A3 Flashcards
In assessing sampling risk, the risk of incorrect rejection and the risk of assessing control risk too high relate to the:
A.
Selection of the items in the sample.
B.
Efficiency of the audit.
C.
Effectiveness of the audit.
D.
Audit quality controls.
Choice “B” is correct. The risk of incorrect rejection and the risk of assessing control risk too high relate to the efficiency of the audit. These two errors generally result in an auditor performing unnecessary additional procedures.
Choice “C” is incorrect because the application of additional procedures will ordinarily still lead the auditor to the appropriate conclusion.
During an audit of a nonissuer’s financial statements, an auditor should perform tests of controls to obtain sufficient appropriate audit evidence about the operating effectiveness of relevant controls if:
A.
More financial documentation is available through tests of controls.
B.
The auditor does not presume that client management has committed fraud.
C.
Substantive procedures alone cannot provide sufficient appropriate audit evidence.
D.
The auditor does not intend to rely on the operating effectiveness of controls.
Choice “C” is correct. The auditor should perform tests of controls when substantive procedures alone cannot provide sufficient appropriate audit evidence.
Choice “B” is incorrect. Even though the auditor does not presume that client management committed a fraud, this does not necessarily mean that the auditor should perform tests of controls. The auditor’s basis for testing controls is when the auditor’s risk assessment is based on the assumption that controls are operating effectively or when substantive procedures alone are insufficient.
Analytical procedures used in planning an audit should focus on:
A.
Identifying material weaknesses in internal control.
B.
Enhancing the auditor’s understanding of the client’s business.
C.
Testing individual account balances that depend on accounting estimates.
D.
Evaluating the adequacy of evidence gathered concerning unusual balances.
Choice “B” is correct. The purpose of applying analytical procedures in planning the audit is to assist in planning the nature, timing, and extent of auditing procedures that will be used to obtain audit evidence for specific account balances or classes of transactions. To accomplish this, the analytical procedures used in planning the audit should focus on (a) enhancing the auditor’s understanding of the client’s business and the transactions and events that have occurred since the last audit date, and (b) identifying areas that may represent specific risks relevant to the audit.
Choice “A” is incorrect. Analytical procedures are generally not useful in detecting material weaknesses in the client’s internal control
Which of the following would be a consideration in planning an auditor’s sample for a test of controls?
A.
Preliminary judgments about materiality levels.
B.
The auditor’s allowable risk of assessing control risk too low.
C.
The level of detection risk for the account.
D.
The auditor’s allowable risk of assessing control risk too high.
Choice “B” is correct. The auditor’s allowable risk of assessing control risk too low has an inverse relationship with sample size when planning a sample for a test of controls.
Choice “A” is incorrect. Preliminary judgments about materiality levels might be a consideration in planning an auditor’s sample for a substantive test, but not for a test of controls.
Which of the following would not be considered an analytical procedure?
A.
Estimating payroll expense by multiplying the number of employees by the average hourly wage rate and the total hours worked and comparing it to the actual payroll expense recorded in the financial statements.
B.
Computing accounts receivable turnover by dividing credit sales by the average net receivables and comparing to prior year.
C.
Projecting an error rate by comparing the results of a statistical sample with the actual population characteristics.
D.
Developing the expected current-year sales based on the sales trend of the prior five years and comparing it to the sales revenues recorded in the financial statements.
Choice “C” is correct. Analytical procedures involve comparison of recorded amounts, or ratios developed from recorded amounts, to expectations developed by the auditor. Projecting an error rate from a statistical sample does not involve such a comparison.
The auditor requests that client management prepare a letter of inquiry to the client’s outside legal counsel. The auditor sends the letter to the attorney’s office. Because of inherent uncertainties regarding several lawsuits involving the client, the client’s attorneys are unable to form any meaningful conclusions at this time. Under this scenario, what is the auditor’s best course of action?
A.
Determine if the financial statement disclosure is adequate and issue an unmodified opinion.
B.
Withdraw from the audit engagement.
C.
Follow up with the client’s attorneys after the audit date and issue a disclaimer of opinion.
D.
Continue the audit but issue a modified opinion explaining the scope limitation
Choice “A” is correct. There are situations in which the inherent uncertainties regarding litigation make it impossible for outside counsel to predict the outcome of pending lawsuits. Because this is not a scope limitation, the auditor should ensure that financial disclosure regarding the lawsuit contingencies are adequate and issue an unmodified opinion assuming all other aspects of the audit are acceptable.
Which of the following pairs of accounts would be analyzed together in the audit documentation?
A.
Interest income and interest expense.
B.
Notes payable and notes receivable.
C.
Accrued interest receivable and accrued interest payable.
D.
Notes receivable and interest income.
Choice “D” is correct. The auditor would most likely analyze notes receivable and its related income statement account, interest income, together.
A primary objective of analytical procedures used in the final review stage of an audit is to:
A.
Assist the auditor in evaluating the overall financial statement presentation.
B.
Identify account balances that represent specific risks relevant to the audit.
C.
Gather evidence from tests of details to corroborate financial statement assertions.
D.
Detect fraud that may cause the financial statements to be misstated.
Choice “A” is correct. The purpose of applying analytical procedures during the overall review stage of an audit is to evaluate the overall financial statement presentation, to assess the conclusions reached, and to assist in forming an opinion on whether the financial statements as a whole are free of material misstatement.
Which of the following statements is correct concerning an auditor’s assessment of control risk?
A.
The lower the assessed level of control risk, the less assurance the evidence must provide that the controls are operating effectively.
B.
Evidence about the operation of controls in prior audits may not be considered during the current year’s assessment of control risk.
C.
Assessing control risk may be performed concurrently during an audit with obtaining an understanding of the entity’s system of internal control.
D.
The basis for an auditor’s conclusions about the assessed level of control risk need not be documented unless the auditor’s risk assessment is based on the effective operation of controls.
Choice “C” is correct. Some risk assessment procedures performed to obtain an understanding of the system of internal control may provide evidence about operating effectiveness, even if they were not intended for that purpose. This is possible because the procedures performed to achieve one objective may also provide evidence regarding the other.m
Choice “B” is incorrect. Audit evidence that was obtained in prior audits about the effective design or operation of controls may be considered by the auditor in assessing control risk in the current audit.
In obtaining an understanding of an entity’s system of internal control, an auditor is required to obtain knowledge about the:
Operating
effectiveness of
controls
Design of
controls
A.
No
No
B.
Yes
No
C.
No
Yes
D.
Yes
Yes
Choice “C” is correct. No - Yes. In obtaining an understanding of an entity’s system of internal control, an auditor is required to obtain knowledge about the design of controls and whether they have been implemented. The auditor is not required to obtain knowledge about the “operating effectiveness of controls” as part of obtaining an understanding of the system of internal control.
If a client will not permit inquiry of outside legal counsel, the auditor’s report ordinarily will contain a(an):
A.
Qualified opinion.
B.
Unmodified opinion with a separate explanatory paragraph.
C.
Disclaimer of opinion.
D.
Adverse opinion.
Choice “C” is correct. A client’s refusal to permit inquiry of outside legal counsel is a significant scope limitation that generally will result in a disclaimer of opinion.
When there are numerous property and equipment transactions during the year, an auditor who plans to assess control risk at a low level usually performs:
A.
Tests of controls and extensive tests of property and equipment balances at the end of the year.
B.
Analytical procedures for property and equipment balances at the end of the year.
C.
Analytical procedures for current year property and equipment transactions.
D.
Tests of controls and limited tests of current year property and equipment transactions.
Choice “D” is correct. Since control risk is assessed at a low level, tests of controls would be required to evaluate the effectiveness of the controls to support that assessed level. However, the need for some substantive tests of transactions is never eliminated.
Which of the following factors affecting the risk associated with a control is not a consideration when designing the current-year audit procedures in an audit of internal control over financial reporting for an issuer?
A.
The results of the previous years’ testing of the control.
B.
Whether the control has been documented in flowchart or narrative form.
C.
The nature, timing, and extent of procedures performed in previous audits.
D.
Whether there have been changes in the operation of a key control since the previous audit.
Choice “B” is correct. Whether a control has been documented in a flowchart or narrative form is not a consideration when designing the current-year audit procedures in an audit of internal control over financial reporting. Either documentation method is acceptable.
Economic indicators are often used to try to predict or explain economic activity. Which of the following is not an example of a leading economic indicator?
A.
Manufacturing and trade sales.
B.
Price changes of materials.
C.
Orders for goods.
D.
Building permits for residential properties.
Choice “A” is correct. Manufacturing and trade sales tend to be coincident indicators, as the increases or decreases tend to occur at the same time as the increases or decreases in overall economic activity.
To obtain audit evidence about control risk, an auditor ordinarily selects tests from a variety of techniques, including:
A.
Comparison.
B.
Reperformance.
C.
Analysis.
D.
Confirmation.
Choice “B” is correct. Reperforming the application of relevant controls provides evidence regarding their operating effectiveness.
The auditor should consider certain factors in assessing the efficiency and effectiveness of analytical procedures as compared to tests of details. In determining whether and to what extent analytical procedures should be used, which of the following should the auditor consider?
A.
Interrelationships of financial information.
B.
Nonfinancial information that may affect financial information.
C.
Explanations provided by the client.
D.
The nature of the assertion tested.
Choice “D” is correct. When evaluating whether and to what extent analytical procedures should be used, the auditor should consider the nature of the assertion tested. The other factors the auditor considers are the plausibility and predictability of the data relationship, availability and reliability of data used to develop the expectation, and the precision of the expectation.
In trying to predict how long the economy will be in its current recovery phase before entering an expansionary phase, economists will look at all of the following indicators except:
A.
The length of time, on average, that job seekers are unemployed.
B.
Data regarding new claims for unemployment.
C.
Building permits for new home construction.
D.
Prices for materials used in production.
Choice “A” is correct. Average time for unemployment is a lagging indicator, which means it follows economic activity and provides signals after the fact. If economists are trying to predict the length of business cycles, they will look to leading indicators.
Which of the following most likely would be considered a mitigating condition concerning an entity’s ability to continue as a going concern?
A.
Recent strong showing of the stock market.
B.
Positive comments about the company from industry analysts.
C.
Plans to increase ownership equity.
D.
A decreasing unemployment rate in the entity’s industry.
Choice “C” is correct. Increasing ownership equity may be a mitigating factor that the auditor may consider when determining whether the entity has an ability to continue as a going concern. Management must show the intent to increase ownership equity and the ability to do so.
In connection with an audit of our financial statements, management has prepared, and furnished to our auditors a description and evaluation of certain contingencies.”
The foregoing passage most likely is from a(an):
A.
Management representation letter.
B.
Audit committee’s communication to the auditor.
C.
Audit inquiry letter to legal counsel.
D.
Financial statement footnote disclosure.
Choice “C” is correct. Legal counsel is best able to corroborate the description and evaluation of contingencies provided by management.
Which of the following events most likely would indicate the existence of related parties?
A.
Selling real estate at a price significantly different from appraised value.
B.
Failure to correct internal control weaknesses on a timely basis.
C.
Entering into multiple market value transactions with the same party.
D.
High turnover of senior management and members of the board of directors.
Choice “A” is correct. Transactions based on terms that are significantly different from those that would be expected in an arm’s-length transaction, such as selling real estate at a price significantly different from appraised value, may be indicative of related party involvement.
Choice “B” is incorrect. Failure to correct internal control weaknesses on a timely basis is a management decision that is unlikely to be related to the existence of related parties.
Choice “C” is incorrect. Entering into multiple transactions with the same party at market terms would not be indicative of a related party transaction.
Which of the following objectives is achieved when an auditor decides to employ classical variable sampling?
A.
To determine the efficiency of the payroll system.
B.
To determine the inventory quantities on hand.
C.
To determine the completeness of billing transactions.
D.
To determine the reliability of voucher processing.
Choice “B” is correct. Determining the inventory quantities on hand is achieved when an auditor decides to employ classical variable sampling. This sampling method helps the auditor determine the reasonableness of the inventory account and is often performed during the inventory count.
In which of the following scenarios would an auditor most likely increase tests of controls?
A.
When the client’s IT system is extensively integrated throughout the company’s accounting system.
B.
When the client’s accounting system is largely based on manual processes.
C.
When the auditor has decided not to rely on controls and instead elects to increase substantive testing.
D.
When the auditor’s assessment of inherent risk is low.
Choice “A” is correct. When a client’s IT system is extensively integrated throughout the company’s accounting system, evidence for a substantive audit test may not be available and the auditor will have to rely more heavily on tests of internal controls related to the IT system.
Which of the following factors most likely would be considered an inherent limitation to an entity’s system of internal control?
A.
The complexity of the entity’s electronic order-processing system.
B.
The lack of resources to monitor controls.
C.
Collusion of employees in circumventing controls.
D.
The ineffectiveness of the entity’s audit committee
Choice “C” is correct. Even well-designed and implemented controls are subject to inherent limitations of internal controls. An example of an inherent limitation of an entity’s system of internal control is deliberate circumvention of controls by collusion of two or more people. The other inherent limitations of internal control include management override of controls and human error. These describe limitations that are inherent in all internal control systems, which can cause controls to fail even if the controls are designed well and implemented.
What is an auditor’s evaluation of a statistical sample for attributes when a test of 50 documents results in 3 deviations if tolerable rate is 7%, the expected population deviation rate is 5%, and the allowance for sampling risk is 2%?
A.
Modify the planned assessed level of control risk because the tolerable rate plus the allowance for sampling risk exceeds the expected population deviation rate.
B.
Accept the sample results as support for the planned assessed level of control risk because the sample deviation rate plus the allowance for sampling risk exceeds the tolerable rate.
C.
Accept the sample results as support for the planned assessed level of control risk because the tolerable rate less the allowance for sampling risk equals the expected population deviation rate.
D.
Modify the planned assessed level of control risk because the sample deviation rate plus the allowance for sampling risk exceeds the tolerable rate.
Choice “D” is correct. The auditor’s evaluation would be to modify the planned assessed level of control risk because the sample deviation rate of 6% (3/50) plus the allowance for sampling risk of 2% (the sum of which is called the upper deviation rate) exceeded the tolerable rate of 7%.
Which of the following would be a consideration in planning an auditor’s sample for a test of controls?
A.
Preliminary judgments about materiality levels.
B.
The auditor’s allowable risk of assessing control risk too low.
C.
The level of detection risk for the account.
D.
The auditor’s allowable risk of assessing control risk too high.
Choice “B” is correct. The auditor’s allowable risk of assessing control risk too low has an inverse relationship with sample size when planning a sample for a test of controls.
To obtain audit evidence about control risk, an auditor ordinarily selects tests from a variety of techniques, including:
A.
Reperformance.
B.
Analysis.
C.
Confirmation.
D.
Comparison.
Choice “A” is correct. Reperforming the application of relevant controls provides evidence regarding their operating effectiveness.
Choices “B”, “C”, and “D” are incorrect. Analysis, confirmation, and comparison are substantive tests of account balances, not tests of controls.
The adverse effects of events causing an auditor to believe there is substantial doubt about an entity’s ability to continue as a going concern would most likely be mitigated by evidence relating to the:
A.
Marketability of assets that management plans to sell.
B.
Committed arrangements to convert preferred stock to long-term debt.
C.
Ability to expand operations into new product lines in the future.
D.
Feasibility of plans to purchase leased equipment at less than market value
Choice “A” is correct. The adverse effects of events causing an auditor to believe there is a substantial doubt about an entity’s ability to continue as a going concern would most likely be mitigated by evidence relating to the marketability of assets that management plans to sell. By providing evidence that there is a ready market for assets that could be converted to cash, management has demonstrated that the company could remain in operation for a longer period of time.
During the initial fieldwork phase of a new audit engagement, the auditor discovers that the client is currently involved in several lawsuits. If the auditor requests that the client prepare a letter of inquiry request to their outside attorneys, and the client refuses, the audit firm should take which of the following courses of action?
A.
Issue a disclaimer of opinion or withdraw from the audit engagement.
B.
Discuss the pending lawsuits with client management and issue an unmodified opinion if their responses are adequate.
C.
Prepare the letter of inquiry and send directly to the outside attorneys.
D.
Perform alternative procedures to gather information regarding these lawsuits.
Choice “A” is correct. In the event the client refuses to prepare a letter of inquiry to be sent by the auditor to the client’s outside attorneys, there is a scope limitation. If the client refuses to prepare or permit a letter of inquiry, the audit firm should either issue a disclaimer of opinion or withdraw from the audit engagement.
An auditor concludes that there is substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time. The entity’s financial statements adequately disclose its financial difficulties. Under these circumstances, the auditor’s report is required to include a separate report section with the heading “Substantial Doubt About the Entity’s Ability to Continue as a Going Concern” that specifically uses the phrase(s):
“Except for the effects
of such adjustments” “Possible discontinuance
of the entity’s operations”
A.
No
No
B.
No
Yes
C.
Yes
No
D.
Yes
Yes
Explanation
Choice “A” is correct. The wording of the separate section must include the terms “substantial doubt” and “going concern.” The phrases in the above question are not required to be used.
After performing all phases of the current audit, the auditor determines that the client is in noncompliance with several required securities regulations. The auditor then prepares a modified audit report to reflect this noncompliance but the client refuses to accept the auditor’s report claiming the level of materiality does not warrant such an opinion. Under this scenario, what is the auditor’s proper course of action?
A.
Withdraw from the engagement and notify those charged with governance in writing.
B.
Issue an unmodified opinion with an emphasis-of-matter paragraph explaining the materiality issue.
C.
Issue the modified report.
D.
Withdraw from the engagement and contact the applicable regulatory authorities in writing.
Choice “A” is correct. Based on the auditor’s due diligence, violations of several required securities regulations have been noted during the audit. If the auditor proceeds to prepare a modified opinion and the client refuses to accept that opinion, the auditor’s best course of action is to withdraw from the engagement and contact those charged with governance in writing regarding the reasons for the audit action.
According to COSO, the reality that human decision making can be faulty and subject to bias is an example of:
A.
The control environment.
B.
A risk assessment.
C.
A control activity.
D.
The limitations of internal control.
Choice “D” is correct. Human error, including faulty or biased judgment used in decision making, is an example of a limitation of internal control. The COSO framework acknowledges there are several sources of limitations related to a system of internal control.
Providing more supervision during an audit of a nonissuer in response to assessed risks of material misstatement at the financial statement level is an example of:
A.
Further audit procedures.
B.
A substantive response.
C.
An overall response.
D.
Tests of controls.
Choice “C” is correct. Providing more supervision during an audit of a nonissuer in response to assessed risks of material misstatement at the financial statement level is an example of an overall response.
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?
A.
Accounts receivable.
B.
Advertising expense.
C.
Accounts payable.
D.
Payroll expense.
Choice “D” is correct. Auditors try to identify predictable relationships when using analytical review procedures. Payroll expense is predictable because it is based on objective information (number of employees and pay rates). It can generally be computed directly by the auditor.
An effective internal control system may be compromised by all of the following, except:
A.
Management collusion and subsequent override of established controls.
B.
The application of fewer than 20 principles.
C.
External events that cannot be controlled by the entity.
D.
Inevitable human errors that result in a major internal control deficiency.
Choice “B” is correct. There are only 17 principles associated with the 5 components of internal control, so applying fewer than 20 will not necessarily have any impact on an effective internal control system.
Which of the following is an inherent limitation of internal controls?
A.
Segregation of duties.
B.
Judgmental sampling.
C.
Collusion.
D.
Employee peer review.
Choice “C” is correct. Inherent limitations of internal control include concepts such as collusion, human error, and management override.
Which of the following is an inherent limitation of internal controls?
A.
Segregation of duties.
B.
Judgmental sampling.
C.
Collusion.
D.
Employee peer review.
Choice “C” is correct. Inherent limitations of internal control include concepts such as collusion, human error, and management override.
In obtaining an understanding of a manufacturing entity’s controls concerning inventory balances, an auditor most likely would:
A.
Perform test counts of inventory during the entity’s physical count.
B.
Analyze the liquidity and turnover ratios of the inventory.
C.
Perform analytical procedures designed to identify cost variances.
D.
Review the entity’s descriptions of controls over inventory.
Choice “D” is correct. This question asks about internal control. Review of descriptions of controls would typically be performed while gaining an understanding of an entity’s system of internal control (for any system or cycle, not just inventory).
For which of the following audit tests would an auditor most likely use attribute sampling?
A.
Making an independent estimate of recorded payroll expense.
B.
Determining that all payables are recorded at year end.
C.
Selecting accounts receivable for confirmation of account balances.
D.
Inspecting purchase orders for proper approval by supervisors.
Choice “D” is correct. Attribute sampling is used by the auditor to test whether the controls put in place by the client operate effectively. By inspecting purchase orders, the auditor can determine whether adequate approvals are in place (documented) to demonstrate that purchases are properly supervised.
An auditor’s analytical procedures most likely would be facilitated if the entity:
A.
Uses a standard cost system that produces variance reports.
B.
Corrects material weaknesses in internal control before the beginning of the audit.
C.
Segregates obsolete inventory before the physical inventory count.
D.
Develops its data from sources solely within the entity.
Choice “A” is correct. An auditor’s analytical procedures are facilitated when an entity uses a standard cost system with variance reports because the comparison of actual to budget will already have been performed. In addition, it is likely that management will already be aware of significant variations from budget and will be better able to address any questions the auditor may have
Which of the following conditions is most true during a recession:
A.
Actual output will exceed potential output.
B.
Potential output will exceed actual output.
C.
The natural rate of unemployment will increase dramatically.
D.
Output (GDP) will be increasing.
Choice “B” is correct. During a recession, potential output will exceed actual output.
Choice “A” is incorrect. Actual output will not exceed potential output except at the peak of the cycle, and perhaps not then.
Choice “C” is incorrect. The natural rate of unemployment will not be affected by the various phases of the business cycle. Actual unemployment will change with the cycle.
Choice “D” is incorrect. GDP is falling during a recession.
The primary reason an auditor requests letters of inquiry be sent to a client’s attorneys is to provide the auditor with:
A.
The attorneys’ opinions of the client’s historical experiences in recent similar litigation.
B.
A description and evaluation of litigation, claims, and assessments that existed at the balance sheet date.
C.
The probable outcome of asserted claims and pending or threatened litigation.
D.
Corroboration of the information furnished by management about litigation, claims, and assessments.
Choice “D” is correct. A letter of audit inquiry to the client’s lawyer is the auditor’s primary means of obtaining corroboration of the information furnished by management concerning litigation, claims, and assessments.
In testing the existence assertion for an asset, an auditor ordinarily works from the:
A.
Accounting records to the supporting evidence.
B.
Supporting evidence to the accounting records.
C.
Financial statements to the potentially unrecorded items.
D.
Potentially unrecorded items to the financial statements.
Choice “A” is correct. In testing the existence assertion for an asset, an auditor ordinarily works from the accounting records to the supporting evidence.
Which of the following documentation is not required for an audit in accordance with generally accepted auditing standards?
A.
A client engagement letter that summarizes the timing and details of the auditor’s planned fieldwork.
B.
The basis for the auditor’s decision not to perform tests of controls concurrently with obtaining an understanding of the system of internal control.
C.
An indication that the accounting records agree or reconcile with the financial statements.
D.
A written audit plan setting forth the procedures necessary to accomplish the audit’s objectives.
Choice “B” is correct. The auditor is not required to evaluate operating effectiveness as part of obtaining an understanding of the system of internal control, and therefore need not document the basis for this decision.
The trough of a business cycle is generally characterized by:
A.
Shortages of essential raw materials and rising costs.
B.
Increasing purchasing power and increasing capital investments.
C.
Declining purchasing power and unused productive capacity.
D.
Unused productive capacity and an unwillingness to risk investments.
Choice “D” is correct. The trough of a business cycle is an economic low point with no positive indicators for the future. It is characterized by unused productive capacity and an unwillingness to risk new investments.
When performing analytical procedures in the planning stage, the auditor most likely would develop expectations by reviewing which of the following sources of information?
A.
Various account assertions in the planning memorandum.
B.
The control risk assessment relating to specific financial assertions.
C.
Comments in the prior-year’s management letter.
D.
Unaudited information from internal quarterly reports.
Choice “D” is correct. Analytical procedures involve comparison of recorded amounts to independent expectations developed by the auditor. During the planning stage, analytical procedures generally use financial data, such as unaudited information from internal quarterly reports.
In obtaining an understanding of the entity and its environment, including its system of internal control, an auditor is required to obtain knowledge about the:
A.
Effectiveness of the internal controls that have been placed in operation.
B.
Controls related to each principal transaction class and account balance.
C.
Consistency with which the internal controls are currently being applied.
D.
Design of relevant controls pertaining to financial reporting in each of the five internal control components.
Choice “D” is correct. In every audit, the auditor should obtain a sufficient understanding of the design of relevant controls pertaining to financial reporting in each of the five internal control components.
Which of the following is least likely to be a continuous activity that an auditor would be expected to perform throughout an audit engagement?
A.
Understanding the entity and its environment
B.
Assessing the risk of material misstatement
C.
Considering client continuance
D.
Inquiring as to the design of controls
Choice “D” is correct. Inquiring regarding the design of controls would typically be done once. It is possible that the auditor may perform the tests of operating effectiveness of the control throughout the engagement, but the test of design typically would be done one time after the auditor has obtained an understanding of the system of internal control.
An audit client failed to maintain copies of its procedures manuals and organizational flowcharts. What should the auditor do in an audit of financial statements?
A.
Assess control risk at the maximum level.
B.
Document the auditor’s understanding of internal controls.
C.
Restrict the auditor’s responsibility to assess the effectiveness of controls in the audit engagement letter.
D.
Issue a qualified opinion on the basis of a scope limitation.
Choice “B” is correct. Although it is helpful when the auditor can review client procedures manuals and organizational flowcharts, not having this documentation simply means that the auditor will need to put forth more effort to obtain an understanding of internal control. As is always the case, the auditor should document his or her understanding of internal control.
The trough of a business cycle is generally characterized by:
A.
Unused productive capacity and an unwillingness to risk investments.
B.
Shortages of essential raw materials and rising costs.
C.
Declining purchasing power and unused productive capacity.
D.
Increasing purchasing power and increasing capital investments.
Choice “A” is correct. The trough of a business cycle is an economic low point with no positive indicators for the future. It is characterized by unused productive capacity and an unwillingness to risk new investments.
In an audit of financial statements in accordance with generally accepted auditing standards, an auditor is required to:
A.
Determine whether controls operated effectively to prevent or detect material misstatements.
B.
Perform tests of controls to evaluate the effectiveness of the entity’s information system relevant to financial reporting.
C.
Search for significant deficiencies in the operation of controls.
D.
Document the auditor’s understanding of the entity’s system of internal control.
Choice “D” is correct. The auditor is required to document key elements of the understanding of the entity and its environment, including each of the components of the system of internal control.
Choice “A” is incorrect. The auditor generally is not required to determine whether the client’s controls operated effectively to prevent or detect material errors. Such determination would only be required for controls on which the auditor plans to rely.
Choice “B” is incorrect. Auditors are not required to perform tests of controls unless they plan to place reliance on a particular control. Since auditors are not required to rely on the client’s controls, tests of controls are generally not required.
Choice “C” is incorrect. Auditors are not required to search for significant deficiencies in the operation of internal control. They are merely required to report such conditions discovered during the audit to those charged with governance.
Which of the following applications of sampling to test controls is most appropriate?
A.
Testing a sample of controls to determine segregation of duties between inventory control and sales processing duties.
B.
Testing a sample of the budget center directors’ allocation of annual budget to sales units.
C.
Testing a sample of accounts receivable confirmations.
D.
Testing a sample of customer orders for evidence of credit approval.
Choice “D” is correct. An auditor may sample orders and inspect those orders for evidence of credit approval. The auditor would select a sample consistent with various factors to determine the extent of the testwork.
Which of the following procedures would an auditor most likely perform prior to the balance sheet date?
A.
Review detail and test significant travel and entertainment expenses.
B.
Send inquiry letter to client’s legal counsel.
C.
Perform search for unrecorded liabilities.
D.
Review subsequent events.
“A” is correct. The auditor may choose to perform detailed audit work during an interim period prior to the balance sheet date, especially for accounts that are reasonably predictable. If travel and entertainment expenses are budgeted and closely monitored, they may very well be predictable and subject to interim testing.
An auditor may decide not to test controls related to certain assertions because the auditor believes:
A.
Sufficient appropriate evidence to support the assertions is likely to be available.
B.
Evaluating the effectiveness of controls is inefficient.
C.
More emphasis on tests of controls than substantive tests is warranted.
D.
Considering the relationship of assertions to specific account balances is more efficient.
Choice “B” is correct. An auditor may decide to assess control risk at the maximum level for certain assertions because the auditor believes evaluating the effectiveness of controls is inefficient (i.e., it would be more efficient to test the assertions substantively).
In planning an audit, the auditor’s knowledge about the design of relevant controls should be used to:
A.
Determine whether controls have been circumvented by collusion.
B.
Assess the operational efficiency of internal control.
C.
Document the assessed level of inherent risk.
D.
Identify the types of potential misstatements that could occur.
Choice “D” is correct. Knowledge about the design and implementation of relevant controls should be used to identify types of misstatements that could occur.
The objective of tests of details of transactions performed as tests of controls is to:
A.
Evaluate whether controls operated effectively.
B.
Monitor the design and use of entity documents such as prenumbered shipping forms.
C.
Determine whether controls have been implemented.
D.
Detect material misstatements in the account balances of the financial statements.
Choice “A” is correct. The objective of tests of details used as tests of controls is to evaluate whether a control operated effectively.
Choice “B” is incorrect. Tests of details of transactions would not typically be used to monitor the design and use of entity documents.
After obtaining an understanding of internal control and performing risk assessment procedures, an auditor decided not to perform tests of controls. The auditor most likely concluded that the:
A.
Evidence obtainable through tests of controls would not support an increased level of control risk.
B.
Additional evidence to support a reduction in control risk was not cost-beneficial to obtain.
C.
Internal control was properly designed and justifiably may be relied on.
D.
Assessed level of inherent risk exceeded the assessed level of control risk.
Choice “B” is correct. When an auditor decides not to perform tests of controls, the auditor most likely concluded that the additional evidence to support a reduction in control risk was not cost-beneficial to obtain. In other words, the additional costs that would be incurred to support a lower assessed level of control risk would not be offset by the anticipated cost savings resulting from a lower level of substantive tests.
An auditor uses the knowledge provided by the understanding of internal control and the final assessed risk of material misstatement primarily to determine the nature, timing, and extent of the:
A.
Attribute tests.
B.
Compliance tests.
C.
Tests of controls.
D.
Substantive tests.
Choice “D” is correct. An auditor uses the knowledge provided by the understanding of internal control and the final assessed risk of material misstatement primarily to determine the nature, timing, and extent of the substantive tests to be performed.
Providing more supervision during an audit of a nonissuer in response to assessed risks of material misstatement at the financial statement level is an example of:
A.
An overall response.
B.
Tests of controls.
C.
Further audit procedures.
D.
A substantive response.
Choice “A” is correct. Providing more supervision during an audit of a nonissuer in response to assessed risks of material misstatement at the financial statement level is an example of an overall response.
In addition to making management inquiries, an auditor should perform the following procedures to identify client contingencies with the exception of:
A.
Discussing sales contracts with the sales manager.
B.
Reviewing the status of long-term leases.
C.
Obtaining a client representation letter.
D.
Reviewing derivative transactions reflected on the quarter-end balance sheet.
Choice “D” is correct. A client is expected to report material contingencies in the footnotes as they have not yet happened and are not reflected in the actual financial statements. Derivatives that are actually reflected on the client’s balance sheet at quarter end are not contingencies (the amount is provided and there is no possible or probable outcome). As a result, reviewing any type of transaction that is already recorded on the balance sheet will not identify a contingency.
During the initial fieldwork phase of a new audit engagement, the auditor discovers that the client is currently involved in several lawsuits. If the auditor requests that the client prepare a letter of inquiry request to their outside attorneys, and the client refuses, the audit firm should take which of the following courses of action?
A.
Discuss the pending lawsuits with client management and issue an unmodified opinion if their responses are adequate.
B.
Perform alternative procedures to gather information regarding these lawsuits.
C.
Prepare the letter of inquiry and send directly to the outside attorneys.
D.
Issue a disclaimer of opinion or withdraw from the audit engagement.
Choice “D” is correct. In the event the client refuses to prepare a letter of inquiry to be sent by the auditor to the client’s outside attorneys, there is a scope limitation. If the client refuses to prepare or permit a letter of inquiry, the audit firm should either issue a disclaimer of opinion or withdraw from the audit engagement.
Which of the following procedures most likely would assist an auditor in determining whether management has identified all accounting estimates that could be material to the financial statements?
A.
Inquire about the existence of related party transactions.
B.
Confirm inventories at locations outside the entity.
C.
Determine whether accounting estimates deviate from historical patterns.
D.
Review the lawyer’s letter for information about litigation
Choice “D” is correct. The auditor should inquire of management concerning pending or threatened litigation, and should obtain a letter from the client’s lawyer to corroborate this information. Included in this letter is either an identification of the omission of any pending or threatened litigation, claims, and assessments, or a statement that the list of such matters (as provided by management) is complete.
An auditor of an issuer concludes that there is substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time. If the entity’s disclosures concerning this matter are adequate, the audit report may include a(an):
Disclaimer
of opinion “Except for”
qualified opinion
A.
Yes
Yes
B.
No
No
C.
No
Yes
D.
Yes
No
Choice “D” is correct. Yes - No.
If an auditor concludes that there is substantial doubt about an entity’s ability to continue as a going concern and that the entity’s disclosures are adequate, then the audit report may be either:
Unqualified with explanatory paragraph, or
Disclaimed.
Generally, an unqualified opinion is issued, but the auditor is not prohibited from choosing to issue a disclaimer.
U.S. auditing standards require the auditor to perform analytical procedures related to:
A.
A management representation letter.
B.
Revenue.
C.
Interest expense.
D.
Internal controls.
Choice “B” is correct. U.S. auditing standards require the auditors to perform analytical procedures related to revenue.
Which of the following best explains why an analytical procedure might be used as a substantive test?
A.
To assess the conclusions reached by staff auditors.
B.
To determine the adequacy of evidence gathered in response to unusual or unexpected balances.
C.
To assist in planning the nature, timing, and extent of the auditing procedures to be performed.
D.
To achieve audit objectives in the most effective and efficient manner possible.
Choice “D” is correct. For some assertions, analytical procedures are more effective and efficient at providing an appropriate level of assurance than are tests of details.
Which of the following statements regarding directional testing is correct?
A.
In order to ensure that an asset has not been overstated, an auditor may want to vouch to source documentation.
B.
In order to test the existence assertion, an auditor may select a sample of items and trace from their corresponding source documentation to corresponding accounting records.
C.
In order to test the completeness assertion, an auditor may select a sample of items from the accounting records, and vouch to their corresponding source documentation.
D.
In order to ensure that an expense has not been understated, an auditor may want to test the existence assertion.
Choice “A” is correct. An auditor would be likely to test for overstatement of an asset by testing the existence assertion. This test would include vouching down to supporting source documentation.
The purpose of applying analytical procedures in the overall review stage of an audit includes assisting the auditor in all of the following except:
A.
Enhancing the understanding of the client’s business.
B.
Evaluating the overall financial statement presentation.
C.
Assessing conclusions reached.
D.
Evaluating the going concern assessment.
Choice “A” is correct. During planning (not during review), the focus of analytical procedures is on enhancing the understanding of the client’s business.
If an auditor performs an inspection of documentation supporting a client’s account balances, he or she would most likely be testing any of the following financial statement assertions, with the exception of:
A.
Understandability of presentation and classification.
B.
Valuation, allocation, and accuracy.
C.
Completeness.
D.
Rights and obligations.
Choice “C” is correct. When testing the completeness assertion, the auditor may observe processes and procedures, trace transactions forward from source documents to the accounting records, and perform analytical review procedures. The inspection of documentation would not be a primary audit procedure used to test the completeness assertion.
PCAOB has established risk assessment standards for issuer audits. Which of the following is not a financial statement assertion as recognized by PCAOB standards?
A.
Occurrence.
B.
Presentation.
C.
Cutoff.
D.
Disclosure.
Choice “C” is correct. Cutoff is not a financial statement assertion recognized by PCAOB standards. PCAOB standards include the assertions of Existence or Occurrence, Completeness, Valuation or Allocation, Rights and Obligations, and Presentation and Disclosure. Cuttoff testing would be covered by the Existence or Occurrence and the Completeness assertions.
Which of the following presumptions is correct about the reliability of audit evidence?
A.
To be reliable, audit evidence should be conclusive rather than persuasive.
B.
Reliability of audit evidence refers to the amount of corroborative evidence obtained.
C.
Information obtained indirectly from outside sources is the most reliable evidential matter.
D.
An effective internal control structure provides more assurance about the reliability of audit evidence.
Choice “D” is correct. Reliability of audit evidence is enhanced by a satisfactory internal control structure.
Analytical procedures performed in the overall review stage of an audit suggest that several accounts have unexpected relationships. The results of these procedures most likely would indicate that:
A.
Additional tests of details are required.
B.
Control activities are not operating effectively.
C.
The communication with those charged with governance should be revised.
D.
Irregularities exist among the relevant account balances.
Choice “A” is correct. If analytical procedures suggest unexpected relationships, the auditor would perform additional tests of details of the accounts involved.
