes to the financial statements. Basis for Qualified Opinion We were unable to obtain audited financial statements supporting the company's investment in a foreign affiliate stated at $1,040,000, or its equity in earnings of that affiliate of $501,000, which is included in net income, as described in Note 14 to the financial statements. Because of the nature of the company's records, we were unable to satisfy ourselves as to the carrying value of the investment or the equity in its earnings by means of other auditing procedures. Required: Prepare the opinion paragraph for the above audit report. Do not date or sign the report. Answer: In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements referred to above present fairly, in all material respects, the financial position of Fast Times Corporation as of September 30, 2012, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Terms: Qualified scope and opinion report Diff: Challenging Objective: LO 3-7 AACSB: Analytic skills Topic: Public
17) Your CPA firm has completed the fieldwork for the 2012 audit of Sharp Corporation, a private company with an October year-end. You were preparing to draft a standard, unqualified audit report when you discovered that the audit manager on the Sharp engagement owns 10 shares of Sharp's common stock. Prepare the appropriate report. Answer: We are not independent with respect to Sharp Corporation, and the accompanying balance sheet as of October 31, 2012, and the related statements of income, retained earnings, and cash flows for the year then ended were not audited by us. Accordingly, we do not express an opinion on them. Note: There is no report title when the auditor issues a disclaimer due to a lack of independence. Terms: Audit report with lack of independence Diff: Moderate Objective: LO 3-7 AACSB: Reflective thinking skills
18) Assume you are the partner in charge of the 2012 audit of Becker Corporation, a private company. The audit report has not yet been prepared. In each independent situation following (1-8), indicate the appropriate action (a-g) to be taken. The possible actions are as follows: a. b. c. d. e. f. g.
Issue a standard unqualified report. Qualify both the scope and opinion paragraphs. Qualify the opinion paragraph. Issue an unqualified opinion with an explanatory paragraph. Issue an unqualified opinion with modified wording (no explanatory paragraph). Issue an adverse opinion. Disclaim an opinion.
The situations are as follows: ________ 1. Becker Corporation carries its property, plant, and equipment accounts at current market values. Current market values exceed historical cost by a highly material amount, and the effects are pervasive throughout the financial statements. ________ 2. Management of Becker Corporation refuses to allow you to observe, or make, any counts of inventory. The recorded book value of inventory is highly material. ________ 3. You were unable to confirm accounts receivable with Becker's customers. However, because of detailed sales and cash receipts records, you were able to perform reliable alternative audit procedures. ________ 4. One week before the end of fieldwork, you discover that the audit manager on the Becker engagement owns a material amount of Becker's common stock. ________ 5. You relied upon another CPA firm to perform part of the audit. Although you were the principal auditor, the other firm audited a material portion of the financial statements. You wish to refer to (but not name) the other firm in your report. ________ 6. You have substantial doubt about Becker's ability to continue as a going concern. ________ 7. Becker Corporation changed its method of computing depreciation in 2012. You concur with the change and the change is properly disclosed in the financial statement footnotes. ________ 8. Ten days after the balance sheet date, one of Becker's buildings was destroyed by a fire. Becker refuses to disclose this information in a footnote to the financial statements, but you believe disclosure is required to conform with GAAP. The amount of the uninsured loss was material, but not highly material.
Answer: 1. f 2. g 3. a 4. g 5. e 6. d or g 7. d 8. c
Terms: Audit reports in various situations Diff: Challenging Objective: LO 3-1, LO 2-4, LO 3-5, and LO 3-7 AACSB: Analytic skills
19) Smith and Jones, CPAs, audited the consolidated financial statements of Concord Inc. and all but one of its subsidiaries for the year ended September 30, 2012 and are expressing an unqualified opinion on the financials presented as a whole. Smith, the engagement partner, instructed Mary, an assistant on the engagement, to draft the auditor's report on November 4, 2012, the date of fieldwork completion. In drafting the report Mary considered the following: • In preparing its financial statements, Concord changed its method of accounting for research and development costs and properly expensed these amounts. Management described the change in principle in Note 10 to the consolidated financial statements. • Ball & Brown, CPAs, audited the financial statements of Biotherm, Inc., a consolidated subsidiary of Concord for the year ended September 30, 2012. The subsidiary's financial statements reflect total assets of 22% and total revenues of 20% of the consolidated totals. Ball & Brown expressed an unqualified opinion and furnished to Smith & Jones a copy of their auditor report. Smith & Jones have decided not to assume responsibility for the work of Ball & Brown insofar as it relates to the expression of an opinion on the consolidated financial statements taken as a whole because of the materiality of Biotherm's financial statements to the consolidated whole. Ball & Brown's report will not be presented together with that of Smith & Jones. • Concord is the subject of a grand jury investigation into possible violations of federal antitrust laws and possible related crimes. Related civil class actions are pending. Concord's management has adequately disclosed in Note 12 to their consolidated financial statements. Because of the early stage of the investigation, the ultimate outcome of these matters cannot be determined at this time. Therefore, no provision for any liability that may result has been recorded. • Concord experienced a net loss in 2012 and is currently in default under substantially all of its debt agreements. Management's plans in regard to these matters are adequately disclosed in Note 14 to Concord's consolidated financial statements. The financials do not include any adjustments that might result from the outcome of this uncertainty. These matters rase substantial doubt about Concord's ability to continue as a going concern. Ball reviewed Mary's draft and indicated in his review notes that there were many deficiencies in Mary's Draft. The audit report that Mary drafted follows. Independent Auditor's Report We have audited the consolidated financial statements of Concord, Inc., and subsidiaries as of September
30, 2012, and the related consolidated statements of income, changes in stockholders equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of Biotherm, Inc., a wholly-owned subsidiary, which statements reflect total assets and revenues constituting 22% and 20% respectively at September 30, 2012 of the consolidated totals. Those statements were audited by Ball & Brown, CPAs, whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for Biotherm, Inc. is based solely on their report. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used, as well as assessing control risk. We believe our audits provide a reasonable basis for our opinion. In our opinion, based on our audit and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Concord Inc., as of September 30, 2012 in conformity with generally accepted accounting principles, except for the uncertainty, which is discussed in Note 12 to the consolidated financials. The accompanying consolidated financial statements have been prepared assuming that the Company will continue in existence for a reasonable period of time. As discussed in Note 14 to the consolidated financial statements, the Company suffered a net loss and is currently in default under substantially all of its debt agreements. Management's plans in regard to these matters are also described in Note 14. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Smith & Jones, CPAs November 4, 2012
Required: The following items present some of the deficiencies in the drafted audit report noted by Smith. For each deficiency, indicate whether: S. Smith's review note is correct M. Mary's draft is correct B. Both Smith's review note and Mary's draft are incorrect Smith's Review Notes 1. An explanatory paragraph is required between the scope and opinion paragraphs is required for the change in accounting principles referring the reader to Note 10. 2. The names of the other auditors do not need to be explicitly stated in the introductory paragraph. Only that "other auditors" performed the audit and provided their report. 3. The opinion paragraph should extend the auditor's opinion beyond financial position to include the
results of Concord's operations and flows. 4. The reference to the uncertainty in the opinion paragraph is incomplete. It should describe the nature of the uncertainty as pertaining to the grand jury investigation into possible violations of federal antitrust laws. 5. The explanatory paragraph following the opinion paragraph does not include the terms "substantial doubt" and "going concern". These terms are required to be used in this paragraph. 6. The explanatory paragraph following the opinion paragraph includes an inappropriate statement that "the consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty." This statement is misleading and should be omitted. Answer: 1. B 2. S 3. S 4. B 5. S 6. M
Terms: Deficiencies in audit reports Diff: Challenging Objective: LO 3-1, LO 3-4, and LO 3-7 AACSB: Analytic skills
20) In auditing the long-term investments account, Arens, CPA, is unable to obtain audited financial statements for an investee located in a foreign country. Levine concludes sufficient appropriate audit evidence regarding this investment cannot be obtained. For each of the following situations below, identify the appropriate opinion type and report modification by selecting a choice from the appropriate tables below.
Situation 1. Assume the potential effect on the financial statements is immaterial. 2. Assume the potential effect on the financial statements is moderate. 3. Assume the potential effect on the financial statements is high.
U Q A D
Opinion Type Unqualified Qualified Adverse Disclaimer
Opinion Type
Intro
Scope
Standard Paragraph Choice O Omit N No change M Modify
0 + -
Opinion
Exp1
Explanatory Paragraph None required Insert before opinion Insert after opinion
Answer: Situation 1. Assume the potential effect on the financial statements is immaterial. 2. Assume the potential effect on the financial statements is moderate. 3. Assume the potential effect on the financial statements is high.
Opinion Type
Intro
Scope
Opinion
Exp1
U
N
N
N
0
Q
N
M
M
+
D
O
M
M
+
Terms: Circumstances and required audit reports Diff: Challenging Objective: LO 3-1, LO 3-4, and LO 3-7 AACSB: Analytic skills
21) Audit situations 1 through 10 present various independent factual situations an auditor might encounter in conducting an audit. List A represents the types of opinions the auditor ordinarily would issue, and List B represents the report modifications (if any) that would be necessary. For each situation, select one response from List A and one from List B. Select, as the best answer for each item, the action the auditor normally would take. Items from either list may be selected once, more than once, or not at all. Assume the following: • The auditor is independent • The auditor previously expressed an unqualified opinion on the prior-year financial statements unless otherwise noted • Only single-year (not comparative) statements are presented for the current year (unless otherwise stated) • The conditions for an unqualified opinion exist unless contradicted in the factual scenario • The conditions stated in the factual scenario are material • No report modifications are to be made except in response to the factual scenario Factual Scenario 1. The financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows in conformity with GAAP. 2. In auditing the Long-Term Investments account, an auditor is unable to obtain audited F/S for an investee located in a foreign country. The auditor concludes that sufficient competent evidential matter regarding this investment cannot be obtained but it is not pervasive to the financials as a whole. 3. Due to recurring operating losses and working capital deficiencies the auditor has substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. However, the F/S disclosures are adequate. 4. The principal auditor decides to refer to the work of another auditor, who audited a wholly owned subsidiary of the entity and issued an unqualified opinion. 5. An entity issues F/S that present financial position and results of operations but omits the related statement of cash flows. Management discloses in the notes to the F/S that it does not believe the statement of cash flows to be useful. 6. An entity changes its depreciation method for production equipment from SL to units of production based on hours of utilization. The auditor concurs with the change, although it has a material effect on the comparability of the entity's F/S. 7. An entity is a defendant in a lawsuit alleging infringement of certain patent rights. However, management. cannot reasonably estimate the ultimate outcome of the litigation. The auditor believes that there is a reasonable possibility of a significant material loss, but the lawsuit is adequately disclosed in the notes to the F/S. 8. An entity discloses certain lease obligations in the notes to the F/S. The auditor believes that the failure to capitalize these leases is a departure from GAAP. 9. The entity wishes to show comparative F/S and include the prior year. However, the prior year F/S contained a qualification due to an inappropriate method of GAAP. Accordingly, management. corrected the prior year GAAP deficiency and included the updated numbers in the comparative financials for the current year. 10. The entity wishes to show comparative F/S and include the prior year. However, the prior year F/S were audited by another auditor who refuses to reissue his opinion.
List A Opinion Choices
A Qualified
B Unqualified
C Adverse
D Disclaimer
E Either Qualified or Adverse
F Either Disclaimer or Adverse
G Either Qualified or Disclaimer
.
List B Report Modification Choices H Describe the circumstances in an explanatory paragraph preceding the opinion paragraph w/o modifying the three standard paragraphs. I Describe the circumstances in the opinion paragraph w/o adding an explanatory paragraph. J Describe the circumstances in an explanatory paragraph preceding the opinion paragraph and modify the opinion paragraph. K Describe the circumstances in an explanatory paragraph following the opinion paragraph and modify the opinion paragraph. L Describe the circumstances in an explanatory paragraph preceding the opinion paragraph and modify the scope & opinion paragraph. M Describe the circumstances in an explanatory paragraph following the opinion paragraph and modify the scope & opinion paragraph. N Describe the circumstances in the scope paragraph w/o adding an explanatory paragraph. O Describe the circumstances in an explanatory paragraph following the opinion paragraph w/o modifying the three standard paragraphs. P Describe the circumstances in the introductory paragraph w/o adding an explanatory paragraph. Q Describe the circumstances in the introductory paragraph w/o adding an explanatory paragraph, and modify the scope & opinion paragraphs. R Issue the standard auditor's report w/o modification. S None of the above.
Answer: 1. B, R 2. A, L 3. B, I 4. B, Q 5. A, J 6. B, I 7. B, R 8. E, J 9. B, H 10. B, R
Terms: Audit situations and required reports with modifications Diff: Challenging Objective: LO 3-1, LO 3-4, LO 3-5, and LO 3-7 AACSB: Analytic skills
22) Financial statement users are typically more concerned with an unqualified report with explanatory paragraphs than they are with a disclaimer of opinion. Answer: FALSE Terms: Financial statement users; Unqualified report with explanatory paragraphs; Disclaimer of opinion Diff: Moderate Objective: LO 3-7 AACSB: Reflective thinking skills
23) A lack of independence will override any other scope limitations and requires a disclaimer of opinion. Answer: TRUE Terms: Lack of independence; Disclaimer of opinion Diff: Moderate Objective: LO 3-7 AACSB: Reflective thinking skills
24) When a qualified opinion is issued, an explanatory paragraph is added immediately after the opinion paragraph to explain the nature of the qualification that affects the opinion. Answer: FALSE Terms: Qualified opinion explanatory paragraph and opinion paragraph Diff: Moderate Objective: LO 3-7 AACSB: Reflective thinking skills
25) In the case of a disclaimer due to lack of independence, the entire scope paragraph is excluded from the report. Answer: TRUE Terms: Disclaimer of opinion Diff: Moderate Objective: LO 3-7 AACSB: Reflective thinking skills
Learning Objective 3-8 1) When accounting principles are not consistently applied, and the materiality level is immaterial, the auditor will issue a(n): A) unqualified opinion. B) unqualified opinion with an explanatory paragraph. C) adverse opinion. D) disclaimer opinion. Answer: A Terms: Audit report and different levels of materiality Diff: Moderate Objective: LO 3-8 AACSB: Analytic skills
2) The first step to be followed when deciding the appropriate audit report in a given set of circumstances is to: A) decide the appropriate type of report for the condition. B) write the report. C) determine whether any conditions exists requiring a departure from a standard unqualified report. D) decide the materiality for each condition. Answer: C Terms: Auditor's decision process for audit reports Diff: Moderate Objective: LO 3-8 AACSB: Reflective thinking skills
3) In most audits, the auditor issues a: A) qualified audit report. B) unqualified audit report. C) scope limited audit report. D) adverse audit report. Answer: B Terms: Standard unqualified audit report Diff: Challenging Objective: LO 3-8 AACSB: Reflective thinking skills
4) More than one modification should be included in the audit report when: A) the auditor is not independent and the auditor knows that the company has not followed generally accepted accounting principles. B) there is substantial doubt about the going concern of the company and information about the causes of the uncertainties is not adequately disclosed in the footnotes. C) there is a scope limitation and there is substantial doubt about the company's ability to continue as a going concern. D) all of the above. Answer: D Terms: Standard report; More than one condition requiring a departure or modification Diff: Moderate Objective: LO 3-8 AACSB: Reflective thinking skills
5) When there is a justified departure from GAAP which is considered material, the auditor should issue a(n): A) standard unqualified audit report. B) disclaimer of opinion. C) unqualified audit report with an explanatory paragraph. D) adverse opinion. Answer: C Terms: Audit report and different levels of materiality Diff: Moderate Objective: LO 3-8 AACSB: Reflective thinking skills
6) If there is a deviation in the statements' preparation in accordance with GAAP and another accounting principle was applied on a basis that was not consistent with that of the preceding year: A) the auditor must choose which modification to include in the audit report. B) only the most material modification can be disclosed. C) more than one modification should be included in the report. D) none of the above. Answer: C Terms: Standard report; More than one condition requiring a departure or modification Diff: Moderate Objective: LO 3-8 AACSB: Reflective thinking skills
7) After the auditor determines whether any conditions exist which require a departure from a standard unqualified report, the next step in the decision process for audit reports is to: A) write the report. B) decide the materiality for each condition. C) decide the appropriate type of report for the condition. D) discuss the report with management. Answer: B Terms: Auditor's decision process for audit reports Diff: Easy Objective: LO 3-8 AACSB: Reflective thinking skills
8) The final step in the auditor's decision process for audit reports is to write the audit report. Answer: TRUE Terms: Auditor's decision process for audit reports Diff: Easy Objective: LO 3-8 AACSB: Reflective thinking skills
9) Academic research is underway to study the effectiveness of communications provided by auditors in the audit report. Answer: TRUE Terms: Research underway on audit report Diff: Moderate Objective: LO 3-8 AACSB: Reflective thinking skills
Learning Objective 3-9
1) Auditing standards in the United States allow an auditor to perform an audit of a U.S. entity in accordance with both generally accepted auditing standards in the U.S. and the ISAs. Answer: TRUE Terms: Auditing standards of United States and International Standards of Auditing Diff: Moderate Objective: LO 3-9 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e (Arens) Chapter 4 Professional Ethics Learning Objective 4-1 1) Ethics are: A) needed in the professions, but is not needed for society in general. B) a set of moral principles or values. C) not formed by life experiences. D) always incorporated in laws. Answer: B Terms: Ethical Principles Diff: Easy Objective: LO 4-1 AACSB: Ethical understanding and reasoning abilities
2) ________ means that a person acts according to conscience, regardless of the situation. A) Caring B) Fairness C) Integrity D) Respect Answer: C Terms: Ethical principles and integrity Diff: Moderate Objective: LO 4-1 AACSB: Ethical understanding and reasoning abilities
3) One of the main reasons people act unethically is that they choose to act selfishly. Answer: TRUE Terms: Ethical Principles Diff: Easy Objective: LO 4-1 AACSB: Ethical understanding and reasoning abilities
Learning Objective 4-2 1) A six-step approach is often used to resolve an ethical dilemma. The first step in this process is to: A) identify the alternative actions available. B) identify the ethical issues from the facts. C) determine who will be affected by the outcome of the dilemma. D) obtain the relevant facts. Answer: D Terms: Ethical dilemma Diff: Moderate Objective: LO 4-2 AACSB: Ethical understanding and reasoning abilities
2) Describe an ethical dilemma that an auditor or an accountant might face in his or her business career, then illustrate how the auditor or accountant might use the six-step approach presented in the text to resolve that dilemma. Be specific. Answer: An ethical dilemma is a situation a person faces in which a decision must be made about an appropriate behavior. Although students' answers will vary depending on the dilemma, their answer should list the following six steps, along with a discussion of how each step relates to their particular dilemma: 1. Obtain the relevant facts. Students should list the key facts from their dilemma. 2. Identify the ethical issues from the facts. Students should identify the key ethical issue(s) in their dilemma. 3. Determine who is affected by the outcome of the dilemma and how each person or group is affected. Students should identify who is involved and how each person is affected by the dilemma. 4. Identify the alternatives available to the person who must resolve the dilemma. Students should list the alternatives available to the auditor or accountant. 5. Identify the likely consequence of each alternative. Students should identify both the short- and long-term effects of each alternative. 6. Decide the appropriate action. Terms: Ethical dilemma Diff: Challenging Objective: LO 4-2 AACSB: Ethical understanding and reasoning abilities
3) A rationalization method that can easily result in unethical behavior is the argument that "everybody does it." Answer: TRUE Terms: Ethical Principles Diff: Easy Objective: LO 4-2 AACSB: Ethical understanding and reasoning abilities
Learning Objective 4-3 1) The underlying reason for a code of professional conduct for any profession is: A) the need for public confidence in the quality of service of the profession. B) it provides a safeguard to keep unscrupulous people out. C) it is required by federal legislation. D) it allows licensing agencies to have a yardstick to measure deficient behavior. Answer: A Terms: Reason for code of professional conduct Diff: Easy Objective: LO 4-3 AACSB: Reflective thinking skills
2) Which of the following statements is true when the CPA has been engaged to perform an audit of financial statements? A) The CPA firm is engaged and paid by the client; therefore, the firm has primary responsibility to be an advocate for the client. B) The CPA firm is engaged and paid by the client, but the primary beneficiaries of the audit are those who rely on the financial statements. C) Should a situation arise where there is no convincing authoritative standard available, and there is a choice of actions which could impact a client's financial statements, the CPA is free to endorse the choice which is in the investors' interests. D) The CPA firm has primary responsibility to the FASB. Answer: B Terms: CPA engaged to perform audit of financial statements Diff: Moderate Objective: LO 4-3 AACSB: Reflective thinking skills
3) Explain why there is a special need for ethical conduct in the auditing profession. Answer: The reason for an expectation of a high level of professional conduct by any profession is the need for public confidence in the quality of service by the profession, regardless of the individual providing it. It is not practical for most customers to evaluate the quality of the performance of professional services because of their complexity. Therefore, since the users (e.g., the general public) of services provided by an auditor generally cannot evaluate the quality of the auditor's performance, it is critical to the auditing profession that the public have a high degree of confidence in the quality of the services provided by the auditor. Public confidence in the quality of professional services is enhanced when the profession encourages high standards of performance and ethical conduct by all its members. If users of auditing services were to lack confidence in the quality of those services, then the value of CPA firms' audits would be diminished, as would the demand for audits. It is essential that the users regard CPA firms as competent and unbiased. Terms: Need for ethical conduct in auditing profession Diff: Easy Objective: LO 4-3 AACSB: Ethical understanding and reasoning abilities
Learning Objective 4-4 1) Which of the following is(are) true concerning the Ethical Principles of the Code of Professional Conduct? I. They identify ideal conduct. II. They are general ideals and are not enforceable. A) I only B) II only C) I and II D) Neither I nor II Answer: C Terms: Ethical principles of the Code of Professional Conduct Diff: Easy Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
2) Which of the following is not one of the four parts of the AICPA's Code of Professional Conduct? A) Principles B) Rules of Conduct C) Interpretations D) Definitions Answer: D Terms: AICPA Code of Professional Conduct Diff: Easy Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
3) One of the AICPA's Ethical Principles deals with the public interest. It states that members should accept the obligation to act in a way that will: A) Honor the public trust Serve the client's interest Yes Yes B) Honor the public trust No
Serve the client's interest No
Honor the public trust Yes
Serve the client's interest No
Honor the public trust No
Serve the client's interest Yes
C)
D)
Answer: C Terms: Ethical Principles; Public interest; Obligations Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
4) According to the Principles section of the Code of Professional Conduct, all members: A) should be independent in fact and in appearance at all times. B) in public practice should be independent in fact and in appearance at all times. C) in public practice should be independent in fact and in appearance when providing auditing and other attestations services. D) in public practice should be independent in fact and in appearance when providing auditing, tax, and other attestation services. Answer: C Terms: Principles section of the Code of Professional Conduct Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
5) Which of the following statements best describes the enforceability of the Interpretations of the Rules of Conduct? A) The Interpretations are not enforceable. B) The Interpretations are enforceable. C) The Interpretations may be enforceable if they have been reviewed and approved by the AICPA's Division of Professional Ethics. D) The Interpretations are not enforceable, but a practitioner must justify departure from them. Answer: D Terms: Enforceability of Interpretations of the Rules of Conduct Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
6) Of the four parts of the AICPA's Code of Professional Conduct, which part is enforceable? A) Ethical Rulings B) Rules of Conduct C) Principles D) Interpretations Answer: B Terms: AICPA Code of Professional Conduct; Enforceable Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
7) Ethical Rulings are: I. explanations relating to broad hypothetical circumstances. II. not enforceable, but one must justify departure. III. explanations relating to specific factual circumstances. A) I and II B) I and III C) II and III D) I, II, and III Answer: C Terms: Ethical Rulings Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
8) The AICPA's Code of Professional Conduct requires independence for all: A) attestation engagements. B) services performed by accountants in public practice. C) accounting and auditing services performed. D) professional work performed by CPAs. Answer: A Terms: Independence Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
9) When a member observes the profession's technical and ethical standards and strives to continually improve her competence and quality of services, she is exercising: A) due care. B) integrity. C) independence. D) objectivity. Answer: A Terms: Independence Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
10) Four of the six Ethical Principles in the AICPA's Code of Professional Conduct are equally applicable to all members of the AICPA. Which of the following principles applies only to members in public practice? A) Scope and Nature of Services B) Integrity C) Due Care D) The Public Interest Answer: A Terms: Ethical Principles apply only to members in public practice Diff: Challenging Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
11) The Code of Professional Conduct is established by the membership of the AICPA, and the Interpretations of the Rules of Conduct are prepared by the: A) Financial Accounting Standards Board. B) Securities and Exchange Commission. C) CPA licensing agencies within each state. D) Professional Ethics Executive Committee of the AICPA. Answer: D Terms: Code of Professional Conduct; Interpretations of Rules of Conduct Diff: Challenging Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
12) Identify and describe each of the four parts to the AICPA's Code of Professional Conduct. Also discuss which parts are officially enforceable and which are not. Answer: The four parts to the Code are: • Principles. These establish ideal standards of ethical conduct stated in philosophical terms. They are not officially enforceable. • Rules of conduct. These are the minimum standards of ethical conduct stated as explicit rules that must be followed by every CPA in the practice of public accounting. They are officially enforceable. • Interpretations. Interpretations of rules are intended to clarify the rules of conduct when there are questions from practitioners about a specific rule. They are not officially enforceable, but a practitioner must justify any departure. • Ethical rulings. These are explanations by the executive committee of the professional ethics division of specific factual circumstances. They are not enforceable, but a practitioner must justify any departure. Terms: Four parts of AICPA Code of Professional Conduct Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
13) Briefly describe the advantages and disadvantages of a code of conduct based on general statements of ideal conduct as opposed to specific rules that define unacceptable behavior. Answer: Advantages Disadvantages General statements
Emphasis on positive activities encouraging a high level of performance.
Difficult to enforce.
Specific rules
Enforceability of minimum behavior and performance standards.
Tendency for rules to be regarded as maximum rather than minimum standards.
Terms: Code of conduct general statements vs. specific rules Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
14) What are the six Ethical Principles stated in the Code of Professional Conduct? Briefly discuss each principle. Are these principles enforceable? Answer: The six Ethical Principles of the Code of Professional Conduct are: 1. Responsibilities. Members should exercise sensitive professional and moral judgments. 2. The Public Interest. Members should demonstrate commitment to professionalism by serving the public interest and honoring the public trust. 3. Integrity. Members should perform all professional responsibilities with the highest sense of integrity. 4. Objectivity and Independence. Members should maintain objectivity and remain free of conflicts of interest. A member in public practice should be independent in both fact and appearance when providing auditing and other attestation services. 5. Due Care. Members should observe the profession's technical and ethical standards, strive continually to improve competence and quality of services, and discharge professional responsibilities to the best of their ability. 6. Scope and Nature of Services. A member in public practice should observe the principles of the Code of Professional Conduct in determining the scope and nature of services to be provided. The Ethical Principles are not enforceable.
Terms: Ethical Principles Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
15) An advantage of specific rules in the Code of Professional Conduct is the enforceability of minimum behavior and performance standards. Answer: TRUE Terms: Code of Professional Conduct Diff: Easy Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
16) The AICPA Code of Professional Conduct permits the auditor to perform a wide variety of non-audit services for audit clients. Answer: FALSE Terms: Code of Professional Conduct Diff: Easy Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
17) An advantage of the principles of professional conduct in the Code of Professional Conduct is that they are more easily enforced than are the specific rules of conduct. Answer: FALSE Terms: Code of Professional Conduct Diff: Easy Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
18) In the AICPA Code of Professional Conduct, ethical rulings are less specific than rules of conduct. Answer: FALSE Terms: AICPA Code of Professional Conduct; Ethical rulings Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
19) Interpretations of rules of conduct in the Code of Professional Conduct are not officially enforceable and practitioners need not justify departure from them. Answer: FALSE Terms: AICPA Code of Professional Conduct; Interpretation of rules Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
20) In the AICPA Code of Professional Conduct, interpretations of rules are more specific than ethical rulings. Answer: FALSE Terms: AICPA Code of Professional Conduct; Ethical rulings; Interpretations of rules Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
21) In the AICPA Code of Professional Conduct, the second principle of professional conduct, entitled "The Public Interest," applies only to members of the AICPA in public practice and not to members who work as accountants in business, government, or education. Answer: FALSE Terms: AICPA Code of Professional Conduct; Public Interest principle Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
22) In the AICPA Code of Professional Conduct, the sixth principle of professional conduct, entitled "Scope and Nature of Services," applies to members of the AICPA who work in public practice, business, government, or education. Answer: FALSE Terms: AICPA Code of Professional Conduct; Scope and nature of services principle Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
23) The Conceptual Framework for AICPA Independence Standards can be used when making decisions on ethical matters not explicitly addressed in the Code. Answer: TRUE Terms: AICPA Code of Professional Conduct Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
24) Each state also has rules of conduct that are required for licensing by the state. Answer: TRUE Terms: AICPA Code of Professional Conduct Diff: Moderate Objective: LO 4-4 AACSB: Ethical understanding and reasoning abilities
Learning Objective 4-5 1) For which of the following professional services must CPAs be independent? A) Management advisory services B) Audits of financial statements C) Preparation of tax returns D) All three of the above Answer: B Terms: Independence Diff: Easy Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
2) "Independence" in auditing means: A) maintaining an indirect financial interest. B) not being financially dependent on a client. C) taking an unbiased viewpoint. D) being an advocate for a client. Answer: C
Terms: Independence Diff: Easy Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
3) When CPAs are able to maintain their actual independence, it is referred to as independence in: A) conduct. B) appearance. C) fact. D) total. Answer: C Terms: Independence Diff: Moderate Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
4) The Sarbanes-Oxley Act ________ a CPA firm from doing both bookkeeping and auditing services for the same public company client. A) encourages B) prohibits C) allows D) allows on a case-by-case basis Answer: B Terms: Sarbanes-Oxley; non-audit services Diff: Easy Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
5) The Sarbanes-Oxley Act requires which employees of an accounting firm to rotate off the engagement every five years? A) In-Charge Auditor Lead audit partner Yes Yes B) In-Charge Auditor No
Lead audit partner No
In-Charge Auditor Yes
Lead audit partner No
In-Charge Auditor No
Lead audit partner Yes
C)
D)
Answer: D
Terms: Sarbanes-Oxley Act; Partner rotation Diff: Moderate Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities Topic: SOX
6) Which of the following statements is true with respect to audit committees? A) Audit committee members should consist of members of the company's management. B) All members of the audit committee must be financial experts. C) The audit committee of a public company is responsible for hiring the auditor. D) Audit committees must have a minimum of ten members. Answer: C Terms: Audit committee Diff: Moderate Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
7) The provisions of the Sarbanes-Oxley Act of 2002 are most likely to allow which of the following nonaudit services for audit clients? A) Appraisal or valuation services (e.g., pension, post-employment benefit liabilities) B) Financial information systems design and implementation C) Internal audit outsourcing D) Tax consulting Answer: D Terms: Sarbanes-Oxley Act of 2002; Allowed non-audit services Diff: Moderate Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
8) Which of the following services are allowed by the SEC whenever a CPA also audits the company? A) Internal audit outsourcing B) Legal services unrelated to the audit C) Appraisal or valuation services D) Services related to assessing the effectiveness of internal control over financial reporting Answer: D Terms: Services allowed by SEC when CPA audits company Diff: Moderate Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
9) Which of the following services is not prohibited by the SEC whenever a CPA also audits the company? A) Actuarial services B) Assisting the company in preparing certain SEC registration statements (e.g., 10-Q, 10-K) C) Investment banker services D) Bookkeeping services Answer: B Terms: Services allowed by SEC when CPA audits company Diff: Moderate Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
10) The members of a client's "audit committee" should be: A) members of management. B) directors who are not a part of company management. C) non-directors and non-managers. D) directors and managers. Answer: B Terms: Members of audit committee Diff: Moderate Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
11) The Sarbanes-Oxley Act requires a cooling off period of ________ before a member of an audit team can work for a client in a key management position? A) One year B) Eighteen months C) Three years D) Five years Answer: A Terms: Sarbanes-Oxley Act; Cooling off period Diff: Easy Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities Topic: SOX
12) In determining independence with respect to any audit engagement, the ultimate decision as to whether or not the auditor is independent must be made by the: A) auditor. B) client. C) audit committee. D) public. Answer: A Terms: Auditor independence Diff: Moderate Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
13) A CPA firm should decline an offer to perform consulting services engagement if: A) the proposed engagement is not accounting-related. B) recommendations made by the CPA firm are to be subject to review by the client. C) acceptance would require the CPA firm to make management decisions for an audit client. D) any of the above is true. Answer: C Terms: CPA firm should decline to perform consulting services Diff: Moderate Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
14) Companies are required to disclose in their proxy statement or annual filings with the SEC the total amount of audit and non-audit fees paid to the audit firm for the two most recent years. Which of the following is not one of the categories of fees that must be disclosed? A) Tax fees B) Consulting fees C) Audit-related fees D) All other fees Answer: B Terms: Annual SEC filings; Audit and non-audit fees Diff: Challenging Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
15) Interpretations of the AICPA Code of Professional Conduct are dominated by the concept of: A) independence. B) compliance with standards. C) accounting. D) acts discreditable to the profession. Answer: A Terms: Interpretations of AICPA Code of Professional Conduct dominated by Diff: Challenging Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
16) A public company may obtain internal audit services from their financial statement auditor if it is approved by the company's audit committee. Answer: FALSE Terms: Public company; Non-audit services purchased Diff: Easy Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities Topic: SOX
17) The audit committee of a private company need not approve all non-audit services provided by the company's financial statement auditor. Answer: TRUE Terms: Private company; Non-audit services purchased Diff: Moderate Objective: LO 4-5 AACSB: Ethical understanding and reasoning abilities
18) For a public company, the Sarbanes-Oxley Act requires audit committee approval of all non-audit services prior to their performance by the company's external auditor. Answer: TRUE Terms: Sarbanes-Oxley Act; Audit committee Diff: Moderate Objective: LO 4-5 AACSB: Reflective thinking skills Topic: SOX
Learning Objective 4-6 1) Interpretations of Independence Rule 101 prohibit covered members from owning any stock or other direct investment in audit clients. Covered members would include which of the following? A) All partners in the engagement office even if they have no engagement Individuals on the attest The firm and its employee responsibility engagement benefit plans Yes Yes Yes B) All partners in the engagement office even if they have no engagement responsibility Yes
Individuals on the attest engagement No
The firm and its employee benefit plans No
Individuals on the attest engagement Yes
The firm and its employee benefit plans Yes
Individuals on the attest engagement No
The firm and its employee benefit plans No
C) All partners in the engagement office even if they have no engagement responsibility No D) All partners in the engagement office even if they have no engagement responsibility No Answer: A
Terms: Independence Rule 101; Direct investment; Covered members Diff: Easy Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
2) In some situations, the interpretations of the Rules of Conduct permit former partners to have relationships with a client of the firm without affecting the firm's independence. Which of the following situations would cause a loss of independence? A) The former partner works in the maintenance department of an audit client of his former firm. B) The former partner's grandson works in the warehouse of an audit client of his former firm. C) The former partner was held out as an associate of the firm. D) The former partner purchased 5% of the stock of an audit client of his former firm. Answer: C Terms: Independence ramifications on auditor and CPA firm Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
3) The financial interests of a CPA's family members can affect the CPA's independence. Which of the following parties would not be included as a "direct financial interest" of the CPA? A) Spouse B) Dependent child C) Relative supported by the CPA D) Sibling living in the same city as the CPA Answer: D Terms: Independence; Direct financial interest Diff: Easy Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
4) Interpretations of the rules regarding independence allow an auditor to serve as: A) a director or officer of an audit client. B) an underwriter for the sale of a client's securities. C) a trustee of a client's pension fund. D) an honorary director for a not-for-profit charitable or religious organization. Answer: D Terms: Independence Diff: Easy Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
5) Independence is required of a CPA when performing: A) external audits. B) all attestation services. C) all attestation and tax services. D) all professional services. Answer: B Terms: Independence Diff: Easy Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
6) CPAs may provide bookkeeping services to their private company audit clients, but there are a number of conditions that must be met if the auditor is to maintain independence. Which of the following conditions is not necessary? A) The CPA must not assume a management role or function. B) The client must hire an external CPA to approve all of the journal entries prepared by the auditor. C) The auditor must comply with GAAS when auditing work prepared by his/her firm. D) The client must accept responsibility for the financial statements. Answer: B Terms: Independence Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
7) An example of an "indirect ownership interest in a client" would be ownership of a client's stock by a member's: A) dependent child. B) spouse. C) non-dependent grandfather. D) All of the above are examples of indirect ownership. Answer: C Terms: Indirect ownership interest in a client Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
8) When determining whether independence is impaired because of an ownership interest in a client company, materiality will affect ownership: A) in all circumstances. B) only for direct ownership. C) only for indirect ownership. D) under no circumstances. Answer: C Terms: Independence; Materiality Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
9) A direct financial interest violates independence in which of the following circumstances? A) When close relatives such as nondependent children, brothers, and sisters have a significant financial interest in the client B) When close relatives such as nondependent children, brothers, and sisters have any financial interest in the client C) When the CPA owns shares in a mutual fund that has an ownership interest in the client D) When close relatives such as brother, sister, or in-laws are employed by the client Answer: A Terms: Direct financial interest, independence Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
10) A CPA sole practitioner purchased stock in a client corporation and placed it in a trust as an
educational fund for the CPA's minor child. The trust securities were not material to the CPA but were material to the child's personal net worth. Would the independence of the CPA be considered to be impaired with respect to the client? A) Yes, because the stock is a direct financial interest B) Yes, because the stock is an indirect financial interest that is material to the CPA's child C) No, because the CPA does not have a direct financial interest in the client D) No, because the CPA does not have a material indirect financial interest in the client Answer: A Terms: Financial interest and independence Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
11) Julie and Lisa are sisters. Julie is a CPA auditing the company where Lisa works. Julie's independence is impaired if: A) Lisa is the controller. B) Lisa owns 25% of the company. C) Lisa is the marketing manager. D) all of the above. Answer: A Terms: Financial interest and independence Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
12) Oehlers, CPA, is a staff auditor participating in the engagement of Capital Trust, Inc. Which of the following circumstances impairs Oehlers independence? A) Oehlers' sister is an internal auditor employed by Capital Trust. B) Oehlers' friend, and employee of another local accounting firm, prepares the tax return of Capital Trust's CEO. C) Oehlers and Capital Trust's 401K plan own stock with the same corporation. D) During the period of professional engagement, Capital Trust and Oehlers discussed business over lunch at a first-class restaurant. Answer: A Terms: Financial interest and independence Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
13) An auditor's independence is considered impaired if the auditor has: A) an immaterial, indirect financial interest in a client. B) an outstanding $8,000 balance on a credit card issued by a client. C) an automobile loan from a client bank, collateralized by the automobile. D) a joint, closely held business investment with the client that is material to the auditor's net worth. Answer: D Terms: Financial interest and independence Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
14) According to the profession's ethical standards, an auditor would be considered independent in
which of the following instances? A) The auditor's checking account, which is fully insured by a federal agency, is held at a client financial institution. B) The auditor is also an attorney who advises the client as its general counsel. C) An employee of the auditor serves as treasurer of a charitable organization that is a client. D) The client owes the auditor fees for two consecutive annual audits. Answer: A Terms: Independence Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
15) Which of the following loans would be prohibited between a CPA firm or its members and an audit client? A) Automobile loans B) Loans fully collateralized by cash deposits at the same financial institution C) New home mortgage loans D) Unpaid credit card balances not exceeding $10,000 in total Answer: C Terms: Independence; Loan exceptions Diff: Challenging Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
16) Under the AICPA independence rules, the auditor: A) is prohibited from performing a company's audit and installing and designing the client's new information system. B) does not need to document the understanding and willingness of the client to perform all management functions associated with the nonaudit service. C) is prohibited from doing any bookkeeping services for the client if performing the audit. D) must follow the more restrictive SEC independence rules when dealing with a public company. Answer: D Terms: Independence Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
17) The Code of Conduct rule on independence indicates that materiality must be considered when: A) Evaluating direct investments Evaluating indirect ownership made by the CPA investments Yes Yes B) Evaluating direct investments made by the CPA No
Evaluating indirect ownership investments No
C) Evaluating direct investments made by the CPA Yes
Evaluating indirect ownership investments No
D) Evaluating direct investments made by the CPA No
Evaluating indirect ownership investments Yes
Answer: D
Terms: Independence; Direct and indirect ownership investments Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
18) Which of the following instances would impair a CPA's independence when they have been retained as the auditor? I. A charitable organization where the CPA serves as treasurer II. A municipality where the CPA owns $250,000 of the $25 million outstanding bonds of the municipality III. A company that the CPA's investment club owns a 10% investment interest A) I and II B) I and III C) II and III D) I, II, and III Answer: D Terms: Impair independence Diff: Challenging Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
19) Under the AICPA independence rules, independence can be considered impaired when: A) billed fees remain unpaid for professional services for more than ninety days. B) a client in bankruptcy has unpaid fees for more than one year. C) there is litigation by the client related to the auditor's tax or other nonaudit services. D) when there is a lawsuit by the client claiming deficiencies in the previous year's audit. Answer: D Terms: Independence ramifications on auditor and CPA firm Diff: Challenging Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
20) Which of the following is least likely to impair a CPA firm's independence with respect to an audit client in the Oklahoma City office of a national CPA firm? A) A partner in the Oklahoma City office owns an immaterial amount of stock in the client. B) A partner in the Jersey City office owns 25% of the client's stock. C) A partner in the Oklahoma City office, who does not work on the audit engagement, previously served as controller for the audit client. D) A partner in the Chicago office previously served as vice president of finance for the audit client. Answer: D Terms: Independence Diff: Challenging Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
21) A CPA's financial interests in nonclients may have an effect on independence if the nonclients are investors in or investees of the client. Which situation would not impair a CPA's independence? A) The client has an immaterial investment in a nonclient investee in which the CPA has an immaterial investment. B) The CPA has a material indirect financial interest in a nonclient in which the client has a material investment. C) The client investor has a nonmaterial investment in the nonclient investee in which the CPA has a material investment. D) The CPA has a joint closely held investment with the client in a nonclient that is material to the client as well as the CPA. Answer: A Terms: Impair CPA independence Diff: Challenging Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
22) Which of the following statements is true? The CPA firm will lose its independence if: A) a staff auditor providing audit services to the client acquires stock in that client. B) a staff tax preparer who provides 15 hours of non-audit services to the client acquires stock in that client. C) an audit manager in an office different than the office providing audit services has a direct, immaterial financial interest in the audit client. D) a covered member has an indirect, immaterial financial interest in an audit client. Answer: A Terms: Independence Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
23) Interpretations to the Rules of Conduct permit a CPA firm to do both bookkeeping and auditing for the same private company client if three criteria are met. Which of the following is not one of those criteria? A) The client must accept full responsibility for the financial statements. B) The client is required to file an annual report, including audited financial statements, with the Securities and Exchange Commission. C) The CPA must not assume the role of employee or of manager. D) The CPA must follow applicable auditing standards. Answer: B Terms: Services allowed by SEC when CPA audits company Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
24) Which of the following circumstances impairs an auditor's independence? I. Litigation by a client against an audit firm claiming a deficiency in the previous audit II. Litigation by a client against an audit firm related to tax services III. Litigation by an audit firm against a client claiming management fraud or deceit A) I and II B) I and III C) II and III D) I, II, and III Answer: B Terms: Impair auditor independence Diff: Challenging Objective: LO 4-6 AACSB: Reflective thinking skills
25) Which of the following circumstances impairs an auditor's independence? I. Litigation by a client against an audit firm claiming a deficiency in the previous audit II. Litigation by a client against an audit firm related to tax services III. Litigation by an audit firm against a client claiming management fraud or deceit A) I and II B) I and III C) II and III D) I, II, and III Answer: B Terms: Impair auditor independence Diff: Challenging Objective: LO 4-6 AACSB: Reflective thinking skills
26) Each of the following situations involves a possible violation of the rule on independence. For each situation, (1) decide whether the Code of Professional Conduct has been violated, and (2) briefly explain how the situation violates (or does not violate) the Code of Professional Conduct. a. Harry Brown is a partner in the Topeka office of Hedley & Co., CPAs. Harry's brother is employed in an audit-sensitive position by Jensen Appliances, a publicly held company in Kansas. Jensen Appliances is one of Hedley & Co.'s audit clients. Neither Harry nor personnel from the Topeka office is involved in the audit of Jensen. Violation? Yes No Explanation: b. John Woods is an audit manager with Calden & Co., CPAs, a one-office CPA firm. John owns 100 shares of common stock in one of the firm's audit clients, but he does not provide any audit or non-audit services to the company. Violation? Yes No Explanation: c. The accounting firm of Fine & Herman, CPAs, provides bookkeeping and tax services for Henderson Corporation, a privately held company. Fine & Herman also performs the annual audit of Henderson Corporation. Violation? Yes No Explanation: d. Bob Shelton CPA, is the auditor of Cafe Ecko. A couple of weeks ago, Cafe Ecko's management commenced litigation against Bob, alleging he was negligent in last year's audit. Violation? Yes No Explanation: e. Hamilton Appliance has not paid Karen Linwood, CPA, her audit fee for the past two years. Karen is starting work on the current year's audit of Hamilton. Violation? Yes No
Explanation: Answer: a. No violation. Although partners in a CPA firm are not allowed to have close relatives employed in a position of significant influence by a client, it is acceptable to have a close relative employed in an auditsensitive position (with no significant influence), as long as the partner does not participate in the engagement and is not in an office that participates on the engagement. b. No violation. John is not a covered member with respect to the audit client as he has no responsibility for the engagement and is not in a position to influence the engagement. c. No violation. The AICPA does not prohibit CPA firms from providing bookkeeping, tax, and audit services to the same non-public client. d. Violation. When there is a lawsuit or intent to start a lawsuit between a CPA and an audit client's management related to audit services, independence is impaired. e. Violation. Independence is impaired if fees remain unpaid for services provided more than one year prior to the date of the report. Terms: Violation of rule on independence; AICPA Code of Professional Conduct Diff: Challenging Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
27) Don Crosby, a partner in a national CPA firm, has just learned that his self sufficient daughter has accepted a position as the CFO of Sunglasses, Inc., a current client within the office with which he is employed. Explain the independence ramifications on 1) Don's independence, 2) his office, and 3) the firm's independence. Answer: 1. Don's non-dependent daughter is considered a close relative. Because she has a key position for the client, Don's independence is impaired. 2. Because Don is considered a covered member any office in which he is employed cannot be independent. 3. The firm will not be considered independent. However, the firm can maintain its independence if they either move: a. Don to an office that does not participate on the engagement or b. the audit engagement to an office in which Don is not employed. Terms: Independence ramifications on auditor and CPA firm Diff: Challenging Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
28) Rule 101, Independence, prohibits a CPA from performing both audit services and bookkeeping services for the same public company in the same year. Answer: TRUE Terms: Rule 101, Independence Diff: Easy Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
29) Under Rule 101, Independence, independence is considered to be impaired if fees remain unpaid for professional services provided more than six months before the date of the current year's report. Answer: FALSE Terms: Rule 101, Independence Diff: Easy Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
30) Auditors are allowed to have an indirect financial interest in an audit client, such as ownership of stock in a client's company by the auditor's brother, as long as the amount of the financial interest is immaterial to the brother. Answer: TRUE Terms: Indirect financial interest; Immaterial Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
31) Rule 101, Independence, applies to members of the AICPA when performing any professional service. Answer: FALSE Terms: Rule 101, Independence Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
32) Rule 101, Independence, applies to covered members in a position to influence an attest engagement. Answer: TRUE Terms: Rule 101, Independence Diff: Moderate Objective: LO 4-6 AACSB: Ethical understanding and reasoning abilities
Learning Objective 4-7 1) The CPA must not subordinate his or her professional judgment to that of others in any: A) engagement. B) audit engagement. C) engagement excluding tax services. D) engagement where the opinion of a specialist is used. Answer: A Terms: CPA subordinate professional judgment Diff: Easy Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
2) Which of the following would be a violation of the rule requiring "objectivity" by the CPA? I. The auditor accepts management's opinion regarding the collection of accounts receivable without an independent evaluation. II. In preparing a client's tax return, the CPA encourages a client to take a deduction for which there is no support. A) I only B) II only C) I and II D) Neither I nor II Answer: C Terms: Violation of rule requiring CPA objectivity Diff: Moderate Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
3) Several months after an unqualified audit report was issued, the auditor discovers the financial statements were materially misstated. The client's CEO agrees that there are misstatements, but refuses to correct them. She claims that "confidentiality" prevents the CPA from informing anyone. Which of the following statements is correct? A) The CEO is correct and the auditor must maintain confidentiality. B) The CEO is incorrect, but since the audit report has been issued, it is too late to correct the report. C) The CEO is correct, but to be ethically correct, the auditor should violate the confidentiality rule and disclose the error. D) The CEO is incorrect, and the auditor has an obligation to issue a revised audit report, even if the CEO will not correct the financial statements. Answer: D Terms: Confidentiality on audit Diff: Moderate Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
4) A CPA firm may charge a contingent fee for: A) an audit. B) consulting services for a client for which they do not perform any attestation services. C) the preparation of an original tax return for a client for which they do not perform any attestation services. D) the preparation of an amended tax return. Answer: B Terms: Contingent fees Diff: Moderate Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
5) A member in public practice shall neither receive from, nor pay to, a client a commission when the member or member's firm also performs certain services for that client. Are commissions allowed if the CPA performs: A) A compilation that will be used An audit of prospective by a third party financial information Yes Yes B) A compilation that will be used by a third party No
An audit of prospective financial information No
C) A compilation that will be used by a third party Yes
An audit of prospective financial information No
D) A compilation that will be used by a third party No
An audit of prospective financial information Yes
Answer: B
Terms: Commissions Diff: Moderate Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
6) The AICPA's Code of Professional Conduct states that a CPA should maintain integrity and objectivity. The term "objectivity" in the Code refers to a CPA's ability to: A) choose independently between alternate accounting principles and auditing standards. B) distinguish between accounting practices that are acceptable and those that are not. C) be unyielding in all matters dealing with auditing procedures. D) maintain an impartial attitude on matters that come under the CPA's review. Answer: D Terms: AICPA Code of Professional Conduct; Objectivity Diff: Moderate Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
7) Which of the following is required for a firm to designate itself "Member of the American Institute of Certified Public Accountants" on its letterhead? A) At least one of the partners must be a member of the AICPA. B) All partners must be members of the AICPA. C) The partners whose names appear in the firm name must be members of the AICPA. D) A majority of the partners must be members of the AICPA. Answer: B Terms: Members of the AICPA requirements Diff: Moderate Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
8) CPAs are prohibited from which of the following forms of advertising? A) Self-laudatory advertising B) Celebrity endorsement advertising C) Use of trade names, such as "Awesome Auditors" D) Use of phrases, such as "Guaranteed largest tax refunds in town!" Answer: D Terms: Prohibited forms of advertising Diff: Challenging Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
9) Which of the following would be considered a violation of the AICPA Code of Conduct? A) The CPA makes the audit files available to the client's bank without the permission of the client. B) The CPA firm charges a contingent fee for nonattestation services to a client for whom he does not perform any attestation services. C) The CPA firm takes a prospective client to lunch to discuss auditing services. D) A CPA firm uses the name San Diego Tax Specialists. Answer: A Terms: Code of ethics Diff: Moderate Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
10) Rule 301 of the AICPA's Code of Professional Conduct requires CPAs to maintain the confidentiality of client information. This rule would be violated if a CPA disclosed information without a client's consent as a result of a: A) subpoena or summons. B) peer review. C) complaint filed with the trial board of the Institute. D) request by a client's largest stockholder. Answer: D Terms: Confidentiality Diff: Moderate Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
11) Which one of the following statements is false? A) Confidentiality is broken when an auditor is presented with a subpoena concerning an audit client. B) Information that a CPA obtains from a client is generally not privileged. C) When a CPA firm conducts an AICPA-authorized peer review of the quality controls of another CPA firm, permission of the client is not needed to examine audit documentation. D) A CPA firm which observes substandard audit documentation of another firm during a peer review can initiate a complaint to the AICPA. Answer: A Terms: Confidentiality Diff: Moderate Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
12) A CPA firm: A) can sell securities to a client for whom they perform an attestation service. B) can receive a commission for a client that they are engaged to perform an attestation service for. C) cannot receive a referral fee for recommending the services of another CPA. D) can receive a commission from a nonattestation client as long as the situation is disclosed. Answer: D Terms: Rule 503, Commissions and Referral Fees Diff: Moderate Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
13) Which of the following represents all of the ways a CPA firm can be organized under Rule 505? A) Proprietorships and partnerships B) Proprietorships, partnerships, and professional corporations C) Proprietorships, general partnerships, general corporations, professional corporations, limited liability companies, and limited liability partnerships if permitted by state law D) Single proprietorships, partnerships, professional corporations if permitted by state law, or regular corporations Answer: C Terms: Rule 505, AICPA Code of Professional Conduct; CPA firm form of organization Diff: Moderate Objective: LO 4-7 AACSB: Reflective thinking skills
14) In which of the following circumstances would a CPA be ethically bound to refrain from disclosing
any confidential client information? A) The CPA is issued a summons enforceable by a court order which orders the CPA to present confidential information. B) A major stockholder of a client company seeks accounting information from the CPA after management declined to disclose the requested information. C) Confidential client information is made available as part of a quality review of the CPA's practice by a peer review team authorized by the AICPA. D) An inquiry by a disciplinary body of a state CPA society requests confidential client information. Answer: B Terms: Confidential client information Diff: Moderate Objective: LO 4-7 AACSB: Ethical understanding and reasoning abilities
15) Which of the following fee arrangements is not a violation of the AICPA's Code of Professional Conduct? A) Basing fees as an expert witness on the amount awarded to the plaintiff, even though the CPA performs a compilation for client use B) Basing consulting fees on a percentage of a bond issue, even though the CPA performs a review of the client's financial statements C) Basing fees for a tax service on the amount of the refund that the client will receive D) Basing consulting fees on a percentage of a bond issue, even though the CPA performs an audit of the client's financial statements Answer: A Terms: Fee arrangements not a violation of AICPA Code of Professional Conduct Diff: Challenging Objective: LO 4-7 AACSB: Reflective thinking skills
16) Which of the following is not defined as an act discreditable in either the Rules or the Interpretations of the AICPA's Code of Professional Conduct? A) The CPA firm's partner in charge failed to file his tax return for the past year. B) The CPA firm discriminates in its hiring practices based on the age of the applicant. C) The CPA retains the client's books and records to enforce past-due payment of the CPA's bill, even after the client has demanded they be returned. D) The CPA firm's partner-in-charge was a passenger in a car driven by his wife. On the way home from the firm's Christmas party, she was charged with "driving while intoxicated." Answer: D Terms: Act discreditable Diff: Challenging Objective: LO 4-7 AACSB: Reflective thinking skills
17) Freedom from ________ means the absence of relationships that might interfere with objectivity or integrity. A) independence. B) acts discreditable. C) impartiality. D) conflicts of interest. Answer: D Terms: Conflicts of interest Diff: Moderate Objective: LO 4-7 AACSB: Analytic skills
18) Rule 201 - General Standards requires members to comply with certain standards and interpretations. Which of the following is not a standard specifically addressed in Rule 201? A) Professional integrity B) Due professional care C) Planning and supervision D) Sufficient relevant data Answer: A Terms: Rule 201, General Standards Diff: Challenging Objective: LO 4-7 AACSB: Reflective thinking skills
19) Which of the following activities is allowed for a CPA firm's attestation clients? A) Contingent fees fixed by a court B) Commissions for referring a review client to an insurance agency for insurance coverage C) Preparation of tax returns for which fees are based upon client refunds D) Each of the above is allowed. Answer: A Terms: Activities allowed for CPA firm's attestation clients Diff: Moderate Objective: LO 4-7 AACSB: Reflective thinking skills
20) Discuss Rule 301–Confidential Client Information, including the four exceptions to the rule. Answer: Rule 301 prohibits a member from disclosing any confidential client information without the specific consent from the client. However, there are four conditions when client permission is not required: • Obligations related to technical standards; i.e., when Rule 202 or Rule 203 requires the disclosure. • In response to a valid subpoena or summons and compliance with laws and regulations. • A peer review is being conducted under AICPA, state CPA Society, or State Board of Accountancy authorization. • The CPA is initiating or responding to an inquiry from a recognized investigative body or the professional ethics division. Terms: Rule 301, Confidential Client Information and exceptions Diff: Challenging Objective: LO 4-7 AACSB: Reflective thinking skills
21) The following situations involve a possible violation of the AICPA's Code of Professional Conduct. For
each situation, (1) determine the applicable rule from the Code, (2) decide whether or not the Code has been violated, and (3) briefly explain how the situation violates (or does not violate) the Code. a. In 2013, Freeman and Johnson, both CPAs, decided to form a CPA practice. In 2015, Freeman and Johnson approached Bill Delaney, a physician and medical expert, and asked him to assist them with their growing medical consulting practice. Delaney agreed, but only after he was given an ownership interest in the firm. Delaney does not intend to quit his private medical practice. Rule: ________ Explanation:
Violation? Yes No
b. Brian DePalie has a successful dentistry practice in Charleston. Brian has recommended one of his patients to Katie Walton, CPA. To show gratitude for the referral, Katie has agreed to pay Brian a token gift of $50. Katie discloses the payment arrangement to her new clients. Rule: ________ Explanation:
Violation? Yes No
c. The accounting firm of Bayer & Peng, CPAs, is negotiating a fee with a new audit client. They agree the client will pay $50,000 if Bayer & Peng issues a clean, unqualified opinion, $40,000 if a qualified opinion is issued, and only $20,000 if an adverse opinion is issued. Rule: ________ Explanation:
Violation? Yes No
d. Don Smith, CPA, is a member of the engagement team that performs the audit of Shaw Corporation. Don's five-year-old daughter, Precious, received ten shares of Shaw Corporation's common stock for her fifth birthday. The stock was a gift from Precious's grandmother. Rule: ________ Explanation:
Violation? Yes No
e. Jennifer Harris, CPA, is a partner in the CPA firm that audits Alltech, Inc., a closely held corporation. Jennifer's sister-in-law is the chief financial officer at Alltech, Inc. Rule: ________ Violation? Yes No Explanation: Answer: a. Violation of the rule on Form of Organization and Name (Rule 505). Non-CPA ownership of firms is allowable, however, non-CPA owners must actively provide services to the firm's clients as their principal occupation. b. No violation of the Commissions and Referral Fees rule (Rule 503). A CPA may pay a referral fee to a non-CPA as long as the payment is disclosed to the client. c. Violation of the Contingent Fees rule (Rule 302). This is a contingent fee agreement and is prohibited by Rule 302. d. Violation of the Independence rule (Rule 101). Don is a covered member for purposes of Rule 101. Because his daughter is a dependent, her ownership interest in Shaw is treated as a direct financial
interest of her father. e. No violation of the Independence rule (Rule 101). According to the Code a close relative is defined as a parent, sibling, or nondependent child. Thus, a sister-in-law is not considered to be a close relative. Terms: Violations of Rules of AICPA Code of Professional Conduct Diff: Challenging Objective: LO 4-5, LO 4-6 and LO 4-7 AACSB: Analytic skills
22) The following situations involve a possible violation of the AICPA's Code of Professional Conduct. For each situation, (1) determine the applicable rule from the Code, (2) decide whether or not the Code has been violated, and (3) briefly explain how the situation violates (or does not violate) the Code. a. Howard Cunningham & Co., CPAs, designates its firm as "Members of the American Institute of Certified Public Accountants." All of the partners of the firm are CPAs. However, one of the partners has recently chosen to allow her membership to lapse because of personal reasons. Rule: ________ Explanation:
Violation? Yes No
b. Brad Long, CPA, was traveling from Orlando to Miami, Florida when he was pulled over by a police officer on suspicion of driving under the influence. He was convicted in court of driving while under the influence of alcohol. Because of past convictions, Brad was sentenced to 5 years in prison. Rule: ________ Explanation:
Violation? Yes No
c. Kelley Brent, CPA, is a partner in a one-office CPA firm that audits Dane, Inc., a closely held corporation. Kelley's sister was recently appointed as the chief financial officer for Dane, Inc. Rule: ________ Explanation:
Violation? Yes No
d. Sarah Martin, CPA, is a senior auditor in the San Francisco office of Cooper & Howell, CPAs. Sarah's father is employed as the controller of Line Electronics, a public company in Detroit, Michigan. Line Electronics is one of the firm's audit clients. Neither Sarah nor the San Francisco office is involved in the audit of Line Electronics. Rule: ________ Explanation:
Violation? Yes No
e. On August 20, 20x6, Hank Anderson, CPA and partner, was offered and accepted the engagement to audit the annual financial statements of Jernigan Corporation for the year ended December 31, 20x6. Preliminary work began on the audit on September 15, 20x6 and the engagement ended on March 7, 20x7. Jernigan is regulated by the SEC. Hank served as controller of Jernigan Corporation from December 1, 20x2, until April 10, 20x6, at which time he terminated his employment with Jernigan. Rule: ________ Violation? Yes No Explanation: Answer: a. Violation of the Form of Organization and Name rule (Rule 505). A firm may not designate itself as "Members of the American Institute of Certified Public Accountants" unless all of its owners are members of the Institute. b. Violation of the Acts Discreditable rule (Rule 501). Felonies are considered acts discreditable. c. Violation of the Independence rule (Rule 101). According to the Code, Kelly's sister is a "close relative" and she occupies a key position at an audit client. Because Kelly is a partner in the office that provides the audit services to Dane, the firm is not independent. d. No violation of the Independence rule (Rule 101). While Sarah's father occupies a key position with an audit client of the firm, there is no independence violation as long as Sarah is not a member of the engagement team. The firm may provide the audit services. e. Violation of the Independence rule (Rule 101). Since Hank had an employment relationship with the client during part of the period covered by the financial statements, his independence is impaired. Terms: Violations of Rules of AICPA Code of Professional Conduct Diff: Challenging Objective: LO 4-5, LO 4-6 and LO 4-7 AACSB: Analytic skills
23) The scenarios below all involve a possible violation of the AICPA's Cod of Professional Conduct. 1. Using the list below, indicate which of the Code of Conduct Rules applies to the scenario. a. 101: Independence b. 102: Integrity and Objectivity c. 302: Contingent Fees d. 501: Acts Discreditable e. 503: Commissions and Referral Fees f. 505: Form of Organization and Name 2. State if the scenario is a violation of the Code. Scenario: 1. Margaret Henry is a partner in the Tupelo office of Jenkins & Thorn, CPAs. Margaret's father is the controller at Markrich Sporting Supplies, Inc., a publicly held company in Tupelo. Markrich is one of Jenkins & Thorn's audit clients. Margaret is not involved in the audit of Markrich. 2. Jason Alexander is an audit manager with Reese & Co., CPAs. Jason owns 100 share of common stock in one of the firm's audit clients, but he does not provide any audit or non-audit services to the company. 3. The accounting firm of Fine & Herman, CPAs, provides bookkeeping and tax services for Henderson Corporation, a privately held company. Mr. Herman also performs the annual audit of Henderson Corporation. 4. Elaine Cooper CPA, is the auditor of Paula's Pizza. Toward the end of the audit, Paula gave Elaine her estimate of receivable collectability and Elaine accepted it without any testing. 5. Charley Ray, CPA, is a member of the engagement team that performs the audit of Desiree Corporation. Charley's five-year-old daughter, Becky, received ten shares of Desiree common stock for her fifth birthday in a trust fund established by Becky's grandmother. 6. Freeman and Johnson formed a successful CPA practice ten years ago. In the current year, they approached Adam Sawtooth, a surgeon and medical expert, and asked him to assist them with their growing medical consulting practice. Sawtooth agreed, but only after he was given an ownership interest in the firm. Sawtooth does intend to reduce his private practice hours and spend 40% of his working hours devoted to the Freeman & Johnson practice. 7. Sally Preen has a successful computer network consulting business. Sally has recommended one of her clients to Sam Walton, CPA. To show gratitude for the referral, Sam has agreed to pay Sally a token gift of $50. Sam has not disclosed the payment arrangement to his ne clients. 8. The accounting firm of Smith & Black, CPAs, is negotiating a fee with a new audit client where the client will pay $50,000 if the client obtains the line of credit needed for working capital purposes. Otherwise, the fee will be $40,000. 9. Brad Barns, CPA, was traveling from Las Vegas to the Grand Canyon when he was pulled over by a police officer for suspicion of driving under the influence. He was convicted in court of driving under the influence of alcohol and received six months probation.
10. Manuel Lopez, CPA, is a senior in a small, local, CPA firm that audits Childress, Inc., a closely held corporation. Manuel's sister was recently appointed as the controller for Childress, Inc. Answer: Part 1: 1. a 2. a 3. a 4. b 5. a Part 2:
1. Yes 2. No 3. No 4. Yes 5. Yes
6. f 7. e 8. c 9. d 10. a 6. Yes 7. Yes 8. Yes 9. No 10. Yes
Terms: AICPA Code of Professional Conduct; Ethical rulings; Interpretations of rules Diff: Challenging Objective: LO 4-5, LO 4-6 and LO 4-7 AACSB: Ethical understanding and reasoning abilities
24) Imprisonment for a period of six months or longer will result in automatic expulsion from the AICPA. Answer: FALSE Terms: Imprisonment; Expulsion Diff: Easy Objective: LO 4-7 AACSB: Reflective thinking skills
25) Rule 505, Form of Organization and Name, prohibits CPA firms from practicing as limited liability partnerships. Answer: FALSE Terms: Rule 505, Form of Organization and Name Diff: Easy Objective: LO 4-7 AACSB: Reflective thinking skills
26) Under Rule 505, Form of Organization and Name, a CPA firm may use any name as long as it is not misleading. Answer: TRUE Terms: Rule 505, Form of Organization and Name Diff: Easy Objective: LO 4-7 AACSB: Reflective thinking skills
27) A CPA firm may practice public accounting only in a form of organization permitted by federal law or regulation. Answer: FALSE Terms: Form of Organization Diff: Moderate Objective: LO 4-7 AACSB: Reflective thinking skills
28) Under Rule 301, Confidential Client Information, permission is not required from the client to use the
audit documentation relating to that client during an AICPA-authorized peer review program with another CPA firm. Answer: TRUE Terms: Rule 301, Confidential Client Information Diff: Moderate Objective: LO 4-7 AACSB: Reflective thinking skills
29) Information obtained by a CPA from a client is legally privileged in federal court. Answer: FALSE Terms: Legally privileged information Diff: Moderate Objective: LO 4-7 AACSB: Reflective thinking skills
30) Rule 502, Advertising and Other Forms of Solicitation, prohibits members of the AICPA in public practice from performing comparative advertising. Answer: FALSE Terms: Rule 502, Advertising and Other Forms of Solicitation Diff: Moderate Objective: LO 4-7 AACSB: Reflective thinking skills
31) Under Rule 505, Form of Organization and Name, a CPA firm may not designate itself as "Members of the American Institute of Certified Public Accountants" unless a majority of its owners are members of the Institute. Answer: FALSE Terms: Rule 505, Form of Organization and Name Diff: Moderate Objective: LO 4-7 AACSB: Reflective thinking skills
32) Under the AICPA's Code of Professional Conduct, CPAs are prohibited from offering audit clients a discount for referring a prospective client even if they are disclosed. Answer: FALSE Terms: AICPA Code of Professional Conduct; Offer audit clients a discount Diff: Moderate Objective: LO 4-7 AACSB: Reflective thinking skills
33) All owners of a CPA firm must be CPAs who are qualified to practice. Answer: FALSE Terms: CPA qualified to practice Diff: Moderate Objective: LO 4-7 AACSB: Reflective thinking skills
Learning Objective 4-8 1) If the board of accountancy in the state in which a CPA firm is licensed has rules that are different than the AICPA's rules, the CPA firm must follow: A) whichever rules are less restrictive. B) whichever rules are more restrictive. C) the rules of the AICPA. D) the rules of the state's board of accountancy. Answer: B Terms: State rules which differ from AICPA rules Diff: Moderate Objective: LO 4-8 AACSB: Reflective thinking skills
2) Describe the methods used by the AICPA and State Boards of Accountancy to enforce the rules of conduct. Answer: The AICPA uses two levels of disciplinary action. For less serious, and probably unintentional violations of Rules of Conduct, the division limits the discipline to a requirement of remedial or corrective action. For more serious violations, the level of disciplinary action goes before the Joint Trial Board. The violator may be suspended or expelled from membership in the AICPA. Violation of a State Boards' rules of conduct is punishable by loss of the violator's CPA certificate and license to practice. Terms: Methods to enforce the rules conduct Diff: Moderate Objective: LO 4-8 AACSB: Reflective thinking skills
3) Expulsion from the AICPA for failing to follow the rules of conduct is, by itself, sufficient to prevent a CPA from practicing public accounting. Answer: FALSE Terms: Expulsion from AICPA for failing to follow rules of conduct Diff: Moderate Objective: LO 4-8 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e Chapter 5 Legal Liability Learning Objective 5-1 1) Discuss three major factors that have contributed to the recent increase in the number of lawsuits against auditors and the size of awards to plaintiffs. Answer: Major factors include: • The growing awareness of the responsibilities of public accountants by users of financial statements. • An increased consciousness on the part of the Securities and Exchange Commission regarding its responsibility for protecting investors' interests. • The complexity of auditing and accounting functions caused by the increasing size of businesses, the globalization of business, and the complexities of business operations. • Large civil court judgments against CPA firms.
• The tendency of society to accept lawsuits by injured parties against anyone who might be able to provide compensation, regardless of who was at fault, coupled with joint and several liability doctrine. • The willingness of CPA firms to settle legal problems out of court to avoid costly legal fees and adverse publicity, rather than pursuing resolution through the judicial process. • The difficulty judges and jurors have understanding and interpreting technical accounting and auditing matters. • The global recession and tough economic times result in business failures, which prompt stakeholders to seek restitution from others, including external auditors. Terms: Major factors that have contributed to the recent increase in the number of lawsuits against auditors Diff: Moderate Objective: LO 5-1 AACSB: Reflective thinking skills
Learning Objective 5-2 1) A(n) ________ failure occurs when an auditor issues an erroneous opinion because it failed to comply with requirements of auditing standards. A) business B) audit C) ethics D) process Answer: B Terms: Failure which occurs when an auditor issues an erroneous opinion Diff: Easy Objective: LO 5-2 AACSB: Reflective thinking skills
2) The expectation gap: A) exists between the auditor and the SEC. B) exists because auditors guarantee the accuracy of the financial statements. C) often results in unwarranted lawsuits against the auditor. D) is a legal concept supported by the federal courts. Answer: C Terms: Expectation gap Diff: Moderate Objective: LO 5-2 AACSB: Reflective thinking skills
3) Distinguish between what is meant by business failure and audit failure. Answer: Business failure occurs when a business is unable to repay its lenders or meet expectations of its investors because of economic or business conditions, such as recession, poor management decisions, or unexpected competition in the industry. Audit failure occurs when the auditor issues an incorrect audit opinion because it failed to comply with the requirements of auditing standards. Terms: Business failure and audit failure Diff: Easy Objective: LO 5-2 AACSB: Reflective thinking skills
4) Audit risk is the risk there will be an audit failure for a given audit engagement. Answer: FALSE Terms: Audit risk Diff: Moderate Objective: LO 5-2 AACSB: Reflective thinking skills
5) The term "audit failure" refers to the situation when the auditor has followed auditing standards yet still fails to discover that the client's financial statements are materially misstated. Answer: FALSE Terms: Audit failure; Followed audit standards and fail to discover material misstatement Diff: Moderate Objective: LO 5-2 AACSB: Reflective thinking skills
Learning Objective 5-3 1) In the performance of an audit, a CPA: A) is legally liable for detecting an immaterial client fraud. B) must strictly follow GAAP for privately held clients. C) must exercise constructive professional care in the performance of their audit responsibilities. D) must exercise due professional care in the performance of their audit responsibilities. Answer: D Terms: Performance of an audit Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
2) If an auditor fails to fulfill a certain requirement in the contract, they may be guilty of: A) contract fraud. B) breach of contract. C) constructive fraud. D) criminal neglect. Answer: B Terms: Liability when auditors fail to exercise due care Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
3) Recklessness in the case of an audit is present if the auditor knew an adequate audit was not done but still issued an opinion, even though there was no intent to deceive financial statement users. This description is the legal term for: A) ordinary negligence. B) gross negligence. C) constructive fraud. D) fraud. Answer: C Terms: Legal term for reckless in an audit with not intent to deceive Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
4) The standard of due care to which the auditor is expected to adhere to in the performance of the audit is referred to as the: A) prudent person concept. B) common law doctrine. C) constructive care concept. D) vigilant person concept. Answer: A Terms: Standard of due care Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
5) Auditors may be liable to their clients if they are found guilty of: A) Ordinary negligence Gross negligence Yes Yes B) Ordinary negligence No
Gross negligence No
Ordinary negligence Yes
Gross negligence No
Ordinary negligence No
Gross negligence Yes
C)
D)
Answer: A
Terms: Auditor liability to clients Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
6) Under the laws of agency, partners of a CPA firm may be liable for the work of others on whom they rely. This would not include: A) employees of the CPA firm. B) employees of the audit client. C) other CPA firms engaged to do part of the audit work. D) specialists employed by the CPA firm to provide technical advice on the audit. Answer: B Terms: Laws of agency. Partners of CPA firm liable for work of others on whom they rely Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
7) "Absence of reasonable care that can be expected of a person in a set of circumstances" defines: A) pecuniary negligence. B) gross negligence. C) extreme negligence. D) ordinary negligence. Answer: D Terms: Absence of reasonable care Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
8) An example of a breach of contract would likely include: A) an auditor's refusal to return the client's general ledger book until the client paid last year's audit fees. B) a bank's claim that an auditor had a duty to uncover material errors in financial statements that had been relied on in making a loan. C) a CPA firm's failure to complete an audit on the agreed-upon date because the firm had a backlog of other work which was more lucrative. D) an auditor's claim that the client staff is unqualified. Answer: C Terms: Breach of contract Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
9) Privity of contract exists between: A) auditor and the federal government. B) auditor and third parties. C) auditor and client. D) auditor and client attorney. Answer: C Terms: Privity of contract Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
10) An individual who is not party to the contract between a CPA and the client, but who is known by both and is intended to receive certain benefits from the contract is known as: A) a third party. B) a common law inheritor. C) a tort. D) a third-party beneficiary. Answer: D Terms: Individual who is not a party to the contract between a CPA and client, but who is known Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
11) Laws that have been passed by the U.S. Congress and other governmental units are: A) statutory laws. B) judicial laws. C) federal laws. D) common laws. Answer: A Terms: Laws passed through state legislatures Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
12) The assessment against a defendant of the full loss suffered by a plaintiff regardless of the extent to which other parties shared in the wrongdoing is called: A) separate and proportionate liability. B) shared liability. C) unitary liability. D) joint and several liability. Answer: D Terms: Assessment against a defendant of the full loss suffered by a plaintiff Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
13) The assessment against a defendant of that portion of the damage caused by the defendant's negligence is called: A) separate and proportionate liability. B) joint and several liability. C) shared liability. D) unitary liability. Answer: A Terms: Assessment against a defendant of that portion of the damages Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
14) Fraud occurs when: A) a misstatement is made and there is both knowledge of its falsity and the intent to deceive. B) a misstatement is made and there is knowledge of its falsity but no intent to deceive. C) the auditor lacks even slight care in the performance in performing the audit. D) the auditor has an absence of reasonable care in the performance of the audit. Answer: A Terms: Fraud and errors Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
15) Which of the following most accurately describes constructive fraud? A) Absence of reasonable care B) Lack of slight care C) Knowledge and intent to deceive D) Extreme or unusual negligence without the intent to deceive Answer: D Terms: Describes constructive fraud Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
16) Which of the following most accurately describes fraud? A) Absence of reasonable care B) Lack of slight care C) Knowledge and intent to deceive D) Extreme or unusual negligence without the intent to deceive Answer: C Terms: Describes fraud Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
17) A third-party beneficiary is one which: A) has failed to establish legal standing before the court. B) does not have privity of contract and is unknown to the contracting parties. C) does not have privity of contract, but is known to the contracting parties and intended to benefit under the contract. D) may establish legal standing before the court after a contract has been consummated. Answer: C Terms: Third-party beneficiary Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
18) If the CPA negligently failed to properly prepare and file a client's tax return, the CPA may be liable for: A) the penalties the client owes the IRS. B) the penalties and interest the client owes. C) the penalties and interest the client owes, plus the tax preparation fee the CPA charged. D) the penalties and interest, the tax preparation fee, and the amount of tax that was underpaid. Answer: C Terms: Liability when a CPA negligently failed to properly prepare and file tax return Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
19) Constructive fraud: A) is also known as recklessness. B) requires an intent to deceive. C) involves collusion with the client. D) is also known as breach of contract. Answer: A Terms: Support a finding of constructive fraud Diff: Moderate Objective: LO 5-3 AACSB: Analytic skills
20) Which of the following statements is true? A) Gross negligence may constitute constructive Fraud requires the fraud intent to deceive Yes Yes
All fraud should be detected during audit No
B) Gross negligence may constitute constructive fraud No
Fraud requires the intent to deceive Yes
All fraud should be detected during audit No
C) Gross negligence may constitute constructive fraud Yes
Fraud requires the intent to deceive No
All fraud should be detected during audit Yes
D) Gross negligence may constitute constructive fraud No
Fraud requires the intent to deceive No
All fraud should be detected during audit No
Answer: A
Terms: Gross negligence, fraud, and constructive fraud Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
21) The laws that have been developed through court decisions are called: A) common laws. B) criminal laws. C) statutory laws. D) civil laws. Answer: A Terms: Common law Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
22) Gregory & Hedrick, a medium-sized CPA firm, employed Elise as a staff accountant. Elise was negligent while auditing several of the firm's clients. Under these circumstances, which of the following statements is true? A) Elise would have no personal liability for negligence. B) Gregory & Hedrick is not liable for Elise's negligence because CPAs are generally considered to be independent contractors. C) Gregory & Hedrick would not be liable for Elise's negligence if Elise disobeyed specific instructions in the performance of the audits. D) Gregory & Hedrick can recover against its insurer on its malpractice policy even if one of the partners was also negligent in reviewing Elise's work. Answer: D Terms: Auditor negligent while auditing Diff: Challenging Objective: LO 5-3 AACSB: Reflective thinking skills
23) The legal term for when an auditor issues an audit opinion, knowing that an adequate audit was not performed is a: A) breach of contract. B) tort action for negligence. C) constructive fraud. D) fraud. Answer: C Terms: Failure of party to meet its obligations, causing injury to another party Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
24) Define ordinary negligence, gross negligence, and constructive fraud. Answer: Ordinary negligence is the absence of reasonable care that can be expected of a person is a set of circumstances. For auditors, it is in terms of what other competent auditors would have done in the same situation. Gross negligence is the lack of even slight care, tantamount to reckless behavior, that can be expected of a person in a set of circumstances. Constructive fraud is the existence of extreme or unusual negligence even though there was no intent to deceive or to do harm. It is also termed reckless, in the case of an audit is present if the auditor knew an adequate audit was not done but still issued an opinion, even though there was no intention of deceiving statement users. Terms: Ordinary negligence, gross negligence, and constructive fraud Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
25) An important concept in contract law for accountants to understand is the "third-party beneficiary doctrine." Explain and give an example. Answer: A third party who does not have privity of contract but is known to the contracting parties and is intended to have certain rights and benefits under the contract. Example: bank has a large loan outstanding at the balance sheet date and requires an audit as part of the loan agreement. Terms: Contract law; Third-party beneficiary doctrine Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
26) Distinguish between constructive fraud and fraud. Answer: Constructive fraud is the existence of extreme or unusual negligence even though there was no intent to deceive or do harm. In contrast, fraud occurs when a misstatement is made and there is both knowledge of its falsity and the intent to deceive. Terms: Constructive fraud and fraud Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
27) Distinguish between "joint and several liability" and "separate and proportionate liability." Answer: Under joint and several liability, the defendant can be assessed the full loss suffered by the plaintiff, regardless of the extent to which other parties shared in the wrongdoing. In contrast, under separate and proportionate liability, the defendant is assessed that portion of the damage caused by the defendant's negligence. Terms: Joint and several liability and separate and proportionate liability Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
28) Match seven of the legal terms (a-j) with the definitions provided below (1-7): a. b. c. d. e. f. g. h. i. j.
Common law Constructive fraud Breach of contract Joint and several liability Ordinary negligence Third-party beneficiary Gross negligence Statutory law Fraud Separate and proportionate liability
________ 1. Laws that have been passed by the U.S. Congress and other governmental units. ________ 2. Absence of reasonable care that can be expected of a person in a set of circumstances. ________ 3. Lack of even slight care, tantamount to reckless behavior that can be expected of a person. ________ 4. The assessment against a defendant of that portion of the damage caused by the defendant's negligence. ________ 5. Failure of one or both parties in a contract to fulfill the requirements of the contract. ________ 6. The assessment against a defendant of the full loss suffered by a plaintiff regardless of the extent to which other parties shared in the wrongdoing. ________ 7. Existence of extreme or unusual negligence even though there was no intent to deceive or do harm; also termed recklessness. Answer: 1. h 2. e 3. g 4. j 5. c 6. d 7. b Terms: Constructive fraud; Breach of contract; Joint and several liability; Separate and proportionate liability; Gross negligence; Ordinary negligence; Statutory law Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
29) The standard of due care to which the auditor is expected to be held is referred to as the prudent person concept. Answer: TRUE Terms: Standard of due care; Prudent person concept Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
30) In a CPA firm operating as a limited liability partnership (LLP), the liability for one partner's actions does not extend to another partner's personal assets. Answer: TRUE Terms: CPA firm operating as a limited liability partnership Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
31) In a CPA firm operating as a limited liability partnership (LLP), the liability for one partner's actions extends to the firm's assets. Answer: TRUE Terms: CPA firm operating as a limited liability partnership Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
32) Statutory laws are laws that have been developed through court decisions rather than through the U.S. Congress and other governmental units. Answer: FALSE Terms: Statutory laws Diff: Easy Objective: LO 5-3 AACSB: Reflective thinking skills
33) The doctrine of joint and several liability is one factor that has contributed to the recent increase in the number of lawsuits against auditors and the size of awards to plaintiffs. Answer: TRUE Terms: Doctrine of joint and several liability; Contributed to increase in lawsuits Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
34) Several states have statutes that permit privileged communication between the client and auditor, allowing a CPA to refuse to testify in state and federal courts. Answer: FALSE Terms: CPA and privileged communication Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
35) Gross negligence is the existence of extreme or unusual negligence with the intent to deceive. Answer: FALSE Terms: Gross negligence; Extreme or unusual negligence; Intent to deceive Diff: Moderate Objective: LO 5-3 AACSB: Reflective thinking skills
Learning Objective 5-4 1) The principal issue in cases involving alleged negligence is usually: A) if an an engagement letter was issued. B) the level of care required. C) if fraud was committed by upper-level management. D) whether the auditor is liable under civil or criminal laws. Answer: B Terms: Level of care; Negligence Diff: Easy Objective: LO 5-4 AACSB: Reflective thinking skills
2) In third-party suits, which of the auditor's defenses contends no implied or expressed contract? A) Lack of duty B) Non-negligent performance C) Contributory negligence D) Absence of causal connections Answer: A Terms: Third-party suits; Auditor defenses contends lack of privity contract Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
3) In connection with the audit of financial statements, an independent auditor could be responsible for failure to detect a material fraud if: A) statistical sampling techniques were not used on the audit engagement. B) the auditor planned the audit in a negligent manner. C) accountants performing important parts of the work failed to discover a close relationship between the treasurer and the cashier. D) the fraud was perpetrated by one employee who circumvented the existing internal controls. Answer: B Terms: Independent auditor could be responsible for failure to detect material fraud Diff: Easy Objective: LO 5-4 AACSB: Reflective thinking skills
4) Which of the following is an illustration of liability to clients under common law? A) Client sues auditor for not discovering a theft of assets by an employee. B) Bank sues auditor for not discovering that borrower's financial statements are misstated. C) Combined group of stockholders sue auditor for not discovering materially misstated financial statements. D) The federal government prosecutes the auditor for knowingly issuing an incorrect audit report. Answer: A Terms: Liability to clients under common law Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
5) Which of the following is an illustration of liability under the federal securities acts? A) A client sues the auditor for not discovering a theft of assets by an employee. B) A bank sues the auditor for not discovering that the borrower's financial statements are misstated. C) A combined group of stockholders sues the auditor for not discovering materially misstated financial statements. D) The auditor sues a client for not cooperating during the engagement. Answer: C Terms: Liability under federal securities acts Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
6) A CPA firm normally uses one or a combination of four defenses when there are legal claims by clients. Which one of the following is generally not a defense? A) Lack of duty B) Nonnegligent performance C) Contributory negligence D) Foreseeable users Answer: D Terms: Defenses when there are legal claims Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
7) Tort actions against CPAs are more common than breach of contract actions because: A) there are more torts than contracts. B) the burden of proof is on the auditor rather than on the person suing. C) the person suing need prove only negligence. D) the amounts recoverable are normally larger. Answer: D Terms: Tort actions against CPAs are more common than breach of contract Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
8) The principal issue to be resolved in cases involving alleged negligence is usually: A) the amount of the damages suffered by plaintiff. B) whether to impose punitive damages on defendant. C) the level of care exercised by the CPA. D) whether defendant was involved in fraud. Answer: C Terms: Principal issue to be resolved in cases involving alleged negligence Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
9) In the auditing environment, failure to meet auditing standards is often: A) an accepted practice. B) a suggestion of negligence. C) conclusive evidence of negligence. D) tantamount to criminal behavior. Answer: C Terms: Failure to meet auditing standards Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
10) A common way for a CPA firm to demonstrate a lack of duty to perform is by use of a(n): A) expert witness' testimony. B) engagement letter. C) management representation letter. D) confirmation letter. Answer: B Terms: Common way to demonstrate lack of duty to perform Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
11) To succeed in an action against the auditor, the client must be able to show that: A) the auditor was fraudulent. B) the auditor was grossly negligent. C) there was a written contract. D) there is a close causal connection between the auditor's behavior and the damages suffered by the client. Answer: D Terms: To succeed in an action against the auditor, client must show that Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
12) Matthews & Co., CPAs, issued an unqualified opinion on Dodgers Corporation. Millennium Bank, which relied on the audited financial statements, granted a loan of $200,00,000 to Dodgers Corporation. Dodgers subsequently defaulted on the loan. To succeed in an action against Matthews & Co., Millennium Bank must prove that the bank was: A) in privity of contract with Dodgers. B) in privity of contract with Millennium. C) free from contributory negligence. D) justified in relying on the financial statements in granting the loan. Answer: D Terms: Legal action where bank relied audited financial statements, granted loan on which customer defaulted Diff: Challenging Objective: LO 5-4 AACSB: Analytic skills
13) One of the changes in auditing procedure which was brought about as a result of the 1136 Tenants case was that auditors were encouraged to begin using: A) letters of representation. B) confirmation letters. C) engagement letters. D) billet doux letters. Answer: C Terms: Audit procedure brought about by 1136 Tenants case Diff: Challenging Objective: LO 5-4 AACSB: Reflective thinking skills
14) The King Surety Company wrote a general fidelity bond covering thefts of assets by the employees of Wilson, Inc. Thereafter, Cooney, an employee of Wilson, embezzled $17,200 of company funds. When the activities were discovered, King paid Wilson the full amount in accordance with the terms of the fidelity bond, and then sought recovery against Wilson's auditors, Lynch & Merritt, CPAs. Which of the following would be Lynch & Merritt's best defense? A) King is not in privity of contract. B) The shortages were the result of clever forgeries and collusive fraud which would not be detected by an examination made in accordance with generally accepted auditing standards. C) Lynch & Merritt were not guilty either of gross negligence or fraud. D) Lynch & Merritt were not aware of the King-Wilson surety relationship. Answer: B Terms: Defense in recovery against auditors with employee theft Diff: Challenging Objective: LO 5-4 AACSB: Analytic skills
15) There are four major sources of an auditor's legal liability. One source is liability to the audit client. List the other three sources. Answer: The other three sources of auditor's legal liability are: • Liability to third parties under common law. • Civil liability under federal securities laws. • Criminal liability. Terms: Sources of auditor's legal liability Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
16) Discuss each of the four defenses a CPA firm can normally use when facing legal claims by clients. Which of these defenses is ordinarily not available against third-party suits? Answer: Lack of duty. The CPA firm claims that there was no implied or expressed contract. Non-negligent performance. The CPA firm claims that the audit was performed in accordance with auditing standards. Contributory negligence. The CPA firm claims that the client's own actions resulted in the loss that is the basis for the damages, or interfered with the conduct of the audit in such a way that prevented that auditor from discovering the cause of the loss. This defense is not available in third-party suits. Absence of causal connection. The CPA firm claims that the auditor's failure to follow auditing standards did not cause the damages suffered by the client. Terms: Four defenses a CPA firm can normally use when facing legal claims by clients Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
17) An example of auditor legal liability to third parties under common law would be the federal government prosecuting an auditor for knowingly issuing an incorrect audit report. Answer: FALSE Terms: Legal liability to third parties under common law Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
18) The 1136 Tenants case was a criminal case concerning a CPA's failure to uncover fraud during a financial statement audit. Answer: FALSE Terms: 1136 Tenants case Diff: Moderate Objective: LO 5-4 AACSB: Reflective thinking skills
19) Many litigation experts believe that a well written engagement letter significantly reduces the likelihood of adverse legal actions. Answer: TRUE Terms: Engagement letter Diff: Easy Objective: LO 5-4 AACSB: Reflective thinking skills
Learning Objective 5-5 1) A financial institution sues the audit firm for failure to discover that a borrower's financial statements are materially misstated. This is an example of which of the following legal liability concepts? A) Liability to clients B) Liability to third parties under common law C) Civil liability under federal securities law D) Criminal liability Answer: B Terms: Legal liability in audit of financial statements that are materially misstated Diff: Easy Objective: LO 5-5 AACSB: Reflective thinking skills
2) Which of the following auditor's defenses usually means nonreliance on the financial statements by the user? A) Lack of duty B) Nonnegligent performance C) Absence of causal connections D) Contributory negligence Answer: C Terms: Auditor defenses which means non-reliance on the financial statements Diff: Easy Objective: LO 5-5 AACSB: Analytic skills
3) A group typically included as "third parties" in common law is: A) Actual and potential stockholders Employees of client Yes Yes B) Actual and potential stockholders No
Employees of client No
Actual and potential stockholders Yes
Employees of client No
Actual and potential stockholders No
Employees of client Yes
C)
D)
Answer: A
Terms: Third-parties in common law Diff: Moderate Objective: LO 5-5 AACSB: Reflective thinking skills
4) The major conclusion of the 1931 Ultramares case was that: A) ordinary negligence is insufficient for liability to third parties. B) third parties must file criminal charges, not civil charges, against the auditor. C) fraud or gross negligence is sufficient for liability to third parties. D) auditors have no liabilities to third parties. Answer: A Terms: Major conclusion of 1931 Ultramares case Diff: Moderate Objective: LO 5-5 AACSB: Reflective thinking skills
5) Under common law, a foreseen user would be treated the same as: A) A primary beneficiary A known third party Yes Yes B) A primary beneficiary No
A known third party No
A primary beneficiary Yes
A known third party No
A primary beneficiary No
A known third party Yes
C)
D)
Answer: A
Terms: Foreseen user under common law treated the same as Diff: Moderate Objective: LO 5-5 AACSB: Reflective thinking skills
6) A broad interpretation of the rights of third-party beneficiaries holds that users that the auditor should have been able to foresee as being likely users of financial statements have the same rights as those with privity of contract. This is known as the concept of: A) foreseen users. B) foreseeable users. C) expected users. D) four-party contracts. Answer: B Terms: Rights of third-party beneficiaries; Privity of contract Diff: Moderate Objective: LO 5-5 AACSB: Reflective thinking skills
7) Which of the auditor's defenses is ordinarily not available when lawsuits are filed by a third party? A) Absence of causal connections B) Contributory negligence C) Non-negligent performance D) Lack of duty Answer: B Terms: Auditor defenses not available when lawsuits filed by a third party Diff: Moderate Objective: LO 5-5 AACSB: Reflective thinking skills
8) According to the principle established by the Restatement of Torts case, foreseen users must be members of: A) any potential user group. B) a legally protected class. C) a reasonably limited and identifiable user group. D) a reasonably limited and established user group. Answer: C Terms: Principle established by Restatement of Torts; Foreseen users must be members Diff: Moderate Objective: LO 5-5 AACSB: Reflective thinking skills
9) In an action against a CPA in a jurisdiction that follows the Ultramares doctrine, lack of privity is a viable defense provided the plaintiff: A) is the client's creditor who sued the CPA for negligence. B) can prove gross negligence. C) violated the Securities Act of 1933. D) violated the Securities Act of 1934. Answer: A Terms: Ultramares doctrine; Lack of privity is viable defense Diff: Moderate Objective: LO 5-5 AACSB: Reflective thinking skills
10) Under common law, an individual or company that (1) does not have a contract with an auditor, (2) is known by the auditor in advance of the audit, and (3) will use the auditor's report to make decisions about the client company has: A) no rights unless an auditor is grossly negligent. B) no rights unless an auditor is fraudulent. C) no rights against an auditor. D) the same rights against an auditor as a client. Answer: D Terms: Common law third-party rights Diff: Challenging Objective: LO 5-5 AACSB: Analytic skills
11) The basic legal concept which was affirmed in the 1985 New York case, Credit Alliance, was that: A) the auditor's defense of privity of contract is still valid against third parties. B) the auditor is liable for ordinary negligence to specifically foreseen third parties. C) the auditor is liable for ordinary negligence to reasonably foreseeable third parties. D) the auditor's defense of contributory negligence is no longer valid. Answer: A Terms: Basic legal concept affirmed in 1985 case, Credit Alliance Diff: Challenging Objective: LO 5-5 AACSB: Analytic skills
12) As a consequence of his failure to adhere to generally accepted auditing standards in the course of his examination of the Lamp Corp., Harrison, CPA, did not detect the embezzlement of a material amount of funds by the company's controller. As a matter of common law, to what extent would Harrison be liable to the Lamp Corp. for losses attributable to the theft? A) He would have no liability, since the ordinary examination cannot be relied upon to detect thefts of assets by employees. B) He would have no liability because privity of contract is lacking. C) He would be liable for losses attributable to his negligence. D) He would be liable only if it could be proven that he was grossly negligent. Answer: C Terms: Under common law, extent of liability where auditor failed to adhere to generally accepted auditing standards in examination of client and failed to detect employee embezzlement Diff: Challenging Objective: LO 5-5 AACSB: Analytic skills
13) The preferred defense in third party suits is: A) lack of duty to perform. B) nonnegligent performance. C) absence of causal connection. D) client fraud. Answer: B Terms: Preferred defense in third-party suits Diff: Moderate Objective: LO 5-5 AACSB: Reflective thinking skills
14) Three approaches to the application of the foreseen users' concept are (1) the Credit Alliance approach, (2) the restatement of torts approach, and (3) the foreseeable user approach. Summarize each of these three approaches. Answer: The Credit Alliance approach upholds the concept of privity of contract established by the Ultramares Corporation v. Touche case. Under this approach, for an auditor to be liable to third parties, the auditor (1) must know and intend that the work product would be used by the third-party for a specific purpose, and (2) the knowledge and intent must be evidenced by the auditor's conduct. Under the restatement of torts approach, foreseen users must be members of a reasonably limited and identifiable group of users that have relied on the CPA's work, such as creditors, even though those persons were not specifically known to the CPA at the time the work was done. Under the foreseeable user approach, any users that the auditor should have reasonably been able to foresee as likely users of the client's financial statements have the same rights as those with privity of contract.
Terms: Three approaches to the application of foreseen users' concepts; Credit Alliance approach; Restatement of torts approach; foreseeable user approach Diff: Challenging Objective: LO 5-5 AACSB: Reflective thinking skills
15) Although there is confusion caused by the differing views of liability to third parties under common law, the movement is clearly away from the foreseeable user approach. Answer: TRUE Terms: Credit Alliance approach; Restatement of torts approach; Foreseeable user approach Diff: Moderate Objective: LO 5-5 AACSB: Reflective thinking skills
16) The restatement of torts approach to the concept of foreseen users states that any users that the auditor should have reasonably been able to foresee as being likely users of financial statements have the same rights as those with privity of contract. Answer: FALSE Terms: Restatement of torts approach; Foreseen users; Privity of contract Diff: Challenging Objective: LO 5-5 AACSB: Reflective thinking skills
17) The Credit Alliance approach to the concept of foreseen users states that to be liable to third parties, an auditor (1) must know and intend that the work product would be used by the third-party for a specific purpose, and (2) the knowledge and intent must be evidenced by the auditor's conduct. Answer: TRUE Terms: Credit Alliance approach; Foreseen users; Liability to third parties Diff: Challenging Objective: LO 5-5 AACSB: Reflective thinking skills
Learning Objective 5-6 1) An adequate system of internal control for SEC registrants was originally required by the: A) Sarbanes-Oxley Act of 2002. B) Securities Act of 1933. C) Foreign Corrupt Practices Act of 1977. D) Securities Act of 1934. Answer: C Terms: Required an adequate system of internal control for SEC registrants Diff: Easy Objective: LO 5-6 AACSB: Reflective thinking skills
2) The increased litigation under the federal securities laws has resulted from: A) The strict liability standards The availability of class-action imposed on CPAs by the litigation securities laws An excess of attorneys Yes Yes Yes B) The strict liability standards The availability of class-action imposed on CPAs by the litigation securities laws Yes No
An excess of attorneys No
C) The strict liability standards The availability of class-action imposed on CPAs by the litigation securities laws Yes Yes
An excess of attorneys No
D) The availability of class-action litigation No
The strict liability standards imposed on CPAs by the securities laws No
Answer: C Terms: Increased litigation under federal securities law resulted from Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
An excess of attorneys No
3) Under the Securities Act of 1933, the auditor's responsibility for making sure the financial statements were fairly stated extends to: A) the date of the financial statements. B) the date the registration statement becomes effective. C) the date of the audit report. D) one year beyond the date of the financial statements. Answer: B
Terms: Securities Act of 1933; Auditor responsibility for making sure financial statements were fairly stated extends Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
4) Under the Securities Exchange Act of 1934, which type of organization is required to submit audited financial statements to the SEC? A) Every company with securities traded on national and over-the-counter exchanges B) Every corporation C) Every company issuing new securities D) Every corporation which is chartered by a state government Answer: A Terms: Securities Act of 1934; Organizations required to submit audited financial statements Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
5) The Securities and Exchange Commission can impose all but which of the following sanctions? A) Suspend a CPA from auditing SEC clients. B) Prohibit a CPA from accepting new SEC clients for a period of time. C) Require a CPA to participate in continuing-education programs and make changes in their practice. D) Revoke a CPA license. Answer: D Terms: Securities and Exchange Commission can impose sanctions Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
6) The Foreign Corrupt Practices Act (FCPA) of 1977: A) requires auditors to review and evaluate systems of internal control as a part of an audit. B) requires SEC registrants to maintain a reasonably complete and accurate set of records and an adequate system of internal control. C) requires auditors to review client's internal control system in a manner which is thorough enough to judge whether client meets the requirements of the FCPA. D) requires auditors to file a report with the SEC if client's internal control system is inadequate. Answer: B Terms: Foreign Corrupt Practices Act of 1977 Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
7) While the Foreign Corrupt Practices Act of 1977 remains in effect, its internal control provisions have been largely superseded by which of the following? A) The Sarbanes-Oxley Act of 2002 B) The Racketeer Influenced and Corrupt Organization Act C) The Federal False Statements Statute D) The Federal Mail Fraud Statute Answer: A Terms: Foreign Corrupt Practices Act of 1977; Internal control provisions Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills Topic: SOX
8) Which of the following is an accurate statement regarding recent actions brought against accountants by clients and third parties? A) Litigants will first seek state remedies because of the availability of class-action litigation. B) Gross negligence by the auditor must be proven under the Securities Acts of 1933 and 1934. C) The greatest growth in CPA liability litigation bas been under the federal securities laws. D) The amount of damages that plaintiffs can receive is greater under common law than under the federal securities laws. Answer: C Terms: Factor in increase in number of lawsuits and sizes of awards Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
9) A major purpose of federal securities regulations is to: A) provide sufficient reliable information to the investing public who purchase securities in the marketplace. B) establish the qualifications for accountants who are members of the profession. C) eliminate incompetent attorneys and accountants who participate in the registration of securities to be offered to the public. D) provide a set of uniform standards and tests for accountants, attorneys, and others who practice before the Securities and Exchange Commission. Answer: A Terms: Major purpose of federal securities regulations Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
10) The 2012 news of a massive alleged bribery scheme involving Wal-Mart has brought charges against the company under the: A) Securities Act of 1933. B) Securities Act of 1934. C) Foreign Corrupt Practices Act of 1977. D) Sarbanes-Oxley Act of 2002 Answer: C Terms: Foreign Corrupt Practices Act of 1977 Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
11) Which of the following statements about the Securities Act of 1933 is not true? A) A third party that purchased securities described in the registration statement may sue the auditor for material misrepresentations or omissions in the audited financial statements. B) A third party user does not have the burden of proof that he/she relied on the financial statements. C) A third party user has the burden of proof that the auditor was either negligent or fraudulent in doing the audit. D) A third party user does not have the burden of proof that the loss was caused by the misleading statements. Answer: C Terms: Securities Act of 1933 Diff: Challenging Objective: LO 5-6 AACSB: Analytic skills
12) The most significant audit issue that came as a result of the court decision in the Escott et al. v. Bar Chris Construction Corporation case in 1968 was: A) the court's reaffirmation that the burden of proof was on the plaintiff to prove the auditor was negligent. B) the affirmation of the increased auditor's responsibility when performing an S-1 review, a review of events subsequent to the balance sheet, for registration statements. C) the increased auditor responsibility when associated with unaudited financial statements. D) the court's refusal to allow the percentage-of-completion method of accounting for revenues. Answer: B Terms: Significant audit issue from Escott et al v. Bar Chris Construction Corporation case in 1968 Diff: Challenging Objective: LO 5-6 AACSB: Reflective thinking skills
13) Under the federal securities acts, one significant result occurring directly due to the Escott et al. v. Bar Chris Construction Corporation case was that SAS was changed to require: A) greater emphasis on subsequent events procedures. B) new standards for unaudited statements. C) a broader definition of third party beneficiaries. D) more companies to file annual reports with the SEC. Answer: A Terms: Significant result from Escott et al v. Bar Chris Construction Corporation case Diff: Challenging Objective: LO 5-6 AACSB: Reflective thinking skills
14) Under the Securities Exchange Act of 1934, most of the litigation against the auditor has been generated because of the auditor's involvement with the: A) 8-K form. B) 10-K form. C) 10-Q form. D) S-1 form. Answer: B Terms: Securities Exchange Act of 1934 Diff: Challenging Objective: LO 5-6 AACSB: Reflective thinking skills
15) Section 10 and Rule 10b-5 of the Securities Exchange Act of 1934 are often referred to as: A) the antifraud provisions. B) the new issues provisions. C) the full employment act for accountants. D) the RICO provisions. Answer: A Terms: Securities Exchange Act of 1934 Section 10 and Rule 10b-5 Diff: Challenging Objective: LO 5-6 AACSB: Reflective thinking skills
16) In a leading securities law and CPA liabilities case, the U.S. Supreme Court ruled in 1976 in Hochfelder v. Ernst & Ernst that before CPAs could be held liable for Rule 10b-5 of the Securities Exchange Act of 1934, what would be required to be shown to the court was the auditor's: A) ordinary negligence. B) gross negligence. C) knowledge and intent to deceive. D) financial gain at the expense of the plaintiff. Answer: C Terms: Securities Exchange Act of 1934 Rule 10b-5; U.S. Supreme Court ruled in 1976 in Hochfelder v. Ernst & Ernst Diff: Challenging Objective: LO 5-6 AACSB: Reflective thinking skills
17) Under the Securities Act of 1933: A) any party who relies on the company's audited financial statements can recover from the auditors. B) third-party users must prove that the auditor was negligent. C) the burden of proof is on the defendant. D) auditors face potential legal exposure for information contained in the Form 10-Q. Answer: C Terms: Securities and Exchange Commission Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
18) The partnership of Booth & Haynes, CPAs, has been engaged to examine the financial statements of Paul, Inc., in connection with the registration of Paul's securities with the Securities and Exchange Commission. Under these circumstances, which of the following statements is true? A) Booth & Haynes is assuming much greater third-party liability than it assumes on engagements under common law. B) If its examination is not fraudulent, Booth & Haynes may issue an appropriate disclaimer to the financial statements and thereby avoid liability. C) Booth & Haynes must incorporate if they wish to practice before the SEC. D) Booth & Haynes must be a large interstate firm if they wish to practice before the SEC. Answer: A
Terms: CPAs engaged to examine financial statements in connection with registration of securities with the Securities and Exchange Commission Diff: Moderate Objective: LO 5-6 AACSB: Analytic skills
19) Discuss the sanctions the Securities and Exchange Commission can impose on auditors. Answer: The SEC has the power in certain circumstances to sanction or suspend practitioners from doing audits for SEC companies. The SEC's Rules of Practice permit them to temporarily or permanently deny a CPA or CPA firm from being associated with financial statements of public companies, either because of lack of appropriate qualifications or having engaged in unethical or improper professional conduct. In recent years, the SEC has temporarily suspended a number of individual CPAs from doing any audits of SEC clients. It has also prohibited a number of CPA firms from accepting any new SEC clients for a period. In some cases, the SEC has required an extensive review of a major CPA firm's practices by another CPA firm, or made CPA firms make changes in their practices. Individual CPAs and their firms have also been required to participate in continuing education programs. Sanctions such as these are published by the SEC and are often reported in the business press, making them a significant embarrassment to those involved. Terms: Sanctions the Securities and Exchange Commission can impose on auditors Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
20) One result from the Escott et al. v. Bar Chris case was a greater emphasis being placed on audit staff understanding the client's business and industry. Answer: TRUE Terms: Result from Escott et al. v. Bar Chris Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
21) The only parties who can recover from auditors under the Securities Act of 1933 are original purchasers of securities. Answer: TRUE Terms: Securities Act of 1933 Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
22) Under the Securities Act of 1933, a third party plaintiff does not have the burden of proof that he or she relied on the financial statements or that the auditor was negligent or fraudulent in doing the audit. Rather, the plaintiff need only prove that the audited financial statements contained a material misrepresentation or omission. Answer: TRUE Terms: Securities Act of 1933; Burden of proof Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
23) Companies with securities traded on national and over-the-counter exchanges are required to submit audited financial statements once every three years to the Securities and Exchange Commission. Answer: FALSE Terms: Securities Act Commission; Securities traded on national exchanges Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
24) The same three defenses available to auditors in common lawsuits by third parties nonnegligent performance, lack of duty, and absence of causal connection–are also available for suits under the Securities Exchange Act of 1934. Answer: TRUE Terms: Securities Act of 1934; Defenses available to auditors in common law suits by third parties Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
25) The United States Supreme Court has ruled that outside professionals such as accountants who don't help run corrupt businesses cannot be sued under the provisions of the Foreign Corrupt Practices Act. Answer: FALSE Terms: United States Supreme Court; Foreign Corrupt Practices Act Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
26) The Sarbanes-Oxley Act requires the CEO and CFO of a public company to certify the annual and quarterly financial statements filed with the PCAOB. Answer: FALSE Terms: Sarbanes-Oxley Act Diff: Moderate Objective: LO 5-6 AACSB: Reflective thinking skills
Learning Objective 5-7 1) In which case were auditors prosecuted for filing false financial statements for a client with the government? A) United States v. Natelli B) United States v. Simon C) Escott et al. v. Bar Chris D) ESM Government Securities v. Alexander Grant & Co. Answer: B Terms: Case where auditors were prosecuted for filing false financial statements Diff: Moderate Objective: LO 5-7 AACSB: Reflective thinking skills
2) A CPA is subject to criminal liability if the CPA: A) refuses to turn over requested audit documentation to a client. B) performs an audit in a negligent manner. C) is knowingly involved with false financial statements. D) willfully breaches a contract with a client. Answer: C Terms: CPA subject to criminal liability Diff: Moderate Objective: LO 5-7 AACSB: Reflective thinking skills
3) Critical lessons learned after analyzing major criminal cases against auditors include the fact that: A) the partner, but not the audit staff, must be independent. B) transactions with related parties are an indication of fraud. C) an investigation of the integrity of management is an important part of deciding whether to accept a new client. D) accounting principles can be relied on exclusively in deciding if the financial statements are fairly presented. Answer: C Terms: CPAs held liable for criminal activity and federal laws; Infamous cases Diff: Moderate Objective: LO 5-7 AACSB: Reflective thinking skills
4) The Sarbanes-Oxley Act of 2002 makes it a felony to destroy or create documents to impede or obstruct a federal investigation. Those provisions were adopted following which of the following legal cases? A) United States v. Natelli B) United States v. Andersen C) ESM Government Securities v. Alexander Grant & Co. D) United States v. Simon Answer: B Terms: Similarity between United States v. Natelli case (i.e., the National Student Marketing case of 1975), and the ESM Government Securities v. Alexander Grant & Co. case of 1986 Diff: Moderate Objective: LO 5-7 AACSB: Analytic skills
5) CPAs can be held liable for criminal activity under both state and federal laws. Infamous cases have involved United States vs. Natelli and ESM Government Securities v. Alexander Grant and Co. Discuss what occurred and prepare a summary of the court findings. Answer: Natelli–two auditors were convicted of criminal liability under the 1934 act for certifying financial statements of National Student Marketing Corporation that contained inadequate disclosures. ESM–management revealed to the partner in charge of the audit of ESM that the previous year's financial statements contained a material misstatement. Rather than complying with the profession and firm standards, the partner agreed to say nothing in the hope that management would work its way out of the problem during the current year. The partner was convicted of criminal charges for his role in sustaining the fraud Terms: CPAs held liable for criminal activity and federal laws; Infamous cases Diff: Moderate Objective: LO 5-7 AACSB: Reflective thinking skills
6) The Sarbanes-Oxley Act of 2002 makes destruction of audit documentation punishable by up to 10 years in prison. Answer: FALSE Terms: Sarbanes-Oxley Act of 2002; Destruction of audit documentation punishable Diff: Challenging Objective: LO 5-7 AACSB: Reflective thinking skills Topic: SOX
Learning Objective 5-8 1) Which of the following resulted in a federal law passed in 1995 that significantly reduced potential damages in securities-related litigation? A) Private Securities Litigation Reform Act B) Public Securities Damages and Settlements Act C) Racketeer Influenced and Corrupt Organization Act D) U.S. Securities Claims Reform Act Answer: A Terms: Federal law passed in 1995 significantly reduced potential damages Diff: Challenging Objective: LO 5-8 AACSB: Reflective thinking skills
2) In order to protect themselves from legal liability, it is important that CPAs: A) are organized as sole-proprietors. B) accept client representations. C) understand the client's business. D) use engagement letters, not representation letters. Answer: C Terms: Protecting individual CPAs from legal liability Diff: Challenging Objective: LO 5-8 AACSB: Reflective thinking skills
3) Discuss at least 3 steps the AICPA and the accounting profession as a whole can and are taking to reduce the practitioner's exposure to lawsuits. Answer: Steps the profession is taking to reduce practitioners' exposure to lawsuits include: • Set standards and revise them the meet the changing needs of auditing. • Oppose lawsuits. • Educate investors and other users of financial statements as to the meaning of the opinion of the auditors and the nature of the auditor's work. • Sanction members for improper conduct and performance. • Lobby for changes in laws. Terms: Steps the AICPA and accounting profession taking to reduce practitioner's exposure to lawsuits Diff: Moderate Objective: LO 5-8 AACSB: Reflective thinking skills
4) Match eight of the following terms (a-n) with the definitions provided below (1-8): a. Foreign Corrupt Practices Act b. Securities Exchange Act of 1934 c. Securities Litigation Uniform Standards Act of 1998 d. Securities Act of 1933 e. Ultramares doctrine f. Audit risk g. Audit failure h. Standards failure i. Business failure j. Absence of causal connection k. Contributory negligence l. Lack of duty to perform m. Private Securities Litigation Reform Act n. Nonnegligent performance ________ 1. A situation in which an incorrect audit opinion is issued because it failed to comply with the requirements of auditing standards. ________ 2. A federal statute dealing with companies that trade securities on national and over-thecounter exchanges. Auditors are involved because the annual reporting requirements include audited financial statements. ________ 3. An auditor's legal defense under which the auditor claims that the client's own actions either resulted in the loss that is the basis for damages or interfered with the conduct of the audit in such a way that prevented the auditor from discovering the cause of the loss. ________ 4. A federal statute that makes it illegal to offer a bribe to an official of a foreign country. ________ 5. A common-law approach to third-party liability in which ordinary negligence is insufficient for liability to third parties, because of the lack of privity of contract between the third-party and the auditor unless the third-party is a primary beneficiary. ________ 6. A federal statute designed to significantly reduce the potential damages in federal securitiesrelated litigation by providing for proportionate liability in most cases. ________ 7. An auditor's legal defense under which the auditor claims that the audit was performed in accordance with generally accepted auditing standards. ________ 8. An auditor's legal defense under which the auditor claims that the failure to follow auditing standards did not cause the damages suffered by the client. Answer: 1. g 2. b 3. k 4. a 5. e 6. c
7. n 8. j Terms: Audit failure; Securities Exchange Act of 1934; Contributory negligence; Foreign Corrupt Practices Act; Securities Litigation Uniform Standards Act of 1998; Ultramares doctrine; Nonnegligent performance; Absence of causal connection Diff: Moderate Objective: LO 5-2, LO 5-4, LO 5-5, LO 5-6 and LO 5-8 AACSB: Reflective thinking skills
5) Discuss some of the steps individual practicing auditors can take to minimize their legal liability. Answer: There are many steps individual practitioners can take to minimize legal liability including: • Deal only with clients possessing integrity. • Hire qualified personnel and train and supervise them properly. • Follow the standards of the profession. • Maintain independence. • Understand the client's business. • Perform quality audits. • Document the work properly. • Obtain an engagement letter and a representation letter. • Maintain confidential relations. • Carry adequate insurance. • Consult with experienced legal counsel. • Choose a form of organization that provides some form of legal liability protection to owners. • Exercise professional skepticism. Terms: Steps auditors can take to minimize legal liability Diff: Easy Objective: LO 5-3 and LO 5-8 AACSB: Reflective thinking skills
6) The Private Securities Litigation Reform Act of 1995 capped damage awards against auditors to the amount of the audit fees charged. Answer: FALSE Terms: Private Securities Litigation Reform Act of 1995 Diff: Easy Objective: LO 5-8 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e (Arens) Chapter 6 Audit Responsibilities and Objectives Learning Objective 6-1 1) The objective of an audit of the financial statements is an expression of an opinion on: A) the fairness of the financial statements in all material respects. B) the accuracy of the financial statements. C) the accuracy of the annual report. D) the accuracy of the balance sheet and income statement. Answer: A
Terms: Objective of ordinary audit of financial statements Diff: Easy Objective: LO 6-1 AACSB: Reflective thinking skills
2) If the auditor believes that the financial statements are not fairly stated or is unable to reach a conclusion because of insufficient evidence, the auditor: A) should withdraw from the engagement. B) should request an increase in audit fees so that more resources can be used to conduct the audit. C) has the responsibility of notifying financial statement users through the auditor's report. D) should notify regulators of the circumstances. Answer: C Terms: Auditor believes that financial statements are nor fairly presented Diff: Easy Objective: LO 6-1 AACSB: Reflective thinking skills
3) Auditors accumulate evidence to: A) defend themselves in the event of a lawsuit. B) determine if the financial statements are correct. C) satisfy the requirements of the Securities Acts of 1933 and 1934. D) reach a conclusion about the fairness of the financial statements. Answer: D Terms: Auditors accumulate evidence Diff: Easy Objective: LO 6-1 AACSB: Reflective thinking skills
Learning Objective 6-2 1) The responsibility for adopting sound accounting policies and maintaining adequate internal control rests with the: A) board of directors. B) company management. C) financial statement auditor. D) company's internal audit department. Answer: B Terms: Responsibility for adopting sound accounting policies and maintaining adequate internal controls Diff: Easy Objective: LO 6-2 AACSB: Reflective thinking skills
2) If management insists on financial statement disclosures that the auditor finds unacceptable, the auditor can withdraw from the engagement or: A) Issue an adverse audit report Issue a qualified audit report Yes Yes B) Issue an adverse audit report No
Issue a qualified audit report No
Issue an adverse audit report Yes
Issue a qualified audit report No
Issue an adverse audit report No Answer: A
Issue a qualified audit report Yes
C)
D)
Terms: Auditor insists on financial statement disclosures that management finds unacceptable Diff: Easy Objective: LO 6-2 AACSB: Reflective thinking skills
3) In certifying their annual financial statements, the CEO and CFO of a public company certify that the financial statements comply with the requirements of: A) GAAP. B) the Sarbanes-Oxley Act. C) the Securities Exchange Act of 1934. D) GAAS. Answer: C Terms: Certifying annual financial statements by CEO and CFO Diff: Easy Objective: LO 6-2 AACSB: Reflective thinking skills Topic: Public
4) Which of the following statements is true of a public company's financial statements? A) Sarbanes-Oxley requires the CEO only to certify the financial statements. B) Sarbanes-Oxley requires the CFO only to certify the financial statements. C) Sarbanes-Oxley requires the CEO and CFO to certify the financial statements. D) Sarbanes-Oxley requires neither the CEO nor the CFO to certify the financial statements. Answer: C Terms: Public company's financial statements Diff: Easy Objective: LO 6-2 AACSB: Reflective thinking skills Topic: SOX
5) The responsibility for the preparation of the financial statements and the accompanying footnotes belongs to: A) the auditor. B) management. C) both management and the auditor equally. D) management for the statements and the auditor for the notes. Answer: B Terms: Responsibility for preparation of the financial statements and the accompanying footnotes Diff: Moderate Objective: LO 6-2 AACSB: Reflective thinking skills
6) Because they operate the business on a daily basis, a company's management knows more about the company's transactions and related assets, liabilities, and equity than the auditors. Answer: TRUE Terms: Responsibility for fair presentation of financial statements Diff: Easy Objective: LO 6-2 AACSB: Reflective thinking skills
7) The annual reports of many public companies include a statement about management's responsibilities and relationship with the CPA firm. Answer: TRUE Terms: Management's responsibility and relationship with CPA firm Diff: Easy Objective: LO 6-2 AACSB: Reflective thinking skills
8) The auditors determine which disclosures must be presented in the financial statements. Answer: FALSE Terms: Responsibility for fair presentation of financial statements Diff: Easy Objective: LO 6-2 AACSB: Reflective thinking skills
Learning Objective 6-3 1) The auditor's best defense when material misstatements are not uncovered is to have conducted the audit: A) in accordance with generally accepted auditing standards. B) as effectively as reasonably possible. C) in a timely manner. D) only after an adequate investigation of the management team. Answer: A Terms: Auditors' best defense when material misstatements are not uncovered Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
2) An audit must be performed with an attitude of professional skepticism. Professional skepticism consists of two primary components: a questioning mind and: A) the assumption that upper-level management is dishonest. B) a critical assessment of the audit evidence. C) the assumption that all employees are motivated by greed. D) verification of all critical information by independent third parties. Answer: B Terms: Attitude of professional skepticism Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
3) Which of the following is not one of the reasons that auditors provide only reasonable assurance on the financial statements? A) The auditor commonly examines a sample, rather than the entire population of transactions. B) Accounting presentations contain complex estimates which involve uncertainty. C) Fraudulently prepared financial statements are often difficult to detect. D) Auditors believe that reasonable assurance is sufficient in the vast majority of cases. Answer: D Terms: Reasons auditors provide only reasonable assurance on financial statements Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
4) Which of the following statements is the most correct regarding errors and fraud? A) An error is unintentional, whereas fraud is intentional. B) Frauds occur more often than errors in financial statements. C) Errors are always fraud and frauds are always errors. D) Auditors have more responsibility for finding fraud than errors. Answer: A Terms: Errors and fraud Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
5) When an auditor believes that an illegal act may have occurred, the auditor should first: A) obtain an understanding of the nature and circumstances of the act. B) consult with legal counsel or others knowledgeable about the illegal act. C) discuss the matter with the audit committee. D) withdraw from the engagement. Answer: A Terms: Auditor believes and illegal act may have occurred Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
6) The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not ________ are detected. A) important to the financial statements B) statistically significant to the financial statements C) material to the financial statements D) identified by the client Answer: C Terms: Auditor has no responsibility to plan and perform audit to obtain reasonable assurance Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
7) Fraudulent financial reporting is most likely to be committed by whom? A) Line employees of the company B) Outside members of the company's board of directors C) Company management D) The company's auditors Answer: C Terms: Fraudulent financial reporting Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
8) Which of the following would most likely be deemed a direct-effect illegal act? A) Violation of federal employment laws B) Violation of federal environmental regulations C) Violation of federal income tax laws D) Violation of civil rights laws Answer: C Terms: Direct-effect illegal act Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
9) The concept of reasonable assurance indicates that the auditor is: A) not a guarantor of the correctness of the financial statements. B) not responsible for the fairness of the financial statements. C) responsible only for issuing an opinion on the financial statements. D) responsible for finding all misstatements. Answer: A Terms: Concept of reasonable assurance Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
10) Which of the following is the auditor least likely to do when aware of an illegal act? A) Discuss the matter with the client's legal counsel. B) Obtain evidence about the potential effect of the illegal act on the financial statements. C) Contact the local law enforcement officials regarding potential criminal wrongdoing. D) Consider the impact of the illegal act on the relationship with the company's management. Answer: C Terms: Illegal acts Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
11) An auditor discovers that the company's bookkeeper unintentionally made an mistake in calculating the amount of the quarterly sales. This is an example of: A) employee fraud. B) an error. C) misappropriation of assets. D) a defalcation. Answer: B Terms: Errors and fraud Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
12) The auditor has considerable responsibility for notifying users as to whether or not the statements are properly stated. This imposes upon the auditor a duty to: A) provide reasonable assurance that material misstatements will be detected. B) be a guarantor of the fairness in the statements. C) be equally responsible with management for the preparation of the financial statements. D) be an insurer of the fairness in the statements. Answer: A Terms: Auditor responsibility for notifying users as to whether statements are properly stated Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
13) "The auditor should not assume that management is dishonest, but the possibility of dishonesty must be considered." This is an example of: A) unprofessional behavior. B) an attitude of professional skepticism. C) due diligence. D) a rule in the AICPA's Code of Professional Conduct. Answer: B Terms: Auditor should consider the possibility of dishonesty of management Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
14) If the auditor were responsible for making certain that all of management's assertions in the financial statements were absolutely correct: A) bankruptcies could no longer occur. B) bankruptcies would be reduced to a very small number. C) audits would be much easier to complete. D) audits would not be economically practical. Answer: D Terms: Auditor responsible for making certain that all of management's assertions were absolutely correct Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
15) One of the characteristics of professional skepticism is ________, which is the conviction to decide for oneself, rather than accepting the claims of others. A) interpersonal understanding B) autonomy C) suspension of judgment D) self-esteem Answer: B Terms: Auditor's best defense when existing material misstatements in the financial statements Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
16) When dealing with laws and regulations that do not have a direct effect on the financial statements, the auditor: A) should inquire of management about whether the entity is in compliance with such laws and regulations. B) has no responsibility to determine if any violations of these laws has occurred. C) must report all violations, including inconsequential violations, to the audit committee. D) should perform the same procedures as for violations having a direct effect on the financial statements. Answer: A Terms: Indirect-effect illegal acts Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
17) Which of the following statements is usually true?
A) Materiality is easy to quantify. B) Fraudulent financial statements are often easy for the auditor to detect, especially when there is collusion among management. C) Reasonable assurance is a low level of assurance that the financial statements are free from material misstatement. D) An item is considered material if it would likely have changed or influenced the decisions of a reasonable person using the statements. Answer: D Terms: Materiality Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
18) Auditing standards make ________ distinction(s) between the auditor's responsibilities for searching for errors and fraud. A) little B) a significant C) no D) various Answer: C Terms: Auditor responsibility for searching for errors and fraud Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
19) In comparing management fraud with employee fraud, the auditor's risk of failing to discover the fraud is: A) greater for management fraud because managers are inherently more deceptive than employees. B) greater for management fraud because of management's ability to override existing internal controls. C) greater for employee fraud because of the higher crime rate among blue collar workers. D) greater for employee fraud because of the larger number of employees in the organization. Answer: B Terms: Management fraud vs. employee fraud and auditor failure to detect both Diff: Challenging Objective: LO 6-3 AACSB: Reflective thinking skills
20) Misappropriation of assets: A) is generally committed by company management. B) harms the users of the financial statements by providing them incorrect financial data for their decision making. C) causes harm to stockholders because the assets are no longer available to their rightful owners. D) causes the financial statements to be misstated since the misappropriation usually involves material amounts. Answer: C Terms: Misappropriation of assets fraud Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
21) When comparing the auditor's responsibility for detecting employee fraud and for detecting errors,
the profession has placed the responsibility: A) more on discovering errors than employee fraud. B) more on discovering employee fraud than errors. C) equally on discovering errors and employee fraud. D) on the senior auditor for detecting errors and on the manager for detecting employee fraud. Answer: C Terms: Fraud and errors Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
22) If several employees collude to falsify documents, the chance a normal audit would uncover such acts is: A) very low. B) very high. C) zero. D) none of the above. Answer: A Terms: Employees collude to falsify documents Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
23) When planning the audit, if the auditor has no reason to believe that illegal acts exist, the auditor should: A) include audit procedures which have a strong probability of detecting illegal acts. B) still include some audit procedures designed specifically to uncover illegalities. C) ignore the issue. D) make inquiries of management regarding their policies for detecting and preventing illegal acts and regarding their knowledge of violations, and then rely on normal audit procedures to detect errors, irregularities, and illegalities. Answer: D Terms: Planning audit and illegal acts Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
24) When the auditor identifies or suspects noncompliance with laws and regulations, the auditor: A) should discuss the matter with those whom they believe committed the illegal act. B) begin communication with the FASB in accordance with PCAOB regulations. C) may disclaim an opinion on the basis of scope limitations if he is precluded by management from obtaining sufficient appropriate evidence. D) should withdraw from the engagement. Answer: C Terms: Illegal acts occurred Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
25) When an auditor knows that an illegal act has occurred, she must: A) report it to the proper governmental authorities.
B) consider the effects on the financial statements, including the adequacy of disclosure. C) withdraw from the engagement. D) issue an adverse opinion. Answer: B Terms: Auditor knows illegal act occurred Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills Topic: Public
26) A questioning mindset: A) means the auditor must prove every statement that management makes to them. B) means the auditor should approach the audit with a "do not trust anyone" mental outlook. C) assures that the auditor will only accept honest clients. D) means the auditor should approach the audit with a "trust but verify" mental outlook. Answer: D Terms: Professional skepticism Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
27) Which of the following is an accurate statement concerning the auditor's responsibility to consider laws and regulations? A) Auditors can follow an easy, step-by-step procedure to determine how laws and regulations impact the financial statements. B) The auditor's responsibility will depend on whether the laws or regulations are expected to have a direct impact on the financial statements. C) It is the responsibility of the auditor to determine if an act constitutes noncompliance. D) The auditor must inform an outside party if management has knowingly not complied with a law or regulation. Answer: B Terms: Illegal acts effect on financial statements Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
28) Which of the following statements best describes the auditor's responsibility with respect to illegal acts that do not have a material effect on the client's financial statements? A) Generally, the auditor is under no obligation to notify parties other than personnel within the client's organization. B) Generally, the auditor is under an obligation to inform the PCAOB. C) Generally, the auditor is obligated to disclose the relevant facts in the auditor's report. D) Generally, the auditor is expected to compel the client to adhere to requirements of the Foreign Corrupt Practices Act. Answer: A Terms: Auditor responsibility with respect to illegal acts Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
29) Which of the following statements best describes the auditor's responsibility regarding the detection of fraud? A) The auditor is responsible for the failure to detect fraud only when such failure clearly results from nonperformance of audit procedures specifically described in the engagement letter. B) The auditor is required to provide reasonable assurance that the financial statements are free of both material errors and fraud. C) The auditor is responsible for detecting material financial statement fraud, but not a material misappropriation of assets. D) The auditor is responsible for the failure to detect fraud only when an unqualified opinion is issued. Answer: B Terms: Auditor responsibility regarding detection of fraud Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
30) The essence of the attest function is to: A) assure the consistent application of correct accounting procedures. B) determine whether the client's financial statements are fairly stated in accordance with an applicable financial reporting framework. C) examine individual transactions so that the auditor may certify as to their validity. D) detect collusion and fraud. Answer: B Terms: Essence of attest function Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
31) The auditor's evaluation of the likelihood of material employee fraud is normally done initially as a part of: A) tests of controls. B) tests of transactions. C) understanding the entity's internal control. D) the assessment of whether to accept the audit engagement. Answer: C Terms: Evaluation of likelihood of material employee fraud Diff: Challenging Objective: LO 6-3 AACSB: Reflective thinking skills
32) One of the characteristics of professional skepticism is_______, which is a desire to investigate beyond the obvious. A) self-esteem B) an interpersonal understanding C) a search for knowledge D) a questioning mindset Answer: C Terms: Professional skepticism Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
33) Most illegal acts affect the financial statements: A) directly. B) only indirectly. C) both directly and indirectly. D) materially if direct; immaterially if indirect. Answer: B Terms: Illegal acts effect on financial statements Diff: Challenging Objective: LO 6-3 AACSB: Reflective thinking skills
34) If a client has violated federal tax laws: A) the auditor must notify the IRS. B) and the amount is significant, the auditor should communicate with those charged with governance. C) the noncompliance generally will not impact the financial statements. D) the auditor does not need to evaluate the effects of the noncompliance on other aspects of the audit. Answer: B Terms: Illegal acts effect on financial statements Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
35) An auditor should recognize that the application of auditing procedures may produce evidence indicating the possibility of errors or fraud and therefore should: A) plan and perform the engagement with an attitude of professional skepticism. B) not rely on internal controls that are designed to prevent or detect errors or fraud. C) design audit tests to detect unrecorded transactions. D) extend the work to audit the majority of the recorded transactions and records of an entity. Answer: A Terms: Audit procedures that product evidence of errors or fraud Diff: Challenging Objective: LO 6-3 AACSB: Reflective thinking skills
36) Discuss the differences between errors, frauds, and illegal acts. Give an example of each. Answer: The primary difference between errors and frauds is that errors are unintentional misstatements of the financial statements, whereas frauds are intentional misstatements. Illegal acts are violations of laws or government regulations, other than frauds. An example of an error is a mathematical mistake when footing the columns in the sales journal. An example of a fraud is the creation of fictitious accounts receivable. An example of an illegal act is the dumping of toxic waste in violation of the federal environmental protection laws. Terms: Errors, frauds, and illegal acts Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
37) Discuss the actions an auditor should take when an illegal act is identified or suspected. Answer: When an auditor discovers or suspects noncompliance with a law or regulation (illegal act), unless the matters involved are inconsequential, the auditor should: 1. Consider the effects of the illegal act on the financial statements, including the adequacy of disclosures. If the auditor concludes that disclosures are inadequate, the auditor should express a qualified or adverse opinion on the financial statements. If the auditor is precluded by management or those charged with governance from obtaining sufficient appropriate evidence to evaluate whether noncompliance that may be material to the financial statements has occurred or is likely to have occurred, the auditor should express a qualified opinion or disclaim an opinion on the financial statements on the basis of the scope limitation. 2. Communicate with those charged with governance matters involving noncompliance with laws and regulations that came to the auditor's attention during the course of the audit. If the matter is believed to be intentional and material, it should be communicated to those charged with governance, such as the board of directors, as soon as practicable. 3. Identify whether a responsibility exists to report the identified or suspected noncompliance to parties outside the entity, such as regulatory authorities. 4. Evaluate the effects of the noncompliance on other aspects of the audit, including the auditor's risk assessment and the reliability of other representations from management. Terms: Actions auditor should take when auditor discovers illegal act Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
38) Discuss three reasons why auditors are responsible for "reasonable" but not "absolute" assurance. Answer: • Most audit evidence results from testing a sample of a population. Sampling involves some risk of not uncovering material misstatements. • Accounting presentations contain complex estimates, which inherently involve uncertainty and can be affected by future events. As a result, the auditor has to rely on evidence that is persuasive but not convincing. • Fraudulently prepared financial statements are often very difficult for the auditor to detect, especially when there is collusion among management. Terms: Reasons auditors are responsible for reasonable but not absolute assurance Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
39) Discuss the differences in the auditor's responsibilities for discovering (1) material errors, (2) material fraud (3) illegal acts having a direct effect on the financial statements, and (4) illegal acts that do not have a direct effect on the financial statements. Answer: Auditing standards make no distinction between the auditor's responsibilities for searching for errors and fraud. In either case, the auditor must obtain reasonable assurance about whether the statements are free of material misstatements. The standards also recognize that fraud is often more difficult to detect because management or the employees perpetrating the fraud attempt to conceal the fraud. Still, the difficulty of detection does not change the auditor's responsibility to properly plan and perform the audit to detect material misstatements, whether caused by error or fraud. The auditor's responsibility for uncovering illegal acts that have a direct effect on the financial statements is the same as for errors and fraud. However, the auditor is not required to search for illegal acts that do not have a direct effect on the financial statements unless there is reason to believe they exist. Terms: Auditor responsibilities for discovering material errors, material fraud, direct-effect illegal acts, and indirecteffect illegal acts Diff: Challenging Objective: LO 6-3 AACSB: Reflective thinking skills
40) The concept of professional skepticism has been a foundational element of auditing standards for year and continues to be difficult to implement in practice. Recent academic research on the topic of professional skepticism suggests that there are six characteristics to skepticism. List and briefly describe each of these characteristics. Answer: The six characteristics of skepticism are: 1. Questioning mindset - a disposition to inquiry with some sense of doubt 2. Suspension of judgment - withholding judgment until appropriate evidence is obtained 3. Search for knowledge - a desire to investigate beyond the obvious, with a desire to corroborate 4. Interpersonal understanding - recognition that people's motivations and perceptions can lead them to provide biased or misleading information 5. Autonomy - the self-direction, moral independence, and conviction to decide for oneself, rather than accepting the claims of others 6. Self-esteem - the self-confidence to resist persuasion and to challenge assumptions or conclusions. Terms: Professional skepticism Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
41) Errors are usually more difficult for an auditor to detect than frauds. Answer: FALSE Terms: Auditor detection of errors and frauds Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
42) Other than inquiring of management about policies they have established to prevent illegal acts and whether management knows of any laws or regulations that the company has violated, the auditor should not search for illegal acts that do not have a direct effect on the financial statements unless there is reason to believe they may exist. Answer: TRUE Terms: Auditor responsibility for searching for illegal acts that do not have a direct effect on the financial statements Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
43) When an auditor believes that an illegal act may have occurred, the first step he or she should take is to gather additional evidence to determine the extent of the illegality and if there is a direct impact on the financial statements. Answer: TRUE Terms: Auditor believes illegal act may have occurred Diff: Easy Objective: LO 6-3 AACSB: Reflective thinking skills
44) Audits are expected to provide a higher degree of assurance for the detection of material frauds than is provided for an equally material error. Answer: FALSE Terms: Degree of assurance for detection of material frauds and errors Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
45) Auditors have a higher degree of responsibility for detecting illegal acts that have a direct effect on the financial statements than illegal acts that do not have a direct effect on the financial statements. Answer: TRUE Terms: Auditor degree of responsibility for detecting illegal acts Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
46) The auditor's first course of action when an illegal act is uncovered should be to immediately notify the appropriate authorities, including but not limited to, law enforcement and the Securities and Exchange Commission. Answer: FALSE Terms: Illegal act uncovered Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
47) An audit generally provides no assurance that illegal acts that do not have a direct effect on the financial statements will be detected. Answer: TRUE Terms: Indirect-effect illegal acts; No assurance Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
48) Auditing standards indicate that reasonable assurance is a moderate, but not absolute, level of assurance that the financial statements are free of material misstatement. Answer: FALSE Terms: Moderate or high risk of management fraud Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
49) Asking the right questions and probing further until the auditor is satisfied with the responses can help the auditor to detect a material misstatement in the financial statements. Answer: TRUE Terms: Professional skepticism Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
50) The objective of the audit of financial statements by an independent auditor is to verify that the financial statements are free of misstatements and accurately represent the company's financial position and results of operations. Answer: FALSE Terms: Objective of audit of financial statements Diff: Challenging Objective: LO 6-3 AACSB: Reflective thinking skills
51) As the impact from noncompliance is further removed from affecting the financial statements, the less likely the auditor is to become aware of or recognize noncompliance when auditing the financial statements. Answer: TRUE Terms: Auditor responsibility for searching for illegal acts that do not have a direct effect on the financial statements Diff: Moderate Objective: LO 6-3 AACSB: Reflective thinking skills
Learning Objective 6-4 1) Why does the auditor divide the financial statements into smaller segments? A) Using the cycle approach makes the audit more manageable. B) Most accounts have few relationships with others and so it is more efficient to break the financial statements into smaller pieces. C) The cycle approach is used because auditing standards require it. D) All of the above are correct. Answer: A Terms: Reason auditor divides financial statements into smaller segments Diff: Moderate Objective: LO 6-4 AACSB: Reflective thinking skills
2) Why does the auditor divide the financial statements into segments around the financial statement cycles? A) Most auditors are trained to audit cycles as opposed to entire financial statements. B) The approach aids in the assignment of tasks to different members of the audit team. C) The cycle approach is required by auditing standards. D) The cycle approach allows the auditor to detect illegal acts. Answer: B Terms: Reason auditor divides financial statements into smaller segments Diff: Moderate Objective: LO 6-4 AACSB: Reflective thinking skills
3) The most important general ledger account included in and affecting several cycles is the: A) cash account. B) inventory account. C) income tax expense and liability accounts. D) retained earnings account. Answer: A Terms: Account included in and affected several cycles Diff: Moderate Objective: LO 6-4 AACSB: Reflective thinking skills
4) When using the cycle approach to segmenting the audit, the reason for treating capital acquisition and repayment separately from the acquisition of goods and services is that: A) the transactions are related to financing a company rather than to its operations. B) most capital acquisition and repayment cycle accounts involve few transactions, but each is often highly material and therefore should be audited extensively. C) both A and B are correct. D) neither A nor B is correct. Answer: C Terms: Cycle approach to segmenting an audit Diff: Challenging Objective: LO 6-4 AACSB: Reflective thinking skills
5) In describing the cycle approach to segmenting an audit, which of the following statements is not true? A) All general ledger accounts and journals are included at least once. B) Some journals and general ledger accounts are included in more than one cycle. C) The "capital acquisition and repayment" cycle is closely related to the "acquisition of goods and services and payment" cycle. D) The "inventory and warehousing" cycle may be audited at any time during the engagement since it is unrelated to the other cycles. Answer: D Terms: Cycle approach to segmenting an audit Diff: Challenging Objective: LO 6-4 AACSB: Reflective thinking skills
6) The cycle approach to auditing: A) ties to the way transactions are recorded in journals and then summarized in the general ledger and financial statements. B) cannot combine transactions recorded in different journals with the general ledger balances that result from those transactions. C) is the only way of segmenting an audit. D) assumes that each account has two or more cycles associated with it. Answer: A Terms: Cycle approach to segmenting an audit Diff: Moderate Objective: LO 6-4 AACSB: Reflective thinking skills
7) Auditors generally use a financial statement cycle approach when performing a financial statement
audit. Describe the transaction flow, using specific examples, from journals to financial statements that produce financial statements. Answer: Transactions–sales, cash receipts, acquisition of goods/services, cash disbursements, payroll services and disbursements, and allocation and adjustments Journals–sales, cash receipts, acquisitions, cash disbursements, payroll, and general General ledger and subsidiary ledgers to General ledger trial balance to financial statements Terms: Financial statement cycle approach when performing a financial statement audit Diff: Moderate Objective: LO 6-4 AACSB: Reflective thinking skills
8) Listed below are several accounts listed from a company's trial balance. Next to each account put the letter corresponding to the transaction cycle used to audit the account: S = Sales and collection cycle I = Inventory and warehousing cycle A = Acquisition and payment cycle C = Capital acquisition and repayment cycle P = Payroll and personnel cycle 1. ________ Sales returns and allowances 2. ________ Capital stock 3. ________ Buildings 4. ________ Notes payable
5. ________ Salaries and commissions 6. ________ Cost of goods sold 7. ________ Trade accounts receivable 8. ________ Rent
Answer: 1. S, 2. C, 3. A, 4. C, 5. P, 6. I, 7. S, 8. A Terms: Financial statement cycle approach when performing a financial statement audit Diff: Moderate Objective: LO 6-4 AACSB: Reflective thinking skills
9) Under the cycle approach to segmenting an audit, transactions recorded in different journals should never be combined with the general ledger balances that result from those transactions. Answer: FALSE Terms: Cycle approach to segmenting an audit Diff: Moderate Objective: LO 6-4 AACSB: Reflective thinking skills
10) Under the cycle approach, the only accounts that have two or more cycles associated with them are cash and accounts receivable. Answer: FALSE Terms: Cycle approach to segmenting an audit Diff: Moderate Objective: LO 6-4 AACSB: Reflective thinking skills
11) Although auditors need to consider the interrelationships between cycles, they typically treat cycles independently to the extent practical to manage complex audits effectively. Answer: TRUE Terms: Cycle approach to segmenting an audit Diff: Moderate Objective: LO 6-4 AACSB: Reflective thinking skills
12) When examining the relationships of the five cycles and general cash, the cycles have no beginning or end except at the origin or final disposition of the company. Answer: TRUE Terms: Cycle approach to segmenting an audit Diff: Moderate Objective: LO 6-4 AACSB: Reflective thinking skills
Learning Objective 6-5 1) Auditors have found that generally the most efficient and effective way to conduct audits is to: A) obtain complete assurance about the correctness of each class of transactions affecting the account. B) obtain some combination of assurance for each class of transactions and for the ending balance in the related accounts. C) obtain assurance about the ending balance of the account only. D) verify each entry that was made into an account. Answer: B Terms: Setting audit objectives Diff: Moderate Objective: LO 6-5 AACSB: Reflective thinking skills
2) The term audit objective refers to all of the following except for: A) transaction-related audit objectives. B) presentation and disclosure-related audit objectives. C) balance-related audit objectives. D) cycle-related audit objectives. Answer: D Terms: Setting audit objectives Diff: Easy Objective: LO 6-5 AACSB: Reflective thinking skills
3) When an auditor is determining what information to include in the notes to the financial statements relating to bonds payable, he is concerned with the transaction-related audit objectives. Answer: FALSE Terms: Setting audit objectives Diff: Moderate Objective: LO 6-4 AACSB: Reflective thinking skills
Learning Objective 6-6 1) Which of the following is not one of the three categories of assertions? A) Assertions about classes of transactions and events for the period under audit B) Assertions about financial statements and correspondence to GAAP C) Assertions about account balances at period end D) Assertions about presentation and disclosure Answer: B Terms: Categories of assertions Diff: Easy Objective: LO 6-6 AACSB: Reflective thinking skills
2) If a short-term note payable is included in the accounts payable balance on the financial statement, there is a violation of the: A) completeness assertion. B) existence assertion. C) cutoff assertion. D) classification assertion. Answer: D Terms: Violation of assertions Diff: Easy Objective: LO 6-6 AACSB: Reflective thinking skills
3) International auditing standards and U.S. GAAP classify assertions into three categories. Which of the following is not a category of assertions that management makes about the accounting information in financial statements? A) Assertions about classes of transactions for the period under audit B) Assertions about account balances at period end C) Assertions about the quality of source documents used to prepare the financial statements D) Assertions about presentation and disclosure Answer: C Terms: Management assertions Diff: Easy Objective: LO 6-6 AACSB: Reflective thinking skills
4) Management assertions are: A) directly related to the financial reporting framework used by the company, usually U.S. GAAP or IFRS. B) stated in the footnotes to the financial statements. C) explicitly expressed representations about the financial statements. D) provided to the auditor in the assertions letter, but are not disclosed on the financial statements. Answer: A Terms: Management assertions Diff: Moderate Objective: LO 6-6 AACSB: Reflective thinking skills
5) Management makes the following assertions about account balances:
A) existence, completeness, classification and cutoff. B) existence, accuracy, classification and rights and obligations. C) existence, completeness, valuation and allocation, and rights and obligations. D) existence, completeness, rights and obligations, and cutoff. Answer: C Terms: Management assertions Diff: Challenging Objective: LO 6-6 AACSB: Reflective thinking skills
6) Which of the following statements is true about the completeness and occurrence assertions? A) Both assertions are relevant to classes of transactions and events and account balances. B) If management asserts that recorded sales transactions represent exchanges of goods or services that actually took place, they are asserting to completeness. C) Violations of the occurrence assertion relate to account overstatements. D) The failure to record a sale that did occur is a violation of the occurrence assertion. Answer: C Terms: Completeness transaction-related audit objective Diff: Moderate Objective: LO 6-6 AACSB: Reflective thinking skills
7) Which of the following assertions is described as "this assertion addresses whether all transactions that should be included in the financial statements are in fact included"? A) Occurrence B) Completeness C) Rights and obligations D) Existence Answer: B Terms: Assertion which addresses whether all transactions that should be included are included Diff: Moderate Objective: LO 6-6 AACSB: Reflective thinking skills
8) Which of the following management assertions is not associated with classes of transactions and events? A) Occurrence B) Classification C) Accuracy D) Rights and obligations Answer: D Terms: Management assertion not associated with transaction-related audit objectives Diff: Moderate Objective: LO 6-6 AACSB: Reflective thinking skills
9) Briefly explain each management assertion related to classes of transactions and events for the period under audit. Answer: • Occurrence. Transactions and events that have been recorded have occurred and pertain to the entity. • Completeness. All transactions and events that should have been recorded have been recorded. • Accuracy. Amounts and other data relating to recorded transactions and events have been recorded appropriately. • Classification. Transactions and events have been recorded in the proper accounts. • Cutoff. Transactions and events have been recorded in the correct accounting period. Terms: Management assertions related to classes of transactions Diff: Moderate Objective: LO 6-6 AACSB: Reflective thinking skills
10) Briefly explain each management assertion related to account balances at period end. Answer: • Existence. Assets, liabilities, and equity interests exist. • Completeness. All assets, liabilities, and equity interests that should have been recorded have been recorded. • Valuation and allocation. Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation adjustments are appropriately recorded. • Rights and obligations. The entity holds or controls the rights to assets, and liabilities are the obligation of the entity. Terms: Management assertions related to account balances at period end Diff: Moderate Objective: LO 6-6 AACSB: Reflective thinking skills
11) Briefly explain each management assertion related to presentation and disclosure. Answer: • Occurrence and rights and obligations. Disclosed events and transactions have occurred and pertain to the entity. • Completeness. All disclosures that should have been included in the financial statements have been included. • Accuracy and valuation. Financial and other information are disclosed appropriately and at appropriate amounts. • Classification and understandability. Financial and other information is appropriately presented and described and disclosures are clearly expressed. Terms: Management assertions related to presentation and disclosure Diff: Moderate Objective: LO 6-6 AACSB: Reflective thinking skills
12) Relevant assertions have a meaningful bearing on whether the account is fairly stated and are used to assess the risk of material misstatement and the design and performance of audit procedures. Answer: TRUE Terms: Management assertions Diff: Moderate Objective: LO 6-6 AACSB: Reflective thinking skills
13) The auditor's audit objectives follow and are closely related to management assertions. Answer: TRUE Terms: Management assertions Diff: Moderate Objective: LO 6-6 AACSB: Reflective thinking skills
Learning Objective 6-7 1) Which of the following statements is true regarding the distinction between general audit objectives and specific audit objectives for each class of transactions? A) The specific audit objectives are applicable to every class of transactions. B) The general audit objectives are applicable to every class of transactions. C) Once the specific transaction-related audit objectives are established, they can be used to develop the general transaction-related objectives. D) For any given class of transactions, usually only one audit objective must be met to conclude the transactions are properly recorded. Answer: B Terms: Difference between general and specific audit objectives Diff: Moderate Objective: LO 6-7 AACSB: Reflective thinking skills
2) The auditor is determining that the the correct selling price was used for billing and that the quantity of goods shipped was the same as the quantity billed. She is gathering evidence about which transaction related audit objective? A) Existence B) Completeness C) Accuracy D) Cut-off Answer: C Terms: Evidence for transaction related audit objective if recorded sales are for amount shipped and correctly billed and recorded Diff: Moderate Objective: LO 6-7 AACSB: Analytic skills
3) The posting and summarization audit objective is the auditor's counterpart to management's assertion of: A) occurrence. B) completeness. C) accuracy. D) classification. Answer: C Terms: Transaction-related audit objectives Diff: Moderate Objective: LO 6-7 AACSB: Reflective thinking skills
4) After the general transaction related-audit objectives are understood, specific transaction-related audit objectives for each material class of transactions can be developed. Which of the following statements is
true? A) There should be at least one specific objective for each relevant general objective. B) There will be only one specific objective for each relevant general objective. C) There will be many specific objectives developed for each relevant general objective. D) There must be one specific objective for each general objective. Answer: A Terms: General and specific audit objectives Diff: Challenging Objective: LO 6-7 AACSB: Reflective thinking skills
5) In the context of the audit of sales, distinguish between the occurrence and completeness transactionrelated audit objectives. State the effect on the sales account (overstatement or understatement) of a violation of each objective. Answer: When testing the occurrence objective for sales, the auditor's focus is on whether the sales that have been recorded in the sales journal actually occurred. In contrast, tests of the completeness objective are concerned with determining whether all sales that actually occurred have been recorded in the sales journal. Violations of the occurrence objective result in overstatements of sales; violations of the completeness objective result in understatements of sales. Terms: General and specific audit objectives Diff: Moderate Objective: LO 6-7 AACSB: Reflective thinking skills
6) Below are five audit procedures, all of which are tests of transactions associated with the audit of the sales and collection cycle. Also below are the six general transaction-related audit objectives and the five management assertions. For each audit procedure, indicate (1) its audit objective, and (2) the management assertion being tested. Audit Objectives A. Occurrence B. Completeness C. Accuracy D. Posting and summarization E. Classification F. Timing
Assertions V. Occurrence W. Completeness X. Accuracy Y. Classification Z. Cutoff
1. Vouch recorded sales from the sales journal to the file of bills of lading. (1) ________. (2) ________. 2. Compare dates on the bill of lading, sales invoices, and sales journal to test for delays in recording sales transactions. (1) ________. (2) ________. 3. Account for the sequence of prenumbered bills of lading and sales invoices. (1) ________. (2) ________. 4. Trace from a sample of prelistings of cash receipts to the cash receipts journal, testing for names, amounts, and dates. (1) ________. (2) ________. 5. Examine customer order forms for credit approval by the credit manager. (1) ________. (2) ________. Answer: 1. (1) A (2) V 2. (1) F (2) Z 3. (1) B (2) W 4. (1) B, C (2) W, X 5. (1) A (2) V Terms: Management assertions and transaction-related audit objectives Diff: Challenging Objective: LO 6-6 and LO 6-7 AACSB: Analytic skills
7) Below are five audit procedures, all of which are tests of transactions associated with the audit of the acquisition and payment cycle. Also below are the six general transaction-related audit objectives and the five management assertions. For each audit procedure, indicate (1) its audit objective, and (2) the management assertion being tested. Audit Objectives A. Occurrence B. Completeness C. Accuracy D. Posting and summarization E. Classification F. Timing
Assertions V. Occurrence W. Completeness X. Accuracy Y. Classification Z. Cutoff
1. Foot the purchases journal and trace the totals to the related general ledger accounts. (1) ________. (2) ________. 2. Recompute the cash discounts taken by the client. (1) ________. (2) ________. 3. Compare dates on cancelled checks with the bank cancellation date. (1) ________. (2) ________. 4. Trace from a sample of cancelled checks to the cash disbursements journal. (1) ________. (2) ________. 5. Examine supporting documentation for a sample of transactions for authorized payee and amount and to determine services or goods were received. (1) ________. (2) ________. Answer: 1. (1) D (2) X 2. (1) C (2) X 3. (1) F (2) Z 4. (1) B (2) W 5. (1) A (2) V Terms: Management assertions and transaction-related audit objectives Diff: Challenging Objective: LO 6-6 and LO 6-7 AACSB: Analytic skills
8) General transaction-related audit objectives vary from audit to audit, depending on the nature and characteristics of the client's business and industry. Answer: FALSE Terms: General transaction-related audit objectives Diff: Moderate Objective: LO 6-7 AACSB: Reflective thinking skills
9) The audit objective of posting and summarization is associated with the management assertion of accuracy. Answer: TRUE Terms: Audit objective of posting and summarization; Accuracy management assertion Diff: Moderate Objective: LO 6-7 AACSB: Reflective thinking skills
10) The transaction-related audit objective of timing is related to the assertion of cutoff. Answer: TRUE Terms: Transaction-related audit objective of timing; Cutoff assertion Diff: Moderate Objective: LO 6-7 AACSB: Reflective thinking skills
11) If a sale was for a valid shipment, but the amount of the sales invoice was calculated incorrectly, the accuracy objective was violated. Answer: TRUE Terms: General transaction-related audit objectives Diff: Moderate Objective: LO 6-7 AACSB: Reflective thinking skills
12) The effect of a violation of the completeness transaction-related audit objective for cash disbursements transactions would be an overstatement of cash disbursements. Answer: FALSE Terms: Completeness transaction-related audit objective Diff: Moderate Objective: LO 6-7 AACSB: Reflective thinking skills
13) The transaction-related audit objective that deals with whether recorded transactions have actually occurred is the completeness objective. Answer: FALSE Terms: Transaction-related audit objective; Completeness objective Diff: Moderate Objective: LO 6-7 AACSB: Reflective thinking skills
Learning Objective 6-8 1) In testing for cutoff, the objective is to determine: A) whether all of the current period's transactions are recorded. B) whether transactions are recorded in the correct accounting period. C) the proper cutoff between capitalizing and expensing expenditures. D) the proper cutoff between disclosing items in footnotes or in account balances. Answer: B Terms: Objective in testing cutoff Diff: Moderate Objective: LO 6-8 AACSB: Reflective thinking skills
2) The detail tie-in objective is not concerned that the details in the account balance: A) agree with related subsidiary ledger amounts. B) are properly disclosed in accordance with GAAP. C) foot to the total in the account balance. D) agree with the total in the general ledger. Answer: B Terms: Detail tie-in objective Diff: Moderate Objective: LO 6-8 AACSB: Reflective thinking skills
3) The detail tie-in is part of the ________ assertion for account balances. A) classification B) valuation and allocation C) rights and obligations D) completeness Answer: B Terms: Detail tie-in is and assertion for account balances Diff: Moderate Objective: LO 6-8 AACSB: Reflective thinking skills
4) The classification balance-related audit objective: A) involves determining if items included on a client's listing are included in the correct general leger accounts. B) is the counterpart to the management assertion of completeness. C) involves determining if items included on a client's listing are disclosed properly in the financial statements. D) involves tying in the account balances to the general ledger. Answer: A Terms: Balance-related audit objectives Diff: Moderate Objective: LO 6-8 AACSB: Reflective thinking skills
5) Which of the following best describes tests of details of balances? A) Audit procedures designed to test for monetary misstatements in the accounts summarized in the financial statements B) Audit procedures designed to test for the monetary amounts of transactions C) Audit procedures designed to test for reasonableness of account balances D) Audit procedures designed to test for effectiveness in recording accounting information Answer: A Terms: Details of balances Diff: Challenging Objective: LO 6-8 AACSB: Reflective thinking skills
6) Which of the following statements is not true? A) Balance-related audit objectives are applied to ending account balances. B) Transaction-related audit objectives are applied to classes of transactions. C) Balance-related audit objectives are applied to the ending balance in balance sheet accounts. D) Balance-related audit objectives are applied to both beginning and ending balances in balance sheet accounts. Answer: D Terms: Balance-related and transaction-related audit objectives Diff: Moderate Objective: LO 6-7 and LO 6-8 AACSB: Reflective thinking skills
7) An important balance related audit objective is realizable value. Describe the purpose of this audit objective, what it is concerned with, and give an example. Answer: Purpose–to make sure that assets are included on the balance sheet at the amounts estimated to be realized. Concept–whether an account balance has been reduced for declines from historical cost or when accounting standards require a fair value accounting treatment for the account. It is concerned with valuation and allocation. Example–allowance for uncollectible accounts, write-downs of inventory. Terms: Balance related objective of realizable value Diff: Challenging Objective: LO 6-8 AACSB: Reflective thinking skills
8) Below are five audit procedures, all of which are tests of balances associated with the audit of accounts receivable. Also below are the eight general balance-related audit objectives and the four management assertions. For each audit procedure, indicate (1) its audit objective, and (2) the management assertion being tested. Audit Objectives A. Existence B. Completeness C. Accuracy D. Classification E. Cutoff F. Detail tie-in G. Realizable value H. Rights and obligations
Assertions V. Existence W. Completeness X. Valuation and allocation Y. Rights and obligations
1. Obtain an aged listing of accounts receivable. For a sample of individual customers on the listing, agree the customer's name, amount, and other information with the corresponding information in the accounts receivable master file. (1) ________. (2) ________. 2. Examine details of sales for five days before and five days after year-end to determine whether sales have been recorded in the proper period. (1) ________. (2) ________. 3. Assess the reasonableness of the balance in the allowance for doubtful accounts. (1) ________. (2) ________. 4. Inquire as to whether any accounts receivable have been factored or sold during the period. (1) ________. (2) ________. 5. Inquire as to whether there are any receivables from related parties. (1) ________. (2) ________. Answer: 1. (1) F (2) X 2. (1) E (2) X 3. (1) G (2) X 4. (1) H (2) Y 5. (1) D (2) X Terms: Management assertions and balance-related audit objectives Diff: Challenging Objective: LO 6-6 and LO 6-8 AACSB: Analytic skills
9) Auditors have found that the most efficient way to conduct audits is to focus primarily on testing classes of transactions and performing tests of ending account balances. Answer: TRUE Terms: Testing classes of transactions and ending account balances Diff: Easy Objective: LO 6-7 and LO 6-8 AACSB: Reflective thinking skills
10) Balance-related audit objectives are usually applied to the ending balance in income statement accounts; transaction-related audit objectives are usually applied to transactions reflected in balance sheet accounts. Answer: FALSE Terms: Balance-related audit objectives; Transaction-related audit objectives Diff: Moderate Objective: LO 6-7 and LO 6-8 AACSB: Reflective thinking skills
11) Tests of details of balances typically involve the use of comparisons and relationships to assess the overall reasonableness of account balances. Answer: FALSE Terms: Test of details of balances Diff: Easy Objective: LO 6-8 AACSB: Reflective thinking skills
12) The general balance-related audit objective that deals with determining that details in the account balance agree with related master file amounts, foot to the total in the account balance, and agree with the total in the general ledger is the detail tie-in objective. Answer: TRUE Terms: Detail tie-in objective; General balance-related objective Diff: Moderate Objective: LO 6-8 AACSB: Reflective thinking skills
13) The cutoff objective, "transactions near the balance sheet date are recorded in the proper period," is a balance-related audit objective. Answer: TRUE Terms: Cutoff objective; Balance-related audit objective Diff: Moderate Objective: LO 6-8 AACSB: Reflective thinking skills
Learning Objective 6-9 1) Determining that the footnote disclosures related to long-term debt are accurate is an example of the ________ audit objective. A) occurrence B) completeness C) presentation and disclosure D) classification and understandability Answer: C Terms: Presentation and disclosure-related objectives Diff: Easy Objective: LO 6-9 AACSB: Reflective thinking skills
2) The presentation and disclosure-related audit objectives are identical to the management assertions for presentation and disclosure. Answer: TRUE Terms: Presentation and disclosure-related objectives Diff: Easy Objective: LO 6-9 AACSB: Reflective thinking skills
Learning Objective 6-10 1) Tests of details of balances are specific audit procedures that are intended to: A) test for monetary misstatements in the financial statements. B) prove that the accounts with material balances are classified correctly. C) prove that the trial balance is in balance. D) identify the details of the internal control system. Answer: A Terms: Tests of details balances; Specific audit procedures Diff: Easy Objective: LO 6-10 AACSB: Reflective thinking skills
2) Which of the following statements is not correct? A) There are many ways an auditor can accumulate evidence to meet overall audit objectives. B) Sufficient appropriate evidence must be accumulated to meet the auditor's professional responsibility. C) It is appropriate to minimize the cost of accumulating evidence. D) Gathering evidence and minimizing costs are equally important considerations that affect the approach the auditor selects. Answer: D Terms: Considerations for accumulating evidence Diff: Moderate Objective: LO 6-10 AACSB: Reflective thinking skills
3) Two overriding considerations affect the many ways an auditor can accumulate evidence: 1. Sufficient appropriate evidence must be accumulated to meet the auditor's professional responsibility. 2. Cost of accumulating evidence should be minimized. In evaluating these considerations: A) the first is more important than the second. B) the second is more important than the first. C) they are equally important. D) it is impossible to prioritize them. Answer: A Terms: Considerations for accumulating evidence Diff: Moderate Objective: LO 6-10 AACSB: Reflective thinking skills
4) If the auditor has obtained a reasonable level of assurance about the fair presentation of the financial statements through understanding internal control, assessing control risk, testing controls, and analytical procedures, then the auditor: A) can issue an unqualified opinion. B) can significantly reduce other substantive tests. C) can write the engagement letter. D) needs to perform additional tests of controls so that the assurance level can be increased. Answer: B Terms: Auditor obtained reasonable level of assurance about fair presentation Diff: Moderate Objective: LO 6-10 AACSB: Reflective thinking skills
5) After the auditor has completed all audit procedures, it is necessary to combine the information obtained to reach an overall conclusion as to whether the financial statements are fairly presented. This is a highly subjective process that relies heavily on: A) generally accepted auditing standards. B) the AICPA's Code of Professional Conduct. C) generally accepted accounting principles. D) the auditor's professional judgment. Answer: D Terms: After auditor completed all audit procedures Diff: Moderate Objective: LO 6-10 AACSB: Reflective thinking skills
6) List the four phases of a Financial Statement Audit Answer: 1. Plan and design an audit approach based on risk assessment procedures 2. Perform tests of controls and substantive tests of transactions 3. Perform analytical procedures and tests of details of balances 4. Complete the audit and issue an audit report Terms: Phases of financial statement audit Diff: Moderate Objective: LO 6-10 AACSB: Reflective thinking skills
7) Describe what analytical procedures and tests of details of balances are and give an example of each. Answer: Analytical procedures consist of evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data. Analytical procedures use comparisons and relationships to assess whether account balances and other data appear reasonable. An example of an analytical procedure is to examine sales transactions in the sales journal for unusually large amounts and/or compare monthly sales with prior years. Tests of details of balances are specific procedures intended to test for monetary misstatements in balances in the financial statements. An example is direct written communication with the client's customers to identify any incorrect amounts. Terms: Analytical procedures and tests of balances Diff: Challenging Objective: LO 6-10 AACSB: Reflective thinking skills
8) Match seven of the terms (a-k) with the definitions provided below (1-7): a. b. c. d. e. f. g. h. i. j. k.
Tests of details of balances Tests of controls Substantive tests of transactions Analytical procedures Transaction-related audit objectives Management assertions Balance-related audit objectives Fraud Illegal act Error Management fraud
________ 1. An intentional misstatement of the financial statements. ________ 2. A set of six audit objectives the auditor must meet, including timing, posting and summarization, and accuracy. ________ 3. Implied or expressed representations made by the client about classes of transactions, account balances and disclosures in the financial statements. ________ 4. Audit procedures testing for monetary misstatements to determine whether the balancerelated audit objectives have been satisfied for each significant account balance. ________ 5. A set of nine audit objectives the auditor must meet, including completeness, detail tie-in, and rights and obligations. ________ 6. Audit procedures designed to test the effectiveness of control policies and procedures. ________ 7. Use of comparisons and relationships to assess whether account balances or other data appears reasonable. Answer: 1. h 2. e 3. f 4. a 5. g 6. b 7. d
Terms: Tests of balances; Tests of controls; Substantive tests of transactions; Analytical procedures; Management assertions; Balance-related audit objectives; Fraud Diff: Moderate Objective: LO 6-3, LO 6-6, LO 6-7, LO 6-8, and LO 6-10 AACSB: Reflective thinking skills
9) When an auditor has reduced assessed control risk based on tests of controls, he or she may then reduce the extent to which the accuracy of the financial statement information directly related to those controls must be supported through the accumulation of evidence using substantive tests. Answer: TRUE Terms: Tests of controls; Assessed control risk Diff: Easy Objective: LO 6-10 AACSB: Reflective thinking skills
10) For a private company audit, tests of controls are normally performed only on those internal controls the auditor believes have not been operating effectively during the period under audit. Answer: FALSE Terms: Tests of controls Diff: Moderate Objective: LO 6-10 AACSB: Reflective thinking skills
11) Rights and obligations is the only balance-related assertion without a similar transaction related assertion. Answer: TRUE Terms: Audit process Diff: Moderate Objective: LO 6-10 AACSB: Reflective thinking skills
12) The audit objectives are the well-defined methodology for organizing an audit to ensure that the evidence gathered is sufficient and appropriate. Answer: FALSE Terms: Audit process Diff: Moderate Objective: LO 6-10 AACSB: Reflective thinking skills
13) Obtaining an understanding of the entity and its environment is part of the analytical procedures phase of the audit. Answer: FALSE Terms: Audit process Diff: Moderate Objective: LO 6-10 AACSB: Reflective thinking skills
14) An auditor assesses the risk of material misstatement to determine the impact on the audit plan and to determine the nature, extent, and timing of the audit procedures. Answer: TRUE Terms: Audit process Diff: Moderate Objective: LO 6-10 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e Chapter 7 Audit Evidence
Learning Objective 7-1 1) All evidence must have the same level of persuasiveness. Answer: FALSE Terms: Audit evidence Diff: Easy Objective: LO 7-1 AACSB: Reflective thinking skills
2) Auditors use evidence to help them draw conclusions. Answer: TRUE Terms: Audit evidence Diff: Easy Objective: LO 7-1 AACSB: Reflective thinking skills
Learning Objective 7-2 1) Auditors must make decisions regarding what evidence to gather and how much to accumulate. Which of the following is a decision that must be made by auditors related to evidence? A) Sample size Timing of audit procedures Yes Yes B) Sample size No
Timing of audit procedures No
Sample size Yes
Timing of audit procedures No
Sample size No
Timing of audit procedures Yes
C)
D)
Answer: A
Terms: Decision to be made by auditors related to evidence Diff: Easy Objective: LO 7-2 AACSB: Reflective thinking skills
2) Audit procedures are concerned with the nature, extent, and timing in gathering audit evidence. Which, of the following, is true as to the timing of audit procedures? A) Prior to the fiscal year-end of Subsequent to the fiscal year-end the client of the client Yes Yes B) Prior to the fiscal year-end of Subsequent to the fiscal year-end the client of the client No No C) Prior to the fiscal year-end of Subsequent to the fiscal year-end the client of the client Yes No D) Prior to the fiscal year-end of Subsequent to the fiscal year-end the client of the client No Yes Answer: A
Terms: Timing of audit procedures Diff: Easy Objective: LO 7-2 AACSB: Reflective thinking skills
3) A(n) ________ is the detailed instruction that explains the audit evidence to be obtained during the audit. A) audit objectives B) audit procedure C) audit assertion D) audit program Answer: B Terms: Audit evidence and audit procedures Diff: Easy Objective: LO 7-2 AACSB: Analytic skills
4) Which of the following is not one of the four decisions about what evidence to gather and how much of it to accumulate? A) Which audit procedures to use B) Which accounts must agree to the general ledger C) When to perform the procedures D) What sample size to select for a given procedure Answer: B Terms: Audit evidence and audit procedures Diff: Easy Objective: LO 7-2
AACSB: Analytic skills
5) An audit program is the list of audit procedures for an audit area or an entire audit. Answer: TRUE Terms: Audit program Diff: Easy Objective: LO 7-2 AACSB: Reflective thinking skills
Learning Objective 7-3 1) Audit evidence has two primary qualities for the auditor; relevance and reliability. Given the choices below, which provides the auditor with the most reliable audit evidence? A) General ledger account balances B) Confirmation of accounts receivable balance received from a customer C) Internal memo explaining the issuance of a credit memo D) Copy of month-end adjusting entries Answer: B Terms: Audit evidence qualities of relevance and reliability Diff: Easy Objective: LO 7-3 AACSB: Analytic skills
2) Which of the following is not a characteristic of the reliability of evidence? A) Effectiveness of client internal controls B) Education of auditor C) Independence of information provider D) Timeliness Answer: B Terms: Characteristic of reliability of evidence Diff: Easy Objective: LO 7-3 AACSB: Reflective thinking skills
3) The auditor must gather sufficient and appropriate evidence during the course of the audit. Sufficient evidence must: A) be well documented and cross-referenced in the audit documents. B) be based on sources that are external to company. C) provide evidence that prove or disprove an audit objective/assertion. D) be persuasive enough to enable the auditor to issue an audit report. Answer: D Terms: Sufficient evidence Diff: Easy Objective: LO 7-3 AACSB: Reflective thinking skills
4) Audit evidence obtained directly by the auditor will not be reliable if: A) the auditor lacks the competence to evaluate the evidence. B) it is provided by the client's attorney. C) the client denies its veracity. D) it is impossible for the auditor to obtain additional corroboratory evidence. Answer: A Terms: Audit evidence obtained directly by auditor Diff: Easy Objective: LO 7-3 AACSB: Reflective thinking skills
5) Appropriateness of evidence is a measure of the: A) quantity of evidence. B) quality of evidence. C) sufficiency of evidence. D) meaning of evidence. Answer: B Terms: Appropriateness of evidence Diff: Easy Objective: LO 7-3 AACSB: Reflective thinking skills
6) Which of the following statements regarding the relevance of evidence is correct? A) To be relevant, evidence must pertain to the audit objective of the evidence. B) To be relevant, evidence must be persuasive. C) To be relevant, evidence must relate to multiple audit objectives. D) To be relevant, evidence must be derived from a system including effective internal controls. Answer: A Terms: Relevance of evidence Diff: Easy Objective: LO 7-3 AACSB: Reflective thinking skills
7) Two determinants of the persuasiveness of evidence are: A) competence and sufficiency. B) relevance and reliability. C) appropriateness and sufficiency. D) independence and effectiveness. Answer: C Terms: Determinants of persuasiveness of evidence Diff: Easy Objective: LO 7-3 AACSB: Reflective thinking skills
8) The two characteristics of the appropriateness of evidence are: A) relevance and timeliness. B) relevance and accuracy. C) relevance and reliability. D) reliability and accuracy. Answer: C Terms: Appropriateness of evidence Diff: Easy Objective: LO 7-3 AACSB: Reflective thinking skills
9) Which of the following forms of evidence would be least persuasive in forming the auditor's opinion about marketable securities and other investments held by the company? A) Responses to auditor's questions by the president and controller regarding the investments account B) Correspondence with a stockbroker regarding the quantity of client's investments held in street name by the broker C) Minutes of the board of directors authorizing the purchase of stock as an investment D) The auditor's count of marketable securities Answer: A Terms: Least persuasive form of evidence Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
10) Which of the following statements is not correct? A) It is possible to vary the sample size from one unit to 100% of the items in the population. B) The decision of how many items to test should not be influenced by the increased costs of performing the additional tests. C) The decision of how many items to test must be made by the auditor for each audit procedure. D) The sample size for any given procedure is likely to vary from audit to audit. Answer: B Terms: Testing of items; Sample size Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
11) For audit evidence to be compelling to the auditor it must be sufficient and appropriate. Which statement below is not correct regarding the appropriateness of audit evidence? A) The more effective the internal control system, the more assurance it provides the auditor about the reliability of financial reporting by the client. B) An auditor's opinion, to be economically useful and profitable to the auditing firm needs to be formed within a reasonable time and based on evidence obtained that assures profits for the auditing firm. C) Evidence obtained from independent sources outside the entity is generally more reliable than evidence secured solely within the entity. D) The independent auditor's direct personal knowledge, obtained through inquiry, observation and inspection, is generally more persuasive than information obtained indirectly. Answer: B Terms: Appropriateness of audit evidence Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
12) Which of the following is a correct statement regarding audit evidence? A) A large sample of evidence provided by an independent party is always considered persuasive evidence. B) A small sample of only one or two pieces of highly appropriate evidence is always considered persuasive evidence. C) The auditor must obtain a sufficient amount of relevant and reliable evidence to form an opinion on the fairness of the financial statements. D) Evidence is usually more reliable for balance sheet accounts when it is obtained within six months of the balance sheet date. Answer: C Terms: Purposes of audit documentation Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
13) Which of the following is the most objective type of evidence? A) A letter written by the client's attorney discussing the likely outcome of outstanding lawsuits B) The physical count of securities and cash C) Inquiries of the credit manager about the collectability of noncurrent accounts receivable D) Observation of cobwebs on some inventory bins Answer: B Terms: Most objective type of evidence Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
14) Which items affect the sufficiency of evidence when choosing a sample? A) Selecting items with a high The randomness of the items likelihood of misstatement selected Yes Yes B) Selecting items with a high likelihood of misstatement No
The randomness of the items selected No
Selecting items with a high likelihood of misstatement Yes
The randomness of the items selected No
Selecting items with a high likelihood of misstatement No
The randomness of the items selected Yes
C)
D)
Answer: C
Terms: Sufficiency of evidence when choosing a sample Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
15) Determine which of the following is most correct regarding the reliability of audit evidence. A) Information that is indirectly obtained from external sources is the most reliable audit evidence. B) Reliability of audit evidence is dependent upon the evidence being subjective. C) Reliability of evidence refers to the amount of evidence obtained. D) If internal controls are effective, evidence obtained is more reliable than when the controls are not effective. Answer: D Terms: Reliability of audit evidence Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
16) Evidence is generally considered appropriate when: A) it has been obtained by random selection. B) there is enough of it to afford a reasonable basis for an opinion on financial statements. C) it is relevant to the audit objective being tested. D) it consists of written statements made by managers of the company under audit. Answer: C Terms: Evidence considered appropriate Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
17) Given the economic and time constraints in which auditors can collect evidence about management assertions about the financial statements, the auditor normally gathers evidence that is: A) irrefutable. B) conclusive. C) persuasive. D) completely convincing. Answer: C Terms: Auditor normally gathers evidence that is Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
18) Which of the following statements is not a correct statement regarding audit evidence? A) Evidence obtained from an independent source outside the client organization is more reliable than that obtained from within. B) Documentary evidence is more reliable when it is received by the auditor indirectly rather than directly. C) Documents that originate outside the company are considered more reliable than those that originate within the client's organization. D) External evidence, such as communications from banks, is generally regarded as more reliable than answers obtained from inquiries of the client. Answer: B Terms: Audit evidence Diff: Challenging Objective: LO 7-3 AACSB: Reflective thinking skills
19) Evidence is usually more persuasive for balance sheet accounts when it is obtained: A) as close to the balance sheet date as possible. B) only from transactions occurring on the balance sheet date. C) from various times throughout the client's year. D) from the time period when transactions in that account were most numerous during the fiscal period. Answer: A Terms: Evidence is more persuasive for balance sheet accounts Diff: Challenging Objective: LO 7-3 AACSB: Reflective thinking skills
20) Which of the following statements is true? A) Evidence must be relevant to all of the audit objectives. B) If evidence is subjective, it cannot be reliable. C) Evidence obtained directly by the auditor may not be reliable if the auditor lacks the qualifications to evaluate the evidence. D) The persuasiveness of evidence can be evaluated after considering its sufficiency. Answer: C Terms: Audit evidence Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
21) Which of the following statements relating to the competence of evidential matter is always true? A) Evidence from outside an enterprise is always reliable. B) Accounting data developed under satisfactory conditions of internal control is not reliable. C) Oral representations made by management are not reliable evidence. D) Evidence must be both reliable and relevant to be considered appropriate. Answer: D Terms: Competence of evidential matter Diff: Challenging Objective: LO 7-3 AACSB: Reflective thinking skills
22) Discuss three of the following influences on the persuasiveness of evidence. 1. Relevance 2. Independence of provider 3. Effectiveness of client's internal controls 4. Auditor's direct knowledge 5. Degree of objectivity 6. Timeliness Answer: 1. Relevance — Evidence must pertain to the audit objective if it is to be persuasive. Relevance must be considered in terms of specific audit objectives as evidence may be relevant to one objective and not another. 2. Independence of provider — Evidence obtained from a source outside the entity is more reliable and persuasive than that obtained from within. 3. Effectiveness of client's internal controls — When a client's internal controls are effective, evidence obtained is more reliable than when they are weak. 4. Auditor's direct knowledge — Evidence obtained directly by the auditor through physical examination, observation, computation and inspection is more competent than information obtained indirectly. 5. Degree of objectivity — Objective evidence is more reliable than evidence that requires considerable judgment to determine whether it is correct. 6. Timeliness — The timeliness of audit evidence can refer either to when it is accumulated or to the period covered by the audit. Evidence is usually more reliable for balance sheet accounts when it is obtained as close to the balance sheet date as possible. Terms: Influences persuasiveness of evidence Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
23) Why is the appropriateness of audit evidence obtained by the auditor important in forming an audit opinion? Describe the qualities information should have to be considered appropriate by the auditor. Answer: Appropriateness is a measure of the quality of evidence. Audit evidence that is considered appropriate contains the characteristics of relevance and reliability. Relevant evidence relates to the assertion being tested. Reliability refers to the degree to which evidence can be believable or worthy of trust. Terms: Appropriateness of audit evidence Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
24) The reliability of evidence refers to the degree to which evidence is considered believable or trustworthy. There are six factors that affect the reliability of audit evidence. One factor is the independence of the provider; i.e., evidence obtained from a source outside the client company is more reliable than that obtained within. Identify and discuss any two of the remaining five factors: Answer: The remaining four factors that affect the reliability of evidence are: • Effectiveness of client's internal control. When a client's internal controls are effective, evidence obtained from the client is more reliable than when controls are weak. • Auditor's direct knowledge. Evidence obtained directly by the auditor is more reliable than information obtained indirectly. • Qualifications of individuals providing the information. Although the source of the information may be independent, the evidence will not be reliable unless the individual providing it is qualified to do so. Also, evidence obtained directly by the auditor many not be reliable if the auditor lacks the qualifications to evaluate the evidence. • Degree of objectivity. Objective evidence is more reliable than evidence that requires considerable judgment to determine whether it is correct. • Timeliness — The timeliness of audit evidence can refer either to when it is accumulated or to the period covered by the audit. Evidence is usually more reliable for balance sheet accounts when it is obtained as close to the balance sheet date as possible. Terms: Reliability of evidence Diff: Challenging Objective: LO 7-3 AACSB: Reflective thinking skills
25) Audit evidence to support an opinion about the fairness of a client's financial statements consists entirely of written information. Answer: FALSE Terms: Audit evidence to support an opinion Diff: Easy Objective: LO 7-3 AACSB: Reflective thinking skills
26) The relevance of audit evidence depends on the audit objective being tested. Answer: TRUE Terms: Relevance of audit evidence Diff: Easy Objective: LO 7-3 AACSB: Reflective thinking skills
27) Inquiries of the client are usually sufficient to provide appropriate evidence to satisfy an audit objective. Answer: FALSE Terms: Inquiries of client; Appropriate evidence Diff: Easy Objective: LO 7-3 AACSB: Reflective thinking skills
28) Objective evidence is more reliable, and hence more persuasive, than subjective evidence. Answer: TRUE Terms: Objective evidence more reliable Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
29) The two most important factors when determining the appropriate sample size in an audit are the auditor's expectation of misstatements and the objectivity of the evidence. Answer: FALSE Terms: Sufficiency of evidence and sample size Diff: Moderate Objective: LO 7-3 AACSB: Reflective thinking skills
Learning Objective 7-4 1) Calculating the gross margin for the current year under audit as a percent of sales and comparing it with previous years is what type of evidence? A) Physical examination B) Analytical procedures C) Observation D) Inquiry Answer: B Terms: Calculate and compare gross margin Diff: Easy Objective: LO 7-4 AACSB: Reflective thinking skills
2) When the auditor develops supporting evidence for amounts posted to account balances with documentary evidence, that process is called: A) inquiry. B) confirmation. C) vouching. D) physical examination. Answer: C Terms: Auditor develops supporting evidence for amounts posted with documentary evidence Diff: Easy Objective: LO 7-4 AACSB: Reflective thinking skills
3) An example of an external document that provides reliable information for the auditor is: A) employees' time reports. B) bank statements. C) purchase order for company purchases. D) carbon copies of checks. Answer: B Terms: External document Diff: Easy Objective: LO 7-4 AACSB: Reflective thinking skills
4) An example of a document the auditor receives from the client, but which was prepared by someone outside the client's organization, is a: A) confirmation. B) sales invoice. C) vendor invoice. D) bank reconciliation. Answer: C Terms: Example of document auditor receives from client but prepared by outside source Diff: Easy Objective: LO 7-4 AACSB: Reflective thinking skills
5) The evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data is the definition of: A) analytical procedures. B) tests of transactions. C) tests of balances. D) auditing. Answer: A Terms: Use of comparisons and relationships to assess whether account balances Diff: Easy Objective: LO 7-4 AACSB: Reflective thinking skills
6) Audit procedures can result in significant, unexpected differences. The auditor should investigate further if: A) Significant differences are not Significant differences are expected but do exist expected but do not exist Yes Yes B) Significant differences are not expected but do exist No
Significant differences are expected but do not exist No
C) Significant differences are not expected but do exist Yes
Significant differences are expected but do not exist No
D) Significant differences are not expected but do exist No
Significant differences are expected but do not exist Yes
Answer: A
Terms: Audit procedures result in significant differences Diff: Easy Objective: LO 7-4
AACSB: Reflective thinking skills
7) When the auditor uses tracing as an audit procedure for tests of transactions she is primarily concerned with which audit objective? A) Occurrence B) Completeness C) Cutoff D) Classification Answer: B Terms: Tracing as an audit procedure concerned with audit objective Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
8) When the auditor uses the audit procedure vouching she is primarily concerned with which of the following audit objectives when testing classes of transactions? A) Occurrence B) Completeness C) Authorization D) Classification Answer: A Terms: Vouching as an audit procedure concerned with audit objective Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
9) When auditors use documentation to support recorded transactions and amounts, the process is usually called: A) tracing. B) confirmations. C) vouching. D) reperformance. Answer: C Terms: Directional testing Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
10) Analytical procedures must be used during which phase(s) of the audit? A) Test of Controls Planning Completion Yes Yes Yes B) Test of Controls No
Planning Yes
Completion Yes
C) Test of Controls Yes
Planning No
Completion No
D) Test of Controls No
Planning No
Completion No
Answer: B
Terms: Analytical procedures use during phases of the audit Diff: Moderate Objective: LO 7-4 AACSB: Analytic skills
11) Auditors may decide to replace tests of details with analytical procedures when possible because the: A) analytical procedures are more reliable. B) analytical procedures are considerably less expensive. C) analytical procedures are more persuasive. D) tests of details are more difficult to interpret. Answer: B Terms: Tests of details of balances; Substantive analytical procedures Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
12) When making decisions about evidence for a given audit, the auditor's goal is to obtain a sufficient amount of timely, reliable evidence that is relevant to the information being verified. In addition, the goal of audit efficiency is to gather and evaluate the information: A) no matter the cost involved in obtaining such evidence. B) even if cost is irrelevant to the auditor, because they bill the client for costs incurred. C) at the lowest possible total cost. D) at the cost suggested in the engagement letter. Answer: C Terms: Goal of audit efficiency Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
13) "Physical examination" is the inspection or count by the auditor of items such as: A) cash, inventory, and payroll timecards. B) cash, inventory, canceled checks, and sales documents. C) cash, inventory, canceled checks, and tangible fixed assets. D) cash, inventory, securities, notes receivable, and tangible fixed assets. Answer: D Terms: Physical examination Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
14) Which of the following statements is most correct regarding the primary purpose of audit procedures? A) To detect all errors or fraudulent activities as well as illegal activities B) To comply with auditing standards promulgated by the PCAOB for publicly held clients C) To gather corroborative audit evidence about management's assertions regarding the client's financial statements D) To determine the amount of errors in the balance sheet accounts in order to adjust the accounts to actual Answer: C Terms: Primary purpose of audit procedures Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
15) Which of the following generally provides the most reliable evidence? A) Confirmations B) Recalculation C) Reperformance D) Observations Answer: A Terms: Audit evidence Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
16) When practical and reasonable, U.S. auditing standards require the confirmation of: A) individual transactions between organizations, such as sales transactions. B) accounts receivable. C) fixed asset additions. D) payroll expenses. Answer: B Terms: Confirmations Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
17) To be considered reliable evidence, confirmations must be controlled by: A) the client's employee responsible for accounts receivable. B) the external auditor. C) the client's internal audit department. D) the client's controller or CFO. Answer: B Terms: Confirmations controlled to be considered reliable evidence Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
18) Indicate whether confirmation of accounts receivable and accounts payable, provided they each are significant accounts, is required or optional: A) Accounts Receivable Accounts Payable Required Required B) Accounts Receivable Required
Accounts Payable Optional
Accounts Receivable Optional
Accounts Payable Required
Accounts Receivable Optional
Accounts Payable Optional
C)
D)
Answer: B Terms: Confirmation of accounts receivable and accounts payable Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
19) The Auditing Standards Board has concluded that analytical procedures are so important that they are required during: A) planning and test of control phases. B) planning and completion phases. C) test of control and completion phases. D) planning, test of control, and completion phases. Answer: B Terms: Analytical procedures required Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
20) A benefit obtained from using industry averages is that it provides a(n): A) benchmark to compare the company's results. B) indication where errors exist in the statements. C) benchmark to be used in evaluating a client's budgets. D) comparison of "what is" with "what should be." Answer: A Terms: Comparing client data with industry averages Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
21) Physical examination: A) is a direct means of verifying that an asset really exists. B) is sufficient evidence to verify that the existing assets are owned by the client. C) can be used for both tangible assets and documents. D) is not generally a reliable type of audit evidence. Answer: A Terms: Audit evidence Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
22) Which of the following is not a correct combination of terms and related type of audit evidence? A) Inquire — inquiries of client B) Count — physical examination C) Recompute — documentation D) Read — documentation Answer: C Terms: Combination of terms and related audit evidence Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
23) Which of the following is a correct statement regarding confirmations? A) Confirmations can be in oral or written form. B) Electronic confirmations are not acceptable under generally accepted auditing standards. C) Confirmations are generally used in the audit of fixed asset additions. D) Auditors consider alternative evidence available when determining if confirmations should be used. Answer: D Terms: Confirmations Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
24) An important benefit of industry comparisons is as: A) an aid to understanding the client's business. B) an indicator of errors. C) an indicator of fraud. D) a least-cost indicator for audit procedures. Answer: A Terms: Benefit of industry comparisons Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
25) The auditor is concerned that a client is failing to bill customers for shipments. An audit procedure that would gather relevant evidence would be to: A) select a sample of duplicate sales invoices and trace each to related shipping documents. B) trace a sample of shipping documents to related duplicate sales invoices. C) trace a sample of Sales Journal entries to the Accounts Receivable subsidiary ledger. D) compare the total of the Schedule of Accounts Receivable with the balance of the Accounts Receivable account in the general ledger. Answer: B Terms: Audit procedure to gather relevant evidence that client fails to bill Diff: Challenging Objective: LO 7-4 AACSB: Analytic skills
26) ________ is the auditor's examination of the client's documents and records to substantiate that the information is included in the financial statements. A) Inspection B) Recalculation C) Observation D) Verification Answer: A Terms: Audit evidence Diff: Moderate Objective: LO 7-4 AACSB: Analytic skills
27) Which of the following statements regarding the appropriateness of evidence is correct? A) The effectiveness of a client's internal control has no influence on the reliability of most types of evidence. B) Analytical procedures will be reliable evidence even if the client's internal controls are weak. C) One type of evidence is generally sufficient by itself to provide appropriate evidence. D) The objectivity of evidence obtained through inspection is high. Answer: D Terms: Audit evidence Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
28) You are auditing the company's purchasing process for goods and services. You are primarily concerned with the company not recording all purchase transactions. Which audit procedure below would be the most effective audit procedure in this case? A) Vouching from the accounts payable account to the vendor invoices B) Tracing vendor invoices to recorded amounts in the accounts payable account C) Confirmation accounts payable recorded amounts D) Reconciling the accounts payable subsidiary ledger to the accounts payable account Answer: B Terms: Audit procedure for recording all purchase transactions Diff: Challenging Objective: LO 7-4 AACSB: Analytic skills
29) Which of the following discoveries through the use of analytical procedures would most likely indicate a relatively high risk of financial failure? A) A decline in gross margin percentages B) An increase in the balance in fixed assets C) An increase in the ratio of allowance for uncollectible accounts to gross accounts receivable, while at the same time accounts receivable turnover also decreased D) A higher than normal ratio of long-term debt to net worth as well as a lower than average ratio of profits to total assets Answer: D Terms: Analytical procedures Diff: Challenging Objective: LO 7-4 AACSB: Analytic skills
30) Which of the following statements is correct regarding the costs involved in obtaining evidence? A) Physical examination is usually the Cost of obtaining evidence may be a least expensive type of audit factor in deciding whether to evidence obtain that evidence Yes Yes B) Physical examination is usually the least expensive type of audit evidence No
Cost of obtaining evidence may be a factor in deciding whether to obtain that evidence No
Physical examination is usually the least expensive type of audit evidence Yes
Cost of obtaining evidence may be a factor in deciding whether to obtain that evidence No
D) Physical examination is usually the least expensive type of audit evidence No
Cost of obtaining evidence may be a factor in deciding whether to obtain that evidence Yes
C)
Answer: D
Terms: Costs in obtaining evidence Diff: Challenging Objective: LO 7-4 AACSB: Reflective thinking skills
31) When using analytical procedures: A) unusual fluctuations occur when significant unexpected differences between the current year's data and other data used in comparisons are found. B) and no unusual fluctuations are noted, the possibility of material misstatement is increased. C) "attention directing" indicates an area where fraud has occurred. D) and no unusual fluctuations are noted, tests of details of balances can be eliminated, Answer: A Terms: Analytical procedures Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
32) One purpose of performing analytical procedures in the planning phase of an audit is to assess the client's financial condition. Explain how the assessment of a client's financial condition can affect the auditor's decisions concerning evidence accumulation in later phases of the audit. Answer: Auditors must obtain knowledge about a client's industry and business as a part of planning an audit. By conducting analytical procedures in which the current year's unaudited information is compared with prior years' audited information or industry data, changes are highlighted. These changes can represent important trends or specific events, all of which will influence audit planning. The use of analytical procedures is often a useful indicator for determining whether the client company has financial problems and if substantial doubt exists about the entity's ability to continue as a going concern. Certain analytical procedures can help the auditor assess the likelihood of failure. The analytical procedures could also indicate the presence of possible misstatements in the financial statements if significant unexpected fluctuations occur. These items may warrant increased audit procedures, whereas when the analytical procedures reveal no unusual fluctuations, the possibility of material misstatement is minimized and it is possible to perform fewer detailed tests on related accounts or to eliminate certain audit procedures, reduce sample sizes, or to move the procedures farther away from the balance sheet date. Terms: Analytical procedures Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
33) There are four important purposes of analytical procedures. Identify three of these four purposes and, for each purpose, give a specific example of an analytical procedure that an auditor might perform. Answer: Four important purposes of analytical procedures are: • To help the auditor understand the client's industry and business, the auditor might analyze recent trends in the client's gross margin percentages to assess the effects of competition in the industry. • To aid in the assessment of the client's ability to continue as a going concern, the auditor might analyze several of the client's key ratios including the ratio of long-term debt to net worth, the ratio of profits to total assets, and the current ratio. • To indicate the presence of possible misstatements in the financial statements, the auditor might compare the current year's unaudited account balances with the previous year's audited balances. • To reduce the extent of detailed tests, the auditor might perform a simple analytical procedure such as multiplying the client's monthly rent times 12 as a test of the client's rent expense account. If the product agrees with the balance in rent expense, no additional testing of the account may be necessary. Terms: Purposes of analytical procedures Diff: Challenging Objective: LO 7-4 AACSB: Reflective thinking skills
34) Define the following terms commonly used in audit procedures: 1. Examine 2. Scan 3. Compute 4. Foot 5. Compare 6. Count 7. Vouch Answer: 1. Examine — A reasonably detailed study of a specific document or record to determine specific facts about it. It is the inspection or count by the auditor of a tangible asset. 2. Scan — A less detailed examination of a document or record to determine whether there is something unusual warranting further investigation. 3. Compute — A calculation done by the auditor independent of the client. 4. Foot — Addition of a column of numbers to determine whether the total is the same as the client's. 5. Compare — A comparison of information in two different locations. 6. Count — A determination of assets on hand at a given time. This is associated with evidence defined as physical examination. 7. Vouch — The use of documents to verify recorded transactions or amounts. Terms: Audit evidence and audit procedures Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
35) Below are 12 audit procedures. Classify each procedure according to the following types of audit evidence: (1) physical examination, (2) confirmation, (3) documentation, (4) observation, (5) inquiry of the client, (6) reperformance, and (7) analytical procedure. Type of Evidence
Audit Procedures 1. Watch client employees count inventory to determine whether company procedures are being followed. 2. Count inventory items and record the amount in the audit files. 3. Trace postings from the sales journal to the general ledger accounts. 4. Calculate the ratio of cost of goods sold to sales as a test of overall reasonableness of gross margin relative to the preceding year. 5. Obtain information about the client's internal controls by asking questions of client personnel. 6. Trace column totals from the cash disbursements journal to the general ledger. 7. Examine a piece of equipment to make sure a recent purchase of equipment was actually received and is in operation. 8. Review the total of repairs and maintenance for each month to determine whether any month's total was unusually large. 9. Compare vendor names and amounts on purchase invoices with entries in the purchases journal. 10. Foot entries in the sales journal to determine whether they were correctly totaled by the client. 11. Make a surprise count of petty cash to verify that the amount of the petty cash fund is intact. 12. Obtain a written statement from the client's bank stating the client's year-end balance on deposit.
Answer: 1. Observation 2. Physical examination 3. Reperformance 4. Analytical procedure 5. Inquiry of the client 6. Reperformance 7. Physical examination 8. Analytical procedure 9. Documentation 10. Reperformance 11. Physical examination 12. Confirmation
Terms: Audit evidence and related evidence Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
36) Match nine of the terms (a-k) with the definitions provided below (1-9): a. b. c. d. e. f. g. h. i. j. k.
Foot Compute Scan Inquire Count Trace Reperform Read Examine Observe Compare
________ 1. A calculation done by the auditor independent of the client. ________ 2. Addition of a column of numbers to determine if the total is the same as the client's. ________ 3. A comparison of information in two different locations. ________ 4. A use of the senses to assess certain activities. ________ 5. Following details of transactions from original documents to journals. ________ 6. A less detailed examination of a document or record to determine if there is something unusual warranting further investigation. ________ 7. Obtaining information from the client in response to specific questions. ________ 8. A determination of assets on hand at a given time. ________ 9. An examination of written information to determine facts pertinent to the audit. Answer: 1. b 2. a 3. k 4. j 5. f 6. c 7. d 8. e 9. h Terms: Audit procedures; Foot; Compute; Scan; Inquire; Count; Trace; Read; Observe; Compare Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
37) Match five of the terms (a-h) with the definitions provided below (1-5): a. b. c. d. e. f. g. h.
Audit documentation Audit procedures Audit objectives Analytical procedures Budgets Reliability of evidence Sufficiency of evidence Persuasiveness of evidence
________ 1. Use of comparisons and relationships to assess the reasonableness of account balances. ________ 2. Detailed instructions for the collection of a type of audit evidence. ________ 3. The degree to which evidence can be considered believable or trustworthy. ________ 4. Contains all the information that the auditor considers necessary to conduct an adequate audit and to provide support for the audit report. ________ 5. This is determined by the amount of evidence obtained. Answer: 1. d 2. b 3. f 4. a 5. g
Terms: Analytical procedures; Audit procedures; Reliability of evidence; Sufficiency of evidence Diff: Moderate Objective: LO 7-2, LO 7-3, and LO 7-4 AACSB: Reflective thinking skills
38) Below are 10 documents typically examined during an audit. Classify each document as either internal or external. Type of Document Documents 1. Canceled checks for payments of accounts payable. 2. Payroll time cards. 3. Duplicate sales invoices. 4. Vendors' invoices. 5. Bank statements. 6. Minutes of the board of directors' meetings. 7. Signed lease agreements. 8. Notes receivable. 9. Subsidiary accounts receivable records. 10. Remittance advices. Answer: 1. External 2. Internal 3. Internal 4. External 5. External
6. Internal 7. External 8. External 9. Internal 10. External
Terms: Internal and external evidence Diff: Moderate Objective: LO 7-4 AACSB: Analytic skills
39) Distinguish between internal documentation and external documentation as types of audit evidence. Give two examples of each. Which type is considered more reliable? Answer: Internal documentation involves the auditor's examination of documents that have been prepared and used within the client's organization and are retained without ever going to an outside party. Examples would include duplicate sales invoices, employees' time reports, and inventory receiving reports. External documentation involves the auditor's examination of documents that have been in the hands of someone outside the client's organization. Examples include vendors' invoices, cancelled checks, cancelled notes payable, and insurance policies. External documents are regarded as more reliable evidence than internal documents. Terms: Internal and external documentation; Reliability of evidence Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
40) Confirmations are among the most expensive type of evidence to obtain. Answer: TRUE Terms: Confirmations; Cost of evidence Diff: Easy Objective: LO 7-4 AACSB: Reflective thinking skills
41) Whenever practical and reasonable, the confirmation of accounts receivable is required of CPAs. Answer: TRUE Terms: Confirmations of accounts receivable required of CPAs Diff: Easy Objective: LO 7-4 AACSB: Reflective thinking skills
42) Inquiries of clients and recalculations normally have a low cost associated with them. Answer: TRUE Terms: Inquiries of clients and reperformance have low cost Diff: Easy Objective: LO 7-4 AACSB: Reflective thinking skills
43) When analytical procedures reveal unusual fluctuations in an account balance, the auditor will probably perform fewer tests of details for that account and increase the tests of controls related to the account. Answer: FALSE Terms: Analytical procedures reveal unusual fluctuations Diff: Easy Objective: LO 7-4 AACSB: Reflective thinking skills
44) The type of audit evidence known as inquiry requires the auditor to obtain oral or written information from the client in response to questions. Answer: TRUE Terms: Audit evidence; Inquiry Diff: Easy Objective: LO 7-4 AACSB: Reflective thinking skills
45) Auditor judgment is the primary determinant in determining the amount of evidence gathered. Answer: TRUE Terms: Auditor judgment; Evidence Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
46) Analytical procedures must be used in the planning and completion phases of the audit. Answer: TRUE Terms: Analytical procedures used in planning and completion phases of audit Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
47) Confirmations are ordinarily used to verify account balances, but may be used to verify transactions. Answer: TRUE Terms: Confirmations to verify balances and transactions Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
48) Accounts receivable confirmations must be controlled by the client from the time they are prepared until the time they are returned to the auditor. Answer: FALSE Terms: Confirmations control Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
49) Cost is never an adequate justification for omitting a necessary procedure or not gathering an adequate sample size. Answer: TRUE Terms: Cost of audit procedures; Sample size Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
50) When the auditor foots the journals and the subsidiary ledgers, it is considered reperformance. Answer: FALSE Terms: Audit evidence Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
51) Inspection consists of looking at a process or procedure being performed by others. Answer: FALSE Terms: Audit evidence Diff: Moderate Objective: LO 7-4 AACSB: Reflective thinking skills
52) A canceled check written by the client, made payable to a local supplier and drawn on the client's bank account is one type of internal document. Answer: FALSE Terms: Internal document Diff: Easy Objective: LO 7-4 AACSB: Reflective thinking skills
Learning Objective 7-5 1) Which of the following best describes one of the primary objectives of audit documentation? A) Defend against claims of a deficient audit. B) Provide a basis for reviewing the work of subordinates. C) Provide reasonable assurance that the audit was conducted in accordance with auditing standards. D) Provide additional support of recorded amounts to the client. Answer: C Terms: Primary objective of audit documentation Diff: Moderate Objective: LO 7-5 AACSB: Reflective thinking skills
2) Audit documents: A) are kept by the client for easy reference for their accounting staff. B) should be considered as a substitute for the clients accounting records. C) are designed to facilitate the review and supervision of the work performed by the audit team by a reviewing partner. D) prepared during the engagement are the property of the client once the audit bill is paid. Answer: C Terms: Audit documentation for audit Diff: Moderate Objective: LO 7-5 AACSB: Reflective thinking skills
3) Audit documentation: A) should identify the items tested when the audit procedures involve sampling of transactions or balances. B) does not aid in the preparation of the tax return since accounting and tax rules differ. C) is another term for the audit program. D) should not be given to anyone outside the audit firm, even if a subpoena has been issued. Answer: A Terms: Audit documentation for audit Diff: Moderate Objective: LO 7-5 AACSB: Reflective thinking skills
4) Due professional care, the third general standard, is concerned with what is done by the independent auditor and how well it is done. For example, due care in the matter of audit documentation requires that audit documentation of the evidence gathered by the auditor meets which of the following criteria? A) Workpapers are prepared in sufficient detail so that they can be given to the client for future reference. B) The content is sufficient to provide support for the auditor's opinion, including the auditor's representation as to compliance with auditing standards. C) Audit evidence is principally gathered to determine if the client's financial statements, as prepared by management, can be relied upon to make managerial decisions about the firm. D) Audit evidence as displayed in the workpapers is primarily performed to protect the auditing firm in the case of a lawsuit by investors. Answer: B Terms: Audit evidence gathered by auditors meets which criteria Diff: Moderate Objective: LO 7-5 AACSB: Reflective thinking skills
5) Audit documentation is the joint property of the auditor and the audit client. Answer: FALSE Terms: Audit documentation Diff: Moderate Objective: LO 7-5 AACSB: Reflective thinking skills
6) Auditing standards require that records for audits of private companies be retained for a minimum of seven years. Answer: FALSE Terms: Audit documentation provided with permission of client Diff: Moderate Objective: LO 7-5 AACSB: Reflective thinking skills
7) The SEC requires the auditors of public companies to retain e-mail correspondence related to the audit. Answer: TRUE Terms: Adjusting entries and reclassification entries Diff: Moderate Objective: LO 7-5 AACSB: Reflective thinking skills
Learning Objective 7-6 1) When preparing and organizing audit files: A) The rules established by the SEC and PCAOB must be followed. B) A lead schedule contains the detailed accounts from the general ledger making up the line item on the trial balance. C) A working trial balance is considered part of the permanent file. D) The audit program is not part of the audit files. Answer: B Terms: Audit files Diff: Challenging Objective: LO 7-6 AACSB: Reflective thinking skills
2) Audit documentation should possess certain characteristics. Which of the following is true regarding those characteristics? A) Audit documentation should be indexed Audit documentation should be and cross-referenced organized to benefit the client's staff Yes Yes B) Audit documentation should be indexed and cross-referenced No
Audit documentation should be organized to benefit the client's staff No
C) Audit documentation should be indexed and cross-referenced Yes
Audit documentation should be organized to benefit the client's staff No
D) Audit documentation should be indexed and cross-referenced No
Audit documentation should be organized to benefit the client's staff Yes
Answer: C
Terms: Audit documentation characteristics Diff: Challenging Objective: LO 7-6 AACSB: Reflective thinking skills
3) The permanent audit file would usually include the following: A) client's working trial balance B) summary of the risk assessment procedures performed C) organizational chart of the company's employees D) summary of the auditors test of controls for the current years audit Answer: C Terms: Permanent file Diff: Challenging Objective: LO 7-6 AACSB: Reflective thinking skills
4) The permanent files included as part of audit documentation do not normally include: A) a copy of the current and prior years' audit programs. B) copies of articles of incorporation, bylaws and contracts. C) information related to the understanding of internal control. D) results of analytical procedures from prior years. Answer: A Terms: Permanent files as audit documentation Diff: Moderate Objective: LO 7-6 AACSB: Reflective thinking skills
5) When determining sufficient and appropriate audit evidence in order to form an opinion on the client's financial statements the auditor compiles audit documentation to support the opinion. The largest portion of audit documentation will include detailed supporting schedules prepared by the client or the auditor in support of specific accounts on the financial statements. The major types of supporting schedules include analysis schedules and tests of reasonableness. Discuss those two schedules and give an example for each schedule. Answer: Analysis: designed to show the activity in a general ledger account during the entire period under audit, tying together the beginning and ending balances. For example, marketable securities, property, plant and equipment, long-term debt, equity accounts. Auditors are focusing on the significance of the activity in the account during the year. Tests of Reasonableness: Contains information that enables the auditor to evaluate whether the client's balance appears to contain a misstatement. Example, depreciation expense, allowance for uncollectibles, income tax provision. Tests are primarily analytical procedure tests in which the auditor forms an expectation of the balance that appears in the working trial balance. Terms: Major types of supporting schedules; Analysis and tests of reasonableness Diff: Moderate Objective: LO 7-6 AACSB: Reflective thinking skills
6) The basis for preparing financial statements for companies is the general ledger. As soon as possible the auditor obtains the general ledger accounts of the client and prepares a working trial balance. Discuss the audit documentation in the current file that relates to the working trial balance. Include a description of lead and support schedules in your answer. Answer: Lead Schedules–each line item on the working trial balance is supported by a lead schedule, containing the detailed accounts from the general ledger making up the line item in the working trial balance. Support Schedules–each detailed account of the lead schedule is supported by proper schedules supporting the audit work performed and the conclusions reached by the auditors. Terms: Audit documentation in current file; Working trial balance; Lead schedules and support schedules Diff: Moderate Objective: LO 7-6 AACSB: Reflective thinking skills
7) Reclassification entries are made in the statements to present accounting information properly, even when the general ledger balances are correct. Answer: TRUE Terms: Adjusting entries and reclassification entries Diff: Moderate Objective: LO 7-6 AACSB: Reflective thinking skills
8) An example of a supporting schedule is a reconciliation of amounts, which consists of the details that make up a year-end balance. Answer: FALSE Terms: Audit files Diff: Moderate Objective: LO 7-6 AACSB: Reflective thinking skills
Learning Objective 7-7 1) Audit evidence is often available only in electronic form, and auditors must evaluate how this affects their ability to gather sufficient, appropriate evidence. Answer: TRUE Terms: Technology and audit evidence Diff: Moderate Objective: LO 7-7 AACSB: Reflective thinking skills
2) An auditor can use engagement management software to facilitate tracking audit progress. Answer: TRUE Terms: Technology and audit evidence Diff: Moderate Objective: LO 7-7 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e Chapter 8 Audit Planning and Analytical Procedures
Learning Objective 8-1 1) A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued is the: A) inherent risk. B) acceptable audit risk. C) statistical risk. D) financial risk. Answer: B
Terms: Measure of how willing auditor is to accept that the financial statements may be materially misstated after audit is completed Diff: Easy Objective: LO 8-1 AACSB: Reflective thinking skills
2) A measure of the auditor's assessment of the likelihood that there are material misstatements in an account before considering the effectiveness of the client's internal control is called: A) control risk. B) acceptable audit risk. C) statistical risk. D) inherent risk. Answer: D
Terms: A measure of auditor's assessment of likelihood that there are material misstatements in an account before considering internal control Diff: Easy Objective: LO 8-1 AACSB: Reflective thinking skills
3) When inherent risk is high, there will need to be: A) A lower assessment of audit risk More evidence accumulated by the auditor Yes Yes B) A lower assessment of audit risk No
More evidence accumulated by the auditor No
A lower assessment of audit risk Yes
More evidence accumulated by the auditor No
A lower assessment of audit risk No
More evidence accumulated by the auditor Yes
C)
D)
Answer: D
Terms: Inherent risk is high Diff: Moderate Objective: LO 8-1 AACSB: Reflective thinking skills
4) In what order should the following steps occur? A. Assess client business risk B. Understand the client's business and industry C. Perform preliminary analytical procedures D. Assess acceptable audit risk A) D, B, C, A B) B, A, C, D C) B, D, A, C D) D, C, B, A Answer: B Terms: Steps in planning an audit Diff: Moderate Objective: LO 8-1 AACSB: Reflective thinking skills
5) The auditor uses knowledge gained from the understanding of the client's business and industry to assess: A) client business risk. B) control risk. C) inherent risk. D) audit risk. Answer: A Terms: First standard of fieldwork; Proper planning Diff: Challenging Objective: LO 8-1 AACSB: Analytic skills
6) There are three main reasons why an auditor should properly plan audit engagements. Discuss each of these reasons. Answer: Three reasons why an auditor should properly plan audit engagements are: • To enable the auditor to obtain sufficient competent evidence for the circumstances. This is essential for minimizing legal liability and maintaining a good profession reputation. • To help keep audit costs reasonable. Given the competitive auditing environment, keeping costs reasonable helps the firm obtain and retain clients. • To avoid misunderstandings with the client. This is important for good client relations. Terms: Reasons auditor should properly plan audit engagement Diff: Moderate Objective: LO 8-1 AACSB: Reflective thinking skills
7) When an auditor decides there is higher inherent risk for an account, one potential effect is that more audit evidence will be required for that account. Answer: TRUE Terms: Inherent risk Diff: Easy Objective: LO 8-1 AACSB: Reflective thinking skills
8) As acceptable audit risk is decreased, the likely cost of conducting an audit increases. Answer: TRUE Terms: Acceptable audit risk Diff: Easy Objective: LO 8-1 AACSB: Reflective thinking skills
9) Obtaining sufficient appropriate evidence is essential if the CPA firm is to minimize legal liability. Answer: TRUE Terms: Acceptable audit risk Diff: Moderate Objective: LO 8-1 AACSB: Reflective thinking skills
10) A 100 % audit risk is complete certainty. Answer: FALSE Terms: Acceptable audit risk Diff: Moderate Objective: LO 8-1 AACSB: Reflective thinking skills
Learning Objective 8-2 1) One of the purposes of an engagement letter is to avoid misunderstandings with the client. This is important for: A) Facilitating high-quality work at a Good client relations reasonable cost Yes Yes B) Good client relations No
Facilitating high-quality work at a reasonable cost No
Good client relations Yes
Facilitating high-quality work at a reasonable cost No
Good client relations No
Facilitating high-quality work at a reasonable cost Yes
C)
D)
Answer: A
Terms: Engagement letter Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
2) The auditor is likely to accumulate more evidence when the audit is for a company: A) Which has large amounts of debt Which is to be sold in the near future Yes Yes B) Which has large amounts of debt No
Which is to be sold in the near future No
Which has large amounts of debt Yes
Which is to be sold in the near future No
Which has large amounts of debt No
Which is to be sold in the near future Yes
C)
D)
Answer: A
Terms: Auditors accumulate more evidence when audit is for company Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
3) Initial audit planning involves four matters. Which of the following is not one of these? A) Develop an overall audit strategy. B) Request that bank balances be confirmed. C) Schedule engagement staff and audit specialists. D) Identify the client's reason for the audit. Answer: B Terms: Initial audit planning Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
4) Smith, CPA has requested permission to communicate with the predecessor auditor in order to review certain workpapers for high risk accounts for a new audit client. The new audit client's refusal to allow this communication to occur would impact Rodgers decision concerning: A) the auditor's ability to design audit tests. B) possible scope exception due to lack of access. C) the desirability of accepting the prospective engagement. D) violation of the GAAP rules concerning consistency and comparability of financial information. Answer: C Terms: New audit clients refusal to allow communication between predecessor and successor auditors Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
5) A successor auditor may perform which of the following for a new audit client? A) Speak to local attorneys, banks and other Speak to the predecessor auditors about businesses regarding the company's reputation disagreements they had with management Yes Yes B) Speak to local attorneys, banks and other businesses regarding the company's reputation No
Speak to the predecessor auditors about disagreements they had with management No
C) Speak to local attorneys, banks and other businesses regarding the company's reputation Yes
Speak to the predecessor auditors about disagreements they had with management No
D) Speak to local attorneys, banks and other businesses regarding the company's reputation No
Speak to the predecessor auditors about disagreements they had with management Yes
Answer: A
Terms: Successor auditor may perform communication for new audit client Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
6) When dealing with audit risk: A) audit risk should not be a factor when determining if a new client should be accepted. B) audits with a low acceptable audit risk generally result in lower audit fees. C) if management of a company has a reputation of integrity, but is also known to take aggressive financial risks, the auditor should not accept the company as a new client. D) if the auditor concludes that acceptable audit risk is low, but the client is still acceptable, the auditor may still accept the engagement but increase the audit fee. Answer: D Terms: Lower acceptable audit risk Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
7) A written understanding detailing what the auditors will do in determining if the financial statements are fair representations of the company's financial statements and what the auditor expects from the client in performing an audit will normally be expressed in the: A) management letter requested by the auditor. B) engagement letter. C) Audit Plan. D) Audit Strategy for the client. Answer: B Terms: Written understanding detailing what auditor will do and what auditor expects from client in performing audit Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
8) If an auditor is requested to perform nonaudit services for a public company audit client, who is responsible for agreeing to those services with the audit firm? A) The client's management B) The client's chief executive officer C) The client's chief financial officer D) The client's audit committee Answer: D Terms: Responsibility for agreeing nonaudit services for a public company audit client Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills Topic: SOX
9) Which of the following statements is true regarding communications between predecessor and successor auditors? A) The burden of initiating the communication rests with the predecessor. B) The predecessor's response can be limited to stating that no information will be provided. C) The predecessor should communicate with the successor only if the client is public. D) The predecessor auditor of a public company does not need permission from the client before communicating with the successor auditor. Answer: B Terms: Communications between predecessor and successor auditors Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
10) The purpose of an engagement letter is to: A) document the CPA firm's responsibility to external users of the audited financial statements. B) document the terms of the engagement. C) notify the audit staff of an upcoming engagement so that personnel scheduling can be facilitated. D) emphasize management's responsibility for approving the audit program. Answer: B Terms: Purpose of engagement letter Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
11) Written communication that the auditor will provide reasonable assurance for the detection of fraud
is found in: A) engagement letter. B) representation letter. C) responsibility letter. D) client letter. Answer: A
Terms: Written communication that auditor will provide reasonable assurance Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
12) Which of the following normally signs the engagement letter for an audit of a private company? A) Management B) Board of directors representative C) Audit committee representative D) Corporate treasurer Answer: A Terms: Normally signs engagement letter for audit of private company Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
13) The two major factors affecting acceptable audit risk are: A) inherent risk and the intended uses of the financial statements. B) control risk and the intended uses of the financial statements. C) the likely statement users and the intended uses of the statements. D) the audit firm and the intended uses of the statements Answer: C Terms: Audit risk Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
14) An engagement letter sent to a publicly held audit client usually would not include a: A) reference to the auditor's responsibility for the detection of errors or irregularities. B) estimation of the time to be spent on the audit work by audit staff and management. C) statement that management advisory services would be made available upon request. D) reference to management's responsibility for the financial statements. Answer: C Terms: Engagement letter sent to publicly held client Diff: Challenging Objective: LO 8-2 AACSB: Reflective thinking skills
15) The preliminary audit strategy: A) is set before the auditor understands the client's reasons for the audit. B) guides the development of the audit plan. C) is determined after the engagement staffing is set. D) is the detailed steps to be followed for the substantive audit tests. Answer: B Terms: Audit strategy Diff: Moderate Objective: LO 8-2 AACSB: Analytic skills
16) The purpose of the requirement in having communication between the predecessor and successor auditors is to: A) allow the predecessor to disclose information which would otherwise be confidential. B) help the successor auditor to evaluate whether to accept the engagement. C) help the client by facilitating the change of auditors. D) ensure the predecessor collects all unpaid fees prior to a change in auditor. Answer: B Terms: Purpose of having communication between predecessor and successor audit Diff: Challenging Objective: LO 8-2 AACSB: Reflective thinking skills
17) The predecessor auditor is required to respond to the request of the successor auditor for information, but the response can be limited to stating that no information will be provided when: A) the predecessor auditor has poor relations with the successor auditor. B) the client is dissatisfied with the predecessor's work. C) there are actual or potential legal problems between the client and the predecessor. D) the predecessor believes that the client lacks integrity. Answer: C Terms: Predecessor auditor respond to request of successor auditor for information Diff: Challenging Objective: LO 8-2 AACSB: Reflective thinking skills
18) Which of the following best expresses the understanding of the terms of the engagement that exist between the client and the CPA firm? A) Management asserts there are no errors, material or immaterial, in the general ledger. B) Auditors assert that the primary audit goal is audit efficiency. C) Auditors assert that their primary responsibility is to plan and perform the audit in order to provide reasonable assurance as to the detection of material misstatement due to error or fraud. D) Management asserts that they will provide the auditor with a risk assessment as to material misstatements due to errors or fraud in the company's financial statements. Answer: C Terms: Understand responsibilities of the auditor and company for the audit Diff: Challenging Objective: LO 8-2 AACSB: Reflective thinking skills
19) When selecting staff for the audit engagement: A) only staff members who are CPAs should be assigned to the audit. B) only managers and above need to have appropriate competence and capabilities to perform the audit. C) continuity of staff members from year to year should not be a factor. D) staff assigned to the audit must be knowledgeable about the client's industry. Answer: D Terms: Selection of audit staff for engagement Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
20) An auditor who accepts an audit engagement and does not possess the industry expertise of the business entity should: A) engage financial experts familiar with the nature of the business entity. B) obtain a knowledge of matters that relate to the nature of the entity's business. C) refer a substantial portion of the audit to another CPA who will act as the principal auditor. D) first inform management that an unqualified opinion cannot be issued. Answer: B Terms: Auditor accepts audit engagement and does not possess industry expertise Diff: Challenging Objective: LO 8-2 AACSB: Reflective thinking skills
21) Which is usually included in an engagement letter? A) Estimate of hours required to Dollar estimate of fees to be billed to complete audit the client Yes Yes B) Estimate of hours required to complete audit No
Dollar estimate of fees to be billed to the client No
Estimate of hours required to complete audit Yes
Dollar estimate of fees to be billed to the client No
Estimate of hours required to complete audit No
Dollar estimate of fees to be billed to the client Yes
C)
D)
Answer: D Terms: Engagement letter Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
22) Which is usually included in an engagement letter? A) A reference to standards acceptable in the United States of America A reference to GAAS Yes Yes B) A reference to standards acceptable in the United States of America No
A reference to GAAS No
C) A reference to standards acceptable in the United States of America Yes
A reference to GAAS No
D) A reference to standards acceptable in the United States of America No Answer: A
Terms: Engagement letter Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
A reference to GAAS Yes
23) Which is usually included in an engagement letter? A) The financial statements are the responsibility of the Ratios to be used by the auditor in the company's management planning phase Yes Yes B) The financial statements are the responsibility of the company's management No
Ratios to be used by the auditor in the planning phase No
The financial statements are the responsibility of the company's management Yes
Ratios to be used by the auditor in the planning phase No
The financial statements are the responsibility of the company's management No
Ratios to be used by the auditor in the planning phase Yes
C)
D)
Answer: C
Terms: Engagement letter Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
24) When may the auditor refer to a specialist in the audit report? A) Only if the specialist's report Only if the specialist assisted in the results in a modification of the audit audit of an account material to the opinion financial statements Yes Yes B) Only if the specialist's report results in a modification of the audit opinion No
Only if the specialist assisted in the audit of an account material to the financial statements No
C) Only if the specialist's report results in a modification of the audit opinion Yes
Only if the specialist assisted in the audit of an account material to the financial statements No
D) Only if the specialist's report results in a modification of the audit opinion No Answer: C
Only if the specialist assisted in the audit of an account material to the financial statements Yes
Terms: Auditors refer to specialist in audit report Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
25) Which is usually included in the engagement letter? A) The projected type of opinion on the financials Name(s) of the client personnel responsible for statement to be audited supplying the auditor with information Yes Yes B) The projected type of opinion on the financials Name(s) of the client personnel responsible for statement to be audited supplying the auditor with information No No C) The projected type of opinion on the financials Name(s) of the client personnel responsible for statement to be audited supplying the auditor with information Yes No D) The projected type of opinion on the financials Name(s) of the client personnel responsible for statement to be audited supplying the auditor with information No Yes Answer: B
Terms: Engagement letter Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
26) Which is usually included in the engagement letter? A) List of audit procedures to be used in inventory observation The auditors' assessment of Audit Risk Yes Yes B) List of audit procedures to be used in inventory observation No
The auditors' assessment of Audit Risk No
List of audit procedures to be used in inventory observation Yes
The auditors' assessment of Audit Risk No
List of audit procedures to be used in inventory observation No
The auditors' assessment of Audit Risk Yes
C)
D)
Answer: B
Terms: Engagement letter Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
27) Discuss the factors an auditor should consider before accepting a company as an audit client. Answer: The auditor should investigate and consider the prospective client's standing in the business community, financial stability, management's integrity, and relations with its bankers, attorneys, and previous CPA firm. The auditor should also determine whether he or she possesses the required competence and independence to do the audit. Terms: Factors to consider before accepting audit client Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
28) Discuss the primary purpose of an audit engagement letter. Is an engagement letter required? Answer: The purpose of an audit engagement letter is to establish a clear understanding between the auditor and the client regarding the terms of the engagement. An engagement is required for both public and private company audits. Terms: Engagement letter Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
29) Discuss the essential activities involved in the initial planning of an audit. Answer: There are four essential activities involved in the initial planning of an audit. These are: 1. Client acceptance or continuation. In the case of a new client, the auditor must determine whether the client is one with which they wish to be associated with. In the case of a continuing client, an auditor must determine whether continuing the relationship is appropriate and in the firm's best interest. 2. The auditor should identify why the client wants or needs an audit. The auditor should determine the reason for the audit as soon as practical. The remainder of the planning activities may be impacted by the client's reason for requesting the audit. 3. Obtain an understanding with the client about the terms of the engagement. An understanding with the client should be obtained to avoid misunderstandings. Auditors are required to obtain an understanding with their clients. This understanding must be written. 4. Develop an overall audit strategy. The strategy should consider the reasons for the audit, including engagement staffing and any required audit specialists. Setting a strategy helps the auditor determine the resources required for the engagement. Terms: Essential activities involved in initial planning of audit Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
30) Discuss the required communications between predecessor and successor auditors. Answer: Auditing standards require a successor auditor to communicate with the predecessor auditor whenever accepting a client that has been previously audited. The purpose of the communication is to help the successor auditor evaluate whether to accept the engagement. While the burden of initiating the communication rests on the successor auditor, the predecessor auditor must respond to the request for information. However, because of the requirements related to confidentiality, the predecessor must obtain the former client's permission prior to providing information to the successor. Terms: Required communications between predecessor and successor auditors Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
31) Discuss several reasons why an auditor may not wish to continue a relationship with an existing audit client. Answer: There are a number of reasons an auditor may choose not to continue a relationship with an existing client. Examples include: 1. Previous conflicts over accounting issues, scope of the audit, type of opinion, or fees. 2. Management integrity may be deemed to be insufficient. 3. Legal action initiated by either the auditor or client related to prior audit services. 4. The presence of excessive risk which could result in financial failure of the client or lawsuits against the audit firm. Terms: Reasons auditor may not wish to continue relationship with existing audit client Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
32) Discuss four of the matters that should be specified in an engagement letter. Answer: Matters that should be specified in the engagement letter include: • the objectives of the engagement. • the responsibilities of the auditor and management. • identification of the financial reporting framework used by management • reference to the expected form and content of the audit report • the engagement's limitation • an agreement as to any other services to be provided. • restrictions to be imposed on the auditor's work • deadlines for completing the audit • assistance to be provided by the client's personnel in obtaining records and documents and schedules to be prepared for the auditor • agreement on fees • auditor cannot guarantee that all acts of fraud will be discovered Terms: Items included in engagement letter Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
33) Before accepting a new client, most CPA firms investigate the company to determine its acceptability. However, AICPA confidentiality requirements prohibit CPA firms from contacting certain parties–namely the company's attorneys and bankers–during this investigation. Answer: FALSE Terms: Acceptance of new client Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
34) For prospective clients that have previously been audited by another CPA firm, the predecessor auditor is required to communicate with the successor auditor. Answer: FALSE Terms: Communications between predecessor and successor auditors Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
35) When a successor auditor contacts a company's previous auditor, the predecessor auditor is required to respond fully and without limit to the request for information. Answer: FALSE Terms: Communications between predecessor and successor auditors Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
36) A predecessor auditor who has been contacted by a successor auditor for information about the client does not have to obtain permission from the former client before providing any confidential information to the successor auditor because the confidentiality requirement does not extend to former clients. Answer: FALSE Terms: Communications between predecessor and successor auditors Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
37) An auditor must evaluate a specialist's professional qualifications and understand the objectives of the specialist's work. Answer: TRUE Terms: Auditor evaluate specialist's work Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
38) Because of audit risk, some CPA firms now refuse any new clients in certain high-risk industries. Answer: TRUE Terms: Audit risk Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
39) An engagement letter establishes a clear understanding of the terms of the engagement between the client and the auditor, but it is optional for private companies. Answer: TRUE Terms: Engagement letter Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
40) Because of the requirements of Rule 201 of the AICPA's Code of Professional Conduct which state that auditors should "undertake only those professional services that the member or the member's firm can reasonably expect to be completed with professional competence," auditors are not normally permitted to consult with, or rely on the work of, outside specialists during an audit engagement. Answer: FALSE Terms: Use of outside specialists during audit engagement Diff: Easy Objective: LO 8-2 AACSB: Reflective thinking skills
41) If a prospective client has been audited in the past, the successor auditor will typically rely solely on the representations about the client by the predecessor auditor. Answer: FALSE Terms: Communications between predecessor and successor auditors Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
42) A major consideration in audit staffing is the need for continuity from year to year. Answer: TRUE Terms: Consideration in assigning staff to audit engagement Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
43) When a successor auditor requests information from a company's previous auditor, and there are legal problems or disputes between the client and the predecessor auditor, the predecessor auditor's response to the new auditor may be limited to stating that no information will be provided. Answer: TRUE Terms: Communications between predecessor and successor auditors Diff: Moderate Objective: LO 8-2 AACSB: Reflective thinking skills
44) An engagement letter can affect the CPA firm's legal responsibilities to the client, but does not affect responsibility to external users of audited financial statements. Answer: TRUE Terms: Engagement letter Diff: Challenging Objective: LO 8-2 AACSB: Reflective thinking skills
Learning Objective 8-3 1) In making client acceptance decisions, the audit firm will consider: A) inherent and control risk of the client. B) audit risk to the CPA Firm. C) the client's business risk and the risk of material misstatements in the financial statements. D) CPA Firm's potential ongoing revenue from the audit client. Answer: C Terms: Client acceptance decisions Diff: Easy Objective: LO 8-3 AACSB: Reflective thinking skills
2) Most auditors assess inherent risk as high for related parties and related-party transactions because: A) of the unique classification of related-party transactions required on the balance sheet. B) of the lack of independence between the parties. C) of the unique classification of related-party transactions required on the income statement. D) it is required by generally accepted accounting principles. Answer: B Terms: Inherent risk assessed high for relate parties and transactions Diff: Easy Objective: LO 8-3 AACSB: Reflective thinking skills
3) The audit team gathers information about a new client's business and industry in order to obtain: A) an understanding of the clients internal control system for financial reporting. B) an understanding of how economic events and transactions have an effect on the company's financial statements. C) information about control risk. D) information regarding whether the company is engaging in financial statement fraud. Answer: B Terms: Information about new client's business and industry Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
4) The auditor determines that Mathews Company occupies the 3rd floor of an office tower for which it pays no rent. The most likely explanation is: A) they got lucky the landlord hasn't noticed the lack of payments. B) landlord has weak internal controls over billings. C) a related party transaction in which a major shareholder owns the office tower. D) Matthews Company is engaging in fraudulent activities. Answer: C Terms: Auditor determines client occupies office for which it pays no rent Diff: Moderate Objective: LO 8-3 AACSB: Analytic skills
5) An official record of meetings of the board of directors and stockholders is included in the corporate: A) bylaws. B) charter. C) minutes. D) license. Answer: C Terms: Official record of meetings of board of directors and stockholders Diff: Easy Objective: LO 8-3 AACSB: Reflective thinking skills
6) A related party transaction may be indicated when another company: A) subsidizes certain operating expenses of the company. B) purchases its securities at their fair value. C) loans to company at market rates. D) has had a distributor relationship with the company for 10 years. Answer: A Terms: Related party transactions Diff: Moderate Objective: LO 8-3 AACSB: Analytic skills
7) Which of the following is not a primary reason for obtaining a good understanding of the client's industry and external environment? A) Risk associated with a specific industry may affect the auditor's assessment of client business risk. B) Risk associated with a specific industry may affect the auditor's assessment of acceptable audit risk. C) Risk associated with a specific industry may affect the auditor's assessment of acceptable control risk. D) Many control risks are common to all clients in certain industries. Answer: C Terms: Inherent risk factor Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
8) An auditor should examine minutes of the board of directors' meetings: A) through the date of the financial statements. B) through the date of the audit report. C) only at the beginning of the audit. D) on a test basis. Answer: B Terms: Minutes of the board of directors' meetings Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
9) Which of the following would most likely not be classified as a related-party transaction? A) An advance of one week's salary to an employee B) Sales of merchandise between affiliated companies C) Loans or credit sales to the principal owner of the client company D) Exchanges of equipment between two companies owned by the same person Answer: A Terms: Related-party transaction Diff: Challenging Objective: LO 8-3 AACSB: Reflective thinking skills
10) Which of the following best describes the corporate minutes of an entity? A) Official record of the meetings of the board of directors and the stockholders B) Unofficial record of the meeting of the board of directors C) Official record of management meeting with investors and creditors of the company D) Unofficial record of the board of directors meetings Answer: A Terms: Corporate minutes Diff: Easy Objective: LO 8-3 AACSB: Reflective thinking skills
11) Related party: A) transactions must be disclosed in the footnotes even if the amounts are immaterial. B) disclosures include the nature of the related party relationship and a description of the transaction. C) transactions are considered arms-length transactions. D) disclosures are required only for public companies. Answer: B Terms: Related party transactions Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
12) Define the term "related party" and discuss why an auditor should identify the client's related parties early in the audit. Answer: A related party is an affiliated company, principal owner of the client company, or any other party with which the client deals where one of the parties can influence the management or operating policies of the other. Auditors need to be aware of who the client's related parties are early in the audit to enable the auditor to identify related-party transactions, especially those that have not been disclosed. Terms: Related party Diff: Easy Objective: LO 8-3 AACSB: Reflective thinking skills
13) What documents do auditors routinely obtain to aid in their understanding of a client's governance system? Briefly discuss each of these documents. Answer: Auditors commonly obtain organizational structure, code of ethics, and the minutes of meetings of the board of directors and shareholders. The organizational structure details the authority and duties among members of an organization. It indicates if the company is centralized or decentralized. Companies frequently communicate the entity's values and ethical standards through policy statements and codes of conduct. The corporate minutes are the official record of the meetings of the board of directors and stockholders. They include summaries of the most important topics discussed and decisions made at the board meetings. Terms: Documents for client's governance system Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
14) What are three factors that have increased the importance of obtaining an understanding of a client's business and industry? How can an auditor obtain this understanding? Answer: Factors that have increased the importance of obtaining an understanding of a client's business and industry include: • Advances in information technology have increased connectivity among companies, customers, and vendors. Auditors must understand the risks associated with this increased connectivity. • Recent significant declines in economic conditions around the world are likely to significantly increase a client's business risks. Auditors need to understand the nature of the client's business to understand the impact of major economic downturns on the client's financial statements and ability to continue as a going concern. • Companies have expanded operations globally, often through joint ventures and strategic alliances. • Information technology affects internal control processes, improving the quality and timeliness of accounting information. • The increased importance of human capital and other intangible assets has increased accounting complexity and the importance of management judgments and estimates. • Many clients have invested in complex financial instruments which may have declined in value, require complex accounting treatments, and often involve unknown counterparties who may create unexpected financial risks for the client. Auditors consider these factors using a strategic systems approach to understand the client's business. The auditor can obtain a sound understanding of the client's business and industry through several means, including discussions with previous auditors and by reviewing the permanent files for the client; conferences with the client's personnel; studying AICPA industry audit guides, textbooks, technical magazines, and specialized journals; and by participating in industry associations and training programs. Terms: Factors that increase the importance of obtaining an understanding of a client's business and industry Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
15) There are three primary reasons for obtaining a thorough understanding of the client's industry and external environment. What are these reasons? Answer: The three reasons are: • Risks associated with specific industries may affect the auditor's assessment of client business risk and acceptable audit risk. • Certain inherent risks are typically common to all clients in certain industries. Familiarity with those risks aids the auditor in assessing their relevance to the client. • Many industries have unique accounting requirements that the auditor must understand to evaluate whether the client's financial statements are in accordance with accounting standards. Terms: Primary reasons for obtaining understanding client's industry and external environment Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
16) Auditors should obtain copies of the client's code of ethics and minutes of the meetings of the board of directors to aid in their understanding of the company's management and governance structure. Answer: TRUE Terms: Code of ethics and board of directors' meeting minutes; Understanding of company management and governance structure Diff: Easy Objective: LO 8-3 AACSB: Reflective thinking skills
17) Many inherent risks are common to all clients in certain industries. Answer: TRUE Terms: Inherent risk Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
18) Transactions with related parties must be disclosed in the financial statements if they are deemed to be material. Answer: TRUE Terms: Related parties Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
19) All know related parties must be identified and included in the auditor's permanent files related to the client. Answer: TRUE Terms: Related parties Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
20) Because of the lack of independence between related parties, the Sarbanes-Oxley Act prohibits all related party transactions. Answer: FALSE Terms: Related parties Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
21) Management's philosophy and operating style influence the risk of material misstatements in the financial statements. Answer: TRUE Terms: Management integrity Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
22) Ordinarily, the auditor should review corporate minutes during the later stages of an audit. Answer: FALSE Terms: Corporate minutes Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
23) Material transactions between the client and the client's related parties must be disclosed in the auditor's report. Answer: FALSE Terms: Material related party transactions Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
24) A tour of the client's facilities can help the auditor assess physical safeguards over assets and interpret accounting data related to assets such as factory equipment. Answer: TRUE Terms: Business risk and factors that impact auditor's assessment Diff: Moderate Objective: LO 8-3 AACSB: Reflective thinking skills
Learning Objective 8-4 1) An auditor has accessed client business risk and the risk of material misstatements to the clients financial statements. These are done in order to: A) apply the audit risk model to determine the appropriate extent of audit evidence. B) determine the reliance on the company's internal control systems for financial reporting. C) determine the test of balances to be performed by the audit team. D) assure the CPA firm that they can perform the audit effectively and efficiently. Answer: A Terms: Business risk and risk of material misstatements Diff: Moderate Objective: LO 8-4 AACSB: Reflective thinking skills
2) Business risk: A) is the risk after considering the effectiveness of top management controls. B) is the risk that the client's internal controls will fail. C) can include a new technology which threatens to erode a company's competitive advantage. D) cannot be mitigated by management. Answer: C Terms: Business risk Diff: Moderate Objective: LO 8-4 AACSB: Reflective thinking skills
3) Define business risk. List several factors that may impact the auditor's assessment of business risk. Answer: Business risk is the risk that a company will fail to achieve its objectives. Factors that may impact business risk include: • General economic conditions, • Significant declines in the economy that threaten the client's cash flows, • New technology eroding a company's competitive advantage • Company failing to execute its strategies as well as its competitors • Extent of competition within an industry, • Changing regulatory requirements, • Competence of management, • Ability to maintain sufficient cash flows and secure financing, and • Successful implementation of business strategies. Terms: Business risk and factors that impact auditor's assessment Diff: Challenging Objective: LO 8-4 AACSB: Reflective thinking skills
4) Management is the primary source for identifying client business risks. Answer: TRUE Terms: Business risk Diff: Easy Objective: LO 8-4 AACSB: Reflective thinking skills
5) Sarbanes-Oxley encourages management to certify that it has informed the auditor and audit committee of any significant deficiencies in internal control. Answer: FALSE Terms: Internal control Diff: Easy Objective: LO 8-4 AACSB: Reflective thinking skills
Learning Objective 8-5 1) Auditors perform preliminary analytical procedures to better understand the client's business and to assess client business risk. Answer: TRUE Terms: Analytical procedures Diff: Easy Objective: LO 8-5 AACSB: Reflective thinking skills
2) In order to be meaningful, a company's ratios should be compared to their prior year's ratios, not industry benchmarks. Answer: FALSE Terms: Analytical procedures Diff: Easy Objective: LO 8-5 AACSB: Reflective thinking skills
Learning Objective 8-6
1) During audit planning, the auditor uses analytical procedures primarily to: A) identify weaknesses in internal control. B) determine if the company's financial statements appear reasonable and are free of material misstatement. C) determine the correspondence of the company's financial statements to the valuation and accuracy audit objectives. D) determine the nature, extent, and timing of audit procedures. Answer: D Terms: Audit planning phase and primary purpose of analytical procedures Diff: Moderate Objective: LO 8-6 AACSB: Reflective thinking skills
2) Which of the following is most correct with respect to the use of analytical procedures? A) Analytical procedures may be used in evaluating balances in the testing phase as long as the auditor also uses them in assessing the going concern assumption. B) Analytical procedures must be used throughout the audit. C) Analytical procedures used in the testing phase of the audit are primarily used to direct an auditor's attention so that the auditor's understanding of the business is improved. D) Analytical procedures are performed by studying plausible relationships between financial and nonfinancial data. Answer: D Terms: Use of analytical procedures Diff: Challenging Objective: LO 8-6 AACSB: Reflective thinking skills
3) Analytical procedures: A) are not a type of audit evidence. B) are not required during the completion phase of the audit. C) performed during the planning phase of the audit are used as a substantive test in support of account balances. D) performed in the completion phase serve as a final review for material misstatements or financial problems. Answer: D Terms: Analytical procedures Diff: Challenging Objective: LO 8-6 AACSB: Reflective thinking skills
4) Discuss the four primary purposes of analytical procedures performed during the planning phase of an audit. Answer: The four primary purposes of preliminary analytical procedures are: • to help the auditor understand the client's industry and business, • to help the auditor assess the going concern assumption, • to indicate areas of possible misstatements, and • to reduce the extent of detailed tests. Terms: Primary purposes of analytical procedures Diff: Moderate Objective: LO 8-6 AACSB: Reflective thinking skills
5) Auditors routinely conduct analytical procedures in the planning, testing, and completion phases of the audit. Identify the primary and secondary purposes of performing analytical procedures in each phase of the audit. Answer: • Planning — primary purposes are to understand the client's business and industry and indicate possible misstatements. Secondary purposes are to assess going concern and reduce detailed tests. • Testing — primary purpose is to reduce detailed tests and secondary purpose is to indicate possible misstatements • Completion — primary purpose is to indicate possible misstatements and secondary purpose is to assess going concern Terms: Primary and secondary purposes of analytical procedures in planning, testing, and completion phases of audit Diff: Challenging Objective: LO 8-6 AACSB: Reflective thinking skills
6) One purpose of performing preliminary analytical procedures in the planning phase of an audit is to help the auditor make a preliminary assessment of control risk. Answer: FALSE Terms: Preliminary analytical procedures Diff: Moderate Objective: LO 8-6 AACSB: Reflective thinking skills
Learning Objective 8-7 1) Which of the following is a correct statement regarding analytical procedures? A) A major strength in using industry ratios for auditing is the difference between the nature of the client's financial information and that of the firms making up the industry totals. B) Common-size financial statements display all items as a percentage change from a base year. C) Auditors should investigate the most significant differences between budgeted and actual results. D) In order to look for a misstatement in the allowance for bad debts, the auditor should divide gross sales by sales returns and allowances. Answer: C Terms: Risk of material misstatement with accounting estimates Diff: Easy Objective: LO 8-7 AACSB: Reflective thinking skills
2) Which of the following would not be classified as an analytical procedure? A) Benchmarking the company's profitability ratios against others in the industry B) Variance analysis of actual versus budgeted amounts for production C) Reperforming the client's depreciation expense using the client's accounting policies for capital expenditures made during the year D) Reconciling fixed asset dispositions with the fixed asset ledger Answer: D Terms: Analytical procedures Diff: Moderate Objective: LO 8-7 AACSB: Reflective thinking skills
3) Which of the following statements is not correct with respect to analytical procedures? A) Auditing standards emphasize the need for auditors to develop and use expectations. B) Analytical procedures must be performed throughout the audit. C) Analytical procedures may be performed at any time during the audit. D) Analytical procedures use comparisons and relationships to assess whether account balances appear reasonable. Answer: B Terms: Analytical procedures Diff: Moderate Objective: LO 8-7 AACSB: Reflective thinking skills
4) When performing planning analytical procedures for a client the auditor detected that the gross profit percentage had declined by 50% from the previous year to the year currently under audit. The auditor should: A) investigate the possibility the client may have made an error in their cost of goods sold computation. B) assist management in developing greater cost efficiencies in their product line. C) prepare a going concern opinion for the client. D) advise the client to have extensive disclosure to alleviate investor concerns. Answer: A Terms: Analytical procedures in planning phase Diff: Challenging Objective: LO 8-7 AACSB: Reflective thinking skills
5) When are auditors likely to encounter judgment problems in the use of analytical procedures? A) Whenever the auditor places reliance on management's explanations for unusual fluctuations in account balances without first developing independent expectations B) Whenever the auditor allows unaudited balances to unduly influence his/her expectations of current balances C) Whenever the auditor fails to consider the pattern reflected by several unusual fluctuations when trying to explain what caused them D) The auditor is likely to encounter judgment problems in each of the above instances. Answer: D Terms: Judgment problems in use of analytical procedures Diff: Challenging Objective: LO 8-7 AACSB: Reflective thinking skills
6) The major concern when using nonfinancial data in analytical procedures is the: A) accuracy of the nonfinancial data. B) source of the nonfinancial data. C) type of nonfinancial data. D) presence of multiple sources of nonfinancial data. Answer: A Terms: Concern when using nonfinancial data in analytical procedures Diff: Challenging Objective: LO 8-7 AACSB: Reflective thinking skills
7) Whenever an auditor compares client data to client-prepared budgets, there are two special concerns. Indicate if the two items below are concerns. A) Assessing whether the budgets were Client data may have been altered to realistic plans conform to the budget A concern A concern B) Assessing whether the budgets were realistic plans Not a concern
Client data may have been altered to conform to the budget Not a concern
C) Assessing whether the budgets were realistic plans A concern
Client data may have been altered to conform to the budget Not a concern
D) Assessing whether the budgets were realistic plans Not a concern
Client data may have been altered to conform to the budget A concern
Answer: A
Terms: Comparison of client data to client-prepared budgets Diff: Challenging Objective: LO 8-7 AACSB: Reflective thinking skills
Learning Objective 8-8 1) Which is a liquidity activity ratio? A) Profit margin B) Inventory turnover C) Return on assets D) Times interest earned Answer: B Terms: Liquidity ratio Diff: Moderate Objective: LO 8-8 AACSB: Reflective thinking skills
2) When using financial ratios, the most important comparisons are to those of previous years for the company and to industry averages or similar companies for the same year. Answer: TRUE Terms: Common financial ratios Diff: Easy Objective: LO 8-8 AACSB: Reflective thinking skills
3) The most widely used profitability ratio is return on assets.
Answer: FALSE
Terms: Common financial ratios Diff: Easy Objective: LO 8-8 AACSB: Reflective thinking skills
4) The quick ratio has the same denominator as the current ratio. Answer: TRUE Terms: Common financial ratios Diff: Easy Objective: LO 8-8 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e (Arens) Chapter 9 Materiality and Risk Learning Objective 9-1 1) If it is probable that the judgment of a reasonable person will be changed or influenced by the omission or misstatement of information, then that information is, by definition of FASB Statement No. 2: A) material. B) insignificant. C) significant. D) relevant. Answer: A Terms: FASB Statement No. 2; Probable judgment of a reasonable person Diff: Easy Objective: LO 9-1 AACSB: Reflective thinking skills
2) The scope paragraph of the standard unqualified auditor's report states that "… the standards require that we plan and perform the audit to obtain ________ assurance about whether the financial statements are free of material misstatement." What type of assurance is given? A) Immediate B) Limited C) Reasonable D) Absolute Answer: C Terms: Type of assurance provided Diff: Easy Objective: LO 9-1 AACSB: Reflective thinking skills
3) Auditors are responsible for determining whether financial statements are materially misstated, so upon discovering a material misstatement they must bring it to the attention of: A) regulators. B) the audit firm's managing partner. C) the client shareholders. D) the client. Answer: D
Terms: Discovery of a material misstatement must bring it to the attention Diff: Easy Objective: LO 9-1 AACSB: Reflective thinking skills
4) Determining materiality requires professional judgment. Answer: TRUE Terms: Materiality Diff: Easy Objective: LO 9-1 AACSB: Reflective thinking skills
Learning Objective 9-2 1) Audit standards require the auditor to consider materiality early in the audit. Which statement(s) regarding preliminary materiality are true? I. Preliminary materiality may change during the engagement. II. Preliminary materiality is the maximum amount by which the auditor believes the financials could be misstated and still not affect the decisions of reasonable users. A) I only B) II only C) both I and II D) neither are true Answer: C Terms: Preliminary materiality assessment Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
2) Why do auditors establish a preliminary judgment about materiality? A) To determine the appropriate level of staff to assign to the audit B) So that the client can know what records to make available to the auditor C) To help plan the appropriate evidence to accumulate D) To finalize the control risk assessment Answer: C Terms: Purpose to establish preliminary judgment about materiality Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
3) If an auditor establishes a relatively high level for materiality, then the auditor will: A) accumulate more evidence than if a lower level had been set. B) accumulate less evidence than if a lower level had been set. C) accumulate approximately the same evidence as would be the case were materiality lower. D) accumulate an undetermined amount of evidence. Answer: B Terms: High level for materiality Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
4) The preliminary judgment about materiality and the amount of audit evidence accumulated are ________ related. A) directly B) indirectly C) not D) inversely Answer: D Terms: Preliminary judgment about materiality and amount of evidence accumulated Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
5) Which of the following is the primary basis used to decide materiality for a for-profit entity? A) Net sales B) Net assets C) Net income before tax D) All of the above Answer: C Terms: Primary basis to decide materiality for a for-profit entity Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
6) Auditing standards ________ that the basis used to determine the preliminary judgment about materiality be documented in the audit files. A) permit B) do not allow C) require D) strongly encourage Answer: C Terms: Auditing standards; Preliminary judgment about materiality documented Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
7) Amounts involving fraud are usually considered ________ important than unintentional errors of equal dollar amounts. A) less B) no less C) no more D) more Answer: D Terms: Amounts involving fraud Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
8) Qualitative factors can affect an auditor's assessment of materiality. Which of the following statements is true? I. Misstatements that are otherwise immaterial may be material if they affect earnings trends. II. Misstatements that are otherwise minor may be material if there are possible consequences arising
from contractual obligations. A) I only B) II only C) I and II D) neither I nor II Answer: C
Terms: Qualitative factors can affect auditor's assessment of materiality Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
9) The five steps in applying materiality are listed below in random order. 1. Estimate the combined misstatement. 2. Estimate the total misstatement in the segment. 3. Set materiality for the financial statements as a whole. 4. Determine performance materiality. 5. Compare combined estimate with preliminary judgment about materiality. The first three steps in correct sequence would be: A) 1, 2, 5 B) 3, 4, 2 C) 2, 1, 5 D) 3, 2, 4 Answer: B Terms: Five steps in applying materiality Diff: Moderate Objective: LO 9-2 AACSB: Reflective thinking skills
10) Which of the following statements is not correct? A) Materiality is a relative rather than an absolute concept. B) The most important base used as the criterion for deciding materiality is total assets. C) Qualitative factors as well as quantitative factors affect materiality. D) Given equal dollar amounts, frauds are usually considered more important than errors. Answer: B Terms: Materiality Diff: Moderate Objective: LO 9-2 AACSB: Reflective thinking skills
11) Certain types of misstatements are likely to be more important than other types to users, even if the dollar amounts are the same. Which of the following demonstrates this? A) Amounts involving frauds are Misstatements that are otherwise considered more important than immaterial may be material if they affect errors of equal amount a trend in earnings Yes Yes B) Amounts involving frauds are considered more important than errors of equal amount No
Misstatements that are otherwise immaterial may be material if they affect a trend in earnings No
Amounts involving frauds are considered more important than errors of equal amount Yes
Misstatements that are otherwise immaterial may be material if they affect a trend in earnings No
Amounts involving frauds are considered more important than errors of equal amount No
Misstatements that are otherwise immaterial may be material if they affect a trend in earnings Yes
C)
D)
Answer: A
Terms: Certain types of misstatements are likely more important than other types Diff: Moderate Objective: LO 9-2 AACSB: Reflective thinking skills
12) When setting a preliminary judgment about materiality: A) more evidence is required for a low dollar amount than for a high dollar amount. B) less evidence is required for a low dollar amount than for a high dollar amount. C) the same amount of evidence is required for either low or high dollar amounts. D) there is no relationship between it and the dollar amount of evidence needed. Answer: A Terms: Setting preliminary judgment about materiality Diff: Challenging Objective: LO 9-2 AACSB: Reflective thinking skills
13) Lewis Corporation has a few large accounts receivable that total one million dollars whereas Clark Corporation has many small accounts receivable that total one million dollars. Misstatement in any one account is more significant for Lewis corporation because of the concept of: A) materiality. B) audit risk. C) reasonable assurance. D) comparative analysis. Answer: A Terms: Misstatements Diff: Challenging Objective: LO 9-2 AACSB: Reflective thinking skills
14) Audit standards require the auditor to consider the combined amount of misstatement early in the audit. This is known as preliminary materiality judgment. List and discuss the three main factors that affect an auditor's preliminary judgment about materiality. Answer: The three main factors that affect an auditor's judgment about materiality are: • Materiality is a relative rather than an absolute concept. A misstatement of a given size might be material for a small company, whereas the same dollar misstatement could be immaterial for a larger one. • Benchmarks are needed for evaluating materiality. Because materiality is relative, it is necessary to have benchmarks for establishing whether misstatements are material. Net income before taxes is normally the most commonly used benchmark, but other possible benchmarks include current assets, total assets, current liabilities, and owners' equity. • Qualitative factors also affect materiality. Certain types of misstatements are likely to be more important to users than others, even if the dollar amounts are the same, such as misstatements involving frauds. Terms: Factors that affect auditor's preliminary judgment Diff: Moderate Objective: LO 9-2 AACSB: Reflective thinking skills
15) Due to qualitative factors, certain types of misstatements are likely to be more important to users than others, even if the dollar amounts are the same. Identify two qualitative factors that might significantly affect an auditor's materiality judgment, and give an example of each. Answer: Qualitative factors that affect an auditor's materiality judgment include: • Amounts involving fraud. Amounts involving fraud are usually considered more important than unintentional errors of equal dollar amounts because fraud reflects on the honesty and reliability of the management or other personnel involved. For example, an intentional misstatement of inventory would be more important to users than a clerical error in inventory of the same amount. • Misstatements affecting contractual obligations. Misstatements that are otherwise minor may be material if there are possible consequences arising from contractual obligations. For example, if a misstatement causes a required minimum account balance to exceed the minimum, when the correct balance is less than the minimum, this misstatement likely would be important to users. • Amounts affecting a trend in earnings. Amounts that are otherwise immaterial may be material if they affect a trend in earnings. An example is if reported income has increased 3 percent annually for the past five years but income for the current year has declined 1 percent, that change may be material. Similarly, a misstatement that would cause a loss to be reported as a profit may be of concern. Terms: Qualitative factors that affect auditor's materiality judgment Diff: Moderate Objective: LO 9-2 AACSB: Reflective thinking skills
16) The auditor's preliminary judgment about materiality is the maximum amount by which the auditor believes the financial statements could be misstated and still not affect the decisions of reasonable users. Answer: TRUE Terms: Preliminary judgments about materiality Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
17) Preliminary judgments about materiality are often changed during the course of the engagement. Answer: TRUE Terms: Preliminary judgments about materiality Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
18) Net assets are the most often used base for deciding materiality. Answer: FALSE Terms: Base for deciding materiality Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
19) The lower the dollar amount of the preliminary judgment the more audit evidence is required. Answer: TRUE Terms: Amount of preliminary judgment and audit evidence required Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
20) Amounts involving fraud are not usually considered qualitative factors affecting the preliminary materiality judgment. Answer: FALSE Terms: Qualitative factors affecting preliminary materiality judgment; Fraud Diff: Easy Objective: LO 9-2 AACSB: Reflective thinking skills
21) CPA firms can establish policy guidelines to help their auditors determine materiality. Answer: TRUE Terms: Difficulty in applying concept of materiality Diff: Moderate Objective: LO 9-2 AACSB: Reflective thinking skills
22) Statements on Auditing Standards provide detailed, objective guidance on how auditors are to establish a preliminary materiality level, thus eliminating the need for subjective auditor judgment in this task. Answer: FALSE Terms: Statements on Auditing Standards; Objective guidance on establishing preliminary materiality level Diff: Moderate Objective: LO 9-2 AACSB: Reflective thinking skills
23) If the preliminary judgment of materiality increases, the amount of audit evidence required will decrease. Answer: TRUE Terms: Preliminary judgment of materiality and audit evidence Diff: Moderate Objective: LO 9-2 AACSB: Reflective thinking skills
24) Net income before tax is the normal base used to determine materiality in a not-for-profit company. Answer: FALSE Terms: Base used to determine materiality Diff: Moderate Objective: LO 9-2 AACSB: Reflective thinking skills
Learning Objective 9-3 1) When auditors allocate the preliminary judgment about materiality to account balances, the materiality allocated to any given account balance is referred to as: A) the materiality range. B) the error range. C) tolerable materiality. D) performance materiality. Answer: D Terms: Allocate preliminary judgment about materiality to account balances Diff: Easy Objective: LO 9-3 AACSB: Reflective thinking skills
2) Auditors generally allocate the preliminary judgment about materiality to the: A) balance sheet only. B) income statement only. C) income statement and balance sheet. D) statement of cash flows. Answer: A Terms: Preliminary materiality allocation Diff: Easy Objective: LO 9-3 AACSB: Reflective thinking skills
3) Which of the following is an incorrect statement regarding the allocation of the preliminary judgment about materiality to balance sheet accounts? A) Auditors expect certain accounts to have more misstatements than others. B) The allocation has virtually no effect on audit costs because the auditor must collect sufficient appropriate audit evidence. C) Auditors expect to identify overstatements as well as understatements in the accounts. D) Relative audit costs affect the allocation. Answer: B Terms: Allocation of preliminary judgment about materiality Diff: Moderate Objective: LO 9-3 AACSB: Reflective thinking skills
4) Which of the following statements is true concerning the allocation of preliminary materiality? A) It is necessary to allocate preliminary materiality to financial statements as a whole rather than by segments. B) Preliminary materiality should be allocated to income statement accounts only. C) Preliminary materiality is required by the SEC. D) The PCAOB term used when preliminary materiality is allocated to segments is tolerable misstatement. Answer: D Terms: Allocation of preliminary materiality Diff: Moderate Objective: LO 9-3 AACSB: Reflective thinking skills
5) Which of the following statements is false? A) Either an overstatement of an asset account or an understatement of a liability account would have the same effect on the income statement. B) A misclassification in the balance sheet will have no effect on operating income. C) Either an overstatement of an asset account or an overstatement of a liability account would have the same effect on the income statement. D) Either an understatement of an asset account or an overstatement of a liability account would have the same effect on the income statement. Answer: C Terms: Effects of misstatements Diff: Moderate Objective: LO 9-3 AACSB: Reflective thinking skills
6) Which of the following are major difficulties auditors face when allocating materiality to balance sheet accounts? A) Certain accounts contain more misstatements Only overstatements Audit costs can than others need be considered affect allocation Yes No Yes B) Certain accounts contain more misstatements than others Yes
Only overstatements need be considered Yes
Audit costs can affect allocation No
Certain accounts contain more misstatements than others Yes
Only overstatements need be considered Yes
Audit costs can affect allocation Yes
Certain accounts contain more misstatements than others No
Only overstatements need be considered Yes
Audit costs can affect allocation No
C)
D)
Answer: A
Terms: Major difficulties auditors face when allocating materiality to balance sheet accounts Diff: Moderate Objective: LO 9-3 AACSB: Reflective thinking skills
7) When allocating performance materiality: A) it is easy to predict in advance which accounts are mot likely to be misstated. B) only overstatements need to be considered. C) professional judgment is critical. D) the sum of all the performance materiality levels cannot exceed the preliminary judgment about materiality. Answer: C Terms: Major difficulties auditors face when allocating materiality to balance sheet accounts Diff: Moderate Objective: LO 9-3 AACSB: Reflective thinking skills
8) When allocating materiality, most practitioners choose to allocate to: A) the income statement accounts because they are more important. B) the balance sheet accounts because most audits focus on the balance sheet. C) both balance sheet and income statement accounts because there could be errors on either. D) all of the financial statements because it is required by GAAS. Answer: B Terms: Allocating materiality Diff: Challenging Objective: LO 9-3 AACSB: Reflective thinking skills
9) Which of the following is a correct statement regarding performance materiality? A) Determining performance materiality is necessary because auditors accumulate evidence by segments. B) The level of performance materiality does not affect the amount of evidence needed. C) Performance materiality cannot vary for different classes of transactions. D) Performance materiality is required for public companies, but not for private companies. Answer: A Terms: Tolerable misstatements Diff: Challenging Objective: LO 9-3 AACSB: Reflective thinking skills
10) Explain why it is necessary to allocate the preliminary judgment about materiality to individual accounts (segments) in the financial statements. Also explain why allocating to balance sheet accounts is more common than allocating to income statement accounts. Answer: Allocating the preliminary judgment about materiality to individual accounts (segments) is necessary because evidence is accumulated for accounts (segments) rather than for the financial statements as a whole. Allocating to accounts (segments) establishes a tolerable misstatement amount for each account, which helps the auditor decide the appropriate audit evidence to accumulate for each account. Most practitioners allocate materiality to balance sheet accounts rather than income statement accounts because most income statement misstatements have an equal effect on the balance sheet due to the nature of double-entry accounting. Because there are fewer balance sheet accounts than income statement accounts in most audits, and because most audit procedures focus on balance sheet accounts, materiality should be allocated only to balance sheet accounts. Terms: Allocation of the preliminary judgment about materiality Diff: Moderate Objective: LO 9-3 AACSB: Reflective thinking skills
11) Auditor's allocate the preliminary judgment about materiality to financial statement segments rather than by financial statements as a whole. What is the term for the auditor's allocation of preliminary misstatement to account balances? What are three difficulties auditor's face when allocating materiality to balance sheet accounts? Answer: Performance materiality is the term for the auditor's allocation of the preliminary judgment of materiality to any given account balance. The three difficulties auditors face when allocating the preliminary materiality to account balances are: 1. Auditors expect certain accounts to have more misstatement than others. 2. Both overstatements and understatements must be considered. 3. Audit costs can affect the allocation. Terms: Allocation of preliminary misstatement to account balances and difficulties that auditors face allocating preliminary materiality judgment to account balances Diff: Moderate Objective: LO 9-3 AACSB: Reflective thinking skills
12) Most practitioners allocate the preliminary judgment about materiality to both the balance sheet and income statement accounts. Answer: FALSE Terms: Allocate preliminary judgment about materiality to balance sheet accounts Diff: Moderate Objective: LO 9-3 AACSB: Reflective thinking skills
13) The primary purpose of allocating the preliminary judgment about materiality to financial statement accounts is to help the auditor decide the appropriate evidence to accumulate. Answer: TRUE Terms: Primary purpose of allocating the preliminary judgment about materiality Diff: Easy Objective: LO 9-3 AACSB: Reflective thinking skills
14) Both overstatements and understatements must be considered when allocating materiality to balance sheet accounts. Answer: TRUE Terms: Allocating materiality; Consideration of overstatements and understatements Diff: Easy Objective: LO 9-3 AACSB: Reflective thinking skills
15) If an auditor assigns a tolerable misstatement of $1,000 to accounts payable, he or she would need to obtain more audit evidence for that account than if $100,000 had been assigned. Answer: TRUE Terms: Tolerable misstatements and audit evidence Diff: Moderate Objective: LO 9-3 AACSB: Reflective thinking skills
16) To maximize audit efficiency, the auditor should allocate less tolerable misstatement to accounts that can be verified by using low-cost audit procedures, such as analytical procedures, than to accounts that are more costly to audit. Answer: TRUE Terms: Maximize audit efficiency, allocate less tolerable misstatements Diff: Moderate Objective: LO 9-3 AACSB: Reflective thinking skills
Learning Objective 9-4 1) Auditors are ________ to document the known and likely misstatements in the financial statements under audit. A) permitted B) required C) not allowed D) strongly encouraged Answer: B Terms: Known and likely misstatements in the financial statements Diff: Easy Objective: LO 9-4 AACSB: Reflective thinking skills
2) ________ misstatements are those where the auditor can determine the amount of the misstatement in the account. A) Potential B) Likely C) Known D) Projected Answer: C Terms: Misstatements where auditor can determine the amount Diff: Moderate Objective: LO 9-4 AACSB: Reflective thinking skills
3) Likely misstatements can result from: A)
Computation of the sampling error for the cash account No
Differences between management's and an auditor's judgment about account balances Yes
Projections of misstatements based on an auditor's tests of a sample from a population Yes
Computation of the sampling error for the cash account Yes
Differences between management's and an auditor's judgment about account balances Yes
Projections of misstatements based on an auditor's tests of a sample from a population No
Computation of the sampling error for the cash account No
Differences between management's and an auditor's judgment about account balances No
Projections of misstatements based on an auditor's tests of a sample from a population Yes
Computation of the sampling error for the cash account Yes
Differences between management's and an auditor's judgment about account balances No
Projections of misstatements based on an auditor's tests of a sample from a population No
B)
C)
D)
Answer: A
Terms: Likely misstatements result from Diff: Moderate Objective: LO 9-4 AACSB: Reflective thinking skills
4) When evaluating the audit findings, the auditor should be satisfied that the: A) amount of known misstatement is documented in the management representation letter. B) estimate of the total known and likely misstatements is less than a material amount. C) estimate of the total likely misstatement includes sample error. D) amount of known misstatement is acknowledged and recorded by the client. Answer: B Terms: Evaluating audit findings and materiality Diff: Challenging Objective: LO 9-4 AACSB: Reflective thinking skills
5) Discuss each of the five steps in applying materiality in an audit, and identify the audit phase(s) in which each step is performed. List these steps in the order in which they occur. Answer: Step 1. Set preliminary judgment about materiality. This is the combined amount of misstatements in the financial statements that would be considered material. This decision is made in the planning stage of the audit. Step 2. Allocate preliminary judgment about materiality to segments. In this step, the auditor normally allocates the preliminary judgment about materiality to the balance sheet accounts. The amount of materiality allocated to an account is referred to as that account's performance materiality. This allocation is performed in the audit planning stage. Step 3. Estimate total misstatement in segment. In this step, the auditor projects the sample results to the population. An allowance for sampling risk is also calculated. This would be performed after the substantive tests for each account are completed. Step 4. Estimate the combined misstatement. In this step, the projected errors for each account are added, along with total sampling error, to calculate the combined misstatement. This would be performed after all substantive tests have been completed. Step 5. Compare combined estimated misstatement with preliminary or revised judgment about materiality. If the combined estimated misstatement is less than or equal to the judgment about materiality, then the auditor concludes the financial statements are fairly presented. This would be performed after all substantive tests have been completed, in the final review stage of the audit. Terms: Five steps in applying materiality in audit Diff: Challenging Objective: LO 9-2, LO 9-3, and LO 9-4 AACSB: Reflective thinking skills
6) The preliminary judgment on materiality is compared to the total estimated misstatement amount to determine if an account balance is materially misstated. Answer: TRUE Terms: Preliminary judgment on materiality; Estimated total misstatements Diff: Moderate Objective: LO 9-4 AACSB: Reflective thinking skills
7) Total estimated misstatements include known misstatements and projected misstatements plus a sampling error. Answer: TRUE Terms: Total estimated misstatements and sampling error Diff: Moderate Objective: LO 9-4 AACSB: Reflective thinking skills
8) If the total misstatement of an account is known, a sampling error still needs to be determined. Answer: FALSE Terms: Total estimated misstatements and sampling error Diff: Moderate Objective: LO 9-4 AACSB: Reflective thinking skills
9) Sampling error represents the minimum misstatement amount that exists in all accounts subjected to sampling. Answer: FALSE Terms: Total estimated misstatements and sampling error Diff: Moderate Objective: LO 9-4 AACSB: Reflective thinking skills
10) If the auditor approaches the audit of the accounts in s sequential manner, the findings of the audit of accounts audited earlier can be used to revise the performance materiality established for accounts audited later. Answer: TRUE Terms: Total estimated misstatements and sampling error Diff: Moderate Objective: LO 9-4 AACSB: Reflective thinking skills
Learning Objective 9-5 1) Which of the following audit risk components may be assessed in non-quantitative terms? A) Control Risk Inherent Risk Detection Risk Yes Yes Yes B) Control Risk Yes
Inherent Risk Yes
Detection Risk No
Control Risk No
Inherent Risk No
Detection Risk Yes
Control Risk No
Inherent Risk No
Detection Risk No
C)
D)
Answer: A
Terms: Audit risk components assessed in non-quantitative terms Diff: Easy Objective: LO 9-5 AACSB: Reflective thinking skills
2) Based on audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would: A) increase materiality levels. B) decrease detection risk. C) decrease substantive testing. D) increase inherent risk. Answer: B Terms: Control risk and planned audit risk model Diff: Challenging Objective: LO 9-5 AACSB: Reflective thinking skills
3) When dealing with audit risk: A) auditors accept some level of risk in performing the audit function. B) most risks that auditors encounter are relatively easy to measure. C) the audit risk model is only used for classes of transactions. D) most audit firms prefer to use a quantitative assessment for risk. Answer: A Terms: Audit risk Diff: Moderate Objective: LO 9-2 and LO 9-5 AACSB: Reflective thinking skills
4) Why do auditors use the audit risk model when planning an audit? Answer: The audit risk model is used primarily for planning purposes in deciding how much evidence to accumulate in each cycle. The auditor sets an acceptable level of audit risk, (AAR) assesses inherent risk (IR) and control risk (CR), and then uses the following audit risk model to determine an appropriate level of planned detection risk (PDR): PDR
=
Terms: Audit risk model Diff: Easy Objective: LO 9-5 AACSB: Reflective thinking skills
5) The most important element of the audit risk model is control risk. Answer: FALSE Terms: Audit risk model and control risk Diff: Easy Objective: LO 9-5 AACSB: Reflective thinking skills
6) The audit risk model that must be used for planning audit procedures and evaluating audit results is: = AAR. Answer: FALSE
Terms: Audit risk model Diff: Moderate Objective: LO 9-5 AACSB: Reflective thinking skills
Learning Objective 9-6 1) The measurement of the auditor's assessment of the likelihood that there are material misstatements due to error or fraud in a segment before considering the effectiveness of internal controls is defined as: A) audit risk. B) inherent risk. C) sampling risk. D) detection risk. Answer: B Terms: Assessment of likelihood of material misstatements due to error or fraud Diff: Easy Objective: LO 9-6 AACSB: Reflective thinking skills
2) The risk that audit evidence for a segment will fail to detect misstatements exceeding performance materiality levels is: A) audit risk. B) control risk. C) inherent risk. D) planned detection risk. Answer: D Terms: Risk audit evidence will fail to detect misstatements Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
3) As the risk of material misstatement increases, detection risk should: A) medium increase. B) decrease. C) stay the same. D) Is indeterminate. Answer: B Terms: Risk of material misstatement increases, detection risk Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
4) Inherent risk is ________ related to detection risk and ________ related to the amount of audit evidence. A) directly, inversely B) directly, directly C) inversely, inversely D) inversely, directly Answer: D Terms: Relationship of inherent risk, detection risk, and amount of audit evidence Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
5) Auditors frequently refer to the terms audit assurance, overall assurance, and level of assurance to refer to ________. A) detection risk B) audit report risk C) acceptable audit risk D) inherent risk Answer: C Terms: Audit assurance, overall assurance and level of assurance Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
6) If planned detection risk is reduced, the amount of evidence the auditor accumulates will: A) increase. B) decrease. C) remain unchanged. D) be indeterminate. Answer: A Terms: Assess control risk Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
7) Planned detection risk I. determines the amount of substantive evidence the auditor plans to accumulate. II. is dependent on inherent risk and business risk. A) I only B) II only C) I and II D) None of the above Answer: A Terms: Planned detection risk Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
8) Inherent risk is often high for an account such as: A) inventory. B) land. C) capital stock. D) notes payable. Answer: A Terms: Inherent risk Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
9) Inherent risk and control risk: A) are inversely related to each other. B) are inversely related to detection risk. C) are directly related to detection risk. D) are directly related to audit risk. Answer: B Terms: Inherent risk and control risk Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
10) To what extent do auditors typically rely on internal controls of their public company clients? A) Extensively B) Only very little C) Infrequently D) Never Answer: A Terms: Extent auditor rely on internal controls of public company client Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills Topic: Public
11) Auditors typically rely on internal controls of their private company clients: A) only as needed to complete the audit and satisfy Sarbanes-Oxley requirements. B) only if the controls are determined to be effective. C) only if the client asks an auditor to test controls. D) only if the controls are sufficient to increase Control Risk to an acceptable level. Answer: B Terms: Extent auditor rely on internal controls of private company client Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
12) Which is a true statement about audit risk? A) Audit risk measures the risk that a material misstatement could occur and not be detected by internal control. B) When auditors decide on a higher acceptable audit risk, they want to be more certain that the financial statements are not materially misstated. C) Audit assurance is the complement of acceptable audit risk. D) There is an inverse relationship between acceptable audit risk and planned detection risk. Answer: C Terms: Acceptable audit risk Diff: Challenging Objective: LO 9-6 AACSB: Reflective thinking skills
13) The risk of material misstatement refers to: A) control risk and acceptable audit risk. B) inherent risk. C) the combination of inherent risk and control risk. D) inherent risk and audit risk. Answer: C Terms: Risk of material misstatements Diff: Challenging Objective: LO 9-6 AACSB: Reflective thinking skills
14) When assessing risk, it is important to remember that: A) for acceptable audit risk, the SEC decides the risk the CPA firm should take for public clients. B) inherent risk can be changed by the auditor. C) detection risk can only be determined after audit risk, inherent risk, and control risk are determined. D) control risk is determined by company management since they are responsible for internal control. Answer: C Terms: Difference between material misstatement and detection risk Diff: Challenging Objective: LO 9-6 AACSB: Reflective thinking skills
15) Auditors may assess inherent risk and control risk: A) Jointly to determine the risk of Separately and combine their effects in material misstatement the audit risk model Yes Yes B) Jointly to determine the risk of material misstatement No
Separately and combine their effects in the audit risk model No
Jointly to determine the risk of material misstatement Yes
Separately and combine their effects in the audit risk model No
Jointly to determine the risk of material misstatement No
Separately and combine their effects in the audit risk model Yes
C)
D)
Answer: A
Terms: Auditor may assess inherent risk and control risk Diff: Challenging Objective: LO 9-6 AACSB: Reflective thinking skills
16) In a financial statement audit, inherent risk is evaluated to help an auditor asses which of the following? A) The internal audit department's objectivity in reporting a material misstatement of a financial statement assertion it detects to the audit committee B) The risk the internal control system will not detect a material misstatement of a financial statement assertion C) The risk that the audit procedures implemented will not detect a material misstatement of a financial statement assertion D) The susceptibility of a financial statement assertion to a material misstatement assuming there are no related controls Answer: D Terms: Inherent risk assessment Diff: Challenging Objective: LO 9-6 AACSB: Reflective thinking skills
17) Which of the following statements is not true? A) Inherent risk is inversely related to the amount of audit evidence whereas detection risk is directly related to the amount of audit evidence required. B) Inherent risk is directly related to evidence whereas detection risk is inversely related to the amount of audit evidence required. C) Inherent risk is the susceptibility of the financial statements to material error, assuming no internal controls. D) Inherent risk and control risk are assessed by the auditor and function independently of the financial statement audit. Answer: A Terms: Inherent risk Diff: Challenging Objective: LO 9-6 AACSB: Reflective thinking skills
18) An auditor who audits a business cycle that has low inherent risk should: A) increase the amount of audit evidence gathered. B) assign more experienced staff to that area. C) increase the performance materiality level for the area. D) expand planning procedures. Answer: C Terms: Low inherent risk Diff: Easy Objective: LO 9-5 AACSB: Reflective thinking skills
19) Match the terms below (a-h) with the definitions provided below (1-8): a. b. c. d. e. f. g. h.
Preliminary judgment about materiality Inherent risk Planned detection risk Audit assurance Acceptable audit risk Performance materiality level Control risk Materiality
________ 1. A measure of the risk that audit evidence for a segment will fail to detect misstatements exceeding the performance materiality amount, should such misstatements exist. ________ 2. A measure of the auditor's assessment of the likelihood that misstatements exceeding a performance materiality in a segment will not be prevented or detected by the client's internal controls. ________ 3. A measure of how much risk the auditor is willing to take that the financial statements may be materially misstated after the audit is completed and an unqualified audit opinion has been issued. ________ 4. The materiality allocated to any given account balance. ________ 5. The maximum amount by which the auditor believes that the statements could be misstated and still not affect the decisions of reasonable users. ________ 6. This term is synonymous with acceptable audit risk. ________ 7. The magnitude of an omission or misstatement of accounting information that makes it probable that the judgment of a reasonable person would have been changed. ________ 8. A measure of the auditor's assessment of the likelihood that there are material misstatements before considering the effectiveness of internal control. Answer: 1. c 2. g 3. e 4. f 5. a 6. d 7.h 8. b Terms: Business risk; Control risk; Acceptable audit risk; Materiality; Audit assurance; Preliminary judgment about materiality; Tolerable misstatement; Diff: Moderate Objective: LO 9-1, LO 9-2, LO 9-3, and LO 9-6 AACSB: Reflective thinking skills
20) Using your knowledge of the relationships among acceptable audit risk, inherent risk, control risk, planned detection risk, performance materiality, and planned evidence, state the effect on planned evidence (increase or decrease) of changing each of the following factors, while the other factors remain unchanged. 1. An increase in acceptable audit risk.________. 2. An increase in inherent risk. ________. 3. A decrease in control risk. ________. 4. An increase in planned detection risk. ________. 5. An increase in performance materiality. ________. Answer: 1. decrease 2. increase 3. decrease 4. decrease 5. decrease
Terms: Relationships among acceptable audit risk, inherent risk, control risk, planned detection risk, and tolerable misstatement with planned evidence Diff: Moderate Objective: LO 9-3, LO 9-4 and LO 9-6 AACSB: Analytic skills
21) If acceptable audit risk is low, and inherent risk and control risk are both low, then planned detection risk should be high. Answer: TRUE Terms: Relationship of acceptable audit risk, inherent risk, control risk, and planned detection risk. Diff: Easy Objective: LO 9-5 and LO 9-6 AACSB: Reflective thinking skills
22) If the audit assurance rate is 95%, then the level of acceptable audit risk is 5%. Answer: TRUE Terms: Audit risk Diff: Moderate Objective: LO 9-3 and LO 9-6 AACSB: Reflective thinking skills
23) A high detection risk equates to a low amount of audit evidence needed. Answer: FALSE Terms: Detection risk and amount of evidence needed Diff: Easy Objective: LO 9-6 AACSB: Reflective thinking skills
24) For a private company client, auditors are required to test any internal controls they believe have not been operating effectively during the period under audit. Answer: FALSE Terms: Auditors required to test internal controls for private companies Diff: Easy Objective: LO 9-6 AACSB: Reflective thinking skills
25) There is a direct relationship between acceptable audit risk and planned detection risk. Answer: TRUE Terms: Inherent risk and control risk Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
26) Acceptable audit risk and the amount of substantive evidence required are inversely related. Answer: TRUE Terms: Acceptable audit risk and substantive evidence Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
27) As control risk increases, the amount of substantive evidence the auditor plans to accumulate should increase. Answer: TRUE Terms: Control risk and substantive evidence Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
28) Inherent risk and control risk are directly related. Answer: FALSE Terms: Inherent risk and control risk Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
29) An acceptable audit risk assessment of low indicates a risky client requiring more extensive evidence, assignment of more experienced personnel, and/or a more extensive review of audit files. Answer: TRUE Terms: Acceptable audit risk Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
30) Audit assurance is the complement of planned detection risk, that is, one minus planned detection risk. Answer: FALSE Terms: Audit assurance and planned detection risk Diff: Moderate Objective: LO 9-6 AACSB: Reflective thinking skills
Learning Objective 9-7 1) If an auditor believes the chance of financial failure is high and there is a corresponding increase in business risk for the auditor, acceptable audit risk would likely: A) be reduced. B) be increased. C) remain the same. D) be calculated using a computerized statistical package. Answer: A Terms: Increase in business risk, acceptable audit risk Diff: Moderate Objective: LO 9-7 AACSB: Reflective thinking skills
2) When management has an adequate level of integrity for the auditor to accept the engagement but cannot be regarded as completely honest in all dealings, auditors normally: A) reduce acceptable audit risk and increase inherent risk. B) reduce inherent risk and control risk. C) increase inherent risk and control risk. D) increase acceptable audit risk and reduce inherent risk. Answer: A Terms: Management integrity Diff: Moderate Objective: LO 9-7 AACSB: Reflective thinking skills
3) When the auditor is attempting to determine the extent to which external users rely on a client's financial statements, they may consider several factors except for: A) client size. B) concentration of ownership. C) nature and amounts of liabilities. D) assessment of detection risk. Answer: D Terms: Extent to which external users rely on client's financial statements Diff: Moderate Objective: LO 9-7 AACSB: Reflective thinking skills
4) There are several factors that affect an audit firm's business risk and, therefore, acceptable audit risk. Discuss three of these factors. Answer: Business risk and acceptable audit risk are affected by: • The degree to which external users will rely on the statements. For large, publicly held clients, business risk is greater, and acceptable audit risk will be less, than for small, privately held clients, all things being equal. • The likelihood that a client will have financial difficulties after the audit report is issued. Business risk is greater, and acceptable audit risk will be lower, when the client is experiencing financial difficulties. • The auditor's evaluation of management's integrity. Business risk is greater and acceptable audit risk will be lower when the client's management has questionable integrity. Terms: Factors that affect business risk and acceptable audit risk Diff: Moderate Objective: LO 9-7 AACSB: Reflective thinking skills
5) Describe the audit risk model and each of its components. Answer: The planning form of the audit risk model is stated as follows: PDR where:
= PDR = AAR = IR = CR =
planned detection risk acceptable audit risk inherent risk control risk
Planned detection risk is a measure of the risk that audit evidence for an account (segment) will fail to detect misstatements exceeding a tolerable amount, should such misstatements exist. Planned detection risk determines the amount of substantive evidence that the auditor plans to accumulate. Acceptable audit risk is a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued. It is influenced primarily by the degree to which external users will rely on the statements, the likelihood that a client will have financial difficulties after the audit report is issued, and the auditor's evaluation of management's integrity. Inherent risk is a measure of the auditor's assessment of the likelihood that there are material misstatements in an account due to error or fraud before considering the effectiveness of internal control. Control risk is a measure of the auditor's assessment of the likelihood that misstatements exceeding a tolerable amount in an account (segment) will be prevented or detected on a timely basis by the client's internal controls. Terms: Audit risk model Diff: Moderate Objective: LO 9-5, LO 9-6, and LO 9-7 AACSB: Reflective thinking skills
6) If an auditor believes the client will have financial difficulties after the audit report is issued, and external users will be relying heavily on the financial statements, the auditor will probably set acceptable audit risk as low. Answer: TRUE Terms: Auditor believes client will have financial difficulties after audit report is issued; External users rely heavily on financial statements Diff: Moderate Objective: LO 9-7 AACSB: Reflective thinking skills
7) Engagement risk is effectively the audit firm's business risk. Answer: TRUE Terms: Engagement risk and business risk Diff: Moderate Objective: LO 9-7 AACSB: Reflective thinking skills
Learning Objective 9-8 1) Which of the following statements regarding inherent risk is correct? A) Inherent risk is unaffected by the auditor's experience with client's organization. B) Most auditors set a low inherent risk in the first year of an audit and increase it if experience shows that it was incorrect. C) Most auditors set a high inherent risk in the first year of an audit and reduce it in subsequent years as they gain more knowledge about the company. D) Inherent risk is dependent upon the strengths in client's internal control system. Answer: C Terms: Inherent risk Diff: Easy Objective: LO 9-8 AACSB: Reflective thinking skills
2) Auditors begin their assessments of inherent risk during audit planning. Which of the following would not help in assessing inherent risk during the planning phase? A) Obtaining client's agreement on the engagement letter B) Obtaining knowledge about the client's business and industry C) Touring the client's plant and offices D) Identifying related parties Answer: A Terms: Assessment of inherent risk during audit planning Diff: Easy Objective: LO 9-8 AACSB: Reflective thinking skills
3) Which of the following is not a primary consideration when assessing inherent risk? A) Nature of client's business B) Existence of related parties C) Degree of separation of duties D) Susceptibility to misappropriation of assets Answer: C Terms: Assessing inherent risk Diff: Challenging Objective: LO 9-8 AACSB: Reflective thinking skills
4) Harker, CPA is in the audit planning phase of Dracule Industries. An understanding needs to be established regarding the responsibilities of Harker and Dracule's Management. For each of the task items listed below indicate the responsible party from the list of choices given. Each choice may be used once, more than once or not at all. Responsible Party: Task to be performed: a. Auditor is responsible 1. Obtain an understanding of internal controls b. Management is responsible 2. Preparation of the financial statements c. Both are responsible 3. Assess inherent risk d. Neither are responsible 4. Following GAAP or IFRS 5. Detect Material Error 6. Comply with laws and regulations 7. Assess the risk of the allowance for doubtful accounts estimate 8. Determine the known and likely errors or misstatements Answer: 1. a 2. b 3. a 4. c 5. a 6. b 7. c 8. a Terms: Responsible parties Diff: Moderate Objective: LO 9-1, LO 9-2, LO 9-3, LO 9-4, LO 9-5, LO 9-6, LO 9-7, and LO 9-8 AACSB: Reflective thinking skills
5) The risk of material misstatement is a combination of two client controlled factors: inherent risk and control risk. What is inherent risk, why is it important and give examples of inherent risk factors. Answer: Inherent risk is the auditor's assessment of the likelihood that there are material misstatements in the audit segment before the consideration of internal controls. Inherent risk is important because it attempts to predict where misstatements are most and least likely to occur. Factors that the auditor considers when assessing inherent risk include but are not limited to: • The nature of the client's business • Results of previous audits • Initial versus repeat engagements • Related parties • Complex or nonroutine transactions • Judgment required to correctly record account balances and transactions • Makeup of the population • Factors related to fraudulent financial reporting • Factors related to misappropriation of assets Terms: Factors affecting inherent risk Diff: Easy Objective: LO 9-8 AACSB: Reflective thinking skills
6) The risk of fraud should be assessed for the entire audit as well as by cycle, account, and objective. Answer: TRUE Terms: Fraud Diff: Moderate Objective: LO 9-8 AACSB: Reflective thinking skills
7) The auditing profession has established guidelines for setting inherent risk. Answer: FALSE Terms: Inherent risk Diff: Moderate Objective: LO 9-8 AACSB: Reflective thinking skills
8) Auditors begin their assessment of inherent risk during the planning phase and update the assessments throughout the audit. Answer: TRUE Terms: Inherent risk Diff: Moderate Objective: LO 9-8 AACSB: Reflective thinking skills
Learning Objective 9-9 1) As the acceptable level of detection risk increases, an auditor may change the: A) timing of substantive tests by performing them at an interim date rather than year end. B) timing of the tests on controls by performing them throughout the year rather than at one time. C) assess the level of inherent risk to a lower amount. D) increase the sample size to achieve a more effective test. Answer: A Terms: Detection risk Diff: Moderate Objective: LO 9-9 AACSB: Reflective thinking skills
2) Auditors respond to risk primarily by: I. changing the extent of testing. II. changing the types of audit procedures. A) I only B) II only C) I and II D) neither I nor i Answer: C Terms: Risk assessment procedures Diff: Moderate Objective: LO 9-9 AACSB: Reflective thinking skills
3) In practice, auditors rarely assign numerical probabilities to inherent risk, control risk, or acceptable audit risk. It is more common to assess these risks as high, medium, or low. For each of the four situations below, fill in the blanks for planned detection risk and the amount of evidence you would plan to gather ("planned evidence") using the terms high, medium, or low. SITUATION SITUATION SITUATION SITUATION 1 2 3 4 Acceptable audit risk Low Low High High Inherent risk High Low Low Low Control risk High Low Medium Low Planned detection risk ________ ________ ________ ________ Planned evidence ________ ________ ________ ________
Answer: 1. low, high 2. medium, medium 3. medium, medium 4. high, low
Terms: Planned detection risk and planned evidence in relation to acceptable audit risk, inherent risk, and control risk Diff: Moderate Objective: LO 9-9 AACSB: Analytic skills
4) Dracule Industries is a privately owned business that sells medical product and devices to hospitals, clinics and the public. Certain changes have occurred in Dracule Industries during the year undergoing the audit. Harker needs to evaluate the effect these changes have on audit risk. Audit risk at the financial statement level is influenced by the risk of material misstatement; which include factors related to management, the industry and the entity or a combination thereof. For each of the following changes that have occurred during the year under audit identify the appropriate audit response for the list of responses. Each response can be used once, more than once or not at all. Client changes: Possible effect on the audit: 1. An internal audit department has been a. Increase the acceptable level of detection risk. established. b. Decrease the acceptable level of detection risk. 2. A new inventory control system has been c. Change has no effect on the acceptable level of installed that reduces the access of unauthorized detection risk. parties. 3. Inexperienced accounting personnel were hired in the accounting department. 4. Excess cash was used to purchase complex derivatives. 5. Controls over the sales credit approval process have laxed. 6. New government regulations now apply to Dracule Industries. 7. Management has become overly aggressive in reaching target goals. 8. An expert was hired to help determine the value of the ore content in ending materials inventory. Answer: 1. a 2. a 3. b 4. b 5. b 6. b 7. b 8. a
Terms: Audit risk Diff: Moderate Objective: LO 9-6, LO 9-7, LO 9-8, and LO 9-9 AACSB: Analytic skills
5) In applying the audit risk model, auditors are concerned about overstatements, not understatements. Answer: FALSE Terms: Audit risk model Diff: Easy Objective: LO 9-9 AACSB: Reflective thinking skills
6) One major limitation in the application of the audit risk model is the difficulty of measuring the components of the model. Answer: TRUE Terms: Audit risk Diff: Easy Objective: LO 9-9 AACSB: Reflective thinking skills
Learning Objective 9-10 1) When taken together, the concepts of risk and materiality in auditing: A) measure the uncertainty of amounts of a given magnitude. B) measure uncertainty only. C) measure magnitude only. D) measure inherent risk. Answer: A Terms: Materiality and risk Diff: Moderate Objective: LO 9-10 AACSB: Reflective thinking skills
2) Which of the following is a correct statement? A) The audit risk model helps in evaluating results. B) Special care must be exercised when the auditor decides on the basis of accumulated evidence that the original assessment of control risk was understated. C) The auditor violates due care if he knows that the original assessment of audit risk is inappropriate and he fails to change it. D) Performance materiality is part of the audit risk model. Answer: C Terms: Risk assessment procedures Diff: Moderate Objective: LO 9-10 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e (Arens) Chapter 10 Internal Control, Control Risk, and Section 404 Audits Learning Objective 10-1 1) Which of the following is not one of the three primary objectives of effective internal control? A) Reliability of financial reporting B) Efficiency and effectiveness of operations C) Compliance with laws and regulations D) Assurance of elimination of business risk Answer: D Terms: Internal control objectives Diff: Easy Objective: LO 10-1 AACSB: Analytic skills
2) Which of management's assertions with respect to implementing internal controls is the auditor primarily concerned? A) Efficiency of operations B) Reliability of financial reporting C) Effectiveness of operations D) Compliance with applicable laws and regulations Answer: B Terms: Management's assertions Diff: Easy Objective: LO 10-1 AACSB: Reflective thinking skills
3) Internal controls: A) are implemented by and are the responsibility of the auditors. B) consist of policies and procedures designed to provide reasonable assurance that the company achieves its objectives and goals. C) guarantee that the company complies with all laws and regulations. D) only apply to SEC companies. Answer: B Terms: Internal control Diff: Moderate Objective: LO 10-1 AACSB: Analytic skills
4) Internal controls are not designed to provide reasonable assurance that: A) all frauds will be detected. B) transactions are executed in accordance with management's authorization. C) the company's resources are used efficiently and effectively. D) company personnel comply with applicable rules and regulations. Answer: A Terms: Internal controls; reasonable assurance Diff: Moderate Objective: LO 10-1 AACSB: Analytic skills
5) Describe each of the three broad objectives management typically has for internal control. With which of these objectives is the auditor primarily concerned? Answer: The three objectives are: • Reliability of financial reporting. Management has both a legal and professional responsibility to be sure that the information is fairly presented in according with reporting requirements such as U.S. GAAP and IFRS. • Efficiency and effectiveness of operations. Controls within an organization are meant to encourage efficient and effective use of its resources to optimize the company's goals. • Compliance with laws and regulations. Public, non-public, and not-for-profit organizations are required to follow many laws and regulations. Some relate to accounting only indirectly, such as environmental protection and civil rights laws. Others are closely related to accounting, such as income tax regulations and anti-fraud legal provisions. The auditor's focus in both the audit of financial statements and the audit of internal controls is on the controls over the reliability of financial reporting plus those controls over operations and compliance with laws and regulations that could materially affect financial reporting. Terms: Three broad objectives management has for internal control Diff: Easy Objective: LO 10-1 AACSB: Reflective thinking skills
6) Section 404 of the Sarbanes-Oxley Act requires that public companies issue an internal control report. Answer: TRUE Terms: Sarbanes-Oxley Act Diff: Easy Objective: LO 10-1 AACSB: Reflective thinking skills Topic: SOX
7) Management has a legal and professional responsibility to be sure that the financial statements are prepared in accordance with reporting requirements of applicable accounting frameworks. Answer: TRUE Terms: Internal control Diff: Moderate Objective: LO 10-1 AACSB: Reflective thinking skills
Learning Objective 10-2 1) Which of the following is responsible for establishing a private company's internal control? A) Senior Management B) Internal Auditors C) FASB D) Audit committee Answer: A Terms: Internal control Diff: Easy Objective: LO 10-2 AACSB: Reflective thinking skills
2) Two key concepts that underlie management's design and implementation of internal control are: A) costs and materiality. B) absolute assurance and costs. C) inherent limitations and reasonable assurance. D) collusion and materiality. Answer: C Terms: Internal control design and implementation Diff: Easy Objective: LO 10-2 AACSB: Analytic skills
3) The PCAOB places responsibility for the reliability of internal controls over the financial reporting process on: A) the company's board of directors. B) the audit committee of the board of directors. C) management. D) the CFO and the independent auditors. Answer: C Terms: PCAOB; internal control responsibility Diff: Easy Objective: LO 10-2 AACSB: Reflective thinking skills Topic: Public
4) Which of the following parties provides an assessment of the effectiveness of internal control over financial reporting for public companies? A) Management Financial statement auditors Yes Yes B) Management No
Financial statement auditors No
Management Yes
Financial statement auditors No
Management No
Financial statement auditors Yes
C)
D)
Answer: A
Terms: Internal control effectiveness Diff: Easy Objective: LO 10-2 AACSB: Reflective thinking skills
5) An act of two or more employees to steal assets and cover their theft by misstating the accounting records would be referred to as: A) collusion. B) a material weakness. C) a control deficiency. D) a significant deficiency. Answer: A Terms: Employees steal assets Diff: Easy Objective: LO 10-2 AACSB: Ethical understanding and reasoning abilities
6) Sarbanes-Oxley requires management to issue an internal control report that includes two specific items. Which of the following is one of these two requirements? A) A statement that management is responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting B) A statement that management and the board of directors are jointly responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting C) A statement that management, the board of directors, and the external auditors are jointly responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting D) A statement that the external auditors are solely responsible Answer: A Terms: Sarbanes-Oxley; Internal control report Diff: Easy Objective: LO 10-2 AACSB: Reflective thinking skills Topic: SOX
7) When management is evaluating the design of internal control, management evaluates whether the control can do which of the following? A) Detect material misstatements Correct material misstatements Yes Yes B) Detect material misstatements Correct material misstatements No No C) Detect material misstatements Correct material misstatements Yes No D) Detect material misstatements Correct material misstatements No Yes Answer: C
Terms: Internal control design Diff: Easy Objective: LO 10-2 AACSB: Analytic skills Topic: SOX
8) When one material weakness is present at the end of the year, management of a public company must conclude that internal control over financial reporting is: A) insufficient. B) inadequate. C) ineffective. D) inefficient. Answer: C Terms: Internal control weakness; Public company Diff: Easy Objective: LO 10-2 AACSB: Analytic skills Topic: Public
9) The auditors primary purpose in auditing the client's system of internal control over financial reporting is: A) to prevent fraudulent financial statements from being issued to the public. B) to evaluate the effectiveness of the company's internal controls over all relevant assertions in the financial statements. C) to report to management that the internal controls are effective in preventing misstatements from appearing on the financial statements. D) to efficiently conduct the Audit of Financial Statements. Answer: B Terms: Primary purpose to audit system of internal control Diff: Moderate Objective: LO 10-2 AACSB: Analytic skills Topic: Public
10) Management must disclose material weaknesses in internal control in its audit report: A) whenever the weakness is deemed significant to a single class of transactions. B) whenever the weakness is significant to overall financial reporting objectives. C) if the weakness exists at the end of the year. D) only if the auditor identifies the weakness as significant. Answer: C Terms: Material weaknesses in internal control Diff: Moderate Objective: LO 10-2 AACSB: Reflective thinking skills Topic: Public
11) In performing the audit of internal control over financial reporting the auditor emphasizes internal control over class of transactions because: A) the accuracy of accounting system outputs depends heavily on the accuracy of inputs and processing. B) the class of transaction is where most fraud schemes occur. C) account balances are less important to the auditor then the changes in the account balances. D) classes of transactions tests are the most efficient manner to compensate for inherent risk. Answer: A Terms: Internal control over class of transactions Diff: Moderate Objective: LO 10-2 AACSB: Reflective thinking skills Topic: Public
12) Internal controls can never be regarded as completely effective. Even if company personnel could design an ideal system, its effectiveness depends on the: A) adequacy of the computer system. B) proper implementation by management. C) ability of the internal audit staff to maintain it. D) competency and dependability of the people using it. Answer: D Terms: Internal control effectiveness Diff: Moderate Objective: LO 10-2 AACSB: Ethical understanding and reasoning abilities
13) When considering internal controls, an important point to consider is that: A) auditors can ignore controls affecting internal management information. B) auditors are concerned with the client's internal controls over the safeguarding of assets if they affect the financial statements. C) management is responsible for understanding and testing internal control over financial reporting. D) companies must use the COSO framework to establish internal controls. Answer: B Terms: Effectively designed internal controls; testing of controls Diff: Moderate Objective: LO 10-2 AACSB: Analytic skills
14) Of the following statements about internal controls, which one is least likely to be correct? A) No one person should be responsible for the custodial responsibility and the recording responsibility for an asset. B) Transactions must be properly authorized before such transactions are processed. C) Because of the cost-benefit relationship, a client may apply controls on a test basis. D) Control procedures reasonably ensure that collusion among employees cannot occur. Answer: D Terms: Internal controls Diff: Moderate Objective: LO 10-2 AACSB: Reflective thinking skills
15) The Sarbanes-Oxley Act requires: A) all public companies to issue reports on internal controls. B) all public companies to define adequate internal controls. C) the auditor of public companies to design effective internal controls. D) the auditor of public companies to withdraw from an engagement if internal controls are weak. Answer: A Terms: Sarbanes-Oxley Act Diff: Challenging Objective: LO 10-2 AACSB: Reflective thinking skills Topic: SOX
16) The financial statements may not correctly reflect accounting frameworks such as GAAP or IFRS if the: A) controls affecting the reliability of financial reporting are inadequate. B) company's controls do not promote efficiency. C) company's controls do not promote effectiveness. D) company's controls do not promote compliance with applicable rules and regulations. Answer: A Terms: Financial statements reflect accounting frameworks Diff: Challenging Objective: LO 10-2 AACSB: Reflective thinking skills
17) The primary emphasis by auditors is on controls over: A) classes of transactions. B) account balances. C) both A and B, because they are equally important. D) both A and B, because they vary from client to client. Answer: A Terms: Primary emphasis by auditors on controls Diff: Challenging Objective: LO 10-2 AACSB: Reflective thinking skills
18) An auditor should consider two key issues when obtaining an understanding of a client's internal controls. These issues are: A) the effectiveness and efficiency of the controls. B) the frequency and effectiveness of the controls. C) the design and operating effectiveness of the controls. D) the implementation and operating effectiveness of the controls. Answer: C Terms: Key issues understanding client's internal controls Diff: Challenging Objective: LO 10-2 AACSB: Reflective thinking skills
19) When a company designs and implements internal controls, cost of the controls is not a valid consideration. Answer: FALSE Terms: Design and implement internal control; cost Diff: Easy Objective: LO 10-2 AACSB: Reflective thinking skills
20) Reasonable assurance allows for: A) low likelihood that material misstatements will not be prevented or detected by internal controls. B) no likelihood that material misstatements will not be prevented or detected by internal control. C) moderate likelihood that material misstatements will not be prevented or detected by internal control. D) high likelihood that material misstatements will not be prevented or detected by internal control. Answer: A Terms: Reasonable assurance Diff: Easy Objective: LO 10-2 AACSB: Reflective thinking skills Topic: Public
21) Which of the following is most correct regarding the requirements under Section 404 of the Sarbanes Oxley Act? A) The audits of internal control and the financial statements provide reasonable assurance as to misstatements. B) The audit of internal control provides absolute assurance of misstatement. C) The audit of financial statements provides absolute assurance of misstatement. D) The audits of internal control and the financial statements provide absolute assurance as to misstatements. Answer: A Terms: Sarbanes Oxley Act Section 404 Diff: Easy Objective: LO 10-2 AACSB: Reflective thinking skills
22) To issue a report on internal control over financial reporting for a public company, an auditor must: A) evaluate management's assessment process. B) independently assess the design and operating effectiveness of internal control. C) evaluate management's assessment process and independently assess the design and operating effectiveness of internal control. D) test controls over significant account balances. Answer: C Terms: Internal control over financial reporting for public company Diff: Moderate Objective: LO 10-2 AACSB: Reflective thinking skills Topic: Public
Learning Objective 10-3 1) Which of the following activities would be least likely to strengthen a company's internal control? A) Separating accounting from other financial operations B) Maintaining insurance for fire and theft C) Fixing responsibility for the performance of employee duties D) Carefully selecting and training employees Answer: B Terms: Not strengthen internal control Diff: Easy Objective: LO 10-3 AACSB: Analytic skills
2) Which of the following components of the control environment define the existing lines of responsibility and authority? A) Organizational structure B) Management philosophy and operating style C) Human resource policies and practices D) Management integrity and ethical values Answer: A Terms: Control environment components; Responsibility and authority Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
3) Which of the following factors may increase risks to an organization? A) Geographic dispersion of Presence of new information company operations technologies Yes Yes B) Geographic dispersion of company operations No
Presence of new information technologies No
Geographic dispersion of company operations Yes
Presence of new information technologies No
Geographic dispersion of company operations No
Presence of new information technologies Yes
C)
D)
Answer: A
Terms: Increase risks to an organization Diff: Moderate Objective: LO 10-3 AACSB: Analytic skills
4) Which of the following statements is most correct with respect to separation of duties? A) A person who has temporary or permanent custody of an asset should account for that asset. B) Employees who authorize transactions should not have custody of related assets. C) Employees who open cash receipts should record the amounts in the subsidiary ledgers. D) Employees who authorize transactions should have recording responsibility for these transactions. Answer: B Terms: Separation of IT duties Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
5) Authorizations can be either general or specific. Which of the following is not an example of a general authorization? A) Automatic reorder points for raw materials inventory B) A sales manager's authorization for a sales return C) Credit limits for various classes of customers D) A sales price list for merchandise Answer: B Terms: General or specific authorizations Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
6) Which of the following is correct with respect to the design and use of business documents? A) The documents should be in paper format. B) Documents should be designed for a single purposes to avoid confusion in their use. C) Documents should be designed to be understandable only by those who use them. D) Documents should be prenumbered consecutively to facilitate control over missing documents. Answer: D Terms: Design and use of business documents Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
7) Which of the following best describes the purpose of control activities? A) The actions, policies and procedures that reflect the overall attitudes of management B) The identification and analysis of risks relevant to the preparation of financial statements C) The policies and procedures that help ensure that necessary actions are taken to address risks to the achievement of the entity's objectives D) Activities that deal with the ongoing assessment of the quality of internal control by management Answer: C Terms: Control activities Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
8) Which of the following deal with ongoing or periodic assessment of the quality of internal control by management? A) Quality monitoring activities B) Monitoring activities C) Oversight activities D) Management activities Answer: B Terms: Quality of internal control Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
9) Which of the following best describes an entity's accounting information and communication system? A) Record and Monitor process transactions transactions Initiate transactions Yes Yes Yes B) Monitor transactions No
Record and process transactions No
Initiate transactions No
Monitor transactions Yes
Record and process transactions No
Initiate transactions No
Monitor transactions No
Record and process transactions Yes
Initiate transactions Yes
C)
D)
Answer: D
Terms: Accounting information and communication system Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
10) An audit procedure that would most likely be used by an auditor in performing tests of control procedures in which the segregation of functions and that leaves no "audit" trail is: A) inspection. B) observation. C) reperformance. D) reconciliation. Answer: B Terms: Tests of control procedures; segregation of functions Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
11) Internal controls normally include procedures designed to provide reasonable assurance that: A) employees act with integrity when performing their assigned tasks. B) transactions are executed in accordance with management's authorization. C) decision processes leading to management's authorization of transactions are sound. D) collusive activities would be detected by segregation of employee duties. Answer: B Terms: Internal controls; reasonable assurance Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
12) Which of the following is not one of the subcomponents of the control environment? A) Management's philosophy and operating style B) Organizational structure C) Adequate separation of duties D) Commitment to competence Answer: C Terms: Subcomponents of control environment Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
13) It is important for the CPA to consider the competence of the clients' personnel because their competence has a direct impact upon the: A) cost/benefit relationship of the system of internal control. B) achievement of the objectives of internal control. C) comparison of recorded accountability with assets. D) timing of the tests to be performed. Answer: B Terms: Competence of client personnel Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
14) Proper segregation of functional responsibilities calls for separation of: A) authorization, execution, and payment. B) authorization, recording, and custody. C) custody, execution, and reporting. D) authorization, payment, and recording. Answer: B Terms: Segregation of functional responsibilities Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
15) Without an effective ________, the other components of the COSO framework are unlikely to result in effective internal control, regardless of their quality. A) risk assessment policy B) monitoring policy C) control environment D) system of control activities Answer: C Terms: Internal control Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
16) Which of the following groups establishes and maintains the company's internal controls? A) Internal auditors B) Board of Directors C) Management D) Audit committee Answer: C Terms: Establishes and maintains company's internal control Diff: Challenging Objective: LO 10-3 AACSB: Reflective thinking skills
17) If a company has an effective internal audit department: A) the internal auditors can express an opinion on the fairness of the financial statements. B) their work cannot be used by the external auditors per PCAOB Standard 5. C) it can reduce external audit costs by providing direct assistance to the external auditors. D) the internal auditors must be CPAs in order for the external auditors to rely on their work. Answer: C Terms: Understanding of internal audit functions Diff: Challenging Objective: LO 10-3 AACSB: Analytic skills
18) To promote operational efficiency, the internal audit department would ideally report to: A) line management. B) PCAOB. C) Chief Accounting Officer. D) audit committee. Answer: D Terms: Operational efficiency Diff: Challenging Objective: LO 10-3 AACSB: Reflective thinking skills
19) Hanlon Corp. maintains a large internal audit staff that reports directly to the accounting department. Audit reports prepared by the internal auditors indicate that the system is functioning as it should and that the accounting records are reliable. An independent auditor will probably: A) eliminate tests of controls. B) increase the depth of the study and evaluation of administrative controls. C) avoid duplicating the work performed by the internal audit staff. D) place limited reliance on the work performed by the internal audit staff. Answer: D Terms: Internal audit Diff: Challenging Objective: LO 10-3 AACSB: Analytic skills
20) External financial statement auditors must obtain evidence regarding what attributes of an internal audit (IA) department if the external auditors intend to rely on IA's work? A) Integrity B) Objectivity C) Competence D) All of the above Answer: D Terms: External auditor reliance on internal auditors' work Diff: Challenging Objective: LO 10-3 AACSB: Reflective thinking skills
21) To obtain an understanding of an entity's control environment, an auditor should concentrate on the substance of management's policies and procedures rather than their form because: A) management may establish appropriate policies and procedures but not act on them. B) the board of directors may not be aware of management's attitude toward the control environment. C) the auditor may believe that the policies and procedures are inappropriate for that particular entity. D) the policies and procedures may be so weak that no reliance is contemplated by the auditor. Answer: A Terms: Substance of management's policies and procedures Diff: Challenging Objective: LO 10-3 AACSB: Analytic skills
22) Control activities help assure that the necessary actions are taken to address risks to the achievement of the company's objectives. List the five types of control activities. Answer: 1. Adequate separation of duties 2. Proper authorization of transactions and activities 3. Adequate documents and records 4. Physical control over assets and records 5. Independent checks on performance Terms: Control activities Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills Topic: Public
23) Certain principles dictate the proper design and use of documents and records. Briefly describe several of these principles. Answer: • Documents should be prenumbered consecutively to facilitate control over missing documents and as an aid in locating documents when they are needed at a later date. • Documents and records should be prepared at the time a transaction takes place, or as soon as possible thereafter, to minimize timing errors. • Documents and records should be designed for multiple uses, when possible, to minimize the number of different forms. For example, a properly designed and used shipping document can be the basis for releasing goods from storage to the shipping department, informing billing of the quantity of goods to bill to the customer and the appropriate billing date, and updating the perpetual inventory records. • Documents and records should be constructed in a manner that encourages correct preparation. This can be done by providing internal checks within the form or record. For example, computer screen prompts may force online data entry of critical information before the record is electronically routed for authorizations and approvals. Similarly, screen controls can validate the information entered, such as when an invalid general ledger account number is automatically rejected when the account number does not match the chart of accounts master file. Terms: Principles for design and use of documents and records Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
24) Management's identification and analysis of risk is an ongoing process and is a critical component of effective internal control. An important first step is for management to identify factors that may increase risk. Identify at least five factors, observable by management, which may lead to increased risk in a typical business organization. Answer: There are many factors that may lead to increased risk in an organization. Some examples include: • failure to meet prior objectives, • quality of personnel, • geographic dispersion of company operations, • significance and complexity of core business processes, • introduction of new information technologies • entrance of new competitors and, • economic downturns Terms: Factors which may lead to increased risk Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
25) Separation of duties is essential in preventing errors and intentional misstatements on the financial statements. List below the four general guidelines. Answer: 1. Separation of custody of the assets from accounting 2. Separation of the authorization of transactions from custody of related assets 3. Separation of operational responsibility from record keeping responsibility 4. Separation of IT duties from user departments Terms: General guidelines for separation of duties Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
26) In developing an understanding of the client's accounting information system the auditor follows a sequential process. Describe the process below: Answer: 1. Major classes of transactions of the entity 2. How these transactions are initiated and recorded 3. What accounting records exist and their nature 4. How the system captures other events that are significant to the financial statements 5. The nature and details of the financial reporting process followed Terms: Sequential process Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
27) The internal control framework developed by COSO includes five so-called "components" of internal control. Discuss each of these five components. Answer: Five components of internal control are: • The control environment. The control environment consists of the actions, policies, and procedures that reflect the overall attitudes of top management, directors, and owners of an entity about internal control and its importance to the company. • Risk assessment. This is management's identification and analysis of risks relevant to the preparation of financial statements in accordance with appropriate accounting frameworks such as GAAP or IFRS. • Information and communication. These are the methods used to initiate, record, process, and report the entity's transactions and to maintain accountability for the related assets. • Control activities. These are the policies and procedures that management has established to meet its objectives for financial reporting. • Monitoring. This is management's ongoing and periodic assessment of the quality of internal control performance to determine whether controls are operating as intended and are modified when needed. Terms: Internal control framework; COSO Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
28) Discuss what is meant by the term "control environment" and identify four control environment subcomponents that the auditor should consider. Answer: The control environment consists of the actions, policies, and procedures that reflect the overall attitudes of top management, directors, and owners of an entity about control and its importance to the entity. Subcomponents include: • integrity and ethical values • commitment to competence • board of director or audit committee participation • management's philosophy and operating style • organizational structure • human resource policies and practices. Terms: Control environment Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
29) List the three steps in management's assessment of risk and then list two of the categories of management assertions that must be satisfied during the risk assessment process. Answer: The steps taken by management in the risk assessment process are: • identify the factors affecting risk • assess the significance of risks and likelihood of occurrence • determine actions necessary to manage the risks. The categories of management assertions that must be satisfied are: • assertions about classes of transactions and other events • assertions about account balances • assertions about presentation and disclosure. Terms: COSO components of internal control and risk assessment Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
30) Control activities are a subcomponent of the information and communication component of internal control. Answer: FALSE Terms: Internal control components Diff: Easy Objective: LO 10-3 AACSB: Analytic skills
31) Adequate documents and records is a subcomponent of the control environment. Answer: FALSE Terms: Control environment Diff: Easy Objective: LO 10-3 AACSB: Reflective thinking skills
32) The chart of accounts is helpful in preventing classification errors if it accurately describes which type of transaction should be in each account. Answer: TRUE Terms: Internal control components Diff: Easy Objective: LO 10-3 AACSB: Reflective thinking skills
33) Auditing standards prohibit reliance on the work of internal auditors due to the lack of independence of the internal auditors. Answer: FALSE Terms: Auditing standards; internal auditors Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
34) If an auditor wishes to rely on the work of internal auditors (IA), the auditor must obtain satisfactory evidence related to the IA's competence, integrity, and objectivity. Answer: TRUE Terms: Internal auditors Diff: Moderate Objective: LO 10-3 AACSB: Reflective thinking skills
Learning Objective 10-4 1) When the auditor attempts to understand the operation of the accounting system by tracing a few transactions through the accounting system, the auditor is said to be: A) tracing. B) vouching. C) performing a walk-through. D) testing controls. Answer: C Terms: Tracing transactions through accounting system Diff: Easy Objective: LO 10-4 AACSB: Analytic skills
2) The purpose of phase 3 in the "process for understanding internal control and assessing control risk" is to: A) design, perform and evaluate tests of controls. B) obtain and document an understanding of internal control design an operation. C) assess control risk. D) decide planned detection risk and substantive tests. Answer: A Terms: Process for understanding internal control and assessing risk Diff: Moderate Objective: LO 10-4 AACSB: Reflective thinking skills
3) Narratives, flowcharts, and internal control questionnaires are three common methods of:
A) testing the internal controls. B) documenting the auditor's understanding of internal controls. C) designing the audit manual and procedures. D) documenting the auditor's understanding of a client's organizational structure. Answer: B Terms: Narratives, flowcharts, and internal control questionnaires Diff: Easy Objective: LO 10-4 AACSB: Reflective thinking skills
4) When dealing with the documentation of internal control: A) in a narrative, most questions simply require a "yes" or "no" response. B) questionnaires offer useful checklists to remind the auditor of the many different types of internal controls that should exist. C) questionnaires and flowcharts should not be used together. D) flowcharts fail to show the segregation of duties in the company. Answer: B Terms: Internal control Diff: Moderate Objective: LO 10-4 AACSB: Reflective thinking skills
5) Audit evidence regarding the separation of duties is normally best obtained by: A) preparing flowcharts of operational processes. B) preparing narratives of operational processes. C) observation of employees applying control activities. D) inquiries of employees applying control activities. Answer: C Terms: Audit evidence of separation of duties Diff: Moderate Objective: LO 10-4 AACSB: Reflective thinking skills
6) Walkthroughs combine observation, inspection, and inquiry to assure that the controls designed by management have been implemented. Answer: TRUE Terms: Walkthroughs; understanding internal control Diff: Easy Objective: LO 10-4 AACSB: Reflective thinking skills Topic: Public
7) A narrative should describe the disposition of every document and record in the system. Answer: TRUE Terms: Understanding internal controls Diff: Easy Objective: LO 10-4 AACSB: Reflective thinking skills
8) For most uses, flowcharts are superior to narratives as a method of communicating the characteristics of internal control. Answer: TRUE Terms: Flowcharts Diff: Moderate Objective: LO 10-4 AACSB: Reflective thinking skills
9) When documenting their understanding of a client's internal controls, auditors are required to use narratives. Answer: FALSE Terms: Understanding internal controls; narratives Diff: Moderate Objective: LO 10-4 AACSB: Reflective thinking skills
Learning Objective 10-5 1) The person responsible for reconciling sales invoices to customer orders does not access to the company's master price list in order to correctly compute sales. This is an example of a(n): A) operating deficiency. B) design deficiency. C) training deficiency. D) management deficiency. Answer: B Terms: Reconciling sales invoices to correctly compute sales Diff: Moderate Objective: LO 10-5 AACSB: Analytic skills
2) You are performing the audit of internal control for Clifton Company. Which of the following would represent a material weakness in internal control? A) The company's audit committee has experienced unusual turnover of members. B) The company's CFO was indicted for embezzling from the company. C) Bank reconciliations are done monthly. D) The CEO retired after twenty years of service to the company. Answer: B Terms: Material weaknesses in internal control Diff: Moderate Objective: LO 10-5 AACSB: Analytic skills Topic: Public
3) The employee in charge of authorizing credit to the company's customers does not fully understand the concept of credit risk. This lack of knowledge would constitute: A) a deficiency in operation of internal controls. B) a deficiency in design of internal controls. C) a deficiency of management. D) not constitute a deficiency. Answer: A Terms: Lack of knowledge Diff: Moderate Objective: LO 10-5 AACSB: Ethical understanding and reasoning abilities
4) When assessing whether the financial statements are auditable, the auditor must consider: A) that the integrity of management and the adequacy of accounting records are the two primary factors determining auditability. B) that the integrity of management and the adequacy of risk management are the two primary factors determining auditability. C) that if all of the transaction information is available only in electronic form without a visible audit trail, the company cannot be audited. D) the control risk before determining if the entity is auditable. Answer: A Terms: Auditability of financial statements Diff: Moderate Objective: LO 10-5 AACSB: Ethical understanding and reasoning abilities
5) Once auditors determine that entity level controls are designed and placed in the operation they: A) make a preliminary assessment for each transaction-related audit objective for each major type of transaction. B) make a preliminary assessment of control risk. C) obtain an understanding of the design and implementation of internal control. D) prepare audit documentation in order to opine on the company's internal control system. Answer: A Terms: Entry level controls Diff: Moderate Objective: LO 10-5 AACSB: Analytic skills
6) Which of the following is the correct definition of "control deficiency"? A) A control deficiency exists if the design or operation of controls does not permit company personnel to prevent or detect misstatements on a timely basis. B) A control deficiency exists if one or more deficiencies exist that adversely affect a company's ability to prepare external financial statements reliably. C) A control deficiency exists if the design or operation of controls results in a more than remote likelihood that controls will not prevent or detect misstatements. D) A control deficiency exists if the design or operation of controls results in a more than probable likelihood that controls will prevent or detect misstatements. Answer: A Terms: Control deficiency Diff: Moderate Objective: LO 10-5 AACSB: Reflective thinking skills
7) Which of the following deficiency exists if a necessary control is missing or not properly formulated? A) Control B) Significant C) Design D) Operating Answer: C Terms: Control deficiency Diff: Moderate Objective: LO 10-5 AACSB: Reflective thinking skills
8) To determine if significant internal control deficiencies are material weaknesses, they must be evaluated on their: A) Likelihood Significance Yes Yes B) Likelihood No
Significance No
Likelihood Yes
Significance No
Likelihood No
Significance Yes
C)
D)
Answer: A Terms: Internal control deficiencies are material weaknesses Diff: Moderate Objective: LO 10-5 AACSB: Reflective thinking skills
9) The auditor must communicate: A) only material weaknesses in internal control to those charged with governance. B) both significant deficiencies and material weaknesses in internal control to those charged with governance. C) any significant deficiencies in internal control to those charged with governance using a management letter. D) issues regarding internal control to those charged with governance in writing within 90 days following the audit report release. Answer: B Terms: Significant deficiencies Diff: Moderate Objective: LO 10-5 AACSB: Reflective thinking skills
10) Before making the final assessment of internal control at the end of an integrated audit, the auditor must: A) Test controls Perform substantive tests of details Yes Yes B) Test controls No
Perform substantive tests of details No
Test controls Yes
Perform substantive tests of details No
Test controls No
Perform substantive tests of details Yes
C)
D)
Answer: A
Terms: Final assessment of internal control for integrated audit Diff: Moderate Objective: LO 10-5 AACSB: Analytic skills Topic: Public
11) Significant deficiencies and material weaknesses in internal control of a public company must be reported in writing to which of the following? A) Public Company Accounting Oversight Board B) Members of management who are responsible for the related area of the company C) Audit committee of the company's board of directors and to management D) AICPA Answer: C Terms: Internal controls; significant deficiencies; material weaknesses Diff: Moderate Objective: LO 10-5 AACSB: Reflective thinking skills Topic: Public
12) Significant deficiencies are matters that come to an auditor's attention and should be communicated to an entity's audit committee because they represent: A) material frauds perpetrated by high-level management. B) internal control deficiencies that could adversely affect a company's ability to initiate, record, process, or report external financial statements reliably. C) flagrant violations of the entity's documented conflict-of-interest policies. D) intentional attempts by client personnel to limit the scope of the auditor's field work. Answer: B Terms: Significant deficiencies; audit committee Diff: Moderate Objective: LO 10-5 AACSB: Analytic skills
13) How must significant deficiencies and material weaknesses be communicated to those charged with governance? A) Either oral or written communication is acceptable. B) Oral communication is required. C) Written communication is required. D) Written communication is required for material weaknesses, but oral communication is allowed for significant deficiencies. Answer: C Terms: Significant deficiencies and material weaknesses; governance Diff: Moderate Objective: LO 10-5 AACSB: Reflective thinking skills
14) A five-step approach can be used to identify deficiencies, significant deficiencies, and material weaknesses. The first step in this approach is: A) identify the absence of key controls. B) consider the possibility of compensating controls. C) determine potential misstatements that could result. D) identify existing controls. Answer: D Terms: Control risk Diff: Moderate Objective: LO 10-5 AACSB: Analytic skills
15) When assessing control risk: A) many auditors use actuarial tables to assist in the control risk assessment process. B) each control can be used to satisfy only one audit objective. C) many auditors use a control risk matrix to assist in the control risk assessment process. D) all controls, including key controls, should be considered. Answer: C Terms: Assessed level of control risk Diff: Challenging Objective: LO 10-5 AACSB: Reflective thinking skills
16) When a compensating control exists, the absence of a key control: A) is no longer a concern because there is no longer a significant deficiency or material weakness. B) is still a major concern to the auditor. C) could cause a material loss, so it must be tested using substantive procedures. D) is magnified and must be removed from the sampling process and examined in its entirety. Answer: A Terms: Compensating control; key control Diff: Challenging Objective: LO 10-5 AACSB: Analytic skills
17) You are the audit manager for a new audit client. Your staff auditors are unsure of what constitutes a control deficiency. Discuss the terms control deficiency, design deficiency, and operating deficiency. Answer: A control deficiency exists if the design or operation of controls does not permit company personnel to prevent or detect misstatements on a timely basis in the normal course of performing assigned functions. A design deficiency exists if a necessary control is missing or not properly designed. An operating deficiency exists if a well-designed control does not operate as designed or if the person performing the control is insufficiently qualified or authorized. Terms: Control deficiency; Design deficiency; Operating deficiency Diff: Moderate Objective: LO 10-5 AACSB: Reflective thinking skills
18) Define the following terms: control deficiency, significant deficiency, and material weakness. Answer: • A control deficiency exists if the design or operation of controls does not permit company personnel to prevent or detect misstatements on a timely basis in the normal course of performing their assigned functions. • A significant deficiency exists if one or more control deficiencies exist that is less severe than a material weakness but important enough to merit attention by those responsible for oversight of the company's financial statements. • A material weakness exists if a significant deficiency, by itself, or in combination with other significant deficiencies, results in a reasonable possibility that internal control will not prevent or detect material financial statement misstatements on a timely basis. Terms: Control deficiency; Significant deficiency; Material weakness Diff: Moderate Objective: LO 10-5 AACSB: Reflective thinking skills
19) Describe the auditor's responsibilities related to required communications between the auditor and those charged with governance (remove auditor committee) regarding internal control. Answer: The auditor must communicate significant deficiencies and material weaknesses in writing to those charged with governance as soon as they become aware of their existence. The communication is usually addressed to the audit committee and to management. Timely communications may provide management an opportunity to address control deficiencies before management's report on internal control must be issued. In some instances, deficiencies can be corrected sufficiently early such that both management and the auditor can conclude that controls are operating effectively as of the balance sheet date. These communications must be made no later than 60 days following the audit report release. Terms: Control activities Diff: Challenging Objective: LO 10-5 AACSB: Reflective thinking skills
20) The text suggested a five-step approach to identify deficiencies, significant deficiencies, and material weaknesses. Describe this approach. Answer: 1. Identify existing controls. Because deficiencies and material weaknesses are the absence of adequate controls, the auditor must first know which controls exist. 2. Identify the absence of key controls. Internal control questionnaires, flowcharts, and walkthroughs are useful tools to identify where controls are lacking and the likelihood of misstatement is therefore increased. 3. Consider the possibility of compensating controls. A compensating control is one elsewhere in the system that offsets the absence of a key control. When a compensating control exists, there is no longer a significant deficiency or material weakness. 4. Decide whether there is a significant deficiency or material weakness. The likelihood of misstatements and their materiality are used to evaluate if there are significant deficiencies or material weaknesses. 5. Determine potential misstatements that could result. This step is intended to identify specific misstatements that are likely to result because of the significant deficiency or material weakness. The importance of a significant deficiency or material weakness is directly related to the likelihood and materiality of potential misstatements. Terms: Required communications between auditor and those charged with governance Diff: Challenging Objective: LO 10-5 AACSB: Reflective thinking skills; Analytic skills
21) The assessment of control risk is the measure of the auditor's expectation that internal controls will prevent material misstatements from occurring or detect and correct them if they have occurred. Answer: TRUE Terms: Internal control risk assessment Diff: Moderate Objective: LO 10-5 AACSB: Reflective thinking skills
Learning Objective 10-6 1) If the results of tests of controls support the design and operations of controls as expected, the auditor uses ________ control risk as the preliminary assessment. A) a lower B) the same C) a higher D) either a lower or higher Answer: B Terms: Control risk as preliminary assessment Diff: Moderate Objective: LO 10-6 AACSB: Analytic skills
2) An auditor is likely to use four types of procedures to support the operating effectiveness of internal controls. Which of the following would generally not be used? A) Make inquiries of appropriate client personnel B) Examine documents, records, and reports C) Reperform client procedures D) Inspect design documents Answer: D Terms: Operating effectiveness of internal controls Diff: Moderate Objective: LO 10-6 AACSB: Reflective thinking skills
3) Which of the following represents a correct statement regarding internal control testing? A) When auditors plan to use evidence about the operating effectiveness of internal control contained in prior audits, auditing standards require tests of the controls' effectiveness at least every other year. B) The greater the risk, the less audit evidence the auditor should obtain that controls are operating effectively. C) The auditor uses control risk assessment and results of tests of controls to determine planned detection risk and the related substantive tests for the financial statement audit. D) Testing of internal controls can only be performed by the auditor at the end of the fiscal year. Answer: C Terms: Internal control risk assessment Diff: Challenging Objective: LO 10-6 AACSB: Analytic skills
4) In evaluating the operational effectiveness of internal controls the auditor is likely to use four types of audit procedures. List the procedures below. Answer: • Make inquiries of appropriate client personnel • Examine documents, records, and reports • Observe control-related activities • Reperform client procedures Terms: Operational effectiveness; internal controls; audit procedures Diff: Moderate Objective: LO 10-6 AACSB: Reflective thinking skills
5) The procedures to obtain an understanding of internal control are only applied when the assessed control risk is high. Answer: FALSE Terms: Internal control Diff: Easy Objective: LO 10-6 AACSB: Analytic skills
6) Controls that are applied throughout the accounting period must be tested both at an interim date and then again on the balance sheet date. Answer: FALSE Terms: Internal controls Diff: Moderate Objective: LO 10-6 AACSB: Analytic skills
Learning Objective 10-7 1) When determining what type of report to issue on internal control under Section 404: A) an adverse opinion on internal control must be given if any weaknesses in a key internal control is discovered. B) a scope limitation requires the auditor to disclaim an opinion on internal controls. C) if the auditor gives a qualified opinion on the financial statements, they must give a qualified opinion on internal controls. D) a scope limitation requires the auditor to express a qualified opinion or a disclaimer of opinion on internal controls. Answer: D Terms: Internal control audit requirements of auditor Diff: Easy Objective: LO 10-7 AACSB: Reflective thinking skills Topic: SOX
2) The scope of the auditor's report on internal control is limited to obtaining reasonable assurance that significant weaknesses in internal control are identified. Answer: FALSE Terms: Section 404 of the Sarbanes-Oxley Act Diff: Moderate Objective: LO 10-7 AACSB: Reflective thinking skills Topic: SOX
3) To issue an unqualified opinion on internal control over financial reporting, there must be no identified material weaknesses and no restrictions on the scope of the audit. Answer: TRUE Terms: Unqualified opinion on internal control Diff: Moderate Objective: LO 10-7 AACSB: Reflective thinking skills Topic: Public
Learning Objective 10-8 1) A control available in a small company, which may be necessitated because of lack of competent personnel, is: A) a wider segregation of duties. B) a voucher system. C) fewer transactions to process. D) the owner-manager's direct involvement in the control process. Answer: D Terms: Control; smaller company; competent personnel Diff: Easy Objective: LO 10-8 AACSB: Ethical understanding and reasoning abilities
2) When auditing a private company, the auditor should obtain an understanding of internal control sufficient to: A) provide reasonable protection against client fraud and defalcations by client employees. B) assess control risk. C) provide a basis for suggestions to the client for improving the accounting system. D) provide a method for safeguarding assets, checking the accuracy and reliability of accounting data, promoting operational efficiency, and encouraging adherence to prescribed managerial policies. Answer: B Terms: Internal control understanding; Private company Diff: Easy Objective: LO 10-8 AACSB: Reflective thinking skills
3) In the audit of a private company, the auditor will test internal controls when control risk is initially assessed at: A) Low Moderate High Yes No Yes B) Low No
Moderate No
High Yes
Low Yes
Moderate Yes
High No
Low No
Moderate Yes
High No
C)
D)
Answer: C
Terms: Control risk Diff: Moderate Objective: LO 10-8 AACSB: Analytic skills
4) The auditor's consideration of a private company's internal control is: A) required by GAAP. B) required by GAAS. C) required by the IRS. D) recommended by the SEC. Answer: B Terms: Private company's internal control Diff: Moderate Objective: LO 10-8 AACSB: Reflective thinking skills
5) Which of the following may represent the biggest challenge smaller public companies face in implementing effective internal control? A) A lack of expertise B) Reduced importance C) Limited resources D) Limited available guidance Answer: C Terms: Internal control biggest challenge Diff: Challenging Objective: LO 10-8 AACSB: Reflective thinking skills Topic: Public
6) Which of the following is most correct for audits of non-public companies? A) An audit of internal control is required. B) An audit of internal control is not required. C) An audit of the design of internal controls is required. D) An audit of the operational effectiveness of internal controls is required. Answer: B Terms: Audits of non-public companies Diff: Moderate Objective: LO 10-8 AACSB: Reflective thinking skills
7) Match seven of the terms (a-i) with the definitions provided below (1-7): a. b. c. d. e. f. g. h. i.
Control environment Control activities Independent checks on performance Internal control Monitoring Separation of duties General authorization Specific authorization Risk assessment
________ 1. Management's ongoing and periodic assessment of the quality of internal control performance to determine that controls are operating as intended and are modified when needed. ________ 2. Company-wide policies for the approval of all transactions within stated limits. ________ 3. The actions, policies, and procedures that reflect the overall attitudes of top management, directors, and owners of an entity about internal control and its importance to the entity. ________ 4. Segregation of the following activities in an organization: custody of assets, accounting, authorization, and operational responsibility. ________ 5. Management's identification and analysis of risks relevant to the preparation of financial statements in accordance with an applicable accounting framework. ________ 6. Policies and procedures that help ensure that necessary actions are taken to address risks in the achievement of the entity's objectives. ________ 7. A process designed to provide reasonable assurance regarding the achievement of management's objectives in the following categories: (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with applicable laws and regulations. Answer: 1. E 2. G 3. A 4. F 5. I 6. B 7. D Terms: Control environment; Control activities; Internal control; Monitoring; Separation of duties; General authorization; Risk assessment Diff: Moderate Objective: LO 10-1 through LO 10-8 AACSB: Reflective thinking skills
8) If, when obtaining an understanding of control activities of a relatively small client, the auditor identified no control activities, the auditor would probably set a high assessment of control risk. Answer: TRUE Terms: Control activities; control risk Diff: Easy Objective: LO 10-8 AACSB: Analytic skills
9) If, when obtaining an understanding of control activities of a relatively small client, the auditor identified no control activities, the auditor would probably reassess whether the client is auditable. Answer: TRUE Terms: Control activities Diff: Easy Objective: LO 10-8 AACSB: Analytic skills
10) Auditors of private companies may rely on prior periods' tests of controls. Answer: TRUE Terms: Private companies; test of controls Diff: Easy Objective: LO 10-8 AACSB: Reflective thinking skills
11) In an audit of a non-public company, the less control risk there is, the smaller the amount of planned substantive evidence that is required. Answer: TRUE Terms: Non-public company; control risk; substantive evidence Diff: Easy Objective: LO 10-8 AACSB: Analytic skills
12) The auditor of a private company is not required by auditing standards to issue a written report on significant deficiencies in internal control. Answer: FALSE Terms: Internal controls for smaller companies Diff: Easy Objective: LO 10-8 AACSB: Reflective thinking skills
13) A company's size should have no impact on the nature of internal control and the controls that are implemented. Answer: FALSE Terms: Internal controls for smaller companies Diff: Moderate Objective: LO 10-8 AACSB: Reflective thinking skills
14) Control risk is generally set at minimum for most private companies. Answer: FALSE Terms: Internal controls for smaller companies Diff: Moderate Objective: LO 10-8 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e (Arens) Chapter 11 Fraud Auditing Learning Objective 11-1 1) Which of the following best defines fraud in a financial statement auditing context? A) Fraud is an unintentional misstatement of the financial statements. B) Fraud is an intentional misstatement of the financial statements. C) Fraud is either an intentional or unintentional misstatement of the financial statements, depending on materiality. D) Fraud is either an intentional or unintentional misstatement of the financial statements, depending on consistency. Answer: B Terms: Definition of fraud in financial statement auditing Diff: Easy Objective: LO 11-1 AACSB: Reflective thinking skills
2) Companies may intentionally understate earnings when income is high to create ________ that may be used in future years to increase earnings. A) income smoothing B) cookie jar reserves C) cash D) sales Answer: B Terms: Intentionally understate earnings; Reserve earnings Diff: Easy Objective: LO 11-1 AACSB: Reflective thinking skills
3) Which of the following is a category of fraud? A) Fraudulent financial reporting Misappropriation of assets Yes Yes B) Fraudulent financial reporting No
Misappropriation of assets No
Fraudulent financial reporting Yes
Misappropriation of assets No
Fraudulent financial reporting No
Misappropriation of assets Yes
C)
D)
Answer: A
Terms: Category of fraud Diff: Easy Objective: LO 11-1 AACSB: Reflective thinking skills
4) Most cases of fraudulent reporting involve: A) inadequate disclosures. B) an overstatement of income. C) an overstatement of liabilities. D) an overstatement of expenses. Answer: B
Terms: Financial statements subject to manipulation Diff: Easy Objective: LO 11-1 AACSB: Reflective thinking skills
5) ________ is fraud that involves theft of an entity's assets. A) Fraudulent financial reporting B) A "cookie jar" reserve C) Misappropriation of assets D) Income smoothing Answer: C Terms: Fraud that involves theft of entity's assets Diff: Easy Objective: LO 11-1 AACSB: Reflective thinking skills
6) Which of the following is a form of earnings management in which revenues and expenses are shifted between periods to reduce fluctuations in earnings? A) Fraudulent financial reporting B) Expense smoothing C) Income smoothing D) Each of the above is correct. Answer: C Terms: Form of earnings management where revenues and expenses are shifted between periods Diff: Easy Objective: LO 11-1 AACSB: Reflective thinking skills
7) Misappropriation of assets is normally perpetrated by: A) members of the board of directors. B) employees at lower levels of the organization. C) management of the company. D) the internal auditors. Answer: B Terms: Misappropriation of assets normally perpetrated by Diff: Easy Objective: LO 11-1 AACSB: Reflective thinking skills
8) Define fraud and distinguish between the two main categories of fraud. Answer: In the context of financial statement auditing, fraud is defined as an intentional misstatement of the financial statements. The two main categories of fraud are fraudulent financial reporting and misappropriation of assets. Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users of the financial statement. Misappropriation of assets involve theft of an entity's assets. Terms: Fraud and main categories Diff: Easy Objective: LO 11-1 AACSB: Reflective thinking skills
9) Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users. Answer: TRUE Terms: Fraud in financial statement auditing Diff: Easy Objective: LO 11-1 AACSB: Reflective thinking skills
10) The two main categories of fraud are fraudulent financial reporting and misappropriation of assets. Answer: TRUE Terms: Categories of fraud; Fraudulent financial reporting and misappropriation of assets Diff: Easy Objective: LO 11-1 AACSB: Reflective thinking skills
11) "Cookie jar reserves" are often created by companies whenever their earnings are high to create
reserves for future periods when earnings need to be "boosted" upward. Answer: TRUE Terms: Cookie jar reserves Diff: Easy Objective: LO 11-1 AACSB: Reflective thinking skills
12) Misappropriation of assets is normally perpetrated at the lowest levels of the organization hierarchy. Answer: TRUE Terms: Misappropriation of assets Diff: Moderate Objective: LO 11-1 AACSB: Reflective thinking skills
13) Fraudulent financial reporting usually involves manipulation of amounts rather than disclosures. Answer: TRUE Terms: Fraudulent financial reporting Diff: Moderate Objective: LO 11-1 AACSB: Reflective thinking skills
Learning Objective 11-2 1) Which of the following are elements of the fraud triangle? A) Attitudes/rationalization Risk Factors Yes No
Opportunities Yes
B) Attitudes/rationalization No
Risk Factors Yes
Opportunities Yes
Attitudes/rationalization Yes
Risk Factors No
Opportunities No
Attitudes/rationalization No
Risk Factors Yes
Opportunities No
C)
D)
Answer: A
Terms: Fraud triangle Diff: Easy Objective: LO 11-2 AACSB: Reflective thinking skills
2) Financial statement manipulation risk is arguably present for all companies' financial statements. However, the risk is elevated for companies that: A) are heavily regulated. B) have low amounts of debt. C) have to make significant judgments for accounting estimates. D) operate in stable economic environments. Answer: C Terms: Financial statement manipulation risk is elevated Diff: Easy Objective: LO 11-2 AACSB: Reflective thinking skills
3) Which of the following is not a factor that relates to opportunities to commit fraudulent financial reporting? A) Lack of controls related to the calculation and approval of accounting estimates B) Ineffective oversight of financial reporting by the board of directors C) Management's practice of making overly aggressive forecasts D) High turnover of accounting, internal audit, and information technology staff Answer: C Terms: Factor relates to opportunities to commit fraudulent financial reporting Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
4) Fraud is more prevalent in smaller businesses and not-for-profit organizations because it is more difficult for them to maintain: A) adequate separation of duties. B) adequate compensation. C) adequate financial reporting standards. D) adequate supervisory boards. Answer: A Terms: Fraud more prevalent in smaller business and not-for-profit organizations Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
5) Which of the following is a factor that relates to incentives or pressures to commit fraudulent financial reporting? A) Significant accounting estimates involving subjective judgments B) Excessive pressure for management to meet debt repayment requirements C) Management's practice of making overly aggressive forecasts D) High turnover of accounting, internal audit, and information technology staff Answer: B Terms: Factor that relates to incentives or pressures to commit fraudulent financial reporting Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
6) Which of the following is a factor that relates to attitudes or rationalization to commit fraudulent financial reporting? A) Significant accounting estimates involving subjective judgments B) Excessive pressure for management to meet debt repayment requirements C) Management's practice of making overly aggressive forecasts to third parties D) High turnover of accounting, internal audit and information technology staff Answer: C Terms: Factor that relates to attitudes or rationalization to commit fraudulent financial reporting Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
7) Which of the following is not a factor that relates to opportunities to misappropriate assets? A) Inadequate internal controls over assets B) Presence of large amounts of cash on hand C) Inappropriate segregation of duties or independent checks on performance D) Adverse relationships between management and employees Answer: D Terms: Factor that relates to opportunities to misappropriate assets Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
8) Which of the following is a factor that relates to incentives to misappropriate assets? A) Significant accounting estimates involving subjective judgments B) Significant personal financial obligations C) Management's practice of making overly aggressive forecasts D) High turnover of accounting, internal audit and information technology staff Answer: B Terms: Factor that relates to incentives to misappropriate assets Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
9) Which of the following does not represent an increased opportunity to commit fraud? A) Related party transactions B) The company founder is the CEO and Chairman of the Board. C) The financial statements involve accounting estimates. D) The company is a new audit client for the CPA firm. Answer: D Terms: Increased opportunity to commit fraud Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
10) In the fraud triangle, fraudulent financial reporting and misappropriation of assets: A) share little in common. B) share most of the same risk factors. C) share the same three conditions. D) share most of the same conditions. Answer: C Terms: Fraud triangle Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
11) Which of the following would the auditor be most concerned about regarding a heightened risk of intentional misstatement? A) Senior management emphasizes that it is very important to beat analyst estimates of earnings every reporting period. B) Senior management emphasizes that budgeted amounts for expenses are to be achieved for each reporting period or explained in the variance analysis report. C) Senior management emphasizes that job rotation is a worthwhile corporate objective. D) Senior management emphasizes that job evaluations are based on performance. Answer: A Terms: Heightened risk of intentional misstatement Diff: Easy Objective: LO 11-2 AACSB: Reflective thinking skills
12) Who is most likely to perpetrate fraudulent financial reporting? A) Members of the board of directors B) Production employees C) Management of the company D) The internal auditors Answer: C Terms: Fraudulent financial reporting Diff: Easy Objective: LO 11-1 and 11-2 AACSB: Reflective thinking skills
13) Determine from the following the factor that would most likely elevate the auditor's concern about the risk of financial statement fraud. A) Company cannot borrow debt capital without restrictive covenants. B) Company finds it difficult to sell equity capital for expansion. C) Company has a significant portion of liquid assets on its balance sheet. D) Company reports substantial net income but ever decreasing cash flow from operations. Answer: D Terms: Most likely elevate auditor's concern about risk of financial statement fraud Diff: Moderate Objective: LO 11-2 AACSB: Analytic skills
14) List and briefly describe the three conditions for fraud. Answer: • Incentives/pressures — Management or other employees have incentives or pressures to commit fraud. • Opportunities — Circumstances provide opportunities for management or employees to commit fraud. • Attitudes/Rationalization — An attitude, character, or set of ethical values exists that allows management or employees to intentionally commit a dishonest act, or they are in an environment that imposes sufficient pressure that causes them to rationalize committing a dishonest act. Terms: Conditions for fraud Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
15) List and briefly describe examples of risk factors for each condition of fraud for fraudulent financial reporting. Answer: Incentives/Pressures: 1. Financial stability or profitability is threatened by economic, industry, or entity operating conditions. 2. Excessive pressure for management to meet debt repayment or other debt covenant requirements. 3. Management or the board of directors' personal net worth is materially threatened by the entity's financial performance. Opportunities: 1. Significant accounting estimates involve subjective judgments or uncertainties that are difficult to verify. 2. Ineffective board of director or audit committee oversight over financial reporting. 3. High turnover or ineffective accounting, internal audit, or information technology staff. 4. Weak internal controls. 5. Significant related party transactions. Attitudes/Rationalization: 1. Inappropriate or ineffective support of the entity's ethics and values. 2. Known history of violations of laws and regulations. 3. Management's practice of making overly aggressive or unrealistic forecasts to analysts, creditors, and other third parties. Terms: Risk factors for conditions of fraud Diff: Challenging Objective: LO 11-2 AACSB: Reflective thinking skills
16) Incentives and opportunities are two conditions that are generally present when financial statement fraud occurs. Answer: TRUE Terms: Conditions present when material misstatements due to fraud occur Diff: Easy Objective: LO 11-2 AACSB: Reflective thinking skills
17) Fraud is more prevalent in large businesses than small businesses and not-for-profit organizations. Answer: FALSE Terms: Fraud prevalence in organizations Diff: Easy Objective: LO 11-2 AACSB: Reflective thinking skills
18) The same three fraud triangle risk conditions apply to fraudulent financial reporting and misappropriation of assets. Answer: TRUE Terms: Fraud triangle risk conditions Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
19) "An attitude, character, or set of ethical values exist that allow management or employees to commit a dishonest act …." describes the opportunities condition included in the fraud triangle. Answer: FALSE Terms: Opportunities conditions included in fraud triangle Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
20) An ineffective board of director oversight over financial reporting is an example of an incentives/pressures risk factor. Answer: FALSE Terms: Fraud risk factor describing incentives/pressures Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
21) A common incentive for companies to manipulate financial statements is a decline in the company's financial prospects. Answer: TRUE Terms: Fraud risk factor describing incentives/pressures Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
22) The pressure to do "whatever it takes" to meet goals is one of the main reasons why financial statement fraud occurs. Answer: TRUE Terms: Risk factors related to incentives, opportunities, and attitudes Diff: Moderate Objective: LO 11-2 AACSB: Reflective thinking skills
Learning Objective 11-3 1) Auditor's need to exhibit professional skepticism when auditing a client. This auditing standard is best expressed by which of the following? A) The auditor neither assumes dishonesty or honesty of management. B) The auditor assumes dishonesty of management. C) The auditor assumes honesty of management. D) The auditor assumes management lacks integrity. Answer: A Terms: Professional skepticism when auditing a client Diff: Moderate Objective: LO 11-3 AACSB: Reflective thinking skills
2) Which of the following matters related to the auditor's consideration of material misstatements due to fraud are required to be documented? A) Reasons supporting a conclusion that there is not a significant risk of material improper expense recognition B) Procedures performed to obtain information necessary to identify and assess the risks of material fraud C) Results of the internal auditor's procedures performed to address the risk of management override of controls D) Discussions with management regarding the hiring of a new plant manager Answer: B Terms: Auditing standards requiring auditors to document matters related to auditor consideration of material misstatements due to fraud Diff: Moderate Objective: LO 11-3 AACSB: Reflective thinking skills
3) As part of the brainstorming sessions, auditors are directed to emphasize: A) How management could perpetrate and The audit team's response to potential conceal fraudulent financial reporting fraud risks Yes Yes B) How management could perpetrate and The audit team's response to potential conceal fraudulent financial reporting fraud risks No No C) How management could perpetrate and The audit team's response to potential conceal fraudulent financial reporting fraud risks Yes No D) How management could perpetrate and The audit team's response to potential conceal fraudulent financial reporting fraud risks No Yes Answer: A
Terms: Auditors directed to emphasize in brainstorming sessions Diff: Moderate Objective: LO 11-3 AACSB: Reflective thinking skills
4) Which of the following questions is the auditor not required to ask company management when assessing fraud risk? A) Does management have knowledge of any fraud or suspected fraud within the company? B) What are the nature of the fraud risks identified by management? C) Is management using all assets effectively? D) What internal controls have been implemented to address the fraud risks? Answer: C Terms: Source of information to assess fraud risks Diff: Moderate Objective: LO 11-3 AACSB: Reflective thinking skills
5) When assessing the risk for fraud, the auditor must be cognizant of the fact that: A) the existence of fraud risk factors means fraud exists. B) analytical procedures must be performed on revenue accounts. C) horizontal analysis is not useful in helping to determine unusual financial statement relationships. D) the auditor cannot make inquiries about fraud to company personnel who have no financial statement responsibilities. Answer: B Terms: Assessment of fraud risk Diff: Moderate Objective: LO 11-3 AACSB: Reflective thinking skills
6) Which of the following is not a likely source of information to assess fraud risks? A) Communications among audit team members B) Inquiries of management C) Analytical procedures D) Consideration of fraud risks discovered during recent audits of other clients Answer: D Terms: Source of information to assess fraud risks Diff: Challenging Objective: LO 11-3 AACSB: Reflective thinking skills
7) Explain professional skepticism and the need for maintaining professional skepticism during an audit. Answer: Auditing standards state that, in exercising professional skepticism, an auditor "neither assumes that management is dishonest nor assumes unquestioned honesty." Auditors need to maintain their skepticism and a questioning mind throughout the audit so that they can identify fraud risk and critically evaluate audit evidence. Terms: Professional skepticism Diff: Moderate Objective: LO 11-3 AACSB: Reflective thinking skills
8) Briefly discuss the brainstorming session required by current auditing standards. Be sure to include a list of ideas that should be addressed in the session. Answer: Auditing standards require the audit team to conduct discussions to share insights from more experienced audit team members and to "brainstorm" ideas that address several ideas. The ideas that should be discussed are: • How and where the entity's financial statements might be susceptible to material misstatements due to fraud. This includes known external and internal factors affecting the entity that might (1) create an incentive or pressure for management to commit fraud (2) provide the opportunity for fraud to be perpetrated and (3) indicate a culture or environment that enables management to rationalize fraudulent acts. • How management could perpetrate and conceal fraudulent financial reporting. • How assets of the entity could be misappropriated. • How the auditor might respond to the susceptibility of material misstatements due to fraud. Terms: Brainstorming session required by auditing standards Diff: Moderate Objective: LO 11-3 AACSB: Reflective thinking skills
9) Describe the sources of information gathered to assess fraud risks. Answer: When the auditor is assessing fraud risks the following information sources should be considered: • Information obtained from communications among audit team members about their knowledge of the company and its industry; including how and where the company's financial statements might be susceptible to material misstatements due to fraud. • Responses to auditor inquiries of management about their views of the risks of fraud and about existing programs and controls to address specific identified fraud risks. • Specific risk factors in fraudulent financial reporting or misappropriation of assets. • The results of analytical procedures obtained during planning that indicate possible implausible or unexpected analytical relationships. • Knowledge obtained through other procedures such as client acceptance and retention decisions, interim review of financial statements, and consideration of inherent and control risks. Terms: Sources of information to assess fraud risks Diff: Challenging Objective: LO 11-3 AACSB: Reflective thinking skills
10) Financial statements of all companies are potentially subject to manipulation. Answer: TRUE Terms: Financial statements subject to manipulation Diff: Easy Objective: LO 11-3 AACSB: Reflective thinking skills
11) Information and idea exchange sessions by the audit team are required by current auditing standards. Answer: TRUE Terms: Information and idea exchange by audit team sessions required by current audit standards Diff: Moderate Objective: LO 11-3 AACSB: Reflective thinking skills
12) Upon discovering information that indicates a material misstatement due to fraud, the auditor must assume that the misstatement is an isolated incident. Answer: FALSE Terms: Assessment of fraud risk Diff: Moderate Objective: LO 11-3 AACSB: Reflective thinking skills
13) The presence of fraud risk factors increases the likelihood of fraud and may suggest that fraud is being perpetrated. Answer: TRUE Terms: Presence of fraud risk factors Diff: Moderate Objective: LO 11-3 AACSB: Reflective thinking skills
14) When the auditor receives inconsistent responses from management and others within the organization, the auditor should obtain additional audit evidence to resolve the inconsistency. Answer: TRUE Terms: Presence of fraud risk factors Diff: Moderate Objective: LO 11-3 AACSB: Reflective thinking skills
Learning Objective 11-4 1) Which of the following is the best reason for management to emphasize fraud prevention and deterrence? A) It is often more effective and economical for companies to focus on fraud prevention and deterrence rather than on fraud detection. B) Collusion is impossible to detect. C) The AICPA requires management to implement a fraud prevention program. D) All of the above are equally valid reasons. Answer: A Terms: Reason for management to emphasize fraud prevention and deterrence Diff: Moderate Objective: LO 11-4 AACSB: Reflective thinking skills
2) Which of the following parties is responsible for implementing internal controls to minimize the likelihood of fraud? A) External auditors B) Audit committee members C) Management D) Committee of Sponsoring Organizations Answer: C Terms: Party responsible for implementing internal controls to minimize likelihood of fraud Diff: Moderate Objective: LO 11-4 AACSB: Reflective thinking skills
3) Research indicates that the most effective way to prevent and deter fraud is to: A) implement programs and controls that are based on core values embraced by the company. B) hire highly ethical employees. C) communicate expectations to all employees on an annual basis. D) terminate employees who are suspected of committing fraud. Answer: A Terms: Most effective way to prevent and deter fraud Diff: Moderate Objective: LO 11-4 AACSB: Reflective thinking skills
4) Fraud awareness training should be: A) broad and all-encompassing. B) extensive and include details for all functional areas. C) specifically related to the employee's job responsibility. D) focused on employees understanding the importance of ethics. Answer: C Terms: Fraud awareness training Diff: Moderate Objective: LO 11-4 AACSB: Reflective thinking skills
5) Which party has the primary responsibility to oversee an organization's financial reporting and internal control process? A) The board of directors B) The audit committee C) Management of the company D) The financial statement auditors Answer: B Terms: Party with primary responsibility to oversee organization's financial reporting and internal control processes Diff: Moderate Objective: LO 11-4 AACSB: Reflective thinking skills
6) Management is responsible for: A) Identifying and measuring fraud risks Yes
Taking steps to mitigate identified risks Yes
B) Identifying and measuring fraud risks No
Taking steps to mitigate identified risks No
C) Identifying and measuring fraud risks Yes
Taking steps to mitigate identified risks No
D) Identifying and measuring fraud risks No
Taking steps to mitigate identified risks Yes
Answer: A
Terms: Management is responsibilities with fraud risks Diff: Moderate Objective: LO 11-4 AACSB: Reflective thinking skills
7) The "tone at the top" provides a foundation upon which a more detailed code of conduct can be developed to provide specific guidance for the organization and its employees. Components of a code of conduct may include sections on 1) general employee conduct, 2) relationships with clients and suppliers and 3) conflicts of interest. Give a narrative description of what might be included in each of the above components of a code of conduct. Answer: (may vary) Employee conduct–Employees should conduct themselves in a professional manner and prohibit unprofessional behavior Relationships with client and suppliers: Employees should avoid investing in or acquiring a financial interest in any business organization that has a contractual relationship with the organizations Conflicts of Interest– Employees are expected to perform their duties conscientiously, honestly, and in accordance with the best interests of the organization and to not use their positions or knowledge gained for private or personal advantage Terms: Elements for Code of Conduct Diff: Challenging Objective: LO 11-4 AACSB: Reflective thinking skills Topic: Public
8) Senior management is responsible for promoting a culture of honesty and ethics. Describe what that implies for the organization. Answer: Management cannot act one way and expect others in the company to behave differently. Through its actions and communications, management can show that dishonest or unethical behavior is not tolerated, even if the results benefit the company. Statements by management about the absolute need to meet operating and financial targets create undue pressures that may lead employees to commit fraud to achieve them. In contrast, statements indicating management's desire to aggressively pursue entity's goals and targets while at the same time requiring honest and ethical actions to achieve those goals clearly indicates to employees that integrity is a requirement. Whichever course management pursues, its actions establish the "tone at the top." Terms: Management responsibility for promoting a culture of honesty and ethics Diff: Challenging Objective: LO 11-4 AACSB: Reflective thinking skills
9) Management and the board of directors are responsible for setting the "tone at the top." Answer: TRUE Terms: Responsibility for setting tone at the top Diff: Easy Objective: LO 11-4 AACSB: Reflective thinking skills
10) If employees have positive feelings about their employers, they are less likely to commit fraud. Answer: TRUE Terms: Responsibility for determining organization financial reporting and internal control Diff: Moderate Objective: LO 11-4 AACSB: Reflective thinking skills
11) Management must recognize that almost any employee is capable of committing a dishonest act under the right circumstances. Answer: TRUE Terms: Primary responsibility to assess fraud risks and establish corporate governance programs Diff: Moderate Objective: LO 11-4 AACSB: Reflective thinking skills
12) Audit committee oversight also serves as a deterrent to fraud by senior management. Answer: TRUE Terms: Strongest internal corporate governance mechanisms Diff: Challenging Objective: LO 11-4 AACSB: Reflective thinking skills
Learning Objective 11-5 1) As part of designing and performing procedures to address management override of controls, auditors must perform which of the following procedures? A) Examine journal entries for evidence of possible misstatements due to fraud Review accounting estimates for biases Yes Yes B) Examine journal entries for evidence of possible misstatements due to fraud Review accounting estimates for biases No No C) Examine journal entries for evidence of possible misstatements due to fraud Review accounting estimates for biases Yes No D) Examine journal entries for evidence of possible misstatements due to fraud Review accounting estimates for biases No Yes Answer: A
Terms: Designing and performing procedures to address override controls Diff: Moderate Objective: LO 11-5 AACSB: Reflective thinking skills
2) Auditors may identify conditions during fieldwork that change or support a judgment about the initial assessment of fraud risks. Which of the following is not a condition which should alert an auditor that the initial assessment should be changed? A) The subsidiary ledger agrees to the general ledger. B) Discrepancies in the accounting records C) Unusual relationships between the auditor and management D) Missing or conflicting evidence Answer: A Terms: Alert auditor to change initial assessment of fraud risks Diff: Moderate Objective: LO 11-5 AACSB: Reflective thinking skills
3) Auditors are required to perform certain procedures in every audit to address the risk of management override of internal controls. What are these procedures? Answer: Auditing procedures require the following to be performed to address the risk of management override of controls: • Examine journal entries and other adjustments for evidence of possible misstatements due to fraud. • Review accounting estimates for bias. • Evaluate the business rationale for significant unusual transactions. Terms: Audit procedures required to address the risk of management override of internal controls Diff: Moderate Objective: LO 11-5 AACSB: Reflective thinking skills
4) Because fraud perpetrators are often knowledgeable about audit procedures, auditors should incorporate unpredictability into the audit plan. Answer: TRUE Terms: Auditors to incorporate unpredictability into audit plan Diff: Moderate Objective: LO 11-5 AACSB: Reflective thinking skills
5) The auditors should pay careful attention to accounting principles that involve subjective measurements or complex transactions. Answer: TRUE Terms: Responding to the risk of fraud Diff: Moderate Objective: LO 11-5 AACSB: Reflective thinking skills
Learning Objective 11-6 1) Auditing standards specifically require auditors to identify ________ as a fraud risk in most audits. A) overstated assets B) understated liabilities C) improper revenue recognition D) overstated expenses Answer: C Terms: Specific fraud risk areas Diff: Moderate Objective: LO 11-6 AACSB: Reflective thinking skills
2) Company management is often under pressure to increase revenue and/or net income. One approach is to use a "bill and hold" arrangement. This is an example of which of the following? A) Significant accounting estimates B) Fictitious revenue recorded C) Premature revenue recognized D) Alteration of cutoff documents Answer: C Terms: Bill and hold arrangement to increase revenue and/or net income Diff: Moderate Objective: LO 11-6 AACSB: Reflective thinking skills
3) A company is concerned with the theft of cash after the sale has been recorded. One way in which fraudsters conceal the theft is by a process called "lapping." Which of the following best describes lapping? A) Reduce the customer's account by recording a sales return B) Write off the customer's account C) Apply the payment from another customer to the customer's account D) Reduce the customer's account by recording a sales allowance Answer: C Terms: Lapping; Theft of cash Diff: Challenging Objective: LO 11-6 AACSB: Reflective thinking skills
4) Analytical procedures can be very effective in detecting inventory fraud. Which of the following analytical procedures would not be useful in detecting fraud? A) Gross margin percentage B) Inventory Turnover C) Cost of sales percentage D) Accounts receivable turnover Answer: D Terms: Analytical procedures to detect inventory fraud Diff: Challenging Objective: LO 11-6 AACSB: Reflective thinking skills
5) When dealing with revenue frauds:
A) the most egregious form of revenue fraud involves premature revenue recognition. B) premature revenue recognition involves recognizing the revenue after the accounting standards requirements have been met. C) premature revenue recognition is the same as cutoff errors. D) side agreements can modify the terms of the sales transaction and should be analyzed carefully. Answer: D Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 11-6 AACSB: Reflective thinking skills
6) Two of the most useful warning signals that can indicate that revenue fraud is occurring are: A) analytical procedures and documentary discrepancies. B) analytical procedures and misappropriation of assets. C) documentary discrepancies and vague responses to inquiries. D) missing audit evidence and vague responses to inquiries. Answer: A Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 11-6 AACSB: Reflective thinking skills
7) Fictitious revenues: A) increase accounts receivable turnover. B) understate the gross margin percentage. C) lower accounts receivable turnover. D) have no impact on the gross margin percentage. Answer: C Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 11-6 AACSB: Reflective thinking skills
8) Which of the following is a correct statement regarding the misappropriation of receipts involving revenue? A) One of the easiest frauds to detect is when a sale is not recorded and the cash from the sale is stolen. B) If a customer's payment is stolen, regular billing of unpaid accounts can uncover the fraud unless the fraud perpetrator does something to hide the theft. C) Misappropriation of cash receipts is generally as material as fraudulent reporting of revenues. D) Analytical procedures can detect relatively small thefts of sales and related cash receipts. Answer: B Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 11-6 AACSB: Reflective thinking skills
9) When analyzing accounts for fraud risk: A) companies will generally attempt to overstate accounts payable and net income. B) the inventory account is generally not susceptible to fraud since the auditor must verify the existence of the inventory. C) payroll is rarely a significant risk for fraudulent financial reporting. D) fixed assets are rarely stolen because of their large size. Answer: C Terms: Fraud risk areas Diff: Moderate Objective: LO 11-6 AACSB: Reflective thinking skills
10) List the three main types of revenue manipulations employed to commit fraudulent financial reporting and give an example for each type. Answer: The three main types of revenue manipulation are: • Fictitious revenues–preparation of fictitious documentary evidence for sales and reduction of inventory • Premature revenue recognition-bill and hold; side agreements; unlimited right of return • Manipulation of adjustments to revenues - adjustments to the sales and returns allowance account; i.e. not recording returns Terms: Types of revenue manipulation Diff: Moderate Objective: LO 11-6 AACSB: Reflective thinking skills
11) The most common fraud in the acquisition and payment cycle is for the perpetrator to issue payments to fictitious vendors and deposit the cash in fictitious accounts. What procedures could the company take to prevent this type of fraud? Answer: Allowing payments to be made only to approved vendors Detailed review of legitimacy of approved vendors Careful review of document authorizing the acquisition Segregation of duties between authorizing payments and authorizing the acquisition Canceling supporting documents to prevent their use as support for multiple payments Terms: Procedures to prevent fraud in the acquisition and payment cycle Diff: Challenging Objective: LO 11-6 AACSB: Reflective thinking skills
12) When the allowance for doubtful accounts is understated, bad debt expense is understated and net income is also understated. Answer: FALSE Terms: Fraud risk areas Diff: Moderate Objective: LO 11-6 AACSB: Reflective thinking skills Topic: Public
13) Fictitious revenue transactions have the same level of documentary evidence as legitimate transactions. Answer: FALSE Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 11-6 AACSB: Reflective thinking skills Topic: Public
14) Auditors should rely on original, rather than duplicate, copies of documents. Answer: TRUE Terms: Fraud risk areas Diff: Moderate Objective: LO 11-6 AACSB: Reflective thinking skills Topic: Public
15) The two most common areas of fraud in payroll are the creation of fictitious employees and the overstatement of individual payroll hours. Answer: TRUE Terms: Fraud risk areas Diff: Moderate Objective: LO 11-6 AACSB: Reflective thinking skills Topic: Public
Learning Objective 11-7 1) To address heightened risks of fraud, the auditor can do all of the following except: A) use specialists to assist in evaluating the accuracy and reasonableness of management's key estimates. B) decrease the amount of substantive tests. C) use CL or IDEA to search for fictitious revenue transactions. D) use EXCEL to perform analytical procedures at the disaggregated level. Answer: B Terms: Fraud risk areas Diff: Moderate Objective: LO 11-7 AACSB: Reflective thinking skills
2) Which of the following is least likely to uncover fraud? A) External auditors B) Internal auditors C) Internal controls D) Management Answer: A Terms: Lease likely to uncover of fraud risks Diff: Moderate Objective: LO 11-7 AACSB: Reflective thinking skills
3) Which of the following is not a category of inquiry used by auditors? A) Assessment inquiry B) Declarative inquiry C) Interrogative inquiry D) Informational inquiry Answer: B Terms: Category of inquiry used by auditors Diff: Challenging Objective: LO 11-7 AACSB: Reflective thinking skills
4) ________ inquiry is used to obtain information about facts and details that the auditor does not have, usually about past or current events or processes. A) Assessment B) Declarative C) Interrogative D) Informational Answer: D Terms: Inquiry used when auditor seeks responses Diff: Challenging Objective: LO 11-7 AACSB: Analytic skills
5) An auditor uses ________ inquiry to corroborate or contradict prior information. A) assessment B) declarative C) interrogative D) informational Answer: A Terms: Inquiry used to ascertain whether information already obtained is correct Diff: Challenging Objective: LO 11-7 AACSB: Reflective thinking skills
6) When the auditor suspects that fraud may be present, auditing standards require the auditor to: A) terminate the engagement with sufficient notice given to the client. B) issue an adverse opinion or a disclaimer of opinion. C) obtain additional evidence to determine whether material fraud has occurred. D) re-issue the engagement letter. Answer: C Terms: Requirements of auditor when fraud is suspected Diff: Challenging Objective: LO 11-7 AACSB: Reflective thinking skills
7) With whom should the auditor communicate whenever he or she determines that senior management fraud may be present, even if the matter might be considered inconsequential? A) PCAOB B) Audit committee C) An appropriate level of management that is at least one level above those involved D) The internal auditors Answer: B Terms: Auditor communicate with whom when senior management fraud may be present Diff: Challenging Objective: LO 11-7 AACSB: Reflective thinking skills
8) What types of inquiry techniques might an auditor use when making inquiries of client personnel? What are the uses of each technique? Answer: There are three main types of inquiry available for use by auditors. These are information inquiry, assessment inquiry, and interrogative inquiry. Information inquiry is used to obtain information about facts and details that the auditor does not have. Assessment inquiry is used to corroborate or contradict prior information. Interrogative inquiry is often used when the auditor seeks responses from an individual about his or her knowledge of an event or circumstances. Terms: Inquiry techniques Diff: Challenging Objective: LO 11-7 AACSB: Reflective thinking skills
9) PCAOB Standard 5 states that fraud of any magnitude by senior management is at least a significant deficiency in internal controls. Answer: TRUE Terms: Senior management fraud Diff: Moderate Objective: LO 11-7 AACSB: Reflective thinking skills Topic: Public
10) Most frauds are discovered via a tip. Answer: TRUE Terms: Fraud Diff: Easy Objective: LO 11-7 AACSB: Reflective thinking skills Topic: Public
11) Interrogative inquiry is often confrontational. Answer: TRUE Terms: Inquiry techniques Diff: Moderate Objective: LO 11-7 AACSB: Reflective thinking skills Topic: Public
12) Auditors may expand other substantive procedures to address the heightened risks of fraud. Answer: TRUE Terms: Fraud risk areas Diff: Moderate Objective: LO 11-7 AACSB: Reflective thinking skills Topic: Public
Auditing and Assurance Services, 15e Chapter 12 The Impact of Information Technology on the Audit Process Learning Objective 12-1 1) The continued integration of IT in accounting systems can impact a company by: A) increasing the costs of handling a large amount of data. B) increasing the number of manual controls needed. C) giving management higher-quality information more quickly than a manual system, thus helping management in their decision making process. D) decreasing the segregation of duties. Answer: C Terms: IT effects on organization Diff: Easy Objective: LO 12-1 AACSB: Reflective thinking skills
2) Which of the following is not a benefit of using IT-based controls? A) Ability to process large volumes of transactions B) Ability to replace manual controls with computer-based controls C) Reduction in misstatements due to consistent processing of transactions D) Reduction in internal control evaluation in setting control risk Answer: D Terms: Not a benefit of using IT-based controls Diff: Easy Objective: LO 12-1 AACSB: Reflective thinking skills
3) Discuss how the integration of IT into accounting systems enhances internal control. Answer: Enhancements to internal control resulting from the integration of IT into accounting systems include: • Computer controls replace manual controls. Replacing manual procedures with programmed controls that apply checks and balances to each processed transaction and that process information consistently can reduce human error that is likely to occur in traditional manual environments. • Higher quality information is available. IT systems typically provide management with more and higher quality information faster than most manual systems. Terms: Integration of IT into accounting systems enhances internal control Diff: Moderate Objective: LO 12-1 AACSB: Reflective thinking skills
4) Control risk may be reduced for a company with a complex IT system when compared to a company
that relies primarily on manual controls. Answer: TRUE
Terms: Control risk reduced for company with complex IT system Diff: Easy Objective: LO 12-1 AACSB: Reflective thinking skills
Learning Objective 12-2 1) One of the unique risks of protecting hardware and data is: A) lack of traditional authorization. B) the decreased risk of loss or destruction of data files if data is stored in a centralized location. C) the ease at which the IT system can be installed and maintained. D) the unauthorized access to the IT system resulting in improper changes in software programs and master files. Answer: D Terms: Risks specific to IT environment Diff: Moderate Objective: LO 12-2 AACSB: Reflective thinking skills
2) ________ is not a risk specific to the IT environments. A) Reliance on the functioning capabilities of hardware and software B) Increased human involvement C) Loss of data due to insufficient backup D) Unauthorized access Answer: B Terms: Risks specific to IT environment Diff: Easy Objective: LO 12-2 AACSB: Reflective thinking skills
3) Which of the following is not a risk in an IT system? A) Need for IT experienced staff B) Separation of IT duties from accounting functions C) Improved audit trail D) Hardware and data vulnerability Answer: C Terms: Risks in an IT system Diff: Easy Objective: LO 12-2 AACSB: Reflective thinking skills
4) Misstatements in the financial statement may not be detected with the increased use of IT due to: I. the loss of a visible audit trail. II. reduced human involvement. A) I only B) II only C) both I and II D) neither I or II Answer: A
Terms: Risks in an IT system Diff: Easy Objective: LO 12-2 AACSB: Reflective thinking skills
5) Computers process information consistently for all transactions. This creates a risk that: A) auditors will not be able to access data quickly. B) auditors will not be able to determine if data is processed consistently. C) erroneous processing can result in the accumulation of a great number of misstatements in a short period of time. D) all of the above. Answer: C Terms: Characteristics of IT and risk Diff: Moderate Objective: LO 12-2 AACSB: Reflective thinking skills
6) What are three specific risks to IT systems? Answer: The three specific risks to IT systems include risks to hardware and data, a reduced audit trail, and the need for IT experience and separation of IT duties. Terms: Risks in an IT system Diff: Easy Objective: LO 12-2 AACSB: Reflective thinking skills
7) Since IT systems can often initiate transactions automatically, proper authorization depends on software procedures and accurate master files used to make the authorization decision. Answer: TRUE Terms: Risks specific to IT environment Diff: Moderate Objective: LO 12-2 AACSB: Reflective thinking skills
8) One potential disadvantage of IT systems is the reduction or elimination of source documents, which reduces the visibility of the audit trail. Answer: TRUE Terms: Disadvantage of IT systems Diff: Easy Objective: LO 12-2 AACSB: Reflective thinking skills
Learning Objective 12-3 1) Old and new systems operating simultaneously in all locations is a test approach known as: A) pilot testing. B) horizontal testing. C) integrative testing. D) parallel testing. Answer: D Terms: Old and new systems operating simultaneously Diff: Easy Objective: LO 12-3 AACSB: Reflective thinking skills
2) Which of the following is a component of general controls? A) Processing controls B) Output controls C) Back-up and contingency planning D) Input controls Answer: C Terms: Component of general controls Diff: Easy Objective: LO 12-3 AACSB: Reflective thinking skills
3) Which of the following statements related to application controls is correct? A) Application controls relate to various aspects of the IT function including software acquisition and the processing of transactions. B) Application controls relate to various aspects of the IT function including physical security and the processing of transactions in various cycles. C) Application controls relate to all aspects of the IT function. D) Application controls relate to the processing of individual transactions. Answer: D Terms: Application controls Diff: Easy Objective: LO 12-3 AACSB: Reflective thinking skills
4) General controls include all of the following except: A) systems development. B) online security. C) processing controls. D) hardware controls. Answer: C Terms: General controls Diff: Easy Objective: LO 12-3 AACSB: Reflective thinking skills
5) Which of the following describes the process of implementing a new system in one part of the organization, while other locations continue to use the current system? A) Parallel testing B) Online testing C) Pilot testing D) Control testing Answer: C Terms: Process implementing new system in one part of organization Diff: Easy Objective: LO 12-3 AACSB: Reflective thinking skills
6) A ________ is responsible for controlling the use of computer programs, transaction files and other computer records and documentation and releases them to the operators only when authorized. A) software engineer B) chief computer operator C) librarian D) data control operator Answer: C Terms: Separation of IT duties Diff: Easy Objective: LO 12-3 AACSB: Reflective thinking skills
7) Security controls should require that users enter a(n) ________ before being allowed access to software and other related data files. A) echo check B) parity check C) self-diagnosis test D) authorized password Answer: D Terms: Required for access to IT programs or files from terminals Diff: Easy Objective: LO 12-3 AACSB: Reflective thinking skills
8) Typical controls developed for manual systems which are still important in IT systems include: A) management's authorization of transactions. B) competent personnel. C) adequate preparation of input source documents. D) all of the above. Answer: D Terms: Typical controls developed for manual systems still important in IT systems Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
9) Which of the following controls prevent and detect errors while transaction data are processed? A) Software B) Application C) Processing D) Transaction Answer: C Terms: Controls that prevent and detect errors while transaction data are processed Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
10) When purchasing software or developing in-house software: A) cost should be the only factor. B) extensive testing of the software is generally not required. C) a team of both IT and non-IT personnel should be involved in the decision process. D) the librarian and the IT manager should be the only ones involved in the decision process. Answer: C Terms: General controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
11) Output controls need to be designed for which of the following data integrity objectives? A) Detecting errors after the processing is completed B) Preventing errors before the processing is completed C) Detecting errors in the general ledger adjustment process D) Preventing errors in separation of duties for IT personnel Answer: A Terms: Output controls need to be designed for Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
12) A control that relates to all parts of the IT system is called a(n): A) general control. B) systems control. C) universal control. D) applications control. Answer: A Terms: Control that relates to all parts of IT system Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
13) Controls that are designed for each software application and are intended to help a company satisfy the transaction-related audit objectives are: A) user controls. B) general controls. C) audit controls. D) application controls. Answer: D Terms: Controls which apply to a specific element of the system, Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
14) Which of the following is not an example of an applications control? A) Back-up of data is made to a remote site for data security. B) There is a preprocessing authorization of the sales transactions. C) There are reasonableness tests for the unit selling price of a sale. D) After processing, all sales transactions are reviewed by the sales department. Answer: A Terms: Application controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
15) Which of the following is not a general control? A) Computer performed validation tests of input accuracy. B) Equipment failure causes error messages on monitor. C) There is a separation of duties between programmer and operators. D) There are adequate program run instructions for operating the computer. Answer: A Terms: General control Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
16) Controls which are built in by the manufacturer to detect equipment failure are called: A) input controls. B) data integrity controls. C) hardware controls. D) manufacturer's controls. Answer: C Terms: Controls built in by manufacturer to detect equipment failure Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
17) Controls which are designed to assure that the information processed by the computer is authorized, complete, and accurate are called: A) input controls. B) processing controls. C) output controls. D) general controls. Answer: A Terms: Controls designed to assure information processed by computer is authorized, complete, and accurate Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
18) Programmers should be allowed access to: A) user controls. B) general controls. C) systems controls. D) applications controls. Answer: D Terms: Programmers should be allowed access Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
19) Which of the following tests determines that every field in a record has been completed? A) Validation B) Sequence C) Completeness D) Programming Answer: C Terms: Tests to determine that every field in a record has been completed Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
20) An example of a physical control is: A) a hash total. B) a parallel test. C) the matching of employee fingerprints to a database before access to the system is allowed. D) the use of backup generators to prevent data loss during power outages. Answer: C Terms: General and application controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
21) Controls specific to IT include all of the following except for: A) adequately designed input screens. B) pull-down menu lists. C) validation tests of input accuracy. D) separation of duties. Answer: D Terms: Controls specific to IT Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
22) An internal control deficiency occurs when computer personnel: A) participate in computer software acquisition decisions. B) design flowcharts and narratives for computerized systems. C) originate changes in customer master files. D) provide physical security over program files. Answer: C Terms: Internal control deficiency Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
23) Which of the following best explains the relationship between general controls and application controls? A) Application controls are effective even if general controls are extremely weak. B) Application controls are likely to be effective only when general controls are effective. C) General controls have no impact on application controls. D) None of the above. Answer: B Terms: General controls and application controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
24) A ________ total represents the summary total of codes from all records in a batch that do not represent a meaningful total. A) record B) hash C) output D) financial Answer: B Terms: Batch input controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
25) In an IT system, automated equipment controls or hardware controls are designed to: A) correct errors in the computer programs. B) monitor and detect errors in source documents. C) detect and control errors arising from the use of equipment. D) arrange data in a logical sequential manner for processing purposes. Answer: C Terms: Equipment or hardware controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
26) If a control total were to be computed on each of the following data items, which would best be identified as a hash total for a payroll IT application? A) Gross wages earned B) Employee numbers C) Total hours worked D) Total debit amounts and total credit amounts Answer: B Terms: Hash total for payroll IT application Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
27) Which of the following is not an application control? A) Preprocessing authorization of sales transactions B) Reasonableness test for unit selling price of sale C) Post-processing review of sales transactions by the sales department D) Logging in to the company's information systems via a password Answer: D Terms: Application controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
28) Which of the following is not a general control? A) Separation of IT duties B) Systems development C) Processing controls D) Hardware controls Answer: C Terms: General control Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
29) In comparing (1) the adequacy of the hardware controls in the system with (2) the organization's methods of handling the errors that the computer identifies, the independent auditor is: A) unconcerned with both (1) and (2). B) equally concerned with (1) and (2). C) less concerned with (1) than with (2). D) more concerned with (1) than with (2). Answer: C Terms: Concern of adequacy of hardware controls and methods of handling errors that computer identifies Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
30) The most important output control is: A) distribution control, which assures that only authorized personnel receive the reports generated by the system. B) review of data for reasonableness by someone who knows what the output should look like. C) control totals, which are used to verify that the computer's results are correct. D) logic tests, which verify that no mistakes were made in processing. Answer: B Terms: Output controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
31) Define control for general controls and application controls. Also list the categories of controls included under general controls and application controls. Answer: General controls are those that relate to all aspects of the IT function. They include controls related to administration, separation of IT duties, systems development, physical and on-line security, backup and contingency planning, and hardware controls. Application controls relate to the processing of individual transactions. Application controls are specific to certain software applications and typically do not affect all IT functions. They include input controls, processing controls, and output controls. Terms: General controls and application controls Diff: Easy Objective: LO 12-3 AACSB: Reflective thinking skills
32) Identify the three categories of application controls, and give one example of each. Answer: Application controls fall into three categories: • Input controls - preformatted screens which prompt the data input personnel for the information to be entered • Processing controls - a reasonableness test for the unit selling price of a sale. • Output controls - postprocessing review of sales transactions by the sales department. Terms: Three categories of application controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
33) One category of general controls is physical and online access controls. Describe the control and give at two examples of implementation of the control. Answer: Physical controls over computer equipment restrict access to hardware, software, and backup data files on magnetic tapes or disks, hard drives, CDs, and external disks. Examples of physical controls include: keypad entrances badge-entry systems security cameras and security personnel employee fingerprints or retinas scanning and matching to database before access is allowed monitoring of cooling and humidity installing fire-extinguishing equipment. Online access controls restrict access to software and related data files, reducing the likelihood that unauthorized changes are made to software applications and data files. Examples include: proper user IDs and passwords separate add-on security software packages firewalls encryption programs. Terms: General control of physical and online security Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
34) Processing controls include the following tests: Validation Sequence Data Reasonableness Completeness Describe what each control is designed to do: Answer: Validation: ensures that a particular type of transaction is appropriate for processing Sequence: determines that the data submitted for processing are in the correct order Data Reasonableness: determines whether the data exceeds prespecified amounts Completeness: determines that every field in a record has been completed Terms: Tests of processing controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
35) What are the two software testing strategies that companies typically use? Which strategy is more expensive? Answer: Companies may use pilot testing and parallel testing to test new software. Pilot testing involves operating the new software at a limited number of facilities, while continuing to operate the old software at all other locations. Parallel testing involves operating the new and old software simultaneously. Parallel testing is more expensive than pilot testing. Terms: Software testing strategies Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
36) Discuss the four areas of responsibility under the IT function that should be segregated in large companies. Answer: The responsibilities for IT management, systems development, operations, and data control should be separated: • IT Management. Oversight of the IT function should be segregated from the systems development, operations, and data control functions. Oversight of IT should be the responsibility of the Chief Information Officer or IT manager. • Systems development. Systems analysts are responsible for the overall design of each application system. Programmers develop, test, and document applications software. Programmers and analysts should not have access to input data or computer operations. • Operations. Computer operators are responsible for the day-to-day operations of the computer. • Data control. Data control personnel independently verify the quality of input and the reasonableness of output. Terms: Areas of responsibility under IT function Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
37) Identify the six categories of general controls and give one example of each. Answer: General controls fall into the following six categories: • Administration of the IT function. The chief information officer (CIO) should report to senior management and board of directors. • Segregation of IT duties. There should be separation of duties between the computer programmers, operators, and the data control group. • Systems development. Users, analysts, and programmers develop and test software. • Physical and online security. Access to hardware is restricted, passwords and user IDs limit access to software and data files, and encryption and firewalls protect data and programs from external parties. • Backup and contingency planning. Written backup plans should be prepared and tested on a regular basis throughout the year. • Hardware controls. Uninterruptible power supplies should be used to avoid loss of data in the event of a power blackout. Terms: Categories of general controls Diff: Challenging Objective: LO 12-3 AACSB: Reflective thinking skills
38) Parallel testing is used when old and new systems are operated simultaneously in all locations. Answer: TRUE Terms: Parallel testing Diff: Easy Objective: LO 12-3 AACSB: Reflective thinking skills
39) Programmers should only be allowed to work with test copies of programs and data. Answer: TRUE Terms: Programmer's responsibilities Diff: Easy Objective: LO 12-3 AACSB: Reflective thinking skills
40) In IT systems, if general controls are effective, it increases the auditor's ability to rely on application
controls to reduce control risk. Answer: TRUE
Terms: Effective general controls and application controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
41) Parallel testing is more expensive than pilot testing. Answer: TRUE Terms: Parallel testing Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
42) The effectiveness of automated controls depends solely on the competence of the personnel performing the controls. Answer: FALSE Terms: Effectiveness of automated controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
43) Knowledge of both general and application controls is crucial for auditors in understanding how accounting information is recorded and reported. Answer: TRUE Terms: Knowledge of general and application controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills Topic: Public
44) A large portion of errors in IT systems result from data entry errors. Answer: TRUE Terms: Application controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
45) Output controls focus on preventing errors during processing. Answer: FALSE Terms: Output controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
46) Processing controls are a category of application controls. Answer: TRUE Terms: Processing controls and application controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
47) Controls that relate to a specific use of the IT system, such as the processing of sales or cash receipts, are called application controls. Answer: TRUE Terms: Application controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
48) IT controls are classified as either input controls or output controls. Answer: FALSE Terms: IT controls, input controls, and output controls Diff: Moderate Objective: LO 12-3 AACSB: Reflective thinking skills
Learning Objective 12-4 1) Auditors typically obtain information about general and application controls through all of the following ways except for: A) interviews with IT personnel. B) reviews of detailed questionnaires completed by IT staff. C) examination of system documentation such as flowcharts. D) filings submitted to the PCAOB or SEC. Answer: D Terms: Auditor's understanding of client's IT controls Diff: Easy Objective: LO 12-4 AACSB: Reflective thinking skills
2) When the client uses a computer but the auditor chooses to use only the non-IT segment of internal control to assess control risk, it is referred to as auditing around the computer. Which one of the following conditions need not be present to audit around the computer? A) Application controls need to be integrated with general controls. B) The source documents must be available in a non-machine language. C) The documents must be filed in a manner that makes it possible to locate them. D) The output must be listed in sufficient detail to enable the auditor to trace individual transactions. Answer: A Terms: Client uses computer but auditor chooses to use non-IT segment of internal control to assess control risk Diff: Easy Objective: LO 12-4 AACSB: Reflective thinking skills
3) Which of the following is a correct statement regarding general controls? A) Auditors should evaluate the effectiveness of application controls before evaluating general controls. B) General controls have a pervasive effect on the effectiveness of application controls. C) Ineffective general controls have no impact on the potential for material misstatements across all system applications. D) General controls have no impact on audit testing. Answer: B Terms: Auditor's understanding of client's IT controls Diff: Easy Objective: LO 12-4 AACSB: Reflective thinking skills
4) Auditors: A) link controls and deficiencies in general controls to specific transaction-related audit objectives. B) can use a control risk matrix to help identify both manual and automated application controls and control deficiencies for each related audit objective. C) can rely on IT-based application controls for all cycles if general controls are ineffective. D) can use the IT staff to determine how much reliance they can place on general controls. Answer: B Terms: Programmers should do Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
5) When the client changes the computer software: A) no additional testing is needed by the auditor. B) and application controls are effective, the auditor can easily identify when software changes are made. C) and general controls are effective, the auditor can easily identify when software changes are made. D) application and general controls can no longer by relied upon by the auditor. Answer: C Terms: Audit procedure to obtain understanding of client general controls Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
6) The approach to auditing where the auditor does not test automated controls to reduce assessed control risk is called: A) the single-stage audit. B) the test deck approach. C) auditing around the computer. D) generalized audit software (GAS). Answer: C Terms: Assessing control risk considering only non-IT controls Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
7) Companies with non-complex IT environments often rely on desktops and networked servers to perform accounting system functions. Which of the following is not an audit consideration in such an environment? A) Limited reliance on automated controls B) Unauthorized access to master files C) Vulnerability to viruses and other risks D) Excess reliance on automated controls Answer: D Terms: Audit consideration in companies with non-complex IT environments Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
8) Which of the following statements is correct? A) Auditors should evaluate application controls before evaluating general controls. B) Auditors should evaluate application controls and general controls simultaneously. C) Auditors should evaluate general controls before evaluating application controls. D) None of these statements is correct. Answer: C Terms: Auditors evaluation of application controls and general controls Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
9) Auditors should evaluate which of the following before evaluating application controls because of the potential for pervasive effects? A) Input controls B) Control environment C) Processing controls D) General controls Answer: D Terms: Evaluate before evaluating application controls Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
10) Which of the following is least likely to be used in obtaining an understanding of client general controls? A) Examination of system documentation B) Inquiry of key users C) Walk through of a sales transaction D) Reviews of questionnaires completed by client IT personnel Answer: C Terms: Understanding of client general controls Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
11) Auditors usually obtain information about general and application controls through: A) interviews with IT personnel. B) examination of systems documentation. C) reading program change requests. D) all of the above methods. Answer: D Terms: General and application controls Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
12) It is important for the auditor to understand both the general controls and the application controls a company has implemented. Which of the following statements is true about these controls? A) Auditors do not link IT controls to audit objectives. B) After identifying specific IT-based application controls that can be used to reduce control risk, auditors can reduce substantive testing. C) General controls affect audit objectives in only one cycle. D) The impact of general controls and application controls on audits does not vary depending on the level of complexity in the IT environment. Answer: B Terms: Application controls Diff: Challenging Objective: LO 12-4 AACSB: Reflective thinking skills
13) General controls in smaller companies are usually less effective than in more complex IT environments. Answer: TRUE Terms: General controls in smaller companies Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
14) Even in a less sophisticated IT environment, automated controls can often be relied on. Answer: TRUE Terms: Auditor's understanding of client's IT controls Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
15) "Auditing around the computer" is acceptable only if the auditor has access to the client's data in a machine-readable language. Answer: FALSE Terms: Auditing around the computer Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
16) "Auditing around the computer" is most appropriate when the client has not maintained detailed output or source documents in a form readable by humans. Answer: FALSE Terms: Auditing around the computer Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
17) When a client uses desktops and networked servers for the accounting functions, there is a risk of computer viruses. Answer: TRUE Terms: Client uses desktop and network servers Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
18) Auditors normally link controls and deficiencies in general controls to specific transaction-related audit objectives. Answer: FALSE Terms: General controls linked to specific transaction-related audit objectives Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
19) Auditors often use their own software to test the client's IT controls. Answer: TRUE Terms: Tests of controls Diff: Moderate Objective: LO 12-4 AACSB: Reflective thinking skills
Learning Objective 12-5 1) The auditor's objective in determining whether the client's automated controls can correctly handle valid and invalid transactions as they arise is accomplished through the: A) test data approach. B) generalized audit software approach. C) microcomputer-aided auditing approach. D) generally accepted auditing standards. Answer: A Terms: Client control can correctly handle valid and invalid transactions Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
2) The audit approach in which the auditor runs his or her own program on a controlled basis to verify the client's data recorded in a machine language is: A) the test data approach. B) called auditing around the computer. C) the generalized audit software approach. D) the microcomputer-aided auditing approach. Answer: C Terms: Audit approach where auditor runs own program on a controlled basis Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
3) Which of the following is not seen as an advantage to using generalized audit software (GAS)? A) Auditors can learn the software in a short period of time. B) It can be applied to a variety of clients after detailed customizations. C) It can be applied to a variety of clients with minimal adjustments to the software. D) It greatly accelerates audit testing over manual procedures. Answer: B Terms: Generalized audit software Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
4) When using the test data approach: A) test data should include data that the client's system should accept or reject. B) application programs tested must be virtually identical to those used by employees. C) select data may remain in the client system after testing. D) none of the above statements is correct. Answer: A Terms: Test data approach Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
5) An auditor who is testing IT controls in a payroll system would most likely use test data that contain conditions such as: A) time tickets with invalid job numbers. B) overtime not approved by supervisors. C) deductions not authorized by employees. D) payroll checks with unauthorized signatures. Answer: A Terms: IT controls in payroll system and use of test data Diff: Challenging Objective: LO 12-5 AACSB: Reflective thinking skills
6) Which of the following computer-assisted auditing techniques inserts an audit module in the client's application system to identify specific types of transactions? A) Parallel simulation testing B) Test data approach C) Embedded audit module D) Generalized audit software testing Answer: C Terms: Computer-assisted auditing techniques allows fictitious and real transactions Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
7) Which of the following best describes the test data approach? A) Auditors process their own test data using the client's computer system and application program. B) Auditors process their own test data using their own computers that simulate the client's computer system. C) Auditors use auditor-controlled software to do the same operations that the client's software does, using the same data files. D) Auditors use client-controlled software to do the same operations that the client's software does, using auditor created data files. Answer: A Terms: Test data approach Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
8) Describe three computer auditing techniques available to the auditor. Answer: Computer auditing techniques available to the auditor are: • Test data approach. Using this approach, the auditor develops different types of transactions that are processed under his or her own control using the client's computer programs on the client's IT equipment. • Parallel simulation. Using parallel simulation, the auditor writes a computer program that replicates some part of the client's application system. The client's data is then processed using the auditor's computer program. The auditor then compares the output generated by his or her program with that generated by the client's program to test the correctness of the client's program. Generalized audit software may be used. • Embedded audit module. Using this approach, the auditor inserts an audit module in the client's application system to capture transactions with characteristics that are of interest to the auditor. Terms: Computer auditing techniques Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
9) Discuss the advantages and benefits of using generalized audit software. Answer: Advantages and benefits of using generalized audit software include: • they are developed in such a manner that most of the audit staff can be trained to use the program even if they have little formal IT education. • a single program can be applied to a wide range of tasks without having to incur the cost or inconvenience of developing individualized programs. • generalize audit software can perform tests much faster and in more detail than using traditional manual procedures. Terms: Advantages and disadvantages using generalized audit software Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
10) Auditors often use Generalized Audit Software during their testing of a client's internal controls. For the following uses of the software provide a description and an example. Verify extensions and footings Print confirmation requests Compare data on separate files Answer: Verify extensions and footings: verify accuracy of the clients computations; foot any subsidiary ledger Print confirmation requests: print data for sample items selected for testing; randomly select accounts receivable customer balances for testing Compare data on separate files: determine that information contained in two or more files agrees; changes in accounts payable or accounts receivables accounts using purchases/sales journals and cash disbursement/cash receipts registers. Terms: Generalized Audit Software and testing of internal controls Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
11) Match eight of the terms (a-n) with the definitions provided below (1-8):
a. Application controls b. Auditing around the computer c. Auditing through the computer d. Error listing e. General controls f. Generalized audit software g. Hardware controls h. Input controls i. Output controls j. Parallel simulation k. Parallel testing l. Pilot testing m. Processing controls n. Test data approach ________ 1. The new and old systems operate simultaneously in all locations. ________ 2. Controls that relate to all parts of the IT system. ________ 3. Involves the use of a computer program written by the auditor that replicates some part of a client's application system. ________ 4. A method of auditing IT systems which uses data created by the auditor to determine whether the client's computer program can correctly process valid and invalid transactions. ________ 5. Controls such as review of data for reasonableness, designed to assure that data generated by the computer is valid, accurate, complete, and distributed only to authorized people. ________ 6. Controls that apply to processing of transactions. ________ 7. A new system is implemented in one part of the organization while other locations continue to rely on the old system. ________ 8. Controls such as proper authorization of documents, check digits, and adequate documentation, designed to assure that the information to be processed by the computer is authorized, complete, and accurate.
Answer: 1. k 2. e 3. j 4. n 5. i 6. a 7. l 8. h
Terms: Application controls; General controls; Parallel testing; Parallel simulation; Input Diff: Moderate Objective: LO 12-3 and LO 12-5 AACSB: Reflective thinking skills
12) The embedded audit module approach requires the auditor to insert an audit module in the client's application system to to identify specific types of transactions. Answer: TRUE Terms: Embedded audit module approach Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
13) The objective of the computer audit technique known as the test data approach is to determine whether the client's computer programs can correctly process valid and invalid transactions. Answer: TRUE Terms: Test data approach Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
14) Parallel simulation is used primarily to test internal controls over the client's IT systems, whereas the test data approach is used primarily for substantive testing. Answer: FALSE Terms: Parallel simulation Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
15) Generalized audit software is used to test automated controls. Answer: TRUE Terms: Generalized audit software Diff: Moderate Objective: LO 12-5 AACSB: Reflective thinking skills
Learning Objective 12-6 1) A database management system: A) allows clients to create databases that include information that can be shared across multiple applications. B) stores data on different files for different purposes, but always knows where they are and how to retrieve them. C) allows quick retrieval of data, but at a cost of inefficient use of file space. D) allows quick retrieval of data, but it needs to update files continually. Answer: A Terms: Database management system Diff: Moderate Objective: LO 12-6 AACSB: Reflective thinking skills
2) When auditing a client who uses a database management system, the auditor is principally aware of elevated risk due to the fact that: A) multiple users can access and update data files. B) the accounting information is only in one place. C) the database administrator may lack appropriate accounting knowledge. D) multiple users could all access the data simultaneously causing a system shutdown. Answer: A Terms: Database management systems and elevated risk Diff: Moderate Objective: LO 12-6 AACSB: Reflective thinking skills
3) General controls may include firewalls which are used to protect from: A) erroneous internal handling of data. B) insufficient documentation of transactions. C) illogical programming commands. D) unauthorized external users. Answer: D Terms: General controls use firewalls to protect Diff: Moderate Objective: LO 12-6 AACSB: Reflective thinking skills
4) What tools do companies use to limit access to sensitive company data? A) Encryption techniques Digital signatures Firewall Yes Yes Yes B) Encryption techniques Yes
Digital signatures No
Firewall No
C) Encryption techniques No
Digital signatures Yes
Firewall Yes
D) Encryption techniques Yes
Digital signatures Yes
Firewall No
Answer: A
Terms: Tools companies use to limit access to sensitive data Diff: Moderate Objective: LO 12-6 AACSB: Reflective thinking skills
5) Rather than maintain an internal IT center, many companies outsource their basic IT functions such as payroll to an: A) external general service provider. B) independent computer service center. C) internal control service provider. D) internal auditor. Answer: B Terms: Outsourced services Diff: Moderate Objective: LO 12-6 AACSB: Reflective thinking skills
6) When the auditor is obtaining an understanding of the independent computer service center's internal controls the auditor should: A) use the same criteria used to evaluate the client's internal controls. B) use different criteria because the service center resides outside the company. C) use the same criteria used to evaluate the client's internal controls but omit tests of transactions. D) use different criteria for the service center by including substantive tests of balances. Answer: A Terms: Service center's internal controls Diff: Challenging Objective: LO 12-6 AACSB: Reflective thinking skills
7) Many clients have outsourced their IT functions. The difficulty the independent auditor faces when a computer service center is used is to: A) gain the permission of the service center to review their work. B) find compatible programs that will analyze the service center's programs. C) determine the adequacy of the service center's internal controls. D) try to abide by the Code of Professional Conduct to maintain the security and confidentiality of client's data. Answer: C Terms: Outsourced IT functions Diff: Challenging Objective: LO 12-6 AACSB: Reflective thinking skills
8) A service center: A) must have an auditor hired by the PCAOB test the controls of the service center. B) audit cannot be relied upon by those outside of the firm. C) can engage a CPA firm to issue a report on their internal controls for use by all customers and their independent auditors. D) must make all of their systems available to any external party. Answer: C Terms: Service auditors Diff: Challenging Objective: LO 12-6 AACSB: Reflective thinking skills
9) What do auditing standards require when a company outsources some of their IT requirements to an independent computer service center? Answer: Auditing standards require the auditor to consider the need to obtain an understanding and test the service center's controls if the provider's application involves processing significant financial data. Terms: Outsources IT requirements to independent computer service center Diff: Challenging Objective: LO 12-6 AACSB: Reflective thinking skills
10) Firewalls can protect company data and software programs. Answer: TRUE Terms: Firewalls protect company data Diff: Easy Objective: LO 12-6 AACSB: Reflective thinking skills
11) LANs link equipment within a single or small cluster of buildings and are used within a company. Answer: TRUE Terms: LANs link equipment Diff: Easy Objective: LO 12-6 AACSB: Reflective thinking skills
12) When auditing a client whose information is processed by an outside service provider, it is not acceptable for the auditor to rely on the audit report of another independent auditor who has previously tested the internal controls of the service provider, rather than testing the service provider's controls himself or herself. Answer: FALSE Terms: Information processed by outside service provider Diff: Moderate Objective: LO 12-6 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e Chapter 13 Overall Audit Strategy and Audit Program Learning Objective 13-1 1) Shown below (1 through 5) are the five types of tests which auditors use to determine whether financial statements are fairly stated. Which three are substantive tests? 1. Risk assessment procedures 2. Tests of controls 3. Tests of transactions 4. Substantive analytical procedures 5. Tests of details of balances A) 1, 2, and 3. B) 3, 4, and 5. C) 2, 3, and 5. D) 2, 3, and 4. Answer: B Terms: Three types of substantive tests which auditors use Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
2) Collectively, procedures performed to obtain an understanding of the entity and its environment, including internal controls, represent the auditor's: A) audit strategy. B) tests of controls. C) risk assessment procedures. D) tests of transactions. Answer: C Terms: Procedures performed to obtain understanding of entity and environment, including internal controls Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
3) Which of the following would not be considered further audit procedures? A) Tests of controls B) Analytical procedures C) Tests of details of balances D) Risk assessment procedures Answer: D
Terms: Not considered a further audit procedure Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
4) Which of the following procedures would most likely be performed in response to the auditor's assessment of the risk of monetary misstatements in the financial statements? A) Ratio analysis B) Tests of controls C) Tests of details of balances D) Risk assessment procedures Answer: C Terms: Procedure performed in response to auditor's assessment of risk of monetary misstatement Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
5) Which of the following further audit procedures are used to determine whether all six transactionrelated audit objectives have been achieved for each class of transactions? A) Tests of controls B) Risk assessment procedures C) Substantive tests of transactions D) Preliminary analytical procedures Answer: C Terms: Further audit procedures to determine whether all six transaction related audit objectives have been achieved Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
6) You are auditing Rodgers and Company. After performing substantive analytical procedures you conclude that, for the accounts tested, the client's balance appears reasonable. This may indicate that: A) details test of balances can be eliminated for those accounts. B) certain tests of details of balances may be eliminated for those accounts. C) control tests may be eliminated for those accounts. D) control tests may be reduced for those accounts. Answer: B Terms: After performing substantive analytic procedures Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
7) The purpose of tests of controls is to provide reasonable assurance that the: A) accounting treatment of transactions and balances is valid and proper. B) internal control procedures are functioning as intended. C) entity has complied with GAAP disclosure requirements. D) entity has complied with requirements of quality control. Answer: B Terms: Purpose of tests of controls Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
8) In the context of an audit of financial statements, substantive tests are audit procedures that: A) may be eliminated under certain conditions. B) are designed to discover significant subsequent events. C) are designed to test for dollar misstatements. D) will increase proportionately with the auditor's reliance on internal control. Answer: C Terms: Substantive tests are audit procedures Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
9) Which of the following is true? A) Tests of details of balances focus on the ending general ledger balances for both balance sheet and income statement accounts. B) Tests of details of balances focus on the transactions during the period for both balance sheet and income statement accounts. C) Tests of details of balances focus on the auditor's understanding of internal controls. D) Tests of details of balances focus on comparisons of recorded amounts to expectations developed by the auditor. Answer: A Terms: Tests of details of balances focus on Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
10) A system walkthrough is primarily used to help the auditor: A) test the ending account balances. B) test the details of transactions. C) determine whether internal controls are in place. D) determine whether the audit engagement should be accepted. Answer: C Terms: System walkthrough Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
11) Risk assessment procedures are performed by auditors during an audit in order to: A) determine the risk of material misstatement in the financial statements. B) determine the amount of testing of internal control. C) determine the extent of testing of details of balances. D) determine the extent of testing of transactions. Answer: A Terms: Risk assessment procedures Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills Topic: Public
12) Tests of controls are directed toward the control's: A) efficiency. B) effectiveness. C) cost and effectiveness. D) cost benefit ratio. Answer: B Terms: Tests of controls directed toward Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
13) A procedure designed to test for monetary misstatements directly affecting the correctness of financial statement balances is a: A) test of controls. B) substantive test. C) test of attributes. D) monetary-unit sampling test. Answer: B Terms: Procedure designed to test for monetary misstatements directly affecting correctness of financial statements Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
14) Analytical procedures: A) involve comparisons of recorded amounts to expectations developed by management. B) are only performed during the planning stage of the audit. C) are required to be performed when auditing an account balance. D) provide substantive evidence. Answer: D Terms: Analytical procedures Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
15) The primary emphasis in most tests of details of balances is on the: A) balance sheet accounts. B) revenue accounts. C) cash flow statement accounts. D) expense accounts. Answer: A Terms: Primary emphasis in most tests of details of balances Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
16) Which of the following statements is not true? A) Analytical procedures emphasize the overall reasonableness of transactions and balances. B) Tests of controls are concerned with evaluating whether controls are sufficiently effective to justify reducing control risk and thereby reducing analytical review procedures. C) Substantive tests of transactions emphasize the verification of transactions recorded in the journals and then posted in the general ledger. D) Tests of details of balances emphasize the ending balances in the general ledger. Answer: B Terms: Tests of controls Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
17) Many auditors perform extensive analytical procedures on audits because: A) they are required by GAAS. B) they pinpoint errors in accounts. C) they indicate areas of potential risk and misstatement. D) they are required for tests of controls. Answer: C Terms: Auditors perform extensive analytical procedures Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
18) When controls are deemed ineffective and assessed control risk is at the maximum for a private company, which of the following would normally be true? A) No emphasis is placed on the controls. B) Relatively little emphasis is placed on the controls. C) Moderate emphasis is placed on the controls. D) Heavy emphasis is placed on the controls. Answer: A Terms: Controls deemed ineffective and assessed control risk is at maximum Diff: Challenging Objective: LO 13-1 AACSB: Reflective thinking skills
19) Which of the following is ordinarily designed to detect material dollar errors on the financial statements? A) Tests of controls B) Analytical review procedures C) Computer controls D) Tests of details of balances Answer: D Terms: Designed to detect material dollar errors on the financial statements Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
20) List each of the five types of audit tests and give at least two types of evidence that may be obtained from each type of test. Answer: • Risk assessment procedures - documentation, observation, inquiries of the client, and reperformance • Tests of controls - documentation, observation, inquiries of the client, and reperformance • Substantive tests of transactions - documentation, inquiries of the client, and reperformance • Analytical procedures - inquiries of the client and analytical procedures • Tests of details of balances - physical examination, confirmation, documentation, inquiries of the client, and reperformance Terms: Audit tests and types of evidence Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
21) Describe the five types of audit tests. Identify which of the five types are substantive tests, and which are used to reduce assessed control risk. Answer: The five types of audit tests used to determine whether financial statements are fairly stated are: risk assessment procedures, tests of controls, substantive tests of transactions, analytical procedures, and tests of details of balances. Substantive tests of transactions, analytical procedures, and tests of details of balances are substantive tests, whereas procedures to obtain an understanding of internal control and tests of controls are used to reduce assessed control risk. Terms: Types of audit tests; Substantive tests which reduce assessed control risk Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
22) Discuss the purposes of (1) substantive tests of transactions, (2) tests of controls, and (3) tests of details of balances. Give an example of each. Answer: The purpose of substantive tests of transactions is to determine whether all six transactionrelated audit objectives have been satisfied for each class of transactions. For example, as part of the auditor's test of the accuracy objective for sales, the auditor would compare the amount recorded in the sales journal for a sample of sales transactions with the total on the corresponding sales invoices. The purpose of tests of controls is to determine the effectiveness of both the design and operations of specific internal controls. For example, the auditor might observe for a month whether statements are mailed to all customers. The purpose of tests of details of balances is to determine the monetary correctness of the accounts to which they relate. The confirmation of accounts receivable is an example. Terms: Substantive tests of transactions, tests of controls and tests of details of balances Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
23) There are three stages of the audit in which analytical procedures are performed. Identify each of these three stages and, for each stage, discuss the purpose of performing analytical procedures in that stage. Also indicate in which stage(s) analytical procedures are required by current professional auditing standards. Answer: Analytical procedures are performed in the audit planning stage to help the auditor decide the other evidence needed to satisfy sufficient competent evidence requirements. Analytical procedures can also be performed as substantive tests in the testing phase of the audit. Analytical procedures are performed in the audit completion phase as a final test of reasonableness. Auditing standards require that analytical procedures be performed in the planning and completion phases of every audit. Terms: Analytical procedures in stages of audit Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
24) There are eight types of audit evidence: physical examination, confirmation, inspection, observation, inquiries of the client, reperformance, analytical procedures, and recalculation. For each of the following types of audit tests, indicate the type(s) of evidence that can be obtained through the test: (1) tests of controls, (2) substantive tests of transactions, (3) analytical procedures, and (4) tests of details of balances. Answer: 1. Tests of controls. Inspection, observation, inquiries of the client, reperformance 2. Substantive tests of transactions. Inspection, inquiries of the client, reperformance, recalculation 3. Analytical procedures. Inquiries of the client, analytical procedures 4. Tests of details of balances. Physical examination, confirmation, inspection, inquiries of the client, reperformance, recalculation Terms: Relationship of audit tests and types of audit evidence Diff: Challenging Objective: LO 13-1 AACSB: Reflective thinking skills
25) Procedures to obtain an understanding of internal control generally provide sufficient appropriate evidence that a a control is operating effectively. Answer: FALSE Terms: Internal controls Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
26) Substantive tests are procedures designed to test for dollar misstatements that directly affect the correctness of financial statement balances. Answer: TRUE Terms: Exception in substantive test of transactions Diff: Easy Objective: LO 13-1 AACSB: Reflective thinking skills
27) A major part of the auditor's risk assessment procedures is done to obtain an understanding of internal control. Answer: TRUE Terms: Risk assessment procedures Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
28) Tests of controls should be performed after substantive tests of transactions. Answer: FALSE Terms: Tests of controls and substantive tests of transactions Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
29) Auditors use analytical procedures and tests of details of balances to satisfy planned detection risk. Answer: TRUE Terms: Detection risk Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
30) Auditors must perform tests of controls separately from substantive tests of transactions. Answer: FALSE Terms: Tests of controls and substantive tests of transactions Diff: Moderate Objective: LO 13-1 AACSB: Reflective thinking skills
31) Analytical procedures are normally designed at the account level, whereas tests of controls and substantive tests of transactions are normally designed at the transaction-related objective level. Answer: TRUE Terms: Analytical procedures designed at the account level Diff: Challenging Objective: LO 13-1 AACSB: Reflective thinking skills
32) Tests of controls are performed to support a reduced assessment of detection risk. Answer: FALSE Terms: Procedures to obtain an understanding of internal control Diff: Challenging Objective: LO 13-1 AACSB: Reflective thinking skills
Learning Objective 13-2 1) In order to promote audit efficiency the auditor considers cost in selecting audit tests to perform. Which of the following audit tests would be the most costly? A) Analytical procedures B) Risk assessment procedures C) Tests of controls D) Tests of details of balances Answer: D Terms: Most costly audit test Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
2) An exception or deficiency found in a test of controls: A) indicates a financial statement misstatement. B) indicates the likelihood of a misstatement. C) indicates that the financial statements are fairly stated. D) indicates that an adverse opinion is warranted on the audit of internal control. Answer: B Terms: Exception or deficiency in test of controls Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
3) If no material differences are found using analytical procedures and the auditor concludes that misstatements are not likely to have occurred: A) other substantive tests may be reduced. B) it will be necessary to increase the tests of balances. C) it will not be necessary to perform tests of balances. D) it will be necessary to increase the tests of transactions. Answer: A Terms: If no material differences are found using analytical procedures Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
4) Which of the following audit tests is usually the least costly to perform? A) Analytical procedures B) Tests of controls C) Tests of balances D) Substantive tests of transactions Answer: A Terms: Least costly audit test Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
5) An increased extent of tests of controls is most likely to occur when: A) it is a first-year audit. B) the auditor is doing a "fraud audit." C) controls are effective and the preliminary control risk assessment is low. D) controls are ineffective and the preliminary control risk assessment is high. Answer: C Terms: Increased extent of tests of controls most likely to occur Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
6) When an auditor believes that analytical procedures indicate a reasonable possibility of misstatement, the auditor usually would: A) Perform additional tests of controls Decide to modify tests of details of balances Yes Yes B) Perform additional tests of controls No
Decide to modify tests of details of balances No
Perform additional tests of controls Yes
Decide to modify tests of details of balances No
D) Perform additional tests of controls No
Decide to modify tests of details of balances Yes
C)
Answer: D Terms: Analytical procedures indicate reasonable possibility of misstatement Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
7) If tests of controls support the control risk assessment, then ________ in the audit risk model is increased. A) planned detection risk. B) planned inherent risk. C) planned fraud risk. D) planned assurance risk. Answer: A Terms: Results of tests of controls, substantive tests of transactions, and analytical procedures Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
8) The auditor would design which of the following audit tests to detect possible monetary errors in the financial statements? A) Control tests B) Analytical procedures C) Risk assessment procedures D) Tests of operating effectiveness of controls over revenue and cash Answer: B Terms: Audit tests to detect possible monetary errors in the financial statements Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
9) The reliance the auditor places on substantive tests in relation to the reliance placed on internal control varies in a relationship that is ordinarily: A) parallel. B) inverse. C) direct. D) equal. Answer: B Terms: Reliance auditor places on substantive tests and internal controls Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
10) A deficiency uncovered in the audit of internal control is explained by which of the following in relation to a financial statement misstatement? A) The amount of the misstatement B) The likelihood of the misstatement C) The amount, likelihood, and classification of the misstatement D) The amount and the classification of the misstatement Answer: B Terms: Deficiency uncovered in audit of internal control Diff: Challenging Objective: LO 13-2 AACSB: Reflective thinking skills
11) Which of the following is not a valid basis for omitting an audit test in forming an opinion on the clients financial statements? A) The difficulty and expense involved in testing a particular item B) The relative risk involved C) The degree of reliance on the relevant internal controls D) The relationship between the cost of obtaining evidence and its usefulness Answer: A Terms: Not a valid basis for omitting an audit test in forming an opinion Diff: Challenging Objective: LO 13-2 AACSB: Reflective thinking skills
12) Three factors the auditor considers when assessing control risk are: the auditor's belief concerning the effectiveness of internal controls, the results of tests of controls, and the cost-effectiveness of a reduced assessed control risk. Identify the combination of conditions for these three factors that is required before a reduction in substantive testing is permitted. Answer: A reduction in substantive testing is permitted when (1) the auditor identifies specific controls he or she believes have been operating effectively during the period under audit, (2) the auditor believes it will be cost-effective to test those controls, and (3) the results of tests of controls indicate that the controls have indeed been operating effectively. Terms: Three factors auditor considers when assessing control risk and conditions before reduction in substantive testing Diff: Easy Objective: LO 13-2 AACSB: Reflective thinking skills
13) Tests of controls are generally more costly to perform than analytical procedures. Answer: TRUE Terms: Cost of tests of controls vs. analytical procedures Diff: Easy Objective: LO 13-2 AACSB: Reflective thinking skills
14) Only tests of details of balances involve physical examination and confirmation. Answer: TRUE Terms: Substantive tests of details of balances cost Diff: Easy Objective: LO 13-2 AACSB: Reflective thinking skills
15) Analytical procedures are the least costly type of audit test. Answer: TRUE Terms: Analytical procedures cost Diff: Easy Objective: LO 13-2 AACSB: Reflective thinking skills
16) If inherent risk is increased to medium from low, tests of details of balances can be reduced. Answer: FALSE Terms: Inherent risk; Details of balances Diff: Easy Objective: LO 13-2 AACSB: Reflective thinking skills
17) The extent of tests of details of balances cannot be reduced when transaction-related audit objectives have been satisfied by tests of controls or substantive tests of transactions. Answer: FALSE Terms: Extent of details of balances; Transaction-related audit objectives; Tests of controls and substantive tests of transactions Diff: Easy Objective: LO 13-2 AACSB: Reflective thinking skills
18) Because of the high cost of tests of details of balances, auditors do not perform this type fo testing unless fraud is suspected.
Answer: FALSE
Terms: Test of details of balances Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
19) The auditor's understanding of internal control performed as part of risk assessment procedures provides the basis for the auditor's initial assessment of control risk. Answer: TRUE Terms: Variation in audit evidence in cycles Diff: Easy Objective: LO 13-2 AACSB: Reflective thinking skills
20) Analytical procedures are the most expensive type of audit test to perform because of the expertise and training required to properly use them. Answer: FALSE Terms: Analytical procedures cost Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
21) The results of tests of controls and substantive tests of transactions affect the design of tests of details of balances. Answer: TRUE Terms: Results of tests of controls affect design of tests of details of balances Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
22) If internal controls are tested and are considered effective, the auditor generally will increase both substantive tests of transactions and tests of details of balances. Answer: FALSE Terms: Auditor's preliminary assessment of control risk Diff: Moderate Objective: LO 13-2 AACSB: Reflective thinking skills
23) Tests of controls provide evidence about the likelihood for misstatements in a client's financial statements. Answer: TRUE Terms: Tests of controls; Misstatements in client's financial statements Diff: Easy Objective: LO 13-2 AACSB: Reflective thinking skills
24) An exception in a test of control provides only an indication of the likelihood of monetary misstatements in the financial statements because tests of controls do not reveal whether monetary misstatements have actually occurred. Answer: TRUE Terms: Exception in test of control; Indication of likelihood of monetary misstatements Diff: Easy Objective: LO 13-2 AACSB: Reflective thinking skills
Learning Objective 13-3 1) Auditors who test manual controls that rely on IT-generated reports must consider: A) the effectiveness of management's review. B) automated controls over the accuracy of information in the report. C) both A and B D) neither A or B. Answer: C Terms: Test manual controls that rely on IT-generated reports Diff: Moderate Objective: LO 13-3 AACSB: Reflective thinking skills
2) Auditing standards recognize that in instances where a significant amount of audit evidence is in electronic form, it may not be possible to reduce detection risk to an acceptable level by performing only substantive tests. Answer: TRUE Terms: Auditing standards; Evidence in electronic form reduces detection risk Diff: Moderate Objective: LO 13-3 AACSB: Reflective thinking skills
3) In the audit of a public company, automated controls must be tested if they are considered to be key controls for reducing the likelihood of material misstatements in the financial statements. Answer: TRUE Terms: Audit of public company testing of computer controls Diff: Challenging Objective: LO 13-3 AACSB: Reflective thinking skills Topic: Public
4) Once auditors determine an automated control is functioning properly, they can focus subsequent tests on assessing whether any changes have occurred that will limit the effectiveness of the control. Answer: TRUE Terms: Automated computer controls Diff: Easy Objective: LO 13-3 AACSB: Reflective thinking skills
Learning Objective 13-4 1) Which of the following is generally not included in the "evidence mix"? A) Tests of controls B) Substantive tests of transactions C) Risk assessment procedures D) Tests of details of balances Answer: C Terms: Evidence mix Diff: Challenging Objective: LO 13-4 AACSB: Reflective thinking skills
2) The evidence mix includes risk assessment procedures. Answer: FALSE Terms: Evidence mix and risk assessment procedures Diff: Moderate Objective: LO 13-4 AACSB: Reflective thinking skills
3) The choice of which types of tests to use and how extensively they need to be performed must be the same for all audits. Answer: FALSE Terms: Evidence mix and risk assessment procedures Diff: Moderate Objective: LO 13-4 AACSB: Reflective thinking skills
Learning Objective 13-5 1) The document that details the specific audit procedures for each type of test is the: A) audit strategy. B) audit program. C) audit procedure. D) audit risk model. Answer: B Terms: Audit program Diff: Easy Objective: LO 13-5 AACSB: Reflective thinking skills
2) Auditors follow a four step approach to reduce assessed control risk. Which of the following is not one of the four? A) Apply transaction related audit objectives to a class of transactions. B) Identify accounts that have high inherent risk. C) Identify key controls that reduce control risk. D) For potential misstatements, design appropriate substantive tests of transactions. Answer: B Terms: Approach to reduce assessed control risk Diff: Moderate Objective: LO 13-5 AACSB: Reflective thinking skills
3) When designing the audit program and the particular audit tests, the auditor should keep in mind that: A) the audit program is broken down into two parts-the risk assessment procedures and the tests of details of balances. B) the tests of controls will not vary depending on assessed control risk. C) analytical procedures performed during substantive testing are generally more focused and more extensive than those done as part of planning. D) auditing standards require that the tests contained in the audit program must be approved by the PCAOB. Answer: C Terms: Important consideration in developing the audit program Diff: Moderate Objective: LO 13-5 AACSB: Reflective thinking skills
4) When designing tests of controls and substantive tests an auditor is gathering evidence to satisfy the transaction related audit objectives. What are the four steps the auditor would normally follow to reduce assessed control risk? Answer: 1. Apply the transaction-related audit objectives to the class of transactions being tested. 2. Identify key controls that should reduce control risk for each transaction- related audit objective. 3. Develop appropriate tests of controls for all internal controls that are used to reduce the preliminary assessment of control risk below maximum. 4. For potential types of misstatements related to each transaction-related audit objective, design appropriate substantive tests of transactions, considering deficiencies in internal control and expected results of the tests of controls. Terms: Four-step approach to reduce assessed control risk Diff: Moderate Objective: LO 13-5 AACSB: Reflective thinking skills
5) Discuss the relationship of each of the following to the extent of planned tests of details of balances: (1) tolerable misstatement, (2) inherent risk, (3) control risk, and (4) acceptable audit risk. Answer: Inherent risk and control risk are directly related to the extent of planned tests of details of balances; that is, as inherent risk and/or control risk increases, the extent of planned tests of details of balances also increases. Tolerable misstatement and acceptable audit risk are inversely related to the extent of planned tests of details of balances; that is, as tolerable misstatement and/or acceptable audit risk increases, the extent of planned tests of details of balances decreases.
Terms: Relationship of extent of planned tests of details of balances and tolerable misstatement, inherent risk, control risk, and acceptable audit risk Diff: Challenging Objective: LO 13-5 AACSB: Reflective thinking skills
6) Auditing standards require a written audit program. Answer: TRUE Terms: Auditing standards; Audit program Diff: Easy Objective: LO 13-5 AACSB: Reflective thinking skills
7) When designing an audit program for tests of details of balances, the auditor should make assumptions about inherent risk and control risk, and predictions concerning the outcome of tests of controls, substantive tests of transactions, and analytical procedures. Answer: TRUE
Terms: Designing audit program; Inherent risk and control risk; Tests of controls, substantive tests of transactions, and analytical procedures Diff: Easy Objective: LO 13-5 AACSB: Reflective thinking skills
8) When testing details of balances, most audit procedures satisfy only one balance-related objective, but more than one audit procedure should be used to test each objective. Answer: FALSE Terms: Testing details of balances and audit procedures Diff: Moderate Objective: LO 13-5 AACSB: Reflective thinking skills
9) Substantive tests of transactions and control tests are often conducted simultaneously. Answer: TRUE Terms: Substantive tests of transactions and control tests Diff: Moderate Objective: LO 13-5 AACSB: Reflective thinking skills
10) Auditors must use considerable professional judgment to determine any change in audit procedures that can be made when the level of inherent risk is increased or decreased. Answer: TRUE Terms: Audit program Diff: Moderate Objective: LO 13-5 AACSB: Reflective thinking skills
Learning Objective 13-6 1) Which of the following types of procedures will be performed in an audit of internal control over financial reporting? A) Procedures to obtain an understanding of internal control Ratio analysis Yes Yes B) Procedures to obtain an understanding of internal control No
Ratio analysis No
Procedures to obtain an understanding of internal control Yes
Ratio analysis No
Procedures to obtain an understanding of internal control No
Ratio analysis Yes
C)
D)
Answer: C
Terms: Types of procedures performed in an audit of internal control Diff: Moderate Objective: LO 13-6 AACSB: Reflective thinking skills Topic: Public
2) What type of test is used to obtain the most types of evidence? A) Substantive tests of transactions B) Tests of controls C) Risk assessment tests D) Tests of details of balances Answer: D Terms: Type of test used to obtain more types of evidence Diff: Challenging Objective: LO 13-6 AACSB: Reflective thinking skills
3) Which audit tests involve physical examination and confirmation? A) Tests of controls B) Tests of transactions C) Tests of balances D) Analytical procedures Answer: C Terms: Audit tests that involve physical examination and confirmation Diff: Challenging Objective: LO 13-6 AACSB: Reflective thinking skills
4) Which of the following types of evidence is not available when using substantive tests of transactions? A) Inspection B) Confirmation C) Inquiries of the client D) Reperformance Answer: B Terms: Types of evidence not available when using substantive tests of transactions Diff: Challenging Objective: LO 13-6 AACSB: Reflective thinking skills
5) If all transaction-related audit objectives are met, the auditor does not need to perform substantive tests of balances to determine realizable value. Answer: FALSE Terms: Transaction-related audit objectives Diff: Moderate Objective: LO 13-6 AACSB: Reflective thinking skills
Learning Objective 13-7 1) Presentation and disclosure related audit objectives would be performed in which phase of the audit process? A) Plan and design audit approach B) Perform audit tests for controls and transactions C) Perform analytical procedures and tests of balances D) Complete the audit and issue the audit report Answer: D Terms: Presentation and disclosure related audit objective performed in what phase of audit process Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills
2) Transaction related audit objectives would most likely be performed in which phase of the audit process? A) Plan and design audit approach B) Perform audit tests for controls and transactions C) Perform analytical procedures and tests of balances D) Complete the audit and issue the audit report Answer: B Terms: Transaction related audit objectives performed in what phase of audit process Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills
3) Analytical procedures must be performed in: A) the planning and test of control stages. B) conjunction with tests of transactions and tests of details of balances. C) the planning and completion stages. D) the planning, test of control, and completion stages. Answer: C Terms: Analytical procedures must be performed Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills
4) Which of the following tests commonly occur together? A) Substantive tests of transactions and tests of controls B) Substantive tests of transactions and obtaining an understanding of internal controls C) Analytical procedures and tests of controls D) Tests of controls and tests of details of balances Answer: A Terms: Tests that occur together Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills
5) Tests of controls and substantive tests of transactions are an important determinant of the extent of the auditor's use of tests of details of balances. Which of the following is true? A) They are likely to be performed prior to the clients end of the fiscal year. B) They are likely to eliminate the need for tests of details of balances. C) They are likely to have no impact on the planned tests of details of balances. D) They are likely to be used only in the audit of internal control. Answer: A Terms: Tests of controls and substantive tests of transactions Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills
6) When the auditor has completed the tests of details of balances and enters phase 4 of the audit process, she must still perform audit procedures for which of the following? A) Contingent liabilities and employee compensation B) Contingent liabilities and subsequent events C) Subsequent events and contractual commitments D) Subsequent events and unrecorded liabilities Answer: B Terms: Audit procedures performed in phase 4 of audit process Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills
7) Which of the following audit tests would be regarded as a test of controls? A) Comparison of the inventory pricing to vendors' invoices B) Tests of the signatures on canceled checks to board of directors' authorizations C) Tests of the additions to property, plant, and equipment by physical inspections D) Review of the specific items making up the balance in a given general ledger account Answer: B Terms: Tests of controls audit tests Diff: Moderate Objective: LO 13-7 AACSB: Analytic skills
8) Which of the following audit tests form the basis for an auditor's report on internal control over financial reporting? A) Analytical procedures B) Tests of transactions C) Tests of controls D) Tests of details of balances Answer: C Terms: Audit tests that form basis for auditor's report on internal control Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills Topic: Public
9) Management implements internal controls to ensure that all required footnote disclosures are accurate. Auditors tests those controls to provide evidence supporting the ________ presentation. A) completeness and valuation B) completeness and accuracy C) rights and obligations and existence D) occurrence and accuracy Answer: B Terms: Phase 4 of audit Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills
10) At what point in the audit process are tests of details most appropriately designed? A) Plan and design audit approach B) Perform audit tests for controls and transactions C) Perform analytical procedures and tests of balances D) Complete the audit and issue the audit report Answer: C Terms: Audit process and test of details Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills
11) Which of the following is/are performed in an audit of internal control over financial reporting? A) Procedures to obtain an understanding of internal control Test of details of balances Analytical Procedures Yes Yes No B) Procedures to obtain an understanding of internal control Yes
Test of details of balances No
Analytical Procedures No
Procedures to obtain an understanding of internal control No
Test of details of balances Yes
Analytical Procedures Yes
Procedures to obtain an understanding of internal control No
Test of details of balances No
Analytical Procedures Yes
C)
D)
Answer: B
Terms: Audit of internal control over financial reporting Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills Topic: Public
12) Which of the following ultimately determines the specific audit procedures necessary to provide an independent auditor with a reasonable basis for the expression of an opinion? A) The audit program B) The auditor's judgment C) Generally accepted auditing standards D) The auditor's working papers Answer: B Terms: Determines specific audit procedures Diff: Challenging Objective: LO 13-7 AACSB: Reflective thinking skills
13) In phase 4 of the audit, complete the audit and issue an audit report, there are five activities required. List below the activities. Answer: 1. Perform additional tests for presentation and disclosure 2. Accumulate final evidence 3. Evaluate results 4. Issue audit report 5. Communicate with audit committee and management Terms: Phase 4 of audit Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills
14) In accumulating final evidence upon which to base an audit opinion, the auditor should perform four activities. List the activities below. Answer: 1. Perform final analytical procedures 2. Evaluate the going concern assumption 3. Obtain a client representation letter 4. Read information in the annual report to ensure that it is consistent with the financial statements Terms: Accumulating final evidence and final activities Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills
15) Discuss the major activities and procedures performed by the auditor in the plan and design of the audit approach. Answer: The major activities performed in the planning and design phase (Phase I) are: • Accept client and perform initial planning • Understand the clients business and industry • Assess client business risk • Perform preliminary analytical procedures • Set materiality and assess acceptable audit risk and inherent risk • Understand internal control and assess control risk • Gather information to assess fraud risks • Develop overall audit plan and audit program Terms: Major activities and procedures performed by auditor in the plan and design of the audit approach Diff: Challenging Objective: LO 13-7 AACSB: Reflective thinking skills
16) The auditor must communicate significant deficiencies in internal control only after the entire audit is complete to ensure the auditor has a sufficient understanding of the circumstances surrounding the deficiency. Answer: FALSE Terms: Auditor communicate significant deficiencies in internal control Diff: Moderate Objective: LO 13-7 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e (Arens) Chapter 14 Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions Learning Objective 14-1 1) Which of the following is an account that is not affected by the sales and collection cycle? A) Cash B) Accounts receivable C) Allowance for doubtful accounts D) Accounts payable Answer: D Terms: Sales and collection cycle Diff: Easy Objective: LO 14-1 AACSB: Reflective thinking skills
2) The auditor's objectives for the sales and cash collections activities when the client is primarily an ecommerce business as compared to a "bricks and mortar" business are: A) unchanged. B) expanded. C) mitigated. D) decreased. Answer: A Terms: Auditor objectives for sales and cash collections
Diff: Moderate Objective: LO 14-1 AACSB: Analytic skills
3) The overall objective in the audit of the sales and collection cycle is to evaluate whether the account balances affected by the cycle are fairly presented in accordance with accounting standards. Answer: TRUE Terms: Objective in audit of sales and collection cycle; Account balances fairly presented Diff: Easy Objective: LO 14-1 AACSB: Reflective thinking skills
4) The sales and collection cycle applies to businesses that transfer goods to customers or provides services to businesses. Answer: TRUE Terms: Sales and collection cycle Diff: Moderate Objective: LO 14-1 AACSB: Reflective thinking skills
Learning Objective 14-2 1) Which of the following is not one of the five classes of transactions included in the sales and collection cycle? A) Sales returns and allowances B) Write-off of uncollectible accounts C) Bad debt expense D) Interest Income Answer: D Terms: Class of transactions; Sales and collection cycle Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
2) What event initiates a transaction in the sales and collection cycle? A) Receipt of cash B) Delivery of product to a customer C) Identification of a new customer D) Customer request for goods Answer: D Terms: Initiates transaction in sales and collection cycle Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
3) A ________ is a document that indicates a request for merchandise by a customer. A) sales invoice B) vendor invoice C) customer order D) sales order Answer: C Terms: Document indicates request for merchandise Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
4) A ________ is a document that is matched with the customer order to assure that the correct quantity and type of goods are shipped. A) sales order B) customer order C) vendor invoice D) sales invoice Answer: A Terms: Document matched with customer order Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
5) What critical event must take place before goods can be shipped in order to assure payment can be reasonably expected? A) Determination of correct delivery address B) Credit approval C) Matching of shipping document with sales invoice D) Receipt of sales order from the customer Answer: B Terms: Event must take place in order to assure payment Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
6) Before goods are shipped on account, a properly authorized person must: A) prepare the sales invoice. B) approve the journal entry. C) approve the customer's credit. D) verify that the unit price is accurate. Answer: C Terms: Goods shipped on account; Properly authorized person Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
7) A document prepared to initiate shipment of the goods sold by an independent shipper is the: A) sales order. B) bill of lading. C) sales invoice. D) customer order. Answer: B Terms: Document prepared to initiate shipment of goods Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
8) The document used to indicate to the customer the amount of a sale and payment due date is the: A) sales invoice. B) bill of lading. C) purchase order. D) sales order. Answer: A Terms: Document used to indicate amount of sale and payment due date Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
9) Generally, when is the earliest point in the sales and collection cycle in which revenue can be recognized? A) When the sale is approved B) When the credit approval process is finalized C) When the cash is collected D) When the goods have been shipped Answer: D Terms: Sales and collection cycle; revenue recognized Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
10) Most companies recognize sales revenue when: A) sales are invoiced. B) payment is received from the customer. C) goods are shipped. D) the customer's order is received. Answer: C Terms: Recognize sales revenue Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
11) Which of the following is not a business function within the "Sales" class of transactions? A) Processing customer orders B) Granting credit C) Processing and recording sales returns and allowances D) Shipping goods Answer: C Terms: Business function within the sales class of transactions Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
12) The total of the individual account balances in the accounts receivable subsidiary ledger should equal the: A) total sales for the period. B) balance of the sales account in the general ledger. C) total sales less the total cash received for the period. D) balance of the accounts receivable account in the general ledger. Answer: D Terms: Accounts receivable subsidiary ledger Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
13) In the accounts receivable subsidiary ledger the length of time the account has been due can be useful to the client and the auditor in preparing the: A) trial balance. B) working trial balance. C) accounts receivable trial balance. D) aged accounts receivable trial balance. Answer: D Terms: Accounts receivable subsidiary ledger Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
14) A document sent to each customer showing his or her beginning accounts receivable balance and the amount and date of each sale, cash payment received, any debit or credit memo issued, and the ending balance is the: A) accounts receivable subsidiary ledger. B) monthly statement. C) remittance advice. D) sales invoice. Answer: B Terms: Document sent to customer showing beginning accounts receivable balance Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
15) The document that accompanies the customer's payment is the: A) credit memo. B) remittance advice. C) vendor invoice. D) monthly statement. Answer: B Terms: Document that accompanies customer's payment Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
16) The document that requires adjustments to the customers subsidiary ledger account is the: A) bill of lading. B) sales invoice. C) credit memo. D) monthly statement. Answer: C Terms: Document that requires adjustment to the customer's account Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
17) A document that initiates shipment of goods and indicates the description of the merchandise, the quantity shipped, and customer name and address is the: A) bill of lading. B) sales invoice. C) picking ticket. D) vendor invoice. Answer: A Terms: Document that initiates shipment of goods Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
18) The ________ is a contract between a carrier (e.g., a trucking company) and the seller of goods that dictates the details surrounding the shipment of goods. A) bill of lading B) sales invoice C) picking ticket D) remittance advice Answer: A Terms: Contract that dictates details for shipment of goods Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
19) Some companies have customers send payments directly to an address maintained by a bank. This is called a(n) ________ system. A) direct deposit B) funds transfer C) lockbox D) interbank transfer Answer: C Terms: Payments sent to post office box Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
20) Which of the following is a business function related to sales returns and allowances? A) Processing customer orders B) Writing off uncollectible accounts C) Processing and recording credit memos D) Granting credit Answer: C Terms: Designing audit procedures sales returns and allowances Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
21) For a firm that practices good internal controls in the sales and collections cycle, the function of indicating credit approval should be recorded on which of the following documents? A) Sales order B) Sales invoice C) Customer order D) Remittance advice Answer: A Terms: Good internal controls in sales and collection cycle; Credit approval Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
22) When posting items from the sales journal, details of the journal and journal totals are posted to which items? A) Details of the journal are posted to Journal totals are posted to The sales account The general ledger B) Details of the journal are posted to The sales account
Journal totals are posted to The accounts receivable subsidiary ledger
Details of the journal are posted to The accounts receivable master file
Journal totals are posted to The general ledger
Details of the journal are posted to The accounts receivable account in the general ledger
Journal totals are posted to The sales account in the general ledger
C)
D)
Answer: C Terms: Posting from sales journal; Details of journal and journal totals posted Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
23) Credit memos are normally issued to: A) adjust the customers balance to the amount owed to the company because of returned goods or an allowance. B) assist in the aging of accounts receivable. C) reduce customer frustration and sales losses. D) inform the customer of the balance due. Answer: A Terms: Credit memos Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
24) Who is generally responsible for opening receipts when a company uses a lockbox to speed the
handling of cash receipts? A) Company personnel B) Temporary employees in the town where the lockbox is located C) Bank employees D) Company controller Answer: C Terms: Opening receipts; Lockbox Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
25) When processing and recording cash receipts, an important fact to consider is: A) the most important concern is depositing cash at least twice daily. B) the most important concern is the possibility of theft. C) theft can occur only after the receipts are entered in the records. D) it the customer fails to include a remittance advice, the check should be returned to the customer. Answer: B Terms: Processing and recording cash receipts Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
26) Sales should be recorded, at the earliest, when: A) the order is received. B) the order is received and credit is approved. C) credit is approved and it is verified that there is enough inventory to fill the order. D) the shipment takes place. Answer: D Terms: Sales recorded Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
27) Explain each of the following types of documents and indicate the class of transactions in which they are commonly used. 1. Customer order 2. Shipping document 3. Remittance advice 4. Sales returns and allowance journal 5. Uncollectible account authorization form Answer: 1. Customer order — request for merchandise by a customer. Appears in the sales class of transactions. 2. Shipping document — document prepared to initiate shipment of goods, indicating the description of the merchandise, the quantity shipped, and other relevant data. Appears in the sales class of transactions. 3. Remittance advice — document that is mailed to the customer and typically returned to the seller with payment. Appears in the cash receipts class of transactions. 4. Sales returns and allowance journal — journal used to record all sales returns and allowances. It performs the same function as the sales journal. Appears in the sales returns and allowance class of transactions. 5. Uncollectible account authorization form — document used internally to indicate authority to write off an account receivable. Appears in the charge off of uncollectible accounts class of transactions. Terms: Documents and class of transactions Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
28) You are an audit manager for Rodgers & Co. and have recently taken on a new client, Manufacturing Company. You are in the initial stages of planning the audit and have decided to start gathering information about the sales/collection cycle of the business. List below the classes of transactions that you need to gather audit evidence for in designing your audit procedures. Answer: The five classes of transactions that comprise the sales and collection cycle are: • Sales • Cash receipts • Sales returns and allowances • Write-off of uncollectible accounts • Bad debt expense Terms: Classes of transactions that comprise the sales and collection cycle Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
29) Customer billing is a critical process which auditors must understand. What are the most important aspects of billing and what are the related objectives? Answer: The most important aspects of billing are: • To make sure that all shipments made have been billed (completeness), • That no shipment has been billed more than once (occurrence), and • That each shipment is billed for the proper amount (accuracy). Terms: Aspects of billing and related objectives Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
30) Discuss the four business functions that result in sales transactions in a typical sales and collection cycle and, for each function, state the key documents and records involved. Answer: The four business functions that result in sales transactions, and related documents and records, are: • Processing customer orders. Key documents include customer order and sales order • Granting credit. Customer order or sales order • Shipping goods. Shipping document (bill of lading) • Billing customers and recording sales. Sales invoice, sales transaction file, sales journal or listing, accounts receivable master file, accounts receivable trial balance, and monthly statements Terms: Business functions that result in sales transactions; Sales and collection cycle; Documents Diff: Challenging Objective: LO 14-2 AACSB: Analytic skills
31) Match seven of the terms for documents and records (a-k) with the descriptions provided below (1-7): a. b. c. d. e. f. g. h. i. j. k.
Customer order form Sales order Bill of lading Sales invoice Summary sales report Accounts receivable master file Monthly statement Remittance advice Prelisting of cash receipts Credit memo Uncollectible account authorization form
________ 1. A list prepared when cash is received by someone who has no responsibility for recording sales, accounts receivable, or cash, and has no access to the accounting records. It is used to verify whether cash received was recorded and deposited at the correct amounts and on a timely basis. ________ 2. A document indicating a reduction in the amount due from a customer because of returned goods or an allowance. ________ 3. A document prepared to initiate shipment of goods, indicating the description of the merchandise, the quantity shipped, and other relevant data. It is a written contract between the carrier and seller of the receipt and shipment of goods. ________ 4. A document for communicating the description, quantity, and related information for goods ordered by a customer. This is frequently used to indicate credit approval and authorization for shipment. ________ 5. A document mailed to the customer and typically returned to the seller with the cash payment. ________ 6. A document used internally to indicate authority to write-off an account receivable as uncollectible. ________ 7. A document or electronic record indicating the description and quantity of goods sold, the price, freight charges, insurance, terms, and other relevant data. Answer: 1. i 2. j 3. c 4. b 5. h 6. k 7. d Terms: Documents and records Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
32) A sales invoice is a document that usually indicates credit approval. Answer: FALSE Terms: Sales invoice; Credit approval Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
33) Credit should be approved before a customer's order is received. Answer: FALSE Terms: Credit approved Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
34) Credit should be approved before goods are shipped to a customer. Answer: TRUE Terms: Credit approved Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
35) The receipt of a customer order from a customer is the starting point for the entire sales and collection cycle. Answer: TRUE Terms: Customer order; Starting point for sales and collection cycle Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
36) The preparation of a sales invoice is the final step in the sales and collection cycle. Answer: FALSE Terms: Sales invoice; Final step in sales and collection cycle Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
37) A bill of lading is a special type of sales invoice used when goods are shipped interstate. Answer: FALSE Terms: Bill of lading; Sales invoice Diff: Easy Objective: LO 14-2 AACSB: Reflective thinking skills
38) The shipping point is critical because it is the first point at which company assets are released to another party. Answer: TRUE Terms: Shipping point critical; Assets released Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
39) A bill of lading is a written contract between the seller and the buyer. Answer: FALSE Terms: Bill of lading; Written contract Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
40) In a lockbox system, bank employees are responsible for opening cash receipts and maintaining records of all payments made by customers at the lockbox address. Answer: TRUE Terms: Lockbox system Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
41) Sales transactions are the result of the following five functions in the sales and collection cycle: processing customer orders, granting credit, shipping goods, billing customers, and recording sales. Answer: TRUE Terms: Sales and collection cycle Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
42) The prelisting of cash receipts should be prepared by the individual who has primary responsibility for the recording of cash receipts. Answer: FALSE Terms: Prelisting of cash receipts Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
43) A credit memo is a document used internally that indicates authority to write-off an account receivable as uncollectible. Answer: FALSE Terms: Credit memos Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
44) If a company uses a periodic inventory system, the shipping records are used to update the inventory quantities. Answer: FALSE Terms: Shipping records and inventory records Diff: Moderate Objective: LO 14-2 AACSB: Analytic skills
45) The sales journal is generated from the sales transaction file. Answer: TRUE Terms: Sales transaction file and sales journal Diff: Moderate Objective: LO 14-2 AACSB: Reflective thinking skills
Learning Objective 14-3 1) When designing audit procedures, tracing of source documents to the customers subsidiary ledger and subsequently to the general ledger is done to satisfy what assertion? A) Valuation B) Cutoff C) Completeness D) Classification Answer: C Terms: Tracing of source documents; Assertion Diff: Easy Objective: LO 14-3 AACSB: Reflective thinking skills
2) When assessing risk control, the auditor must do all of the following except: A) assess control risk for each objective by evaluating the controls and deficiencies for each objective. B) perform the detailed test of balances. C) identify the key internal controls and deficiencies. D) associate the key controls and deficiencies with the objectives. Answer: B Terms: Assess control risk Diff: Easy Objective: LO 14-3 AACSB: Reflective thinking skills
3) When sales invoices are automatically calculated and posted by a computer, the auditor may be able to reduce substantive tests of transactions for which, if any, assertion? A) Accuracy B) Existence C) Completeness D) None of the above Answer: A Terms: Reduce substantive tests of transactions Diff: Easy Objective: LO 14-3 AACSB: Reflective thinking skills
4) In many audits, no substantive tests of transactions are made for the ________ assertion on the grounds that understatement of sales is not a concern. A) accuracy B) existence C) completeness D) none of the above Answer: C Terms: No substantive tests of transactions; Assertion; understatement of sales Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
5) Which one the following procedures performed for the billing function provides evidence for the completeness assertion? A) Making sure that all shipments have been billed B) Making sure that no shipment has been billed more than twice C) Making sure that each shipment is billed at the correct amount D) Making sure that each shipment is billed to the proper customer Answer: A Terms: Procedures; Billing function; Completeness assertion Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
6) When assessing planned control risk for sales: A) the key internal controls and deficiencies for sales will be the same for every company. B) the audit objectives for sales will differ from company to company. C) a flowchart is required to help assess control risk for sales. D) assessing control risk for sales is a highly subjective decision. Answer: D Terms: Access control risk Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
7) The document that the accounting staff will use as the primary basis for recording sales transactions and updating the customers accounts receivable subsidiary ledger is the: A) sales order. B) bill of lading. C) sales journal. D) sales invoice. Answer: D Terms: Document used as primary basis for recording sales transactions Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
8) In determining the level of audit efficiency, once the auditor has identified the key internal controls and identified any deficiencies in order to determine the level of control risk appropriate for a private company client, it is appropriate to decide whether: A) substantive tests can be reduced sufficiently to justify costs of performing tests of controls. B) substantive tests can be increased sufficiently to justify costs of performing tests of controls. C) tests of controls can be increased sufficiently to justify costs of performing substantive tests. D) tests of controls can be reduced sufficiently to justify costs of performing substantive tests. Answer: A Terms: Audit efficiency and internal controls Diff: Challenging Objective: LO 14-3 AACSB: Reflective thinking skills
9) Which one of the following statements is true? In deciding on substantive tests of transactions: A) some procedures are commonly employed on every audit regardless of the circumstances. B) all procedures are dependent on the adequacy of the controls and the results of the tests of controls. C) results obtained in the prior year's audit will not affect the procedures used this year. D) the materiality of the item will not influence the choice of procedures used. Answer: A Terms: Substantive tests of transactions Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
10) To test for recorded sales for which there were no actual shipments, the auditor vouches from the: A) bill of lading to the sales journal. B) sales journal to the shipping documents. C) sales journal to the accounts receivable subsidiary ledger. D) bill of lading to the supporting customer order and sales order. Answer: B Terms: Test for recorded sales with no actual shipments Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
11) An effective procedure to test for unbilled shipments is to trace from the: A) sales journal to the shipping documents. B) shipping documents to the sales journal. C) sales journal to the accounts receivable ledger. D) sales journal to the general ledger sales account. Answer: B Terms: Procedure for unbilled shipments Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
12) The auditor traces items from the source documents to the journals in order to accumulate audit evidence that will satisfy the: A) existence objective. B) completeness objective. C) ownership objective. D) valuation objective. Answer: B Terms: Trace items from source documents to journals Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
13) In many audits of sales transactions substantive tests of transactions can be reduced in determining the completeness objective because: A) understatements of assets and income are a greater concern than overstatements. B) overstatements of assets and income are a greater concern than understatements. C) it doesn't matter if income is understated because the savings on income tax offsets the reduced revenue and net income is correct. D) the unrecorded sales cause a reduction of accounts receivable; therefore, the ratios of the two financial statements will not be misleading. Answer: B Terms: Audit of sales transactions; Substantive tests of transactions; Completeness objective Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
14) To determine that sales are accurately recorded, the unit prices on the duplicate sales invoices are normally compared with: A) the original invoices. B) an approved master price list. C) the amounts recorded in the sales journal for that transaction. D) the amounts posted to the customer's account in the accounts receivable master file. Answer: B Terms: Sales accurately recorded; Unit prices compared with Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
15) Prenumbered documents are intended to help: A) Prevent the failure to bill or Prevent duplicate billings or record sales recordings of sales Yes Yes B) Prevent the failure to bill or record sales No
Prevent duplicate billings or recordings of sales No
Prevent the failure to bill or record sales Yes
Prevent duplicate billings or recordings of sales No
D) Prevent the failure to bill or record sales No
Prevent duplicate billings or recordings of sales Yes
C)
Answer: A
Terms: Prenumbered documents Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
16) Prenumbered documents will only be useful for control purposes if: A) a different numerical sequence is used for each company. B) the sequence is accounted for periodically. C) employees are allowed to use documents out of numerical sequence. D) the same numerical sequence is used each accounting period. Answer: B Terms: Prenumbered documents; Control purposes Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
17) ________ tests are for omitted transactions, while ________ tests are for nonexistent transactions. A) Tracing, vouching B) Vouching, tracing C) Verifying, tracking D) Tracking, verifying Answer: A Terms: Tests for omitted transactions and nonexistent transactions Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
18) Which one of the following best describes the auditors responsibilities regarding appropriate
authorizations in the sales/collections cycle? A) B, C, and D should all be of concern to the auditor. B) Credit must be authorized before the sale. C) Goods must be shipped after the authorization. D) Prices must be authorized. Answer: A Terms: Authorizations in sales/collection cycle Diff: Challenging Objective: LO 14-3 AACSB: Reflective thinking skills
19) Which one of the following is of the least concern to the auditor when designing substantive tests of transactions for the sales/collection cycle? A) Sales being included in the journal for which no shipment was made B) Sales to related parties, such as officers and subsidiaries C) Sales recorded more than once D) Shipments being made to nonexistent customers and recorded as sales Answer: B Terms: Substantive tests of transactions for sales/collection cycle Diff: Challenging Objective: LO 14-3 AACSB: Reflective thinking skills
20) An auditor needs to determine whether all customers of an electric utility company are being billed. The auditor should test from the: A) sales register to the accounts receivable ledger. B) sales register to the meter department records. C) accounts receivable ledger to the sales register. D) meter department records to the sales register. Answer: D Terms: All customers being billed Diff: Challenging Objective: LO 14-3 AACSB: Analytic skills
21) Which one of the following would the auditor consider to be an incompatible operation if the cashier receives remittances from the mailroom? A) The cashier prepares the daily deposit. B) The cashier makes the daily deposit at a local bank. C) The cashier posts the receipts to the accounts receivable subsidiary ledger cards. D) The cashier endorses the checks. Answer: C Terms: Incompatible operation if cashier receives remittance; Separation of duties Diff: Challenging Objective: LO 14-3 AACSB: Reflective thinking skills
22) Which of the following is the appropriate point at which the auditor deems authorization to be critical? A) Credit granting Price authorization Shipment of goods Yes Yes Yes B) Credit granting Yes
Price authorization No
Shipment of goods Yes
Credit granting No
Price authorization Yes
Shipment of goods No
Credit granting Yes
Price authorization No
Shipment of goods No
C)
D)
Answer: A
Terms: Point authorization deemed critical Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
23) Which of the following would least concern an auditor regarding the lack of a specific authorization to conduct the sales transaction? A) Granting of credit B) Shipment of goods C) Determination of discounts D) Selling of goods for cash Answer: D Terms: Specific authorization to conduct sales transactions Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
24) In designing substantive audit procedures for tests of transactions for sales the auditor needs to test for evidence of misstatements due to errors or fraud. Describe at least 2 potential errors (unintentional) and at least 1 intentional (fraud). Answer: 1. Unintentional–sales included in the journals for which no shipment was made and sales that were recorded more than once. 2. Intentional (fraud)–shipments made to nonexistent customers and were recorded as sales. Terms: Substantive audit procedures for tests of transactions for sales; Misstatements; Fraud Diff: Challenging Objective: LO 14-3 AACSB: Reflective thinking skills
25) For each of the following potential misstatements, provide one potential audit test that could be used to detect the misstatement. • Sales included in the journals for which there was no shipment • Sale recorded more than once • Shipments made to nonexistent customers and recorded as sales Answer: The potential audit tests include the following: • Sales included in the journals for which there was no shipment. Vouch selected entries in the sales journal to related copies of shipping and other supporting documents. • Sale recorded more than once. Review a numerically sorted list of recorded sales transactions for duplicate numbers. The auditor can also test for proper cancellation of shipping documents. • Shipments made to nonexistent customers and recorded as sales. Trace customer information on sales invoices to the customer master file. Terms: Audit test used to detect misstatement Diff: Challenging Objective: LO 14-3 AACSB: Reflective thinking skills
26) When assessing planned control risk for sales, the auditor is concerned about proper authorization at three key points. Discuss each of these three points. Answer: Credit must be properly authorized before a sale takes place; goods should be shipped only after proper authorization; and prices including base terms, freight, and discounts must be properly authorized. Terms: Assessing planned control risk; Proper authorization Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
27) Separation of duties in the sales/collection cycle should mandate that the credit-granting function be separate from the sales function. Answer: TRUE Terms: Separation of duties in the sales/collection cycle; credit-granting function Diff: Easy Objective: LO 14-3 AACSB: Reflective thinking skills
28) Tracing from source documents to the journal is useful for testing the existence objective. Answer: FALSE Terms: Tracing; Existence objective Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
29) In converting from a design format audit program to a performance format audit program, procedures are combined. Answer: FALSE Terms: Design and performance format audit procedures Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
30) Management's assertions for sales and collection activities remain the same whether sales are generated through traditional or e-commerce activities. Answer: TRUE Terms: Management's assertions for sales and collection activities Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
31) Misstatements involving the completeness objective for sales lead to overstatements of assets and income. Answer: FALSE Terms: Misstatements involving the completeness objective for sales Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
32) Violations of the existence objective for sales are of greater concern to the auditor than violations of the completeness objective. Answer: TRUE Terms: Violations of the existence objective for sales; violations of the completeness objective Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
33) An effective procedure to test the existence objective for sales is to vouch sales journal entries to copies of sales orders, shipping documents, and sales invoices. Answer: TRUE Terms: Procedure to test the existence objective for sales Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
34) For each significant internal control deficiency identified by the auditor, he or she should design one or more tests of controls to assess the extent of the deficiency and its effect on the financial statements. Answer: TRUE Terms: Significant internal control deficiency; Tests of controls Diff: Challenging Objective: LO 14-3 AACSB: Analytic skills
35) The appropriate test of controls for separation of duties are ordinarily restricted to the auditor's observations of activities and discussions with personnel. Answer: TRUE Terms: Test of controls for separation of duties Diff: Moderate Objective: LO 14-3 AACSB: Reflective thinking skills
36) Sales should be billed and recorded as soon as possible after the shipment takes place. Answer: TRUE Terms: Internal control Diff: Moderate Objective: LO 14.2, 14.3, and 14.5 AACSB: Reflective thinking skills
Learning Objective 14-4 1) Transaction-related audit objectives are essentially the same for processing credit memos as for sales with certain differences. Which of the following are two key differences? A) Risk and emphasis on the completeness objective. B) Materiality and emphasis on the accuracy objective C) Risk and emphasis on the classification objective D) Materiality and emphasis on the occurrence objective Answer: D Terms: Transaction-related audit objectives; Credit memos Diff: Challenging Objective: LO 14-4 AACSB: Reflective thinking skills
2) Smith Manufacturing Company's accounts receivable clerk has a friend who is also a Smith's customer. The accounts receivable clerk has issued fictitious credit memos to his friend for goods supposedly returned. The most effective procedure for preventing this activity is to: A) prenumber and account for all credit memorandums. B) require receiving reports that provide evidence of returned inventory items to support all credit memorandums before they are approved. C) have independent sales and accounts receivable departments. D) mail monthly statements to customers. Answer: B Terms: Fictitious credit memos; Procedure to prevent activity Diff: Moderate Objective: LO 14-4 AACSB: Analytic skills
3) The transaction-related audit objectives and the client's methods of controlling misstatements are essentially the same for credit memos as for sales with the exception of two differences. What are the two differences from the auditor's perspective? Answer: The first difference is materiality. In many instances, sales returns and allowances are so immaterial that auditors ignore them. The second difference is the emphasis on the occurrence objective. For sales returns and allowances, auditors usually emphasize testing recorded transactions to uncover any theft of cash from the collection of accounts receivable that was covered up by fictitious sales returns and allowances. Terms: Transaction-related audit objectives for credit memos and sales Diff: Challenging Objective: LO 14-4 AACSB: Reflective thinking skills
4) When auditors evaluate sales returns and allowances, a primary emphasis is on the objective of occurrence. Answer: TRUE Terms: Sales returns and allowances; Objective of occurrence Diff: Easy Objective: LO 14-4 AACSB: Reflective thinking skills
5) Sales returns and allowances are often ignored by auditors because they are often immaterial. Answer: TRUE Terms: Sales returns and allowances; Immaterial Diff: Moderate Objective: LO 14-4 AACSB: Reflective thinking skills
6) When auditing sales returns and allowances, the emphasis is normally on testing the completeness objective. Answer: FALSE Terms: Auditing sales returns and allowances; Completeness objective Diff: Moderate Objective: LO 14-4 AACSB: Reflective thinking skills
Learning Objective 14-5 1) When an employee who is authorized to make customer entries in the accounts receivable subsidiary ledger, purposefully enters cash received into the wrong customer's account that employee may be suspected of: A) kiting. B) lapping. C) floating. D) shorting. Answer: B Terms: Employee authorized to make customer entries Diff: Moderate Objective: LO 14-5 AACSB: Analytic skills
2) An audit procedure that compares the name, amount, and dates shown on remittance advices, either paper of electronic via direct deposit, with cash receipts journal entries and with related duplicate deposit slips would be effective in detecting: A) kiting. B) lapping. C) illicit write-offs of customers as uncollectible accounts. D) sales without proper credit authorization. Answer: B Terms: Audit procedure compares names with cash receipts journal entries Diff: Moderate Objective: LO 14-5 AACSB: Reflective thinking skills
3) To prevent fraud, management should deny cash access to anyone responsible for: A) Opening mail from Entering sales Entering cash receipts customers transactions transactions Yes Yes Yes B) Opening mail from customers No
Entering sales transactions No
Entering cash receipts transactions Yes
Opening mail from customers No
Entering sales transactions Yes
Entering cash receipts transactions Yes
Opening mail from customers Yes
Entering sales transactions No
Entering cash receipts transactions No
C)
D)
Answer: C
Terms: Fraud; Cash access Diff: Moderate Objective: LO 14.2, 14.3, and 14.5 AACSB: Reflective thinking skills
4) The audit procedure referred to as proof of cash receipts is particularly useful to test: A) time lags in making deposits. B) whether all recorded cash receipts have been deposited in the bank. C) whether there are cash receipts that have not been recorded in the journals. D) the client's reconciliation between cash receipts and bank deposits. Answer: B Terms: Audit procedure; Proof of cash receipts Diff: Moderate Objective: LO 14-5 AACSB: Analytic skills
5) Which of the following test of controls is useful to test the completeness objective for cash receipts? A) Compare shipping documents with sales records. B) Observe endorsement of incoming checks. C) Examine evidence that the receivable master file is reconciled to the general ledger. D) Observe if the client reconciles the bank account. Answer: B Terms: Audit procedures; Test completeness objective (assertion) for cash receipts Diff: Moderate Objective: LO 14-5 AACSB: Reflective thinking skills
6) When designing tests of controls and substantive tests of transactions for cash receipts, it is important
to remember that: A) the test of controls are designed to test for monetary misstatements. B) auditors use the same methodology for designing tests of controls and substantive tests of transactions for cash receipts as they use for sales. C) the tests of controls are not dependent on the controls the auditor identifies. D) the tests of controls is not dependent on whether the company being audited is publicly traded/ Answer: B Terms: Designing tests of controls and substantive tests of transactions for cash receipts Diff: Moderate Objective: LO 14-5 AACSB: Reflective thinking skills
7) Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this fraud and be least likely to be detected by an auditor? A) Understating the sales journal by not recording cash sales B) Overstating the accounts receivable control account by intentionally misstating prices charged for goods sold C) Overstating the accounts receivable subsidiary ledger by not recording payments made by customers D) Understating the cash receipts journal by purposely recording incorrect amounts Answer: A Terms: Cash receipts from sales on account; Misappropriated; Fraud Diff: Challenging Objective: LO 14-5 AACSB: Reflective thinking skills
8) Which of the following would offer the best protection for a company that wishes to prevent a reoccurrence of a previously detected "lapping" problem with trade accounts receivable? A) Segregate duties so that the bookkeeper in charge of the general ledger has no access to incoming mail. B) Segregate duties so that no employee has access to both checks from customers and currency from daily cash receipts. C) Have customers send payments directly to the company's depository bank. D) Request that customer's payment checks be made payable to the company and addressed to the treasurer. Answer: C Terms: Prevent lapping problem Diff: Challenging Objective: LO 14-5 AACSB: Reflective thinking skills
9) Preparation of a proof of cash would not be useful in discovering differences between the actual and reported cash balances if the differences were due to: A) deposits in transit. B) collections on the company's behalf by the bank which are deposited directly to the company's account. C) cash receipts that were not recorded in the relevant accounting records. D) service charges. Answer: C Terms: Proof of cash Diff: Challenging Objective: LO 14-5 AACSB: Analytic skills
10) The completeness transaction-related audit objective must be considered when determining key controls for for sales. List three key controls that must be considered when cash received is recorded in the cash receipts journal. Answer: (1) is a prelisting of cash receipts prepared, (2) are checks restrictively endorsed (3) are the batch totals of cash receipts compared with the computer summary or other applicable reports, and (4) are statements sent to customers each month. Terms: Completeness assertion for cash receipts and existing controls Diff: Moderate Objective: LO 14-5 AACSB: Reflective thinking skills
11) Explain what lapping means, and discuss the internal control deficiency that allows it to occur. Also discuss the procedures the auditor can perform to detect lapping. Answer: Lapping, which is a common type of embezzlement, is the postponement of entries for the collection of receivables to conceal an existing cash shortage. The embezzlement is perpetrated by a person who handles cash receipts and then enters them into the computer system. He or she defers recording the cash receipts from one customer and covers the shortages with subsequent receipts from another. These in turn are covered from the receipts of a third customer a few days later. The employee must continue to cover the shortage through repeated lapping, replace the stolen money, or find another way to conceal the shortage. The embezzlement can be easily prevented by segregation of duties and a mandatory vacation policy for employees who hand cash and enter cash receipts into the system. It can be detected by comparing the name, amount, and dates shown on remittance advices with cash receipts, journal entries and related duplicate deposit slips. Because this procedure is relatively time-consuming, it is ordinarily performed only when specific concerns with embezzlement exist because of a deficiency in internal control. Terms: Lapping; Internal control deficiency Diff: Challenging Objective: LO 14-5 AACSB: Reflective thinking skills
12) You are part of the audit team that is auditing Hillsburg Hardware Co. and you have been assigned to the sales and collection business process. You are testing whether the cash received has been recorded in the cash receipts journal. (completeness objective /assertion). List two tests of controls and at least one test of transactions that you would do to satisfy yourself regarding the completeness assertion. Answer: Control Tests: 1. Observe prelisting of cash receipts. 2. Observe endorsement of incoming checks. 3. Examine file of batch totals to initials of data control clerk. 4. Observe whether monthly statements are sent. Transaction Tests: 1. Trace amounts of prelisted cash receipts to the cash receipts journal, testing for names, amounts, dates. 2. Compare the prelisting with the duplicate deposit slip. Terms: Sales and collection business process; Tests of controls and test of transactions for completeness objective/assertion Diff: Challenging Objective: LO 14-5 AACSB: Reflective thinking skills
13) In planning the audit, an auditor takes 3 basic steps in determining the audit procedures to be performed for any business cycle or class of transactions in order to gather audit evidence concerning possible misstatement due to error or fraud. List those three basic steps below. Answer: The three basic steps in designing tests of controls and substantive tests of transactions are: • Determine key internal controls for each audit objective. • Design tests of controls for each control used to support a reduced control risk. • Design substantive tests of transactions to test for monetary misstatements for each objective. Terms: Audit procedures performed for business cycle or class of transactions Diff: Challenging Objective: LO 14-5 AACSB: Reflective thinking skills
14) The most difficult type of cash embezzlement for the auditor to detect is when the cash is stolen before it can be recorded in the cash receipts journal. Answer: TRUE Terms: Cash embezzlement Diff: Moderate Objective: LO 14-5 AACSB: Reflective thinking skills
15) An essential part of the auditors responsibility in auditing cash receipts is to identify deficiencies in internal control that increase the likelihood of fraud. Answer: TRUE Terms: Cash receipts from sales on account; Misappropriated; Fraud Diff: Moderate Objective: LO 14-5 AACSB: Reflective thinking skills
Learning Objective 14-6 1) The auditor's primary concern in performing audit procedures of the write-off of uncollectible accounts relates to the risk that the client writes offs customer accounts that have already been collected. The primary control for preventing this fraud is: A) examining authorized credit memos. B) examining the uncollectible account authorization form. C) examining debit memos. D) examining the vouchers payable register. Answer: B Terms: Audit procedures; Write-off of uncollectible accounts; Fraud Diff: Challenging Objective: LO 14-6 AACSB: Reflective thinking skills
2) The estimation of bad debts expense relates to the write-off of uncollectible accounts. Answer: TRUE Terms: Audit test for write-off of uncollectible accounts Diff: Easy Objective: LO 14-6 AACSB: Reflective thinking skills
3) There should generally be correspondence in the client's file establishing the uncollectibility of their account. Answer: TRUE Terms: Audit test for write-off of uncollectible accounts Diff: Easy Objective: LO 14-6 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e Chapter 15 Audit Sampling for Tests of Controls and Substantive Tests of Transactions Learning Objective 15-1 1) A sample in which the characteristics of the sample are the same as those of the population is a(n): A) variables sample. B) representative sample. C) attributes sample. D) random sample. Answer: B Terms: Sample in which characteristics of sample are same as population Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
2) When the auditor decides to select less than 100 percent of the population for testing, the auditor is said to use: A) audit sampling.
B) representative sampling. C) poor judgment. D) estimation sampling. Answer: A
Terms: Auditor selects less than 100 percent of population for testing Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
3) To determine if a sample is truly representative of the population, an auditor would be required to: A) conduct multiple samples of the same population. B) never use sampling because of the expense involved. C) audit the entire population. D) use systematic sample selection. Answer: C Terms: Sample truly representative of population Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
4) One of the causes of nonsampling risk is: A) improper supervision and instruction of the client's employees. B) ineffective audit procedures. C) inadequate sample size. D) exceptions being found in the sample. Answer: B Terms: Nonsampling risk Diff: Moderate Objective: LO 15-1 AACSB: Reflective thinking skills
5) Which one of the choices below is most correct regarding a cause of sampling risk? A) Ineffective use of audit procedures B) Testing less than the entire population C) Use of extensive tests of controls D) The use of random sampling Answer: B Terms: Correct regarding sampling risk Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
6) An auditor can increase the likelihood that a sample is representative by using care in: A) Designing the sampling process Designing the sample selection Yes Yes B) Designing the sampling process No
Designing the sample selection No
Designing the sampling process Yes
Designing the sample selection No
Designing the sampling process No
Designing the sample selection Yes
C)
D)
Answer: A Terms: Increase likelihood that sample is representative Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
7) Which of the following is the risk that audit tests will not uncover existing exceptions in a sample? A) Sampling risk B) Nonsampling risk C) Audit risk D) Detection risk Answer: B Terms: Risk that audit tests will not uncover existing exceptions Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
8) Which of the following is the risk that an auditor will reach an incorrect conclusion because a sample is not representative of the population? A) Sampling risk B) Nonsampling risk C) Audit risk D) Detection risk Answer: A Terms: Risk auditor will reach an incorrect conclusion Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
9) Sampling risk may be controlled by: A) Adjusting the sample size Yes
Using an appropriate method of selecting sample items Yes
Adjusting the sample size No
Using an appropriate method of selecting sample items No
Adjusting the sample size Yes
Using an appropriate method of selecting sample items No
Adjusting the sample size No
Using an appropriate method of selecting sample items Yes
B)
C)
D)
Answer: A Terms: Sampling risk controlled by Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
10) Which of the following statements is most correct? A) A sample of all items of a population will eliminate sampling risk, but increase nonsampling risk. B) The use of an appropriate sample selection technique ensures a representative sample. C) The auditor's failure to recognize an exception is a significant cause of sampling risk. D) The use of inappropriate audit procedures is a significant cause of nonsampling risk. Answer: D Terms: Sample selection; Sampling and nonsampling risk Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
11) Briefly explain why auditors utilize audit sampling. Answer: Auditors use sampling techniques primarily because it is generally impractical to audit all transactions or balances. Consequently, auditors must design strategies to select items from the population that are likely to be representative of the remaining unaudited population items. In addition, auditors often use sampling techniques because of economic realities. That is, clients generally do not want to incur the substantial fees associated with auditing every transaction or balance. Terms: Audit sampling Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
12) Discuss what is meant by "sampling risk" and "nonsampling risk." Answer: Sampling risk is the risk that an auditor reaches an incorrect conclusion because the sample is not representative of the population. Sampling risk is an inherent part of sampling that results from testing less than the entire population. Nonsampling risk is the risk that the auditor reaches an incorrect conclusion for any reason not related to the sampling risk. Terms: Sampling and nonsampling risks Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
13) List the two ways auditors can control sampling risk. Answer: Auditors can control sampling risk by: 1. adjusting the sample size 2. using an appropriate method of selecting sample items from the population. Terms: Sampling risk controlled by Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
14) Discuss two causes of nonsampling risk. Also discuss ways the auditor can control nonsampling risk. Answer: The two causes of nonsampling risk are (1) the auditor's failure to recognize exceptions and (2) inappropriate or ineffective audit procedures. The auditor can control nonsampling risk through careful design of audit procedures and through proper instruction, supervision, and review. Terms: Nonsampling risk Diff: Moderate Objective: LO 15-1 AACSB: Reflective thinking skills
15) Sampling risk results from the auditor's failure to recognize exceptions in transaction data. Answer: FALSE Terms: Sampling risk Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
16) If an auditor does a test in the wrong direction, sampling risk will increase. Answer: FALSE Terms: Nonsampling risk Diff: Easy Objective: LO 15-1 AACSB: Reflective thinking skills
17) If a particular internal control is not followed by the client exactly 6% of the time, and the auditor's tests of that control find three control violations in a sample of 50, the sample is considered to be representative. Answer: TRUE Terms: Sample considered to be representative Diff: Moderate Objective: LO 15-1 AACSB: Reflective thinking skills
18) In practice, auditors do not know whether a sample is representative, even after all testing is complete. Answer: TRUE Terms: Representative sample Diff: Moderate Objective: LO 15-1 AACSB: Reflective thinking skills
19) One way to control sampling risk is to increase sample size. Answer: TRUE Terms: Control sampling risk is with sample size Diff: Moderate Objective: LO 15-1 AACSB: Reflective thinking skills
20) A sample of all items in a population will have a zero sampling risk. Answer: TRUE Terms: Sample of all items in a population will have zero sampling risk Diff: Moderate Objective: LO 15-1 AACSB: Reflective thinking skills
21) It is virtually impossible to reduce sampling risk to zero. Answer: TRUE Terms: Sampling risk Diff: Moderate Objective: LO 15-1 AACSB: Reflective thinking skills
Learning Objective 15-2 1) There are three phases in both statistical and nonstatistical sampling. The first phase is to: A) generate random numbers for the sample. B) evaluate the results. C) plan the sample. D) select the sample. Answer: C Terms: Statistical and nonstatistical sampling Diff: Easy Objective: LO 15-2 AACSB: Reflective thinking skills
2) When auditors wish to evaluate a sample statistically, an acceptable selection method is: A) systematic sample selection. B) judgmental selection. C) haphazard selection. D) block sample selection. Answer: A Terms: Sample statistically Diff: Easy Objective: LO 15-2 AACSB: Reflective thinking skills
3) Which of the following statements is most correct with concerning the quantification of sampling risk? A) Sampling risk cannot be quantified. B) Sampling risk can be quantified only when nonprobabilistic selection techniques are used to select the sample. C) Sampling risk can be quantified only when probabilistic selection techniques are used to select the sample. D) None of the above. Answer: C Terms: Quantification of sampling risk Diff: Easy Objective: LO 15-2 AACSB: Reflective thinking skills
4) Which of the following statements is most correct with respect to the evaluation of nonprobabilistic sample results? A) It is acceptable to make nonprobabilistic evaluations only when probabilistic sample selection is used. B) It is acceptable to make nonprobabilistic evaluations only if the auditor cannot quantify sampling risk. C) It is never acceptable to evaluate a nonprobabilistic sample using statistical methods. D) All of the above are correct. Answer: C Terms: Evaluation of non-probabilistic sample results Diff: Moderate Objective: LO 15-2 AACSB: Reflective thinking skills
5) Which of the following statements is a valid criticism of nonstatistical sampling? A) Many audit tests, such as footing of journals, must be performed outside a statistical sampling context. B) The cost of performing random selection or testing often exceeds the benefits. C) Nonstatistical sampling does not differ substantially from statistical sampling methods. D) Conclusions may be drawn in more precise ways when using statistical sampling methods. Answer: D Terms: Criticism of non-statistical sampling Diff: Moderate Objective: LO 15-2 AACSB: Reflective thinking skills
6) Which of the following statements is not correct regarding probabilistic and nonprobabilistic sample selection? A) In probabilistic selection, every population item has a known chance of being selected. B) It is acceptable to evaluate a nonprobabilistic sample using statistical methods. C) Probabilistic selection is required for all statistical sampling methods. D) Both methods are acceptable and commonly used. Answer: B Terms: Probabilistic and non-probabilistic sample selection Diff: Challenging Objective: LO 15-2 AACSB: Reflective thinking skills
7) Nonprobabilistic selection methods are not based on mathematical probabilities; therefore: A) the extent to which a sample is representative of the population may be difficult to determine. B) they are discouraged by the AICPA. C) they are not allowed by the Statements on Auditing Standards. D) they are not as effective as statistical sampling. Answer: A Terms: Non-probabilistic selection methods Diff: Challenging Objective: LO 15-2 AACSB: Reflective thinking skills
8) An advantage of using statistical sampling techniques is that such techniques: A) mathematically measure risk. B) eliminate the need for judgmental decisions. C) define the values of precision and reliability required to provide audit satisfaction. D) have been established in the courts to be superior to judgmental sampling. Answer: A Terms: Advantage of using statistical sampling techniques Diff: Challenging Objective: LO 15-2 AACSB: Reflective thinking skills
9) Auditors who prefer statistical to nonstatistical sampling believe that the principal advantage of statistical sampling flows from its ability to: A) quantify sampling risk. B) promote a more legally defensible procedural approach. C) define the precision required to provide audit satisfaction. D) establish conclusive audit evidence with decreased audit effort. Answer: A Terms: Advantage of statistical sampling over nonstatistical sampling Diff: Challenging Objective: LO 15-2 AACSB: Reflective thinking skills
10) Which of the following statements best expresses the impact that the performance of audit procedures has on statistical vs. nonstatistical sampling? A) Audit procedures on the sample item will vary as a result of using either statistical or nonstatistical sampling. B) The audit procedures will be the same for either statistical or nonstatistical sampling but they must be performed differently for each. C) Statistical sampling requires quantitative audit procedures, whereas nonstatistical sampling requires judgmental audit procedures. D) Audit procedures on the sample item will not vary as a result of using either statistical or nonstatistical sampling. Answer: D Terms: Statistical and nonstatistical sampling Diff: Challenging Objective: LO 15-2 AACSB: Reflective thinking skills
11) Describe the differences between statistical and nonstatistical sampling in terms of (1) the sample selection methods used, and (2) quantification of sampling risk. Answer: Nonstatistical sampling differs from statistical sampling in that non-probabilistic sampling can be used for the former but not the latter. In addition, sampling risk can be quantified when using statistical sampling but not when using nonstatistical sampling. Terms: Differences between statistical and nonstatistical sampling applying sample selection methods and quantification of sampling risk Diff: Moderate Objective: LO 15-2 AACSB: Reflective thinking skills
12) You are designing the audit plan for Mathews & Company. You are a strong proponent for statistical
sampling over nonstatistical sampling. Make your case. Answer: • More efficient samples • Quantifies sampling risk • Improved correlation between the sample and the population Terms: Statistical sampling vs. nonstatistical sampling Diff: Moderate Objective: LO 15-2 AACSB: Reflective thinking skills
13) It is equally acceptable under professional auditing standards for auditors to use either statistical or nonstatistical sampling methods. Answer: TRUE Terms: Equally acceptable to use statistical or nonstatistical sampling methods Diff: Moderate Objective: LO 15-2 AACSB: Reflective thinking skills
14) When using nonstatistical sampling, the sample must be a probabilistic one. Answer: FALSE Terms: Nonstatistical sampling; sample must be probabilistic Diff: Moderate Objective: LO 15-2 AACSB: Reflective thinking skills
15) The use of haphazard sample selection is encouraged under professional auditing standards. Answer: FALSE Terms: Haphazard sample selection Diff: Moderate Objective: LO 15-2 AACSB: Reflective thinking skills
16) Directed sample selection, block sample selection, and haphazard sample selection are three types of probabilistic sample selection methods. Answer: FALSE Terms: Probabilistic sample selections; Directed sample selection, block sample selection and haphazard selections Diff: Moderate Objective: LO 15-2 AACSB: Reflective thinking skills
Learning Objective 15-3 1) A sample in which every possible combination of items in the population has an equal chance of constituting the sample is a: A) random sample. B) statistical sample. C) judgment sample. D) representative sample. Answer: A Terms: Sample in which every possible combination has equal chance of constituting sample Diff: Easy Objective: LO 15-3 AACSB: Reflective thinking skills
2) The process which requires the calculation of an interval and then selects the items based on the size of the interval is: A) statistical sampling. B) random sample selection. C) systematic sample selection. D) computerized sample selection. Answer: C Terms: Process which requires calculation of an interval Diff: Easy Objective: LO 15-3 AACSB: Reflective thinking skills
3) In systematic sample selection, the population size is divided by the number of sample items desired in order to determine the: A) sampling interval. B) tolerable exception rate. C) computed upper exceptions rate. D) mean. Answer: A Terms: Systematic sample selection Diff: Easy Objective: LO 15-3 AACSB: Reflective thinking skills
4) Which of the following methods of sample selection is appropriately used when selecting a random sample? A) Auditor's judgmental Use of random number selection of items generators Generalized audit software Yes No Yes B) Auditor's judgmental selection of items No
Use of random number generators Yes
Generalized audit software Yes
Auditor's judgmental selection of items Yes
Use of random number generators No
Generalized audit software No
Auditor's judgmental selection of items No
Use of random number generators Yes
Generalized audit software No
C)
D)
Answer: B
Terms: Methods of sample selection in selecting a random sample Diff: Moderate Objective: LO 15-3 AACSB: Reflective thinking skills
5) Simple random sampling: A) is used when there is a need to emphasize one or more types of population items. B) requires both input and output parameters to be set when using a random number generator. C) is generally used with replacement sampling. D) is a probabilistic sampling method. Answer: D Terms: Random sampling Diff: Moderate Objective: LO 15-3 AACSB: Reflective thinking skills
6) When a population is divided into subpopulations, usually by dollar size, and larger samples are taken from the subpopulation with the larger sizes, ________ is being used. A) sampling with probability proportional to size B) stratified sampling C) block sampling D) haphazard sampling Answer: B Terms: Random number tables Diff: Moderate Objective: LO 15-3 AACSB: Reflective thinking skills
7) The advantage of systematic sample selection is that: A) it is easy to use. B) there is limited possibility of it being biased. C) it is unnecessary to determine if the population is arranged randomly. D) it automatically selects items material to the financial statements. Answer: A Terms: Advantage of systematic sample selection Diff: Moderate Objective: LO 15-3 AACSB: Reflective thinking skills
8) In performing a review of a client's cash disbursements, an auditor uses systematic sample selection with a random start. The primary disadvantage of this technique is population items: A) may occur twice in the sample. B) must be reordered in a systematic pattern before the sample can be drawn. C) may occur in a systematic pattern, thus negating the randomness of the sample. D) must be replaced in the population after sampling to permit valid statistical inference. Answer: C Terms: Disadvantage of systematic sample selection with random start Diff: Moderate Objective: LO 15-3 AACSB: Reflective thinking skills
9) Which of the following is a correct statement regarding block sampling? A) It is acceptable to use block sampling only if a reasonable number of blocks are used. B) Block sampling uses sampling with replacement. C) Block sampling is a probabilistic sampling method. D) There is considerable cost and time involved when block sampling is used. Answer: A Terms: Block sampling Diff: Moderate Objective: LO 15-3 AACSB: Reflective thinking skills
10) The most serious shortcoming of the haphazard sample selection method is: A) it is not subject to statistical sampling methods. B) it is time consuming to use. C) it is costly to use. D) it is difficult to remain completely unbiased in the selection. Answer: D Terms: Haphazard sample selection Diff: Easy Objective: LO 15-3 AACSB: Reflective thinking skills
11) Which of the following statements regarding block sampling is least likely to be true? A) Block sampling is the selection of several items in sequence. B) It is acceptable to use block sampling for tests of transactions only if a reasonable number of blocks is used. C) Only one block should be selected to increase the probability of a representative sample. D) Once the first item in the block is selected, the remainder of the block is chosen automatically. Answer: C Terms: Block sampling Diff: Challenging Objective: LO 15-3 AACSB: Reflective thinking skills
12) When the auditor goes through a population and selects items using nonprobabilistic selection methods, without regard to their size, source, or other distinguishing characteristics, it is called: A) block sample selection. B) haphazard selection. C) systematic sample selection. D) statistical selection. Answer: B Terms: Nonprobabilistic selection methods Diff: Easy Objective: LO 15-3 AACSB: Reflective thinking skills
13) What is the key advantage and disadvantage associated with systematic sample selection? How must auditors address this disadvantage? Answer: The key advantage is its ease of use. Generally, systematic samples are easily drawn from the population and supporting documentation is easily developed. The key disadvantage is the potential for bias. Once the first item in the sample is selected, all other items are chosen automatically. Auditors should be careful to consider any potential pattern in the data prior to selecting their sample to ensure that their selection considers the possible bias. Terms: Systematic sample selection Diff: Moderate Objective: LO 15-3 AACSB: Reflective thinking skills
14) Describe each of the four types of sample selection methods commonly associated with statistical audit sampling. Answer: Four types of sample selection methods commonly associated with statistical audit sampling are: • Simple random sample selection. Every possible combination of elements in the population has an equal chance of constituting the sample. • Systematic sample selection. A probabilistic method of sampling in which the auditor calculates an interval (the population size divided by the number of sample items desired) and selects the items for the sample based on the size of the interval and a randomly selected number between zero and the interval size. • Probability proportional to size sample selection. The probability of selecting any individual population item is proportional to its recorded amount. • Stratified sample selection. A probabilistic method of sampling in which the population is divided into subpopulations, and samples are taken from each of the subpopulations. Terms: Types of sample selection methods associated with statistical audit sampling Diff: Challenging Objective: LO 15-3 AACSB: Reflective thinking skills
15) When selecting a sample, random numbers may be obtained either with replacement or without replacement. Although both selection methods are theoretically sound, auditors rarely use replacement sampling. Answer: TRUE Terms: Selecting same with random numbers Diff: Moderate Objective: LO 15-3 AACSB: Reflective thinking skills
16) Although systematic sample selection is easy to use, its primary disadvantage is that it is not a probabilistic sampling method. Answer: FALSE Terms: Systematic sample selection; probabilistic sampling method Diff: Moderate Objective: LO 15-3 AACSB: Reflective thinking skills
17) Nonprobabilistic sampling methods are not based on mathematical probabilities and therefore the representativeness of the sample may be difficult to determine. Answer: TRUE Terms: Nonprobabilistic selection methods Diff: Moderate Objective: LO 15-3 AACSB: Reflective thinking skills
Learning Objective 15-4 1) Which of the following occurrences would be least likely to warrant further audit attention for the auditor? A) Deviations from client's established control procedures B) Deviations from client's budgeted values C) Monetary misstatements in populations of transaction data D) Monetary misstatements in populations of account balance details Answer: B Terms: Warrant further audit attention for auditor Diff: Easy Objective: LO 15-4 AACSB: Reflective thinking skills
2) Which of the following statements is correct when dealing with sampling for exception rates? A) The term exception refers to both deviations from the client's control procedures and amounts that are not monetarily correct. B) When used with sampling, the term deviation is synonymous with the term exception. C) The actual population exception rate is the same as the sample exception rate. D) In using audit sampling for exception rates, the auditor is most concerned with the confidence interval. Answer: A Terms: Sample exception rate Diff: Moderate Objective: LO 15-4 AACSB: Reflective thinking skills
3) In using audit sampling for exception rates: A) the auditor wants to know the most the exception rate is likely to be. B) sampling error is the likelihood that the auditor will miss a monetary misstatement. C) the upper limit of the interval estimate is known as the sampling risk. D) CUER cannot be considered in the context of specific audit objectives. Answer: A Terms: Sample exception rate Diff: Moderate Objective: LO 15-4 AACSB: Reflective thinking skills
4) Which of the following is most correct when using audit sampling for exception rates? A) Auditor is concerned with the lowest rate. B) Auditor is concerned with the highest rate. C) Auditor is concerned with the average on previous audits. D) This doesn't impact the auditor's decision. Answer: B Terms: Auditing sampling for exception rates Diff: Moderate Objective: LO 15-4 AACSB: Reflective thinking skills
5) The highest estimated exception rate in the population at a particular acceptable risk of assessing control risk too low is: A) the upper exception rate. B) estimated population exception rate. C) the computed upper exception rate. D) the tolerable exception rate. Answer: C Terms: Highest estimated exception rate in population; Acceptable risk of assessing control risk too low Diff: Moderate Objective: LO 15-4 AACSB: Reflective thinking skills
6) You are determining the significance of the following: you set a 5% risk of assessing control risk to low and your computation of the upper deviation risk is 7%. What could you conclude? A) There is a 95% chance the deviation rate is the population is less than 5%. B) There is a 5% chance the deviation rate in the population is less than 7%. C) There is a 95% chance the deviation rate in the population exceeds 95%. D) There is a 5% chance the deviation rate in the population exceeds 7%. Answer: D Terms: Risk of assessing control risk low and computation of upper deviation risk Diff: Moderate Objective: LO 15-4 AACSB: Reflective thinking skills
7) What types of exceptions are auditors most concerned with when evaluating populations of accounting data? Answer: There are three types of exceptions that auditors are generally concerned with when evaluating populations of accounting data. They are: 1. Deviations from client's established controls. 2. Monetary misstatements in populations of transaction data. 3. Monetary misstatements in populations of account balance details. Terms: Types of exceptions and concern when evaluating populations of accounting data Diff: Moderate Objective: LO 15-4 AACSB: Reflective thinking skills
8) If the auditor concludes that the CUER is 5% at a 8% sampling risk, this means that the exception rate in the population is no greater than 5% with an 8% risk of the exception rate exceeding 5%. Answer: TRUE Terms: Estimated population exception rate Diff: Moderate Objective: LO 15-4 AACSB: Reflective thinking skills
9) The upper limit of the interval estimate is also known as the confidence interval. Answer: FALSE Terms: Computed upper exception rate (CUER) Diff: Moderate Objective: LO 15-4 AACSB: Reflective thinking skills
Learning Objective 15-5
1) The risk which the auditor is willing to take in accepting a control as being effective when the true population exception rate is greater than a tolerable rate is the: A) finite correction factor. B) tolerable exception rate. C) acceptable risk of overreliance. D) estimated population exception rate. Answer: C Terms: Risk auditor is willing to take in accepting a control as being effective Diff: Easy Objective: LO 15-5 AACSB: Reflective thinking skills
2) The exception rate the auditor will permit in the population and still be willing to reduce the assessed level of control risk is called the: A) tolerable exception rate. B) estimated population exception rate. C) acceptable risk of overreliance. D) sample exception rate. Answer: A Terms: Exception rate auditor will permit and still be willing to reduce assessed level of control risk Diff: Easy Objective: LO 15-5 AACSB: Reflective thinking skills
3) If the auditor decides to assess control risk at the moderate level in a private company audit, when in previous years the auditor set control risk at the maximum level, then tests of controls for the current year would be: A) increased in number. B) reduced in number. C) not performed. D) unchanged from prior planned settings. Answer: A Terms: Assess control risk Diff: Easy Objective: LO 15-5 AACSB: Analytic skills
4) When the computed upper exception rate is greater than the tolerable exception rate, it is necessary for the auditor to take specific action. Which of the following courses of action would be most difficult to justify? A) Reduce the tolerable exception rate so as to accept the sample results. B) Expand the sample size and perform more tests. C) Revise the assessed control risk. D) Write a letter to management which outlines the control deficiencies. Answer: A Terms: Computed upper exception rate is greater than tolerable exception rate Diff: Easy Objective: LO 15-5 AACSB: Reflective thinking skills
5) Which of the following would have the least impact in determining sample size? A) Acceptable risk of overreliance B) Risk of assessing control risk too low C) Tolerable exception rate D) Population size Answer: D Terms: Least impact on determining sample size Diff: Easy Objective: LO 15-5 AACSB: Reflective thinking skills
6) Which of the following represents the best description of the tolerable exception? A) The highest exception rate the auditor will permit in the control being tested and still conclude it is operating effectively B) The highest exception rate the auditor expects to find in the population C) The number of exceptions found in the sample divided by the sample size D) The highest estimated exception rate in a population at a given EPER Answer: A Terms: Tolerable exception rate Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
7) When analyzing exceptions, the auditor should keep in mind that: A) all exceptions must be reported to management. B) they should determine the breakdown in the internal controls that allowed the exceptions to occur. C) the nature of an exception and its causes have no effect on the qualitative evaluation of the system. D) exceptions do not need to be analyzed if it is too costly. Answer: B Terms: Sample size and analyzing exceptions Diff: Moderate Objective: LO 15-5 AACSB: Analytic skills
8) The exception rate that the auditor will permit in the population and still be willing to use the preliminary control risk assessment is called the: A) acceptable exception rate. B) estimated population exception rate. C) sample exception rate. D) tolerable exception rate. Answer: D Terms: Exception rate; Preliminary control risk assessment Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
9) Auditors often use the ________ to determine the estimated population exception rate. A) current year's audit results B) tolerable exception rate C) preceeding year's audit results D) estimated computed by management Answer: A Terms: Estimate of population exception rate Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
10) Place the following steps in their proper order: 1. Analyze exceptions 2. Select the sample 3. Define attributes and exception conditions 4. State the objectives of the audit test 5. Specify the tolerable exception rate A) 1, 3, 2, 4, 5. B) 4, 3, 1, 2, 5. C) 4, 3, 5, 2, 1. D) 1, 2, 3, 4, 5. Answer: C Terms: Auditing sampling steps Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
11) If an auditor judgmentally selects a sample of one hundred items from a population and finds two exceptions, the auditor: A) can conclude that the sample exception rate is 2%. B) can conclude that the population exception rate is 2%. C) can calculate the highest exception rate expected in the population. D) cannot make any conclusions about either the sample or the population. Answer: A Terms: Sample selected from population and found exceptions Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
12) In testing controls, an overreliance on internal controls that reduces substantive tests and increases the likelihood of not detecting a material misstatement occurs because: A) true deviation in the population was less than the sample. B) true deviation in the population was greater than the sample. C) auditor judgment was flawed. D) it is inherent in the audit risk model. Answer: B Terms: Testing controls; Overreliance on internal controls Diff: Challenging Objective: LO 15-5 AACSB: Reflective thinking skills
13) Which of the following is the exception rate that the auditor expects to find before testing? A) Sample exception rate B) Estimated population exception rate C) Computed exception rate D) Tolerable exception rate Answer: B Terms: Exception rate auditor expects to find before testing Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
14) Which of the following is not a term related to evaluating results in audit sampling until after a sample is tested and evaluated? A) Sample exception rate B) Estimated population exception rate C) Computed upper exception rate D) Exception Answer: B Terms: Term not related to evaluating results in audit sampling Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
15) The relationship of tolerable exception rate (TER) to sample size is: A) direct (larger TER = larger sample). B) inverse (larger TER = smaller sample). C) variable (sometimes larger, sometimes smaller). D) not determinable. Answer: B Terms: Relationship of tolerable exception rate (TER) to sample size Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
16) Which of the following must be set prior to testing a sample? A) Sample exception rate B) Achieved upper precision limit C) Computed exception rate D) Tolerable exception rate Answer: D Terms: Set prior to testing sample Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
17) The acceptable risk of overreliance: A) is the risk that the auditor will erroneously conclude that the controls are less effective than they actually are. B) is less of a concern to the auditors than the risk of underreliance. C) represents the auditor's measure of sampling risk. D) is determined by a statistical formula, and not by professional judgment. Answer: C Terms: Acceptable risk of overreliance Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
18) The sample exception rate equals: A) the number of exceptions in the population divided by the sample size. B) the number of items in the population multiplied by the number of exceptions in the sample. C) the number of exceptions in the sample divided by the sample size. D) the number of exceptions in the population divided by the population size. Answer: C Terms: Sample exception rate Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
19) When defining the population: A) it may be necessary to define separate populations for different audit procedures. B) the auditor may generalize only about the population that has been sampled. C) auditors can define the population to include any items they want. D) all of the above. Answer: D
Terms: Population considered acceptable based on acceptable risk of assessing control risk too low; Upper exception rate Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
20) One way to evaluate sampling risk when nonstatistical sampling is used is to: A) subtract the sample exception rate from the tolerable exception rate. B) add the sample exception rate and the tolerable exception rate. C) subtract the sample exception rate from the acceptable risk of overreliance. D) add the sample exception rate and the acceptable risk of overreliance. Answer: A Terms: Sampling risk Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
21) A danger in setting the acceptable risk of overreliance too low is: A) The risk that the auditor is willing to The risk that the auditor is willing to take of accepting a control as take of accepting a control as effective ineffective when it is effective when it is ineffective Yes Yes B) The risk that the auditor is willing to take of accepting a control as ineffective when it is effective No
The risk that the auditor is willing to take of accepting a control as effective when it is ineffective No
C) The risk that the auditor is willing to take of accepting a control as ineffective when it is effective Yes
The risk that the auditor is willing to take of accepting a control as effective when it is ineffective No
D) The risk that the auditor is willing to take of accepting a control as ineffective when it is effective No
The risk that the auditor is willing to take of accepting a control as effective when it is ineffective Yes
Answer: D Terms: Acceptable risk of overreliance Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
22) When using statistical sampling, the auditor would most likely require a smaller sample if the: A) population increases. B) desired reliability decreases. C) desired precision interval narrows. D) expected exception rate increases. Answer: B Terms: Statistical sampling; Auditor requires smaller sample Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
23) Whenever auditors use sampling, they risk making incorrect conclusions about the population. The risk that the auditor concludes that controls are nore effective than they actually are is known as the: A) risk of overreliance. B) risk of underreliance. C) risk that the sample is not representative of the population. D) risk that the sample conclusions cannot be useful because of nonprobability sampling. Answer: A Terms: Sampling and the risk of making incorrect conclusions about the population Diff: Challenging Objective: LO 15-5 AACSB: Reflective thinking skills
24) When choosing the appropriate acceptable risk of overreliance, the auditor needs to: A) rely on his/her professional judgment. B) err on the side of conservatism. C) consult the professional standards. D) follow SEC guidelines. Answer: A Terms: Acceptable risk of overreliance Diff: Challenging Objective: LO 15-5 AACSB: Reflective thinking skills
25) The difference between the tolerable exception rate and the estimated population exception rate is called: A) accuracy of the initial sample estimate. B) inflation factor of the initial sample estimate. C) precision of the initial sample estimate. D) reliability of the initial sample estimate. Answer: C Terms: Difference between tolerable exception and estimated population exception rate Diff: Challenging Objective: LO 15-5 AACSB: Reflective thinking skills
26) If the result obtained from a particular sample for control and substantive tests of transactions is critical to the formation of an audit opinion, which of the following is the most important to the auditor in concluding of the appropriateness and sufficiency of evidence gathered? A) Acceptable risk of overreliance B) Estimated population exception rate C) Tolerable exception rate D) Size of the population Answer: A Terms: Control and substantive tests of transactions; Important in concluding appropriateness and sufficiency of evidence Diff: Challenging Objective: LO 15-5 AACSB: Reflective thinking skills
27) There is a(n) ________ relationship between acceptable risk of overreliance and planned sample size. A) direct. B) inverse. C) proportional. D) exponential. Answer: B Terms: Acceptable risk of overreliance Diff: Challenging Objective: LO 15-5 AACSB: Reflective thinking skills
28) Which of the following results in a larger sample size? A) Decrease the estimated population exception rate and decrease the tolerable exception rate. B) Increase the estimated population exception rate and decrease the tolerable exception rate. C) Decrease the estimated population exception rate and increase the tolerable exception rate. D) Increase the estimated population exception rate and increase the tolerable exception rate. Answer: B Terms: Results in larger sample size Diff: Moderate Objective: LO 15-1 and LO 15-5 AACSB: Reflective thinking skills
29) An auditor plans to examine a sample of 40 canceled checks for a countersignature which is prescribed in the client's control procedures manual. Two of the checks in sample cannot be located by the company or the auditor. The auditor would most likely: A) treat the missing checks as a deviation when evaluating the results of the sample. B) draw a conclusion on a sample size of 38. C) substitute two more checks to get to a sample size of 40. D) recalculate the sample excluding the original 40 checks. Answer: A Terms: Missing canceled checks in population Diff: Challenging Objective: LO 15-4 and LO 15-5 AACSB: Analytic skills Topic: Public
30) You are determining the appropriate sample size to test accounts receivable. What three factors are the most important to consider?
Answer: 1. Tolerable exception rate (TER) 2. Acceptable risk of overreliance (ARO) 3. Estimated population exception rate (EPER) Terms: Factors to determine appropriate sample size Diff: Easy Objective: LO 15-5 AACSB: Reflective thinking skills
31) Explain the effect on sample size of increasing each of the following: (1) tolerable exception rate, (2) estimated population exception rate, (3) acceptable risk of overreliance, and (4) population size. Answer: The tolerable exception rate and acceptable risk of overreliance are inversely related to sample size; that is, as TER or ARO increase, sample size will decrease. The estimated population exception rate and the population size are directly related to sample size; that is, as EPER increases, sample size will also increase, and as population size increases, sample size may slightly increase. Terms: Effects on sample size when increasing tolerable exception, estimated population exception rate, acceptable risk of assessing control risk too low, and population size Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
32) The auditor must use the same TER and ARO levels for all attributes of an audit test. Answer: FALSE Terms: Acceptable risk of overreliance Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
33) The tolerable exception rate is the rate that the auditor will permit in the population and still be willing to conclude a control is effective. Answer: TRUE Terms: Tolerable exception rate Diff: Easy Objective: LO 15-5 AACSB: Reflective thinking skills
34) The only way to know with certainty whether a sample is representative is to subsequently audit the entire population. Answer: TRUE Terms: Know with certainty whether sample is representative is to audit entire population Diff: Moderate Objective: LO 15-1 and LO 15-5 AACSB: Reflective thinking skills
35) Acceptable risk of overreliance is the risk that the auditor is willing to take in accepting a control as effective when the true population exception rate is greater than the estimated population exception rate. Answer: FALSE Terms: Acceptable risk of overreliance Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
36) Acceptable risk of overreliance is normally lower for a public company audit than a private company audit. Answer: TRUE Terms: Acceptable risk of overreliance Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills Topic: Public
37) The conjoined sample exception rate is the auditor's "best estimate" of the actual exception rate in the entire population. Answer: FALSE Terms: Sample exception rate Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
38) When the sample exception rate is greater than the tolerable exception rate in attributes sampling, one possible appropriate course of action is to increase sample size. Answer: TRUE Terms: Sample exception rate and tolerable exception rate Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
39) Tolerable exception rate (TER) is inversely related to sample size. Answer: TRUE Terms: Tolerable exception rate and sample size relationship Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
40) When the SER exceeds the TER, the auditor should decide whether to increase sample size or to revise assessed control risk on the basis of cost versus benefit. Answer: FALSE Terms: Control risk assessment Diff: Moderate Objective: LO 15-5 AACSB: Reflective thinking skills
41) In nonstatistical sampling, the calculated sampling error is the difference between the tolerable exception rate and the sample exception rate. Answer: TRUE
Terms: Nonstatistical sampling; Calculated sampling error; Difference between tolerable exception rate and sample exception rate Diff: Challenging Objective: LO 15-5 AACSB: Reflective thinking skills
Learning Objective 15-6 1) Rodgers CPA believes that the rate of client billing errors is 4% and has established a tolerable deviation rate of 6%. In auditing client invoices Rodgers should use: A) stratified sampling. B) classical sampling. C) proportional sampling. D) attributes sampling. Answer: D Terms: Auditing client invoices Diff: Easy Objective: LO 15-6 AACSB: Analytic skills
2) Attributes sampling would be an appropriate method to use on which one of the following procedures in an audit program? A) Review sales transactions for large and unreasonable amounts. B) Observe whether the duties of the accounts receivable clerk are separate from handling cash. C) Examine a sample of duplicate sales invoices for credit approval by the credit manager. D) Review the aged schedule of accounts receivable to determine if receivables from officers are included. Answer: C Terms: Attributes sampling Diff: Easy Objective: LO 15-6 AACSB: Reflective thinking skills
3) Attributes sampling is based on the ________ distribution, in which each possible sample in the population has one of two possible values, such as yes or no. A) random B) binomial C) statistical D) nonstatistical Answer: B Terms: Attribute sampling and binomial distribution Diff: Easy Objective: LO 15-6 AACSB: Reflective thinking skills
4) For which of the following audit procedures would audit sampling not be appropriate? A) Review sales transactions for large and unusual amounts. B) Examine a sample of duplicate sales invoices for credit approval. C) Compare the quantity on duplicate sales invoices with the quantity on related shipping documents. D) Audit sampling is appropriate for each of the above procedures. Answer: A Terms: Audit sampling not appropriate for which audit procedure Diff: Moderate Objective: LO 15-5 and LO 15-7 AACSB: Reflective thinking skills
5) Match eight of the terms (a-k) with the definitions provided below (1-8): a. b. c. d. e. f. g. h. i. j. k.
Haphazard selection Attributes sampling Block sample selection Judgmental sampling Non-probabilistic sample selection Probabilistic sample selection Random sample Representative sample Statistical sampling Systematic sample selection Sampling distribution
________ 1. The use of mathematical measurement techniques to calculate formal statistical results and quantify sampling risk. ________ 2. A non-probabilistic method of sample selection in which items are selected in measured sequences. ________ 3. A sample whose characteristics are the same as those of the population. ________ 4. A statistical, probabilistic method of sample evaluation that results in an estimate of the proportion of items in a population containing a characteristic of interest. ________ 5. A non-probabilistic method of sample selection in which items are chosen without regard to their size, source, or other distinguishing characteristics. ________ 6. An auditor selects items such that each population item has a known probability of being included in the sample. ________ 7. A frequency distribution of the results of all possible samples of a specified size that could be obtained from a population containing some specific parameters. ________ 8. A sample in which every possible combination of elements in the population has an equal chance of constituting the sample.
Answer: 1. i 2. c 3. h 4. b 5. a 6. f 7. k 8. g
Terms: Haphazard selection; Attributes sampling; Block sample selection; Probabilistic sample selection; Random sample; Representative sample; Statistical sampling; Sampling distribution Diff: Moderate Objective: LO 15-1, LO 15-2, LO 15-3, LO 15-5, and LO 15-6 AACSB: Reflective thinking skills
Learning Objective 15-7 1) A principal advantage of statistical methods of attributes sampling over nonstatistical methods is that they provide a scientific basis for establishing the: A) risk of assessing control risk too low. B) tolerable exception rate. C) expected population exception rate. D) sample size. Answer: D Terms: Advantage of statistical methods of attributes sampling Diff: Moderate Objective: LO 15-7 AACSB: Reflective thinking skills
2) In using sampling distribution for attributes, which one of the following must be known to evaluate the sample results? A) Estimated dollar value of the population B) Standard exception of the values in the population C) Actual exception rate of the attribute in the population D) Sample size Answer: D Terms: Estimation sampling for attributes Diff: Moderate Objective: LO 15-7 AACSB: Reflective thinking skills
3) When audit procedures have been completed for an attributes sampling application, the auditor must generalize from the sample to the population. Which of the following statements would be incorrect regarding this process? A) The auditor would use an attributes sampling table to determine the computed upper exception rate. B) If the sample size is not equal to those provided for in the attributes sampling evaluation tables, the auditor cannot use attribute sampling. C) It would be wrong for the auditor to conclude that the population exception rate is exactly the same as the sample exception rate. D) In selecting the table corresponding to the ARO, it should be the same as the ARO used for determining the initial sample size. Answer: B Terms: Attributes sampling application Diff: Challenging Objective: LO 15-7 AACSB: Reflective thinking skills
4) When deciding the acceptability of the population: A) the methodology for deciding the acceptability of the population for attributes differs from determining the acceptability for nonstatistical sampling. B) before the population can be considered acceptable, the CUER determined on the basis of the actual sample results must be less than or equal to TER when both are based on the same ARO. C) when the CUER is greater than the TER, the auditor must increase the sample size. D) the CUER is compared with the TER in total, not for each attribute. Answer: B Terms: Acceptability of the population and attribute sampling Diff: Challenging Objective: LO 15-7 AACSB: Reflective thinking skills
5) In the evaluation of the results of an attributes sample, the fact that the exception rate in the sample was 2% rather than the estimated population exception rate of 4% would cause the computed upper exception rate to: A) be less than the tolerable exception rate. B) equal the tolerable exception rate. C) exceed the tolerable exception rate. D) cannot be determined from the information given. Answer: A Terms: Attributes sample; Exception rate in sample, estimated population exception rate, and computed upper exception rate Diff: Challenging Objective: LO 15-7 AACSB: Reflective thinking skills
6) As the auditor you are assessing the proper sample size to use in testing controls. When using attributes sampling which of the following is most correct? A) A 10% change in population size will have the least effect on sample size. B) A 10% change in the tolerable deviation rate will have the least effect on sample size. C) A 10% change in the expected deviation rate will have the least effect on sample size. D) A 10% change in the tolerable will have the least effect on sample size. Answer: A Terms: Attributes sampling Diff: Moderate Objective: LO 15-7 AACSB: Reflective thinking skills
7) In attributes sampling, an estimate of the expected population exception rate is necessary to plan the sample size. The relationship of expected population exception rate (EPER) to sample size is: A) direct (small EPER = small sample). B) inverse (small EPER = large sample). C) a variable (sometimes small, sometimes large) dependent on other factors present. D) indeterminate. Answer: A Terms: Attributes sampling; Expected population exception rate and sample size Diff: Moderate Objective: LO 15-5 and LO 15-7 AACSB: Reflective thinking skills
8) There are 14 steps to attributes sampling, divided into three sections: plan the sample, select the sample and perform the audit procedures, and evaluate the results. Discuss the three steps that comprise the "evaluate the results" section. Answer: The steps that comprise the "evaluate the results" section in attributes sampling are: 1. Generalize from the sample to the population. Tables can be used to determine the upper precision limit (computed upper exception rate) at a specified acceptable risk of overreliance. 2. Analyze exceptions. In this step, the auditor should analyze individual exceptions to determine the breakdown in the internal controls that caused them. 3. Decide the acceptability of the population. In the final step, the auditor compares the computed upper exception rate with the tolerable exception rate. If the computed upper exception rate is less than or equal to the tolerable exception rate, then the population is considered acceptable. Terms: Steps that comprise evaluate the results section of 14 steps to attributes sampling Diff: Challenging Objective: LO 15-7 AACSB: Reflective thinking skills
9) There are 14 steps to attributes sampling, divided into three sections: plan the sample, select the sample and perform the audit procedures, and evaluate the results. In the planning section there are 9 steps, beginning with "state the audit objective" and ending with "determine the initial sample size." Name and discuss at least 3 steps between the ones listed above. Answer: The steps that comprise the "plan the sample" section in attributes sampling are: 1. State the objectives of the audit test. Typically, in attributes sampling, the overall objective is to test the application of controls and determine whether transactions contain monetary misstatements. 2. Decide whether audit sampling applies. Audit procedures involving documentation normally can be performed using sampling, whereas procedures involving observation, inquiry of the client, and analytical procedures are not suited to audit sampling. 3. Define attributes and exception conditions. In this step, the auditor carefully defines the attributes of interest and the conditions that constitute exceptions or errors. 4. Define the population. The population is the body of data about which the auditor wished to generalize, from which the sample must be drawn. 5. Define the sampling unit. In attributes sampling, the sampling unit is normally a document, identified by document numbers, or a transaction recorded in a journal. 6. Specify tolerable exception rate. This is the exception rate that the auditor will permit in the population and still be willing to rely on internal controls. 7. Specify acceptable risk of overreliance. This is the risk that the auditor is willing to take in accepting a control as effective when the true population exception rate is greater than the tolerable exception rate. 8. Estimate the population exception rate. This is the exception rate the auditor expects to find in the population before testing begins. 9. Determine the initial sample size. The initial sample size is determined from tables, based on values for the tolerable exception rate, acceptable risk of assessing control risk too low, and the estimated exception rate. Terms: Steps in Plan the sample in attributes sampling Diff: Challenging Objective: LO 15-7 AACSB: Reflective thinking skills
10) Statistical sampling eliminates any professional judgment for the auditor. Answer: FALSE Terms: Statistical sampling and professional judgment Diff: Moderate Objective: LO 15-7 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e (Arens) Chapter 16 Completing the Tests in the Sales and Collection Cycle: Accounts Receivable Learning Objective 16-1 1) The two primary classes of transactions in the sales and collection cycle are: A) sales and sales discounts. B) sales and cash receipts. C) sales and sales returns. D) sales and accounts receivable. Answer: B
Terms: Classes of transactions; Sales and collection cycle Diff: Easy Objective: LO 16-1 AACSB: Reflective thinking skills
2) The appropriate and sufficient evidence to be obtained from tests of details must be decided on an: A) efficiency basis. B) effectiveness basis. C) audit objectives basis. D) none of the above. Answer: C Terms: Tests of details Diff: Easy Objective: LO 16-1 AACSB: Reflective thinking skills
3) Auditors are especially concerned with three aspects of internal control for the sales and collection cycle. Which of the following is not one of their major concerns? A) Controls over cutoff B) Controls that prevent or detect embezzlements C) Controls over sales discounts D) Controls related to the allowance for uncollectible accounts Answer: C Terms: Sales and collection cycle Diff: Easy Objective: LO 16-1 AACSB: Reflective thinking skills
4) For sales, the occurrence transaction-related audit objective affects which of the following balancerelated audit objective? A) Existence B) Completeness C) Rights D) Detail tie-in Answer: A Terms: Sales transaction-related audit objective Diff: Moderate Objective: LO 16-1 AACSB: Reflective thinking skills
5) For cash receipts, the occurrence transaction-related audit objective affects which of the following balance-related audit objective? A) Existence B) Completeness C) Rights D) Detail tie-in Answer: B Terms: Cash receipts transaction-related objective Diff: Moderate Objective: LO 16-1 AACSB: Reflective thinking skills
6) For sales, the completeness transaction-related audit objective affects the existence balance-related audit objective. Answer: FALSE Terms: Completeness transaction-related audit objective; Existence balance-related audit objective Diff: Moderate Objective: LO 16-1 AACSB: Reflective thinking skills
7) Recording a sale that did not occur violates the occurrence transaction-related audit objective and the existence balance-related audit objective. Answer: TRUE Terms: Cash receipts; Occurrence transaction-related audit objective; existence balance-related audit objective Diff: Moderate Objective: LO 16-1 AACSB: Reflective thinking skills
8) The accounts receivable balance-related audit objective net realizable value is not affected by assessed control risk for sales or cash receipts. Answer: TRUE Terms: Accounts receivable balance-related audit objective net realizable value; Assessed control risk Diff: Moderate Objective: LO 16-1 AACSB: Reflective thinking skills
9) The results of the tests of controls determine whether assessed control risk for sales and cash receipts needs to be revised. Answer: TRUE Terms: Tests of controls and control risk Diff: Easy Objective: LO 16-1 AACSB: Reflective thinking skills
10) Auditors use the results of the substantive tests of transactions of sales and the collection cycle to determine the extent to which inherent risk is satisfied for each accounts receivable balance-related audit objective. Answer: FALSE Terms: Tests of controls and substantive tests of transactions Diff: Easy Objective: LO 16-1 AACSB: Reflective thinking skills
Learning Objective 16-2 1) Which of the following types of receivables would not deserve the special attention of the auditor? A) Accounts receivables with credit balances B) Accounts that have been outstanding for a long time C) Receivables from related parties D) Each of the above would receive special attention. Answer: D Terms: Receivables; Special attention Diff: Easy Objective: LO 16-2 AACSB: Reflective thinking skills
2) Analytical procedures are substantive tests and, if the results of the analytical procedures are favorable, the auditor would normally: A) reduce the extent of tests of details of balances. B) reduce the extent of tests of controls. C) reduce the tests of transactions. D) reduce all of the other tests. Answer: A Terms: Analytical procedures; Substantive tests Diff: Moderate Objective: LO 16-2 AACSB: Reflective thinking skills
3) Analytical procedures: A) are only done during the planning of the audit and when performing detailed tests. B) performed during the detailed testing phase are done before tests of details of balances. C) performed during the detailed testing phase are done before the balance sheet date. D) are performed only on accounts receivable, not on the entire sales and collection cycle. Answer: B Terms: Analytical procedures Diff: Moderate Objective: LO 16-2 AACSB: Reflective thinking skills
4) Which of the following is a correct statement regarding analytical procedures? A) If an auditor identifies a possible misstatement in sales using analytical procedures, accounts payable will be the likely offsetting misstatement. B) Auditors should also compare the results of their analytical procedures to budgets and industry trends. C) If sales are overstated, the income statement will be incorrect, but the balance sheet will be correct. D) If an analytical procedure uncovers an unusual fluctuation, the auditor must assume fraud is involved. Answer: B Terms: Analytical procedures Diff: Moderate Objective: LO 16-2 AACSB: Analytic skills
5) An auditor is comparing the write-off of uncollectible accounts as a percentage of total accounts receivable with previous years. A possible misstatement this procedure could uncover is: A) overstatement or understatement of sales. B) overstatement or understatement of accounts receivable. C) overstatement or understatement of bad debt expense. D) overstatement or understatement of sales returns and allowances. Answer: C Terms: Understatement of sales and accounts receivable Diff: Challenging Objective: LO 16-2 AACSB: Analytic skills
6) Below are listed possible misstatements that could occur in the sales and collections cycle. Provide the analytical procedure that would be most useful in detecting the possible misstatement. a. Overstatement of sales and accounts receivable b. Uncollectible accounts receivable that have not been provided for c. Overstatement of sales returns and allowances Answer: a. compare gross margin percentage with previous year by product line; compare sales by month, (by product line), over time b. compare bad debt expense as a percentage of sales from previous years c. compare sales returns and allowances as a percentage of gross sales with previous years Terms: Analytical procedures; Sales and collection cycle Diff: Moderate Objective: LO 16-2 AACSB: Analytic skills
7) Favorable results from analytical procedures may reduce the extent to which the auditor needs to test details of balances. Answer: TRUE Terms: Analytical procedures; Test details of balances Diff: Easy Objective: LO 16-2 AACSB: Reflective thinking skills
8) When analytical procedures in the sales and collection cycle uncover unusual fluctuations, the auditor should make additional inquiries of management. Answer: TRUE Terms: Analytical procedures; Sales and collection cycle Diff: Easy Objective: LO 16-2 AACSB: Reflective thinking skills
9) A high inherent risk increases planned detection risk and decreases planned substantive tests. Answer: FALSE Terms: Analytical procedures Diff: Moderate Objective: LO 16-2 AACSB: Reflective thinking skills
Learning Objective 16-3 1) The understatement of sales and accounts receivable is best uncovered by: A) testing internal controls. B) testing the aged accounts receivable trial balance. C) substantive tests of transactions for shipments made but not recorded. D) substantive tests of transactions for bad debts. Answer: C Terms: Understatement of sales and accounts receivable Diff: Easy Objective: LO 16-3 AACSB: Reflective thinking skills
2) Tests of which balance-related audit objective are normally performed first in an audit of the sales and collection? A) Accuracy B) Completeness C) Rights D) Detail tie-in Answer: D Terms: Tests of balance-related audit objective; Sales and collection Diff: Easy Objective: LO 16-3 AACSB: Reflective thinking skills
3) A listing of the balances in the accounts receivable master file at the balance sheet date, by total balance outstanding and by the amount of time the component parts have been outstanding, is the: A) customer list. B) aged trial balance. C) accounts receivable ledger. D) schedule of accounts receivable. Answer: B Terms: Listing of balances in accounts receivable master file Diff: Easy Objective: LO 16-3 AACSB: Reflective thinking skills
4) Testing the information on the aged trial balance for detail tie-in is a necessary audit procedure, which would normally include: A) Test-footing the total column and the columns depicting the Comparing the total of the aged trial balance with aging the general ledger accounts receivable account Yes Yes B) Test-footing the total column and the columns depicting the aging No
Comparing the total of the aged trial balance with the general ledger accounts receivable account No
Test-footing the total column and the columns depicting the aging Yes
Comparing the total of the aged trial balance with the general ledger accounts receivable account No
Test-footing the total column and the columns depicting the aging No
Comparing the total of the aged trial balance with the general ledger accounts receivable account Yes
C)
D)
Answer: A
Terms: Detail tie-in; Audit procedure Diff: Easy Objective: LO 16-3 AACSB: Reflective thinking skills
5) Audit procedures designed to uncover credit sales made after the client's fiscal year end that relate to the current year being audited provide evidence for which of the following audit objective? A) Realizable value B) Accuracy C) Cutoff D) Existence Answer: C Terms: Audit procedures to uncover credit sales Diff: Easy Objective: LO 16-3 AACSB: Reflective thinking skills
6) Cutoff misstatements occur when: A) The auditor fails to obtain the end-of-year bank statement directly from the bank, Subsequent period obtaining instead the transactions are statement which includes the recorded in the two succeeding weeks current period Yes Yes
Current period transactions are recorded in the subsequent period No
B) The auditor fails to obtain the end-of-year bank statement directly from the bank, obtaining instead the statement which includes the two succeeding weeks Yes
Subsequent period transactions are recorded in the current period No
Current period transactions are recorded in the subsequent period Yes
C) The auditor fails to obtain the end-of-year bank statement directly from the bank, obtaining instead the statement which includes the two succeeding weeks No
Subsequent period transactions are recorded in the current period Yes
Current period transactions are recorded in the subsequent period Yes
D) The auditor fails to obtain the end-of-year bank statement directly from the bank, obtaining instead the statement which includes the two succeeding weeks No
Subsequent period transactions are recorded in the current period Yes
Current period transactions are recorded in the subsequent period No
Answer: C
Terms: Cutoff misstatements Diff: Easy Objective: LO 16-3 AACSB: Reflective thinking skills
7) Cutoff misstatements occur: A) either by error or fraud. B) by error only. C) by fraud only. D) randomly without causes related to errors or fraud. Answer: A Terms: Cutoff misstatements Diff: Easy Objective: LO 16-3 AACSB: Reflective thinking skills
8) Which of the following is likely to be determined first when performing tests of details for accounts receivable? A) Recorded accounts receivable exist. B) Accounts receivable in the aged trial balance agree with related master file amounts, and the total is correctly added and agrees with the general ledger. C) Accounts receivable are owned. D) Existing accounts receivable are included. Answer: B Terms: Tests of details for accounts receivable Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
9) An auditor is performing a credit analysis of customers with balances over 60 days due. She is most likely obtaining evidence for which audit related objective? A) Realizable value B) Existence C) Completeness D) Occurrence Answer: A Terms: Audit-related objective Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
10) The most important test of details of balances to determine the existence of recorded accounts receivable is: A) tracing details of sales invoices to shipping documents. B) tracing the credits in accounts receivable to bank deposits. C) tracing sales returns entries to credit memos issued and receiving room reports. D) the confirmation of customers' balances. Answer: D Terms: Test of details of balances; Existence of accounts receivable Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
11) Because of its central role in auditing of accounts receivable, which of the following would normally be one of the first items tested? A) Accounts receivable master file B) Customer file C) Aged trial balance D) Sales register Answer: C Terms: Central role in auditing accounts receivable Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
12) Confirmation of accounts receivable selected from the trial balance is the most common test of details of balances for the ________ of accounts receivable. A) presentation B) valuation C) accuracy. D) detail tie-in Answer: C Terms: Accounts receivable confirmation Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
13) Most tests of accounts receivable are based on what schedule, file, or listing? A) Sales master file B) Aged accounts receivable trial balance C) Accounts receivable master file D) Accounts receivable general ledger account Answer: B Terms: Tests of accounts receivable Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
14) If the client's internal control for recording sales returns and allowances is evaluated as ineffective: A) a larger sample may be needed to verify cutoff. B) sampling is not appropriate. C) all sales returns must be traced to supporting documentation. D) all sales returns must be confirmed with the customer. Answer: A Terms: Internal control; Sales returns and allowances Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
15) A customer mails and records a check to a client for payment of an unpaid account on December 30. The client receives and records the amount on January 2. The records of the two organizations will be different on December 31. This represents: A) A cutoff misstatement A timing difference Yes Yes B) A cutoff misstatement No
A timing difference No
A cutoff misstatement Yes
A timing difference No
A cutoff misstatement No
A timing difference Yes
C)
D)
Answer: D
Terms: Records will be different Diff: Moderate Objective: LO 16-3 AACSB: Analytic skills
16) Which of the following audit procedures would not likely detect a client's decision to pledge or factor accounts receivable? A) A review of the minutes of the board of directors' meetings B) Discussions with the client C) Confirmation of receivables D) Examination of correspondence files Answer: C Terms: Audit procedures; Pledge or factor accounts receivable Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
17) When do most companies record sales returns and allowances? A) During the month in which the sale occurs B) During the accounting period in which the return occurs C) Whenever the customer contacts the company regarding the credit D) During the month after the sale occurs Answer: B Terms: Record sales returns and allowances Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
18) Cutoff misstatements can occur for: A) Sales Sales returns and allowances Yes Yes B) Sales No
Sales returns and allowances No
Sales Yes
Sales returns and allowances No
Sales No
Sales returns and allowances Yes
C)
D)
Answer: A
Terms: Cutoff misstatements Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
19) The most important aspect of evaluating the client's method of obtaining a reliable cutoff is to: A) perform extensive detailed testing of cutoff. B) evaluate the client's control procedures around cutoff. C) confirm a sample of transactions near period end with customers. D) confirm transaction with customers. Answer: B Terms: Reliable cutoff Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
20) Which of the following audit procedure would normally be included in the audit plan when auditing the allowance for doubtful accounts? A) Send positive confirmations. B) Inquire of the client's credit manager. C) Send negative confirmations. D) Examine sales invoices. Answer: B Terms: Auditing allowance for doubtful accounts Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
21) Generally accepted accounting principles require that revenue be reported net of sales returns and allowances: A) if practical. B) if required by industry practice. C) if the amounts are material. D) any of the above. Answer: C Terms: Generally accepted accounting principles Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
22) For which of the following accounts is cutoff least important? A) Sales B) Sales returns and allowances C) Cash collections D) Inventory Answer: C Terms: Cutoff Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
23) Which of the following most likely would be detected by a review of a client's sales cutoff? A) Excessive sales discounts B) Unrecorded sales for the year C) Unauthorized goods returned for credit D) Lapping of year-end accounts receivable Answer: B Terms: Sales cutoff Diff: Moderate Objective: LO 16-3 AACSB: Analytic skills
24) How might the auditor determine whether a client has limited rights to accounts receivable? A) Review minutes from board of directors meetings Inquiries of the client Yes Yes B) Review minutes from board of directors meetings No
Inquiries of the client No
C) Review minutes from board of directors meetings Yes
Inquiries of the client No
D) Review minutes from board of directors meetings No
Inquiries of the client Yes
Answer: A
Terms: Limited rights to accounts receivable Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
25) You are reviewing sales to discover cutoff problems. If the client's policy is to record sales when title to the merchandise passes to the buyer, then the books and records would contain errors if the December 31 entries were for sales recorded: A) before the merchandise was shipped. B) at the time the merchandise was shipped. C) several days subsequent to shipment. D) at a time after the point at which title passed. Answer: A Terms: Cutoff problems Diff: Challenging Objective: LO 16-3 AACSB: Analytic skills
26) A procedure to test for a cash receipts cutoff error is: A) reconciling the bank statement. B) performing a four-column proof-of-cash. C) observing the counting of cash at the balance sheet date. D) tracing recorded cash receipts to bank deposits on the bank statement of a different period. Answer: D Terms: Test for cash receipts cutoff Diff: Challenging Objective: LO 16-3 AACSB: Reflective thinking skills
27) If material, all of the following are required to be separately disclosed in the financial statements except for: A) accounts receivable from officers. B) accounts receivable from affiliates. C) sales and assets for different business segments. D) sales for the last ten days of the fiscal year. Answer: D Terms: Accounts receivable presentation and disclosure Diff: Easy Objective: LO 16-3 AACSB: Analytic skills
28) For effective internal control, employees maintaining the accounts receivable subsidiary ledger should not also approve: A) employee overtime wages. B) credit granted to customers. C) write-offs of customer accounts. D) cash disbursements. Answer: C Terms: Internal control; Accounts receivable Diff: Challenging Objective: LO 16-3 AACSB: Reflective thinking skills
29) For most audits, a proper cash receipts cutoff is less important than the sales cutoff because the improper cutoff of cash: A) is detected and correct when cash is separately audited. B) is unlikely to have a material impact on the balance sheet or the income statement. C) affects items on the balance sheet but does not affect net income. D) rarely occurs given the control consciousness of most entities. Answer: C Terms: Cash receipts cutoff; Sales cutoff Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
30) One of the shortcomings in evaluating the allowance for uncollectible accounts by reviewing individual noncurrent balances on the aged trial balance is: I. it is difficult to compare the results of the current year with those of the previous year. II. current accounts are ignored in establishing the adequacy of the allowance. A) I only B) II only C) both I and II D) neither I or II Answer: C Terms: Accounts receivable; Realizable value Diff: Moderate Objective: LO 16-3 AACSB: Analytic skills
31) An auditor selects a sample from the file of shipping documents to determine whether invoices were
prepared. This test is to satisfy the audit objective of: A) accuracy. B) existence. C) control. D) completeness. Answer: D Terms: Sample of shipping documents; Audit objective Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
32) When designing tests of details of balances, an important point to remember is: A) auditors emphasize income statement accounts. B) the audit procedures selected depends heavily on whether planned evidence for a given objective is low, medium, or high. C) if accounts receivable are overstated, then sales will be understated. D) sales cutoff is the most important test of details of accounts receivable. Answer: B Terms: Accounts receivable audit evidence Diff: Easy Objective: LO 16-3 AACSB: Reflective thinking skills
33) The net realizable value of accounts receivable is equal to: A) gross accounts receivable less allowance for uncollectible accounts. B) gross accounts receivable less bad debt expense. C) gross accounts receivable less returns and allowances. D) gross accounts receivable less sales discounts. Answer: A Terms: Revenue recognition Diff: Easy Objective: LO 16-3 AACSB: Reflective thinking skills
34) Describe how the auditor tests the accuracy objective for accounts receivable. Answer: Confirmation of accounts selected from the trial balance is the most common test of details of balances for the accuracy of accounts receivable. When customers do not respond to confirmation requests, auditors examine supporting documents to verify shipment of goods and evidence of subsequent cash receipts to determine whether the accounts were collected. Auditors perform tests of the debits and credits to individual customers' balances by examining supporting documentation for shipments and cash receipts. Terms: Auditors test the accuracy objective for accounts receivable Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
35) Cutoff misstatements can occur for sales, sales returns, and cash receipts. List below the threefold approach an auditor performs for each account above to determine the reasonableness of the cutoff. Answer: 1. Decide on the appropriate criteria for cutoff 2. Evaluate whether the client has established adequate procedures to ensure a reasonable cutoff 3. Test whether the cutoff was correct Terms: Cutoff for Accounts Receivable Diff: Moderate Objective: LO 16-3 AACSB: Analytic skills
36) Discuss the audit procedures performed when testing the detail tie-in objective for accounts receivable, and explain why this objective is ordinarily tested before any other objectives for accounts receivable. Answer: When testing the detail tie-in objective for accounts receivable, the total column and the columns depicting the aging on the aged trial balance are footed, and the total is compared to the general ledger. In addition, a sample of individual balances on the aged trial balance should be traced to supporting documents to verify the customer's name, balance, and proper aging. Auditors test the information on the aged trial balance for detail tie-in before any other tests to verify that the population being tested agrees with the general ledger and accounts receivable master file. Terms: Audit objectives for accounts receivable Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
37) Assuming the client's internal controls are adequate, describe how the auditor can verify proper cutoff of sales transactions. Answer: Assuming the client's internal controls are adequate, the auditor can verify proper cutoff of sales transactions by obtaining the shipping document number for the last shipment made at the end of the period and comparing this number with current and subsequent period recorded sales. Terms: Adequate internal controls; Cutoff of sales transactions Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
38) Tests of detail tie-in are normally conducted last in the audit of the sales and collections cycle. Answer: FALSE Terms: Tests of detail tie-in; Sales and collections cycle Diff: Easy Objective: LO 16-3 AACSB: Reflective thinking skills
39) The criterion used by most merchandising and manufacturing clients for determining when revenue recognition takes place is whether title to the goods has passed. Answer: FALSE Terms: Revenue recognition Diff: Easy Objective: LO 16-3 AACSB: Reflective thinking skills
40) The balance-related audit objectives of realizable value and rights are not affected by assessed control risk. Answer: TRUE Terms: Balance-related audit objectives; Realizable value and rights; Assessed control risk Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
41) Tests of the presentation and disclosure-related objectives are generally done as part of the completion phase of the audit. Answer: TRUE Terms: Tests of presentation and disclosure-related objectives; Completion phase of audit Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
42) Confirmation is the most common test of details of balances for the accuracy of accounts receivable. Answer: TRUE Terms: Confirmation; Test of details of balances Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
43) Tests of the realizable value balance-related audit objective are for the purpose of evaluating the allowance for doubtful accounts. Answer: TRUE Terms: Tests of realizable value balance-related audit objective Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
44) For most audits, a proper cash receipts cutoff is less important than either the sales or the sales returns and allowances cutoff since cash only affects the balance sheet, and not earnings. Answer: TRUE Terms: Cash receipts cutoff; Sales or sales returns and allowances cutoff Diff: Moderate Objective: LO 16-3 AACSB: Reflective thinking skills
Learning Objective 16-4 1) Which of the following is the principle "weakness" of using negative confirmations for your tests of details of balances for accounts receivable? A) They can only be used for large balance accounts. B) They cannot not be used when account balances "bunch" around a mean value. C) Conclusions drawn from receiving no reply may not be correct. D) Response rates are generally too low to draw any conclusions. Answer: C Terms: Negative confirmations; Tests of details of balances of accounts receivable Diff: Easy Objective: LO 16-4 AACSB: Reflective thinking skills
2) Communication addressed to the debtor requesting him or her to confirm whether the balance as stated on the communication is correct or incorrect is a: A) representation letter. B) negative confirmation. C) bank confirmation. D) positive confirmation. Answer: D Terms: Confirm balance Diff: Easy Objective: LO 16-4 AACSB: Reflective thinking skills
3) A type of positive confirmation known as a blank confirmation: A) requests the recipient to fill in the amount of the balance. B) is considered less reliable than the regular positive confirmation. C) generates as high a response rate as the regular positive confirmation form. D) is used when the auditor is confirming several small balances. Answer: A Terms: Positive confirmation; Blank confirmation Diff: Easy Objective: LO 16-4 AACSB: Reflective thinking skills
4) The most effective audit evidence gathered for accounts receivable is the: A) detail tie-in of the records. B) analysis of the allowance for doubtful accounts. C) confirmation of accounts receivable. D) examination of sales invoices. Answer: C Terms: Accounts receivable audit evidence Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
5) The audit procedure that provides the auditor with the most appropriate evidence when performing test of details of balances for accounts receivable is: A) confirmations. B) recalculation of the aged receivables and uncollectible accounts. C) tracing credit memos for returned merchandise to receiving room reports. D) tracing from shipping documents to journals to the accounts receivable ledger. Answer: A Terms: Tests of balances for accounts receivable Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
6) When should auditors not perform alternative procedures in testing the accounts receivable balance? A) When customers do not return positive confirmation requests B) When customers do not return negative confirmation requests C) When confirmations are deemed to be ineffective as an audit procedure D) When confirmations are too costly to use Answer: B Terms: Alternative procedures in testing accounts receivable Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
7) A positive confirmation is more reliable evidence than a negative confirmation because: A) fewer confirmations can be sent out. B) the auditor has a document which can be used in court. C) the debtor's lack of response indicates agreement with the stated balance. D) follow-up procedures are performed if a response is not received from the debtor. Answer: D Terms: Positive confirmation; Negative confirmation Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
8) When positive confirmations are used, auditing standards require alternative procedures for confirmations not returned by the customer. Which of the following would not be considered an alternative procedure? A) Send a second confirmation request. B) Examine subsequent cash receipts to determine if the receivable has been paid. C) Examine shipping documents to verify that the merchandise was shipped. D) Examine customer's purchase order and the duplicate sales invoice to determine that the merchandise was ordered. Answer: A Terms: Positive confirmations follow-up procedures Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
9) The positive (as opposed to the negative) form of receivables confirmation may be preferred when: A) internal control surrounding accounts receivable is considered to be effective. B) there is reason to believe that a substantial number of accounts may be in dispute. C) a large number of small balances are involved. D) the auditor believes that the recipients of the confirmations will give the requests adequate consideration. Answer: B Terms: Positive confirmation Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
10) An auditor should perform alternative procedures to substantiate the existence of accounts receivable when: A) no reply to a positive confirmation request is received. B) no reply to a negative confirmation request is received. C) collectability of the receivables is in doubt. D) pledging of the receivables is probable. Answer: A Terms: Auditor perform alternative procedures to substantiate existence of accounts receivable Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
11) Confirmation of accounts receivable balances normally provides evidence concerning the: A) valuation of the balances. B) rights of the balances. C) existence of the balances. D) completeness of the balances. Answer: C Terms: Confirmation of accounts receivable balances Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
12) If the auditor decides not to confirm accounts receivable, the auditor should: A) always use alternative procedures to audit the accounts receivable. B) include copies of customer statements in the audit files. C) document the reasons for such a decision in the audit files. D) include copies of customer sales invoices in the audit files. Answer: C Terms: Confirm accounts receivable Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
13) The most reliable evidence from confirmations is obtained when they are sent: A) as close to the balance sheet date as possible. B) at various times throughout the year to different segments of the sample, so that the entire sample is representative of account balances scattered throughout the year. C) several months before the year-end, so the auditor will have adequate time to perform alternate procedures if they are required. D) at various times throughout the year to the same group in the sample, so that the sample will not have a time bias. Answer: A Terms: Reliable evidence from confirmations Diff: Challenging Objective: LO 16-4 AACSB: Reflective thinking skills
14) A type of positive confirmation in which an individual invoice is confirmed, rather than the customer's entire accounts receivable balance is the ________ confirmation. A) invoice B) specific C) balance D) voucher Answer: A Terms: Confirmations Diff: Challenging Objective: LO 16-4 AACSB: Reflective thinking skills
15) Confirmation of accounts receivable provide evidence related to the existence, accuracy and cutoff objectives. Answer: TRUE Terms: Confirmation of accounts receivable; Existence, accuracy, and cutoff objectives Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
16) Auditing standards require the confirmation of accounts receivable in normal circumstances. What are the two exceptions to this requirement? Answer: The two exceptions are: 1. The auditor considers confirmations ineffective evidence because response rates will likely be inadequate or unreliable. 2. The combined level of inherent risk and control risk is low and other substantive evidence can be accumulated to provide sufficient evidence. Terms: Exceptions to auditing standards requiring confirmations Diff: Easy Objective: LO 16-4 AACSB: Reflective thinking skills
17) Describe the differences between positive and negative confirmations. Which type is generally viewed as more reliable? Answer: A positive confirmation requests the recipient to respond regardless of whether the balance as stated on the confirmation is correct or incorrect. In contrast, a negative confirmation requests the recipient to respond only if the balance as stated on the confirmation is incorrect. Positive confirmations are more reliable because the auditor can perform follow-up procedures if a response is not received from the customer. With a negative confirmation, failure to reply must be regarded as a correct response, even though the debtor may have ignored the confirmation request. Terms: Positive and negative confirmations Diff: Easy Objective: LO 16-4 AACSB: Reflective thinking skills
18) Discuss the alternative procedures an auditor can perform to test the existence objective for accounts receivable when customers do not respond to confirmation requests. Answer: For any positive confirmation not returned, the auditor can examine the following to verify the existence of individual sales transactions making up the ending balance in accounts receivable: • Subsequent cash receipts–evidence of the receipt of cash after the confirmation date includes examining remittance advices and entries in the cash receipts records. • Duplicate sales invoices-useful to verify the actual issuance of a sales invoice and the actual date of the billing • Shipping documents-used to establish whether the shipment was made and as a test of cutoff • Correspondence with the client-used to disclose disputed and questionable receivables not uncovered by other means Terms: Alternative procedures; Existence objective for accounts receivable; Confirmation requests Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
19) Discuss the advantages and disadvantages of using negative accounts receivable confirmations rather than positive confirmations. Answer: The primary advantage of negative confirmations is that they are less expensive than positive confirmations because there are no second requests and no follow-up of no responses. The primary disadvantage of negative confirmations is that they are less reliable than positive confirmations because a nonresponse must be regarded as a correct response, even though the debtor may have ignored the confirmation request. The determination of which type of confirmation to use is an auditor's decision and it should be based on the facts in the audit. Terms: Negative accounts receivable confirmations; Positive confirmations Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
20) Briefly describe the circumstances in which it is acceptable to use negative confirmation requests. Answer: It is acceptable to use negative confirmation requests only when all of the following circumstances are present: • The auditor has assessed the risk of material misstatements as low and has obtained sufficient appropriate evidence regarding the design and operating effectiveness of controls relevant to the assertion being tested by the confirmation procedures. • The population of items subject to negative confirmation procedures is made up of a large number of small, homogeneous account balances, transactions, or other items. • The auditor expects a low exception rate. • The auditor reasonably believes that recipients of negative confirmation requests will give the request adequate consideration. Terms: Negative confirmation requests Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
21) Describe each of the following types of confirmations: • Positive confirmation • Blank confirmation • Invoice confirmation • Negative confirmation Answer: • Positive confirmations are communications addressed to a debtor requesting the recipient to confirm whether the balance as stated on the confirmation is correct or incorrect. • Blank confirmation is a type of positive confirmation that does not state the amount, but requests the recipient to fill in the balance or furnish other information. • Invoice confirmation is a type of positive confirmation in which an individual invoice is confirmed rather than a customer's entire accounts receivable balance. • Negative confirmations are addressed to debtor, but request responses only if the information is incorrect. Terms: Positive confirmation; Blank confirmation; Invoice confirmation; Negative confirmation Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
22) List three of the major factors affecting sample size for confirming accounts receivable. Answer: The factors include: • performance materiality • inherent risk (e.g., relative size of total accounts receivable, number of accounts, prior-year results, and expected misstatements) • control risk • achieved detection risk from other substantive tests (extent and results of substantive tests of transactions, analytical procedures, and other tests of details) • type of confirmation (negatives normally require a larger sample size) Terms: Sample size for confirming accounts receivable Diff: Challenging Objective: LO 16-4 AACSB: Reflective thinking skills
23) When an auditor uses negative confirmations, several factors must be considered. What are those factors? Answer: When negative confirmations are used, the auditor puts considerable emphasis on: • the effectiveness of internal controls • substantive tests of transactions • analytical procedures as evidence of the fairness of accounts receivable, and • assumes that the large majority of recipients will provide a conscientious reading and response to the confirmation request Terms: Negative confirmations Diff: Challenging Objective: LO 16-4 AACSB: Reflective thinking skills
24) A confirmation is a type of audit evidence. Answer: TRUE Terms: Confirmation of accounts receivable balances Diff: Easy Objective: LO 16-4 AACSB: Reflective thinking skills
25) Tests of details of balances focus on testing the year-end balances of balance sheet accounts. Answer: TRUE Terms: Tests of details of balances Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
26) Both U.S. and international auditing standards require the use of confirmations for accounts receivable. Answer: FALSE Terms: Accounts receivable confirmed Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
27) Blank confirmations are considered less reliable than standard positive confirmations. Answer: FALSE Terms: Blank confirmations; Standard positive confirmations Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
28) Negative confirmations are less expensive, and less reliable, than positive confirmations. Answer: TRUE Terms: Negative confirmations; Positive confirmations Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
29) It is common to use a combination of positive and negative confirmations by sending the latter to accounts with large balances and the former to those with small balances. Answer: FALSE Terms: Positive confirmations; Negative confirmations Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
30) If auditors consider confirmations of accounts receivable to be ineffective evidence because response rates will be very low, they need not confirm accounts receivable. Answer: TRUE Terms: Confirmations of accounts receivable Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
31) Negative confirmations normally require a larger sample size than positive confirmations. Answer: TRUE Terms: Negative confirmations; Positive confirmations Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
32) When sending confirmations during most audits of accounts receivable, the emphasis is often on confirming larger and older accounts. Answer: TRUE Terms: Confirmations of accounts receivable Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
33) When a customer disagrees with the amount shown on an account receivable confirmation, the auditor should not ask the client to reconcile the difference. Answer: FALSE Terms: Accounts receivable confirmation Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
34) Auditors must maintain control of confirmations until they are returned from the customer. Answer: TRUE Terms: Control of confirmations Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
35) When a customer does not return an accounts receivable confirmation, it is acceptable, without performing alternative procedures, to assume the amount is 100% overstated when generalizing from the sample to the population. Answer: TRUE Terms: Alternative procedures; Accounts receivable confirmation Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
36) Stratification of accounts receivable is desirable when using confirmations. Answer: TRUE Terms: Stratification of accounts receivable Diff: Easy Objective: LO 16-4 AACSB: Reflective thinking skills
37) Each client misstatement in accounts receivable must be analyzed to determine whether it was consistent with the original assessed level of control risk. Answer: TRUE Terms: Alternative procedures; Accounts receivable confirmation Diff: Moderate Objective: LO 16-4 AACSB: Reflective thinking skills
Learning Objective 16-5 1) Match seven of the terms (a-k) with the definitions provided below (1-7): a. b. c. d. e. f. g. h. i. j. k.
Accounts receivable balance-related audit objectives Aged trial balance Alternative procedures Blank confirmation form Cutoff misstatements Evidence planning worksheet Negative confirmation Positive confirmation Realizable value of accounts receivable Timing difference in an account receivable confirmation Invoice confirmation
________ 1. The follow-up of a positive confirmation not returned by the debtor with the use of documentation evidence to determine whether the recorded receivable exists and is collectible. ________ 2. A letter, addressed to the debtor, requesting that the recipient indicate directly on the letter whether the stated account balance is correct or incorrect and, if incorrect, by what amount. ________ 3. Misstatements that take place as a result of current period transactions being recorded in a subsequent period, or subsequent period transactions being recorded in the current period. ________ 4. A form used to help the auditor decide whether planned detection risk for tests of details of balances should be low, medium, or high for each balance-related audit objective. ________ 5. A letter, addressed to the debtor, requesting a response only if the recipient disagrees with the amount of the stated account balance. ________ 6. A reported difference in a confirmation from a debtor that is determined to be a timing difference between the client's and debtor's records and therefore not a misstatement. ________ 7. A listing of the balances in the accounts receivable master file at the balance sheet date broken down according to the amount of time that has passed between the date of sale and the balance sheet date.
Answer: 1. c 2. h 3. e 4. f 5. g 6. j 7. b
Terms: Alternative procedures; Positive and negative confirmations; Aged trial balance; Cutoff misstatements; Evidence planning worksheet; Timing difference; Accounts receivable confirmation Diff: Moderate Objective: LO 16-3, LO 16-4, and LO 16-5 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e (Arens) Chapter 17 Audit Sampling for Tests of Details of Balances Learning Objective 17-1 1) Both sampling and nonsampling risks are associated with: A) Tests of controls. Substantive tests of transactions. Yes Yes B) Tests of controls. No
Substantive tests of transactions. No
Tests of controls. Yes
Substantive tests of transactions. No
Tests of controls. No
Substantive tests of transactions. Yes
C)
D)
Answer: A Terms: Sampling and nonsampling risks Diff: Easy Objective: LO 17-1 AACSB: Reflective thinking skills
2) Tests for rates of occurrence are appropriately used in all but which of the following situations? A) Testing of internal Substantive testing of Substantive testing of controls transactions details of balances Yes Yes Yes B) Testing of internal controls No
Substantive testing of transactions Yes
Substantive testing of details of balances Yes
Testing of internal controls Yes
Substantive testing of transactions Yes
Substantive testing of details of balances No
Testing of internal controls No
Substantive testing of transactions No
Substantive testing of details of balances Yes
C)
D)
Answer: C
Terms: Tests for rates of occurrence Diff: Easy Objective: LO 17-1 AACSB: Reflective thinking skills
3) The most important difference among tests of controls, substantive tests of transactions, and tests of details of balances lies in what the auditor wants to measure. Explain what each type of test attempts to measure. Answer: Tests of controls focus on testing the effectiveness of internal controls. In substantive tests of transactions, the auditor is concerned about both the effectiveness of internal controls and the monetary correctness of transactions in the accounting system. In tests of details of balances, the concern is determining whether the dollar amount of an account balance is materially misstated. Terms: Difference among tests of controls, substantive tests of transactions, and tests of details of balances Diff: Moderate Objective: LO 17-1 AACSB: Reflective thinking skills
Learning Objective 17-2 1) When selecting a sample size for substantive tests of balances which factor, other factors being equal, would result in a larger sample? A) A decrease in the tolerable misstatement B) Small expected misstatements C) An increase in the tolerable misstatement D) An increase in the acceptable risk of incorrect acceptance Answer: A Terms: Selecting sample size for substantive tests of balance Diff: Easy Objective: LO 17-2 AACSB: Reflective thinking skills
2) The auditors principal objective when using a sample of tests of details of balances is whether the: A) account balance being audited is fairly stated. B) transactions being audited are free of misstatements. C) controls being tested are operating effectively. D) transactions and account balances being audited are fairly stated. Answer: A Terms: Principal objective when using sample of tests of details of balances Diff: Easy Objective: LO 17-2 AACSB: Reflective thinking skills
3) What is the purpose of applying stratified sampling to a population? A) To avoid items that may To emphasize certain items contain misstatements and deemphasize others Yes Yes B) To avoid items that may contain misstatements No
To emphasize certain items and deemphasize others No
To avoid items that may contain misstatements Yes
To emphasize certain items and deemphasize others No
To avoid items that may contain misstatements No
To emphasize certain items and deemphasize others Yes
C)
D)
Answer: D
Terms: Purpose of stratified sampling of populations Diff: Easy Objective: LO 17-2 AACSB: Reflective thinking skills
4) If an auditor desires a greater level of assurance in auditing a balance, the acceptable risk of incorrect acceptance: A) is reduced. B) is increased. C) is not changed. D) may be reduced or increased depending upon other circumstances. Answer: A Terms: Greater level of assurance; Acceptable risk of incorrect acceptance Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
5) In estimating the population misstatement, the first step in projecting from the sample to the population is to: A) make a point estimate. B) revise the upper error bound. C) calculate the precision interval. D) determine the population mean. Answer: A Terms: Estimating population misstatement; First step in projecting sample to population Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
6) Tolerable misstatement is used to: A) Determine sample size Select the sample. Yes Yes
Evaluate results. No
B) Determine sample size No
Select the sample. Yes
Evaluate results. No
Determine sample size No
Select the sample. No
Evaluate results. Yes
Determine sample size Yes
Select the sample. No
Evaluate results. Yes
C)
D)
Answer: D
Terms: Tolerable misstatement Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
7) The word below that best explains the relationship between required sample size and the acceptable risk of incorrect acceptance is: A) inverse. B) direct. C) proportional. D) indeterminate. Answer: A Terms: Relationship between required sample size and acceptable risk of incorrect acceptance Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
8) The final step in the evaluation of the audit results is the decision to: A) accept the population as fairly stated or to require further action. B) determine sampling error and calculate the estimated total population error. C) project the point estimate. D) determine the error in each sample. Answer: A Terms: Final step in evaluation of audit results Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
9) Which of the following does not have to be considered in determining the initial sample size of a test of details? A) Tolerable misstatement B) Acceptable risk of incorrect rejection C) Estimate of misstatements in the population D) Acceptable audit risk Answer: B Terms: Not considered in determining initial sample size of test of details Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
10) If an auditor concludes that internal controls are likely to be effective, the preliminary assessment of control risk can be reduced, leading to which of the following impacts on the acceptable risk of incorrect acceptance? A) The acceptable risk of incorrect acceptance will be reduced. B) The acceptable risk of incorrect acceptance will be increased. C) The acceptable risk of incorrect acceptance will be eliminated. D) The acceptable risk of incorrect acceptance will not be impacted. Answer: B Terms: Auditor concludes internal controls are effective; Reduction of preliminary assessment of control risk; Impact on acceptable risk of incorrect acceptance Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
11) If acceptable audit risk is increased, acceptable risk of incorrect acceptance should be: A) increased. B) reduced. C) unaffected. D) modified. Answer: A Terms: Acceptable audit risk is increased, acceptable risk of incorrect acceptance Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
12) You are auditing Raji and Company. You discover an item of inventory with an audited value of $5,000 with a recorded amount of $3,000. If this is the only error you discover the projected misstatement for the sample would be: A) $5,000. B) $2,000. C) $3,000. D) $4,000. Answer: B Terms: Projected misstatement for sample for audited value and recorded amount Diff: Moderate Objective: LO 17-2 AACSB: Analytic skills
13) One of the steps involved in planning the sample for the tests of details of balances is to: A) select the sample. B) perform the audit procedures. C) define a misstatement. D) analyze the misstatements. Answer: C Terms: Steps in the audit sampling for tests of details of balances Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
14) The risk the auditor is willing to take of accepting a balance as correct when the true misstatement in the balance under audit is greater than the tolerable misstatement is: A) the upper bound. B) the tolerable risk. C) the acceptable risk of incorrect acceptance. D) the lower bound. Answer: C Terms: Risk auditor is willing to take of accepting a balance as correct when the true misstatement in the balance under audit is greater than the tolerable misstatement Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
15) As the amount of misstatements expected in the population approaches tolerable misstatement, the planned sample size will: A) decrease. B) increase. C) vary based on characteristics of the population. D) be unaffected. Answer: B Terms: Effect on planned sample size of amount of misstatements expected in population approached tolerable misstatement Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
16) An auditor using nonstatistical sampling cannot formally measure sampling error and therefore must subjectively consider the possibility that the true population misstatement exceeds a tolerable amount.
Which of the following factors should be considered by the auditor in making this assessment? A) The dollar difference between the point The extent to which items in the population estimate and tolerable misstatement. have been audited 100 percent. Yes Yes B) The dollar difference between the point The extent to which items in the population estimate and tolerable misstatement. have been audited 100 percent. No No C) The dollar difference between the point The extent to which items in the population estimate and tolerable misstatement. have been audited 100 percent. Yes No D) The dollar difference between the point The extent to which items in the population estimate and tolerable misstatement. have been audited 100 percent. No Yes Answer: A
Terms: Nonstatistical sampling; Auditor subjectively consider possibility of true population misstatements Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
17) The appropriate assumption to make regarding the overall percent of error in those population items containing an error is: A) determined using random number tables. B) set after a quantitative analysis of client's internal control system. C) based on the auditor's personal judgment in the circumstances. D) based on statistical analysis using confidence limits. Answer: C Terms: Assumption made regarding overall percent of error in population Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
18) When errors are found in a sample, auditors in practice generally make the assumption: A) of a 100% assumption for all errors. B) that the population errors are larger than the sample errors. C) that the population errors are smaller than the sample errors. D) that the actual sample errors are representative of the population errors. Answer: D Terms: Errors found in sample assumption Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
19) Which of the following needs to be considered when the auditor generalizes from the sample to the population? A) Acceptable risk of incorrect acceptance Sampling error Yes Yes B) Acceptable risk of incorrect acceptance No
Sampling error No
C) Acceptable risk of incorrect acceptance Yes
Sampling error No
D) Acceptable risk of incorrect acceptance No
Sampling error Yes
Answer: A
Terms: Factors considered when auditor generalizes from sample to populations Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
20) The client's trial balance has a balance of $410,000 for merchandise inventory. As the auditor you are willing to accept a balance that is within $20,000 of either side of the recorded balance. You compute a 95% confidence interval of $395,000 to $425,000. You could therefore: A) reject the trial balance amount. B) accept the trial balance amount. C) increase the sample size to assure more precision. D) use alternative audit procedures to satisfy yourself as to the correct balance. Answer: B Terms: Confidence interval decisions Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
21) While performing a substantive test of details during an audit, the auditor determined that the sample results supported the conclusion that the recorded account balance was not materially misstated. It was, in fact, materially misstated. This situation illustrates the risk of: A) incorrect rejection. B) incorrect acceptance. C) assessing control risk too low. D) assessing control risk too high. Answer: B Terms: Substantive test of details; Sample results support conclusion that recorded account balance was not materially misstated which it was materially misstated Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
22) While performing a substantive test of details during an audit, the auditor determined that the sample results supported the conclusion that the recorded account balance was materially misstated. Which of the following is the least likely auditor reaction to this discovery? A) Perform expanded audit tests in the relevant areas. B) Increase detection risk in the relevant areas. C) Increase the sample size. D) Take no action until tests of other audit areas are completed. Answer: B Terms: Performing substantive test of details; Sample results support conclusion that account balance was materially misstated; Auditor reaction Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
23) When selecting a stratified sample, the sample size is: A) determined for the unstratified population and then apportioned to each stratum. B) determined for each stratum and selected from that stratum. C) determined for each stratum and selected randomly from the entire unstratified population. D) always larger than if unstratified sampling had been used. Answer: B Terms: Sample size for stratified sample Diff: Challenging Objective: LO 17-2 AACSB: Reflective thinking skills
24) Factors considered by an auditor to determine the possibility that the true population misstatement exceeds a tolerable amount in a nonstatistical sample include all of the following except for: A) the extent to which items in the population have been audited 100%. B) the difference between the point estimate and acceptable control risk. C) whether misstatements tend to be offsetting or in only one direction. D) the amounts of individual misstatements. Answer: B Terms: Generalize from the sample to the population Diff: Challenging Objective: LO 17-2 AACSB: Reflective thinking skills
25) When defining the population and the sampling unit for tests of details of balances:
A) the population is defined as all of the transactions in the journal for the period. B) the sampling unit must be the same for all balance sheet accounts. C) if sampling for completeness, the sampling unit will be customers with zero balances. D) if sampling for completeness, the sampling unit will be the items making up the recorded population. Answer: C Terms: Population and sampling unit Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
26) Which of the following is a correct statement? A) When internal controls are effective, control risk can be reduced, and therefore the auditor will decrease the ARIA. B) There is a direct relationship between ARIA and the required sample size. C) A lower control risk risk requires a lower ARO in testing the controls. D) ARO measures the auditor's desired assurance for an account balance. Answer: C Terms: Acceptable risk of incorrect acceptance Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
27) If no exceptions were found in the substantive tests of transactions: A) ARIA would stay the same. B) the sample size would stay the same. C) ARIA would increase. D) the sample size would increase. Answer: C Terms: Acceptable risk of incorrect acceptance Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
28) If analytical procedures are performed with no indications of likely misstatements, ARIA will ________ and the sample size will ________. A) remain the same, increase B) decrease, decrease C) increase, decrease D) decrease, increase Answer: C Terms: Sample sizes, ARIA and analytical procedures Diff: Challenging Objective: LO 17-2 AACSB: Reflective thinking skills
29) Which of the following conditions would lead to a larger sample size? A) Larger tolerable misstatement B) Low inherent risk C) High control risk D) Smaller account balance Answer: C Terms: Factors influencing sample sizes for tests of details of balances Diff: Challenging Objective: LO 17-2 AACSB: Reflective thinking skills
30) The AICPA audit sampling formula for computing nonstatistical tests of details of balances sample size is to multiply the population recorded amount by the ________ and then divide by the ________. A) confidence factor, ARIA B) confidence factor, tolerable misstatement C) ARO, tolerable misstatement D) risk of incorrect acceptance, confidence factor Answer: B Terms: Formula for computing nonstatistical tests of details of balances sample size Diff: Challenging Objective: LO 17-2 AACSB: Reflective thinking skills
31) If the population is not considered acceptable, one step the auditor is likely to take is to: A) retest all internal controls. B) ask the client to adjust the account balance. C) test the entire population. D) decrease inherent risk. Answer: B Terms: Action when a population is rejected Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
32) There are 14 steps to audit sampling for details of balances, divided into three sections: plan the sample, select the sample and perform the audit procedures, and evaluate the results. Discuss each of the steps included in the "evaluate the results" section for nonstatistical sampling. Answer: The steps included in the "evaluate the results" section are: 1. Generalize from the sample to the population. This involves (1) projecting misstatements found in the sample to the population and (2) allowing for sampling risk. 2. Analyze the misstatements. The auditor should evaluate the nature and cause of each misstatement found in the sample. 3. Decide the acceptability of the population. If the projected misstatement (point estimate), combined with the allowance for sampling risk, is less than tolerable misstatement, the auditor will accept the population as fairly stated. Terms: Steps included in the Evaluate the Results section for nonstatistical sampling Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
33) Consider the steps in sampling for tests of details and for tests of controls. Explain the differences in
applying sampling to these two types of tests. Answer: The differences are as follows: Tests of Details 1. Define a misstatement 2. Specify tolerable misstatement 3. Specify acceptable risk of incorrect acceptance 4. Estimate misstatements in the population 5. Analyze misstatements
Tests of Controls 1. Define attributes and exception conditions 2. Specify tolerable exception rate 3. Specify acceptable risk of overreliance 4. Estimate population exception rate 5. Analyze exceptions
Terms: Steps in sampling for tests of details and tests of controls Diff: Challenging Objective: LO 17-2 AACSB: Reflective thinking skills
34) Identify each of the seven factors that influence sample size for nonstatistical tests of details of balances, and state whether each factor is directly or inversely related to sample size. Answer: Factors that influence sample size for nonstatistical tests are: • Control risk. Control risk is directly related to sample size; as control risk increases, sample size also increases. • Results of other substantive tests related to the same assertion. Directly related to sample size; as these risks increase, sample size also increases. • Dollar amount of the population. Directly related to sample size, smaller account balances lead to smaller sample size and larger account balances lead to larger sample sizes. • Tolerable misstatement for a specific account. Inversely related; as tolerable misstatement increases, sample size decreases. • Inherent risk. Directly related; as inherent risk increases, sample size also increases. • Expected size and frequency of misstatements. Directly related; as the size and frequency of expected misstatements increase, sample size also increases. • Number of items in the population. Directly related, but has only a minor effect on sample size. Terms: Factors that influence sample size for nonstatistical tests of details of balances Diff: Challenging Objective: LO 17-2 AACSB: Reflective thinking skills
35) There are 14 steps to audit sampling for details of balances, divided into three sections: plan the sample, select the sample and perform the audit procedures, and evaluate the results. Discuss 5 of the 9 steps included in the "plan the sample" section for nonstatistical sampling. Answer: The steps comprising the "plan the sample" section are: 1. State the objectives of the audit test. For tests of details of balances, the objective is to determine whether the account balance being audited is fairly stated. 2. Decide whether audit sampling applies. In certain situations, the auditor may choose to test all large items and no small items. In those situations, the auditor has not sampled. 3. Define a misstatement. A misstatement exists whenever a sample item is misstated. 4. Define the population. The population is defined as the items making up the recorded dollar population. 5. Define the sampling unit. For nonstatistical sampling in tests of details of balances, the sampling unit is almost always the items making up the account balance. 6. Specify tolerable misstatement. This is the amount of materiality allocated to the account under audit. 7. Specify the acceptable risk of incorrect acceptance. This is the risk that the auditor is willing to take of accepting a balance as correct when the true misstatement in the balance is greater than tolerable misstatement. 8. Estimate misstatements in the population. The auditor typically makes this estimate based on prior experience with the client and by assessing inherent risk, considering the results of test of controls, substantive tests of transactions, and analytical procedures already performed. 9. Determine the initial sample size. In nonstatistical sampling, this is determined judgmentally considering the previous eight factors. Terms: Audit sampling for tests of details of balances Diff: Challenging Objective: LO 17-2 AACSB: Reflective thinking skills
36) When using nonstatistical sampling, the auditor must subjectively consider whether the true population misstatement exceeds a tolerable amount. This is done by considering five factors. One factor is the difference between the point estimate and tolerable misstatement. State the other four factors the auditor must consider. Answer: Other factors the auditor must consider are: • The extent to which items in the population have been audited 100%. • Whether misstatements tend to be offsetting or in only one direction. • The amounts of individual misstatements. • Sample size. Terms: Factors to consider whether population misstatement exceeds tolerable misstatement Diff: Challenging Objective: LO 17-2 AACSB: Reflective thinking skills
37) Discuss each of the six possible courses of action the auditor can take when he or she has concluded that the population is misstated by more than a tolerable amount. Answer: The six possible courses of action the auditor can take when he or she has concluded that the population is misstated by more than a tolerable amount are: • Take no action until tests of other audit areas are completed. If offsetting misstatements are found in other parts of the audit, the auditor may conclude that the population is acceptable. • Perform expanded audit tests in specific areas. • Increase the sample size. As sample size increases, sampling error is reduced if the rate of misstatements in the expanded sample, their dollar amount, and their direction are similar to those in the original sample. This may result in the population being acceptable. • Adjust the account balance. In some circumstances, if the client corrects the misstatements discovered by the auditor, the book value of the account may become acceptable. • Request the client to correct the population. • Refuse to give an unqualified opinion. If none of the prior courses of action results in an acceptable population, the auditor will have to qualify the audit report in an appropriate manner. Terms: Possible courses of action auditor can take when conclusion that population is misstated by more than tolerable amount Diff: Challenging Objective: LO 17-2 AACSB: Reflective thinking skills
38) For stratified sampling, the auditor selects samples independently from each stratum. Answer: TRUE Terms: Stratification of accounts receivable Diff: Easy Objective: LO 17-2 AACSB: Reflective thinking skills
39) The larger the sample size, the more confident the auditor can be that the point estimate is close to the true population value. Answer: TRUE Terms: Evaluating sample results Diff: Easy Objective: LO 17-2 AACSB: Reflective thinking skills
40) Acceptable risk of incorrect acceptance is directly affected by acceptable audit risk. Answer: TRUE Terms: Acceptable risk of incorrect acceptance and acceptable audit risk Diff: Easy Objective: LO 17-2 AACSB: Reflective thinking skills
41) Tolerable misstatement is inversely related to sample size. Answer: TRUE Terms: Tolerable misstatements related to sample size Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
42) Acceptable risk of incorrect acceptance (ARIA) and sample size are inversely related; that is, as ARIA increases, sample size decreases. Answer: TRUE Terms: Relation of acceptable risk of incorrect acceptance and sample size Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
43) Estimated misstatement in the population and sample size are inversely related; that is, as estimated misstatement increases, sample size decreases. Answer: FALSE Terms: Relation of estimated misstatement in the population and sample size Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
44) The purpose of stratification is to permit auditors to emphasize certain aspects of a population and deemphasize others. Answer: TRUE Terms: Purpose of stratification Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
45) An auditor using nonstatistical sampling cannot formally measure sampling error. Answer: TRUE Terms: Nonstatistical sampling Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
46) If the misstatement in a population is larger then tolerable misstatement without considering sampling error, the population will be considered unacceptable. Answer: FALSE Terms: Population not considered acceptable Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
47) When using nonstatistical sampling, the larger the sample size, the greater the auditor's confidence that the point estimate is close to the true population value. Answer: TRUE Terms: Nonstatistical sampling Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
48) Required sample size increases as the auditor's tolerable misstatement for an account balance or class of transactions decreases. Answer: TRUE Terms: Required sample size and tolerable misstatement Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
49) The primary factor affecting the auditor's decision about acceptable risk of incorrect acceptance (ARIA) is assessed inherent risk. Answer: FALSE Terms: Acceptable risk of incorrect acceptance Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
50) The purpose of stratified sampling is to achieve a greater confidence level (lower risk of incorrect acceptance) for a given sample size. Answer: FALSE Terms: Stratified sampling; Confidence level and sample size Diff: Challenging Objective: LO 17-2 AACSB: Reflective thinking skills
51) ARIA measures the auditor's desired assurance for an account balance. Answer: TRUE Terms: Acceptable risk of incorrect acceptance Diff: Easy Objective: LO 17-2 AACSB: Reflective thinking skills
52) Acceptable audit risk and acceptable risk of incorrect acceptance are inversely related; that is, as AAR increases, ARIA decreases. Answer: FALSE Terms: Acceptable audit risk and acceptable risk of incorrect acceptance Diff: Challenging Objective: LO 17-2 AACSB: Reflective thinking skills
53) An increased sample size will always cause the population to be accepted. Answer: FALSE Terms: Sample size and analyzing exceptions Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
54) Sampling used for tests of details of balances provides results in terms of exception rates. Answer: FALSE Terms: Sampling used for tests of details of balances Diff: Moderate Objective: LO 17-2 AACSB: Reflective thinking skills
Learning Objective 17-3 1) In monetary unit sampling, a sampling interval of 900 means that: A) every 900th item will be selected. B) every 900th dollar in the account will be sampled. C) expected misstatement is 900. D) tolerable misstatement is 900. Answer: B Terms: Monetary unit sampling; Sampling interval Diff: Easy Objective: LO 17-3 AACSB: Reflective thinking skills
2) Monetary unit sampling is not particularly effective at detecting: A) overstatements. B) understatements. C) errors in current assets. D) errors in noncurrent assets. Answer: B Terms: Monetary unit sampling not effective at detecting Diff: Easy Objective: LO 17-3 AACSB: Reflective thinking skills
3) The auditor must consider the possibility that the true population misstatement is greater than the amount of misstatement that is tolerable when the auditor is performing: A) Nonstatistical sampling. Monetary unit sampling. Yes Yes B) Nonstatistical sampling. No
Monetary unit sampling. No
Nonstatistical sampling. Yes
Monetary unit sampling. No
Nonstatistical sampling. No
Monetary unit sampling. Yes
C)
D)
Answer: D
Terms: Auditor must consider the possibility that the true population misstatement is greater than the amount of misstatement that is tolerable Diff: Easy Objective: LO 17-3 AACSB: Reflective thinking skills
4) The most commonly used method of statistical sampling for tests of details of balances is: A) attributes sampling. B) systematic sampling. C) discovery sampling. D) monetary unit sampling. Answer: D Terms: Most commonly used method of statistical sampling for details of balances Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
5) When using monetary unit sampling, the recorded dollar population is a definition of all the items in the: A) population. B) population which the auditor has included in the sample. C) population which contain errors. D) sample which contain errors. Answer: A Terms: Monetary-unit sampling; Recorded dollar population Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
6) When the sample selection is done using probability proportional to size sample selection (PPS): A) the actual number of units selected for testing may be more than the computed sample size. B) the auditor must use systematic selection, rather than random selection of dollars. C) population items with a zero recorded balance have no chance of being selected. D) negative balances must be treated as positive balances. Answer: C Terms: Monetary unit sampling Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
7) An accounts receivable population contains a total of four customers. The accounts, the amounts, and the cumulative total are shown below. Monetary unit sampling is to be used. Account Recorded Cumulative Name Amount Total Blue $ 357 $ 357 Brown 281 638 Gray 60 698 Green 574 1,272 Based on the information above, the population size is: A) 4. B) 574. C) 1,272. D) $2,684. Answer: C Terms: Using monetary-unit sampling, population is Diff: Moderate Objective: LO 17-3 AACSB: Analytic skills
8) An auditor uses monetary unit sampling with a sampling interval of $20,000 and detects an item with a recorded amount of $10,000 with an audited value of $4,000. The projected misstatement of the sample is: A) $12,000. B) $6,000. C) $10,000. D) $3,000. Answer: A Terms: Monetary unit sampling projected misstatement of the sample Diff: Moderate Objective: LO 17-3 AACSB: Analytic skills
9) The auditor must deal with layers of the computed upper deviation rate from the attributes table because there are different error assumptions for each error. Assume a sample of 100 had found one error, and the computed upper deviation rate is shown in the following table: Number of Errors 0 1
Upper Precision Limit from Table .023 .038
The precision limit for the layer with one error is: A) 2.3%. B) 3.8% C) 6.1%. D) 1.5%. Answer: D
Terms: Computed upper deviation from the attributes table; Precision limit with one error Diff: Moderate Objective: LO 17-3 AACSB: Analytic skills
10) Which balance-related audit objective cannot be assessed using monetary unit sampling? A) Accuracy B) Completeness C) Existence D) All of the above can be assessed using monetary unit sampling. Answer: B Terms: Balance-related audit objective that cannot be assessed using monetary unit sampling Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
11) PPS samples can be obtained in an efficient manner using all but which of the following? A) Hand selection by the auditor B) Computer software C) Random number tables D) Systematic sampling techniques Answer: A Terms: PPS samples obtained Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
12) Which of the following item(s) are needed to determine the sample size using MUS? A) Recorded population A point estimate for misstatements. value A confidence factor No Yes No B) A point estimate for misstatements. Yes
Recorded population value No
A confidence factor Yes
A point estimate for misstatements. No
Recorded population value Yes
A confidence factor Yes
A point estimate for misstatements. Yes
Recorded population value No
A confidence factor No
C)
D)
Answer: C
Terms: Determining sample sizes using MUS Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
13) An estimate of the largest likely overstatement in a population at a given ARIA, using monetary unit sampling is the: A) point estimates. B) precision intervals. C) confidence intervals. D) misstatement bounds. Answer: D Terms: Maximum misstatements in monetary-unit sampling Diff: Challenging Objective: LO 17-3 AACSB: Reflective thinking skills
14) When using monetary unit sampling, evaluating the likelihood of unrecorded items in the population is: A) unnecessary. B) impossible. C) possible but difficult. D) an automatic outcome of the process. Answer: B Terms: Likelihood of unrecorded items in population in monetary-unit sampling Diff: Challenging Objective: LO 17-3 AACSB: Reflective thinking skills
15) The statistical methods used to evaluate monetary unit samples: A) neither exclude nor include units twice. B) may permit the inclusion of a unit in the sample more than once. C) do not permit a unit to be included in the sample more than once. D) ignore the possibility that a unit may be included in a sample more than once. Answer: B Terms: Statistical methods used to evaluate monetary-unit samples Diff: Challenging Objective: LO 17-3 AACSB: Reflective thinking skills
16) Which of the following is not a problem with monetary unit selection? A) Population items with a zero recorded balance B) Population items that should have a zero balance but do not C) Accounts with negative balances D) Accounts with small recorded balances that are significantly understated Answer: B Terms: Not a problem with monetary-unit selection Diff: Challenging Objective: LO 17-3 AACSB: Reflective thinking skills
17) The allowance for sampling risk when no misstatements are found in the sample is: A) tolerable risk of misstatement. B) basic precision. C) confidence factor. D) population variance. Answer: B Terms: Basic precision and MUS Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
18) Which of the following is not a disadvantage of monetary unit sampling? A) It may be difficult to select samples from large population without computer assistance. B) The total misstatement bounds resulting when misstatements are found may be too low to be useful to the auditor. C) The total misstatement bounds resulting when misstatements are found may be too high to be useful to the auditor. D) Each of the above is a disadvantage. Answer: B Terms: Disadvantage of monetary-unit sampling Diff: Challenging Objective: LO 17-3 AACSB: Reflective thinking skills
19) Calculating the sample size using monetary unit sampling depends on which of the following factors? A) Estimated population misstatement Recorded population value Yes Yes B) Estimated population misstatement No
Recorded population value No
Estimated population misstatement Yes
Recorded population value No
Estimated population misstatement No
Recorded population value Yes
C)
D)
Answer: A Terms: Sample size and monetary unit sampling Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
20) Using statistical sampling to assist in verifying the year-end accounts payable balance, an auditor has accumulated the following data:
Population: Sample:
Number of accounts
Book balance
4,000 200
$5,000,000 $250,000
Balance determined by the auditor ? $300,000
Projecting the misstatement to the population, the auditor's estimate of year-end accounts payable balance would be: A) $5,050,000. B) $5,125,000. C) $6,000,000. D) $6,150,000. Answer: C Terms: Using statistical sampling project the misstatement to the population Diff: Challenging Objective: LO 17-3 AACSB: Analytic skills
21) Why do auditors find MUS appealing? A) MUS increases the likelihood of selecting a balance of high and low dollar items. B) MUS is easy to use in the audit environment. C) MUS provides a nonstatistical, rather than a statistical, conclusion. D) When misstatements are found, MUS rarely produces bounds in excess of materiality. Answer: B Terms: MUS appeal to auditors Diff: Challenging Objective: LO 17-3 AACSB: Reflective thinking skills
22) In monetary unit sampling, the relationship between tolerable misstatement size and required sample size is: A) direct. B) inverse. C) varied. D) indeterminable. Answer: B Terms: Monetary-unit sampling; Relationship between tolerable misstatement size and required sample size Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
23) Explain the decision rule used in monetary unit sampling to determine whether the population is acceptable. Answer: The results are considered acceptable if the upper misstatement bound amount is less than the tolerable misstatement. If the upper misstatement bound exceeds tolerable misstatement, the population is not acceptable based on the results of the sample. Terms: Monetary unit sampling Diff: Easy Objective: LO 17-3 AACSB: Reflective thinking skills
24) Explain why monetary unit sampling, or probability proportional to size sampling, is not useful for detecting understatements. Answer: Monetary unit sampling is a technique that assigns physical units to an item in the population based on the dollar value of the item. Larger dollar items are more likely to be chosen for the sample than smaller items. So, if a client has understated an item there is less likelihood that the item will be selected. Consequently, auditors do not commonly use monetary unit sampling when they are concerned with potential understatements. Terms: Monetary-unit sampling; Probability proportional to size sampling; Detecting understatements Diff: Easy Objective: LO 17-3 AACSB: Reflective thinking skills
25) Discuss the advantages and disadvantages of monetary-unit sampling over other sampling methods. Answer: Advantages of monetary unit sampling: • It automatically increases the likelihood of selecting high dollar items from the population being audited. • It frequently reduces the cost of doing the audit testing because several sample items are tested at once. • It is appealing to auditors because of its ease of application. • It provides a statistical conclusion rather than a nonstatistical one, which aids auditors in making better and more defensible conclusions. Disadvantages of monetary unit sampling: • The total misstatement bounds resulting when exceptions are found may be too high to be useful to the auditor. • It is cumbersome to select probability proportional to size samples from large populations without computer assistance. Terms: Advantages and disadvantages of monetary-unit sampling Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
26) How might auditors include negative balances when using monetary unit sampling to evaluate a population? Answer: There are two basic alternatives to testing negative balances when using MUS. First, the auditor may choose to ignore negative balances for MUS selection and test those amounts by some other means. Second, the auditor could treat the negative balances as positive and add them to the number of monetary units being tested. Terms: Monetary-unit sampling to evaluate population with negative balances Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
27) To determine the sampling interval, the population is divided by the confidence factor. Answer: FALSE Terms: Sample size and monetary unit sampling Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
28) MUS has the statistical simplicity of attributes sampling, yet provides a statistical result expressed as a percentage. Answer: FALSE Terms: Monetary unit sampling Diff: Easy Objective: LO 17-3 AACSB: Reflective thinking skills
29) In monetary unit sampling, the likelihood of high dollar items from the population being included in the sample is lower than the likelihood for small dollar items. Answer: FALSE Terms: Monetary unit sampling Diff: Easy Objective: LO 17-3 AACSB: Reflective thinking skills
30) When auditors apply MUS to a sample, the sample is selected using random sampling techniques. Answer: FALSE Terms: MUS applied to a sample; Random sampling techniques Diff: Easy Objective: LO 17-3 AACSB: Reflective thinking skills
31) The use of monetary unit sampling is most appropriate when the auditor expects to find many errors and when a monetary result is desired. Answer: FALSE Terms: Monetary-unit sampling most appropriate Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
32) When using MUS, the projected misstatement is the percentage misstatement times the sampling interval. Answer: TRUE Terms: Monetary unit sampling; projected misstatement Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
33) Accounts with zero or negative year-end balances have no chance of being included in a standard probability proportional to size (PPS) sample. Answer: TRUE Terms: Standard probability proportionate to size (PPS) sample Diff: Challenging Objective: LO 17-3 AACSB: Reflective thinking skills
34) If the misstatement bound exceeds tolerable misstatement, the population is considered acceptable. Answer: FALSE Terms: Monetary unit sampling Diff: Moderate Objective: LO 17-3 AACSB: Reflective thinking skills
Learning Objective 17-4 1) You are auditing Nelson and Company and determined that the sample results support a conclusion that the account is materially misstated, when in fact it was not misstated. This illustrates the risk of: A) incorrect acceptance. B) incorrect rejection. C) control risk too low. D) control risk too high. Answer: B Terms: Sample results support conclusion that account is materially misstated, when in Diff: Easy Objective: LO 17-4 AACSB: Reflective thinking skills
2) The method used to measure the estimated total error amount in a population when there is both a recorded value and an audited value for each item in the sample is: A) difference estimation. B) mean-per-unit estimation. C) ratio estimation. D) monetary unit sampling. Answer: A Terms: Method used to measure estimated total error amount in a population Diff: Moderate Objective: LO 17-4 AACSB: Reflective thinking skills
3) The auditor is concerned with the audited value rather than the error amount of each item in the sample when using: A) difference estimation. B) mean-per-unit estimation. C) ratio estimation. D) monetary-unit sampling. Answer: B Terms: Auditor concerned with audited value rather than error amount of each item Diff: Moderate Objective: LO 17-4 AACSB: Reflective thinking skills
4) Acceptable risk of incorrect rejection affects auditors' action only when they conclude that a population is: A) fairly stated. B) acceptable. C) not fairly stated. D) acceptable after certain adjustments. Answer: C Terms: Acceptable risk of incorrect rejection Diff: Challenging Objective: LO 17-4 AACSB: Reflective thinking skills
5) If the auditor believes that there will be more than just a few exceptions discovered, and desires an accurate estimate of the dollar value of the exceptions, he or she will use: A) attributes sampling. B) monetary unit sampling. C) block sampling. D) variables sampling. Answer: D
Terms: Auditor desires accurate estimate of dollar value of exceptions and believes more than just a few exceptions will be discovered Diff: Challenging Objective: LO 17-4 AACSB: Reflective thinking skills
6) The risk of incorrect rejection is important only when there is a ________ cost to increasing the sample size. A) high B) low C) moderate D) marginal Answer: A Terms: Risk of incorrect rejection Diff: Challenging Objective: LO 17-4 AACSB: Reflective thinking skills
7) Stratified sampling is applicable to difference, mean-per-unit, and ratio estimation, but it is most commonly used with: A) ratio estimation. B) discovery sampling. C) difference estimation. D) mean-per-unit estimation. Answer: D Terms: Stratified sampling; Difference, mean-per-unit, and ratio estimation Diff: Challenging Objective: LO 17-4 AACSB: Reflective thinking skills
8) Which of the following sampling plans would be designed to estimate a numerical measurement of a population, such as a dollar value? A) Numerical sampling B) Discovery sampling C) Attributes sampling D) Variable sampling Answer: D Terms: Sampling plan designed to estimate a numerical measurement of population Diff: Challenging Objective: LO 17-4 AACSB: Reflective thinking skills
9) When dealing with variables sampling and sampling risk, it is important to understand that: A) for variables sampling, auditors uses ARIA but not ARIR. B) ARIR is of serious concern to the auditor because of potential legal implications. C) ARIA is a one-tailed statistical test. D) the confidence coefficients for ARIA are the same as the confidence level. Answer: C Terms: Sampling risk Diff: Challenging Objective: LO 17-4 AACSB: Reflective thinking skills
10) When working with the different variables methods: A) difference estimation frequently results in larger sample sizes than any other method. B) ratio estimation is the method preferred by most auditors since it is simpler to calculate confidence intervals. C) the difference between the mean-per-unit estimate and the difference estimate is the definition of what is being measured. D) stratification can only be used with difference estimation. Answer: C Terms: Variables sampling Diff: Challenging Objective: LO 17-4 AACSB: Reflective thinking skills
11) Which of the following is not a type of statistical method that provides results in dollar terms? A) Variables sampling B) Attributes sampling C) Monetary unit sampling D) Sampling with probability proportional to size Answer: B Terms: Not a type of statistical method that provides results in dollar terms Diff: Easy Objective: LO 17-3 and LO 17-4 AACSB: Reflective thinking skills
12) The confidence limits in variables sampling are similar to the_________ in monetary-unit sampling. A) point estimate B) misstatement bounds C) standard deviation D) standard error of the mean Answer: B Terms: Confidence limits in variable sampling similar to monetary-unit sampling Diff: Challenging Objective: LO 17-3 and LO 17-4 AACSB: Reflective thinking skills
13) When making statistical inferences, the auditor must remember that: A) the true population value must always be known. B) auditors can state the conclusions drawn from a confidence interval in different ways. C) there can be no possibility that the sample is not sufficiently representative of the population. D) the knowledge of sampling distributions does not help the auditors to draw statistical conclusions. Answer: B Terms: Confidence limits in variable sampling similar to monetary-unit sampling Diff: Challenging Objective: LO 17-4 AACSB: Reflective thinking skills
14) Explain acceptable risk of incorrect acceptance and acceptable risk of incorrect rejection within the context of variables sampling. Answer: After an audit test is performed and statistical results are calculated, the auditor must conclude either that the population is not materially misstated or that it is materially misstated. ARIA is the statistical risk that the auditor has accepted a population that is actually materially misstated. This is a serious concern to auditors because there are potential legal implications in concluding that an account balance is fairly stated when it is misstated by a material amount. ARIR is the statistical risk that the auditor has concluded that a population is materially misstated when it is not. The only time that ARIR affects the auditor's actions is when an auditor concludes that a population is not fairly stated. ARIR is important only when there is a high cost to increasing the sample size or performing other tests. Terms: Variables sampling Diff: Challenging Objective: LO 17-2 and LO 17-4 AACSB: Reflective thinking skills
15) Match six of the terms (a-l) with the definitions provided below (1-6):
a. b. c. d. e. f. g. h. i. j. k. l.
Acceptable risk of incorrect acceptance Acceptable risk of incorrect rejection Difference estimation Misstatement bounds Monetary unit sampling Mean-per-unit estimation Point estimate Probability proportional to size sample selection Ratio estimation Statistical inferences Stratified sampling Variable sampling
________ 1. Conclusions drawn from sample results based on knowledge of sampling distributions. ________ 2. Sampling techniques for tests of details that use the statistical inference processes. ________ 3. The risk that the auditor is willing to take of concluding a balance is materially misstated when it is, in fact, fairly stated. ________ 4. A statistical sampling method that provides upper and lower misstatement bounds expressed in monetary amounts. ________ 5. A method of variables sampling in which the auditor estimates the population misstatement by multiplying the average misstatement in the sample by the total number of population items and also calculates sampling risk. ________ 6. The risk that the auditor is willing to take of accepting a balance as correct when the true misstatement in the balance is greater than tolerable misstatement. Answer: 1. j 2. l 3. b 4. e 5. c 6. a Terms: Acceptable risk of incorrect acceptance; Acceptable risk of incorrect rejection Diff: Moderate Objective: LO 17-2, LO 17-3, LO and 17-4 AACSB: Reflective thinking skills
16) Acceptable risk of incorrect rejection is the statistical risk that the auditor has concluded that a population is materially misstated when it is not. Answer: TRUE Terms: Acceptable risk of incorrect rejection Diff: Easy Objective: LO 17-4 AACSB: Reflective thinking skills
17) Difference estimation frequently results in smaller sample sizes than any other variables sampling method. Answer: TRUE Terms: Difference estimation Diff: Moderate Objective: LO 17-4 AACSB: Reflective thinking skills
Learning Objective 17-5 1) An important statistic to consider when using a statistical sampling audit plan is the population variability. The population variability is measured by the: A) sample mean. B) standard deviation. C) standard error of the sample mean. D) estimated population total minus the actual population. Answer: B Terms: Population variability Diff: Challenging Objective: LO 17-5 AACSB: Reflective thinking skills
2) There are four steps to generalize from the sample to the population using difference estimation sampling. Identify each of these four steps. Answer: The four steps to generalize from the sample to the population using difference estimation sampling are: 1. Compute the point estimate of the total misstatement. 2. Compute an estimate of the population standard deviation. 3. Compute the precision interval. 4. Compute the confidence limits. Terms: Four steps to generalize sample to population using difference estimation sampling Diff: Moderate Objective: LO 17-5 AACSB: Reflective thinking skills
3) When using difference estimation, the precision interval is calculated by a statistical formula. Answer: TRUE Terms: Precision interval Diff: Moderate Objective: LO 17-5 AACSB: Reflective thinking skills
4) The sample size is inversely related to the computed precision interval in difference estimation; that is,
as sample size increases, the computed precision interval decreases. Answer: TRUE
Terms: Sample size and computed precision interval in difference estimation Diff: Moderate Objective: LO 17-5 AACSB: Reflective thinking skills
5) In difference estimation sampling, the confidence limits are calculated by combining the point estimate of the total misstatements and the computed precision interval at the desired confidence level. Answer: TRUE Terms: Difference estimation sampling; Confidence limits Diff: Moderate Objective: LO 17-5 AACSB: Reflective thinking skills
6) The population standard deviation has a significant effect on the computed precision interval. Answer: FALSE Terms: Difference estimation; Population standard deviation; Computed precision interval Diff: Moderate Objective: LO 17-5 AACSB: Reflective thinking skills
Auditing and Assurance Services, 15e (Arens) Chapter 18 Audit of the Acquisition and Payment Cycle: Tests of Controls, Substantive Tests of Transactions, and Accounts Payable Learning Objective 18-1 1) The overall objective in the audit of the acquisition and payment cycle is: A) to ensure the reliability of the affected accounts. B) to ensure the accuracy of the affected accounts. C) to evaluate whether the affected accounts are fairly presented in accordance with accounting standards. D) to evaluate whether fraudulent payments were made. Answer: C Terms: Overall objective of audit of acquisition and payment cycle Diff: Easy Objective: LO 18-1 AACSB: Reflective thinking skills
2) Which of the following accounts is not part of the acquisition and payment cycle? A) Prepaid expenses B) Accounts payable C) Sales returns and allowances D) Property, plant, and equipment Answer: C Terms: Overall objective of audit of acquisition and payment cycle Diff: Easy Objective: LO 18-1
AACSB: Reflective thinking skills
3) The acquisition and payment cycle consists of one class of transactions. Answer: FALSE Terms: Acquisition and payment cycle and class of transactions Diff: Easy Objective: LO 18-1 AACSB: Reflective thinking skills
4) The cash account is not part of the acquisitions and payment cycle. Answer: FALSE Terms: Cash account and acquisitions and payment cycle Diff: Easy Objective: LO 18-1 AACSB: Reflective thinking skills
5) Auditing the acquisition and payment cycle often takes more time than any other cycle. Answer: TRUE Terms: Acquisitions and payment cycle Diff: Easy Objective: LO 18-1 AACSB: Reflective thinking skills
Learning Objective 18-2 1) What typically initiates the acquisitions and payment cycle? A) Issuance of a purchase requisition or request for purchase of goods/services B) Issuance of payment to vendor C) Approval of a new vendor D) Purchase requisition Answer: A Terms: Initiates acquisition and payment cycle Diff: Easy Objective: LO 18-2 AACSB: Reflective thinking skills
2) What typically ends the acquisitions and payment cycle? A) Issuance of a purchase requisition or request for purchase of goods/services B) Issuance of a payment on accounts payable C) Approval of a new vendor D) Purchase requisition Answer: B Terms: Ends acquisition and payment cycle Diff: Easy Objective: LO 18-2 AACSB: Reflective thinking skills
3) Which of the following accounts is not included in the acquisitions class of transactions? A) Inventory B) Prepaid expenses C) Purchase discounts D) Accounts payable Answer: C Terms: Account not included in acquisition class of transactions Diff: Easy Objective: LO 18-2 AACSB: Reflective thinking skills
4) A document indicating a reduction in the amount owed to a vendor because of returned goods is: A) a debit memo. B) a credit memo. C) a receiving report. D) a contractual adjustment form. Answer: A Terms: Document indicating a reduction in the amount owed to a vendor for returned goods Diff: Easy Objective: LO 18-2 AACSB: Reflective thinking skills
5) A document used by organizations to establish a formal means of recording and controlling acquisitions which usually contains a package of documents about the acquisition is the: A) voucher. B) purchase order. C) receiving report. D) purchase requisition. Answer: A Terms: Document used to establish formal means of recording and controlling acquisitions Diff: Easy Objective: LO 18-2 AACSB: Reflective thinking skills
6) The computer-generated file which records acquisitions, disbursements and allowances for each vendor is the: A) Accounts payable master file. B) Cash disbursements file. C) Acquisitions transaction file. D) Purchase approval file. Answer: A Terms: Computer-generated file which records acquisitions, disbursements and allowances for vendor Diff: Easy Objective: LO 18-2 AACSB: Reflective thinking skills
7) Which of the following business functions is not considered to be part of the acquisitions class of transactions? A) Processing purchase orders B) Recognizing liabilities C) Receiving goods and services D) Processing cash disbursements Answer: D Terms: Business function not a part of acquisitions class of transactions Diff: Moderate Objective: LO 18-2 AACSB: Reflective thinking skills
8) Smaller privately held companies may not maintain an accounts payable master file by vendor. These companies pay on the basis of: A) vendors' monthly statements. B) individual vendors' invoices. C) the accounts payable account in the general ledger. D) dunning letters. Answer: B Terms: Accounts payable master file and small companies Diff: Moderate Objective: LO 18-2 AACSB: Reflective thinking skills
9) After a purchase requisition is approved, a ________ must be initiated to purchase the goods or services. A) purchase order B) vendor order C) call order D) vendor invoice Answer: A Terms: Purchase requisition Diff: Easy Objective: LO 18-2 AACSB: Reflective thinking skills
10) A document generally received from the vendor which indicates a reduction in the amount owed due to the company granting an allowance is a: A) vendor invoice. B) debit memo. C) credit adjustment form. D) credit memo. Answer: B Terms: Document received from vendor which indicates a reduction of amount owed Diff: Moderate Objective: LO 18-2 AACSB: Reflective thinking skills
11) Absent disputed amounts and minor timing differences, the vendor's statements should reconcile to the: A) acquisition journal. B) accounts payable master file. C) cash disbursements amount for purchases. D) vouchers payable amount for vendors. Answer: B Terms: Vendor's statements should reconcile to Diff: Moderate Objective: LO 18-2 AACSB: Reflective thinking skills
12) List the four business functions in the acquisition and payment cycle. Answer: 1. Processing purchase orders 2. Receiving goods and services 3. Recognizing the liability 4. Processing and recording cash disbursements Terms: Role in acquisition and payment cycle Diff: Moderate Objective: LO 18-2 AACSB: Reflective thinking skills
13) Discuss each of the four business functions that comprise the acquisition and payment cycle. Answer: The four business functions that comprise the acquisition and payment cycle are: • Processing purchase orders. This function involves the preparation of a purchase requisition and a purchase order to acquire goods and services. • Receiving goods and services. When goods are received, a receiving report is prepared that indicates the description of goods, the quantity received, the date received, and other relevant data. • Recognizing the liability. In most companies, the liability for acquisitions is recognized when the goods and services are received. • Processing and recording cash disbursements. This function involves the signing and mailing of the check for payment of the acquisition and recording of the cash disbursement in the cash disbursements journal. Terms: Business functions of the acquisition and payment cycle Diff: Moderate Objective: LO 18-2 AACSB: Reflective thinking skills
14) Describe purchase requisitions and purchase orders. What is a key difference between the two documents? Answer: Purchase requisitions represent requests for goods and services by an authorized employee. Requisitions may originate from any authorized company employee such as a storeroom supervisor or manufacturing manager. Purchase orders are documents that identify the description, quantity, and other related information for goods or services that the company is purchasing. Unlike requisitions, purchase orders are directed to specific vendors. Terms: Purchase requisitions and purchase orders Diff: Moderate Objective: LO 18-2 AACSB: Reflective thinking skills
15) Match seven of the terms for documents and records (a-m) used in the acquisitions and cash disbursement cycle with the descriptions provided below (1-7): a. Purchase requisition b. Purchase order c. Receiving report d. Acquisitions journal e. Summary acquisitions report f. Vendor's invoice g. Debit memo h. Voucher i. Accounts payable master file j. Accounts payable trial balance k. Vendor's statement l. Check m. Cash disbursements journal ________ 1. A document indicating a reduction in the amount owed to a vendor because of returned goods or an allowance granted. ________ 2. A document that specifies the details of an acquisition transaction and amount of money owed to the vendor for an acquisition. ________ 3. A document prepared by the purchasing department indicating the description, quantity, and related information for goods and services that the company intends to purchase. ________ 4. A listing of the amount owed to each vendor at a point in time. ________ 5. A document used to establish a formal means of recording and controlling acquisitions; it includes a cover sheet and a package of relevant documents. ________ 6. A document used to request goods and services by an authorized employee. ________ 7. The listing or report that includes all cash payments for a given period. Answer: 1. g 2. f 3. b 4. j 5. h 6. a 7. m
Terms: Purchase requisition; Purchase order; Vendor's invoice; Debit memo; Voucher; Accounts payable trial balance; Cash disbursements journal Diff: Moderate Objective: LO 18-2 AACSB: Reflective thinking skills
16) The acquisition and payment cycle typically begins with the initiation of purchase requisition for goods and services from an authorized individual. Answer: TRUE Terms: Acquisition and payment cycle begins with Diff: Moderate Objective: LO 18-2 AACSB: Reflective thinking skills
17) A vendor invoice is normally prepared at the time tangible goods are received and indicates the description of goods, the quantity received, the date received, and other relevant data. Answer: FALSE Terms: Vendor invoice Diff: Moderate Objective: LO 18-2 AACSB: Reflective thinking skills
18) A document received from the vendor indicating such things as the description and quantity of goods and services received, price including freight, cash discount terms, and date of billing is called the voucher. Answer: FALSE Terms: Voucher Diff: Moderate Objective: LO 18-2 AACSB: Reflective thinking skills
19) An acquisitions transaction file is a computer generated file that includes all information entered into the system regarding acquisition transactions. Answer: TRUE Terms: Acquisition transaction file Diff: Moderate Objective: LO 18-2 AACSB: Reflective thinking skills
20) Receiving reports are normally only used to document the receipt of goods and are not used to document the receipt of services. Answer: TRUE Terms: Receiving reports Diff: Challenging Objective: LO 18-2 AACSB: Reflective thinking skills
Learning Objective 18-3 1) You have been assigned to the accounts payable transaction cycle as part of your auditing responsibilities. You have decided to vouch a sample of entries in the accounts payable master file to supporting documents. Which assertion is this test of controls most likely to support? A) Accuracy B) Classification C) Completeness D) Occurrence Answer: D Terms: Assertion for test of controls Diff: Easy Objective: LO 18-3 AACSB: Reflective thinking skills
2) An auditor is gathering evidence on the completeness assertion. To do so she performs a test to verify that all goods received by the company have been recorded properly. The document population for this test would consist of all: A) vendor invoices. B) purchase orders. C) receiving reports. D) cash disbursements for accounts payables. Answer: C Terms: Evidence on completeness assertion to verify all goods received are recorded properly Diff: Easy Objective: LO 18-3 AACSB: Reflective thinking skills
3) Which of the following is not an accurate statement regarding the acquisition and payment cycle? A) The personnel in the receiving department should be independent of the storeroom personnel. B) Goods received should be physically controlled from the time of their receipt until their use or disposal. C) Accounting records should transfer responsibility for the goods each time they are moved. D) The accounting department should be responsible for receiving goods and preparing the receiving report. Answer: D Terms: Internal control test to detect erroneous recording of purchase Diff: Easy Objective: LO 18-3 AACSB: Reflective thinking skills
4) When reviewing the controls and procedures in the acquisition and payment cycle: A) companies cannot record the liability for the acquisition until the invoice is received from the vendor. B) the purchasing department has the responsibility for verifying for appropriateness of the acquisition. C) personnel who record the acquisitions should not have access to cash or other assets. D) the accounts payable department should account for all receiving reports to assure that the occurrence objective is satisfied. Answer: C Terms: Tests of controls for cash disbursement system; Audit procedures Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
5) A written purchase order is a contractual document that is: A) an offer to buy goods or services. B) not enforceable if it is not in writing. C) a binding agreement between purchaser and vendor. D) an acceptance of a vendor's catalog offer to sell. Answer: A Terms: Written purchase order is a legal contractual document Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
6) Which one of the following duties should not be assigned the purchases department? A) Finding the lowest cost vendor B) Reviewing vendors' catalog descriptions and prices for standardized items C) Designing the purchase order form D) Authorizing the acquisition of goods Answer: D Terms: Duties not to be assigned to the purchases department Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
7) The accounts payable department usually has responsibility for approving acquisitions for payment by comparing the details on the: A) vendor's invoice and the receiving report. B) vendor's invoice and the purchase requisition. C) purchase order, receiving report, and vendor's invoice. D) purchase requisition, purchase order, and receiving report. Answer: C Terms: Accounts payable department responsibility for approving acquisitions for payment by comparing details Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
8) A substantive tests of transactions for acquisitions that would be used to provide evidence regarding the occurrence assertion would be to: A) compare the classification with the chart of accounts by referring to vendors' invoices. B) recompute the clerical accuracy on the vendors' invoice. C) review the acquisitions journal for large or unusual amounts. D) trace from a file of receiving reports to the acquisition journal. Answer: C Terms: Substantive test of accounts payable to provide evidence regarding occurrence assertion Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
9) When testing the controls for the completeness transaction-related audit objectives: A) failure to record the acquisition of goods or services will generally understate net income. B) failure to record the acquisition of goods or services has no impact on the balance sheet. C) it is generally easy for the auditor to determine whether unrecorded transactions exist. D) the audit time for accounts payable can be reduced if the client has effective internal controls and the auditor properly tests those controls. Answer: D Terms: Acquisition and payment cycle Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
10) Which of the following is not a key control in the acquisition and payment cycle? A) Authorization of purchases B) Authorization of credit C) Timely recording and independent review of transactions D) Authorization of payments Answer: B Terms: Not a key control in acquisition and payment cycle Diff: Easy Objective: LO 18-3 AACSB: Reflective thinking skills
11) A key internal control over the acquisition cycle is to ensure that the company requires recording transactions as soon as possible after the goods and services have been received. This satisfies the transaction-related audit objective of: A) accuracy. B) completeness. C) timing. D) occurrence. Answer: C Terms: Controls over acquisition cycle; timing Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
12) When a client uses perpetual inventory records, the tests of details of balances for inventory can be significantly reduced if the auditor believes the records are accurate. The controls over the acquisitions included in the records are normally tested as a part of the: A) tests of controls for acquisitions. B) tests of controls and substantive tests of transactions for acquisitions. C) tests of details of balances for acquisitions. D) analytical procedures and tests of controls for acquisitions. Answer: B Terms: Tests of details of balances for inventory Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
13) The auditor's internal control objective to determine that "recorded acquisitions are for goods and services received" satisfies the audit objective of: A) accuracy. B) occurrence. C) authorization. D) completeness. Answer: B Terms: Internal control objective that recorded acquisitions are for goods and services received Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
14) Failure to record the acquisition of goods is a violation of which audit objective? A) Accuracy B) Occurrence C) Authorization D) Completeness Answer: D Terms: Failure to record acquisition is violation of which audit objective Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
15) The internal control that requires that "checks are prenumbered and accounted for" satisfies the objective of: A) accuracy. B) existence. C) completeness. D) posting and summarization. Answer: C Terms: Internal control that requires that checks are prenumbered and accounted for Diff: Easy Objective: LO 18-3 AACSB: Reflective thinking skills
16) Because of the importance of tests of controls and substantive tests of transactions for acquisitions and cash disbursements, it is common in this audit area to use: A) block sampling. B) variables sampling. C) attributes sampling. D) probability proportional to size sampling. Answer: C Terms: Tests of controls and substantive tests of transactions for acquisitions and cash disbursements Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
17) Which of the following tests of controls is least useful in assessing the transaction-related audit objective related to occurrence? A) Examine documents in voucher package for occurrence. B) Examine supporting documents for indication of approval. C) Account for sequence of vouchers. D) Attempt to input transactions with valid and invalid vendors. Answer: C Terms: Tests of controls for transaction-related audit objectives related to occurrence Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
18) You are performing the audit of Jenkins and Company. Your tests of controls and tests of transactions for accounts payable demonstrate that the controls are operating effectively. This would normally allow you to: A) eliminate the need for substantive testing of balances for accounts payable. B) reduce the need for substantive testing of balances for accounts payable. C) reduce control tests in other transactions cycles. D) increase the need for substantive testing of balances for accounts payable. Answer: B Terms: Tests of controls and tests of transactions demonstrate controls are operating effectively Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
19) An auditor is using audit sampling to test transactions in the acquisition and payment cycle. She would normally set the tolerable exception rate at what level? A) Low B) Medium C) High D) Indeterminate Answer: A Terms: Test of transactions in the acquisition and payment cycle; Tolerable exception Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
20) Which of the following is the most effective control procedure to detect vouchers that were prepared for the payment of goods that were not received? A) Count goods upon receipt in storeroom. B) Match purchase order, receiving report, and vendor's invoice for each voucher in accounts payable department. C) Compare goods received with goods requisitioned in receiving department. D) Verify vouchers for accuracy and approval in internal audit department. Answer: B
Terms: Most effective control procedure to detect vouchers that were prepared, and payment for goods not received Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
21) Which of the following should sign checks under conditions of effective internal control? A) Treasurer B) Purchasing agent C) Accounts payable clerk D) Person preparing the checks Answer: A Terms: Effective internal controls; Responsible for signing checks Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
22) Internal controls that are likely to prevent the client from including as a business expense those transactions that primarily benefit management or other employees rather than the entity being audited satisfy the control objective that: A) acquisitions are correctly valued. B) existing acquisitions are recorded. C) acquisitions are correctly classified. D) recorded acquisitions are for goods and services received. Answer: D Terms: Internal controls for asset acquisitions Diff: Challenging Objective: LO 18-3 AACSB: Reflective thinking skills
23) The test of transactions which requires one to "reconcile recorded cash disbursements with the cash disbursements on the bank statement" satisfies the objective of: A) occurrence. B) completeness. C) accuracy. D) posting and summarization. Answer: B Terms: Test of transactions to reconcile recorded cash disbursement with those on bank statement Diff: Challenging Objective: LO 18-3 AACSB: Reflective thinking skills
24) For effective internal control purposes, the vouchers payable department generally should: A) approve the purchase order. B) have the authority to sign the checks. C) establish the agreement of the vendor's invoice with the receiving report and purchase order. D) supervise the preparation of the receiving report. Answer: C Terms: Effective internal control, vouchers payable department Diff: Challenging Objective: LO 18-3 AACSB: Reflective thinking skills
25) An auditor performs a test to determine whether all merchandise for which the client was billed was received. The population for this test consists of all: A) merchandise received. B) vendors' invoices. C) canceled checks. D) receiving reports. Answer: B Terms: Auditor performs test to determine whether all merchandise for which client was billed was received Diff: Challenging Objective: LO 18-3 AACSB: Reflective thinking skills
26) Matching the supplier's invoice, the purchase order, and the receiving report prior to preparing the voucher would normally be the responsibility of the: A) warehouse receiving function. B) purchasing function. C) general accounting function. D) treasury function. Answer: C Terms: Responsibility for matching supplier's invoice with the purchase order and receiving report Diff: Challenging Objective: LO 18-3 AACSB: Reflective thinking skills
27) A CPA learns that his client has paid a vendor twice for the same shipment, once based upon the original invoice and once based upon the monthly statement. A control procedure that should have prevented this duplicate payment is: A) attachment of the receiving report to the disbursement report. B) prenumbering of disbursement vouchers. C) use of a limit or reasonableness test. D) prenumbering of receiving reports. Answer: A Terms: Control procedure that prevents duplicate payment on invoice Diff: Challenging Objective: LO 18-3 AACSB: Reflective thinking skills
28) With respect to a small company's system of purchasing supplies, an auditor's primary concern should be to obtain satisfaction that supplies ordered and paid for have been: A) requested by and approved by the same individual. B) used in the course of business and solely for business purposes during the year under audit. C) received, counted, and checked to quantities and amounts on purchase orders and invoices. D) properly recorded as assets and systematically amortized over the estimated useful life of the supplies. Answer: C Terms: Auditor's primary concern in system of purchasing supplies for supplies ordered and paid for Diff: Challenging Objective: LO 18-3 AACSB: Analytic skills
29) Authorization for accepting goods in the receiving department should be based on the: A) vendor invoice. B) requisition request. C) purchase order from the purchasing department. D) vendor statement. Answer: C Terms: Authorization for accepting goods Diff: Easy Objective: LO 18-2 and LO 18-3 AACSB: Reflective thinking skills
30) What are the three most important controls over cash disbursements? Answer: • Signing of check by an individual with proper authority. • Separation of responsibilities for signing checks and performing the accounts payable function. • Careful examination of supporting documents by the check signer at the time the check is signed. Terms: Important controls over cash disbursements Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
31) Discuss the key internal controls that should be present in the processing purchase orders function in the acquisitions and payment cycle. Answer: Proper authorization for acquisitions ensures that the goods and services acquired are for authorized company purposes, and it avoids the acquisition of excessive or unnecessary items. Most companies require different levels of authorization for different types of acquisitions or dollar amounts . A purchasing department that is independent of the authorization or receiving functions is often established by companies to ensure an adequate quantity of goods and services at a minimum price. Purchase orders should be prenumbered to permit easier accounting for all outstanding purchase orders and should be designed to minimize the likelihood of unintentional omissions on the form when goods are ordered. Terms: Key internal controls for processing purchase orders in the acquisitions and payment cycle Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
32) Discuss the key internal controls that should be present in the receiving goods and services function in the acquisitions and payment cycle. Answer: For good internal control over the receiving goods and services function, most companies require that the receiving department initiate a receiving report as evidence of the receipt and examination of the goods. One copy of the report is sent to the storeroom and another to the accounts payable department for their information needs. To prevent theft, it is important that the goods be physically controlled from the time of their receipt until their disposal. The personnel in the receiving department should be independent of the storeroom personnel and the accounting department. In addition, the accounting records should transfer responsibility for the goods as they are transferred from receiving to storage and from storage to manufacturing. Terms: Key internal controls in receiving goods and services in the acquisitions and payment cycle Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
33) How do auditors determine the extent of testing of internal controls in the acquisition and payment cycle? Answer: When auditors intend to rely on controls to support a preliminary control risk below maximum, the auditor performs tests of controls to obtain evidence that controls are operating effectively. As the operating effectiveness of controls improves and is supported by additional tests of controls, the auditor is able to reduce substantive tests. If the company is an accelerated filer public company, then the auditor must document and test controls sufficiently to issue an opinion on internal control over financial reporting. Terms: Extent of testing of internal controls in the acquisitions and payment cycle Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
34) Listed below are some management assertions made for the acquisition and payment cycle. For each one give an example of how the auditor by using the documents normally found in the process can apply an auditing procedure to test the assertion. Completeness Timing Accuracy Answer: (may vary based on student response) Completeness: Trace from a file of receiving reports to the acquisitions journal or Trace from a file of vendors' invoices to the acquisition journal Timing: Compare dates of receiving reports and vendors' invoices with dates in the acquisitions journal. Accuracy: Compare recorded transactions in the acquisitions journal with the vendors' invoice, receiving report, and other supporting documentation or Recompute the clerical accuracy on the vendor's invoice, including discounts and freight Terms: Tests for management assertions for acquisition and payment cycle Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
35) Significant audit efficiencies can be achieved on many audits when controls are operating effectively. Answer: TRUE Terms: Audit efficiency and internal controls Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
36) Failure to record the acquisition of goods and services received overstates both accounts payable and net income. Answer: FALSE Terms: Failure to record acquisition of goods Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
37) The controls over acquisitions included in the perpetual inventory records are normally tested as a part of the test of controls and substantive tests of transactions for the sales and collection cycle. Answer: FALSE Terms: Tests of controls and substantive tests of transactions Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
38) Because of the importance of tests of controls and substantive tests of transactions for acquisitions and cash disbursements, attributes sampling is commonly used when testing the acquisitions and cash disbursements cycle. Answer: TRUE Terms: Importance of tests of controls and substantive tests of transactions; Attributes sampling Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
39) A substantive test of transactions commonly used to test the completeness objective for acquisitions is "Trace from a file of receiving reports to the acquisitions journal." Answer: TRUE Terms: Substantive test of transactions to test completeness objective for acquisitions Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
40) The audit procedure "Test clerical accuracy by footing the journals and tracing postings to general ledger and to accounts payable and inventory master files" is used to test the posting and summarization objective for acquisitions. Answer: TRUE Terms: Audit procedure to test clerical accuracy to test posting and summarization objective Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
41) Auditors are normally more concerned about violations of the completeness objective for acquisitions than about violations of the occurrence objective for acquisitions. Answer: TRUE Terms: Auditor more concerned with violation of completeness objective than occurrence objective for acquisitions Diff: Challenging Objective: LO 18-3 AACSB: Reflective thinking skills
42) It is common in the acquisition and payment cycle for transactions to require significant judgment. Answer: TRUE Terms: Acquisition and payment cycle Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
43) Since there are a large number of accounts involved in the acquisition and payment cycle, there is the potential for classification misstatements, some of which are likely to affect income. Answer: TRUE Terms: Acquisition and payment cycle Diff: Moderate Objective: LO 18-3 AACSB: Reflective thinking skills
44) The audit procedure "Examine canceled check for authorized signature, proper endorsement, and cancellation by the bank" is used to test the occurrence objective for cash disbursements. Answer: TRUE Terms: Audit procedure for occurrence objective for cash disbursements Diff: Challenging Objective: LO 18-3 AACSB: Reflective thinking skills
Learning Objective 18-4 1) Auditors need to distinguish between accounts payable and accrued liabilities in designing the appropriate control and substantive tests. A liability is properly accounted for as an account payable if: A) the amount is known and owed as of the balance sheet date. B) the amount can be estimated and is owed at the balance sheet date. C) the amount is known at the balance sheet date and owed by the end of the next fiscal year. D) the amount is estimated and owed within 90 days of the balance sheet date. Answer: A Terms: Liability is properly accounted for as accounts payable Diff: Moderate Objective: LO 18-4 AACSB: Reflective thinking skills
2) When determining the methodology for designing tests of details of balances for accounts payable: A) supply-chain management activities has led to numerous changes in the design of systems used to initiate and record acquisition and payment activities. B) it is relatively inexpensive to audit accounts payable. C) performance materiality for accounts payable is set relatively low. D) inherent risk is often set at low. Answer: A Terms: Risk and accounts payable Diff: Moderate Objective: LO 18-4 AACSB: Reflective thinking skills
3) Auditors are especially concerned about the ________ and ________ balance-related audit objectives because of the potential for understatements in the account balance. A) completeness, cutoff B) completeness, accuracy C) classification, realizable value D) classification, cutoff Answer: A Terms: Balance-related audit objectives for accounts payable Diff: Moderate Objective: LO 18-4 AACSB: Reflective thinking skills
4) Describe the methodology for designing tests of details of balances for accounts payable. Answer: The methodology for designing tests of accounts payable consists of: 1. Identify client and business risks affecting accounts payable. 2. Set performance materiality and assess inherent risk for accounts payable. 3. Assess control risk for the acquisition and payment cycle. 4. Design and perform tests of controls and substantive tests of transactions for the acquisition and payment cycle. 5. Design and perform analytical procedures for accounts payable. 6. Design tests of details of accounts payable balance to satisfy balance-related audit objectives. Decide audit procedures to perform, sample size, items to select, and timing of tests. Terms: Methodology for designing tests of details of balances for accounts payable Diff: Moderate Objective: LO 18-4 AACSB: Reflective thinking skills
5) The auditor's ultimate substantive tests depend on the relative effectiveness of internal controls related to accounts payable. Answer: TRUE Terms: Substantive tests for accounts payable Diff: Easy Objective: LO 18-4 AACSB: Reflective thinking skills
Learning Objective 18-5 1) The overall objective in the audit of accounts payable is to determine whether accounts payable: A) is fairly stated and properly disclosed. B) is overstated. C) is understated. D) is accurately stated. Answer: A Terms: Liabilities and balance-related audit objectives Diff: Easy Objective: LO 18-5 AACSB: Reflective thinking skills
2) ________ is a balance-related audit objective that is not applicable to liabilities. A) Existence B) Accuracy C) Detail tie-in D) Realizable value Answer: D Terms: Liabilities and balance-related audit objectives Diff: Easy Objective: LO 18-5 AACSB: Reflective thinking skills
3) Explain why auditors should compare current year expense totals with prior year expense totals as an analytical procedure for accounts payable. Answer: Auditors should compare current year expense totals with prior years to uncover misstatements in accounts payable as well as in the expense accounts. Because of double-entry accounting, a misstatement of an expense account usually also results in an equal misstatement of accounts payable. Therefore, comparing current expenses such as rent, utilities, and other regularly scheduled bills with prior years is an effective procedure for analyzing accounts payable when expenses from year to year are expected to be relatively stable. Terms: Analytical procedures for accounts payable Diff: Moderate Objective: LO 18-5 AACSB: Reflective thinking skills
Learning Objective 18-6 1) At what point do most companies recognize liabilities in the acquisition and payment cycle when the goods are shipped FOB destination? A) When the purchase order is issued B) When the vendor acknowledges receipt of the order C) When the goods or services are received D) When the vendor invoice is received Answer: C Terms: Companies recognize liabilities in acquisition and payment cycle; FOB destination Diff: Easy Objective: LO 18-6 AACSB: Reflective thinking skills
2) Cutoff procedures for inventory purchased should be designed by companies to assure the company that: A) inventory owned by the company has been received. B) inventory included in the year end inventory count has been paid. C) inventory received before year end was recorded before year end. D) inventory was correctly valued at year end. Answer: C Terms: Cutoff procedures for inventory purchased Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
3) You are the in-charge auditor and are designing audit procedures for accounts payable. Which of the following management assertions would you normally be most concerned about? A) Occurrence B) Accuracy C) Completeness D) Existence Answer: C Terms: Audit procedures for accounts payable; Management assertions Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
4) The main focus taken by the auditor in verifying liability balances is on the discovery of: I. understated liabilities. II. omitted liabilities. A) I only B) II only C) both I and II D) neither I nor II Answer: C Terms: Main focus in verifying liability balances Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
5) By tracing receiving reports issued at and before year-end to vendors' invoices and making sure they are included in accounts payable, the auditor is testing for: A) theft of merchandise by employees. B) unrecorded obligations. C) lapping. D) kiting. Answer: B Terms: Tracing receiving reports issued at and before year-end to vendors' invoices Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
6) The extent of a search for unrecorded liabilities largely depends on: A) materiality and inherent risk. B) materiality and control risk. C) materiality only. D) inherent risk only. Answer: B Terms: Unrecorded liabilities Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
7) A document review of which of the following is most likely to yield evidence of any unrecorded liabilities? A) Debit memos B) Vendor memos C) Unpaid accounts payable D) Sales invoices out of sequence Answer: C Terms: Document review for unrecorded liabilities Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
8) When the client's physical inventory occurs before the last day of the year, it is still necessary to perform an accounts payable cutoff at the time of the count. In addition, the auditor must verify whether all acquisitions taking place between the count and the end of the year were added to: A) the physical inventory. B) accounts payable. C) accounts payable and cost of goods sold. D) the physical inventory and accounts payable. Answer: D Terms: Accounts payable cutoff; Physical inventory before last day of year Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
9) Peprah Company pays its accounts payable 45 days after receipt of the goods or services. In this case which audit procedure should be used to detect any unrecorded liabilities? A) Examine cash disbursements for several weeks after the balance sheet date. B) Reconcile purchase orders to requisition orders. C) Reconcile purchase orders to receiving reports. D) Reconcile purchase orders to vendor invoices. Answer: A Terms: Audit procedure for unrecorded liabilities Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
10) Cutoff information for inventory acquisitions should be obtained during: A) the interim period prior to year-end. B) the interim period immediately following year-end. C) the physical observation of inventory. D) either the interim period prior to or immediately following year-end. Answer: C Terms: Cutoff information for inventory acquisitions Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
11) The auditor has decided to use accounts payables confirmations when testing substantive testing for balances. Which two management assertions is she testing? A) Existence and completeness B) Existence and occurrence C) Existence only D) Completeness only Answer: A Terms: Accounts payable confirmations; Substantive testing for balances Diff: Challenging Objective: LO 18-6 AACSB: Reflective thinking skills
12) In searching for unrecorded liabilities the purpose of the audit procedure to "examine underlying documentation for subsequent cash disbursements" is to: A) uncover liabilities on the balance sheet which should not have been recorded until a subsequent period. B) find the documentation relating to a cash disbursement. C) uncover payments made in a subsequent accounting period for liabilities that existed at the balance sheet date. D) uncover cash disbursements recorded in a subsequent accounting period which should be recorded in this period. Answer: C Terms: Unrecorded liabilities Diff: Challenging Objective: LO 18-6 AACSB: Reflective thinking skills
13) To test for cutoff errors which overstate liabilities, the auditor should trace, to vendors' invoices, the receiving reports issued: A) after year-end. B) before year-end. C) the last day of the fiscal year. D) both before and after year-end. Answer: A Terms: Test for cutoff errors which overstate liabilities Diff: Challenging Objective: LO 18-6 AACSB: Reflective thinking skills
14) In determining that the accounts payable cutoff is correct, it is essential that the cutoff tests be coordinated with the: A) confirmation of payables. B) tests of long-term liabilities. C) observation of inventory. D) cash count. Answer: C Terms: Accounts payable cutoff test coordinated with Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
15) An inventory acquisition is received late in the afternoon of December 31 after the physical inventory is completed. If the acquisition is included in accounts payable and purchases, but excluded from inventory, the result: A) is an understatement of net earnings. B) is an overstatement of net earnings. C) is an overstatement of working capital. D) is an overstatement of owner's equity. Answer: A Terms: Inventory acquisition received after year end, but included in accounts payable and purchases Diff: Challenging Objective: LO 18-6 AACSB: Analytic skills
16) When an acquisition is on an FOB origin basis, the inventory and related accounts payable must be recorded in the current period if the goods were: A) received prior to the balance sheet date. B) shipped on or before the balance sheet date. C) both shipped and received prior to the balance sheet date. D) paid for in advance. Answer: B Terms: Acquisition of inventory on FOB basis Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
17) When assets are being verified, auditors focus much of their attention on making sure that the accounts are not overstated. Alternatively, auditors focus their efforts on understatement when auditing liabilities. What is the primary reason for this difference in focus? A) Auditors' legal liability B) GAAP C) GAAS requirements D) All of the above Answer: A Terms: Basis for testing of asset accounts for overstatement and testing of liabilities for understatement Diff: Challenging Objective: LO 18-3 and LO 18-6 AACSB: Reflective thinking skills
18) A company recorded an acquisition of merchandise and its related liability, but failed to include the merchandise in ending inventory. The effect on the financial statements was to: A) understate liabilities. B) understate net income. C) overstate net income. D) have no impact on the financial statements since the errors cancel each other out. Answer: B Terms: Effect on financial statements of inventory cutoff Diff: Challenging Objective: LO 18-6 AACSB: Analytic skills
19) Auditors examine supporting documentation for cash disbursements subsequent to the balance sheet
date in order to determine whether the cash disbursement was for a current period liability. Describe at least two audit procedures the auditor would perform to provide evidence that the cash disbursement was made for a current period liability. Answer: 1. Trace vendor invoice to accounts payable subsidiary ledger and to the trial balance 2. Trace receiving report to vendor invoice and to accounts payable subsidiary ledger 3. Examine vendor invoices for inclusion in the proper period 4. Examine cash disbursements for several weeks after the company's year end Terms: Audit procedures for cash disbursements Diff: Challenging Objective: LO 18-6 AACSB: Reflective thinking skills
20) Describe the audit procedures typically used to test for out-of-period liabilities (also referred to as the search for unrecorded accounts payable). Answer: The audit procedures typically used to test for out-of-period liabilities are: • Examine underlying documentation for subsequent cash disbursement. • Examine underlying documentation for bills not paid several weeks after the year-end. • Trace receiving reports issued before year-end to related vendors' invoices. • Trace vendors' statements that show a balance due to the accounts payable trial balance. • Send confirmations to vendors with which the client does business, including zero balance confirmations. Terms: Audit procedures for out-of-period liabilities Diff: Challenging Objective: LO 18-6 AACSB: Reflective thinking skills
21) The balance-related audit objective realizable value is not applicable when auditing accounts payable. Answer: TRUE Terms: Balance-related audit objective of realizable value Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
22) When auditing accounts payable, the auditor is more concerned about the possibility of understatements than overstatements. Answer: TRUE Terms: Auditing accounts payable, auditor concerned with understatement Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
23) To test for overstatement cutoff amounts when auditing accounts payable, the auditor should trace receiving reports issued before year-end to related vendors' invoices to make sure they are not recorded as accounts payable. Answer: FALSE Terms: Test for overstatement cutoff amounts in Accounts Payable Diff: Challenging Objective: LO 18-6 AACSB: Reflective thinking skills
24) The "rights "aspect of the "rights and obligations" objective is not applicable to liabilities.
Answer: TRUE
Terms: Rights and obligations; accounts payable Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
25) Auditors primarily emphasize the understatement of liabilities in the audit of accounts payable because they are concerned about potential legal liability. Answer: TRUE Terms: Auditors emphasize understatement of liabilities because of potential legal liability Diff: Moderate Objective: LO 18-6 AACSB: Reflective thinking skills
Learning Objective 18-7 1) The documents typically used to reconcile the balance on the accounts payable list with the confirmation or vendor's statements include all of the following except for: A) receiving reports. B) vendor's invoices. C) sales invoices. D) cancelled checks. Answer: C Terms: Account payable reconciliation Diff: Moderate Objective: LO 18-7 AACSB: Reflective thinking skills
2) Which of the following is most reliable for verifying the correct balance of accounts payable? A) Vendors' invoices B) Vendors' statements C) Confirmations D) Bills of lading Answer: C Terms: Most reliable for verifying correct balance of accounts payable Diff: Moderate Objective: LO 18-7 AACSB: Reflective thinking skills
3) Vendors' statements and vendors' invoices are both relatively reliable evidence because they: A) come directly to the auditor without being in client's possession. B) originate from a third party. C) validate the effectiveness of the control system. D) are compared to and reconciled with sales invoices. Answer: B Terms: Reliable evidence; Vendors' statements and vendors' invoices Diff: Moderate Objective: LO 18-7 AACSB: Reflective thinking skills
4) The auditor is performing tests of transactions for individual accounts payable transactions with vendors. Which document provides more reliable information about individual transactions with vendors? A) Receiving report B) Vendors' invoices C) Vendors' statements D) Purchase orders Answer: B Terms: Tests of transactions for accounts payable; Reliable evidence Diff: Moderate Objective: LO 18-7 AACSB: Reflective thinking skills
5) Auditor confirmation of accounts payable balances at the balance sheet date may not need to be performed by the auditor because: A) this is a duplication of cutoff tests. B) there is likely to be other reliable external evidence available to support the balances. C) accounts payable balances at the balance sheet date may not be paid before the audit is completed. D) correspondence with the audit client's attorney will reveal all legal action by vendors for nonpayment. Answer: B Terms: Confirmation of accounts payable Diff: Moderate Objective: LO 18-7 AACSB: Reflective thinking skills
6) Under which of the following circumstances would it be advisable for the auditor to confirm accounts payable with creditors? A) Internal accounting control over accounts payable is adequate, and there is sufficient evidence on hand to minimize the risk of a material misstatement. B) Confirmation response is expected to be favorable, and accounts payable balances are of immaterial amounts. C) Creditor statements are not available and internal control over payables is unsatisfactory. D) The majority of accounts payable balances are with associated companies. Answer: C Terms: Confirm accounts payable with creditors Diff: Moderate Objective: LO 18-7 AACSB: Reflective thinking skills
7) The auditor is performing substantive tests of balances for accounts payable. What documentation
would provide the best evidence for the ending balance? A) Vendors' invoices B) Vendors' statements C) Receiving reports D) Purchase orders Answer: B
Terms: Best evidence for substantive tests of balances for accounts payable Diff: Moderate Objective: LO 18-7 AACSB: Reflective thinking skills
8) The auditor gets highly reliable evidence about individual transactions by examining: A) vendors' invoices. B) vendors' statements. C) confirmations of accounts payable balances. D) detailed inventory counting instructions. Answer: A Terms: Auditor gets highly reliable evidence about individual transactions Diff: Challenging Objective: LO 18-7 AACSB: Reflective thinking skills
9) Which of the following documents is best for verifying the correct balance in accounts payable? A) Bills of lading B) Confirmations C) Vendors' invoices D) Vendors' statements Answer: D Terms: Document best for verifying correct balance in accounts payable Diff: Challenging Objective: LO 18-7 AACSB: Reflective thinking skills
10) When auditors examine vendors' statements or receive confirmations, there must be a reconciliation of the statement or confirmation with the: A) accounts payable list. B) vendors' invoices. C) purchase orders. D) receiving reports. Answer: A Terms: Substantive tests of balances with vendor statements or vendor confirmations Diff: Moderate Objective: LO 18-7 AACSB: Reflective thinking skills
11) You are performing an audit of Hawk Company. In evaluating the accounts payable balance you are concerned with the completeness assertion. Which of the following audit procedures best satisfy your concern? A) Send confirmations to only vendors with large balances. B) Send confirmations to vendors with large, active, zero balance accounts and a representative sample of all others. C) Send confirmations to vendors chosen from sample stratified by the dollar balance. D) Send confirmations to all vendors. Answer: B Terms: Accounts payable and completeness assertion Diff: Moderate Objective: LO 18-7 AACSB: Reflective thinking skills
12) Discuss the circumstances in which it is desirable to send confirmation requests to the client's vendors. Answer: It is desirable to send confirmation requests to the client's vendors when the client's internal controls are weak, when vendors' statements are not available, or when the auditor questions the client's integrity. Terms: Confirmations Diff: Moderate Objective: LO 18-7 AACSB: Reflective thinking skills
13) A vendor's statement is unreliable and auditors rarely use it. Answer: FALSE Terms: Vendor's statement reliability Diff: Easy Objective: LO 18-7 AACSB: Reflective thinking skills
14) When verifying the correct balance in accounts payable, vendors' invoices are more useful than vendors' statements. Answer: FALSE Terms: Vendors' invoices more useful than vendors' statements Diff: Moderate Objective: LO 18-7 AACSB: Reflective thinking skills
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