1.8.19 Flashcards
While performing an audit of the financial statements of a company for the year ended December 31, Year 1, the auditor notes that the company’s sales increased substantially in December Year 1, with a corresponding decrease in January Year 2. In assessing the risk of fraudulent financial reporting or misappropriation of assets, what should be the auditor’s initial indication about the potential for fraud in sales revenue?
There is a broad indication of financial reporting fraud.
The types of fraud relevant to the auditor include misstatements arising from fraudulent financial reporting. These are intentional misstatements or omissions to deceive users, such as altering accounting records or documents, misrepresenting or omitting significant information, and misapplying accounting principles. Fraud also includes misappropriation of assets. These result from, for example, (1) theft of physical assets, (2) embezzlement (e.g., stealing collections of receivables), (3) an action that causes payment for items not received, or (4) using entity assets for personal reasons. The substantial increase in sales revenue at year end followed by a substantial decrease in January is a broad indicator of a failure to apply cut-off procedures, i.e., financial reporting fraud.
Which of the following areas of professional responsibility should be observed by a CPA not in public practice?
Objectivity:
Independence:
Yes
No
Under the Integrity and Objectivity Rule, members in public practice and in business must maintain objectivity and integrity, be free of conflicts of interest, not knowingly misrepresent facts, and not subordinate his or her judgment to others when performing professional services. But the Independence Rule applies only to CPAs in public practice.
Which of the following circumstances would most likely cause an auditor to suspect that fraud exists in a client’s financial statements?
Significantly fewer responses to confirmation requests are received than expected.
If a condition or circumstance differs adversely from the auditor’s expectation, the auditor needs to consider the reason for such a difference. An example of such a condition is that confirmation requests disclose significant differences or yield fewer responses than expected.
According to SEC independence regulations,
Preapproval of accountants’ services may be in accord with detailed policies and procedures rather than explicit.
Audit committees ordinarily must preapprove the services performed by accountants (permissible nonaudit services and all audit, review, and attest engagements). Approval must be either explicit or in accordance with detailed policies and procedures. If approval is based on detailed policies and procedures, the audit committee must be informed, and no delegation of its authority to management is allowed.
An auditor’s engagement letter most likely would include a statement regarding
Management’s responsibility to provide certain written representations to the auditor.
The terms of the engagement should be documented in an engagement letter that states the following: (1) objective and scope of the audit, (2) responsibilities of the auditor and management, (3) inherent limitations of the audit and internal control, (4) the financial reporting framework, and (5) the expected form and content of audit reports. The written agreement includes, among other things, that management will give the auditor a letter confirming certain representations made during the audit (AU-C 210).
When documenting internal control, the independent auditor sometimes uses a systems flowchart, which can best be described as a
Symbolic representation of a system or series of sequential processes.
A systems flowchart is a symbolic representation of the flow of documents and procedures through a series of steps in the accounting process of the client’s organization.
Which of the following statements correctly defines the term “reasonable assurance”?
A high, but not absolute, level of assurance to allow an auditor to detect a material misstatement.
The required basis for the auditor’s opinion is reasonable assurance about whether the financial statements as a whole are free of material misstatement, whether due to fraud or error. This standard of assurance is high but not absolute. It is obtained when the auditor has gathered sufficient appropriate evidence to reduce audit risk to an acceptably low level.
Which of the following statements is correct with respect to fraud encountered during an audit engagement of a nonissuer?
It is often difficult to detect fraudulent intent in matters involving accounting estimates and the application of accounting principles.
Intent is often difficult to determine, particularly in matters involving accounting estimates and the application of accounting principles. For example, unreasonable accounting estimates may be unintentional or may be the result of an intentional attempt to misstate the financial statements. Although an audit is not designed to determine intent, the auditor’s objective is to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error.
Based on past experience with a client, an auditor determined performance materiality for current assets should be calculated at 1/4 of total materiality (6% of total current assets) and noncurrent assets should be calculated at 1/3 of total materiality (3% of total noncurrent assets). Calculate performance materiality for current assets based on the following: Cash and cash equivalents $800,000 Land 300,000 Accounts receivable 125,000 Prepaids 175,000 Building 200,000 Fixtures and equipment 600,000 Inventory 100,000 Leasehold improvements 150,000
$18,000
Materiality is a matter of professional judgment about whether misstatements could reasonably influence the economic decisions of users as a group, given their common informational needs. Performance materiality is the amount(s) set by the auditor at less than the materiality for (1) the statements as a whole or (2) particular classes of transactions, balances, or disclosures. Performance materiality is an adjustment to reduce to an appropriately low level the probability that the sum of (1) uncorrected and (2) undetected misstatements (whether or not individually material) exceeds the applicable materiality.
$18,000= [$800,000 + $125,000 + $175,000 + $100,000] × [6% (total materiality %) × 1/4 (performance materiality)].
Which of the following types of risk increases when an auditor performs substantive analytical audit procedures for financial statement accounts at an interim date?
Detention.
Detection risk is the risk that procedures performed to reduce audit risk to an acceptably low level will not detect a material misstatement. It relates to the nature, timing, and extent of audit procedures and is therefore the auditor’s risk. For example, performing an audit procedure at an interim date instead of year-end increases detection risk because of the need to cover the interim period.
Which of the following factors most likely would heighten an auditor’s concern about the risk of fraudulent financial reporting?
An overly complex organizational structure involving unusual lines of authority.
Certain risk factors are related to misstatements arising from fraudulent reporting. One of the risk factors relating to the opportunity to commit fraud is an overly complex organizational structure involving numerous or unusual legal entities or managerial lines of authority.
Which of the following statements most likely would be included in an engagement letter from an auditor to a client?
The CPA firm will involve information technology specialists in the performance of the audit.
The engagement letter should include the nature and limitations of the services to be performed. If the use of an auditor’s specialist is expected, inclusion of this information in the letter is a courtesy that provides notice to the client.
Which of the following circumstances most likely would cause an auditor to believe that material misstatements may exist in an entity’s financial statements?
Accounts receivable confirmation requests yield significantly fewer responses than expected.
When a condition or circumstance differs adversely from expectations, the auditor should consider the reasons for the difference. Thus, confirmation requests that disclose significant differences or yield fewer responses than expected should cause the auditor to suspect that material misstatements may exist.
Auditors sometimes use comparison of ratios as audit evidence. For example, an unexplained decrease in the ratio of gross profit to sales suggests which of the following possibilities?
Unrecorded sales.
Fraud or error that decreases gross profit relative to sales (or increases sales relative to gross profit) causes the ratio to decline. Unrecorded sales cause inventory to decrease and cost of sales to increase with no increase in sales, thereby decreasing gross profit relative to sales and lowering the ratio.
Which of the following procedures would an auditor ordinarily perform first in evaluating the reasonableness of management’s accounting estimates?
Obtain an understanding of how management makes its estimates.
The auditor should obtain sufficient appropriate evidence about whether, in the context of the applicable reporting framework, the accounting estimates are reasonable and the related disclosures are adequate. Understanding how management makes accounting estimates includes considering (1) the methods and models used, (2) relevant controls, (3) whether management used a specialist, (4) the underlying assumptions, (5) changes in methods or assumptions that were or should have been made, and (6) whether and how management assessed estimation uncertainty. Estimation uncertainty is an estimate’s inherent lack of measurement precision.
