3.3 Flashcards
An auditor reviews an audit client’s accounting policies when considering which of the following matters?
Understanding the entity and its environment, including its internal control.
Among the reasons for obtaining the understanding is the consideration of the entity’s accounting policies and disclosures. Thus, the auditor should understand the entity’s selection and application of accounting policies, including the reasons for changes. The auditor evaluates whether policies are appropriate for the entity and consistent with the appropriate reporting framework (AU-C 315).
Which of the following matters generally is included in an auditor’s engagement letter?
Management’s responsibility for the entity’s compliance with laws and regulations.
The primary purpose of an engagement letter is to provide written record of the agreement with the client as to the services to be provided by 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. Management’s responsibility for compliance with laws and regulations applicable to its activities should be included in the agreement.
Which of the following is an aspect of scheduling and controlling the audit engagement?
Include in the audit plan a column for estimated and actual time.
The audit plan is a tool for scheduling and controlling the audit. It should contain a detailed set of procedures for accomplishing audit objectives, estimated times for each step, and the personnel required. Thus, it can be used to document the progress of the audit and the auditor’s compliance with requirements for planning and supervision.
Analytical procedures used to form an overall audit conclusion generally include
Considering unusual or unexpected account balances that were not previously identified.
Analytical procedures should be applied near the end of the audit. The purpose is to form an overall audit conclusion about whether the statements are consistent with the auditor’s understanding of the entity. Procedures ordinarily should include reading the statements and considering (1) the adequacy of evidence regarding previously identified unusual or unexpected balances and (2) unusual or unexpected balances or relationships not previously noted (AU-C 520).
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?
The auditor’s judgment.
The auditor’s professional judgment must determine the necessary audit plans and the specific audit procedures that will gather sufficient appropriate evidence to reduce audit risk to an acceptably low level and enable the auditor to draw reasonable conclusions on which to base the opinion.
Which of the following analytical procedures most likely would be used during the planning stage of an audit?
Comparing current-year to prior-year sales volumes.
Analytical procedures are required to be used as risk assessment procedures (analytical procedures used to plan the audit) in all financial statement audits. Analytical procedures are evaluations of financial statement 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. Analytical procedures also include investigating fluctuations or relationships that are (1) inconsistent with other information or (2) differ significantly from expectations (AU-C 315). Thus, the sources of information for the expectations generally are not developed by the auditor. For example, they include information for comparable prior periods and ratios typical for the client’s industry.
On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed risks of material misstatement from those originally planned. To achieve an overall audit risk that is substantially the same as the planned audit risk, the auditor would
Decrease detection risk.
Control risk and inherent risk are the components of the risk of material misstatement (RMM). Thus, audit risk is a function of inherent risk, control risk, and detection risk. The only risk the auditor directly controls is detection risk. The auditor can assess what control risk and inherent risk are believed to be, but (s)he can change detection risk directly. Thus, the auditor can achieve the desired audit risk based on the assessed RMMs and the acceptable level of detection risk. Because detection risk has an inverse relationship with the RMMs, increasing the assessed RMMs requires a decrease in the acceptable detection risk if overall audit risk is held constant.
When determining whether uncorrected misstatements are material, individually or in the aggregate, an auditor of a nonissuer would consider each of the following, except
The cost of correcting the misstatements.
The auditor should determine whether uncorrected misstatements are material, individually or in the aggregate. The auditor should consider the size and nature of misstatements relative to (1) classes of transactions, account balances, or disclosures and (2) the financial statements as a whole. The auditor also considers the circumstances of each misstatement and the effect of uncorrected misstatements in prior periods on the relevant classes of transactions, etc. However, the authoritative guidance does not address the cost of correcting the misstatements.
Which of the following actions should be taken by a CPA who has been asked to audit the financial statements of a company whose fiscal year has ended?
Ascertain whether circumstances are likely to permit the auditor to obtain sufficient appropriate evidence and express an unmodified opinion.
Before acceptance of an engagement near or after the close of the fiscal year, an independent auditor should determine whether circumstances permit him or her to obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level and to express an unmodified opinion. If they do not, the auditor and client should discuss the possibility of a qualified opinion or a disclaimer of opinion. In some cases, the auditor may be able to remedy the audit limitations, for example, by observation of another physical inventory.
An auditor’s preliminary analysis of accounts receivable turnover revealed the following rates over these accounting periods:
Year 3: 4.3
Year 2: 6.2
Year 1: 7.3
Which of the following is the most likely cause of the decrease in accounts receivable turnover?
Liberalization of credit policy.
The accounts receivable turnover ratio equals net credit sales over average accounts receivable. Accounts receivable turnover will decrease if net credit sales decrease or average accounts receivable increase. Liberalization of credit policy will increase receivables.
Analytical procedures enable the auditor to predict the balance or quantity of an item under audit. Information to develop this estimate can be obtained from all of the following except
Tracing transactions through the system to determine whether procedures are being applied as prescribed.
Tracing transactions through the system is a test of controls directed toward the operating effectiveness of internal control, not an analytical procedure.
Richard, CPA, performs compilation services for Norton Corporation, a nonpublic entity. The compilation reports issued by Richard disclose lack of independence and are not used by third parties. Richard has accepted a commission from a software company for recommending its products to Norton. The commission agreement was disclosed to Norton. Richard also refers Norton to Cruz, CPA, who is more competent with respect to engagements involving the industry in which Norton operates. Cruz performs an audit of Norton’s financial statements and subsequently remits to Richard a portion of the fee collected. The referral fee agreement was likewise disclosed to Norton. Richard accepts the fee. Who, if anyone, has violated the Code of Professional Conduct?
Neither Richard nor Cruz.
A commission is “compensation, except a referral fee, for recommending or referring any product or service to be supplied by another person” (FTC Order dated August 3, 1990). Receipt of a disclosed commission is prohibited only if the CPA performs for the client an audit, a review, a compilation when the report will be used by third parties and the report does not disclose the CPA’s independence, or an examination of prospective financial information. A referral fee is “compensation for recommending or referring any service of a CPA to any person” (FTC Order cited above). Referral fees are allowed if they are disclosed to the client. Consequently, Richard has not violated the Code by accepting either the disclosed commission or the disclosed referral fee. Cruz has not violated the Code by paying the disclosed referral fee.
Which of the following procedures is the auditor most likely to perform after accepting an initial audit engagement?
Tour the client’s facilities.
The auditor performs risk assessment procedures to obtain an understanding of the entity and its environment, including internal control. They include (1) inquiries within the entity, (2) analytical procedures, and (3) observation and inspection. An example of observation and inspection is touring the client’s facilities.
Auditors try to identify predictable relationships when using analytical procedures. Relationships involving transactions from which of the following accounts most likely would yield the highest level of evidence?
Payroll Expense.
Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts because income statement accounts represent transactions over a period of time. Balance sheet accounts represent amounts at a moment in time. Thus, the relationships of payroll expense transactions tend to be more predictable than those for such balance sheet accounts as accounts payable and accounts receivable. Furthermore, relationships involving transactions subject to management discretion, e.g., advertising expense, also tend to be less predictable.
In a financial statement audit of a nonissuer, an auditor would consider a judgmental misstatement to be a misstatement that
Involves an estimate.
To assist the auditor in evaluating the effect of misstatements accumulated during the audit and in communicating misstatements to management and those charged with governance, the auditor may find it useful to distinguish between factual misstatements, judgmental misstatements, and projected misstatements. Judgmental misstatements are differences arising from the judgments of management about accounting estimates that the auditor considers unreasonable or the selection or application of accounting policies that the auditor considers inappropriate.
