3.9 Flashcards
Which of the following statements is correct concerning analytical procedures used in planning an audit engagement?
They usually use financial and nonfinancial data aggregated at a high level.
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). Moreover, they ordinarily use highly aggregated data.
Before accepting an audit engagement, an auditor should make specific inquiries of the predecessor auditor regarding
Disagreements the predecessor had with the client concerning auditing procedures and accounting principles.
The auditor should make specific and reasonable inquiries of the predecessor auditor that include specific questions regarding, among other things, disagreements with management as to accounting principles and auditing procedures.
Management’s emphasis on meeting projected profit goals most likely would significantly influence an entity’s control environment when
A significant portion of management compensation is represented by stock options.
The control environment is the foundation for all other control components. It provides discipline and structure, sets the tone of the organization, and influences the control consciousness of employees. It includes, among other things, integrity and ethical values. This element of the control environment may be significantly influenced when a significant portion of management compensation consists of stock options. Such compensation creates an incentive to engage in earnings management.
Which of the following parties should an auditor notify first when discovering an immaterial fraud is committed by an accounting clerk?
An appropriate level of management.
Communications about fraud are required given evidence that fraud may exist. Inconsequential fraud should be communicated to the appropriate management. Other fraud should be reported directly to those charged with governance.
As a result of analytical procedures, the independent auditor determines that the gross profit percentage has declined from 30% in the preceding year to 20% in the current year. The auditor should
Consider the possibility of a misstatement in the financial statements.
The auditor should consider the possibility of a misstatement when (s)he has identified unexpected differences between recorded amounts and expectations. The auditor’s judgments about materiality and the desired level of assurance determine the significance of the difference. Because a change of 10% is likely to be significant, the auditor should reconsider the expectations used and make inquiries of management. If the difference still cannot be explained, additional procedures should be performed.
Which of the following procedures would an auditor most likely include in the initial planning of a financial statement audit?
Determining the extent of involvement of the client’s internal auditors.
AU-C 610, The Auditor’s Consideration of the Internal Audit Function in an Audit of Financial Statements, states that the independent auditor should obtain an understanding of the internal audit function when obtaining an understanding of a client’s internal control. The understanding should be sufficient to identify internal audit activities relevant to audit planning. Thus, an internal audit function is one of many factors to be considered in determining the nature, timing, and extent of audit procedures.
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
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.
An auditor most likely will use analytical procedures to form an overall conclusion to
Determine whether additional audit evidence may be needed.
Analytical procedures should be used to assist the audit to form an overall conclusion. The purpose of those procedures is to determine whether the statements are consistent with the auditor’s understanding of the entity (AU-C 520). When analytical procedures reveal inconsistent fluctuations or relationships or significant differences, the auditor should investigate the results. Thus, the auditor should (1) make inquires of management, (2) corroborate the responses with other audit evidence, and (3) perform other necessary procedures.
The scope and nature of an auditor’s contractual obligation to a client is ordinarily set forth in the
Engagement letter.
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. An engagement letter should be sent by the CPA to the prospective client on each engagement, audit or otherwise.
Which of the following procedures would least likely result in the discovery of possible noncompliance with laws and regulations?
Reviewing an internal control questionnaire.
Auditors should design the audit to provide reasonable assurance of detecting noncompliance having a material effect on the financial statements. Internal control questionnaires document the auditor’s understanding of internal control. Reviewing the responses to the questionnaire may reveal control deficiencies but not noncompliance.
Based on new information gained during an audit of a nonissuer, an auditor determines that it is necessary to modify materiality for the financial statements as a whole. In this circumstance, which of the following statements is accurate?
Materiality levels for particular classes of transactions, account balances, or disclosures might also need to be revised.
Materiality for the financial statements as a whole and, if applicable, the materiality level or levels for particular classes of transactions, account balances, or disclosures may need to be revised. Performance materiality also may need to be revised. Revision may result from a change in circumstances that occurred during the audit, new information, or a change in the auditor’s understanding of the entity and its operations after performing further audit procedures.
As the acceptable level of detection risk decreases, an auditor may change the
Nature of substantive procedures from a less effective to a more effective procedure.
For a given audit risk, the acceptable detection risk is inversely related to the assessed risks of material misstatement. As the RMMs increase, the acceptable detection risk decreases, and the auditor requires more persuasive audit evidence. The auditor may (1) change the types of audit procedures and their combination, e.g., confirming the terms of a contract as well as inspecting it; (2) change the timing of substantive procedures, such as from an interim date to year end; or (3) change the extent of testing, such as by using a larger sample (AU-C 330 and AS 2301).
Fact Pattern:
During the annual audit of BCD Corp., an issuer, Smith, CPA, a continuing auditor, determined that illegal political contributions had been made during each of the past 7 years, including the year under audit. Smith notified the directors of BCD Corp. of the illegal contributions, but they refused to take any action because the amounts involved were immaterial to the financial statements.
Because management took no action, Smith should
Consider withdrawing from the engagement.
Under AU-C 250, if the client does not take the remedial action considered necessary by the auditor, the auditor should consider withdrawal from the engagement even when the illegal act is not material. (S)he should weigh the effects on his or her ability to rely on management’s representations and the possible results of continued association with the client. The auditor may also wish to seek legal advice.
Although planning continues throughout the audit, it initially involves
Developing an overall audit strategy.
The audit plan is based on the overall audit strategy. It addresses, among other things, the reporting objectives, the timing of the audit, areas of high risk, industry specific issues, and the audit resources required.
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
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.
