Ch 3 - Quiz Flashcards
Hill, CPA, has been retained to audit the financial statements of Monday Co. Monday’s predecessor auditor was Post, CPA, who has been notified by Monday that Post’s services have been terminated.
Under these circumstances, which party should initiate the communications between Hill and Post?
A.) Monday’s controller or CFO.
B.) The chairman of Monday’s board of directors.
C.) Hill, the successor auditor.
D.) Post, the predecessor auditor.
C.) Hill, the successor auditor.
The initiative belongs to Hill, the successor auditor. When an auditor has been retained to audit the financial statements of an entity, the auditor contacts the predecessor auditor to obtain information about matters that may affect the conduct of the audit and to review the prior year audit documentation. The successor auditor should contact the predecessor auditor prior to final acceptance of the engagement.
Which of the following matters does an auditor usually include in the engagement letter?
A.) Analytical procedures that the auditor plans to perform.
B.) Identification of working capital deficiencies.
C.) Indications of negative cash flows from operating activities.
D.) Arrangements regarding fees and billing.
D.) Arrangements regarding fees and billing.
The engagement letter identifies the respective responsibilities of the entity and the auditor, and essentially constitutes the contract between the parties. It is customary for the engagement letter to address fee-related issues.
Which of the following factors most likely would influence an auditor’s determination of the auditability of an entity’s financial statements?
A.) The complexity of the accounting system.
B.) The operating effectiveness of control procedures.
C.) The existence of related-party transactions.
D.) The adequacy of the accounting records.
D.) The adequacy of the accounting records.
Inadequate accounting records may cause an auditor to conclude that it is unlikely that sufficient appropriate evidence will be available to support an opinion on the financial statements; accordingly, an auditor may determine that the financial statements are not auditable.
Which of the following statements is not correct about materiality?
A.) Materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and qualitative judgments.
B.) An auditor’s consideration of materiality is influenced by the auditor’s perception of the needs of a reasonable person who will rely on the financial statements.
C.) An auditor considers materiality for planning purposes in terms of the largest aggregate level of misstatements that could be material to any one of the financial statements.
D.) The concept of materiality recognizes that some matters are important for fair presentation of financial statements in conformity with GAAP, while other matters are not important.
C.) An auditor considers materiality for planning purposes in terms of the largest aggregate level of misstatements that could be material to any one of the financial statements.
An auditor considers materiality for planning purposes in terms of the SMALLEST aggregate level of misstatements that could be material to any one of the financial statements.
As a lower acceptable level of materiality is established, the auditor should plan more work on individual accounts to
Find larger misstatements.
Decrease the risk of assessing control risk too low.
Find smaller misstatements.
Increase the tolerable misstatement in the accounts.
Find smaller misstatements.
This answer is correct because a decrease in acceptable levels of materiality requires the auditor to do one or more of the following: (1) select a more effective auditing procedure, (2) perform auditing procedures closer to the balance sheet date, or (3) increase the extent of a particular auditing procedure. By increasing the extent of a procedure concerning an individual account and/or selecting a more effective procedure, the auditor will find the smaller misstatements that in aggregate might exceed his preliminary judgments about materiality. The auditor, therefore, should plan to find smaller misstatements as a lower acceptable level of materiality is established.
Which of the following is an example of an inherent risk that an auditor should consider?
Inaccurate physical inventory count.
An incorrect formula in a worksheet used to calculate a LIFO inventory reserve.
Technological developments that may render inventory obsolete.
Posting of unauthorized journal entries.
Technological developments that may render inventory obsolete.
Correct! Inherent risks are defined as risks of material misstatement before consideration of any related controls. External circumstances that influence business risks may also affect inherent risks. Technological developments causing inventory to be obsolete (and therefore susceptible to overstatement) are specifically identified as inherent risks in AICPA Professional Standards (AU-C 200.A42).
The acceptable level of detection risk is inversely related to the
Assurance provided by substantive tests.
Preliminary judgment about materiality levels.
Risk of failing to discover material misstatements.
Risk of misapplying auditing procedures.
Assurance provided by substantive tests.
Detection risk is inversely related to the assurance provided by substantive tests. The lower the detection risk, the more assurance needed from substantive testing.
As a result of control testing, a CPA has decided to reduce control risk. What is the impact on substantive testing sample size if all other factors remain constant?
The sample size would be lower.
The sample size would be higher.
The sample size would be unaffected.
The sample size would be irrelevant.
The sample size would be lower.
Correct! Lowering the assessment of control risk would permit a somewhat higher level of detection risk. Taking a smaller sample size would be associated with a higher level of detection risk, which would be appropriate in view of the reduced control risk.
As the acceptable level of detection risk increases, an auditor may change the
Assurance provided by tests of controls by using a larger sample size than planned.
Nature of substantive tests from a less effective to a more effective procedure.
Timing of substantive tests from year end to an interim date.
Assessed level of control risk from below the maximum to the maximum level.
Timing of substantive tests from year end to an interim date.
Correct answer icon
Performing substantive tests at an interim date increases the risk that misstatements that exist at the balance sheet date will not be detected by the auditor. Evidence collected at an interim date is therefore less strong than evidence collected at year end. Increasing detection risk means that the auditor can obtain less or weaker evidence. As a result, the auditor may be able to push the timing of substantive tests from year end to an interim date.
Which of the following factors would be most likely to heighten an auditor’s concern about the risk of fraudulent financial reporting?
Low growth and profitability as compared to other entities in the same industry.
Large amounts of liquid assets that are easily convertible into cash.
Financial management’s participation in the initial selection of accounting principles.
An overly complex organizational structure involving unusual lines of authority
An overly complex organizational structure involving unusual lines of authority
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 situations most likely represents the highest risk of a misstatement arising from misappropriations of assets?
A large number of transactions processed in a short period of time.
A large number of inventory items with low sales prices.
A large number of bearer bonds on hand.
A large number of fixed assets with easily identifiable serial numbers.
A large number of bearer bonds on hand.
Risk factors associated with opportunities to misappropriate assets include easily convertible assets, such as bearer bonds.
Which of the following statements is correct with respect to fraud encountered during an audit engagement of a nonissuer?
The distinguishing factor between fraud and error is the materiality of the transaction involved.
Fraudulent financial reporting can include the unintentional misstatement of amounts or disclosures in financial statements.
An auditor who initially detects fraud ultimately makes the legal determination of whether fraud has actually occurred.
It is often difficult to detect fraudulent intent in matters involving accounting estimates and the application of accounting principles.
It is often difficult to detect fraudulent intent in matters involving accounting estimates and the application of accounting principles.
CORRECT! The determination of whether a misstatement is intentional (fraud) or unintentional (error) may be difficult, especially in subjective circumstances involving accounting estimates or the application of accounting principles.
Which of the following factors most likely would cause a CPA to not accept a new audit engagement?
The prospective client is unwilling to make all financial records available to the CPA.
The CPA is unable to review the predecessor auditor’s documentation.
The prospective client has already completed its physical inventory count.
The CPA lacks an understanding of the prospective client’s operations and industry.
The prospective client is unwilling to make all financial records available to the CPA.
A CPA would not accept a client who was unwilling to make all financial records available.
Access to all financial records would be a minimum requirement for the audit, and management is required to state in the management representation letter that all financial records and data have been made available to the auditors.
Which of the following circumstances most likely would cause an auditor to consider whether material misstatements exist in an entity’s financial statements?
Significant deficiencies previously communicated have not been corrected.
Supporting records that should be readily available are frequently not produced when requested.
Clerical errors are listed on a monthly computer-generated exception report.
Differences are discovered during the client’s annual physical inventory count.
Supporting records that should be readily available are frequently not produced when requested.
An auditor would consider whether material misstatements exist if supporting records that should be readily available are frequently not produced when requested. This could indicate a lack of internal control and the possibility of management misrepresentation which, in turn, could indicate an opportunity for material misstatements to be present.
When considering clients like Boeing, inventory will most likely be the largest current asset and prepaid expenses will be one of the smallest. As a result, the auditors should plan to _______.
devote more audit time to the inventory account than the prepaid expenses account
devote more audit time to prepaid expenses to the inventory account
observe more material misstatements in prepaid expenses due to timing differences as compared to the inventory account
use more complex audit tests for inventory and more simple audit tests for prepaid expenses
devote more audit time to the inventory account than the prepaid expenses account
