2.12.19

Question 1

As part of a fraud audit, a CPA wishes to identify employees with invalid Social Security numbers in the client’s payroll-transaction data. Which of the following audit tests of controls using computer-assisted audit techniques would best meet the objective?

Answer 1

Comparing Social Security numbers paid in the payroll transaction file to a file of government- authorized Social Security numbers.

Comparing Social Security numbers of paid employees to the government file would identify Social Security numbers that are not valid.

Question 2

During its fiscal year, a company issued, at a discount, a substantial amount of first-mortgage bonds. When performing audit work in connection with the bond issue, the independent auditor should

Answer 2

Review the minutes for authorization.

Bonds issued during the year under audit should be traced to the minutes of the shareholders’ or board of directors’ meetings to check for proper authorization. The amount sold should be no greater than the amount authorized in the minutes.

Question 3

An auditor’s inquiries of management disclosed that the entity recently invested in a series of energy derivatives to hedge against the risks associated with fluctuating oil prices. Under these circumstances, the auditor should

Answer 3

Evaluate management’s conclusion about the recognition of an impairment loss.

The auditor (1) evaluates management’s conclusion about recognition of an impairment loss for a decline in fair value below cost or carrying amount and (2) obtains support for the amount of the recorded adjustment, including compliance with the reporting framework.

Question 4

Which of the following internal control activities would an entity most likely use to assist in satisfying the completeness assertion related to long-term investments?

Answer 4

The internal auditor compares the securities in the bank safe-deposit box with recorded investments.

The items being tested consist of the assets in the safe-deposit box. This population should be compared with the records of the investments to provide assurance that the balance is complete, that is, contains all long-term investments.

Question 5

Subsequent events are defined as events that occur subsequent to the

Answer 5

Balance sheet date but prior to the auditor’s report date.

Subsequent events occur between the date of the financial statements and the date of the auditor’s report. The auditor should perform procedures to determine whether subsequent events that require adjustment of, or disclosure in, the statements are appropriately reflected in the statements in accordance with the applicable financial reporting framework (AU-C 560).

Question 6

When an auditor becomes aware of a possible act of noncompliance with laws or regulations, the auditor should obtain an understanding of the nature of the act to

Answer 6

Evaluate the effect on the financial statements.

When the auditor becomes aware of information concerning possible noncompliance with laws or regulations, the auditor should obtain (1) an understanding of the nature of the act and the circumstances in which it occurred and (2) further information to evaluate the effect on the financial statements.

Question 7

An auditor observes the mailing of monthly statements to a client’s customers and reviews evidence of follow-up on errors reported by the customers. This test of controls most likely is performed to support management’s financial statement assertion(s) of

Classification & understandability:
Existence:

Answer 7

No
Yes

The existence assertion relates to whether the related balance exists at the balance sheet date. Observation of the mailing of monthly statements as well as observing the correction of reported errors provides evidence that controls may be effective in ensuring that client customers are genuine.

Question 8

In planning a statistical sample for a test of controls, an auditor increased the expected population deviation rate from the prior year’s rate because of the results of the prior year’s tests of controls and the overall control environment. The auditor most likely would then increase the planned

Answer 8

Sample size.

To determine the sample size for a test of controls, the auditor considers (1) the tolerable rate of deviations, (2) the expected actual rate of deviations, and (3) the allowable risk of overreliance. An increase in the expected rate has the effect of increasing the degree of assurance to be provided by the sample and therefore increasing the planned sample size.

Question 9

Each time an auditor draws a conclusion based on evidence from a sample, an additional risk, i.e., sampling risk, is introduced. An example of sampling risk is

Answer 9

Drawing an erroneous conclusion from sample data.

Sampling risk is the risk that the auditor’s conclusion based on a sample may differ from the conclusion if the same audit procedure were applied to every item in the population. Sampling risk can result in two types of erroneous conclusions: those affecting effectiveness or those affecting efficiency (AU-C 530).

Question 10

An auditor’s audit documentation will least likely show how the

Answer 10

Client’s schedules were prepared.

The objectives of audit documentation are to provide (1) a sufficient and appropriate record of the basis of the auditor’s report and (2) evidence that the audit was performed in accordance with GAAS and other requirements. Audit documentation is the record of (1) the audit procedures performed, (2) relevant evidence obtained, and (3) conclusions reached. But how the client’s schedules were prepared may not be relevant to the audit.

Question 11

Appropriate control over obsolete materials requires that they be

Answer 11

Determined by an approved authority to be unusable for their normal purposes.

Because auditors, storekeepers, etc., may not have the expertise to determine whether materials are usable, that decision often is made by a designated independent authority. To provide effective control of materials, this determination, asset custody, and authorization for disposal are functions that should be segregated.

Question 12

Davis, CPA, believes there is substantial doubt about the ability of Hill Co. to continue as a going concern for a reasonable period of time. In evaluating Hill’s plans for dealing with the adverse effects of future conditions and events, Davis most likely will consider, as a mitigating factor, Hill’s plans to

Answer 12

Negotiate reductions in required dividends being paid on preferred stock.

Once an auditor has identified conditions and events indicating that a substantial doubt exists about an entity’s ability to continue as a going concern, the auditor should consider management’s plans to mitigate their adverse effects. The auditor should consider managerial actions relating to plans to (1) dispose of assets, (2) borrow money or restructure debt, (3) reduce or delay expenditures, and (4) increase equity. Plans to negotiate reductions in required dividends being paid on preferred stock are intended to increase ownership equity.

Question 13

Which one of the following statements is correct concerning the concept of materiality?

Answer 13

Materiality is a matter of professional judgment.

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. Users are assumed to be knowledgeable and reasonable economic decision makers with an understanding of financial statements and their limits. Materiality judgments are made in light of surrounding circumstances and depend on the size (quantitative considerations) or nature (qualitative considerations) of a misstatement (or both).

Question 14

Which of the following statements is correct about the sample size in statistical sampling when testing internal controls?

Answer 14

The auditor should consider the tolerable population rate of deviation from the controls being tested in determining sample size.

A test of controls is an application of attribute sampling. The initial size for an attribute sample is based on (1) the desired assurance (complement of the risk of overreliance) that the tolerable population deviation rate is not exceeded by the actual rate, (2) the tolerable population deviation rate, (3) the expected population deviation rate, and (4) the population size. However, a change in the size of the population has a very small effect on the required sample size when the population is large. Consequently, population size is often not considered unless it is small.

Question 15

If deemed necessary, the auditor should request that an audit client send a letter of inquiry to those attorneys who have been consulted regarding litigation, claims, or assessments. The primary reason for this request is to provide

Answer 15

Corroborative evidence.

AU-C 501 states that a letter of inquiry to the entity’s legal counsel is the primary means of corroborating information provided by management about material litigation, claims, or assessments. The auditor should send the letter after it has been prepared by management.

Question 16

Auditors may need to plan and perform auditing procedures for financial statement assertions about derivatives and hedging activities. Which of the following substantive procedures most clearly tests the completeness assertion about derivatives?

Answer 16

Requesting counterparties to provide information about them, such as whether side agreements have been made.

An audit of the completeness assertion addresses whether balances and transactions related to derivatives and hedging activities that should be recorded are recorded. A substantive procedure for the completeness assertion about derivatives and hedging activities is a request to the counterparty to a derivative for information about it, for example, whether an agreement exists to repurchase securities sold or whether side agreements have been made.

Question 17

In verifying the amount of goodwill recorded by a client in the current period, the most convincing evidence an auditor can obtain is by comparing the recorded amounts of assets acquired and liabilities assumed with the

Answer 17

Fair values as evidenced by independent appraisals.

Goodwill is recorded in a business combination when the fair value of (1) the consideration transferred, (2) any noncontrolling interest, and (3) any previously held equity interest exceeds the fair value of the net assets acquired. If the carrying amount of an investment reflects (1) factors such as goodwill not recognized by the investee or (2) fair values materially different from the investee’s carrying amounts, the auditor should consider obtaining current appraisals of these amounts. Evaluations by persons independent of the investor and investee usually provide greater assurance of reliability than those by persons associated with those entities, although evaluations by associated parties may be acceptable. The acquiring entity should subsequently test goodwill for impairment at least annually.

Question 18

Cain Company’s management engaged Bell, CPA, to audit the effectiveness of Cain’s internal control over financial reporting. Bell’s report, which was accompanied by management’s separate report presenting its written assessment about the effectiveness of internal control, described several material weaknesses and potential errors and fraudulent activities that could occur. Subsequently, management included Bell’s report in its annual report to the board of directors with a statement that the cost of correcting the weaknesses would exceed the benefits. Bell should

Answer 18

Disclaim an opinion as to management’s cost-benefit statement.

If the assessment accompanying the auditor’s report includes a statement that the cost of corrective action exceeds the benefits of implementing new controls, the auditor should include language that disclaims an opinion on the cost-benefit statements as the last paragraph of the report. Also, given material weaknesses, the auditor should express an adverse opinion on the effectiveness of internal control.

Question 19

As a result of sampling procedures applied as tests of controls, an auditor incorrectly underrelies on controls. The most likely explanation for this situation is that

Answer 19

The deviation rate in the auditor’s sample exceeds the tolerable population deviation rate, but the deviation rate in the population is less than the tolerable population deviation rate.

If the auditor underrelies on controls, the result is likely to be an unnecessary extension of substantive procedures, which affects audit efficiency. Underreliance is the erroneous conclusion that controls are less effective than they actually are. The most likely explanation is that (1) the auditor expected the sample to be representative of the population, (2) the sample deviation rate exceeded the tolerable population deviation rate, and (3) the actual population deviation rate is less than the tolerable population deviation rate.

Question 20

A CPA has received legal counsel’s letter in which no significant disagreements with the client’s assessments of contingent liabilities were noted. The resignation of the client’s legal counsel shortly after receipt of the letter should alert the auditor that

Answer 20

Undisclosed unasserted claims may have arisen.

Legal counsel may be required to resign from an engagement (under his or her Code of Professional Responsibility) if the client disregards advice about financial accounting and reporting for litigation, claims, and assessments. Because the response to the letter of inquiry stated that the client’s assessment of contingent liabilities was satisfactory, the source of disagreement may be undisclosed, unasserted claims.