Chapter 3

Question 1

gaining an understanding of the client, identifying risk factors, developing an audit strategy, and assessing materiality

Answer 1

Planning stage

Question 2

information that impacts the decision-making process of the users of the financial statements

Answer 2

Materiality

Question 3

a strategy that sets the scope, timing, and direction of the audit and provides the basis for developing a detailed audit plan

Answer 3

Audit strategy

Question 4

detailed testing of controls and substantive testing of transactions and accounts

Answer 4

Execution stage

Question 5

evaluating the results of the detailed testing in light of the auditor’s understanding of their client and forming an opinion on the fair presentation of the client’s financial statements

Answer 5

Reporting stage

Question 6

the quantity and quality of the evidence that has been gathered

Answer 6

Sufficient appropriate evidence

Question 7

the viability of a company to remain in business for the foreseeable future

Answer 7

Going concern

Question 8

an intentional act through the use of deception to obtain an unjust or illegal advantage

Answer 8

Fraud

Question 9

the rules, systems, and processes within companies used to guide and control

Answer 9

Corporate governance

Question 10

processes used by a client when finalizing the books for an accounting period

Answer 10

Closing procedures

Question 11

At the outset of every audit, an auditor must gain an understanding of their client. The purpose of this procedure is to assess the risk that the financial statements contain a material misstatement due to:

Answer 11

the nature of the client’s business

the industry in which the client operates

the level of competition within that industry

the client’s customers and suppliers

the regulatory environment in which the client operates.

Question 12

Some examples of related party transactions that require disclosure are listed below:

Answer 12

purchase and sales transactions between companies under common control or when one party has significant influence over another

rent paid from one related party to another

loans made to shareholders or senior management

loan guarantees provided by a shareholder of the company.

Question 13

CAS 550 Related Parties requires the auditor to do the following:

Answer 13

discuss with the engagement team the susceptibility of the financial statements to material misstatement due to fraud or error that could result from the entity’s related party relationships and transactions

ask management to identity all related parties and to provide an explanation as to the nature, type, and purpose of transactions with these entities

obtain an understanding of the processes and procedures management has in place to ensure all related party transactions are identified, authorized, accounted for, and disclosed in accordance with the chosen financial reporting framework

remain alert when inspecting documents such as bank confirmations, unusual sales and purchase invoices, minutes of board of director and shareholder meetings, and contracts for indicators that related party transactions may not have not been identified or disclosed to the auditor

identify and assess the risk that transactions may not be in the normal course of operations. For such transactions, inspect any underlying documents and determine the business rationale for such transactions to ensure that they are not an attempt to fraudulently misstate the financial results.

Question 14

maintaining an attitude that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence

Answer 14

Professional scepticism

Question 15

An auditor can use red flags to alert them to the possibility that a fraud may have occurred. Red flags include:

Answer 15

a high turnover of key employees

key finance personnel refusing to take leave

overly dominant management

poor compensation practices

inadequate training programs

a complex business structure

no (or ineffective) internal auditing staff

a high turnover of auditors

unusual transactions

weak internal controls.

Question 16

Financial reporting frauds

Answer 16

• Improper asset valuations
• Unrecorded liabilities
• Timing differences—bringing forward the recognition of revenues and delaying the recognition of expenses
• Recording fictitious sales
• Understating expenses
• Inappropriate application of accounting principles

Question 17

Misappropriation of assets frauds

Answer 17

• Using a company credit card for personal use
• Employees remaining on the payroll after ceasing employment
• Unauthorized discounts or refunds to customers
• Theft of inventory by employees or customers
• Using a company car for unauthorized personal use

Question 18

Examples of incentives and pressures that increase the risk of a client committing fraud include:

Answer 18

• operation in a highly competitive industry
• a significant decline in demand for products or services
• falling profits
• a threat of takeover
• a threat of bankruptcy
• ongoing losses
• rapid growth
• poor cash flows combined with high earnings
• pressure to meet market expectations
• planning to list on a stock exchange
• planning to raise debt or renegotiate a loan
• about to enter into a significant new contract
• a significant proportion of remuneration tied to earnings (that is, bonuses, options)

Question 19

Examples of opportunities that increase the risk that a fraud may have been perpetrated include:

Answer 19

• accounts that rely on estimates and judgement
• a high volume of transactions close to year end
• significant adjusting entries and reversals after year end
• significant related party transactions
• poor corporate governance mechanisms
• poor internal controls
• a high turnover of staff
• reliance on complex transactions
• transactions out of character for a business (for example, if a client leases its motor vehicles it should not have car registration expenses).

Question 20

Examples of attitudes and rationalizations used to justify a fraud include:

Answer 20

• a poor tone at the top (that is, from senior management)
• the implementation of an effective internal control structure not seen as a priority
• an excessive focus on maximization of profits and/or share price
• a poor attitude to compliance with accounting regulations
• rationalization that other companies make the same inappropriate accounting choices.

Question 21

the use of computers to store and process data and other information

Answer 21

Information technology

Question 22

When gaining an understanding of the client, the auditor will identify the geographic location of the client because:

Answer 22

more spread-out clients are harder to control.
the auditor will need to visit the various locations to assess processes and procedures at each site.
the auditor will plan to use staff from affiliated offices to visit overseas locations.

Question 23

When gaining an understanding of the client’s sources of financing, the auditor:

Answer 23

will assess if the client is meeting interest payments when they are due.

Question 24

When gaining an understanding of the client at the industry level the auditor:

Answer 24

will not ignore information about the client’s industry.

Question 25

The CSA’s Corporate Governance Guidelines are designed to help companies:

Answer 25

improve their corporate structure.
improve performance.
enhance their accountability to shareholders and other interested third parties.

Question 26

An attitude of professional scepticism means:

Answer 26

any indicator of fraud is properly investigated.

Question 27

An example of an incentive or pressure that increases the risk of fraud is:

Answer 27

the client operates in a highly competitive industry.
the client has a history of making losses.
a significant percentage of management remuneration is tied to earnings.

Question 28

The auditor must consider whether it is appropriate to assume that the client will remain as a going concern:

Answer 28

because this means that assets are valued on the basis that they will continue to be used for the purposes of conducting a business.

Question 29

The planning stage of an audit does not include:

Answer 29

executing and reporting on an audit.

Question 30

When gaining an understanding of the client, the auditor will consider:

Answer 30

related party identification.
the appropriateness of the client’s system of internal controls to mitigate identified business risks.
controls over the technology used to process and store data electronically.

Question 31

Client closing procedures:

Answer 31

are the responsibility of those charged with governance who must ensure that transactions are recorded in the correct accounting period.

Question 32

the risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated

Answer 32

Audit risk

Question 33

the susceptibility of the financial statements to a material misstatement without considering internal controls

Answer 33

Inherent risk

Question 34

statement made by management regarding the recognition, measurement, presentation, and disclosure of items included in the financial statements

Answer 34

Assertion

Question 35

an identified and assessed risk of material misstatement that, in the auditor’s judgement, requires special audit consideration

Answer 35

Significant risk

Question 36

When classifying risks as being significant, consideration is given to whether the risk:

Answer 36

• involves fraud
• is related to significant economic or accounting developments
• involves complex transactions
• involves significant related party transactions
• involves significant subjectivity in measurement of financial information
• involves significant transactions outside the client’s normal course of business.

Question 37

the risk that a client’s system of internal controls will not prevent or detect a material misstatement

Answer 37

Control risk