Chapter 4

Question 1

Which of the following is an example of a strong internal control in the investment and financing cycle for a company that sells electric cars?

Answer 1

Verify that all common stock issued has been properly approved is correct. This is the only option that represents an internal control since all of the other options are substantive procedures that would be performed by the audit team. Every company should have internal controls around the issuance of common stock being properly authorized. As shown in the visual below, the Board of Directors or those charged with governance would be the party responsible for approving/authorizing any common stock to be issued.

Question 2

Which of the following acts of fraud can most likely be committed as a result of a lack of internal controls on the revenue cycle?

Answer 2

The person who processes credit memos is also the same person who issues the refund to the customer is correct. This would present a risk of fraud as that person could process credit memos and issue the refund to their own bank account. This represents a process where there is not proper segregation of duties as the authorization and record keeping are not separated from custody.

Question 3

A senior auditor conducted a dual-purpose test on a client’s invoice to determine whether the invoice was approved and to ascertain the amount and other terms of the invoice. Which of the following lists two tests that the auditor performed?

Answer 3

Tests of controls and tests of details is correct. A dual-purpose test is when the auditor can check two boxes by performing one audit procedure. The audit procedure would test internal controls and be a test of details (substantive test). A great example is testing bank reconciliations as the audit team would test the control and substantively test the bank reconciliation balances.

Question 4

Which of the following is considered an ideal method of preventing and detecting lapping?Implementing a lock box system is correct. Implementing a lockbox addresses the fact that someone in the company has custody of funds and access to record keeping (segregation of duties issue). Implementing a lockbox places custody of cash with the bank since all of the company’s customers send the funds directly to the bank.

Answer 4

Implementing a lock box system is correct. Implementing a lockbox addresses the fact that someone in the company has custody of funds and access to record keeping (segregation of duties issue). Implementing a lockbox places custody of cash with the bank since all of the company’s customers send the funds directly to the bank.

Question 5

A check being drawn on one bank is deposited into another bank while no record is made of the expenditure in the balance of the first bank best describes:

Answer 5

Kiting is correct. Check kiting is a form of fraud that involves floating checks from one bank account to another. Generally, the objective of check kiting is for the client to attempt to make use of a fund or bank account that might not actually exist. Proper segregation of duties and strong internal controls around cash can help prevent the risk of kiting.
Lapping is incorrect. Kiting is different from lapping since lapping is described as the theft of cash and failing to record the cash receipt in the company’s accounting records.

Question 6

“Cash recorded in two places at once” best describes:

Answer 6

Kiting is correct. kiting is a form of fraud that involves floating checks from one bank account to another so that sounds like cash being recorded in two places at once.

Question 7

The auditor of a nonissuer would most appropriately use reperformance to obtain audit evidence for which of the following purposes?

Answer 7

To test the operating effectiveness of a bank reconciliation control is correct. Within the cash cycle, bank reconciliations are a key internal control that pretty much every company should perform. The audit team will need to assess whether or not the company performs effective bank reconciliations. The easiest way to test whether the bank reconciliation control is operating effectively is for the auditor to “reperform” the bank reconciliation.

Question 8

An auditor decides to perform substantive tests on a client’s property and equipment balance as of an interim date. The auditor has not obtained evidence about the operating effectiveness of relevant controls. What additional work must be performed to extend the audit conclusions from the interim date to the balance sheet date?

Answer 8

Substantive procedures for the period between the interim date and the balance sheet date is correct. Since the audit team is performing substantive testing as of an interim date, they will need to perform additional substantive testing procedures to roll-forward their conclusion to the report date of the balance sheet.

Question 9

In regard to substantive procedures related to the expenditure cycle, all of the following are considered potential substantive procedures when testing for completeness except:

Answer 9

Verifying that the purchase order, receiving report, and invoice agree (3 way match) is correct. Remember that another term for the 3 way match is the “vendor package”, which is how the exam likes to refer to this concept. While this relates to the expenditure cycle, the audit team would perform this during test of controls and not during substantive testing. In addition, this test could be used for substantive purposes, but it would be testing the accuracy assertion and not the completeness assertion.

Question 10

Emily is an auditing a Jet Ski Company based in Bali. Which of the following procedures would Emily, the senior auditor, most likely perform to identify unusual sales transactions?

Answer 10

Comparing quarterly sales trends by product or customer is correct. Emily should start by performing analytical procedures and assessing sales trends by looking at specific products, locations, or customers and see if there are any unusual trends.`

Question 11

Kenny, from East Bound Audit Firm, wants to know which of the following best describes substantive procedures related to payroll and personnel when testing for the completeness assertion?

Answer 11

Verify that a sample of time sheets are included in the payroll register is correct. This procedure would test the completeness assertion by selecting time sheets and verifying they are listed in the payroll register (as shown in the visual below). If the audit team selects a time sheet for an employee and cannot locate the record in the payroll register, then the audit team would know that the payroll register is not complete. The payroll register is generally used to support the balance in the financial statements.

Question 12

Which of the following procedures would most likely confirm the existence of long-term investments made by a company in the current year?

Answer 12

Obtain third-party confirmations from the investments broker dealer to confirm the number of shares owned by the client is correct. Confirmations requested from custodians and third-party relationships such as broker dealers, would confirm the existence of investments owned by the client.

Question 13

Ringo, the auditor, is reviewing an invoice sent to a customer for $99.99. Ringo wants to ensure the invoice was accurately recorded in the accounting records. What assertion is Ringo testing if he/she obtained the invoice and compared it to the journal entry for the sale?

Answer 13

Accuracy is correct. If Ringo obtains the invoice and wants to verify that the sale amount of $99.99 per the invoice is what was recorded in the accounting records, then he or she is testing the accuracy assertion. Accuracy addresses the fact that transactions are properly recorded in the accounting records. What if the company was constantly taking real invoices and sales, but incorrectly inputting them into the accounting records? Well that is why the audit team would perform substantive tests in revenue to test the accuracy of sales being recorded in the accounting records.

Question 14

An auditor concerned with the completeness of dividend income would most likely:

Answer 14

Review dividend record books produced by outside service companies is correct. Dividend income is income that a company receives from owning stock in another company. When a company issues dividends, a 3rd party broker (i.e. E-Trade or Robinhood) would help verify the shareholders and who is entitled to receive the dividend.

Question 15

Slick Mick at Sandy Beach CPAs is considering whether the omission of the confirmation of investments impairs the auditor’s ability to support a previously expressed unmodified opinion. Which of the following is a true statement that explains why the team can issue an unmodified opinion assuming the investment is material?

Answer 15

The results of alternative procedures that were performed compensate for the omission is correct. If confirmation procedures for the audit team fail, the audit team can perform alternative procedures to obtain assurance that the investment balance is free of material misstatement.

Question 16

The Double Eagle audit team, which is based in San Francisco, is required to assess whether the company’s financial statements include all required disclosures for the inventory cycle. All of the following are required inventory disclosures EXCEPT:

Answer 16

The top 5 vendors that the company purchased raw materials from is correct. This is not a required disclosure, which is why this is the correct answer. Required disclosures:
Cost and valuation method
Raw materials, work-in-process, and finished goods balances
Pledged or assigned inventory
Consigned inventory
Warranty obligations
Significant losses from inventory write-downs or purchase commitments

Question 17

When determining whether uncorrected misstatements are material, individually or in the aggregate, an auditor of a nonissuer would consider each of the following, except:

Answer 17

The cost of correcting the misstatements is correct. This is the only option that an auditor should not consider when it comes to uncorrected misstatements. The auditor is responsible for bringing misstatements to the attention of management and those charged with governance, but they can’t require the company to correct the misstatement. The company can definitely choose not to record the misstatement and the auditor will have to assess the impact that has on their opinion. Overall, the cost or time it takes to correct a misstatement is not the concern of the auditor.

Question 18

According to PCAOB standards, which one of the following statements does not reflect a qualitative standard that should be considered when evaluating the materiality of an uncorrected misstatement?

Answer 18

The dollar amount of the error is correct. The keyword to focus on in the question is “qualitative”, which is different than quantitative. The question is asking which “does not reflect” a qualitative standard that should be considered. Since misstatements can either be quantitative or qualitative, we are looking for a quantitative reason (numbers based).

Question 19

An auditor has determined a materiality threshold of $100,000 for a client. The auditor has accumulated audit evidence that supports an allowance for bad debts in the range of $1.5 million to $1.8 million. The client recorded $800,000 as the allowance for bad debts and declines to record any additional allowance. What proposed adjustment will the auditor include in the summary of unadjusted differences?

Answer 19

Debit bad debt expense $700,000; credit allowance for bad debts $700,000 is correct. Since the client has a bad debt allowance of $800,000 recorded, that falls outside the audit estimate, which was $1,500,000 on the low end of the range. The difference of $800,000 far exceeds the materiality threshold of $100,000. Therefore, the audit team would propose an adjustment for the client to record.

Question 20

Misstatements discovered by the auditor were immaterial in the aggregate in prior years. Such misstatements should be:

Answer 20

Considered in the evaluation of audit findings in the current year is correct. Documentation of uncorrected misstatements in the audit file is critical and is required under GAAS.
The audit team needs to use the prior year summary of uncorrected misstatements and consider them when evaluating the current year misstatements. The audit team will need to see if the combination of the prior year and current year misstatements results in an aggregated misstatement.

Question 21

Nio Technology received legal services from Samson Law Firm during Year 3. The company’s auditors received back legal confirmations from Samson that indicated that Year 3 unpaid legal fees for Nio totaled $150,000. Nio currently has $130,000 of legal fees accrued for Samson on their balance sheet. Assuming performance materiality is $50,000, what adjusting entry should the auditors propose?

Answer 21

No adjusting entry is necessary as the difference is less than performance materiality is correct. Based on the legal confirmation, Nio’s accrual for Samson Year 3 legal fees is $20,000 understated. However, since performance materiality is $50,000, the misstatement is not material, so the auditors would not propose an adjusting entry. However, the auditors would add the $20,000 difference to the summary of uncorrected misstatements to verify there is no material misstatement when aggregated with other misstatements.

Question 22

An auditor’s evaluation of uncorrected misstatements for an audit of an issuer should include evaluation of the effects of uncorrected misstatements detected in:

Answer 22

The prior years and misstatements detected in the current year that relate to prior years is correct. Uncorrected misstatements from the prior year, along with those identified in the current year that relate to the prior year, should be considered as they may aggregate and result in a material misstatement. Audit teams should maintain a summary of uncorrected misstatements to continually assess whether the uncorrected misstatements result in a material misstatement when aggregated.

Question 23

In planning an audit, an auditor established materiality at $40,000. The auditor received an attorney’s letter indicating that it was probable that each of three lawsuits would be settled for $30,000. Which of the following actions should the auditor take?

Answer 23

Ask the client to record the liability for the three contingencies is correct. Since it is probable that the lawsuits will be settled for $30,000 each, then that results in a total liability of $90,000, which exceeds materiality of $40,000. Therefore, the audit team would propose a journal entry to have the client record the contingent liability related to the lawsuits.

Question 24

Whose signatures should be included in the management representation letter to the auditor?

Answer 24

President and chief financial officer is correct. The written representation letter would be addressed to and signed by the CEO (President) and CFO of the company. These are the two key executives involved with the financial statements, so just remember these two individuals would be part of the written representation letter.

Question 25

Which of the following is the principal reason for the requirement to obtain a management representation letter from client management?

Answer 25

To complement other auditing procedures that have been performed is correct. A management representation letter is “additional” or “complimentary” audit evidence and should never “reduce” or “replace” other audit procedures.

Question 26

The ultimate purpose of assessing control risk is to contribute to the auditor’s evaluation of the risk that:

Answer 26

Material misstatements may exist in the financial statements is correct. The ultimate purpose of assessing control risk is to contribute to the auditor’s evaluation of the risk that the material misstatements may exist within the financial statements. Control risk plus inherent risk provides a basis for the auditor’s overall assessment of the client’s risk of material misstatements.

Question 27

Which of the following should an auditor do when control risk is assessed at the maximum level?

Answer 27

Document the assessment is correct. The professional standards require documentation of the assessment when control risk is assessed at a maximum level.

Question 28

Detection risk is a function of:

Answer 28

The effectiveness of audit procedures and of the manner in which they are applied is correct. Detection risk is controlled by the audit team and is based on the combined assessment of inherent risk and control risk. If detection risk is set at low, that means that the audit team needs to perform more effective audit procedures to detect material misstatements. Therefore, the audit team would perform substantive tests that are more effective like observation or confirmations, rather than relying on internal evidence from the company.