Deck 1

Question 1

In a situation where there are 2 auditors (like a component auditor), which paragraphs change if the primary auditor decides they dont want to assume responsibility of the component auditor?

Answer 1

A division of responsibility affects the auditor’s responsibility paragraph and the opinion paragraph.

Also keep in mind that if the component auditor issued an opinion other than a unmodified opinion, if the reason for the unmodified opinion is not big enough to matter at the group level, the group will still issue an unmodified opinion if the group originally had an unmodified opinion.

Question 2

The most important factor concerning an auditor’s responsibility to detect errors and fraud is what?

Answer 2

The risk that mistakes, falsifications, and omissions may cause the financial statements to contain material misstatements

Question 3

All of the following may be an indication of a related party transaction with the exception of what?

Nonrecurring transaction near year-end
A loan guarantee
Consignment sale
Compensating balance arrangements

Answer 3

Consignment sale

A consignment sale is effectively a “trial sale” where the customer has a stipulated amount of days to return the product without making payment to the company. Although not a typical transaction for many companies, it is used as a sales vehicle depending on the nature of the product sold (i.e., magazines). Since it is considered an arms-length transaction, it would not be indicative of a related party transaction.

Question 4

An auditor who is unable to form an opinion on a new client’s opening inventory balances may issue an unmodified opinion on which of the current year’s statements?

Answer 4

Balance Sheet Only

If the auditor is unable to form an opinion on a new client’s opening inventory balances, the auditor will issue an opinion on the closing balance sheet only and will issue a disclaimer of opinion on the statements of income, retained earnings and cash flows.

Question 5

As it relates to analytical procedures, when would a review of FSs and disclosures for unusual transactions or unexpected balances be performed?

Answer 5

In the overall review stage

Question 6

What is an item that is not a required part of the understanding between the client and the auditor?

Answer 6

Management’s responsibility to correct control deficiencies identified by the auditor

Management may choose not to correct internal control deficiencies due to cost-benefit considerations, and this is not part of the understanding between the auditor and the client.

Question 7

What do entity level controls include?

Answer 7

Entity level controls include controls related to the control environment, the risk assessment process, and the policies over risk management practices.

Question 8

When obtaining an understanding of internal control, why should an auditor concentrate on the substance of the procedures rather than their form?

Answer 8

Because management may establish appropriate procedures but not enforce compliance with them.

The auditor should be more concerned with the effective functioning of controls than with their form.

Question 9

An auditor suspects that a client’s cashier is misappropriating cash receipts for personal use by lapping customer checks received in the mail. In attempting to uncover this embezzlement scheme, the auditor most likely would compare what?

Answer 9

Dates checks are deposited per bank statements with the dates remittance credits are recorded.

When lapping occurs, an employee uses current remittances to conceal remittances that have been stolen previously. Thus, a lag will exist from the time that this current payment is deposited until the current customer’s account is actually credited. (The current payment is applied to the previous customer’s account).

Question 10

In evaluating the reasonableness of an accounting estimate, an auditor would use what approaches?

Answer 10

• Review and test the process used to develop the estimate
• Develop an independent expectation of the estimate
• Review subsequent events or transactions occurring prior to audit completion

Question 11

What types of methods are appropriate when testing the design effectiveness of controls in an integrated audit?

Answer 11

Inquiry, Observation, and Inspection

Recalculation and reperformance are appropriate testing methods when testing operating effectiveness.

Question 12

Some items that would go in the perm file include what?

Answer 12

Items that affect more than just one year:
Lease agreements
Pension Plans
Stock based options (typically relate to more than one year)
Articles of Incorporation
Minutes of the BOD Meetings

Question 13

For PPS Sampling, how do you do the following?

1. Calculate sampling interval
   Calculate Sample size
2. When given a random starting point of 900 for a PPS sample selection and the first 3 items in the population, how do you determine what items to choose as selections?
3. How do you calculate the tainting and the projected error in a PPS sample

Answer 13

1. Calculate sampling interval = Tolerable misstatement/ reliability factor
   Calculate Sample size = BV of Population/sampling interval
2. You would take 900 (the random starting point) and once you find a cumulative amount that is = 900 or more then the next one you are looking for is 900 + sampling interval. Let’s say that the sampling interval is 100, so look at the 3 items in the pop:

item # BV Cumulative BV PPS calc
1 500 500 900
2 1,000 1,500 900
3 300 1,800 900+100

So in this example, i would select selections 2 because it is the first cumulative amount over 900, then I’m looking for the next one that is 900+100 and selection 3 is over 900+100, so i choose it to and then the next one i would be looking for is the one that is 900+100+100 until i get to the end of the sample list.

3. Tainting = difference in BV and audited value / BV
   Projected error = Tainting * Sampling Interval

Question 14

What is something an auditor would most likely perform to obtain evidence about the occurrence of subsequent events?

Answer 14

The auditor would most likely inquire of the entity’s legal counsel concerning litigation, claims and assessments arising after year-end in order to obtain evidence about the occurrence of subsequent events. Claims arising after year-end might well impact the year-end financial statements.

Question 15

What is an audit procedure that most likely would assist an auditor in identifying conditions and events that may indicate substantial doubt about an entity’s ability to continue as a going concern?

Answer 15

Confirming with third parties the details of arrangements to provide or “maintain (needed) financial support” is an audit procedure that may identify doubts about an entity’s ability to continue as a going concern.

Question 16

Regarding the nature and timing of independence communications between an accounting firm performing an initial audit of an issuer and the issuer’s audit committee, how should that communication be delivered?

Answer 16

Communication regarding independence must be made in writing prior to accepting the engagement.

Question 17

When there has been a change in accounting principles, but the effect of the change on the comparability of the financial statements is not material, what should the auditor do?

Answer 17

NOT refer to the change in the auditor’s report

If the change in accounting principles has an immaterial effect on the comparability of financial statements, no revision to the audit report is necessary.

Question 18

Auditors try to identify predictable relationships when using analytical procedures. Relationships involving transactions from which of the following accounts most likely would yield the highest level of evidence?

AR
Payroll Expense
Advertising Expense
AP

Answer 18

Payroll Expense

Payroll expense is predictable because it is based on objective information (number of employees and pay rates). It can generally be computed directly by the auditor.

The other account balances are less predictable because they are affected by other factors. Payable and receivable balances can be affected by cash payments or receipts; advertising expense is subject to management discretion.

Question 19

What are examples of evidence of failure in the operation of internal controls?

What are examples of evidence of failure in the design of internal controls?

Answer 19

Examples of deficiencies in the operation of internal controls include Management override of controls, Undue bias or lack of objectivity, and Misrepresentation by client personnel to the auditor

An example of a deficiency in the design of internal controls includes Insufficient control consciousness

Question 20

When auditing a client’s PP&E transactions, which test of details can be used to support the existence and occurrence assertion?

Answer 20

Vouch a sample of purchases to the vendor invoice and receiving report

Question 21

What is an example of an inherent risk?

Answer 21

An example of an inherent risk that an auditor should consider is technological developments that may render inventory obsolete. Inherent risk is the susceptibility that an error or omission will occur in a financial statement due to a factor other than a failure of control.

Question 22

An auditor confirmed AR as of an interim date, and all confirmations were returned and appeared reasonable. What is an additional procedure that would most likely be performed at year-end?

Answer 22

Review supporting documents for new large balances occurring after the interim date, and evaluate any significant changes in balances at year-end.

Question 23

When an independent CPA is associated with the FSs of a publicly held entity but has not audited or reviewed such statements, the appropriate form of report to be issued must include a(an) what type of report?

Answer 23

A “disclaimer of opinion” must be issued when a CPA is “associated” with FS of a publicly held entity, but has not audited or (interim) reviewed such FS.

Question 24

Does the sample size of a test of controls vary inversely with the expected population deviation rate or the tolerable rate?

Answer 24

expected population deviation rate - No
tolerable rate - Yes

The sample size for a test of controls varies directly with the expected deviation rate and inversely with the tolerable rate. If the auditor expects more errors, he or she would increase sample size; conversely, if the tolerable rate of deviation increases, not as many items need to be selected.

Question 25

An auditor’s independence is considered impaired if the auditor has what:

• An immaterial, indirect financial interest in a client
• A mortgage loan, executed with a financial institution client on March 1, 1990, that is material to the auditor’s net worth
• An automobile loan from a client bank, collateralized by the automobile
• A joint, closely-held business investment with the client that is material to the auditor’s net worth

Answer 25

A joint, closely-held business investment with the client that is material to the auditor’s net worth

According to the Independence Rule, independence is impaired with an audit client if the auditor has a direct financial interest regardless of materiality, or a material indirect financial interest in the client. A joint, closely-held business investment with the client that was material would be a clear violation.

Question 26

In determining whether transactions have been recorded, the direction of the audit testing should be from the:

General ledger balances
General JEs
Original source documents
Adjusted TB

Answer 26

Original source documents

To determine whether transactions have been recorded (completeness assertion), the auditor should trace from the source documents to the accounting records (general ledger, trial balances, etc.).

Question 27

Does the audit commiteee help solve disagreements related to the accounting treatment of material and immaterial items in the FSs?

Answer 27

No, not immaterial items

The main function of an audit committee is to enhance internal control by creating a means of direct communication between the “outside directors” and the independent auditor. The audit committee typically selects and appoints the independent auditor, sets the audit fee, assures independence of the auditor, and reviews the scope of the audit. The audit committee helps solve disagreements relating to the accounting treatment of only material items in the financial statements.

Question 28

When issuing letters for underwriters, commonly referred to as comfort letters, an accountant may provide negative assurance concerning what?

Answer 28

The conformity of the entity’s unaudited condensed interim financial information with GAAP.

When issuing letters for underwriters, commonly referred to as comfort letters, an accountant may provide negative assurance concerning the conformity of the entity’s unaudited condensed interim financial information with generally accepted accounting principles (GAAP).

Question 29

How do you calculate the allowance for sampling risk with the following information?

A sample of 200 invoices was examined and 7 of them were lacking approval. Upper deviation rate is 8%.

Answer 29

The allowance for sampling risk is the excess of the 8% upper deviation rate over the 3.5% (= 7 ÷ 200) sample deviation rate, or 4.5% (8% - 3.5%).

Question 30

What is an example of an inherent risk?

Answer 30

The entity enters into derivative transactions as hedges

The auditor would most likely consider derivative transactions as an inherent risk factor. Derivative transactions entered into as hedges may result in an increased assessment of inherent risk. For example, derivatives entered into as hedges may involve complex calculations and/or may be based on accounting estimates that are subject to significant measurement uncertainty.