Chapter 5 [Professional Auditing Standards and the Audit Opinion Formulation Process] Flashcards
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.
Accounting cycle
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).
Audit documentation
Information used by the auditor in arriving at the conclusions on which the auditor’s opinion is based.
Audit evidence
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).
Audit procedures
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.
Audit program
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.
Control risk
An audit that includes tests of controls and
substantive procedures.
Controls reliance audit
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.
Dual-purpose test
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.
Inherent risk
An assertion having a meaningful bearing on whether a financial statement account is fairly stated.
Relevant assertion
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.
Risk assessment procedure
An agreement made between the organization and its customer that includes agreements made outside of publicly known contracts.
Side agreement
An audit that includes substantive procedures and does not include tests of controls.
Substantive audit
An audit procedure designed to detect material misstatements at the assertion level. __________________________ comprise tests of details and substantive analytical procedures.
Substantive procedure
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).
Sufficient appropriate audit evidence
An audit procedure designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements, typically at the assertion level.
Test of controls
Adjusting journal entries made by top management in the period-end financial reporting process.
Top-side journal entries
Auditors of U.S. public companies should follow the PCAOB’s auditing standards. (T/F)
TRUE
There is not much overlap; i.e., things in common among the auditing standards set by the PCAOB, AICPA, and IAASB. (T/F)
FALSE
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.
e
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.
a
The AICPA’s and PCAOB’s standards underlying an audit are the same, and each contain four categories of standards. (T/F)
FALSE
The purpose of an audit is to enhance the degree of confidence that users can place on the financial statements. (T/F)
TRUE
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.
a
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.
b
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)
TRUE
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)
FALSE
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.
b
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.
b
The cycle approach to auditing provides a way for breaking the audit up into manageable components. (T/F)
TRUE
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)
TRUE
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.
c
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
a
The completeness assertion is typically the more relevant assertion for assets and revenue. (T/F)
FALSE
The completeness assertion is typically the more relevant assertion for liabilities and expenses.
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)
FALSE
A classic inventory fraud involves management overstating ending inventory, thereby yielding a reduction in cost of goods sold and an overstatement of profitability.
Which of the following is not a management assertion?
a. Completeness.
b. Existence.
c. Rights and obligations.
d. Valuation.
e. Placement.
e
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.
a
Risk assessment procedures provide sufficient appropriate audit evidence on which to base an audit opinion. (T/F)
FALSE
The auditor’s selection of audit procedures depends on the accounts and assertions the auditor is testing. (T/F)
TRUE
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.
b
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.
a
The PCAOB, but not the AICPA, requires auditors to prepare audit documentation. (T/F)
FALSE
Audit checklists and audit programs are examples of audit documentation. (T/F)
TRUE
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.
d
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.
b
Audit firm portfolio management decisions are influenced only by audit fee considerations. (T/F)
FALSE
Auditors are required to perform an audit for any organization that needs one. (T/F)
FALSE
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.
e
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
b
In conducting a substantive audit, the auditor uses only substantive procedures, and does not rely on tests of internal controls. (T/F)
TRUE
The auditor assesses the risk of material misstatement at only the account level. (T/F)
FALSE
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.
a
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
e
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)
TRUE
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)
TRUE
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.
d
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.
e
The auditor is expected to perform substantive procedures for each relevant assertion of each significant account and disclosure. (T/F)
TRUE
Substantive procedures include substantive analytical procedures and tests of details. (T/F)
TRUE
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.
a
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.
d
Once the auditor completes the substantive procedures in Phase IV, the auditor is in a position to issue the audit
opinion. (T/F)
FALSE
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)
FALSE
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.
b
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.
b
