Chapter 5 [Professional Auditing Standards and the Audit Opinion Formulation Process]

Question 1

Recording and processing transactions that affect a group of related accounts. The _____________________ begins when a transaction occurs and ends when it is recorded in the financial statements.

Answer 1

Accounting cycle

Question 2

The record of audit procedures performed, relevant audit evidence obtained, and conclusions the auditor reached (terms such as working papers or workpapers are also sometimes used).

Answer 2

Audit documentation

Question 3

Information used by the auditor in arriving at the conclusions on which the auditor’s opinion is based.

Answer 3

Audit evidence

Question 4

Procedures designed to obtain audit evidence to support the audit opinion(s). Three categories of procedures include risk assessment procedures, tests of controls, and substantive procedures (including substantive analytical procedures and tests of details).

Answer 4

Audit procedures

Question 5

An audit document that lists the audit procedures to be followed in gathering audit evidence and helps those in charge of the audit to monitor the progress and supervise the work.

Answer 5

Audit program

Question 6

The risk that a misstatement that could occur in an assertion about a class of transaction, account balance, or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the organization’s internal control. _______________ is a function of the effectiveness of the design and operation of internal control.

Answer 6

Control risk

Question 7

An audit that includes tests of controls and
substantive procedures.

Answer 7

Controls reliance audit

Question 8

A substantive test and a related test of a relevant control that are performed concurrently, for example, a substantive test of sales transactions performed concurrently with a test of controls over those transactions.

Answer 8

Dual-purpose test

Question 9

The susceptibility of an assertion about a class of transaction, account balance, or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.

Answer 9

Inherent risk

Question 10

An assertion having a meaningful bearing on whether a financial statement account is fairly stated.

Answer 10

Relevant assertion

Question 11

A procedure performed by the auditor to obtain information for identifying and assessing the risks of material misstatement in the financial statements whether due to error or fraud. _______________________ by themselves do not provide sufficient, appropriate evidence on which to base an audit opinion but are used for purposes of planning the audit.

Answer 11

Risk assessment procedure

Question 12

An agreement made between the organization and its customer that includes agreements made outside of publicly known contracts.

Answer 12

Side agreement

Question 13

An audit that includes substantive procedures and does not include tests of controls.

Answer 13

Substantive audit

Question 14

An audit procedure designed to detect material misstatements at the assertion level. __________________________ comprise tests of details and substantive analytical procedures.

Answer 14

Substantive procedure

Question 15

A measure of the quality of audit evidence (i.e., its adequacy, relevance, and reliability in providing support for the conclusions on which the auditor’s opinion is based).

Answer 15

Sufficient appropriate audit evidence

Question 16

An audit procedure designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements, typically at the assertion level.

Answer 16

Test of controls

Question 17

Adjusting journal entries made by top management in the period-end financial reporting process.

Answer 17

Top-side journal entries

Question 18

Auditors of U.S. public companies should follow the PCAOB’s auditing standards. (T/F)

Answer 18

TRUE

Question 19

There is not much overlap; i.e., things in common among the auditing standards set by the PCAOB, AICPA, and IAASB. (T/F)

Answer 19

FALSE

Question 20

Which of the following statements is true regarding auditing standard setting in the United States?

a. The AICPA is responsible for setting auditing standards for audits of nonpublic entities.
b. The PCAOB is responsible for setting auditing standards for audits of public companies.
c. The AICPA is responsible for setting auditing standards for audits of both public and nonpublic companies.
d. The SEC sets auditing standards for auditors of public and nonpublic companies.
e. Both (a) and (b) are correct.

Answer 20

e

Question 21

The following describes a situation in which an auditor has to determine the most appropriate standards to follow.

The audited company is headquartered in Paris but has substantial operations within the United States (60% of all operations) and has securities registered with the SEC and is traded on the New York Stock Exchange (NYSE). The company uses International Financial Reporting Standards (IFRS) for its accounting framework.

What would be the most appropriate set of auditing standards to follow?

a. PCAOB.
b. Either PCAOB or AICPA.
c. Either IAASB or AICPA.
d. Only the AICPA standards would be appropriate.

Answer 21

a

Question 22

The AICPA’s and PCAOB’s standards underlying an audit are the same, and each contain four categories of standards. (T/F)

Answer 22

FALSE

Question 23

The purpose of an audit is to enhance the degree of confidence that users can place on the financial statements. (T/F)

Answer 23

TRUE

Question 24

Which of the following statements is false?

a. The purpose of an audit is to enhance the degree of confidence that managers can place in the financial statements, thereby facilitating their decision making.
b. Auditors are responsible for having the appropriate competence and capabilities to perform the audit, should comply with ethical requirements, and maintain professional skepticism throughout the audit.
c. The auditor needs to obtain reasonable assurance as to whether the financial statements are free from material misstatement.
d. An audit has inherent limitations such that the auditor is not able to obtain absolute assurance about whether the financial statements are free from
misstatement.

Answer 24

a

Question 25

Which of the following is included as part of the AICPA’s principles governing an audit?

a. Auditors need to obtain a high level of assurance that the financial statements are free of all misstatements.
b. An audit has inherent limitations such that the auditor cannot provide absolute assurance about whether the financial statements are free of misstatement.
c. Auditors need to maintain professional skepticism only on audits where there is a high risk of material misstatement.
d. All of the above are included as part of the AICPA’s principles governing an audit.

Answer 25

b

Question 26

An important precursor to implementing the audit opinion formulation process includes management’s acknowledgement that they have important responsibilities for internal control over financial reporting and the financial statements. (T/F)

Answer 26

TRUE

Question 27

The audit opinion formulation process consists of five phases, all of which must be performed on every audit engagement, regardless of the client’s public trading status. (T/F)

Answer 27

FALSE

Question 28

Which of the following statements is true about the audit opinion formulation process presented in this chapter?

a. The audit opinion formulation process is different for the financial statement only audit and the integrated audit.
b. The audit opinion formulation process is based on the premise that management has responsibility to prepare the financial statements and maintain internal control over financial reporting.
c. The audit opinion formulation process is comprised of seven phases.
d. All of the above are true statements regarding the audit opinion formulation process.

Answer 28

b

Question 29

Which of the following activities is not part of the activities within the audit opinion formulation process?

a. The auditor develops a common understanding of the audit engagement with the client.
b. The auditor determines the appropriate nonaudit consulting services to provide to the client.
c. The auditor identifies and assesses risks of material misstatements and then responds to those identified risks.
d. The auditor determines the appropriate audit opinion(s) to issue.

Answer 29

b

Question 30

The cycle approach to auditing provides a way for breaking the audit up into manageable components. (T/F)

Answer 30

TRUE

Question 31

Within a particular cycle, the auditor focuses on the flow of transactions within that cycle, including how transactions are initiated, authorized, recorded, and reported. (T/F)

Answer 31

TRUE

Question 32

Which of the following is a reason that the auditor uses an accounting cycle approach when performing an audit?

a. The accounting cycle approach allows the auditor to focus exclusively on either the balance sheet or the income statement.
b. COSO internal control components are based on the accounting cycles.
c. The accounting cycles provide a convenient way to break the audit up into manageable pieces.
d. The auditor needs to be able to provide an opinion related to each accounting cycle.

Answer 32

c

Question 33

Which of the following accounts would not be included in the Acquisition and Payment for Long-Lived Assets Cycle?

a. Revenue
b. Depreciation expense
c. Gain on disposal
d. Equipment

Answer 33

a

Question 34

The completeness assertion is typically the more relevant assertion for assets and revenue. (T/F)

Answer 34

FALSE

The completeness assertion is typically the more relevant assertion for liabilities and expenses.

Question 35

A classic inventory fraud involves management understating ending inventory, thereby yielding a reduction in cost of goods sold and an overstatement of profitability. (T/F)

Answer 35

FALSE

A classic inventory fraud involves management overstating ending inventory, thereby yielding a reduction in cost of goods sold and an overstatement of profitability.

Question 36

Which of the following is not a management assertion?

a. Completeness.
b. Existence.
c. Rights and obligations.
d. Valuation.
e. Placement.

Answer 36

e

Question 37

Which management assertion is usually most relevant for liability accounts?

a. Completeness.
b. Existence.
c. Rights and obligations.
d. Presentation and disclosure.
e. None of the above.

Answer 37

a

Question 38

Risk assessment procedures provide sufficient appropriate audit evidence on which to base an audit opinion. (T/F)

Answer 38

FALSE

Question 39

The auditor’s selection of audit procedures depends on the accounts and assertions the auditor is testing. (T/F)

Answer 39

TRUE

Question 40

Audit procedures fall into three categories. Which of the following is not a category of audit procedures?

a. Risk assessment procedures.
b. Tests of risks.
c. Tests of controls.
d. Substantive procedures.
e. All of the above are categories of audit procedures.

Answer 40

b

Question 41

Which of the following is a true statement regarding audit evidence and audit procedures?

a. The auditor has a responsibility to design and perform audit procedures to obtain sufficient appropriate audit evidence.
b. Inquiry is a type of audit procedure that typically does not require the auditor to perform additional procedures.
c. Substantive procedures are performed to test the operating effectiveness of a client’s internal control.
d. Risk assessment procedures alone provide sufficient appropriate audit evidence on which to base an audit opinion.

Answer 41

a

Question 42

The PCAOB, but not the AICPA, requires auditors to prepare audit documentation. (T/F)

Answer 42

FALSE

Question 43

Audit checklists and audit programs are examples of audit documentation. (T/F)

Answer 43

TRUE

Question 44

Which of the following information should be included in audit documentation?

a. Procedures performed.
b. Audit evidence examined.
c. Conclusions reached with respect to relevant financial statement assertions.
d. All of the above should be included.

Answer 44

d

Question 45

Which of the following statements is false regarding audit documentation?

a. An audit program is an example of audit
documentation.
b. The only purpose of audit documentation is to provide evidence that the audit was planned and performed in accordance with auditing standards.
c. Audit documentation helps facilitate internal and external inspections of completed audits.
d. Audit documentation is required on all audit engagements.

Answer 45

b

Question 46

Audit firm portfolio management decisions are influenced only by audit fee considerations. (T/F)

Answer 46

FALSE

Question 47

Auditors are required to perform an audit for any organization that needs one. (T/F)

Answer 47

FALSE

Question 48

Which of the following factors would an auditor typically not consider when making a client acceptance decision?

a. Any potential independence-impairing relationships.
b. Any internal control deficiencies.
c. Management’s commitment to GAAP.
d. Management integrity.
e. An auditor would consider all of the above factors.

Answer 48

e

Question 49

Which of the following statements regarding client acceptance/continuance decisions is false?

a. An audit firm’s client portfolio is impacted by both audit firm decisions and client decisions.
b. It would not be appropriate for audit firms to perform background checks on management of a potential client.
c. Auditors are not required to perform audits for any organization that asks for an audit.
d. Auditors should assess the background and experience of accounting personnel of a potential client

Answer 49

b

Question 50

In conducting a substantive audit, the auditor uses only substantive procedures, and does not rely on tests of internal controls. (T/F)

Answer 50

TRUE

Question 51

The auditor assesses the risk of material misstatement at only the account level. (T/F)

Answer 51

FALSE

Question 52

Which of the following statements is true regarding the design of controls related to credit limits?

a. The effectiveness of the control design is contingent on the credit manager’s process for establishing and reviewing credit limits.
b. Because the process of establishing credit limits is fairly time consuming, the control should be designed so that the marketing manager has the ability to approve sales on an ad hoc basis while waiting for the credit approval.
c. The control should be designed so that the sales manager has final approval regarding credit limits.
d. All are true statements regarding the design of controls related to credit limits.

Answer 52

a

Question 53

The baseline for quality financial reporting is that the organization will have controls over which of the following?

a. Significant, unusual transactions, particularly those that result in late or unusual journal entries.
b. Top-side journal entries.
c. Related-party transactions.
d. Significant management estimates.
e. All of the above

Answer 53

e

Question 54

One valid approach to testing controls over credit review and approval for customers that are granted credit involves taking a sample of customer orders and tracing them through the system to determine whether: (a) there was proper review of credit and (b) credit authorization or denial was proper. (T/F)

Answer 54

TRUE

Question 55

The results of the tests of controls allow the auditor to determine how much assurance about the reliability of
account balances can be obtained from the effective operation of controls. (T/F)

Answer 55

TRUE

Question 56

What actions should auditors take if they identify control deficiencies at their client?

a. Assess the severity of those deficiencies.
b. Determine whether and how the preliminary control risk assessment should be modified.
c. Provide documentation about the effect of the control risk assessment on modifications to substantive procedures.
d. Actions (a), (b), and (c) are all appropriate.
e. Only (a) and (c) are appropriate.

Answer 56

d

Question 57

In testing controls over adjusting journal entries, which of the following would the auditor likely review?

a. Supporting documentation for the entry.
b. Evidence proving that the entry is material.
c. Evidence that the debits and credits are to appropriate accounts.
d. All of the above.
e. Only two of the above (a–c) are appropriate.

Answer 57

e

Question 58

The auditor is expected to perform substantive procedures for each relevant assertion of each significant account and disclosure. (T/F)

Answer 58

TRUE

Question 59

Substantive procedures include substantive analytical procedures and tests of details. (T/F)

Answer 59

TRUE

Question 60

In performing substantive procedures, which of the following statements provides appropriate guidance to the auditor?

a. The auditor can perform both substantive analytical procedures and substantive tests of details.
b. The auditor should perform substantive procedures for all assertions of all financial statement accounts.
c. The auditor should perform more (or more rigorous) substantive procedures when control risk is low than when control risk is high.
d. All of the above statements provide appropriate guidance.
e. Only two of the above statements (a–c) provide appropriate guidance.

Answer 60

a

Question 61

In which of the following scenarios is the auditor most likely to obtain more (or more rigorous) substantive evidence?

a. When subjectivity related to the assertion is low.
b. When controls are determined to be operating effectively.
c. When the account is immaterial.
d. When the design of controls is determined to be ineffective.

Answer 61

d

Question 62

Once the auditor completes the substantive procedures in Phase IV, the auditor is in a position to issue the audit
opinion. (T/F)

Answer 62

FALSE

Question 63

If the auditor issues an opinion on the client’s internal controls and the client’s financial statements, the auditor
is required to issue two separate reports. (T/F)

Answer 63

FALSE

Question 64

Which of the following procedures is least likely to be performed during Phase V of the audit opinion formulation process?

a. Assessment of misstatements detected during the performance of substantive procedures and tests of controls.
b. Performance of preliminary analytical review procedures.
c. Performance of an engagement quality review.
d. Determination of the appropriate audit opinion(s) to issue.

Answer 64

b

Question 65

Which of the following statements is true regarding the auditor’s report on a public company’s internal control over financial reporting?

a. The audit report will indicate whether it was the company or the auditor that initially identified the indicated material weakness.
b. The auditor must explicitly reference the criteria for evaluating internal control using, for example, the COSO framework.
c. The audit is performed in conjunction with the auditing standards promulgated by the AICPA’s ASB.
d. The auditor must report on whether management used the appropriate tools in its assessment of internal control over financial reporting.

Answer 65

b