Chapter 4

Question 1

Client firms engaged in international trade would be considered to have

Answer 1

Higher inherent risk

Question 2

The concept of inherent risk is most closely tied to the idea of

Answer 2

underlying business risks

Question 3

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

Answer 3

determines if the client is meeting principal and interest payments when they are due

Question 4

Effects illegal acts have on financial statements relating to non-compliance for material misstatements

Answer 4

Direct and material effect

Question 5

Increase an auditor’s concern pertaining to the risk of fraudulent financial reporting

Answer 5

an extremely confusing and overly complex institutional structure, with blurred lines of authority

Question 6

Representation of a risk factor in fraudulent financial reporting

Answer 6

High degree of competition in the particular industry

Question 7

Companies use profitability measures to assess performance and

Answer 7

assess their ability to compete

Question 8

Refers to measurements, agreed to beforehand, that can be quantified and reflect the success factors of an organization

Answer 8

Key performance indicators

Question 9

If the management of an entity is close to breaching a debt covenant that requires maintaining a prespecified current ratio, management may have an incentive to

Answer 9

either overstate current assets or understate current liabilities

Question 10

When scrutinizing a statement of cash flows in an attempt to gain a better understanding of the client, what would be most surprising to an auditor?

Answer 10

negative operating cash flows

Question 11

Price-earnings (PE) ratio

Answer 11

how much a stockholder is willing to pay per dollar of earnings.

Question 12

A company’s ability to meet its needs for cash

Answer 12

liquidity

Question 13

Reflects the earnings return on each issued share

Answer 13

Earnings per share ratio

Question 14

Cash earnings per share (CEPS) ratio

Answer 14

Operating cash flow/common shares issued

Question 15

sustainable cash flow from operations

Answer 15

cash flow from operations adjusted for one-time influences

Question 16

Measures the ability to generate income from funds invested by common stockholders.

Answer 16

Return on stockholders’ equity (ROE) ratio

Question 17

evaluations of financial information by studying plausible relationships among both financial and nonfinancial data

Answer 17

Analytical procedures

Question 18

Indicates the ability to generate income from average investment in total assets.

Answer 18

Return on assets

Question 19

a comparison of account balances to a single line item, such as total assets

Answer 19

common-size (vertical) analysis

Question 20

a comparison of account balances over time.

Answer 20

Trend (horizontal) analysis

Question 21

Reason for an increase in days in receivables

Answer 21

Decrease in accounts receivable turnover ratio due to poor internal controls related to credit granting procedures

Question 22

Ratios used to assess the long-term viability of a company.

Answer 22

Solvency ratios

Question 23

Use of analytical procedures during the risk assessment phase

Answer 23

Identify the accounts at risk of material misstatement.

Question 24

audit procedures least likely to disclose the existence of related-party transactions of a client during the period under audit?

Answer 24

Confirming large purchase and sales transactions with the vendors and/or customers involved.

Question 25

When auditing related-party transactions, an auditor places primary emphasis on

Answer 25

Evaluating the disclosure of the related party transactions

Question 26

An audit committee of a publicly traded company should be composed of

Answer 26

members of the board of directors who are independent directors

Question 27

Reason for maintaining an audit trail for a computer system

Answer 27

Query answering
Monitoring purposes
Deterrent to irregularities

Question 28

Risk of material misstatements associated with a client’s IT system

Answer 28

access to log on to the IT system by a terminated employee
no schedule for backing up data
Installation of new software that still needs modifications

Question 29

Client closing procedures

Answer 29

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