3.1.1

Question 1

When planning an audit, an auditor should

Answer 1

Determine materiality for the financial statements as a whole.

Planning involves establishing an overall audit strategy. For this purpose, the auditor determines materiality for the financial statements as a whole. Circumstances also may indicate that misstatements of classes of transactions, balances, or disclosures of lesser amounts could influence the economic decisions of users. In those cases, the auditor also determines materiality for particular classes of transactions, balances, and disclosures.

Question 2

Before accepting an engagement to audit a new client, a CPA is required to obtain

Answer 2

The prospective client’s consent to make inquiries of the predecessor, if any.

The auditor should communicate with the predecessor auditor before accepting the engagement. Initiation of the communication is the responsibility of the auditor. Moreover, the auditor should seek permission from the prospective client to inquire of the predecessor before final engagement acceptance. Thus, the auditor should ask the client to authorize the predecessor to make a full response.

Question 3

Audit plans are modified to suit the circumstances of particular engagements. A complete audit plan for an engagement usually should be developed

Answer 3

After the auditor has obtained an understanding of existing internal control.

The effectiveness of a client’s internal control has an inverse relationship with the evidence that must be gathered to support an opinion. Only after the understanding of the entity and its environment, including its internal control, is obtained and the risks of material misstatement have been assessed can the auditor determine the nature, timing, and extent of further audit procedures (AU-C 315).

Question 4

During the initial planning phase of an audit, a CPA most likely would

Answer 4

During the initial planning phase of an audit, a CPA most likely would

The first step in the audit process is the auditor’s decision whether to accept a client. After having decided to perform an audit, the auditor enters the initial planning phase. During initial planning, an auditor should, among other things, meet with the client to agree on the type, scope, and timing of certain aspects of the engagement (e.g., observation of inventory).

Question 5

Certain individuals may have an attitude, character, or set of values that permit them to rationalize fraud. Moreover, individuals may have an incentive or be under pressure to commit fraud, or circumstances may provide an opportunity. The auditor’s concern about the risk of material misstatements due to fraud is least likely to be increased if management

Answer 5

Consists of many individuals that make operating and financing decisions.

Domination of the decision process by one individual or a small group (an opportunity to commit fraud) is a fraud risk factor. In that case, compensating controls, e.g., effective oversight by the audit committee, reduce risk (AU-C 240, Appendix).

Question 6

An auditor who discovers that client employees have committed illegal activities that have a material effect on the client’s financial statements most likely would withdraw from the engagement if

Answer 6

The client does not take the remedial action that the auditor considers necessary.

When the auditor concludes that an illegal act has or is likely to have occurred, (s)he should discuss the matter with the appropriate level of management and request that any necessary remedial actions be taken. If the alleged illegal act has a material effect on the financial statements, or the client does not take the remedial action that the auditor considers necessary, the auditor should express a qualified or adverse opinion, depending on the level of materiality, or withdraw from the engagement.

Question 7

Which of the following factors most likely would lead a CPA to conclude that a potential audit engagement should not be accepted?

Answer 7

It is unlikely that sufficient appropriate evidence is available to support an opinion on the financial statements.

The terms of the engagement should include management’s responsibility to provide access to all information and persons deemed necessary to the audit. Depending on the pervasiveness of the potential effects of the inability to obtain sufficient appropriate evidence, the result may be a qualification of the opinion or a disclaimer of an opinion if the engagement is accepted.

Question 8

If accounts receivable turned over 7.1 times in Year 1 as compared with only 5.6 times in Year 2, it is possible that there were

Answer 8

Fictitious sales in Year 2.

The accounts receivable turnover is the ratio of sales to average receivables. Fictitious sales would increase both the numerator and denominator. Adding an equal amount to both the numerator and denominator decreases a fraction greater than 1.0. For example, adding 1 to both parts of the fraction 3/2 decreases it to 4/3. The turnover ratio would decrease still more in the next period because the fictitious items would continue to increase receivables (which are cumulative) but not sales (which are closed periodically).

Question 9

Which of the following statements would least likely appear in an auditor’s engagement letter?

Answer 9

After performing our preliminary analytical procedures, we will discuss with you the other procedures we consider necessary to complete the engagement.

The terms of the engagement should be documented in an engagement letter that states the (1) objective and scope of the audit, (2) responsibilities of the auditor and management, (3) inherent limitations of the audit and internal control, (4) applicable financial reporting framework, and (5) expected form and content of audit reports. But the engagement letter does not describe the specific evidence collection process to be completed by the auditor.

Question 10

If the auditor considers an act of noncompliance with laws and regulations to be sufficiently serious to warrant withdrawing from the engagement, the auditor would likely

Answer 10

Consult with legal counsel as to what other action, if any, should be taken.

According to AU-C 250, the auditor should consider consulting legal counsel in these circumstances. Such consultation may be necessary in determining the effects of continued association with the client or whether the auditor may have a duty to notify parties outside the client that overrides his or her duty of confidentiality to the client.

Question 11

Analytical procedures are most appropriate when testing which of the following types of transactions?

Answer 11

Operating expense transactions.

Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts. Income statement accounts represent transactions over a period of time, but balance sheet accounts represent an amount at a moment in time. Thus, operating expense transactions are likely to be more predictable than balance sheet accounts.

Question 12

An auditor should design the audit plan to

Answer 12

Implement the audit strategy.

An audit plan is developed and documented based on the overall audit strategy. It is more detailed than the audit strategy because it includes the nature, timing, and extent of work to be performed. The plan includes (1) risk assessment procedures, (2) further audit procedures at the assertion level, and (3) other procedures to comply with GAAS.

Question 13

The objective of performing analytical procedures in planning an audit is to identify the existence of

Answer 13

Unusual transactions and events.

The objective of analytical procedures is to identify such things as the existence of unusual transactions and events, and amounts, ratios, and trends that might indicate matters that have financial statement and audit planning ramifications.

Question 14

Which of the following would be considered an analytical procedure?

Answer 14

Comparing inventory balances to recent sales activities.
Analytical procedures are evaluations of financial data made by a study of plausible relationships among financial and nonfinancial data. Comparing inventory balances with recent sales activities is a study of a plausible relationship between these activities.

Question 15

Which of the following circumstances would most likely cause an auditor to suspect that fraud exists in a client’s financial statements?

Answer 15

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.

Question 16

Analytical procedures performed to assist in forming an overall conclusion suggest that several accounts have unexpected relationships. The results of these procedures most likely indicate that

Answer 16

Additional audit procedures are required.

Analytical procedures used to form an overall conclusion ordinarily include reading the financial statements and considering (1) the adequacy of evidence regarding unusual or unexpected balances detected during the audit and (2) such balances or relationships not detected previously. If analytical procedures detect a previously unrecognized risk of material misstatement, the auditor must revise the assessments of the RMMs and modify the further planned procedures. Inconsistent fluctuations or relationships or significant differences should result in (1) inquiries of management, (2) corroboration of responses with other audit evidence, and (3) performance of any necessary other procedures. Moreover, the RMM due to fraud should be considered.

Question 17

Which of the following statements describes why a properly planned and performed audit may not detect a material misstatement due to fraud?

Answer 17

Audit procedures that are effective for detecting an error may be ineffective for detecting fraud that is concealed through collusion.

Absolute assurance is unattainable because of the characteristics of fraud and the limitations of audit evidence. Management may override controls in unpredictable ways or alter accounting records, and fraud may be concealed through collusion, falsifying documentation (including electronic approvals), or withholding evidence. Moreover, procedures that effectively detect an error (an unintentional misstatement) may not detect fraud (an intentional act that a perpetrator typically attempts to conceal).

Question 18

Which of the following statements best describes an auditor’s responsibility to detect fraud or error?

Answer 18

The auditor should assess the risk that fraud or error may cause the financial statements to contain material misstatements and design the audit to provide reasonable assurance of detecting material errors and fraud.

The auditor has a responsibility to obtain reasonable assurance about whether the financial statements are free of material misstatements, whether caused by error or fraud (AU-C 240). Thus, the consideration of fraud should be logically integrated into the overall audit process in a manner consistent with other pronouncements, e.g., those on planning and supervision, audit risk and materiality, and internal control. This consideration entails (1) understanding fraud, (2) discussing fraud risks with members of the engagement team, (3) obtaining information needed to identify fraud risks, (4) identifying those risks, (5) assessing fraud risks, (6) responding to the assessments, (7) evaluating evidence at the end of the audit, (8) making appropriate communications about fraud, and (9) documenting the consideration.

Question 19

An auditor compared the current-year gross margin with the prior-year gross margin to determine if cost of sales is reasonable. What type of audit procedure was performed?

Answer 19

Analytical procedures.

According to AU-C 520, Analytical Procedures, analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. They involve comparisons of recorded amounts, or ratios developed from recorded amounts, to expectations developed by the auditor.

Question 20

Which of the following statements most likely would be included in an engagement letter from an auditor to a client?

Answer 20

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.

Question 21

Which of the following steps should be performed first in applying analytical procedures?

Answer 21

Develop an expectation of a balance or ratio by using relationships that are expected to exist.

Analytical procedures are evaluations of financial information made by a study of plausible relationships among financial and nonfinancial data using models that range from simple to complex. Plausible relationships among data are reasonably expected to exist and continue in the absence of known conditions to the contrary. The first step is to develop an expectation.

Question 22

An auditor is reviewing changes in sales for a product. Sales volume (quantity) declined 10% while sales price increased by 25% for the product. Prior year sales were $75,000. The auditor expects this year’s sales for the product to be approximately

Answer 22

$84,375.

The first step is to calculate the change in volume holding price constant. The next step is to calculate the effects of the price change.
Prior year: $75,000
Volume change: (7,500) (10%)
Before price change: $67,500
Price change: 16,875 (25%)
Total: $84,375

Question 23

After testing a client’s internal control activities, an auditor discovers a number of significant deficiencies in the operation of a client’s internal controls. Under these circumstances, the auditor most likely would

Answer 23

Increase the assessment of control risk and increase the extent of substantive tests.

When an auditor discovers significant deficiencies, the risk is higher that internal control will not timely prevent, or detect and correct, a material misstatement that could occur in an assertion. This discovery increases the assessment of the risks of material misstatement. The result is less reliance on tests of controls and more reliance on substantive procedures.