Engagement Planning, Obtaining an Understanding of the Client and Assessing Risks

Question 1

1. Financial statement assertions are established for account
balances,
Classes of transactions Disclosures
a. Yes Yes
b. Yes No
c. No Yes
d. No No

Answer 1

1. (a) The requirement is to identify the categories of
   fi nancial statement assertions. Answer (a) is correct because
   the professional standards establish fi nancial statement
   assertions for account balances, classes of transactions
   and disclosures. Answer (b) is incorrect because fi nancial
   statement assertions are established for disclosures. Answer
   (c) is incorrect because fi nancial statement assertions are
   established for classes of transactions. Answer (d) is incorrect
   because fi nancial statement assertions are established for both
   classes of transactions and disclosures

Question 2

2. Which of the following is not a fi nancial statement
assertion relating to account balances?
a. Completeness.
b. Existence.
c. Rights and obligations.
d. Valuation and competence

Answer 2

2. (d) The requirement is to identify the item that is not
   a fi nancial statement assertion relating to account balances.
   Answer (d) is correct because valuation and allocation is an
   account balance assertion, not valuation and competence.
   Answer (a) is incorrect because completeness is an assertion
   relating to account balances. Answer (b) is incorrect because
   existence is an assertion relating to account balances. Answer (c) is incorrect because rights and obligations is an assertion
   relating to account balances.

Question 3

3. As the acceptable level of detection risk decreases, an
   auditor may
   a. Reduce substantive testing by relying on the
   assessments of inherent risk and control risk.
   b. Postpone the planned timing of substantive tests from
   interim dates to the year-end.
   c. Eliminate the assessed level of inherent risk from
   consideration as a planning factor.
   d. Lower the assessed level of control risk from the
   maximum level to below the maximum.

Answer 3

3. (b) The requirement is to determine a likely auditor
   reaction to a decreased acceptable level of detection risk.
   Answer (b) is correct because postponement of interim
   substantive tests to year-end decreases detection risk by
   reducing the risk for the period subsequent to the performance
   of those tests; other approaches to decreasing detection risk
   include changing to more effective substantive tests and
   increasing their extent. Answer (a) is incorrect because increased,
   not reduced, substantive testing is required. Answer
   (c) is incorrect because inherent risk must be considered in
   planning, either by itself or in combination with control risk.
   Answer (d) is incorrect because tests of controls must be
   performed to reduce the assessed level of control risk.

Question 4

4. The risk that an auditor will conclude, based on substantive
   tests, that a material misstatement does not exist in an account
   balance when, in fact, such misstatement does exist is
   referred to as
   a. Sampling risk.
   b. Detection risk.
   c. Nonsampling risk.
   d. Inherent risk.

Answer 4

4. (b) The requirement is to identify the risk that an auditor
   will conclude, based on substantive tests, that a material error
   does not exist in an account balance when, in fact, such error does exist. Answer (b) is correct because detection risk is the
   risk that the auditor will not detect a material misstatement
   that exists in an assertion. Detection risk may be viewed
   in terms of two components (1) the risk that analytical
   procedures and other relevant substantive tests would fail to
   detect misstatements equal to tolerable misstatement, and (2)
   the allowable risk of incorrect acceptance for the substantive
   tests of details. Answer (a) is incorrect because sampling
   risk arises from the possibility that, when a test of controls
   or a substantive test is restricted to a sample, the auditor’s
   conclusions may be different from the conclusions he or she
   would reach if the tests were applied in the same way to all
   items in the account balance or class of transactions. When
   related to substantive tests sampling risk is only a part of
   the risk that the auditor’s substantive tests will not detect
   a material misstatement. Answer (c) is incorrect because
   nonsampling risk includes only those aspects of audit risk
   that are not due to sampling. Answer (d) is incorrect because
   inherent risk is the susceptibility of an assertion to a material
   misstatement, assuming that there are no related controls

Question 5

5. As the acceptable level of detection risk decreases, the
assurance directly provided from
a. Substantive tests should increase.
b. Substantive tests should decrease.
c. Tests of controls should increase.
d. Tests of controls should decrease.

Answer 5

5. (a) The requirement is to identify an effect of a decrease
   in the acceptable level of detection risk. Answer (a) is correct
   because as the acceptable level of detection risk decreases,
   the assurance provided from substantive tests should increase.
   To gain this increased assurance the auditors may (1) change
   the nature of substantive tests to more effective procedures
   (e.g., use independent parties outside the entity rather than
   those within the entity), (2) change the timing of substantive
   tests (e.g., perform them at year-end rather than at an interim
   date), and (3) change the extent of substantive tests (e.g., take
   a larger sample). Answer (b) is incorrect because the assurance
   provided from substantive tests increases, it does not decrease.
   Answers (c) and (d) are incorrect because the acceptable
   level of detection risk is based largely on the assessed levels
   of control risk and in-herent risk. Accordingly, any tests of
   controls will already have been performed.

Question 6

6. Which of the following audit risk components may be
   assessed in nonquantitative terms?
   Control risk Detection risk Inherent risk
   a. Yes Yes No
   b. Yes No Yes
   c. Yes Yes Yes
   d. No Yes Yes

Answer 6

6. (c) The requirement is to determine whether inherent
   risk, control risk, and detection risk may be assessed in
   nonquantitative terms. Answer (c) is correct because all of
   these risks may be assessed in either quantitative terms such as
   percentages, or nonquantitative terms such as a range from a
   minimum to a maximum.

Question 7

7. Inherent risk and control risk differ from detection risk in
   that they
   a. Arise from the misapplication of auditing procedures.
   b. May be assessed in either quantitative or
   nonquantitative terms.
   c. Exist independently of the fi nancial statement audit.
   d. Can be changed at the auditor’s discretion.

Answer 7

7. (c) The requirement is to determine a manner in which
   inherent risk and control risk differ from detection risk.
   Answer (c) is correct because inherent risk and control risk
   exist independently of the audit of the fi nancial statements as
   functions of the client and its environment, whereas detection
   risk relates to the auditor’s procedures and can be changed
   at his or her discretion. Answer (a) is incorrect because
   inherent risk and control risk are functions of the client and its
   environment and do not arise from misapplication of auditing
   procedures. Answer (b) is incorrect because inherent risk,
   control risk and detection risk may each be assessed in either
   quantitative or nonquantitative terms. Answer (d) is incorrect
   because inherent risk and control risk are functions of the
   client and its environment, they cannot be changed at the
   auditor’s discretion. However, the assessed levels of inherent
   and control risk (not addressed in this question) may be affected by auditor decisions relating to the cost of gathering
   evidence to substantiate assessed levels below the maximum

Question 8

8. On the basis of the audit evidence gathered and evaluated,
   an auditor decides to increase the assessed level of control risk
   from that originally planned. To achieve an overall audit risk
   level that is substantially the same as the planned audit risk
   level, the auditor would
   a. Decrease substantive testing.
   b. Decrease detection risk.
   c. Increase inherent risk.
   d. Increase materiality levels.

Answer 8

8. (b) The requirement is to determine the best way for
   an auditor to achieve an overall audit risk level when the
   audit evidence relating to control risk indicates the need to
   increase its assessed level. Answer (b) is correct because a
   decrease in detection risk will allow the auditor achieve an
   overall audit risk level substantially the same as planned.
   Answer (a) is incorrect because a decrease in substantive
   testing will increase, not decrease, detection risk and thereby
   increase audit risk. Answer (c) is incorrect because an increase
   in inherent risk will also increase audit risk. Answer (d) is
   incorrect because there appears to be no justifi cation for
   increasing materiality levels beyond those used in planning the
   audit.

Question 9

9. Relationship between control risk and detection risk is
ordinarily
a. Parallel.
b. Inverse.
c. Direct.
d. Equal.

Answer 9

9. (b) The requirement is to determine the relationship
   between control risk and detection risk. Inverse is correct
   because as control risk increases (decreases) detection risk
   must decrease (increase).

Question 10

10. Which of the following would an auditor most likely
    use in determining the auditor’s preliminary judgment about
    materiality?
    a. The anticipated sample size of the planned substantive
    tests.
    b. The entity’s annualized interim fi nancial statements.
    c. The results of the internal control questionnaire.
    d. The contents of the management representation letter.

Answer 10

10. (b) The requirement is to identify the information that
    an auditor would most likely use in determining a preliminary
    judgment about materiality. Answer (b) is correct because
    many materiality measures relate to an annual fi gure (e.g., net
    income, sales). Answer (a) is incorrect because the preliminary
    judgment about materiality is a factor used in determining the
    anticipated sample size, not the reverse as suggested by the
    reply. Answers (c) and (d) are incorrect because materiality
    will not normally be affected by the results of the internal
    control questionnaire or the contents of the management
    representation letters.

Question 11

11. Which of the following statements is not correct about
    materiality?
    a. The concept of materiality recognizes that some
    matters are important for fair presentation of fi nancial
    statements in conformity with GAAP, while other
    matters are not important.
    b. An auditor considers materiality for planning
    purposes in terms of the largest aggregate level of
    misstatements that could be material to any one of the
    fi nancial statements.
    c. Materiality judgments are made in light of
    surrounding circumstances and necessarily involve
    both quantitative and qualitative judgments.
    d. An auditor’s consideration of materiality is infl uenced
    by the auditor’s perception of the needs of a reasonable
    person who will rely on the fi nancial statements

Answer 11

11. (b) The requirement is to identify the statement that is
    not correct concerning materiality. Answer (b) is the proper
    reply because the auditor considers materiality for planning
    purposes in terms of the smallest, not the largest, aggregate
    amount of misstatement that could be material to any one of
    the fi nancial statements. Answers (a), (c), and (d) all represent
    correct statements about materiality.

Question 12

13. Which of the following is correct concerning performance
    materiality on an audit?
    a. It will ordinarily be less than fi nancial statement
    materiality.
    b. It should be established at beginning of an audit and
    not be revised thereafter.
    c. It should be established at separate amounts for the
    various fi nancial statements.
    d. It need not be documented in the working papers.

Answer 12

13. (a) The requirement is to determine the correct statement
    with respect to performance materiality on an audit. Answer
    (a) is correct because performance materiality is largely
    established to help provide assurance that several immaterial
    misstatements do not combine to a material undetected amount
    of misstatement; accordingly, it ordinarily is established at a
    level lower than that of materiality for the fi nancial statements. Answer (b) is incorrect because performance materiality
    may be revised throughout the audit, particularly when
    circumstances depart from those which had been expected
    while planning the audit. Answer (c) is incorrect because
    performance materiality is ordinarily established for the
    fi nancial statements as a whole, and if applicable, materiality
    levels for particular classes of transactions, account balances,
    or disclosures. Answer (d) is incorrect because performance
    materiality must be documented in the working papers.

Question 13

14. Which of the following would an auditor most likely
    use in determining the auditor’s preliminary judgment about
    materiality?
    a. The results of the initial assessment of control risk.
    b. The anticipated sample size for planned substantive tests.
    c. The entity’s fi nancial statements of the prior year.
    d. The assertions that are embodied in the fi nancial
    statements.

Answer 13

14. (c) The requirement is to identify the information that an
    auditor would be most likely to use in making a preliminary
    judgment about materiality. Answer (c) is correct because
    auditors often choose to use a measure relating to the prior
    year’s fi nancial statements (e.g., a percentage of total assets,
    net income, or revenue) to arrive at a preliminary judgment
    about materiality. Answer (a) is incorrect because materiality
    is based on the magnitude of an omission or misstatement
    and not on the initial assessment of control risk. Answer (b)
    is incorrect because while an auditor’s materiality judgment
    will affect the anticipated sample size for planned substantive
    tests, sample size does not affect the materiality judgment.
    Answer (d) is incorrect because the assertions embodied in
    the fi nancial statements remain the same from one audit to
    another.

Question 14

15. Holding other planning considerations equal, a decrease
    in the amount of misstatement in a class of transactions that an
    auditor could tolerate most likely would cause the auditor to
    a. Apply the planned substantive tests prior to the
    balance sheet date.
    b. Perform the planned auditing procedures closer to the
    balance sheet date.
    c. Increase the assessed level of control risk for relevant
    fi nancial statement assertions.
    d. Decrease the extent of auditing procedures to be
    applied to the class of transactions.

Answer 14

15. (b) The requirement is to identify the most likely
    effect of a decrease in the tolerable amount of misstatement
    (tolerable misstatement) in a class of transactions. Answer (b)
    is correct because auditing standards state that decreasing the
    tolerable amount of misstatement will require the auditor to do
    one or more of the following: (1) perform auditing procedures
    closer to the balance sheet date (answer [b]); (2) select a more
    effective auditing procedure; or (3) increase the extent of a
    particular auditing procedure. Answer (a) is incorrect because
    in such a circumstance substantive tests are more likely to be
    performed at or after the balance sheet date than prior to the
    balance sheet date. Answer (c) is incorrect because decreasing
    the tolerable amount of misstatement will not necessarily lead
    to an increase in the assessed level of control risk. Answer (d)
    is incorrect because the extent of auditing procedures will be
    increased, not decreased.

Question 15

16. When issuing an unmodifi ed opinion, the auditor who
    evaluates the audit fi ndings should be satisfi ed that the
    a. Amount of known misstatement is documented in the
    management representation letter.
    b. Estimate of the total likely misstatement is less than a
    material amount.
    c. Amount of known misstatement is acknowledged and
    recorded by the client.
    d. Estimate of the total likely misstatement includes the
    adjusting entries already recorded by the client.

Answer 15

16. (b) The requirement is to identify the necessary
    condition for an auditor to be able to issue an unmodifi ed
    opinion. Answer (b) is correct because if the estimate of likely
    misstatement is equal to or greater than a material amount
    a material departure from generally accepted accounting
    principles exists and thus AU-C 705 requires either a qualifi ed
    or adverse opinion in such circumstances. Answer (a) is
    incorrect because the amount of known misstatement (if any)
    need not be documented in the management representation
    letter. Answer (c) is incorrect because it ordinarily is not
    necessary for the client to acknowledge and record immaterial
    known misstatements. Answer (d) is incorrect because the
    total likely misstatement need not include the adjusting entries
    already recorded by the client.

Question 16

17. Which of the following is an example of fraudulent
    fi nancial reporting?
    a. Company management changes inventory count tags
    and overstates ending inventory, while understating
    cost of goods sold.
    b. The treasurer diverts customer payments to his
    personal due, concealing his actions by debiting an
    expense account, thus overstating expenses.
    c. An employee steals inventory and the “shrinkage” is
    recorded in cost of goods sold.
    d. An employee steals small tools from the company
    and neglects to return them; the cost is reported as a
    miscellaneous operating expense.

Answer 16

17. (a) The requirement is to identify the example
    of fraudulent fi nancial reporting. Answer (a) is correct
    because fraudulent fi nancial reporting involves intentional
    misstatements or omissions of amounts or disclosures in fi nancial statements to deceive fi nancial statement users
    and changing the inventory count tags results in such a
    misstatement. Answers (b), (c), and (d) are all incorrect
    because they represent the misappropriation of assets.
    See AU-C 240, which divides fraudulent activities into
    misstatement arising from fraudulent fi nancial reporting
    and misstatements arising from misappropriation of assets
    (sometimes referred to as defalcation).

Question 17

18. Which of the following best describes what is meant by
    the term “fraud risk factor?”
    a. Factors whose presence indicates that the risk of fraud
    is high.
    b. Factors whose presence often have been observed in
    circumstances where frauds have occurred.
    c. Factors whose presence requires modifi cation of
    planned audit procedures.
    d. Material weaknesses identifi ed during an audit.

Answer 17

18. (b) The requirement is to identify the best description
    of what is meant by a “fraud risk factor.” Answer (b)
    is correct because AU-C 240 suggests that while fraud risk
    factors do not necessarily indicate the existence of fraud,
    they often have been observed in circumstances where frauds
    have occurred. Answer (a) is incorrect because the risk of
    fraud may or may not be high when a risk factor is present.
    Answer (c) is incorrect because the current audit plan may in
    many circumstances appropriately address a fraud risk factor.
    Answer (d) is incorrect because a fraud risk factor may or may
    not represent a material weakness.

Question 18

19. Which of the following is correct concerning
    requirements about auditor communications about fraud?
    a. Fraud that involves senior management should be
    reported directly to the audit committee regardless of
    the amount involved.
    b. Fraud with a material effect on the fi nancial
    statements should be reported directly by the auditor
    to the Securities and Exchange Commission.
    c. Fraud with a material effect on the fi nancial
    statements should ordinarily be disclosed by the
    auditor through use of an “emphasis of a matter”
    paragraph added to the audit report.
    d. The auditor has no responsibility to disclose fraud
    outside the entity under any circumstances.

Answer 18

19. (a) The requirement is to identify the reply which
    represents an auditor communication responsibility relating
    to fraud. Answer (a) is correct because all fraud involving
    senior management should be reported directly to the audit
    committee. Answer (b) is incorrect because auditors are
    only required to report fraud to the Securities and Exchange
    Commission under particular circumstances. Answer (c) is
    incorrect because auditors do not ordinarily disclose fraud
    through use of an “emphasis of a matter” paragraph added
    to their report. Answer (d) is incorrect because under certain
    circumstances auditors must disclose fraud outside the entity.

Question 19

20. When performing a fi nancial statement audit, auditors are
    required to explicitly assess the risk of material misstatement
    due to
    a. Errors.
    b. Fraud.
    c. Illegal acts.
    d. Business risk.

Answer 19

20. (b) The requirement is to identify the risk relating to
    material misstatement that auditors are required to assess.
    Answer (b) is correct because auditors must specifi cally
    assess the risk of material misstatements due to fraud and
    consider that assessment in designing the audit procedures
    to be performed. Answer (a) is incorrect because while
    AU-C 315 also requires an assessment of the overall risk of
    material misstatement (whether caused by error or fraud)
    there is no requirement to explicitly assess the risk of material
    misstatement due to errors. Answer (c) is incorrect because the
    auditor need not explicitly assess the risk of misstatement due
    to illegal acts. Answer (d) is incorrect because no assessment
    of business risk is required.

Question 20

21. Audits of fi nancial statements are designed to obtain
assurance of detecting misstatement due to
Errors
Fraudulent
fi nancial reporting
Misappropriation
of assets
a. Yes Yes Yes
b. Yes Yes No
c. Yes No Yes
d. No Yes No

Answer 20

21. (a) The requirement is to determine whether audits
    are designed to provide reasonable assurance of detecting
    misstatements due to errors, fraudulent fi nancial reporting,
    and/or misappropriation of assets. Answer (a) is correct
    because AU-C 240 requires that an audit obtain reasonable
    assurance that material misstatements, whether caused by error
    or fraud, be detected. Fraudulent fi nancial reporting and the
    misappropriation of assets are the two major types of fraud
    with which an audit is relevant.

Question 21

22. An auditor is unable to obtain absolute assurance that
    misstatements due to fraud will be detected for all of the
    following except
    a. Employee collusion.
    b. Falsifi ed documentation.
    c. Need to apply professional judgment in evaluating
    fraud risk factors.
    d. Professional skepticism

Answer 21

22. (d) The requirement is to identify the reply which is not
    a reason why auditors are unable to obtain absolute assurance
    that misstatements due to fraud will be detected. Answer (d)
    is correct because while an auditor must exercise professional
    skepticism when performing an audit it does not represent a limitation that makes is impossible to obtain absolute
    assurance. Answers (a), (b), and (c) are all incorrect because
    they represent factors considered in the professional literature
    for providing reasonable, and not absolute assurance.

Question 22

23. An attitude that includes a questioning mind and a critical
    assessment of audit evidence is referred to as
    a. Due professional care.
    b. Professional skepticism.
    c. Reasonable assurance.
    d. Supervision.

Answer 22

23. (b) The requirement is to determine which concept
    requires an attitude that includes a questioning mind and a
    critical assessment of audit evidence. Answer (b) is correct
    because AU-C 200 states that professional skepticism
    includes these qualities. Answer (a) is incorrect because due
    professional care is a broader concept that concerns what
    the independent auditor does and how well he or she does
    it. Answer (c) is incorrect because reasonable assurance is
    based on the concept that an auditor is not an insurer and his
    or her report does not provide absolute assurance. Answer
    (d) is incorrect because supervision involves the directing of
    the efforts of assistants who are involved in accomplishing
    the objectives of the audit and determining whether those
    objectives were accomplished.

Question 23

24. Professional skepticism requires that an auditor assume
    that management is
    a. Honest, in the absence of fraud risk factors.
    b. Dishonest until completion of audit tests.
    c. Neither honest nor dishonest.
    d. Offering reasonable assurance of honesty.

Answer 23

24. (c) The requirement is to determine what presumption
    concerning management’s honesty that professional skepticism
    requires. Answer (c) is correct because professional skepticism
    requires that an auditor neither assume dishonesty nor
    unquestioned honesty. Answers (a) and (b) are incorrect
    because neither honesty in the absence of fraud risk factor
    nor dishonesty are assumed. Answer (d) is incorrect because
    the concept of reasonable assurance is not directed towards
    management’s honesty.

Question 24

25. The most diffi cult type of misstatement to detect is fraud
    based on
    a. The overrecording of transactions.
    b. The nonrecording of transactions.
    c. Recorded transactions in subsidiaries.
    d. Related-party receivables

Answer 24

25. (b) The requirement is to identify the type of fraudulent
    misstatement that is most diffi cult to detect. Answer (b) is
    correct because transactions that have not been recorded
    are generally considered most diffi cult because there is no
    general starting point for the auditor in the consideration of
    the transaction. Answers (a), (c), and (d) all represent recorded
    transactions which, when audited, are in general easier to
    detect.

Question 25

26. When considering fraud risk factors relating to
    management’s characteristics, which of the following is least
    likely to indicate a risk of possible misstatement due to fraud?
    a. Failure to correct known signifi cant defi ciency on a
    timely basis.
    b. Nonfi nancial management’s preoccupation with the
    selection of accounting principles.
    c. Signifi cant portion of management’s compensation
    represented by bonuses based upon achieving unduly
    aggressive operating results.
    d. Use of unusually conservative accounting practices

Answer 25

26. (d) The requirement is to identify the least likely
    indicator of a risk of possible misstatement due to fraud.
    Answer (d) is correct because one would expect unusually
    aggressive, rather than unusually conservative accounting
    practices to indicate a risk of misstatement due to fraud.
    Answers (a), (b), and (c) are all incorrect because they
    represent risk factors explicitly included in AU-C 240, which
    provides guidance on fraud.

Question 26

27. Which of the following conditions identifi ed during
    fi eldwork of an audit is most likely to affect the auditor’s
    assessment of the risk of misstatement due to fraud?
    a. Checks for signifi cant amounts outstanding at yearend.
    b. Computer generated documents.
    c. Missing documents.
    d. Year-end adjusting journal entries.

Answer 26

27. (c) The requirement is to determine the reply which
    represents information most likely to affect the auditor’s
    assessment of the risk of misstatement due to fraud. Answer
    (c) is correct because AU-C 240 states that missing documents
    may be indicative of fraud. Answer (a) is incorrect because
    checks for signifi cant amounts are normally expected to be
    outstanding at year-end. Answer (b) is incorrect because
    almost all audits involve computer generated documents
    and their existence is not considered a condition indicating
    possible fraud. Answer (d) is incorrect because while lastminute
    adjustments that signifi cantly affect fi nancial results
    may be considered indicative of possible fraud, year-end
    adjusting journal entries alone are to be expected.

Question 27

28. Which of the following is most likely to be a response to
    the auditor’s assessment that the risk of material misstatement
    due to fraud for the existence of inventory is high?
    a. Observe test counts of inventory at certain locations
    on an unannounced basis.
    b. Perform analytical procedures rather than taking test
    counts.
    c. Request that inventories be counted prior to year-end.
    d. Request that inventory counts at the various locations
    be counted on different dates so as to allow the same
    auditor to be present at every count.

Answer 27

28. (a) The requirement is to identify the most likely
    response to the auditor’s assessment that the risk of material
    misstatement due to fraud for the existence of inventory is
    high. Answer (a) is correct because observing test counts of
    inventory on an unannounced basis will provide evidence as
    to whether record inventory exists. Answer (b) is incorrect
    because replacing test counts with analytical procedures is
    not likely to be particularly effective. Answers (c) and (d) are
    incorrect because the inventories might well be counted at
    year-end, all on the same date, rather than prior to year-end
    and at differing dates.

Question 28

29. Which of the following is most likely to be an example of
    fraud?
    a. Defalcations occurring due to invalid electronic
    approvals.
    b. Mistakes in the application of accounting principles.
    c. Mistakes in processing data.
    d. Unreasonable accounting estimates arising from
    oversight.

Answer 28

29. (a) The requirement is to identify the reply that is
    most likely to be an example of fraud. Answer (a) is most
    likely, since “defalcation” is another term for misstatements
    arising from misappropriation of assets, a major type of fraud.
    Answers (b), (c), and (d) are all incorrect because mistakes in
    the application of accounting principles or in processing data,
    and unreasonable accounting estimates arising from oversight
    are examples of misstatements rather than fraud.

Question 29

30. Which of the following characteristics most likely
    would heighten an auditor’s concern about the risk of
    intentional manipulation of fi nancial statements?
    a. Turnover of senior accounting personnel is low.
    b. Insiders recently purchased additional shares of the
    entity’s stock.
    c. Management places substantial emphasis on meeting
    earnings projections.
    d. The rate of change in the entity’s industry is slow.

Answer 29

30. (c) The requirement is to identify the characteristic
    most likely to heighten an auditor’s concern about the risk of
    intentional manipulation of fi nancial statements. Answer (c)
    is correct because the placement of substantial emphasis on
    meeting earnings projections is considered a risk factor. Answer
    (a) is incorrect because high turnover, not low turnover, is
    considered a risk factor. Answer (b) is incorrect because insider
    purchases of additional shares of stock are less likely to be
    indicative of intentional manipulation of the fi nancial statements
    than is undue emphasis on meeting earnings projections.
    Answer (d) is incorrect because a rapid rate of change in an
    industry, not a slow rate, is considered a risk factor.

Question 30

31. Which of the following statements refl ects an auditor’s
    responsibility for detecting misstatements due to errors and
    fraud?
    a. An auditor is responsible for detecting employee
    errors and simple fraud, but not for discovering
    fraud involving employee collusion or management
    override.
    b. An auditor should plan the audit to detect
    misstatements due to errors and fraud that are caused
    by departures from GAAP.
    c. An auditor is not responsible for detecting
    misstatements due to errors and fraud unless
    the application of GAAS would result in such
    detection.
    d. An auditor should design the audit to provide
    reasonable assurance of detecting misstatements due
    to errors and fraud that are material to the fi nancial
    statements.

Answer 30

31. (d) The requirement is to identify an auditor’s responsibility
    for detecting errors and fraud. Answer (d) is
    correct because AU-C 200 requires that an auditor design
    the audit to provide reasonable assurance of detecting
    misstatements due to errors and fraud that are material to the
    fi nancial statements. Answer (a) is incorrect because audits
    provide reasonable assurance of detecting material errors
    and fraud. Answer (b) is incorrect because it doesn’t restrict
    the responsibility to material errors and fraud. Answer (c)
    is incorrect because it is less precise than answer (d), which
    includes the AU-C 200 responsibility on errors and fraud.

Question 31

32. Disclosure of fraud to parties other than a client’s senior
management and its audit committee or board of directors
ordinarily is not part of an auditor’s responsibility. However,
to which of the following outside parties may a duty to
disclose fraud exist?
To the
SEC when
the client
reports an
auditor
change
To a successor
auditor when the
successor makes
appropriate
inquiries
To a
government
funding agency
from which the
client receives
fi nancial
assistance
a. Yes Yes No
b. Yes No Yes
c. No Yes Yes
d. Yes Yes Yes

Answer 31

32. (d) The requirement is to identify the circumstances in
    which an auditor may have a responsibility to disclose fraud
    to parties other than a client’s senior management and its audit
    committee or board of directors. Answer (d) is correct because
    AU-C 240 states that such a responsibility may exist to the
    SEC when there has been an auditor change to a successor
    auditor or to comply with SEC 1995 Private Securities Reform
    Act communication requirement, when the successor auditor
    makes inquiries, and to a government agency from which the
    client receives fi nancial assistance. In addition, that section
    states that an auditor may have such a disclosure responsibility
    in response to a subpoena, a circumstance not considered in
    this question.

Question 32

33. Under Statements on Auditing Standards, which of the
    following would be classifi ed as an error?
    a. Misappropriation of assets for the benefi t of
    management.
    b. Misinterpretation by management of facts that existed
    when the fi nancial statements were prepared.
    c. Preparation of records by employees to cover a
    fraudulent scheme.
    d. Intentional omission of the recording of a transaction
    to benefi t a third party.

Answer 32

33. (b) Errors refer to unintentional mistakes in fi nancial
    statements such as misinterpretation of facts. Answers (a), (c), and (d) all represent fraud which are defi ned as intentional
    distortions of fi nancial statements.

Question 33

33. Under Statements on Auditing Standards, which of the
    following would be classifi ed as an error?
    a. Misappropriation of assets for the benefi t of
    management.
    b. Misinterpretation by management of facts that existed
    when the fi nancial statements were prepared.
    c. Preparation of records by employees to cover a
    fraudulent scheme.
    d. Intentional omission of the recording of a transaction
    to benefi t a third party.

Answer 33

33. (b) Errors refer to unintentional mistakes in financial
    statements such as misinterpretation of facts. Answers (a), (c), and (d) all represent fraud which are defi ned as intentional
    distortions of financial statements.

Question 34

34. What assurance does the auditor provide that misstatements
    due to errors, fraud, and direct effect illegal acts that are material
    to the fi nancial statements will be detected?
    Errors Fraud
    Direct effect
    of illegal acts
    a. Limited Negative Limited
    b. Limited Limited Reasonable
    c. Reasonable Limited Limited
    d. Reasonable Reasonable Reasonable

Answer 34

34. (d) The requirement is to identify the level of assurance
    an auditor provides with respect to detection of material errors,
    fraud, and direct effect illegal acts. Answer (d) is correct
    because AU-C 200 requires the auditor to design the audit
    to provide reasonable assurance of detecting material errors,
    fraud and direct effect illegal acts. (A “direct effect” illegal
    act is one that would have an effect on the determination of
    fi nancial statement amounts.)

Question 35

35. Because of the risk of material misstatement, an audit of
    fi nancial statements in accordance with generally accepted
    auditing standards should be planned and performed with an
    attitude of
    a. Objective judgment.
    b. Independent integrity.
    c. Professional skepticism.
    d. Impartial conservatism.

Answer 35

35. (c) The requirement is to identify the proper attitude
    of an auditor who is performing an audit in accordance with
    generally accepted auditing standards. Answer (c) is correct
    because the auditor should plan and perform the audit with
    an attitude of professional skepticism, recognizing that the
    application of the auditing procedures may produce evidence
    indicating the possibility of misstatements due to errors
    or fraud. Answer (a) is incorrect because while the CPA
    must exhibit objective judgment, “professional skepticism”
    more accurately summarizes the proper attitude during an
    audit. Answer (b) is incorrect because while a CPA must
    be independent and have integrity, this is not the “attitude”
    used to plan and perform the audit. Answer (d) is incorrect
    because the audit is not planned and performed with impartial
    conservatism.

Question 36

36. Which of the following most accurately summarizes what
    is meant by the term “material misstatement?”
    a. Fraud and direct-effect illegal acts.
    b. Fraud involving senior management and material
    fraud.
    c. Material error, material fraud, and certain illegal
    acts.
    d. Material error and material illegal acts.

Answer 36

36. (c) The requirement is to identify the meaning of the
    term “material misstatement” when used in the professional
    standards. Answer (c) is correct because AU-C 240 states that
    a material misstatement may occur due to errors, fraud, and
    illegal acts with a direct effect on financial statement amounts.

Question 37

37. Which of the following statements best describes
    the auditor’s responsibility to detect conditions relating to
    fi nancial stress of employees or adverse relationships between
    a company and its employees?
    a. The auditor is required to plan the audit to detect these
    conditions on all audits.
    b. These conditions relate to fraudulent fi nancial
    reporting, and an auditor is required to plan the audit
    to detect these conditions when the client is exposed
    to a risk of misappropriation of assets.
    c. The auditor is required to plan the audit to detect
    these conditions whenever they may result in
    misstatements.
    d. The auditor is not required to plan the audit to
    discover these conditions, but should consider them if
    he or she becomes aware of them during the audit

Answer 37

37. (d) The requirement is to identify an auditor’s responsibility
    for detecting fi nancial stress of employees or
    adverse relationships between a company and its employees.
    Answer (d) is correct because AU-C 240 states that, while the
    auditor is not required to plan the audit to discover information
    that is indicative of fi nancial stress of employees or adverse
    relationships between the company and its employees, such
    conditions must be considered when an auditor becomes aware
    of them. Answers (a), (b), and (c) are all incorrect because the
    auditor does not plan the audit to detect these conditions.

Question 38

38. When the auditor believes a misstatement is or may be
    the result of fraud but that the effect of the misstatement is not
    material to the fi nancial statements, which of the following
    steps is required?
    a. Consider the implications for other aspects of the
    audit.
    b. Resign from the audit
    c. Commence a fraud examination.
    d. Contact regulatory authorities

Answer 38

38. (a) The requirement is to identify an auditor’s responsibility
    when he or she believes that a misstatement
    is or may be the result of fraud, but that the effect of the
    misstatements is immaterial to the fi nancial statements.
    Answer (a) is correct because AU-C 240 states that in such
    circumstances the auditor should evaluate the implications
    of the fraud, especially those dealing with the organizational
    position of the person(s) involved.

Question 39

39. Which of the following statements is correct relating to
    the auditor’s consideration of fraud?
    a. The auditor’s interest in fraud consideration relates to
    fraudulent acts that cause a material misstatement of
    fi nancial statements.
    b. A primary factor that distinguishes fraud from error
    is that fraud is always intentional, while errors are
    generally, but not always, intentional.
    c. Fraud always involves a pressure or incentive to
    commit fraud, and a misappropriation of assets.
    d. While an auditor should be aware of the possibility of
    fraud, management, and not the auditor, is responsible
    for detecting fraud

Answer 39

39. (a) The requirement is to identify the correct statements
    relating to the auditor’s consideration of fraud. Answer (a)
    is correct because AU-C 240 states that the auditor’s interest
    relates to fraudulent acts that cause a material misstatement
    of fi nancial statements. Answer (b) is incorrect because errors
    are unintentional. Answer (c) is incorrect because fraud does
    not necessarily involve the misappropriation of assets (it may
    involve fraudulent fi nancial reporting). Answer (d) is incorrect
    because an auditor must design an audit to obtain reasonable assurance of detecting misstatements, regardless of whether
    they are caused by errors or fraud.

Question 40

40. Which of the following factors or conditions is an auditor
    least likely to plan an audit to discover?
    a. Financial pressures affecting employees.
    b. High turnover of senior management.
    c. Inadequate monitoring of signifi cant controls.
    d. Inability to generate positive cash fl ows from operations

Answer 40

40. (a) The requirement is to identify the factor or condition
    that an audit is least likely to be planned to discover. Answer
    (a) is correct because it represents a fi nancial stress, and
    auditors are not required to plan audits to discover information
    that is indicative of fi nancial stress of employees or adverse
    relationships between the entity and its employees. Answers
    (b), (c), and (d) are all incorrect because they represent
    examples of risk factors that should be considered in an audit
    and are included in AU-C 240

Question 41

41. At which stage(s) of the audit may fraud risk factors be
identifi ed?
Planning
Obtaining
understanding
Conducting
fi eldwork
a. Yes Yes Yes
b. Yes Yes No
c. Yes No No
d. No Yes Yes

Answer 41

41. (a) The requirement is to determine when audit risk
    factors may be identifi ed. Answer (a) is correct because
    AU-C 240 states that fraud risk factors may be identifi ed
    during planning, obtaining an understanding, or while
    conducting fi eldwork; in addition, they may be identifi ed
    while considering acceptance or continuance of clients and
    engagements.

Question 42

42. Management’s attitude toward aggressive fi nancial
    reporting and its emphasis on meeting projected profi t goals
    most likely would signifi cantly infl uence an entity’s control
    environment when
    a. External policies established by parties outside the
    entity affect its accounting practices.
    b. Management is dominated by one individual who is
    also a shareholder.
    c. Internal auditors have direct access to the board of
    directors and the entity’s management.
    d. The audit committee is active in overseeing the
    entity’s fi nancial reporting policies.

Answer 42

42. (b) The requirement is to identify the circumstance in
    which it is most likely that management’s attitude toward
    aggressive fi nancial reporting and toward meeting projected
    profi t goals would most likely signifi cantly infl uence an
    entity’s control environment. Answer (b) is correct because
    when management is dominated by one individual, that individual
    may be able to follow overly aggressive accounting
    principles.

Question 43

43. Which of the following is least likely to be required on an
    audit?
    a. Test appropriateness of journal entries and adjustment.
    b. Review accounting estimates for biases.
    c. Evaluate the business rationale for signifi cant unusual
    transactions.
    d. Make a legal determination of whether fraud has
    occurred.

Answer 43

43. (d) The requirement is to identify the procedure least
    likely to be required on an audit. Answer (d) is correct because
    fraud is a broad legal concept and auditors do not make legal
    determinations of whether fraud has occurred. Answers (a),
    (b), and (c) are incorrect because considering journal entries,
    estimates, and unusual transactions are ordinarily required
    audit procedures to address the risk of management override
    of controls. See AU-C 240 for information on the auditor’s
    responsibility for the consideration of fraud in a fi nancial
    statement audit.

Question 44

44. Which of the following is most likely to be an overall
    response to fraud risks identifi ed in an audit?
    a. Supervise members of the audit team less closely and
    rely more upon judgment
    b. Use less predictable audit procedures.
    c. Only use certifi ed public accountants on the
    engagement.
    d. Place increased emphasis on the audit of objective
    transactions rather than subjective transactions.

Answer 44

44. (b) The requirement is to identify the most likely
    response when a risk of fraud has been identifi ed on an
    audit. Answer (b) is correct because AU-C 240 indicates that
    overall responses to the risk of material misstatements due to
    fraud include (1) assigning personnel with particular skills
    relating to the area and considering the necessary extent of
    supervision to the audit, (2) increasing the consideration
    of management’s selection and application of accounting
    principles, and (3) making audit procedures less predictable.
    Answer (a) is incorrect because closer supervision, not less
    close supervision, is more likely to be appropriate. Answer (c)
    is incorrect because individuals with specialized skills may
    be needed who are not CPAs. Answer (d) is incorrect because
    subjective transactions (e.g., accounting estimates) often
    provide more risk than objective transactions.

Question 45

45. Which of the following is least likely to be included in an
    auditor’s inquiry of management while obtaining information
    to identify the risks of material misstatement due to fraud?
    a. Are fi nancial reporting operations controlled by and
    limited to one location?
    b. Does it have knowledge of fraud or suspect fraud?
    c. Does it have programs to mitigate fraud risks?
    d. Has it reported to the audit committee the nature of
    the company’s internal control?

Answer 45

45. (a) The requirement is to identify the least likely inquiry
    of management relating to identifying the risk of material
    misstatement due to fraud. Answer (a) is correct because
    fi nancial operations of many companies are not ordinarily
    controlled by and limited to one location. Answers (b), (c), and (d) are all incorrect because they are included in AU-C 240 as
    inquiries that should be made of management

Question 46

46. Individuals who commit fraud are ordinarily able to
rationalize the act and also have an
Incentive Opportunity
a. Yes Yes
b. Yes No
c. No Yes
d. No No

Answer 46

46. (a) The requirement is to identify the attributes
    ordinarily present when individuals commit fraud. Answer (a)
    is correct because AU-C 240 suggests that the three conditions
    generally present when fraud occurs are that individuals have
    an (1) incentive or pressure, (2) opportunity, and (3) ability to
    rationalize. Answers (b), (c), and (d) are all incorrect because
    they suggest that one of the three elements is not ordinarily
    present.

Question 47

47. What is an auditor’s responsibility who discovers
    management involved in what is fi nancially immaterial fraud?
    a. Report the fraud to the audit committee.
    b. Report the fraud to the Public Company Oversight
    Board.
    c. Report the fraud to a level of management at least one
    below those involved in the fraud.
    d. Determine that the amounts involved are immaterial,
    and if so, there is no reporting responsibility.

Answer 47

47. (a) The requirement is to determine an auditor’s
    reporting responsibility when he or she has discovered that
    management is involved in a fi nancially immaterial fraud.
    Answer (a) is correct because AU-C 240 requires that all
    management fraud, regardless of materiality, be reported to
    the audit committee. Answer (b) is incorrect because fraud
    is not directly reported to the Public Company Accounting
    Oversight Board. Answer (c) is incorrect because if anything,
    in addition to the audit committee, the fraud is reported to a
    level of management at least one level above those involved
    in a fraud. Answer (d) is incorrect because there is a reporting
    responsibility for fi nancially immaterial management fraud.

Question 48

48. Which of the following is most likely to be considered a
    risk factor relating to fraudulent fi nancial reporting?
    a. Domination of management by top executives.
    b. Large amounts of cash processed.
    c. Negative cash fl ows from operations.
    d. Small high-dollar inventory items.

Answer 48

48. (c) The requirement is to identify the most likely risk
    factor relating to fraudulent fi nancial reporting. Answer (c)
    is correct because negative cash fl ows from operations may
    result in pressure upon management to overstate the results
    of operations. Answer (a) is incorrect because one would
    expect a company’s top executives to dominate management—
    domination by one or a few might be considered a risk factor.
    Answers (b) and (d) are incorrect because large amounts of
    cash being processed and small high-dollar inventory items
    are more directly related to the misappropriation of assets than
    they are to fraudulent fi nancial reporting.

Question 49

49. Which of the following is most likely to be presumed to
    represent fraud risk on an audit?
    a. Capitalization of repairs and maintenance into the
    property, plant, and equipment asset account.
    b. Improper revenue recognition.
    c. Improper interest expense accrual.
    d. Introduction of signifi cant new products.

Answer 49

49. (b) The requirement is to identify the most likely
    fraud risk factor on an audit. Answer (b) is correct because
    the possibility of improper revenue recognition is ordinarily
    presumed on audits. Answers (a), (c), and (d) all represent
    potential risks, but risks that are not ordinarily presumed
    on an audit. See AU-C 240 for information on the auditor’s
    responsibility for the consideration of fraud in a fi nancial
    statement audit.

Question 50

50. An auditor who discovers that a client’s employees paid
    small bribes to municipal offi cials most likely would withdraw
    from the engagement if
    a. The payments violated the client’s policies regarding
    the prevention of illegal acts.
    b. The client receives fi nancial assistance from a federal
    government agency.
    c. Documentation that is necessary to prove that the
    bribes were paid does not exist.
    d. Management fails to take the appropriate remedial
    action.

Answer 50

50. (d) The requirement is to identify the circumstances
    relating to the discovery of the payment of small bribes to
    municipal offi cials that is most likely to cause an auditor
    to withdraw from an engagement. Answer (d) is correct
    because AU-C 250 states that management failure to take
    the appropriate remedial action is particularly problematical
    since it may affect the auditor’s ability to rely on management
    representation and may therefore lead to withdrawal. Answers
    (a), (b), and (c) all represent circumstances which the auditor
    will consider, but are not ordinarily considered as serious as
    failure to take the appropriate remedial action

Question 51

51. Which of the following factors most likely would cause a
    CPA to not accept a new audit engagement?
    a. The prospective client has already completed its
    physical inventory count.
    b. The CPA lacks an understanding of the prospective
    client’s operation and industry.
    c. The CPA is unable to review the predecessor auditor’s
    working papers.
    d. The prospective client is unwilling to make all
    fi nancial records available to the CPA.

Answer 51

51. (d) The requirement is to identify the factor most likely
    to cause a CPA not to accept a new audit engagement. Answer
    (d) is correct because a part of the understanding an auditor
    must obtain with a client is that management is responsible for
    making all fi nancial records and related information available. Accordingly, if the client refuses to make such information
    available the auditor is unlikely to accept the audit client.
    Answer (a) is incorrect because a circumstance-imposed scope
    limitations such as completion of the physical inventory count
    results in a situation in which the auditor may consider using
    alternative procedures (including making some test counts)
    to determine whether inventory counts are proper. Answer (b)
    is incorrect because an auditor may obtain an understanding
    of the client’s operations and industry while performing the
    audit. Answer (c) is incorrect because while a review of the
    predecessor auditor’s working papers is ordinarily desirable, it
    is not required.

Question 52

52. Which of the following factors would most likely
    heighten an auditor’s concern about the risk of fraudulent
    fi nancial reporting?
    a. Large amounts of liquid assets that are easily
    convertible into cash.
    b. Low growth and profi tability as compared to other
    entities in the same industry.
    c. Financial management’s participation in the initial
    selection of accounting principles.
    d. An overly complex organizational structure involving
    unusual lines of authority.

Answer 52

52. (d) The requirement is to identify the factor most likely
    to heighten an auditor’s concern about the risk of fraudulent
    fi nancial reporting. Answer (d) is correct because AU-C 240,
    which presents a variety of risk factors, suggests that an overly
    complex organizational structure is such a risk factor. Answer
    (a) is incorrect because large amounts of liquid assets that are
    easily convertible into cash represent more of a risk relating to
    misappropriation of assets rather than to fraudulent fi nancial
    reporting. Answer (b) is incorrect because high growth, rather
    than low growth, is considered a risk factor. Answer (c) is
    incorrect because one would expect fi nancial management’s
    participation in the initial selection of accounting principles.

Question 53

53. An auditor who discovers that a client’s employees
    have paid small bribes to public offi cials most likely would
    withdraw from the engagement if the
    a. Client receives fi nancial assistance from a federal
    government agency.
    b. Evidence that is necessary to prove that the illegal acts
    were committed does not exist.
    c. Employees’ actions affect the auditor’s ability to rely
    on management’s representations.
    d. Notes to the fi nancial statements fail to disclose the
    employees’ actions.

Answer 53

53. (c) The requirement is to identify the situation in
    which an auditor would be most likely to withdraw from an
    engagement when he or she has discovered that a client’s
    employees have paid small bribes to public offi cials. Answer
    (c) is correct because AU-C 250 states that resignation
    should be considered when an illegal act does not receive
    proper remedial action, because such inaction may affect the
    auditor’s ability to rely on management representations and
    the effects of continued association with the client. Answer
    (a) is incorrect because the receipt of federal funds in such
    a situation is not as likely to result in auditor withdrawal
    as is answer (c). Answer (b) is incorrect because it seems
    inconsistent with the premise of the question in that, if no
    evidence exists, the auditor is unlikely to know that bribes
    have been paid. Answer (d) is incorrect because such small
    bribes will not ordinarily need to be disclosed. Alternatively,
    if the auditor believes that there is such a need, the lack of
    such disclosure represents a departure from generally accepted
    accounting principles and either a qualifi ed or adverse opinion
    is appropriate.

Question 54

54. Which of the following illegal acts should an audit be
    designed to obtain reasonable assurance of detecting?
    a. Securities purchased by relatives of management
    based on knowledge of inside information.
    b. Accrual and billing of an improper amount of revenue
    under government contracts.
    c. Violations of antitrust laws.
    d. Price fi xing.

Answer 54

54. (b) The requirement is to identify the illegal act that an
    audit should be designed to obtain reasonable assurance of
    detecting. Answer (b) is correct because the accrual and billing
    of an improper amount of revenue under government contracts is
    an illegal act with a direct effect on the determination of fi nancial
    statement amounts, and audits are designed to detect such illegal
    acts. Answers (a), (c), and (d) are all incorrect because they
    represent illegal acts with an indirect fi nancial statement effect
    and an audit provides no assurance that such acts will be detected
    or that any contingent liabilities that may result will be disclosed.
    See AU-C 250 for detailed guidance on auditor responsibility
    with respect to direct and indirect illegal acts.

Question 55

55. Which of the following relatively small misstatements
    most likely could have a material effect on an entity’s fi nancial
    statements?
    a. An illegal payment to a foreign offi cial that was not
    recorded.
    b. A piece of obsolete offi ce equipment that was not
    retired.
    c. A petty cash fund disbursement that was not properly
    authorized.
    d. An uncollectible account receivable that was not
    written off.

Answer 55

55. (a) The requirement is to identify the small misstatement
    that is most likely to have a material effect on an entity’s fi nancial statements. Answer (a) is correct because an
    illegal payment of an otherwise immaterial amount may be
    material if there is a reasonable possibility that it may lead to a
    material contingent liability or a material loss of revenue.

Question 56

56. During the annual audit of Ajax Corp., a publicly held
    company, Jones, CPA, a continuing auditor, determined that
    illegal political contributions had been made during each of the
    past seven years, including the year under audit. Jones notifi ed
    the board of directors about the illegal contributions, but they
    refused to take any action because the amounts involved were
    immaterial to the fi nancial statements. Jones should reconsider
    the intended degree of reliance to be placed on the
    a. Letter of audit inquiry to the client’s attorney.
    b. Prior years’ audit plan.
    c. Management representation letter.
    d. Preliminary judgment about materiality levels.

Answer 56

56. (c) The requirement is to determine what an auditor
    might reconsider when a client’s board of directors has refused
    to take any action relating to an auditor’s disclosure that the
    company has made immaterial illegal contributions. Answer
    (c) is correct because in such a circumstance the failure to take
    remedial action may cause an auditor to decrease reliance on
    management representations. Answer (a) is incorrect because
    the reply by the attorney is likely to disclose any claims,
    litigation or assessments that the client has improperly omitted
    from the letter of audit inquiry. Answer (b) is incorrect because
    the prior years’ audit plans are not being relied upon for this
    year’s audit. Answer (d) is incorrect because the preliminary
    judgment about materiality levels would not be expected to
    change.

Question 57

57. The most likely explanation why the auditor’s
    examination cannot reasonably be expected to bring
    noncompliance with all laws by the client to the auditor’s
    attention is that
    a. Illegal acts are perpetrated by management override of
    internal control.
    b. Illegal acts by clients often relate to operating aspects
    rather than accounting aspects.
    c. The client’s internal control may be so strong that the
    auditor performs only minimal substantive testing.
    d. Illegal acts may be perpetrated by the only person in
    the client’s organization with access to both assets and
    the accounting records.

Answer 57

57. (b) The requirement is to identify a reason why audits
    cannot reasonably be expected to bring all illegal acts to the
    auditor’s attention. Answer (b) is correct because illegal acts
    relating to the operating aspects of an entity are often highly
    specialized and complex and often are far removed from
    the events and transactions refl ected in fi nancial statements.
    Answer (a) is partially correct since management override
    represents a limitation of the effectiveness of internal control.
    Yet, auditors are more likely to identify such transactions
    because they relate to events and transactions refl ected in the
    fi nancial statements. Answer (c) is incorrect because many
    illegal acts are not subject to the client’s internal control.
    Answer (d) is incorrect because illegal acts may be perpetrated
    without access to both assets and accounting records.

Question 58

58. If specifi c information comes to an auditor’s attention
    that implies noncompliance with laws that could result in a
    material, but indirect effect on the fi nancial statements, the
    auditor should next
    a. Apply audit procedures specifi cally directed to
    ascertaining whether noncompliance has occurred.
    b. Seek the advice of an informed expert qualifi ed to
    practice law as to possible contingent liabilities.
    c. Report the matter to an appropriate level of
    management at least one level above those involved.
    d. Discuss the evidence with the client’s audit committee,
    or others with equivalent authority and responsibility

Answer 58

58. (a) The requirement is to determine an auditor’s
    responsibility when information comes to his/her attention that
    implies the existence of possible illegal acts with a material,
    but indirect effect on the fi nancial statements. Answer (a)
    is correct because AU-C 250 requires the auditor to apply
    audit procedures specifi cally designed to determine whether
    an illegal act has occurred when such information comes to
    his/her attention. Answers (b), (c), and (d) are all incorrect
    because they represent procedures the auditor would perform
    after initial procedures had confi rmed the existence of the
    possible illegal act(s).

Question 59

59. An auditor who discovers that client employees have
    committed an illegal act that has a material effect on the
    client’s fi nancial statements most likely would withdraw from
    the engagement if
    a. The illegal act is a violation of generally accepted
    accounting principles.
    b. The client does not take the remedial action that the
    auditor considers necessary.
    c. The illegal act was committed during a prior year that
    was not audited.
    d. The auditor has already assessed control risk at the
    maximum level.

Answer 59

59. (b) The requirement is to determine the circumstance
    in which it is most likely that a CPA would withdraw from
    an audit engagement after having discovered that client
    employees have committed an illegal act. Answer (b) is correct
    because the auditor may conclude that withdrawal is necessary
    when the client does not take the remedial action, even when
    the illegal act is not material to the fi nancial statements.
    Answers (a) and (c) are incorrect because whether generally
    accepted accounting principles have been violated and whether
    the illegal act occurred during a prior year that was not audited
    may or may not have an effect on the decision to withdraw
    from the engagement. Answer (d) is incorrect because the
    assessed level of control risk will not have a direct relationship
    on the decision to withdraw from the engagement.

Question 60

60. Under the Private Securities Litigation Reform Act
    of 1995, Baker, CPA, reported certain uncorrected illegal
    acts to Supermart’s board of directors. Baker believed that
    failure to take remedial action would warrant a qualifi ed
    audit opinion because the illegal acts had a material effect
    on Supermart’s fi nancial statements. Supermart failed to
    take appropriate remedial action and the board of directors
    refused to inform the SEC that it had received such notifi cation from Baker. Under these circumstances, Baker is
    required to
    a. Resign from the audit engagement within ten business
    days.
    b. Deliver a report concerning the illegal acts to the SEC
    within one business day.
    c. Notify the stockholders that the fi nancial statements
    are materially misstated.
    d. Withhold an audit opinion until Supermart takes
    appropriate remedial action.

Answer 60

60. (b) The requirement is to identify a CPA’s
    responsibility under the Securities Litigation Reform
    Act of 1995 for uncorrected illegal acts which have been
    communicated to the board of directors which refuses to
    inform the SEC of their existence. Answer (b) is correct
    because CPAs are required under the law to deliver a report
    on those illegal acts to the SEC within one business day in
    such circumstances. Answer (a) in incorrect because there is
    no requirement to resign, although the auditor may decide
    to do so. Answer (c) is incorrect because the Act sets up
    reporting to the SEC, not to the stockholders. Answer (d)
    is incorrect because withholding of the audit opinion is not
    suggested in the Act.

Question 61

61. Which of the following would be least likely to be
considered an audit planning procedure?
a. Use an engagement letter.
b. Develop the overall audit strategy.
c. Perform risk assessment.
d. Develop the audit plan.

Answer 61

61. (c) The requirement is to identify the procedure least
    likely to be considered an audit planning procedure. Answer
    (c) is correct because performing the risk assessment occurs
    subsequent to audit planning. Answer (a) is incorrect because
    an engagement letter is used to establish an understanding
    with the client, and this is a planning procedure. Answer (b)
    is incorrect because auditors develop the overall audit strategy
    during audit planning. Answer (d) is incorrect because the
    audit plan is developed during planning.

Question 62

62. Which of the following factors would most likely cause a
    CPA to decide not to accept a new audit engagement?
    a. The CPA’s lack of understanding of the prospective
    client’s internal auditor’s computer-assisted audit
    techniques.
    b. Management’s disregard of its responsibility to
    maintain an adequate internal control environment.
    c. The CPA’s inability to determine whether related-party
    transactions were consummated on terms equivalent to
    arm’s-length transactions.
    d. Management’s refusal to permit the CPA to perform
    substantive tests before the year-end.

Answer 62

62. (b) The requirement is to identify the factor most
    likely to cause a CPA to decide not to accept a new audit
    engagement. Answer (b) is correct because a certain level of
    internal control is essential for fi nancial statement reporting,
    and management’s disregard in this area may lead the CPA to
    reject the engagement. Answer (a) is incorrect both because a
    CPA may not need an understanding of the prospective client’s
    internal auditor’s computer-assisted audit technique to form
    an opinion on the fi nancial statements, and because if such
    understanding is necessary, it can be obtained subsequent to
    engagement acceptance. Answer (c) is incorrect because
    AU-C 550 indicates that a CPA often will be unable to
    determine whether related-party transactions were consummated
    on terms equivalent to arm’s-length transactions. Answer (d)
    is incorrect because while management’s refusal to permit
    the performance of substantive tests before the year-end may
    present a problem, the auditor may be able to effectively
    perform such tests after year-end.

Question 63

63. Before accepting an engagement to audit a new client, a
    CPA is required to obtain
    a. An understanding of the prospective client’s industry
    and business.
    b. The prospective client’s signature to the engagement
    letter.
    c. A preliminary understanding of the prospective
    client’s control environment.
    d. The prospective client’s consent to make inquiries of
    the predecessor auditor, if any.

Answer 63

63. (d) The requirement is to identify a requirement prior
    to accepting an engagement to audit a new client. Answer (d)
    is correct because AU-C 210 requires that an auditor attempt
    to obtain client permission to contact the predecessor prior
    to accepting a new engagement. Answers (a), (b), and (c)
    are incorrect because they may all be obtained subsequent to
    accepting an engagement.

Question 64

64. Before accepting an audit engagement, a successor
    auditor should make specifi c inquiries of the predecessor
    auditor regarding
    a. Disagreements the predecessor had with the client
    concerning auditing procedures and accounting
    principles.
    b. The predecessor’s evaluation of matters of continuing
    accounting signifi cance.
    c. The degree of cooperation the predecessor received
    concerning the inquiry of the client’s lawyer.
    d. The predecessor’s assessments of inherent risk and
    judgments about materiality.

Answer 64

64. (a) The requirement is to determine the nature of
    the inquiries that a successor auditor should make of the
    predecessor auditor prior to accepting an audit engagement.
    Answer (a) is correct because the inquiries should include
    specifi c questions to management on (1) disagreements
    with management as to auditing procedures and accounting
    principles (answer [a]), (2) facts that might bear on
    the integrity of management and (3) the predecessor’s
    understanding as to the reasons for the change of auditors.
    Answers (b), (c), and (d) are incorrect because, if made at all,
    they will be after the engagement has been accepted.

Question 65

65. Before accepting an audit engagement, a successor
    auditor should make specifi c inquiries of the predecessor
    auditor regarding the predecessor’s
    a. Opinion of any subsequent events occurring since the
    predecessor’s audit report was issued.
    b. Understanding as to the reasons for the change of
    auditors.
    c. Awareness of the consistency in the application of
    GAAP between periods.
    d. Evaluation of all matters of continuing accounting
    signifi cance.

Answer 65

65. (b) The requirement is to identify the correct statement
    regarding a successor auditor’s inquiries of the predecessor
    auditor. Answer (b) is correct because the successor should
    request information such as (1) facts that might bear on the
    integrity of management, (2) disagreements with management
    as to accounting principles, auditing procedures, or other
    signifi cant matters, and (3) the predecessor’s understanding of
    the reasons for the change of auditors. Answers (a), (c), and
    (d) all relate to matters not required to be discussed prior to
    accepting an audit engagement.

Question 66

66. An auditor is required to establish an understanding
    with a client regarding the services to be performed for each
    engagement. This understanding generally includes
    a. Management’s responsibility for errors and the illegal
    activities of employees that may cause material
    misstatement.
    b. The auditor’s responsibility for ensuring that the audit
    committee is aware of any signifi cant defi ciencies in
    internal control that come to the auditor’s attention.
    c. Management’s responsibility for providing the
    auditor with an assessment of the risk of material
    misstatement due to fraud.
    d. The auditor’s responsibility for determining preliminary
    judgments about materiality and audit risk factors.

Answer 66

66. (b) The requirement is to identify the item ordinarily
    included when an auditor establishes an understanding with
    a client regarding the services to be performed. Answer (b)
    is correct because auditing standards require that an auditor
    ensure that the audit committee is aware of any signifi cant
    defi ciencies which come to the CPA’s attention. Answer (a)
    is incorrect because while an understanding will include a
    statement that management is responsible for the entity’s
    fi nancial statements, an explicit statement about errors and
    illegal activities of employees is not ordinarily included.
    Answer (c) in incorrect because management does not
    provide the auditor with an assessment of the risk of material
    misstatement due to fraud. Answer (d) is incorrect because
    no such statement about an auditor’s responsibility for
    determining preliminary judgments about materiality and
    audit risk factors is ordinarily included in establishing an
    understanding. See AU-C 210 for information on establishing
    an understanding with a client.

Question 67

67. Which of the following matters is generally included in an
    auditor’s engagement letter?
    a. Management’s responsibility for the entity’s
    compliance with laws and regulations.
    b. The factors to be considered in setting preliminary
    judgments about materiality.
    c. Management’s vicarious liability for illegal acts
    committed by its employees.
    d. The auditor’s responsibility to search for signifi cant
    internal control defi ciencies.

Answer 67

67. (a) The requirement is to identify the matter generally
    included in an auditor’s engagement letter. Answer (a) is
    correct because AU-C 210, which outlines requirements for
    engagement letters, indicates that an engagement letter should
    include an indication that management is responsible for
    identifying and ensuring that the company complies with the
    laws and regulations applicable to its activities. Answer
    (b) is incorrect because such detailed information on
    materiality is not generally included in an engagement letter.
    Answer (c) is incorrect because management liability (if
    any) for illegal acts committed by employees is not generally
    included in an engagement letter. Answer (d) is incorrect
    because while an auditor is required to obtain an understanding
    of internal control, he or she is not required to search for
    signifi cant internal control defi ciencies.

Question 68

68. During the initial planning phase of an audit, a CPA most
    likely would
    a. Identify specifi c internal control activities that are
    likely to prevent fraud.
    b. Evaluate the reasonableness of the client’s accounting
    estimates.
    c. Discuss the timing of the audit procedures with the
    client’s management.
    d. Inquire of the client’s attorney as to whether any
    unrecorded claims are probable of assertion.

Answer 68

68. (c) The requirement is to identify the most likely
    procedure during the initial planning phase of an audit.
    Answer (c) is correct because during initial planning the
    timing of procedures will be discussed due to the need for
    client assistance with many of these procedures. Answer (a)
    is incorrect because the timing of audit procedures will occur
    subsequent to the initial planning stage of an audit. Answer
    (b) is incorrect because the evaluation of reasonableness of the
    client’s accounting estimates will occur after planning—see
    AU-C 540. Answer (d) is incorrect because the inquiry of a
    client’s attorney will occur subsequently to initial planning—
    see AU-C 501.

Question 69

69. Which of the following statements would least likely
    appear in an auditor’s engagement letter?
    a. Fees for our services are based on our regular per diem
    rates, plus travel and other out-of-pocket expenses.
    b. During the course of our audit we may observe
    opportunities for economy in, or improved controls
    over, your operations.
    c. Our engagement is subject to the risk that material
    misstatements or fraud, if they exist, will not be
    detected.
    d. After performing our preliminary analytical procedures
    we will discuss with you the other procedures we
    consider necessary to complete the engagement.

Answer 69

69. (d) The requirement is to identify the statement that is
    least likely to appear in an auditor’s engagement letter. Answer
    (d) is correct because auditors ordinarily will not discuss with management the details of procedures that are necessary
    to perform the audit. Answers (a), (b), and (c) are incorrect
    because engagement letters will include a statement on the risk
    of not detecting material errors and fraud, and may include
    information on fees and observed opportunities for economy.

Question 70

70. Which of the following documentation is not required for an
    audit in accordance with generally accepted auditing standards?
    a. A written audit plan setting forth the procedures
    necessary to accomplish the audit’s objectives.
    b. An indication that the accounting records agree or
    reconcile with the fi nancial statements.
    c. A client engagement letter that summarizes the timing
    and details of the auditor’s planned fi eldwork.
    d. The assessment of the risks of material misstatement.

Answer 70

70. (c) The requirement is to identify the item for which
    the generally accepted auditing standards do not require
    documentation. Answer (c) is correct because while a CPA
    fi rm will include an engagement letter in the working papers,
    it will not detail the auditor’s planned fi eldwork. Answer (a)
    is incorrect because SAS 300 requires a written audit plan.
    Answer (b) is incorrect because AU-C 230 requires that the
    working papers document the agreement or reconciliation of
    the accounting records with the fi nancial statements. Answer
    (d) is incorrect because AU-C 315 requires the auditor to
    document the assessment of the risks of material misstatement.

Question 71

71. An engagement letter should ordinarily include
information on the objectives of the engagement and
CPA
responsibilities
Client
responsibilities
Limitation of
engagement
a. Yes Yes Yes
b. Yes No Yes
c. Yes No No
d. No No No

Answer 71

71. (a) The requirement is to determine what types of items
    are ordinarily included in an engagement letter in addition
    to the objectives of the engagement. Answer (a) is correct
    because AU-C 210 also requires inclusion of information on
    CPA responsibilities, client responsibilities, and limitations of
    the engagement.

Question 72

72. Arrangements concerning which of the following are least
    likely to be included in engagement letter?
    a. A predecessor auditor.
    b. Fees and billing.
    c. CPA investment in client securities.
    d. Other services to be provided in addition to the audit.

Answer 72

72. (c) The requirement is to determine the reply which is
    least likely to be included in an engagement letter. Answer
    (c) is correct because AU-C 210, which provides information
    on obtaining an understanding with the client, does not
    suggest any arrangement concerning CPA investment in client
    securities; indeed such investments are prohibited by the Code
    of Professional Conduct. Answers (a), (b), and (d) all represent
    arrangements which AU-C 210 suggests may be included in an
    engagement letter (or other form of understanding with a client).

Question 73

73. The auditor should document the understanding
    established with a client through a(n)
    a. Oral communication with the client.
    b. Written communication with the client.
    c. Written or oral communication with the client.
    d. Completely detailed audit plan.

Answer 73

73. (b) The requirement is to identify form(s) of documentation
    of the understanding obtained with a client.
    Answer (b) is correct because the professional standards
    require that an auditor document the understanding through a
    written communication with the client. Answer (a) is incorrect
    because an oral communication is not suffi cient. Answer (c)
    is incorrect because the communication should be in writing.
    Answer (d) is incorrect because the understanding is not
    documented in a completely detailed audit plan—a term of
    questionable meaning.

Question 74

74. Which of the following factors most likely would
    infl uence an auditor’s determination of the auditability of an
    entity’s fi nancial statements?
    a. The complexity of the accounting system.
    b. The existence of related-party transactions.
    c. The adequacy of the accounting records.
    d. The operating effectiveness of control
    |procedures.

Answer 74

74. (c) The requirement is to identify the factor that
    most likely would infl uence an auditor’s determination of
    the auditability of an entity’s fi nancial statements. Answer
    (c) is correct because inadequate accounting records may
    cause an auditor to conclude that it is unlikely that suffi cient
    appropriate evidence will be available to support an opinion
    on the fi nancial statements; accordingly, an auditor may
    determine that the fi nancial statements are not auditable.
    Answer (a) is incorrect because an auditor should be able to
    obtain the knowledge necessary to audit a complex accounting
    system. Answer (b) is incorrect because while related-party
    transactions may raise transaction valuation issues due to the
    lack of an “arm’s-length transaction,” the problem is normally
    not so severe as to make the entity not auditable. Answer (d) is
    incorrect because a lack of operating effectiveness of controls
    may often be overcome through an increase in the scope of
    substantive tests.

Question 75

75. Which of the following is most likely to require special
    planning considerations related to asset valuation?
    a. Inventory is comprised of diamond rings.
    b. The client has recently purchased an expensive copy
    machine
    c. Assets costing less than $250 are expensed even when
    the expected life exceeds one year.
    d. Accelerated depreciation methods are used for
    amortizing the costs of factory equipment.

Answer 75

75. (a) The requirement is to identify the area that is
    most likely to require special audit planning considerations.
    Answer (a) is correct because an inventory comprised of
    diamond rings is likely to require that the auditor plan ahead
    to involve a specialist to assist in valuation issues. Answer
    (b) is incorrect because valuation of an asset such as a new
    copy machine is not ordinarily expected to provide valuation
    diffi culties. Answer (c) is incorrect because the expensing
    purchases of such small assets is ordinarily acceptable due to
    the immateriality of the transactions. Answer (d) is incorrect
    because accelerated depreciation methods are ordinarily
    acceptable

Question 76

76. A CPA wishes to determine how various publicly held
    companies have complied with the disclosure requirements of
    a new fi nancial accounting standard. Which of the following
    information sources would the CPA most likely consult for
    information?
    a. AICPA Codifi cation of Statements on Auditing
    Standards.
    b. AICPA Accounting Trends and Techniques.
    c. SEC Quality Control Review.
    d. SEC Statement 10-K Guide.

Answer 76

76. (b) The requirement is to identify the information
    source that a CPA would most likely consult for information
    on how various publicly held companies have complied with
    the disclosure requirements of a new fi nancial accounting
    standard. Answer (b) is correct because AICPA Accounting
    Trends and Techniques, which is issued annually, summarizes
    such disclosures of 600 industrial and merchandising
    corporations. Answer (a) is incorrect because the AICPA
    Codifi cation of Statements on Auditing Standards codifi es
    the various Statements on Auditing Standards and does not
    include information on individual company compliance with
    disclosure requirements. Answer (c) is incorrect because
    Quality Control Review standards are established by the
    AICPA and because they do not include information on
    individual company compliance with disclosure requirements.
    Answer (d) is incorrect because Form 10-K itself provides
    information on preparing Form10-K and this form does not
    include information on individual company compliance with
    disclosure requirements.

Question 77

77. An auditor should design the audit plan so that
    a. All material transactions will be selected for
    substantive testing.
    b. Substantive tests prior to the balance sheet date will be
    minimized.
    c. The audit procedures selected will achieve specifi c
    audit objectives.
    d. Each account balance will be tested under either tests
    of controls or tests of transactions.

Answer 77

77. (c) The requirement is to determine the correct
    statement regarding to an audit plan. Answer (c) is correct
    because an audit plan sets forth in detail the audit procedures
    that are necessary to accomplish the objectives of the audit.
    Answer (a) is incorrect because audit plans address topics
    beyond selecting material transactions and this is not their
    primary focus. Answer (b) is incorrect because a program may
    include numerous substantive tests to be performed prior to the
    balance sheet date. Answer (d) is incorrect because immaterial
    accounts often are not tested and because tests of transactions,
    tests of balances, and analytical procedures are used to test
    account balances; account balances are not directly tested
    through tests of controls.

Question 78

78. The audit plan generally is modifi ed when
    a. Results of tests of control differ from expectations.
    b. An engagement letter has been signed by the auditor
    and the client.
    c. A signifi cant defi ciency has been communicated
    to the audit committee of the board of directors.
    d. The search for unrecorded liabilities has been
    performed and obtained results as had been expected
    during the planning of the audit

Answer 78

78. (a) The requirement is to determine the situation that
    will ordinarily result in modifi cation of the audit plan. Answer
    (a) is correct because results which differ from expectations
    may be expected to lead to modifi cation of planned substantive
    procedures. Answer (b) is incorrect because the signing of the
    engagement letter is unlikely to result in a change in the audit
    plan. Answer (c) is incorrect because the communication itself
    of a signifi cant defi ciency is unlikely to result in a change to
    the audit plan. Answer (d) is incorrect because audit expected
    results obtained by such a procedure are unlikely to result in
    a change to the audit plan, since the plan is already based on
    expected results.

Question 79

79. Audit plans should be designed so that
    a. Most of the required procedures can be performed
    as interim work.
    b. Inherent risk is assessed at a suffi ciently low
    level.
    c. The auditor can make constructive suggestions to
    management.
    d. The audit evidence gathered supports the auditor’s
    conclusions.

Answer 79

79. (d) The requirement is to determine the manner in which
    audit plans should be designed. Answer (d) is correct becausean audit plan should be designed so that the audit evidence
    gathered is suffi cient to support the auditor’s conclusions.
    Answer (a) is incorrect because, often, most audit procedures
    will not be performed as interim work. Answer (b) is incorrect
    because inherent risk need not be assessed at a low level.
    Answer (c) is incorrect because while providing constructive
    suggestions to management is desirable, the audit plan is not
    based on developing constructive suggestions.

Question 80

80. In designing written audit plans, an auditor should
    establish specifi c audit objectives that relate primarily
    to the
    a. Timing of audit procedures.
    b. Cost-benefi t of gathering evidence.
    c. Selected audit techniques.
    d. Financial statement assertions.

Answer 80

80. (d) The requirement is to determine what specifi c audit
    objectives are addressed when designing an audit plan. Answer
    (d) is correct because in obtaining evidence in support of
    fi nancial statement assertions, the auditor develops specifi c
    audit objectives in the light of those assertions. Answers (a),
    (b), and (c) are all incorrect because these replies do not relate
    specifi cally to the audit objectives as do the fi nancial statement
    assertions.

Question 81

81. With respect to planning an audit, which of the following
    statements is always true?
    a. It is acceptable to perform a portion of the audit of a
    continuing audit client at interim dates.
    b. An engagement should not be accepted after the
    client’s year-end.
    c. An inventory count must be observed at year-end.
    d. Final staffi ng decisions must be made prior to
    completion of the planning stage.

Answer 81

81. (a) The requirement is to identify the statement that is
    always true with respect to planning an audit. Answer (a) is
    correct because it is acceptable for an auditor to perform a
    certain portion of the audit at an interim date; for example,
    performing a portion of planning prior to year-end is always
    acceptable for a continuing client. Also, when a new client
    has engaged an auditor prior to year-end, a portion of the
    audit may be conducted prior to year-end. Answer (b) is
    incorrect because an engagement may be accepted after the
    client’s year-end. Answer (c) is incorrect because alternative
    procedures may be possible when an inventory count was not
    observed at year-end. Answer (d) is incorrect because fi nal
    staffi ng decisions need not be made prior to completion of the
    planning stage of an audit.

Question 82

82. The element of the audit planning process most likely to
    be agreed upon with the client before implementation of the
    audit strategy is the determination of the
    a. Evidence to be gathered to provide a suffi cient basis
    for the auditor’s opinion.
    b. Procedures to be undertaken to discover litigation,
    claims, and assessments.
    c. Pending legal matters to be included in the inquiry of
    the client’s attorney.
    d. Timing of inventory observation procedures to be
    performed.

Answer 82

82. (d) The requirement is to identify the element of the
    audit planning process most likely to be agreed upon with the
    client before implementation of the audit strategy. Answer
    (d) is correct because the auditor will ordinarily observe
    the counting of inventory and this will require a degree of
    coordination between the performance of audit procedures and
    client count procedures. Answer (a) is incorrect because the
    client will not determine the evidence to be gathered to provide
    a suffi cient basis for the auditor’s opinion. Answers (b) and
    (c) are incorrect because these procedures will be determined
    subsequent to implementation of the audit strategy.

Question 83

83. To obtain an understanding of a continuing client’s
    business, an auditor most likely would
    a. Perform tests of details of transactions and balances.
    b. Review prior year working papers and the permanent
    fi le for the client.
    c. Read current issues of specialized industry journals.
    d. Reevaluate the client’s internal control environment.

Answer 83

83. (b) The requirement is to determine the manner in which
    an auditor plans an audit of a continuing client. Answer (b)
    is correct because a review of prior year working papers and
    the permanent fi le may provide useful information about the
    nature of the business, organizational structure, operating
    characteristics, and transactions that may require special
    attention. Answer (a) is incorrect because tests of details
    of transactions and balances occur subsequent to planning.
    Answer (c) is incorrect because while reading specialized
    industry journals will help the auditor to obtain a better
    understanding of the client’s industry, it is likely to be less
    helpful than reviewing the working papers. Answer (d) is
    incorrect because a reevaluation of the client’s internal control
    environment occurs subsequent to the ordinal planning of the
    audit.

Question 84

84. On an audit engagement performed by a CPA fi rm with one
    offi ce, at the minimum, knowledge of the relevant professional
    accounting and auditing standards should be held by
    a. The auditor with fi nal responsibility for the audit.
    b. All professionals working upon the audit.
    c. All professionals working upon the audit and the
    partner in charge of the CPA fi rm.
    d. All professionals working in the offi ce.

Answer 84

84. (a) The requirement is to determine who, at a minimum,
    must have knowledge of the relevant professional accounting
    and auditing standards when an audit is being performed.
    Answer (a) is correct because AU-C 200 requires that, at a
    minimum, the auditor with fi nal responsibility have such
    knowledge. Answers (b), (c), and (d) are all incorrect because
    they suggest a higher minimum requirement.

Question 85

85. An auditor obtains knowledge about a new client’s
    business and its industry to
    a. Make constructive suggestions concerning
    improvements to the client’s internal control.
    b. Develop an attitude of professional skepticism
    concerning management’s fi nancial statement
    assertions.
    c. Evaluate whether the aggregation of known
    misstatements causes the fi nancial statements taken as
    a whole to be materially misstated.
    d. Understand the events and transactions that may have
    an effect on the client’s fi nancial statements.

Answer 85

85. (d) The requirement is to determine why an auditor
    obtains knowledge about a new client’s business and its
    industry. Answer (d) is correct because obtaining a level of
    knowledge of the client’s business and industry enables the
    CPA to obtain an understanding of the events, transactions, and
    practices that, in the CPA’s judgment, may have a signifi cant
    effect on the fi nancial statements. Answer (a) is incorrect
    because providing constructive suggestions is a secondary,
    and not the primary, reason for obtaining knowledge about
    a client’s business and industry. Answer (b) is incorrect
    because while a CPA must develop an attitude of professional
    skepticism concerning a client, this attitude is not obtained by
    obtaining knowledge about the client’s business and industry.
    Answer (c) is incorrect because in-formation on the business
    and industry of a client will provide only limited information
    in determining whether fi nancial statements are materially
    misstated, and numerous other factors are considered in
    evaluating audit fi ndings.

Question 86

86. Which of the following procedures would an auditor least
    likely perform while obtaining an understanding of a client in
    a fi nancial statement audit?
    a. Coordinating the assistance of entity personnel in data
    preparation.
    b. Discussing matters that may affect the audit with fi rm
    personnel responsible for nonaudit services to the
    entity.
    c. Selecting a sample of vendors’ invoices for
    comparison to receiving reports.
    d. Reading the current year’s interim fi nancial
    statements.

Answer 86

86. (c) The requirement is to identify the least likely
    procedure to be performed in planning a fi nancial statement
    audit. Answer (c) is correct because selecting a sample
    of vendors’ invoices for comparison to receiving reports
    will occur normally as a part of the evidence accumulation
    process, not as a part of the planning of an audit. Answer (a)
    is incorrect because coordination of the assistance of entity
    personnel in data preparation occurs during planning. Answer
    (b) is incorrect because while planning the audit, CPAs may
    discuss matters that affect the audit with fi rm personnel
    responsible for providing nonaudit services to the entity.
    Answer (d) is incorrect because any available current year
    interim fi nancial statements will be read during the planning
    stage

Question 87

87. Ordinarily, the predecessor auditor permits the successor
auditor to review the predecessor’s working paper analyses
relating to
Contingencies Balance sheet accounts
a. Yes Yes
b. Yes No
c. No Yes
d. No No

Answer 87

87. (a) The requirement is to identify whether a predecessor
    auditor should permit a successor auditor to review working
    paper analyses relating to contingencies, balance sheet
    accounts, or both. Answer (a) is correct because AU-C 210
    states that a predecessor auditor should ordinarily permit the
    successor to review working papers, including documentation
    of planning, internal control, audit results, and other matters of
    continuing accounting and auditing signifi cance, such as the
    working paper analysis of balance sheet accounts and those
    relating to contingencies.

Question 88

88. In auditing the fi nancial statements of Star Corp., Land
    discovered information leading Land to believe that Star’s
    prior year’s fi nancial statements, which were audited by Tell,
    require substantial revisions. Under these circumstances,
    Land should
    a. Notify Star’s audit committee and stockholders that
    the prior year’s fi nancial statements cannot be relied
    on.
    b. Request Star to reissue the prior year’s fi nancial
    statements with the appropriate revisions.
    c. Notify Tell about the information and make inquiries
    about the integrity of Star’s management.
    d. Request Star to arrange a meeting among the three
    parties to resolve the matter

Answer 88

88. (d) The requirement is to determine a successor
    auditor’s responsibility when fi nancial statements audited
    by a predecessor auditor are found to require substantial
    revisions. Answer (d) is correct because when a successor
    auditor becomes aware of information that indicates that
    fi nancial statements reported on by the predecessor may
    require revision, the successor should request that the client
    arrange a meeting among the three parties to discuss and
    attempt to resolve the matter. Answer (a) is incorrect because the successor is not required to notify the audit committee and
    stockholders. Answer (b) is incorrect because the client should
    fi rst communicate with the predecessor before revising the
    fi nancial statements. Answer (c) is incorrect because a meeting
    of the three parties is arranged by the client and because the
    situation may or may not have anything to do with the integrity
    of management.

Question 89

89. A successor auditor should request the new client to
authorize the predecessor auditor to allow a review of the
predecessor’s
Engagement letter Working papers
a. Yes Yes
b. Yes No
c. No Yes
d. No No

Answer 89

89. (c) The requirement is to determine whether a
    successor auditor should request a new client to authorize the
    predecessor auditor to allow a review of the predecessor’s
    engagement letter, working papers, or both. Answer (c) is
    correct because AU-C 510 states that it is advisable that
    a successor auditor request to be allowed to review the
    predecessor’s working papers.

Question 90

90. Which of the following procedures would an auditor most
    likely perform in planning a fi nancial statement audit?
    a. Inquiring of the client’s legal counsel concerning
    pending litigation.
    b. Comparing the fi nancial statements to anticipated
    results.
    c. Examining computer generated exception reports to
    verify the effectiveness of internal control.
    d. Searching for unauthorized transactions that may aid
    in detecting unrecorded liabilities.

Answer 90

90. (b) The requirement is to identify the audit procedure
    that an auditor will most likely perform during risk assessment
    for a fi nancial statement audit. Answer (b) is correct because
    AU-C 315 requires that an auditor perform analytical
    procedures such as comparing the fi nancial statements to
    anticipated results during the planning stage of an audit.
    Answers (a), (c), and (d) are all incorrect because these
    procedures will all occur subsequent to planning.

Question 91

91. The in-charge auditor most likely would have a
    supervisory responsibility to explain to the staff assistants
    a. That immaterial fraud is not to be reported to the
    client’s audit committee.
    b. How the results of various auditing procedures
    performed by the assistants should be evaluated.
    c. What benefi ts may be attained by the assistants’
    adherence to established time budgets.
    d. Why certain documents are being transferred from the
    current fi le to the permanent fi le.

Answer 91

91. (b) The requirement is to identify the information that
    is most likely to be communicated by a supervisor to staff
    assistants. Answer (b) is correct because staff assistants must
    be aware of how their procedures should be evaluated in order
    to perform these procedures effectively. Answer (a) is incorrect
    because some immaterial fraud may be reported to the client’s
    audit committee. Answer (c) is incorrect because the emphasis
    in an audit must be on performing the audit effectively and not
    merely on adhering to time budgets. Answer (d) is incorrect
    because decisions regarding transferring documents from
    the current fi le to the permanent fi le are generally of less
    importance than the procedure suggested by answer (b).

Question 92

92. The audit work performed by each assistant should be
    reviewed to determine whether it was adequately performed
    and to evaluate whether the
    a. Auditor’s system of quality control has been
    maintained at a high level.
    b. Results are consistent with the conclusions to be
    presented in the auditor’s report.
    c. Audit procedures performed are approved in the
    professional standards.
    d. Audit has been performed by persons having adequate
    technical training and profi ciency as auditors.

Answer 92

92. (b) The requirement is to determine why the work
    of each assistant should be reviewed. Answer (b) is correct
    because AU-C 300 suggests that the work performed by each
    assistant should be reviewed to determine whether it was
    adequately performed and to evaluate whether the results are
    consistent with the conclusions to be presented in the auditor’s
    report. Answer (a) is incorrect because CPA fi rms, not
    individual auditors within the fi rms, have systems of quality
    control. Answer (c) is incorrect because the professional
    standards do not in general approve specifi c audit procedures.
    Answer (d) is incorrect because while determining that
    the audit has been performed by persons having adequate
    technical training and profi ciency as auditors is important, it
    should be addressed prior to the commencement of fi eldwork.

Question 93

93. Analytical procedures used during risk assessment in an
    audit should focus on
    a. Reducing the scope of tests of controls and substantive
    tests.
    b. Providing assurance that potential material
    misstatements will be identifi ed.
    c. Enhancing the auditor’s understanding of the client’s
    business.
    d. Assessing the adequacy of the available evidence

Answer 93

93. (c) The requirement is to determine the proper focus
    of analytical procedures used during risk assessment of an
    audit. Answer (c) is correct because analytical procedures
    used during risk assessment may enhance the auditor’s
    understanding of the client’s business and signifi cant
    transactions and events that have occurred since the prior
    audit and also may help to identify the existence of unusual
    transactions or events and amounts, ratios, and trends that
    might indicate matters that have audit implications.

Question 94

94. A primary purpose of performing analytical procedures
    as risk assessment procedures is to identify the existence of
    a. Unusual transactions and events.
    b. Illegal acts that went undetected because of internal
    control weaknesses.
    c. Related-party transactions.
    d. Recorded transactions that were not properly
    authorized.

Answer 94

94. (a) The requirement is to identify a primary purpose
    of performing analytical procedures during an audit’s
    risk assessment. Answer (a) is correct because analytical
    procedures used during risk assessment may enhance the
    auditor’s understanding of the client’s business and signifi cant
    transactions and events that have occurred since the prior
    audit and also may help to identify the existence of unusual
    transactions or events and amounts, ratios, and trends that
    might indicate matters that have audit implications. Answers
    (b), (c), and (d) are all incorrect because while analytical
    procedures may lead to the discovery of illegal acts, relatedparty
    transactions, and unauthorized transactions, this is not
    the primary objective.

Question 95

95. Which of the following nonfi nancial information would
    an auditor most likely consider in performing analytical
    procedures during risk assessment?
    a. Turnover of personnel in the accounting
    department.
    b. Objectivity of audit committee members.
    c. Square footage of selling space.
    d. Management’s plans to repurchase stock.

Answer 95

95. (c) The requirement is to identify the type of
    nonfi nancial information an auditor would most likely
    consider in performing analytical procedures during the risk
    assessment phase of an audit. Answer (c) is correct because
    the square footage of selling space may be used in considering
    the overall reasonableness of sales. Answer (a) is incorrect
    because while the turnover of personnel in the accounting
    department may provide a measure of risk relating to the
    accounting function, it is not ordinarily used in performing
    analytical procedures. Similarly, answer (b) is incorrect
    because while the objectivity of audit committee members
    is an important consideration, it is not ordinarily used in
    performing analytical procedures. Answer (d) is also incorrect
    because management’s plans to repurchase stock is not directly
    related to analytical procedures. See AU-C 315 and AU-C 520
    for information on analytical procedures.

Question 96

96. The accounts receivable turnover ratio increased during
    20X2. This is consistent with:
    a. Items shipped on consignment during December were
    recorded as credit sales; no cash receipts have yet
    been received on these consignments.
    b. The company increased credit sales by 10% by
    allowing more lenient credit terms—30 days are
    now allowed whereas previously only 20 days were
    allowed.
    c. A major credit sale on which title passed as of
    December 31, 20X2 was recorded in January of 20X3.
    d. Sales for each month are approximately 25% higher
    than those of the preceding year.

Answer 96

96. (c) The requirement is to identify the reply which is
    consistent with an increase in the accounts receivable turnover
    ratio (credit sales / accounts receivable). Answer (c) is correct
    because not including the sale in either the 20X2 sales or
    year-end accounts receivable increases the ratio. For example,
    assume that the actual total year sales are $100,000 and yearend
    receivables are $20,000—a turnover of 5—when the
    sale, assume for $5,000, is included in 20X2. Subtracting the
    $5,000 from 20X2 sales and receivables results in a turnover
    ratio of 6.33 ($95,000 / $15,000)—an increase. Answer (a) is
    incorrect because the consignment increases the numerator
    and denominator by an equal amount—this decreases the ratio.
    Answer (b) is incorrect because the denominator of the ratio is
    likely to increase disproportionately when 30 days rather than
    20 days are allowed—this results in a decrease in the ratio.
    Answer (d) is incorrect because one would expect a pro-rata
    increase in accounts receivable, thus resulting in no change to
    the ratio.

Question 97

97. A company’s gross margin percentage increased in 20X2.
    This is consistent with which of the following occurring in 20X2?
    a. An increase in the tax rate on income.
    b. An increase in units sold.
    c. A decrease in the rate of sales commissions paid to
    sales personnel.
    d. Outsourcing of a part of the manufacturing process
    which resulted in no additional costs.

Answer 97

97. (b) The requirement is to identify which reply is
    consistent with an increase in a company’s gross margin
    percentage ([sales – cost of goods sold] / sales). Answer (b)
    is correct because fi xed overhead costs will not increase with
    the increase in units—thus allowing costs of goods sold to
    increase less proportionately to the increase in units sold.
    Answers (a) and (c) are incorrect because income taxes
    and sales commissions are not included in the gross margin
    calculation. Answer (d) is incorrect because cost of goods sold
    should remain the same due to the outsourcing.

Question 98

98. The following summarizes your client’s inventory
    turnover for Years 1 and 2.
    Year 1 Year 2
    Inventory turnover 7.00 6.00
    This change is most consistent with
    a. A number of expense items were erroneously
    included in cost of goods sold (but not in ending
    inventory).
    b. While inventory levels remained the same in Year
    2, total sales increased and a higher percentage of
    customers are paying their accounts.
    c. Although sales for Year 2 were the same as for Year 1,
    inventory is a bit higher than normal because the last
    month of year 2’s sales were lower than anticipated.
    d. The year-end physical inventory count omitted a
    number of signifi cant items. A periodic accounting
    inventory system is in use.

Answer 98

98. (c) The requirement is to identify the reply that is most
    consistent with a decrease in the inventory turnover (cost
    of goods sold / inventory). Answer (c) is correct because an
    increase in inventory with no change in cost of goods sold will
    decrease the ratio. Answer (a) is incorrect because an increase
    in cost of goods sold will increase the ratio. Answer (b) is
    incorrect because the increased sales would be expected to
    increase the turnover ratio in year 2 since the increased sales,
    with no increase in inventory levels, results in an increase in
    the inventory turnover (through an increase in cost of goods
    sold), not a decrease—more clients paying their accounts does
    not directly affect the ratio. Answer (d) is incorrect because
    this will increase the turnover ratio since cost of goods sold
    will be overstated and inventory will be understated.

Question 99

99. While assessing the risks of material misstatement
    auditors identify risks, relate risk to what could go wrong,
    consider the magnitude of risks and
    a. Assess the risk of misstatements due to illegal acts.
    b. Consider the complexity of the transactions involved.
    c. Consider the likelihood that the risks could result in
    material misstatements.
    d. Determine materiality levels.

Answer 99

99. (c) The requirement is to identify the next step in
    assessing the risks of material misstatement after auditors
    identify risks, relate risks to what could go wrong, and
    consider the magnitude of risks. Answer (c) is correct because
    the professional standards suggest that auditors should then
    consider the likelihood that risks involved could result in
    material misstatements. Answer (a) is incorrect because
    the assessment is not limited to illegal acts. Answer (b) is
    incorrect because the complexity of transactions is not next to
    be considered. Answer (d) is incorrect because determining
    materiality levels occurs prior to this stage of the audit.

Question 100

100. Which of the following are considered further audit
procedures that may be designed after assessing the risks of
material misstatement?
Substantive
tests of details
Risk assessment
procedures
a. Yes Yes
b. Yes No
c. No Yes
d. No No

Answer 100

100. (b) The requirement is to identify whether substantive
     tests of details and/or risk assessment procedures are
     considered further audit procedures that may be designed after
     assessing the risks of material misstatement. Further audit
     procedures are composed of substantive procedures (tests of
     details and analytical procedures) and tests of controls. Answer
     (b) is correct because while substantive tests of details are
     further audit procedures, risk assessment procedures are not.
     Answer (a) is incorrect because risk assessment procedures are
     not further audit procedures. Answer (c) is incorrect because
     substantive tests of details are further audit procedures and
     because risk assessment procedures are not. Answer (d) is
     incorrect because substantive tests of details are further audit
     procedures.

Question 101

101. Which of the following is least likely to be considered a
     risk assessment procedure?
     a. Analytical procedures.
     b. Confi rmation of ending accounts receivable.
     c. Inspection of documents.
     d. Observation of the performance of certain accounting
     procedures.

Answer 101

101. (b) The requirement is to identify the procedure that
     is least likely to be considered a risk assessment procedure.
     Answer (b) is correct because confi rmation is a substantive
     test, rather than a risk assessment procedure. Answers (a),
     (b), and (c) are all risk assessment procedures, as are certain
     inquiries of others outside the entity.

Question 102

102. In an audit of a nonissuer (nonpublic) company, the
     auditors identify signifi cant risks. These risks often
     a. Involve routine, high-volume transactions.
     b. Do not require special audit attention.
     c. Involve items with lower levels of inherent risk.
     d. Involve judgmental matters

Answer 102

102. (d) Answer (d) is correct because signifi cant risks
     often involve accounting estimates or complex accounting
     that involves signifi cant judgments. Answer (a) is incorrect
     because routine, high-volume transactions typically have
     lower risk. Answer (b) is incorrect because signifi cant risks do
     require special audit attention. Answer (c) is incorrect because
     signifi cant risks involve items with high levels of inherent risk.

Question 103

103. After fi eldwork audit procedures are completed, a
     partner of the CPA fi rm who has not been involved in the audit
     performs a second or wrap-up working paper review. This
     second review usually focuses on
     a. The fair presentation of the fi nancial statements in
     conformity with GAAP.
     b. Fraud involving the client’s management and its
     employees.
     c. The materiality of the adjusting entries proposed by
     the audit staff.
     d. The communication of internal control weaknesses to
     the client’s audit committee.

Answer 103

103. (a) The requirement is to identify the focus of a fi nal
     wrap-up review performed by a second partner who has not
     been involved in the audit. Answer (a) is correct because this
     second or “cold” review aims at determining whether the
     fi nancial statements result in fair presentation in conformity
     with GAAP and with whether suffi cient appropriate evidence
     has been obtained. Answer (b) is incorrect because most
     frequently fraud involving the client’s management and
     its employees have not been discovered and, even if they
     have been, the focus of the review is still on the fairness
     of presentation of the fi nancial statements. Answers (c)
     and (d) are incorrect because decisions on materiality and
     communications with the audit committee are only two of the
     many matters the review may address in an effort to address
     fairness of presentation of the fi nancial statements.

Question 104

104. Which of the following statements is correct concerning
     an auditor’s use of the work of a specialist?
     a. The work of a specialist who is related to the client
     may be acceptable under certain circumstances.
     b. If an auditor believes that the determinations made by
     a specialist are unreasonable, only a qualifi ed opinion
     may be issued.
     c. If there is a material difference between a specialist’s
     fi ndings and the assertions in the fi nancial statements,
     only an adverse opinion may be issued.
     d. An auditor may not use a specialist in the
     determination of physical characteristics relating to
     inventories.

Answer 104

104. (a) The requirement is to identify the correct statement
     concerning an auditor’s use of the work of a specialist.
     Answer (a) is correct because the work of a specialist who
     is related to the client may be acceptable under certain
     circumstances. Answer (b) is incorrect because if the auditor
     believes that the fi ndings of the specialist are unreasonable,
     it is generally appropriate to obtain the fi ndings of another
     specialist. Answer (c) is incorrect because a material difference
     between a specialist’s fi ndings and those included in the
     fi nancial statements may result in the need for an explanatory
     paragraph, a qualifi ed opinion, a disclaimer, or an adverse
     opinion. Answer (d) is incorrect because an auditor may
     use a specialist in the determination of various physical
     characteristics of assets.

Question 105

105. In using the work of a specialist, an auditor may refer
     to the specialist in the auditor’s report if, as a result of the
     specialist’s fi ndings, the auditor
     a. Becomes aware of conditions causing substantial
     doubt about the entity’s ability to continue as a going
     concern.
     b. Desires to disclose the specialist’s fi ndings, which
     imply that a more thorough audit was performed.
     c. Is able to corroborate another specialist’s earlier
     fi ndings that were consistent with management’s
     representations.
     d. Discovers signifi cant defi ciencies in the design of the
     entity’s internal control that management does not
     correct.

Answer 105

105. (a) The requirement is to identify a circumstance in
     which an auditor may refer to the fi ndings of a specialist in
     the auditor’s report. Answer (a) is correct because the auditor
     may refer to the specialist when the specialist’s fi ndings result
     in inclusion of an explanatory paragraph to an audit report, in
     this case on going concern status. Answers (b), (c), and (d) are
     all incorrect because a specialist is only referred to in an audit
     report when that specialist’s fi ndings identify a circumstance
     requiring modifi cation of the audit report. Auditors do not
     modify audit reports to simply inform the user that a specialist
     was involved.

Question 106

106. Which of the following statements is correct about the
     auditor’s use of the work of a specialist?
     a. The specialist should not have an understanding
     of the auditor’s corroborative use of the specialist’s
     fi ndings.
     b. The auditor is required to perform substantive
     procedures to verify the specialist’s assumptions and
     fi ndings.
     c. The client should not have an understanding
     of the nature of the work to be performed by the
     specialist.
     d. The auditor should obtain an understanding of the
     methods and assumptions used by the specialist

Answer 106

106. (d) The requirement is to identify the statement that
     is correct about the auditor’s use of the work of a specialist.
     Answer (d) is correct because the auditor should obtain
     an understanding of the nature of the work performed by
     the specialist. Answer (a) is incorrect because ordinarily a
     specialist will have a basic understanding of the auditor’s
     corroborative use of the fi ndings. Answer (b) is incorrect
     because the auditor need not perform substantive procedures to
     verify the specialist’s assumptions and fi ndings. Answer (c) is
     incorrect because the client may have an understanding of the
     nature of the work performed by the specialist. See AU-C 620
     for information on the auditor’s use of the work of a specialist

Question 107

107. In using the work of a specialist, an auditor referred to
     the specialist’s fi ndings in the auditor’s report. This would be
     an appropriate reporting practice if the
     a. Client is not familiar with the professional
     certifi cation, personal reputation, or particular
     competence of the specialist.
     b. Auditor, as a result of the specialist’s fi ndings, adds an
     explanatory paragraph emphasizing a matter regarding
     the fi nancial statements.
     c. Client understands the auditor’s corroborative
     use of the specialist’s fi ndings in relation to the
     representations in the fi nancial statements.
     d. Auditor, as a result of the specialist’s fi ndings, decides
     to indicate a division of responsibility with the
     specialist.

Answer 107

107. (b) The requirement is to identify the circumstance in
     which an auditor may appropriately refer to the fi ndings of a
     specialist. Answer (b) is correct because an auditor may refer
     to a specialist when the report is being modifi ed due to the
     specialist’s fi ndings. Answers (a) and (c) are incorrect because
     a client’s familiarity with a specialist or understanding of the
     auditor’s use of the fi ndings of a specialist does not result
     in modifi cation of the audit report. Answer (d) is incorrect
     because an auditor does not divide responsibility with a
     specialist.

Question 108

108. In using the work of a specialist, an understanding
     should exist among the auditor, the client, and the specialist
     as to the nature of the specialist’s work. The documentation of
     this understanding should cover
     a. A statement that the specialist assumes no
     responsibility to update the specialist’s report for
     future events or circumstances.
     b. The conditions under which a division of
     responsibility may be necessary.
     c. The specialist’s understanding of the auditor’s
     corroborative use of the specialist’s fi ndings.
     d. The auditor’s disclaimer as to whether the specialist’s
     fi ndings corroborate the representations in the
     fi nancial statements.

Answer 108

108. (c) The requirement is to identify the statement that an
     auditor must document when using the work of a specialist.
     Answer (c) is correct because the specialist’s understanding of
     the auditor’s corroborative use of his or her fi ndings must be
     documented. See AU-C 620 for this and other documentation
     requirements. Answer (a) is incorrect because no statement
     concerning an update of the specialist’s report is required to
     be documented. Answer (b) is incorrect because a division
     of responsibility relates to circumstances in which other
     auditors, not specialists, are involved. Answer (d) is incorrect
     because an auditor will not normally issue a disclaimer
     related to whether the specialist’s fi ndings corroborate the
     representations in the fi nancial statements. The specialist’s
     report is only referred to when there is a material difference
     between the specialist’s fi ndings and the representations in
     the fi nancial statements. See AU-C 620 for information on the
     effect of a specialist’s work on an auditor’s report.

Question 109

109. Which of the following is not a specialist upon whose
work an auditor may rely?
a. Actuary.
b. Appraiser.
c. Internal auditor.
d. Engineer.

Answer 109

109. (c) The requirement is to determine which individual is
     not considered a specialist upon whose work an independent
     auditor may rely. The professional standards relating to using
     the work of a specialist do not apply to using the work of an
     internal auditor. Answers (a), (b), and (d), actuary, appraiser,
     and engineer, respectively, are all examples of specialists per
     the professional standards. Note here that the question and
     its reply do not imply that a CPA cannot use the work of an
     internal auditor. What is being suggested is that an internal
     auditor is not considered a specialist under the professional
     standards.

Question 110

E. Required Communication to Those
Charged with Governance
110. In identifying matters for communication with those
charged with governance of an audit client, an auditor most
likely would ask management whether
a. The turnover in the accounting department was
unusually high.
b. It consulted with another CPA fi rm about accounting
matters.
c. There were any subsequent events of which the
auditor was unaware.
d. It agreed with the auditor’s assessed level of control risk.

Answer 110

110. (b) The requirement is to determine the matter that an
     auditor would communicate to those charged with governance.
     Answer (b) is correct because AU-C 260 requires that when
     the auditor is aware of such consultation with another CPA, s/
     he should discuss with the audit committee his/her views about
     signifi cant matters that were the subject of such consultation;
     accordingly, such a discussion with management is to be
     expected. While the information suggested in answers (a), (c),
     and (d) may all be communicated to the audit committee, they
     are not included as required disclosures under AU-C 260. See
     AU-C 260 for the various matters that must be communicated
     to those charged with governance.

Question 111

111. Which of the following statements is correct concerning
     an auditor’s required communication with those charged with
     governance of an audit client?
     a. This communication is required to occur before the
     auditor’s report on the fi nancial statements is issued.
     b. This communication should include discussion of
     any signifi cant disagreements with management
     concerning the fi nancial statements.
     c. Any signifi cant matter communicated to the audit
     committee also should be communicated to management.
     d. Signifi cant audit adjustments proposed by the
     auditor and recorded by management need not be
     communicated to those charged with governance.

Answer 111

111. (b) The requirement is to identify the correct statement
     concerning an auditor’s required communication with those
     charged with governance. Answer (b) is correct because
     the communication should include such information on
     disagreements. See AU-C 260 for this and other required
     communications with those charged with governance.
     Answer (a) is incorrect because the communication may occur
     before or after issuance of the auditor’s report. Answer (c)
     is incorrect because not all matters need be communicated
     to management. Answer (d) is incorrect because signifi cant
     adjustments need to be communicated to those charged with
     governance.

Question 112

112. An auditor would least likely initiate a discussion with
     those charged with governance of an audit client concerning
     a. The methods used to account for signifi cant unusual
     transactions.
     b. The maximum dollar amount of misstatements that
     could exist without causing the fi nancial statements to
     be materially misstated.
     c. Indications of fraud and illegal acts committed by a
     corporate offi cer that were discovered by the auditor.
     d. Disagreements with management as to accounting
     principles that were resolved during the current year’s
     audit.

Answer 112

112. (b) The requirement is to identify the discussion that
     it is least likely that an auditor will initiate with those charged
     with governance. Answer (b) is correct because auditors do
     not generally initiate a discussion on materiality, although they
     do occasionally respond to such questions. See AU-C 260 for
     auditor communications with those charged with governance.

Question 113

113. Which of the following statements is correct about an
     auditor’s required communication with those charged with
     governance of an audit client?
     a. Any matters communicated to the entity’s audit
     committee also are required to be communicated to
     the entity’s management.
     b. The auditor is required to inform those charged
     with governance about signifi cant misstatements
     discovered by the auditor and subsequently corrected
     by management
     c. Disagreements with management about the
     application of accounting principles are required to
     be communicated in writing to those charged with
     governance.
     d. Weaknesses in internal control previously reported
     to those charged with governance need not be
     recommunicated

Answer 113

113. (b) The requirement is to identify the correct statement
     about an auditor’s required communication with those
     charged with governance. Answer (b) is correct because
     the communication must include signifi cant misstatements
     discovered, even if corrected by management. Answer (a)
     is incorrect because while such communications may be
     communicated to management, there is no such requirement.
     Answer (c) is incorrect because disagreements with
     management, as well as the other required disclosures, may
     be communicated either orally or in writing. Answer (d)
     is incorrect because an auditor must recommunicate such
     weaknesses in internal control. Also, see AU-C 260 for the
     matters communicated to those charged with governance.

Question 114

114. Which of the following matters is an auditor required to
     communicate to an entity’s audit committee?
     I. Disagreements with management about matters
     signifi cant to the entity’s fi nancial statements that have
     been satisfactorily resolved.
     II. Initial selection of signifi cant accounting policies in
     emerging areas that lack authoritative guidance.
     a. I only.
     b. II only.
     c. Both I and II.
     d. Neither I nor II.

Answer 114

114. (a) The requirement is to determine whether
     disagreements with management and initial selection of
     signifi cant accounting policies need to be communicated to
     those charged with corporate governance. Answer (a) is correct
     because disagreements should be communicated directly to those charged with corporate governance. Answer (b) is
     incorrect because direct communication by the auditor is not
     required for selection of accounting principles. Management
     may engage in this communication with those charged
     with corporate governance. Answer (c) is incorrect because
     the auditor only needs to make sure that management has
     communicated with the committee concerning initial selection
     of signifi cant accounting policies in emerging areas that
     lack authoritative guidance. Answer (d) is incorrect because
     disagreements should be communicated directly to those
     charged with corporate governance

Question 115

115. Should an auditor communicate the following matters to
those charged with governance of an audit client?
Signifi cant audit
adjustments
recorded by the
entity
Management’s consultation
with other accountants
about signifi cant accounting
matters
a. Yes Yes
b. Yes No
c. No Yes
d. No No

Answer 115

115. (a) The requirement is to determine the information
     that an auditor should communicate to those charged with
     corporate governance. Answer (a) is correct because both
     signifi cant audit adjustments and management’s consultation
     with other accountants about signifi cant accounting matters
     should be communicated to an audit committee. See AU-C 260
     for these and other matters that should be so communicated.