Chapter 3 Homework Flashcards
Which of the following would an auditor most likely use in determining overall materiality when planning the audit?
A) The results of tests of controls
B) The entity’s income before taxes for the period-to-date (e.g., six months)
C) The contents of the engagement letter
D) The anticipated sample size of the planned substantive tests
The entity’s income before taxes for the period-to-date (e.g., six months)
Tolerable misstatement is:
A) The amount of misstatement that management is willing to tolerate in the financial statements.
B) Materiality used to establish a scope for the audit procedures for the individual account balance or disclosures.
C) Materiality for the income statement as a whole.
D) Materiality for the balance sheet as a whole.
Materiality used to establish a scope for the audit procedures for the individual account balance or disclosures.
Which of the following best describes an audit committee?
A) An audit committee is a committee made up of the board of directors and all members of the audit team to assist in the communication related to the audit.
B) An audit committee is a committee made up of the board of directors and the upper levels of the audit team to assist in the communication related to the audit.
C) An audit committee is a subcommittee of the board of directors that is responsible for the financial reporting and disclosure process.
An audit committee is a subcommittee of the board of directors that is responsible for the financial reporting and disclosure process.
Which of the following best describes why audit committees are formed?
A) Audit committees are formed because the government wants to obtain some authority into the communication and management of the business.
B) Audit committees are formed so that management can maintain the confidentiality of information.
C) Audit committees are formed to satisfy the shareholders’ need for assurance that directors are exercising due care in the performance of their duties.
Audit committees are formed to satisfy the shareholders’ need for assurance that directors are exercising due care in the performance of their duties.
Select all of the following that are functions of the audit committee:
A) Selection of the independent auditor, discussion of audit fee with the auditor, and review of the auditor’s engagement letter.
B) Review of the independent auditor’s overall audit plan (scope, purpose, and general audit procedures).
C) Review of the annual financial statements before submission to the full board of directors for approval.
D) Review of the results of the auditor’s examination including experiences, restrictions, cooperation received, findings, and recommendations. Matters that the auditor believes should be brought to the attention of the directors or shareholders should be considered.
E) Review of the independent auditor’s evaluation of the company’s internal control systems.
F) Review of the company’s accounting, financial, and operating controls.
G) Review of the reports of internal audit staff.
H) Review of interim financial reports to shareholders before the board of directors approves them.
I) Review of the audit workpapers to ensure that the audit was conducted properly.
J) Review of the makeup of the board of directors to ensure that they are qualified to oversee the audit process.
K) Review of the qualifications of the audit staff to ensure that they are qualified to conduct the audit.
L) Review of the applicable audit standards to ensure that they apply to the audited company.
A, B, C, D, E, F, G, H.
Successor auditors need to communicate with predecessor auditors __________ accepting the engagement.
Before
__________ must ask management to authorize the predecessor auditors to discuss confidential information.
Successor auditors.
If predecessor auditors refuse communication, successor auditors __________ accept the engagement.
Can
Communication between predecessor and successor auditors aids in evaluating the __________ of management.
Integrity
Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding the predecessor’s:
A) Understanding as to the reasons for the change of auditors.
B) Awareness of the consistency in the application of generally accepted accounting principles between periods.
C) Opinion of any subsequent events occurring since the predecessor’s audit report was issued.
D) Evaluation of all matters of continuing accounting significance.
Understanding as to the reasons for the change of auditors.
A written understanding between the auditor and the entity concerning the auditor’s responsibility for fraud is usually set forth in a(n):
A) Engagement letter.
B) Internal control letter.
C) Management letter.
D) Letter of audit inquiry.
Engagement letter.
Suppose that you are the auditor of a major retail client who has reported the following income before taxes (IBT) for the first two quarters of the year: 1st quarter = $1,200,000 and 2nd quarter = $1,500,000. You are in the process of establishing overall materiality for the client. Based on prior years, the client has a 10 percent decline in IBT from the 2nd quarter to the 3rd quarter. You also know that IBT in the 4th quarter increases by 25 percent over the 3rd quarter.
Required:
Determine the amount of overall materiality for the audit based on these preliminary amounts.
Note: Round your answer to the nearest thousand value.
$287,000
Explanation
To determine overall materiality based on the information provided, the auditor would make the following calculation for the full year income before taxes:
Quarters Income before taxes
1Q $1,200,000
2Q 1,500,000
3Q 1,350,000= 1,500,000 × 0.90
4Q 1,687,500= 1,350,000 × 1.25
Estimated income before taxes: $5,737,500
Using 5% as a benchmark, overall materiality based on the estimated income before taxes would be $287,000 (rounded).
