AUD 2 Flashcards
When an auditor increases the assessed level of control risk because certain control procedures were determined to be ineffective, the auditor would most likely increase the A. Extent of tests of controls. B. Level of detection risk. C. Extent of tests of details. D. Level of inherent risk.
C. Extent of tests of details.
Explanation - An increase in the assessed level of control risk means that the risk of a material misstatement occurring and not being detected has increased. To offset that increased risk, the auditor should make decisions that decrease the level of detection risk. Increasing the emphasis on tests of details would decrease detection risk.
In a financial statement audit, inherent risk is evaluated to help an auditor assess which of the following?
A. The internal audit department’s objectivity in reporting a material misstatement of a financial statement assertion it detects to the audit committee.
B. The risk that the internal control system will not detect a material misstatement of a financial statement assertion.
C. The risk that the audit procedures implemented will not detect a material misstatement of a financial statement assertion.
D. The susceptibility of a financial statement assertion to a material misstatement assuming there are no related controls.
D. The susceptibility of a financial statement assertion to a material misstatement assuming there are no related controls. Explanation - AICPA Professional Standards define inherent risk as "...the susceptibility of an assertion about a class of transactions, account balance, or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls."
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. Control. C. Detection. D. Sampling.
C. Detection.
Explanation - The timing of an auditor’s substantive procedures has implications to the resulting level of detection risk. When important substantive procedures are moved from year-end testing to an interim date, the auditor’s detection risk increases.
Which of the following courses of action is the most appropriate if an auditor concludes that there is a high risk of material misstatement?
A. Use smaller, rather than larger, sample sizes.
B. Perform substantive tests as of an interim date.
C. Select more effective substantive tests.
D. Increase of tests of controls.
C. Select more effective substantive tests.
Explanation - When there is a high risk of material misstatement, the auditor would want to decrease detection risk. That can be accomplished by emphasizing procedures that result in a stronger basis for conclusions, such as performing more effective substantive tests.
The acceptable level of detection risk is inversely related to the
A. Assurance provided by substantive tests.
B. Risk of misapplying auditing procedures.
C. Preliminary judgment about materiality levels.
D. Risk of failing to discover material misstatements.
A. Assurance provided by substantive tests.
Explanation - Detection risk is inversely related to the assurance provided by substantive tests. The lower the detection risk, the more assurance needed from substantive testing.
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.
B. Projecting an error rate by comparing the results of a statistical sample with the actual population characteristics.
C. Computing accounts receivable turnover by dividing credit sales by the average net receivables.
D. Developing the expected current-year sales based on the sales trend of the prior five years.
B. Projecting an error rate by comparing the results of a statistical sample with the actual population characteristics.
Explanation - This answer can be selected by a process of elimination. Analytical procedures involve the comparison of recorded amounts, or ratios developed from recorded amounts, to expectations developed by the auditor. Projecting an error rate by comparing the results of a statistical sample with the actual population characteristics does NOT involve a comparison between an auditor expectation and a recorded balance, and would not be considered an analytical procedure. If you considered the error rate to be part of a test of control effort, then clearly it is not an analytical procedure. If you considered the error rate to be part of a substantive procedure intended to verify the validity of an account balance then it would be classified as a substantive test of details, not an analytical procedure.
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. Interest expense. C. Accounts payable. D. Travel and entertainment expense.
B. Interest expense.
Explanation - Estimation of interest expense, based on interest rates and principal balances, would most likely yield the highest level of evidence because the relationship is highly predictable. Relationships involving income statement accounts are more predicable than relationships involving balance sheet accounts because income statement accounts involve transactions occurring over a period of time, rather than at a point in time.
Analytical procedures used in planning an audit should focus on
A. Identifying possible scope limitations and gathering evidence in assessing control risk environmental factors.
B. Enhancing the understanding of the entity’s business and the transactions and events that have occurred since the last audit.
C. Aggregating data at a low level and substantiating management’s assertions that are embodied in the financial statements.
D. Discovering material weaknesses in the internal control structure and reporting them to the entity’s management for corrective action.
B. Enhancing the understanding of the entity’s business and the transactions and events that have occurred since the last audit.
Explanation - Analytical procedures used in planning the audit should focus on:
1) enhancing the auditor’s understanding of the client’s business and the transactions and events that have occurred since the last audit; and
2) identifying areas of specific risk to the audit.
Which of the following factors would be most likely to heighten an auditor’s concern about the risk of fraudulent financial reporting?
A. Large amounts of liquid assets that are easily convertible into cash.
B. Low growth and profitability as compared to other entities in the same industry.
C. Financial management’s participation in the initial selection of accounting principles.
D. An overly complex organizational structure involving unusual lines of authority.
D. An overly complex organizational structure involving unusual lines of authority.
Explanation - The risk of fraudulent financial reporting is heightened by the existence of an overly complex organizational structure involving unusual lines of authority. This type of structure would make it easier to override internal controls to materially misstate the financial statements.
Which of the following matters would an auditor most likely communicate to an entity’s audit committee?
A. A list of negative trends that may lead to working capital deficiencies and adverse financial ratios.
B. The level of responsibility assumed by management for the preparation of the financial statements.
C. Difficulties encountered in achieving a satisfactory response rate from the entity’s customers in confirming accounts receivables.
D. The effects of significant accounting policies adopted by management in emerging areas for which there is no authoritative guidance.
D. The effects of significant accounting policies adopted by management in emerging areas for which there is no authoritative guidance.
Explanation - The auditor would be required to discuss the effects of significant accounting policies adopted by management in emerging areas for which there is no authoritative guidance. The audit committee should be kept informed about such areas in order to provide proper guidance and oversight to management. The auditor is required to communicate with the audit committee regarding:
1) the auditor’s responsibility under GAAS;
2) significant accounting policies;
3) management judgments and accounting estimates;
4) audit adjustments;
5) auditor’s judgments about the quality of the entity’s accounting principles;
6) disagreements with management;
7) consultation with other accountants; and
8) difficulties encountered in performing the audit.
An auditor is obligated to communicate an uncorrected audit adjustment to an entity’s audit committee (or those charged with governance) only if the adjustment
A. Is individually material.
B. Is not believed to be trivial.
C. Is a recurring matter that was proposed to management the prior year.
D. Results from the correction of a prior period’s departure from GAAP.
B. Is not believed to be trivial.
Explanation - All uncorrected misstatements must be communicated to the audit committee (or those charged with governance), unless they are deemed to be trivial.
Obtaining an understanding of an internal control involves evaluating the design of the control and determining whether the control has been A. Authorized. B. Implemented. C. Tested. D. Monitored.
B. Implemented.
Explanation - Obtaining an understanding of an entity’s internal controls over financial reporting involves evaluating the design of relevant controls and determining whether they have been implemented (sometimes referred to as “placed into operation”).
In planning an audit of certain accounts, an auditor may conclude that specific procedures used to obtain an understanding of an entity's internal control structure need not be included because of the auditor's judgments about materiality and assessments of A. Control risk. B. Detection risk. C. Sampling risk. D. Inherent risk.
D. Inherent risk.
Explanation - If the auditor has concluded that an account is immaterial and that inherent risk is low, the auditor might decide to skip the procedures used to obtain an understanding of the related internal controls because the risk of a material misstatement occurring is low.
This is really a rather tricky question because GAAS require the auditor to obtain an understanding of the internal control structure sufficient to plan the audit. In the case of immateriality combined with low inherent risk, the auditor does not need to understand the internal controls specifically related to the account in order to plan the audit.
The primary objective of procedures performed to obtain an understanding of the internal control structure is to provide an auditor with
A. Knowledge necessary for audit planning.
B. Evidential matter to use in assessing inherent risk.
C. A basis for modifying tests of controls.
D. An evaluation of the consistency of application of management’s policies.
A. Knowledge necessary for audit planning.
Explanation - The auditor is required to gain a sufficient understanding of the entity and its environment, including the internal control structure in order to determine the nature, timing, and extent of the tests to be performed. In reviewing internal control, the auditor first considers the design of controls relevant to a financial statement audit and whether such controls are in operation. Control risk is then assessed for the various financial statement assertions. Based upon the understanding of the internal control and the assessed control risk, the auditor can determine the auditing procedures to be performed.
When obtaining an understanding of an entity’s internal control procedures, an auditor should concentrate on the substance of the procedures, rather than their form, because
A. The procedures may be operating effectively but may not be documented.
B. Management may establish appropriate procedures but not enforce compliance with them.
C. The procedures may be so inappropriate that no reliance is contemplated by the auditor.
D. Management may implement procedures whose costs exceed their benefits.
B. Management may establish appropriate procedures but not enforce compliance with them.
Explanation - Internal controls may have been placed in operation, yet may not be effective because they are not properly acted upon. The auditor is concerned about the effectiveness of the control and its ability to prevent or detect material misstatements in the financial statements. As a result, the auditor must focus on the substance of the control rather than the form.
