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Question 1

A company that retains a CPA with the appropriate knowledge, skills, and abilities to prepare timely and effective financial reporting is applying the ideas from which principle of effective internal control over financial reporting?

A. Accountability

B. Board independence and oversight

C. Commitment to competence

D. Commitment to ethics and integrity

Answer 1

C. Commitment to competence

Question 1

The external auditors for the Horace Company assess the achievement of internal control objectives each year and communicate the assessment to management and the board. Communication by the external auditor illustrates which principle of the information and communication component of the Committee of Sponsoring Organizations’ Integrated Framework?

A. Internal Communication

B. Obtain and use information

C. External Communication

D. Accountability

Answer 1

C. External Communication

Question 2

An auditor would most likely be concerned with controls that provide reasonable assurance about the:

A. Methods of assigning production tasks to employees.

B. Appropriate prices the entity should charge for its products.

C. Entity’s ability to process and summarize financial data.

D. Efficiency of management’s decision-making process.

Answer 2

C. Entity’s ability to process and summarize financial data.

Question 3

Objectives of an entity include:

Information an Communication Systems:
Reliable Financial Reporting:
Effective and Efficient Operations:

Answer 3

Information an Communication Systems: No
Reliable Financial Reporting: Yes
Effective and Efficient Operations: Yes

Question 4

Which of the following statements is true regarding internal control objectives of information systems?

A. Control objectives primarily emphasize output distribution issues.

B. A secure system may have inherent risks due to management’s analysis of trade-offs identified by cost-benefit studies.

C. An entity’s corporate culture is irrelevant to the objectives.

D. Primary responsibility of viable internal control rests with the internal audit division.

Answer 4

B. A secure system may have inherent risks due to management’s analysis of trade-offs identified by cost-benefit studies.

Question 5

The Gotham Corporation regularly produces budget vs. actual data for its managers. The company is particularly sensitive to personnel costs, and division variances of greater than five percent for any period are promptly investigated to determine if budgeted positions have not been filled or if there has been extraordinary overtime. Timely exception resolution of this character illustrates the information and communication principles typically associated with:

A. Internal Communication.

B. Obtain and Use Information.

C. External Communication.

D. Financial Reporting Information.

Answer 5

B. Obtain and Use Information.

Question 6

An internal audit manager requested information detailing the amount and type of training that the IT department’s staff received during the last year. According to COSO, the training records would provide documentation for which of the following principles?

A. Developing general control activities over technology to support the achievement of objectives.

B. Demonstrating a commitment to retain competent individuals in alignment with objectives.

C. Holding individuals responsible for their internal control responsibilities in the pursuit of objectives.

D. Exercising oversight of the development and performance of internal control.

Answer 6

B. Demonstrating a commitment to retain competent individuals in alignment with objectives.

Question 7

According to COSO, each of the following is a principle relating to the risk assessment component of internal control, except:

A. The organization specifies objectives with sufficient clarity to enable the identification and assessment of risks relating to objectives.

B. The organization identifies and assesses changes that could significantly impact the system of internal control.

C. The organization selects and develops activities contributing to the mitigation of risks to the achievement of objectives to acceptable levels.

D. The organization considers the potential for fraud in assessing risks to the achievement of objectives.

Answer 7

C. The organization selects and develops activities contributing to the mitigation of risks to the achievement of objectives to acceptable levels.

Question 8

Which of the following would an auditor most likely consider in evaluating the control environment of an audit client?

A. Management reviews of monthly financial statements.

B. The entity’s process to regularly monitor control performance.

C. Management’s operating style.

D. Overall employee satisfaction with assigned duties.

Answer 8

C. Management’s operating style.

Question 9

Which of the following components of internal control would be considered the foundation for the other components?

A. Control environment.

B. Risk assessment.

C. Control activities.

D. Information and communication.

Answer 9

A. Control environment.

Question 10

A company has established and communicated baseline expectations for performance to all employees. The company’s action demonstrates a focus on which of the following components of the COSO Internal Control framework?

A. Control environment

B. Monitoring activities

C. Information and communication

D. Control activities

Answer 10

A. Control environment

Question 11

Which of the following components (elements) of an entity’s system of internal control includes the development of personnel manuals documenting employee promotion and training policies?

A. Information and communication system.

B. Control environment.

C. Quality control system.

D. Monitoring.

Answer 11

B. Control environment.

Question 12

Which of the following factors would an auditor most likely consider in evaluating the control environment for an audit client?

A. Organizational structure used for tax purposes.

B. The ethical values demonstrated by management.

C. The number of employees in each department.

D. Monthly bank reconciliations with supervisor sign-offs.

Answer 12

B. The ethical values demonstrated by management.

Question 13

Which of the following statements is true regarding the risk assessment component of internal control?

A. An auditor evaluates an entity’s risk assessment to understand how management addresses risks relevant to financial reporting.

B. An auditor’s evaluation of an entity’s risk assessment may not be applicable to the audit of every entity.

C. An auditor need not consider an entity’s risk assessment because he or she is primarily concerned with audit risk in a financial statement audit.

D. An auditor evaluates an entity’s risk assessment because it is a component of overall audit risk in a financial statement audit.

Answer 13

A. An auditor evaluates an entity’s risk assessment to understand how management addresses risks relevant to financial reporting.

Question 14

The monitoring component of internal control excludes:

A. Improving controls that are not operating effectively.

B. Assessing the quality of control performance over time.

C. Eliminating controls that are not operating effectively.

D. Assessing information derived from external parties.

Answer 14

C. Eliminating controls that are not operating effectively.

Question 15

Within the COSO Internal Control—Integrated Framework, which of the following components is designed to ensure that internal controls continue to operate effectively?

A. Information and communication.

B. Risk assessment.

C. Monitoring.

D. Control environment.

Answer 15

C. Monitoring.

Question 16

Which of the following is a management control that most likely could improve management’s ability to supervise company activities effectively?

A. Establishing budgets and forecasts to identify variances from expectations.

B. Limiting direct access to assets by physical segregation and protective devices.

C. Supporting employees with the resources necessary to discharge their responsibilities.

D. Monitoring compliance with control requirements imposed by regulatory bodies.

Answer 16

A. Establishing budgets and forecasts to identify variances from expectations.

Question 17

Proper segregation of duties reduces the opportunities to allow any employee to be in a position to both:

A. Adopt new accounting pronouncements and authorize the recording of transactions.

B. Monitor internal controls and evaluate whether the controls are operating as intended.

C. Record and conceal fraudulent transactions in the normal course of assigned tasks.

D. Journalize cash receipts and disbursements and prepare the financial statements.

Answer 17

C. Record and conceal fraudulent transactions in the normal course of assigned tasks.

Question 18

Inherent risk and control risk differ from detection risk in that they:

A. Arise from the misapplication of auditing procedures.

B. Exist independently of the financial statement audit.

C. May be assessed in either quantitative or nonquantitative terms.

D. Can be changed at the auditor’s discretion.

Answer 18

B. Exist independently of the financial statement audit.

Question 19

On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed risk of material misstatement from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would:

A. Decrease substantive testing.

B. Increase inherent risk.

C. Decrease detection risk.

D. Increase materiality levels.

Answer 19

C. Decrease detection risk.

Question 20

Which of the following best describes a type of judgmental misstatement?

A. An inaccuracy in processing data.

B. Differences between management and the auditor’s judgment regarding estimates.

C. A clerical error that resulted in an amount recorded as $5,000 that should have been recorded as $500.

D. A difference between the classification of a reported financial statement element and the classification according to generally accepted accounting principles.

Answer 20

B. Differences between management and the auditor’s judgment regarding estimates.

Question 21

Which of the following matters relating to an entity’s operations would an auditor most likely consider as an inherent risk factor in planning an audit?

A. The entity’s fiscal year ends on June 30.

B. The entity’s financial statements are generated at an outside service center.

C. The entity enters into derivative transactions as hedges.

D. The entity’s financial data are available only in computer-readable form.

Answer 21

C. The entity enters into derivative transactions as hedges.

Question 22

Which of the following characteristics most likely would heighten an auditor’s concern about the risk of material misstatements in an entity’s financial statements?

A. The entity’s industry is experiencing declining customer demand.

B. Bank reconciliations usually include in-transit deposits.

C. Employees who handle cash receipts are not bonded.

D. Equipment is often sold at a loss before being fully depreciated.

Answer 22

A. The entity’s industry is experiencing declining customer demand.

Question 23

Which of the following is an example of an inherent risk that an auditor should consider?

A. Technological developments that may render inventory obsolete.

B. An incorrect formula in a worksheet used to calculate a LIFO inventory reserve.

C. Posting of unauthorized journal entries.

D. Inaccurate physical inventory count.

Answer 23

A. Technological developments that may render inventory obsolete.

Question 24

In an engagement to examine management’s discussion and analysis (MD&A), which of the following best defines control risk?

A. The risk that an assertion within the MD&A will lead to a material misstatement.

B. The risk that the practitioner will not uncover a material misstatement within an MD&A assertion.

C. The risk of detecting misstatements that are material to the MD&A presentation taken as a whole.

D. The risk that material misstatements in the MD&A presentation will not be prevented in a timely manner.

Answer 24

D. The risk that material misstatements in the MD&A presentation will not be prevented in a timely manner.

Question 25

As the acceptable level of detection risk decreases, an auditor may:

A. Reduce substantive testing by relying on the assessments of inherent risk and control risk.

B. Eliminate the assessed level of inherent risk from consideration as a planning factor.

C. Postpone the planned timing of substantive tests from interim dates to the year-end.

D. Lower the assessed level of control risk.

Answer 25

C. Postpone the planned timing of substantive tests from interim dates to the year-end.

Question 26

As the acceptable level of detection risk increases, an auditor may change the:

A. Assessed level of control risk from low to high.

B. Timing of substantive tests from year-end to an interim date.

C. Assurance provided by tests of controls by using a larger sample size than planned.

D. Nature of substantive tests from a less effective to a more effective procedure.

Answer 26

B. Timing of substantive tests from year-end to an interim date.

Question 27

Which of the following best identifies the effect of an increase in the risk of material misstatement on detection risk and the extent of substantive procedures?

A. The acceptable level of detection risk decreases, and the extent of substantive procedures increases.

B. The acceptable level of detection risk decreases, and the extent of substantive procedures decreases.

C. The acceptable level of detection risk increases, and the extent of substantive procedures increases.

D. The acceptable level of detection risk increases, and the extent of substantive procedures decreases.

Answer 27

A. The acceptable level of detection risk decreases, and the extent of substantive procedures increases.

Question 28

As a result of control testing, a CPA has decided to reduce control risk. What is the impact on substantive testing sample size if all other factors remain constant?

A. The sample size would be irrelevant.

B. The sample size would be lower.

C. The sample size would be higher.

D. The sample size would be unaffected.

Answer 28

B. The sample size would be lower.

Question 29

Under which of the following circumstances should an auditor consider confirming the terms of a large complex sale?

A. When the assessed level of control risk over the sale is low.

B. When the combined assessed level of inherent and control risk over the sale is moderate.

C. When the assessed level of detection risk over the sale is high.

D. When the combined assessed level of inherent and control risk over the sale is high.

Answer 29

D. When the combined assessed level of inherent and control risk over the sale is high.

Question 30

Which of the following types of risk increases when an auditor performs substantive analytical audit procedures for financial statement accounts at an interim date?

A. Inherent.

B. Detection.

C. Control.

D. Sampling.

Answer 30

B. Detection.

Question 31

An audit team has concluded that inventory is highly susceptible to misappropriation and that a potential misstatement would be material to the financial statements. How should the audit team address the audit procedures to the increased risk?

A. Review the client’s control procedures over the safeguarding of inventory, and perform a physical inventory count on the last day of the current year.

B. Review the client’s control procedures over the safeguarding of inventory, but do not modify substantive procedures over inventory.

C. Review the client’s control procedures over the safeguarding of inventory, incorporate the use of substantive analytical procedures, and develop an expectation.

D. Review the client’s control procedures over the safeguarding of inventory, and perform physical inventory counts throughout the current year.

Answer 31

A. Review the client’s control procedures over the safeguarding of inventory, and perform a physical inventory count on the last day of the current year.

Question 32

In an audit of financial statements for which an auditor’s assessment of risk is judgmental and may not be sufficiently precise to identify all risks of material misstatement, the auditor should take which of the following actions?

A. Determine the effectiveness of general controls over classes of transactions characterized by high transaction volume.

B. Discuss strategies to eliminate such risks with top management or those with equivalent authority and responsibility.

C. Perform substantive procedures for all relevant assertions related to each significant class of transactions.

D. Consider whether risk assessment procedures are appropriate given preliminary levels of materiality and tolerable misstatement.

Answer 32

C. Perform substantive procedures for all relevant assertions related to each significant class of transactions.

Question 33

The auditor is in the process of assessing the risk of material misstatement for selected client transactions and account balances considered to be significant. If the auditor decides to change the level of detection risk based on new information pertaining to the risk of material misstatement, he or she may do all of the following, except for:

A. Eliminating the use of substantive procedures for certain relevant assertions if the assessed risk of material misstatements sufficiently declines.

B. Modifying the timing of the substantive tests by including year-end testing.

C. Changing the sample size used in the related substantive procedures.

D. Changing the nature of testing by using more or less effective substantive audit procedures.

Answer 33

A. Eliminating the use of substantive procedures for certain relevant assertions if the assessed risk of material misstatements sufficiently declines.

Question 34

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

A. An auditor has a responsibility to detect material errors, but has no responsibility to detect fraud that is concealed through employee collusion or management override of internal control.

B. An auditor should design an audit to provide reasonable assurance of detecting errors and fraud that are material to the financial statements.

C. An auditor has no responsibility to detect errors and fraud unless analytical procedures or tests of transactions identify conditions causing a reasonably prudent auditor to suspect that the financial statements were materially misstated.

D. An auditor has no responsibility to detect errors and fraud because an auditor is not an insurer and an audit does not constitute a guarantee.

Answer 34

B. An auditor should design an audit to provide reasonable assurance of detecting errors and fraud that are material to the financial statements.

Question 35

Which of the following factors most likely would heighten an auditor’s concern about the risk of fraudulent financial reporting?

A. Low growth and profitability as compared to other entities in the same industry.

B. Large amounts of liquid assets that are easily convertible into cash.

C. Financial management’s participation in the initial selection of accounting principles.

D. An overly complex organizational structure involving unusual lines of authority.

Answer 35

D. An overly complex organizational structure involving unusual lines of authority.

Question 36

Which of the following factors most likely would heighten an auditor’s concern about the risk of fraudulent financial reporting?

A. Management’s lack of interest in increasing the entity’s stock trend.

B. Inability to generate cash flows from operations while reporting substantial earnings growth.

C. Large amounts of liquid assets that are easily convertible into cash.

D. Inability to borrow necessary capital without granting debt covenants.

Answer 36

B. Inability to generate cash flows from operations while reporting substantial earnings growth.

Question 37

Which of the following circumstances would an auditor most likely consider a risk factor relating to misstatements arising from fraudulent financial reporting?

A. Several members of the board of directors have recently sold shares of the entity’s stock.

B. Several members of management have recently purchased additional shares of the entity’s stock.

C. The entity distributes financial forecasts to financial analysts that predict conservative operating results.

D. Management is interested in maintaining the entity’s earnings trend by using aggressive accounting practices.

Answer 37

D. Management is interested in maintaining the entity’s earnings trend by using aggressive accounting practices.

Question 38

During a new audit engagement, the auditor notices that the client has had three external audit firms perform their annual audits over the past five years due primarily to increases in audit fees. The auditor also notes that the client has been twice downgraded by several of the major credit rating agencies over the past two years and that its current issuer credit rating is at the lowest investment grade level by both Standard & Poor’s and Moody’s Investors Service. Which (if any) of the following fraud risk factors would be most concerning to the auditor?

A. Rationalization/Attitude.

B. Opportunity.

C. Incentives/Pressures.

D. No fraud risk factor exists.

Answer 38

C. Incentives/Pressures.

Question 39

Which statement is true with respect to discussion among engagement personnel regarding the risk of material misstatement due to fraud?

A. All key members of the audit team should be brought to a single location to facilitate communication.

B. Discussion among engagement personnel regarding the risk of material misstatement due to fraud is recommended but not required.

C. The discussion should occur only during the planning stage of the audit.

D. Audit documentation must include a description of the discussion.

Answer 39

D. Audit documentation must include a description of the discussion.

Question 40

Prior to, or in conjunction with, the information-gathering procedures for an audit, audit team members should discuss the potential for material misstatement due to fraud. Which of the following best characterizes the mind-set that the audit team should maintain during this discussion?

A. Judgmental.

B. Presumptive.

C. Criticizing.

D. Questioning.

Answer 40

D. Questioning.

Question 41

While performing a preliminary assessment for a new client audit, the auditor determines that the client has had excessive growth over the past several years due to recent acquisitions and internal expansion. Through discussions with management, the auditor concludes that the company’s operational staff is too lean and that controls in several operational functions may be currently insufficient to accommodate this rapid growth. Which of the following fraud risk factors related to the client would the auditor have the greatest concern?

A. Inadequate organizational structure.

B. Rationalization/attitude.

C. Opportunity.

D. Incentives/pressures.

Answer 41

C. Opportunity.

Question 42

Each of the following questions is appropriate to ask internal audit personnel, except:

A. Do you have knowledge of any fraud or suspected fraud affecting the entity?

B. How did you communicate to employees your views on business practices and ethical behavior?

C. What procedures did you perform to identify or detect fraud during the year?

D. Has management responded satisfactorily to any findings from the fraud-related procedures you performed?

Answer 42

B. How did you communicate to employees your views on business practices and ethical behavior?

Question 43

Which of the following circumstances would likely cause an auditor to assess that there is a high risk of material misstatement due to fraud?

A. Transactions are recorded daily.

B. Employee access to systems and records is controlled by passwords.

C. Inventory is of significant magnitude.

D. Management assumes the responsibility to make period-end adjustments that significantly affect final results.

Answer 43

D. Management assumes the responsibility to make period-end adjustments that significantly affect final results.

Question 44

Which of the following journal entries would the auditor least likely examine in an effort to address the risk of management override of controls?

A. A journal entry made by an individual who does not typically make journal entries.

B. A journal entry made to record recurring periodic accounting estimates.

C. A journal entry recorded as a post-closing entry that has no explanation or description.

D. A journal entry made to a seldom-used account.

Answer 44

B. A journal entry made to record recurring periodic accounting estimates.

Question 45

Which of the following statements is correct with respect to fraud encountered during an audit engagement of a nonissuer?

A. An auditor who initially detects fraud ultimately makes the legal determination of whether fraud has actually occurred.

B. The distinguishing factor between fraud and error is the materiality of the transaction involved.

C. Fraudulent financial reporting can include the unintentional misstatement of amounts or disclosures in financial statements.

D. It is often difficult to detect fraudulent intent in matters involving accounting estimates and the application of accounting principles.

Answer 45

D. It is often difficult to detect fraudulent intent in matters involving accounting estimates and the application of accounting principles.

Question 46

Which of the following circumstances most likely would cause an auditor to suspect that there are material misstatements in an entity’s financial statements?

A. Supporting accounting records and files that should be readily available are not produced promptly when requested.

B. Senior financial management participates in the selection of accounting principles and the determination of significant estimates.

C. Related party transactions take place in the ordinary course of business with an entity that is audited by another CPA firm.

D. Senior management has an excessive interest in upgrading the entity’s information technology capabilities.

Answer 46

A. Supporting accounting records and files that should be readily available are not produced promptly when requested.

Question 47

When performing a substantive test of a random sample of cash disbursements, an auditor is supplied with a photocopy of vendor invoices supporting the disbursements for one particular vendor rather than the original invoices. The auditor is told that the vendor’s original invoices have been misplaced. What should the auditor do in response to this situation?
A. Reevaluate the risk of fraud, and design alternate tests for the related transactions.

B. Increase randomly the number of items in the substantive test to increase the reliance that may be placed on the overall test.

C. Increase testing by agreeing more of the payments to this particular vendor to the photocopies of its invoices.

D. Count the missing original documents as misstatements, and project the total amount of the error based on the size of the population and the dollar amount of the errors.

Answer 47

A. Reevaluate the risk of fraud, and design alternate tests for the related transactions.

Question 48

An entity has failed to provide documentation for a newly acquired material asset and informs its auditors that the documentation is lost. According to generally accepted government auditing standards, what would this situation typically indicate to the auditors?

A. Abusive activity.

B. Fraudulent activity.

C. Misappropriation of assets.

D. A heightened risk of fraud.

Answer 48

D. A heightened risk of fraud.

Question 49

Which of the following factors most likely would heighten an auditor’s concern about the risk of fraudulent financial reporting?

A. A lack of competition in the entity’s industry, accompanied by increasing profit margins.

B. The audit committee’s approval of the initial selection of accounting principles.

C. Management’s disclosure of unresolved litigation and contingent liabilities.

D. Year-end adjustments by the entity that significantly affect financial results.

Answer 49

D. Year-end adjustments by the entity that significantly affect financial results.

Question 50

During the course of an audit, an auditor finds evidence that an officer has entered fraudulent transactions in the financial statements. The fraudulent transactions can be adjusted so the statements are not materially misstated. What should the auditor do?

A. Consider the fraud a scope limitation and disclaim an opinion.

B. Report the matters to regulatory authorities.

C. Communicate the matter to those charged with governance.

D. Immediately withdraw from the engagement.

Answer 50

C. Communicate the matter to those charged with governance.

Question 51

During an audit, an auditor discovers a fraudulent expense reimbursement for a low-level manager. The auditor determines that this transaction is inconsequential and several similar transactions would not be material to the financial statements in the aggregate. Which of the following statements best describes the auditor’s required response to the discovery?

A. The auditor should bring the transaction to the attention of an appropriate level of management.

B. The auditor should fully investigate other transactions related to this manager to determine if fraud exists.

C. The auditor should report this finding to those charged with governance.

D. The auditor’s responsibility is satisfied by documenting that the single transaction is inconsequential.

Answer 51

A. The auditor should bring the transaction to the attention of an appropriate level of management.