3.2 Flashcards
Which of the following is an effective audit planning and control procedure that helps prevent misunderstandings and inefficient use of audit personnel?
Arrange a preliminary conference with the client to discuss audit objectives, fees, timing, and other information.
A preliminary conference with the client to discuss various audit objectives, fees, timing, the reports to be prepared, the use of client personnel, etc., is an appropriate procedure to prevent misunderstandings during the audit. The arrangement should be documented in the engagement letter.
Which of the following is a definition of control risk?
The risk that a material misstatement will not be prevented or detected on a timely basis by the client’s internal controls.
The risk of material misstatement of relevant assertions consists of the following: (1) inherent risk is the susceptibility of a relevant assertion to material misstatement in the absence of related controls, and (2) control risk is the risk that internal control will not timely prevent, or detect and correct, basis a material misstatement that could occur in a relevant assertion.
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).
Which of the following circumstances would permit an independent auditor to accept an engagement after the close of the fiscal year?
Remedy of limitations resulting from accepting the engagement after the close of the end of the year, such as those relating to the existence of physical inventory.
The auditor may accept the engagement if (s)he can obtain sufficient appropriate evidence by performing alternative procedures, e.g., tests of prior transactions affecting inventory or reviews of the records of prior counts.
The audit risk against which the auditor and those who rely on his or her opinion require reasonable protection is a combination of two separate risks at the assertion level. The first risk (consisting of inherent risk and control risk) is that balances, classes of transactions, or disclosures contain material misstatements. The second is that
Material misstatements that occur will not be detected by the audit.
Audit risk is a function of the risks of material misstatement and detection risk. Detection risk is the risk that the procedures performed to reduce audit risk to an acceptably low level will not detect a misstatement that exists and could be material individually or combined with other misstatements. The auditor assesses the risk of material misstatement after obtaining an understanding of the entity and its environment, including its internal control. It exists at the overall financial statement level and assertion level. The RMM at the assertion level consists of inherent risk and control risk. Some auditors use a mathematical model based on the relationships of the components of audit risk to arrive at an acceptable level of detection risk. For example, it reflects that the acceptable detection risk has an inverse relationship with the RMMs at the assertion level (AU-C 200 and AS 1101).
Before accepting an engagement to audit a new client, an auditor is required to
Make inquiries of the predecessor auditor after obtaining the consent of the prospective client.
The auditor should request management to authorize the predecessor to respond fully to inquires. The auditor should inquire about (1) reasons for the change in auditors, (2) disagreements with management about accounting policies and auditing procedures, (3) facts about management’s integrity, (4) communications to those charged with governance about fraud or noncompliance, and (5) communications to those charged with governance or management about internal control problems (AU-C 210, Terms of Engagement).
If new information becomes available that could require a reevaluation of the quantitative level of materiality applied during an audit of an issuer, then the auditor should
Raise or lower the materiality level as appropriate to the situation.
According to the PCAOB, the auditor may need to reevaluate the established materiality level(s) and tolerable misstatement. Changes in the circumstances or additional information may indicate a substantial likelihood that misstatements of amounts that differ significantly from the materiality level(s) established initially could influence the judgment of a reasonable investor. The reevaluation of materiality levels may result in higher or lower amounts. If so, the auditor must determine whether risk assessments and audit procedures need to be modified.
Which of the following nonfinancial information would an auditor most likely consider in performing analytical procedures during the planning phase of an audit?
Square footage of selling space.
Although analytical procedures used in planning the audit often use only financial data, sometimes relevant nonfinancial information is considered as well. For example, number of employees, square footage of selling space, volume of goods produced, and similar information may contribute to accomplishing the purpose of the procedures.
In comparison with the detailed audit plan of the independent auditor who is engaged to audit the financial statements of a large publicly held company, the audit client’s comprehensive internal audit plan is
More detailed and covers areas that normally are not considered by the independent auditor.
The independent auditor’s objective is limited to expressing an opinion on the fairness of the financial statements. The internal auditors’ work is more comprehensive because they must evaluate and help to improve the effectiveness of the organization’s governance, risk management, and control processes. Accordingly, they evaluate risks and the adequacy and effectiveness of controls regarding (1) the reliability and integrity of operational and financial information; (2) the effectiveness and efficiency of operations; (3) the safeguarding of assets; and (4) compliance with laws, regulations, and contracts.
The most likely reason the audit cannot reasonably be expected to bring all noncompliance with laws and regulations by the client to the auditor’s attention is that
Noncompliance by clients often relates to operating aspects rather than accounting aspects.
Some noncompliance, such as violations of tax law, has a direct effect on the financial statements. Other noncompliance, such as violations of environmental protection laws, relates more to an entity’s operating aspects than to its financial and accounting aspects, and their financial statement effect is indirect. An audit in accordance with GAAS usually does not include audit procedures specifically designed to detect noncompliance that has such indirect effects. Thus, no assurance is provided that such noncompliance will be detected or that resulting contingent liabilities will be disclosed. However, an audit should be designed to provide reasonable assurance that noncompliance having a direct and material effect on the financial statements will be detected.
In addition to descriptions of the nature, timing, and extent of planned risk assessment procedures and planned further audit procedures, which of the following additional pieces of information should be documented in the audit plan?
Other audit procedures to be performed to comply with generally accepted auditing standards.
An audit plan based on the overall audit strategy is required for every audit. It includes the nature, timing, and extent of procedures expected to reduce audit risk to an acceptably low level. The audit plan includes (1) a description of risk assessment procedures; (2) a description of further audit procedures at the assertion level for material classes of transactions, account balances, and disclosures; and (3) other audit procedures required by GAAS or the PCAOB.
An auditor discovers that a client’s accounts receivable turnover is substantially lower for the current year than for the prior year. This trend may indicate that
Fictitious credit sales have been recorded during the year.
The accounts receivable turnover ratio equals net credit sales divided by average accounts receivable. Accounts receivable turnover will decrease if net credit sales decrease or average accounts receivable increases. Fictitious sales 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 will decrease still more in the next period because fictitious items will continue to increase receivables (a real account) but not sales (a nominal account).
Which of the following would be least likely to suggest to an auditor that the client’s management may have overridden internal control?
Differences are always disclosed on a computer exception report.
The disclosure of differences on a computer exception report suggests that management is not overriding internal control (presumably, exceptions would not be listed if management were overriding the system).
Which of the following statements is correct regarding the auditor’s consideration of the possibility of noncompliance with laws and regulations by clients?
If specific information concerning noncompliance with laws and regulations comes to the auditor’s attention, the auditor should apply audit procedures specifically directed to ascertaining whether an act of noncompliance has occurred.
Instances of noncompliance are violations of laws or governmental regulations that do not include personal misconduct by the client’s personnel unrelated to their business activities. The auditor’s responsibility for detection of misstatements arising from noncompliance having direct and material effects is the same as that for material errors and fraud. If information comes to the auditor’s attention concerning noncompliance, the auditor should apply specific audit procedures to determine whether an act of noncompliance has occurred.
An auditor’s analytical procedures most likely would be facilitated if the entity
Uses a standard cost system that produces variance reports.
A comparison of anticipated results, such as budgets or forecasts prepared by management, with actual results is an analytical procedure. Thus, the use of standard costs and variance analysis facilitates the application of analytical procedures.
