AUD Becker A3 - Risk, Evidence, and Sampling Part 1 Flashcards
To measure how effectively an entity employs its resources, an auditor calculates inventory
turnover by dividing average inventory into:
A. Gross sales.
B. Net sales.
C. Cost of goods sold.
D. Operating income.
Choice “3” is correct. The appropriate numerator for calculating inventory turnover is cost of goods sold. Cost of goods sold is the expense most clearly associated with the sale (turnover) of inventory, which is priced at acquisition cost, not selling price.
Choice “1” is incorrect. Gross sales is a measure of revenue that reflects the price at which inventory was sold, not its recorded inventoriable value.
Choice “2” is incorrect. Net sales is a measure of revenue that reflects the price at which inventory was sold, not its recorded inventoriable value.
Choice “4” is incorrect. Operating income does not tie specifically to the recorded value of inventory sold because it reflects the sales price after all operating expenses.
Which of the following circumstances would most likely cause an auditor to suspect that
material misstatements arising from fraud exist in a client’s financial statements?
A. Clerical errors are listed on an EDP-generated exception report.
B. Monthly bank reconciliations usually include several in-transit items.
C. Property and equipment are usually sold at a loss before being fully depreciated.
D. Significantly fewer responses to confirmation requests are received than expected.
Choice “4” is correct. Material fraud (“intentional” misstatements or omissions) may result from large amounts of fictitious accounts receivable. Receiving significantly fewer confirmation responses than expected implies some accounts receivable may be fictitious.
Choice “1” is incorrect. Clerical errors listed on an exception report would be a control over data processing that would tend to minimize the risk of material misstatement.
Choice “2” is incorrect. Bank reconciliations typically include in-transit items (e.g., deposits in transit and outstanding checks), and this would not necessarily be indicative of fraud.
Choice “3” is incorrect. Selling property and equipment at a loss from book value is not unusual and would not necessarily be indicative of fraud.
Which of the following groups within an entity is typically in the best position to perpetrate a material fraud? A. Customers. B. Directors. C. Management. D. Entry-level personnel.
Choice “3” is correct. Management is typically in the best position to perpetrate a material fraud because management can override controls to manipulate accounting records and prepare fraudulent financial statements.
Choice “1” is incorrect. Customers are typically not in the best position to perpetrate a material fraud because there are typically controls in place to prevent customers from committing fraud and customers do not have access to the company’s accounting records. In addition, even if a customer is able to commit fraud, it probably would not be at a material level.
Choice “2” is incorrect. Directors are typically not in the best position to perpetrate a material fraud because they usually are not involved in the day-to-day business of the organization. Also, directors often do not have direct access to manipulate accounting records.
Choice “4” is incorrect. Entry-level personnel typically are not in the best position to perpetrate a material fraud because there are usually controls in place to prevent or detect fraud from occurring. Also, entry-level employees typically do not have the ability to override controls.
When using classical variables sampling for estimation, an auditor normally evaluates the
sampling results by calculating the possible error in either direction. This statistical concept
is known as:
A. Standard deviation.
B. Precision.
C. Reliability.
D. Projected error.
Choice “2” is correct. The statistical concept of precision is used to describe the auditor’s evaluation of sampling results by calculating the possible error in either direction.
Choice “1” is incorrect. Standard deviation is a measure of the variability of a frequency distribution about its mean.
Choice “3” is incorrect. Reliability measures how frequently the procedure used will yield differences between the estimated value and the population value.
Choice “4” is incorrect. Projected error is the auditor’s best estimate of the error in the total population based upon evaluating the actual error rate in the sample results. The auditor then adds an allowance for sampling risk to develop a “precision interval” within which the population is expected to fall.
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. Inspecting purchase orders for proper approval by supervisors.
C. Determining that all payables are recorded at year end.
D. Selecting accounts receivable for confirmation of account balances.
Choice “2” 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.
Choice “1” is incorrect. Sampling is not used to make an independent estimate of payroll expense.
Choice “3” is incorrect. Determining that all payables are recorded at year end would not use attribute sampling because a specific control (or attribute) put in place by the client is not being tested. The completeness of year-end accounts receivable is typically tested using the search for unrecorded liabilities, which is a substantive procedure. Variables sampling and PPS sampling are typically used in substantive testing.
Choice “4” is incorrect. The selection of confirmations to verify account balances is part of substantive testing and would use variables sampling or PPS sampling, not attributes sampling.
Which of the following circumstances most likely would cause an auditor to consider
whether material misstatements exist in an entity’s financial statements?
A. Differences are discovered during the client’s annual physical inventory count.
B. Clerical errors are listed on a monthly computer-generated exception report.
C. Significant deficiencies in internal control previously communicated have not been
corrected.
D. Supporting records that should be readily available are frequently not produced when
requested.
Choice “4” is correct. Supporting records that should be readily available but are frequently not produced when requested would cause an auditor to consider whether material misstatements exist.
Choice “1” is incorrect. Differences being discovered during the client’s annual physical inventory count is a common occurrence at most companies and would not necessarily indicate that a material misstatement exists.
Choice “2” is incorrect. Clerical errors listed on a monthly computer-generated exception report would be a control over data processing that would tend to minimize the risk of material misstatement.
Choice “3” is incorrect. Failure to correct significant deficiencies in internal control may represent a conscious decision by management to accept that degree of risk because of cost or other considerations. Although this is a fraud risk factor, the auditor is more likely to be concerned about missing audit evidence.
Which of the following comparisons would an auditor most likely make in evaluating an
entity’s costs and expenses?
A. The budgeted current year’s warranty expense with the current year’s contingent
liabilities.
B. The current year’s payroll expense with the prior year’s payroll expense.
C. The budgeted current year’s sales with the prior year’s sales.
D. The current year’s accounts receivable with the prior year’s accounts receivable.
Choice “2” is correct. The most likely analytical review procedure involving costs and expenses would be to compare the current year’s payroll expense (average amount per employee) to the prior year, taking into consideration an average increase in wage rates. This is a very effective technique in auditing payroll expense.
Choice “1” is incorrect. The current year’s budgeted warranty expense would likely be compared to the current year’s actual warranty expense, not to all of the contingent liabilities for the year.
Choice “3” is incorrect. Comparing the budgeted current year’s sales with the prior year’s sales provides evidence regarding the reasonableness of the current year sales budget, but does not provide evidence about costs and expenses.
Choice “4” is incorrect. Comparing the current year’s accounts receivable balance with the prior year provides little evidence because accounts receivable may fluctuate based on timing of cash payments, which is unpredictable.
As part of risk assessment procedures for an audit of a nonissuer, an auditor would most
likely perform which of the following procedures concerning related party transactions?
A. Examine receiving and shipping records between the client and its affiliates.
B. Perform a direct test of related party account balances.
C. Confirm related party transaction amounts and terms with the other party.
D. Evaluate the entity’s procedures for identifying related party transactions
Choice “4” is correct. During risk assessment, the auditor would inquire of management to obtain an understanding and evaluate the company’s process (including controls) for identifying related parties, authorizing and approving transactions with related parties, and accounting for and disclosing relationships and transactions.
Choice “1” is incorrect. In order to examine receiving and shipping records between the client and its affiliates, the auditor must have an understanding of the company’s process for identifying related parties. Therefore, this would not happen until after many risk assessment procedures had been performed.
Choice “2” is incorrect. The auditor may perform a direct test of related party account balances, but that would be completed after the risk assessment procedures had been performed. Prior to testing the balances, the auditor must obtain an understanding and evaluate the company’s process for identifying related parties.
Choice “3” is incorrect. Confirming related party transaction amounts and terms with the other party may be a procedure performed by the auditor when performing substantive test work. This would be completed after the auditor had an understanding of how the related party transactions had been identified.
Which of the following statements reflects an auditor’s responsibility for detecting errors and
fraud?
A. An auditor is not responsible for detecting errors and fraud unless the application of
GAAS would result in such detection.
B. An auditor is responsible for detecting employee errors and fraud, but not for
discovering fraud involving employee collusion or management override.
C. An auditor should plan the audit to detect errors and fraud that are caused by
departures from GAAP.
D. An auditor should design the audit to provide reasonable assurance of detecting errors
and fraud that are material to the financial statements.
Choice “4” is correct. The auditor should assess the risk that errors and fraud may cause the financial statements to contain a material misstatement. Based on that assessment, the auditor should design the audit to provide reasonable assurance of detecting material errors and fraud.
Choice “1” is incorrect. The auditor is responsible for designing the audit to provide reasonable assurance that material misstatements due to errors or fraud have been detected. The proper application of GAAS should result in an audit designed to detect errors and fraud.
Choice “2” is incorrect. An auditor is responsible for designing the audit to provide reasonable assurance of detecting material misstatement. This responsibility is the same regardless of the cause of the misstatement. The presence of employee collusion or management override does not change the auditor’s responsibility, although it might explain why a properly planned and executed audit did not result in the discovery of material fraud.
Choice “3” is incorrect. The audit should be designed to detect material errors and fraud, regardless of the cause.
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. Perform substantive procedures for all relevant assertions related to each material
class of transactions.
B. Consider whether risk assessment procedures are appropriate given preliminary
levels of materiality and tolerable misstatement.
C. Discuss strategies to eliminate such risks with top management or those with
equivalent authority and responsibility.
D. Determine the effectiveness of general controls over classes of transactions
characterized by high transaction volume.
Choice “1” is correct. In an audit of financial statements, substantive procedures will always be necessary for all relevant assertions related to material transaction classes.
Choice “2” is incorrect. Considering the appropriateness of risk assessment procedures does not adequately respond to the fact that the auditor’s assessment of risk is always subjective rather than objective. The appropriate response is to perform substantive procedures for all relevant assertions related to each material class of transactions.
Choice “3” is incorrect. The auditors are responsible for their own assessment of risk and response to risks. They should not discuss strategies to eliminate risks with top management.
Choice “4” is incorrect. An auditor is not required to determine the effectiveness of controls in a financial statement audit.
What is the definition of fraud in an audit of financial statements?
A. An intentional act that results in a material misstatement in financial statements that
are the subject of an audit.
B. The unintentional misapplication of accounting principles relating to amounts,
classification, manner of presentation, or disclosure.
C. An intentional act that results in a material weakness in financial statements that are
the subject of an audit.
D. Management’s inability to design and implement programs and controls to prevent,
deter, and detect material misstatements.
Choice “1” is correct. The definition of fraud is an intentional act that results in a material misstatement in financial statements that are the subject of an audit.
Choice “2” is incorrect. The definition of error is an unintentional misapplication of accounting principles relating to amounts, classification, manner of presentation, or disclosure.
Choice “3” is incorrect. Fraud is an intentional act that results in a material misstatement (not material weakness) in financial statements that are the subject of an audit.
Choice “4” is incorrect. Management’s inability to design and implement programs and controls to prevent, deter, and detect material misstatements is not the definition of fraud. However, this situation most likely would increase the auditor’s assessment of risk of material misstatement.
Which of the following is the primary objective of probability proportional to sample size?
A. To identify overstatement errors.
B. To identify zero and negative balances.
C. To increase the proportion of smaller-value items in the sample.
D. To identify items where controls were not properly applied.
Choice “1” is correct. PPS sampling is a method designed to estimate overstatement errors. Zero balances, negative balances, and understated balances require special design considerations.
Choice “2” is incorrect. PPS sampling does not identify zero and negative balances; however, if such balances exist in the population, special design considerations are required in order to use PPS sampling.
Choice “3” is incorrect. PPS sampling emphasizes larger items, which are more likely to be selected for the sample.
Choice “4” is incorrect. PPS sampling is a technique used to estimate a dollar amount of error in a population. It does not identify items where controls were lacking.
For audits of financial statements made in accordance with generally accepted auditing standards, the use of analytical procedures is required to some extent: I. As a substantive test II. In the final review stage A. No Yes B. Yes Yes C. Yes No D. No No
Choice “1” is correct. Analytical procedures are required to be applied to some extent in planning and in the final review stage. In addition, although not required, analytical procedures may be used as a substantive test when they are more effective or efficient than tests of details.
Choices “2”, “3”, and “4” are incorrect, per the above explanation.
After obtaining an understanding of the entity and its environment, including its internal
control, an auditor decided to perform tests of controls. This is likely because:
A. Evidence to support a reduction in control risk is not available.
B. An increase in the assessed level of control risk is justified for certain financial
statement assertions.
C. There were many internal control weaknesses that could allow errors to enter the
accounting system.
D. The auditor’s risk assessment is based on the effective operation of controls.
Choice “4” is correct. After obtaining an understanding the entity and its environment, including its internal control, the auditor may make a risk assessment that assumes controls are operating effectively. In such cases, the auditor performs tests of controls to obtain evidence supporting this assessment.
Choice “1” is incorrect. If evidence to support a reduction in control risk is not available, tests of controls would, by definition, not be possible.
Choice “2” is incorrect. When auditors decide to perform tests of controls, they have made a preliminary assessment that controls are operating effectively. Accordingly, the performance of tests of controls is not indicative of an increase in the assessed level of control risk.
Choice “3” is incorrect. When many internal control weaknesses are identified, the auditor would not be likely to perform tests of controls. The assessed level of control risk is increased, and more reliance would be placed on substantive tests as opposed to tests of controls.
Which of the following is always necessary in a financial statement audit? I. Tests of the operating effectiveness of controls. II. Analytical procedures. III. Risk assessment procedures. A. I, II, and III. B. I and III. C. II and III. D. I and II.
Choice “3” is correct. Risk assessment procedures must be performed to assess the risk of material misstatement and to determine whether and to what extent further audit procedures are necessary. In addition, the planning process and the overall review stage of the audit must include application of analytical procedures. Tests of the operating effectiveness of controls, however, are only performed when the auditor’s risk assessment is based on the assumption that controls are operating effectively, or when substantive procedures alone are insufficient.
Choices “1”, “2”, and “4” are incorrect, based on the above explanation.
