Audit 1 - Audit Standards & Engagement Planning Flashcards
1.14 - Quality Control:
Which of the following factors does not influence a CPA firm’s quality control policies and procedures?
A) The size of the firm.
B) Cost-benefit considerations
C) The Sarbanes Oxley Act.
D) The nature of the firm’s practice.
C) The Sarbanes Oxley Act.
Quality control policies and procedures will vary from firm to firm depending on the size of the firm, the nature of its practice, and cost-benefit considerations. A CPA firm’s quality control policies and procedures are required to comply with Statements on Quality Control Standards established by the AICPA, not the Sarbanes-Oxley Act.
1.11-Audit Risk, Fraud and Errors:
Which of the following procedures would be most effective in reducing attestation risk?
A) Analytical procedures
B) Examination of evidence
C) Inquiries of senior management
D) Discussion with responsible individuals
B) Examination of evidence
Examination of evidence would be most effective in reducing attestation risk, which, similar to audit risk, is the risk that the CPA will not identify and report on something that should be identified and reported upon.
Types of audit evidence may include discussions with responsible individuals, inquiries of senior management, and the performance of analytical procedures.
1.14 - Quality Control:
According to the profession’s standards, which of the following statements is correct regarding the standards a CPA should follow when recommending tax return positions and preparing tax returns?
A) A CPA may recommend a position in which the CPA has a good faith belief that the position has substantial authority in support of its being sustained if challenged.
B) A CPA may recommend a position that the CPA concluded is frivolous as long as the position is adequately disclosed on the return.
C) A CPA may sign a tax return as tax preparer knowing that the return takes position that will not be sustained if challenged.
D) A CPA will usually not advise the client of the potential penalty consequences of the recommended tax return position.
A) A CPA may recommend a position in which the CPA has a good faith belief that the position has substantial authority in support of its being sustained if challenged.
A tax preparer should never take a position the preparer believes is frivolous. The standard for adoption of a position is that there be substantial authority in support of its being sustained if challenged.
If the CPA believes that there are potential penalties from adopting a certain position, the client should be advised of this potential.
A tax preparer should not sign a return that takes a position the CPA believes will not withstand a challenge.
1.09 - Planning Procedures:
The audit program usually cannot be finalized until the
A) Engagement letter has been signed by the auditor and the client.
B) Consideration of the entity’s internal control structure has been completed.
C) Internal control deficiencies have been communicated to the audit committee.
D) Search for unrecorded liabilities has been performed and documented.
B) Consideration of the entity’s internal control structure has been completed.
The audit program is a step-by-step list of audit procedures. These procedures are designed to achieve specific audit objectives and the audit program describes the nature, timing and extent of audit procedures.
The auditor must gain an understanding of the entity’s internal controls to design appropriate tests to achieve audit objectives. The auditor’s understanding of internal control is one of the factors considered in determining the nature, timing, and extent of further audit procedures, which will be specified in the audit programs.
1.12 - Consideration of Fraud in the Financial Statements and Fraud Risk Factors:
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) Large amounts of liquid assets that are easily convertible into cash.
C) Inability to borrow necessary capital without granting debt covenants.
D) Inability to generate cash flows from operations while reporting substantial earnings growth.
D) Inability to generate cash flows from operations while reporting substantial earnings growth.
Growth in earnings would ordinarily be associated with positive cash flows. Inability to generate cash flows when reporting earnings growth should seem unusual to the auditor and may be an indication of fraudulent financial reporting.
Management’s lack of interest in increasing the entity’s stock trend would reduce the risk of fraudulent financial reporting.
Large amounts of liquid assets may increase the likelihood of asset misappropriation but would not affect the risk of fraudulent financial reporting.
Many debt instruments involve covenants, which do not necessarily increase the risk of fraudulent financial reporting.
1.11 - Audit Risk, Fraud and Errors:
Which of the following is a step in an auditor’s decision to assess control risk below the maximum level?
A) Identify specific internal policies and procedures that are likely to detect or prevent material misstatements.
B) Apply analytical procedures to both financial data and nonfinancial information to detect conditions that may indicate weak controls.
C) Perform tests of details and account balances to identify potential errors and irregularities.
D) Document that the additional audit effort to perform tests of controls exceeds the potential reduction in substantive testing.
A) Identify specific internal policies and procedures that are likely to detect or prevent material misstatements.
An auditor would lower control risk below the maximum level if, based on the understanding of internal control, there appear to be controls that he or she could rely on to detect or prevent material misstatements. By relying on those controls, the auditor could reduce the amount of substantive testing and so improve the efficiency of the audit.
1.12 Consideration of Fraud in the Financial Statements and Fraud Risk Factors:
Which of the following parties should an auditor notify first when discovering an immaterial fraud is committed by an accounting clerk?
A) The client’s legal counsel.
B) The audit committee
C) The client’s internal auditor
D) An appropriate level of management
D) An appropriate level of management
When an auditor becomes aware, or suspicious, of fraud, the auditor should notify management at a level above the level at which the fraud occurred.
Although communication with management about fraud will be communicated to the audit committee, it is not notified first.
1.11 - Audit Risk, Fraud and Errors:
Control risk should be assessed in terms of
A) Specific control procedures
B) Control environment factors
C) Financial statement assertions
D) Types of potential misstatements
C) Financial statement assertions
Control risk is the possibility that the client’s internal controls will not prevent or detect a material misstatement on the financial statements.
A misstatement on the financial statements occurs when one or more of management’s assertions is contradicted by audit evidence.
As a result, control risk is assessed in terms of whether controls will provide reasonable assurance that management’s assertions are valid.
1.11 - Audit Risk, Fraud and Errors:
Which of the following statements is correct regarding the auditor’s consideration of the possibility of noncompliance (illegal acts) by clients?
A) The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance that no compliance (illegal acts) have been committed by clients.
B) If specific information concerning noncompliance (illegal acts) comes to the auditor’s attention, the auditor should apply audit procedures specifically directed to ascertaining whether an illegal act has occurred.
C) If an illegal act has occurred, the auditor should express a qualified opinion or an adverse opinion on the financial statements taken as a whole.
D) The auditor’s training, experience, and understanding of the client should be used to provide a basis for the determination as to whether noncompliance (illegal acts) has occurred.
C) If an illegal act has occurred, the auditor should express a qualified opinion or an adverse opinion on the financial statements taken as a whole.
When the auditor has reason to believe that an illegal act may have occurred, the auditor should perform procedures to determine if, in fact, it has and, if so, whether or not it is more than inconsequential.
The auditor is concerned about noncompliance (illegal acts) that are potentially consequential to the financial statements, not all illegal acts.
Although the auditor’s qualifications may increase the likelihood that illegal acts will be detected, they alone are not a sufficient basis for evaluating whether or not illegal acts have occurred.
The occurrence of an illegal act will only affect the auditor’s opinion if, as a result, the financial statements are materially misstated.
1.07 Engagement Letter (FACSIMILE):
Which of the following matters generally is included in an auditor’s engagement letter?
A) Management’s vicarious liability for noncompliance (illegal acts) committed by its employees.
B) The factors to be considered in setting preliminary judgments about materiality.
C) Management’s responsibility for the entity’s compliance with laws and regulations.
D) The auditor’s responsibility to search for significant internal control deficiencies.
C) Management’s responsibility for the entity’s compliance with laws and regulations.
An understanding established between the auditor and the client will include a section with the auditor’s responsibility to perform the engagement in accordance with GAAS and…
Management’s responsibilities for the preparation and fair presentation of the financial statements; for designing, implementing, and maintaining internal controls over financial reporting; for the prevention and detection of fraud; and for the entity’s compliance with applicable laws and regulations.
Factors affecting materiality are a matter of the auditor’s professional judgment and are not addressed in the engagement letter.
Management is not liable for the noncompliance (illegal acts) committed by employees and the auditor is required to obtain an understanding of internal control but not to search for significant deficiencies.
1.11 - Audit Risk, Fraud and Errors:
Which of the following audit risk components may be assessed in non-quantitative terms?
A) Control risk and detection risk
B) Control risk, detection risk, and inherent risk
C) Detection risk
D) Control risk and inherent risk
B) Control risk, detection risk, and inherent risk
Control risk and inherent risk are components of the risk of material misstatement (RMM). RMM and detection risk are components of audit risk.
All may be expressed in quantitative or non-quantitative terms.
1.09 - Planning Procedures:
Which of the following circumstances would permit an independent auditor to accept an engagement after the close of the fiscal year?
A) Issuance of a disclaimer of opinion as a result of inability to conduct certain tests required by GAAS due to the timing of acceptance of the engagement.
B) Assessment of control risk below the maximum level./
C) Receipt of an assertion from the preceding auditor that the entity will be able to continue as a going concern.
D) Remedy of limitations resulting from accepting the engagement after the close of the end of the year, such as those relating to the existence of physical inventory.
D) Remedy of limitations resulting from accepting the engagement after the close of the end of the year, such as those relating to the existence of physical inventory.
An auditor would be able to accept an engagement after the close of the fiscal year if the auditor had a means of obtaining sufficient appropriate audit evidence regarding opening balances, such as developing a remedy for the inability to observe inventory by performing alternate procedures.
The inability to obtain evidence regarding opening balances may result in a disclaimer of opinion in regard to the income statement, the statement of cash flows, and the statement of changes in equity, but it would not preclude the auditor from expressing an opinion on the balance sheet.
The auditor does not assess control risk until after the engagement has been accepted.
The auditor’s evaluation as to the ability of the client to continue as a going concern will be based on the auditor’s evaluation of evidence obtained during the course of the engagement, not a representation from the predecessor.
