Exam 2

Question 1

____ risk represents the auditor’s assessment of the susceptibility of an assertion to material misstatement, before considering the effectiveness of the client’s internal control.

a. Material
b. Account balance
c. Control
d. Inherent

Answer 1

d. Inherent

Question 2

Risk assessment procedures include inquiries of management and others by the auditor. As part of these procedures, the auditor should talk to

a. Internal auditors
b. Board of directors
c. Individuals involved with regulatory compliance
d. All of the above

Answer 2

d. All of the above

Question 3

Based on 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. Increase materiality levels
b. Decrease detection risk
c. Decrease substantive testing
d. Increase inherent risk

Answer 3

b. Decrease detection risk

Question 4

The risk that audit evidence for an audit objective will fail to detect misstatements exceeding performance materiality levels is

a. Audit risk
b. Control risk
c. Inherent risk
d. Planned detection risk

Answer 4

d. Planned detection risk

Question 5

Inherent risk is ____ related to planned detection risk and ____ related to the amount of audit evidence.

a. Directly; inversely
b. Directly; directly
c. Inversely; inversely
d. Inversely; directly

Answer 5

d. Inversely; directly

Question 6

Auditors typically rely on internal controls of their private company clients

a. Only as needed to complete the audit and satisfy SOX’s requirements
b. Only if the controls are determined to be effective
c. Only if the client asks an auditor to test controls
d. Only if the controls are sufficient to increase control risk to an acceptable level.

Answer 6

b. Only if the controls are determined to be effective

Question 7

Which of the following is not a primary consideration when assessing risk?

a. Nature of clients business
b. Existence of related controls
c. Effectiveness of internal controls
d. Susceptibility to misappropriation of assets

Answer 7

c. Effectiveness of internal controls

Question 8

Which of the following best defines fraud in a financial statement auditing context?

a. Fraud is an unintentional misstatement of the financial statements
b. Fraud is an intentional misstatement of the financial statements
c. Fraud is either an intentional or unintentional misstatement of the financial statements, depending on materiality
d. Fraud is either an intentional or unintentional misstatement of the financial statements, depending on consistency.

Answer 8

b. Fraud is an intentional misstatement of the financial statements

Question 9

Most cases of fraudulent reporting involve

a. Inadequate disclosures
b. An overstatement of income
c. An overstatement of liabilities
d. An overstatement of expenses

Answer 9

b. An overstatement of income

Question 10

____ is fraud that involves theft of an entity’s assets

a. Fraudulent financial reporting
b. A “cookie jar” reserve
c. Misappropriation of assets
d. Income smoothing

Answer 10

c. Misappropriation of assets

Question 11

Misappropriation of assets is normally perpetrated by

a. Members of the board of directors
b. Employees at lower levels of the organization
c. Management of the company
d. The internal auditors

Answer 11

b. Employees at lower levels of the organization

Question 12

Which of the following is an accurate statement regarding the misappropriation of
assets?
a. In most cases, the amounts involved are material to the financial statements
b. Misappropriation of assets can easily increase in size over time and can lead to
significant reputational harm
c. Management should not be concerned about minor misappropriations
d. Asset misappropriation schemes are less common than fraudulent financial
statement schemes.

Answer 12

b. Misappropriation of assets can easily increase in size over time and can lead to
significant reputational harm

Question 13

Although the financial statements of all companies are potentially subject to
manipulation, the risk is greater for companies that
a. Are heavily regulated
b. Have low amounts of debt
c. Have to make significant judgments for accounting estimates
d. Operate in stable economic environments

Answer 13

c. Have to make significant judgments for accounting estimates

Question 14

Fraud is more prevalent in smaller businesses and not-for-profit organizations because it
is more difficult for them to maintain
a. Adequate separation of duties
b. Adequate compensation
c. Adequate financial reporting standards
d. Adequate supervisory boards

Answer 14

a. Adequate separation of duties

Question 15

Upon discovering information that indicates a material misstatement due to fraud may
have occurred, auditors should
a. Acquire additional evidence as needed
b. Thoroughly probe the issues
c. Consult with other team members
d. All of the above

Answer 15

d. All of the above

Question 16

Which of the following questions is the auditor not required to ask company
management when assessing fraud risk?
a. Does management have knowledge of any fraud or suspected fraud within the
company?
b. What is the nature of the fraud risks identified by management?
c. Is management using all assets effectively?
d. What internal controls have been implemented to address the fraud risks?

Answer 16

c. Is management using all assets effectively?

Question 17

When assessing the risk for fraud, the auditor must be cognizant of the fact that
a. The existence of fraud risk factors means fraud exists
b. Analytical procedures must be performed on revenue accounts
c. Horizontal analysis is not useful in helping to determine unusual financial
statements relationships
d. The auditor cannot make inquires about fraud to company personnel who have
no financial statements responsibilities

Answer 17

b. Analytical procedures must be performed on revenue accounts

Question 18

Which of the following is not a likely source of information to assess fraud risks?
a. Communication among audit team member
b. Inquiries of management
c. Analytical procedures
d. Consideration of fraud risks discovered during recent audits of other
clients

Answer 18

d. Consideration of fraud risks discovered during recent audits of other
clients

Question 19

When assessing fraud risk
a. Fraud risk is assessed only at the overall financial statement level
b. The auditor’s assessment of fraud risk should be ongoing throughout the
audit
c. If the auditor concludes that there is a risk of material misstatement due to fraud,
auditing standards require that the risks be treated as pervasive
d. Auditing standards require that the auditor presume there is a risk of fraud in the
inventory account

Answer 19

b. The auditor’s assessment of fraud risk should be ongoing throughout the
audit

Question 20

Which of the following parties is responsible for implementing internal controls to
minimize the likelihood of fraud?
a. External auditors
b. Audit committee members
c. Management
d. Committee of Sponsoring Organizations

Answer 20

c. Management

Question 21

Which party has the primary responsibility to oversee an organization's financial
reporting and internal control process?
a. The board of directors
b. The audit committee
c. Management of the company
d. The financial statement auditors

Answer 21

b. The audit committee

Question 22

Auditing standards specifically require auditors to identify ____ as a fraud in most audits.

a. Overstated assets
b. Understated liabilities
c. Revenue recognition
d. Overstated expenses

Answer 22

c. Revenue recognition

Question 23

To address heightened risk of fraud, the auditor can do all of the following except
a. Use specialists to assist in evaluating the accuracy and reasonableness of
management’s key estimates
b. Decrease the amount of substantive tests
c. Use ACL or IDEA to search for fictitious revenue transactions
d. Use EXCEL to perform analytical procedures at the disaggregated level

Answer 23

b. Decrease the amount of substantive tests

Question 24

When the auditor suspects that fraud may be present, auditing standards require the
auditor to
a. Terminate the engagement with sufficient notice given to the client
b. Issue an adverse opinion or a disclaimer of opinion
c. Obtain additional evidence to determine whether material fraud has
occurred
d. Re-issue the engagement letter

Answer 24

c. Obtain additional evidence to determine whether material fraud has
occurred

Question 25

. The inventory and warehousing cycle can be thought of as having two separate but
closely related systems, one involving the actual physical flow of goods, and the other
the
a. Related costs
b. Strong of the goods
c. Internal control over the goods
d. Prevention of waste, obsolescence, and theft

Answer 25

a. Related costs

Question 26

Which of the following is a continuously updated computerized record of inventory items
purchased, used, sold, and on hand for merchandise, raw materials, and finished
goods?
a. Job cost system
b. Standard cost records
c. Cost accounting records
d. Perpetual inventory master file

Answer 26

d. Perpetual inventory master file

Question 27

Inventory is often significant part of a company’s current assets. Because of its
importance
a. Auditors are required by auditing standards to observe the client taking a
physical inventory count
b. Price tests must be performed to verify whether the physical counts were
correctly summarized
c. Companies are required to use perpetual inventory systems
d. Auditors are required by auditing standards to take the physical inventory for the
client

Answer 27

a. Auditors are required by auditing standards to observe the client taking a
physical inventory count

Question 28

. To ensure proper segregation of duties, who should maintain the perpetual inventory
master file?
a. Production personnel
b. Inventory storeroom personnel
c. Inventory receiving personnel
d. Accounting department personnel

Answer 28

d. Accounting department personnel

Question 29

Which of the following statements is correct regarding the audit of inventory cost
accounting?
a. Cost accounting systems and controls are the same for all manufacturing
companies
b. All companies that have WIP must use a perpetual inventory system
c. Auditors test perpetual inventory master files by examining documents that
supports additions and reductions of inventory amount in the master file
d. Manufacturing companies keep their cost accounting records separate from the
production and other accounting records

Answer 29

c. Auditors test perpetual inventory master files by examining documents that
supports additions and reductions of inventory amount in the master file

Question 30

A major difficulty in the verification of inventory cost records for the purpose of inventory
valuations is in determining the reasonableness of the
a. Direct labor costs
b. Raw material costs
c. Manufacturing overhead costs
d. Period costs

Answer 30

c. Manufacturing overhead costs

Question 31

The audit of cost accounting begins with the internal transfer of assets from raw
materials to WIP to
a. Manufacturing overhead
b. Finished good inventory
c. The perpetual inventory master files
d. Retail sales

Answer 31

b. Finished good inventory

Question 32

Which of the following substantive analytical procedures would be most useful in altering
the auditor to the possibility of obsolete inventory?
a. Compare gross margin percentage with that of previous years
b. Compare units costs of inventory with previous years
c. Compare inventory turnover ratio with previous years
d. Compare current year manufacturing costs with previous years

Answer 32

c. Compare inventory turnover ratio with previous years

Question 33

When determining the sample size for the number of items the auditor should count
during the physical inventory
a. It is easy to quantify the number of items based on a formula developed by the
AICPA
b. One of the key determinants that must be considered is internal control
over the physical count
c. One of the key determinants that must be considered is the cost involved
d. Generally accepted auditing standards require that at least 80% of the dollar
value of the inventory should be included in the sample

Answer 33

b. One of the key determinants that must be considered is internal control
over the physical count

Question 34

There must be a periodic physical count by the client of the inventory items on hand

a. Only if the client uses the LIFO method
b. Only if the clients uses a lower-of-cost-or-market method
c. Regardless of the client’s inventory valuation method
d. Only if the client uses either the LIFO or FIFO method

Answer 34

c. Regardless of the client’s inventory valuation method

Question 35

If the auditor concludes that physical controls over inventory are so inadequate that the
inventory will be difficult to count, the auditor should ordinarily
a. Withdraw from the engagement
b. Issue a qualified audit report
c. Conduct expanded observation tests of physical inventory
d. Hire a specialist to assist the auditor

Answer 35

c. Conduct expanded observation tests of physical inventory

Question 36

When auditors observe the client counting inventory, they should be careful to do all the
following except
a. Inquire about items that are likely to be obsolete or damaged
b. Calculate the unit cost of the inventory items
c. Discuss with management the reasons for excluding any material items
d. Observe the counting of the most significant items

Answer 36

b. Calculate the unit cost of the inventory items

Question 37

. A common inventory observation procedure is to select a random sample of tag numbers
and identify the tag with that number attached to the actual inventory item. The audit
objective being achieved by this procedure is
a. Inventory as recorded on tags actually exists (existence)
b. Existing inventory is counted and tagged (completeness)
c. Inventory is counted accurately (accuracy)
d. Inventory is classified correctly (classification)

Answer 37

a. Inventory as recorded on tags actually exists (existence)

Question 38

A common inventory observation procedure is to be alert for items that are damaged,
rust-or-dust-covered, or located in inappropriate places. The balance=related audit
objective being achieved by this procedure is
a. Classification
b. Cutoff
c. Realizable value
d. Rights

Answer 38

c. Realizable value

Question 39

When an auditor observes that personnel who are responsible for physically counting
inventory are not following the inventory instructions, the auditor should
a. Contact a clients supervisor to correct the problem
b. Modify the client’s physical inventory instructions
c. Not discuss the problem with clients supervisor in order to maintain
independence
d. Assign audit staff to the inventory count

Answer 39

a. Contact a clients supervisor to correct the problem

Question 40

When the auditor attempts to understand the operation of the accounting system by
tracing a few transactions through the accounting system, the auditor is said to be
a. Tracing
b. Vouching
c. Performing a walkthrough
d. Testing controls

Answer 40

c. Performing a walkthrough

Question 41

Narratives, flowcharts, and internal control questionnaires are three common methods of

a. Testing the internal controls
b. Documenting the auditor’s understanding of internal controls
c. Designing the audit manual and procedures
d. Documenting the auditor’s understanding of a client’s organizational structure

Answer 41

b. Documenting the auditor’s understanding of internal controls

Question 42

Once auditors determine that entity level controls are designed and placed in the
operation, they
a. Make a preliminary assessment for each transaction related audit objective
for each major type of transaction
b. Make a preliminary assessment of control risk
c. Obtain an understanding of the design and implementation of internal control
d. Prepare audit documentation in order to express their opinion on the company’s
internal control system

Answer 42

a. Make a preliminary assessment for each transaction related audit objective
for each major type of transaction

Question 43

Which of the following is the correct definition of “control deficiency”?
a. A control deficiency exists if the design or operation of controls does not
permit company personnel to prevent or detect misstatements on a timely
basis
b. A control deficiency exists if one or more deficiencies exist that adversely affect a
company’s ability to prepare external financial statements reliably
c. A control deficiency exists if the design or operation of controls results in a more
than remote likelihood that controls will not prevent or detect misstatements
d. A control deficiency exists if the design or operation of controls result in a more
than probable likelihood that controls will prevent or detect misstatements

Answer 43

a. A control deficiency exists if the design or operation of controls does not
permit company personnel to prevent or detect misstatements on a timely
basis

Question 44

A(n) \_\_\_\_ control is a control elsewhere in the system that offsets the absence of a key
control.
a. Significant
b. Alternate
c. Design
d. Compensating

Answer 44

d. Compensating

Question 45

A ____ exists if one or more control deficiencies exist that are less severe than a
material weakness, but are important enough to merit by those responsible for oversight
of the company’s financial reporting.
a. Potential misstatement
b. Significant weakness
c. Significant deficiency
d. Fraud symptom

Answer 45

c. Significant deficiency

Question 46

If the result of tests of controls support the design and operations of controls as
expected, the auditor uses ____ control risk as the preliminary assessment.
a. A lower
b. The same
c. A higher
d. Either a lower or higher

Answer 46

b. The same

Question 47

When a client uses a service center for processing transactions,
a. The auditor can assume that the controls are adequate because it is and
independent enterprise
b. Auditing standards require the auditor to test the service center’s controls
if the service center application involves processing significant financial
data
c. And the user auditor decides to rely on the service auditor’s report, the user
auditor must make reference to the report of the service auditor in the opinion on
the user organization’s financial statements
d. Non of the above

Answer 47

b. Auditing standards require the auditor to test the service center’s controls
if the service center application involves processing significant financial
data

Question 48

How must significant deficiencies and material weaknesses be communicated to those
charged with governance?
a. Either oral or written communication is acceptable
b. Oral communication is required
c. Written communication is required
d. Written communication is required for material weaknesses, but oral
communication is allowed for significant deficiencies

Answer 48

c. Written communication is required

Question 49

The auditor will issue an unqualified opinion on internal control over financial reporting
when
a. There are no identified material weaknesses as of the end of the fiscal year
b. There have been no restrictions on the scope of the auditor’s wok
c. Both a and b
d. Either a or b

Answer 49

c. Both a and b

Question 50

. Which of the following is true regarding the auditor’s opinion on the effectiveness of
internal control?
a. The auditor is attesting to the effectiveness of internal controls as of the
end of the fiscal year
b. If the client remedies a material weakness before the end of the fiscal year, the
auditor must still issue a qualified opinion or a disclaimer of opinion
c. A scope limitation requires the auditor to issue an adverse opinion
d. Section 404 requires that the auditor design the audit to detect all deficiencies in
internal control

Answer 50

a. The auditor is attesting to the effectiveness of internal controls as of the
end of the fiscal year

Question 51

The auditor designs and performs a combination of tests of controls and substantive
procedures to obtain reasonable assurance that the financial statements are fairly stated
when control risk
a. Is assessed above the maximum
b. Is assessed below the maximum
c. Cannot be assed
d. None of the above

Answer 51

a. Is assessed above the maximum

Question 52

When using the test data approach,
a. Test data should include data that the client’s system should accept or
reject
b. Application programs tested by the auditor’s test data must be different from
those used by the client throughout the year
c. Select data may remain in the client system after testing
d. None of the above statements is correct

Answer 52

a. Test data should include data that the client’s system should accept or
reject

Question 53

Collectively, procedures performed to obtain an understanding of the entity and its
environment, including internal controls, represent the auditor’s
a. Audit strategy
b. Test of controls
c. Risk assessment procedures
d. Test of transactions

Answer 53

c. Risk assessment procedures

Question 54

The purpose of tests of controls is to provide reasonable assurance that the

a. Accounting treatment of transactions and balances is valid and proper
b. Internal control procedures are functioning as intended
c. Entity has complied with GAAP disclosure requirements
d. Entity has complied with requirements of quality control

Answer 54

b. Internal control procedures are functioning as intended

Question 55

In the context of an audit of financial statements, substantive tests are audit procedures
that
a. May be eliminated under certain conditions
b. Are designed to discover significant subsequent events
c. Are designed to test for dollar misstatements
d. Will increase proportionately with the auditors reliance on internal control

Answer 55

c. Are designed to test for dollar misstatements

Question 56

Which of the following is true?
a. Tests of details of balances focus on the ending general ledger balances
for both balance sheet and income statement accounts
b. Tests of details of balances focus on the transactions during the period for both
balance sheet and income statement accounts
c. Tests of details of balances focus on the auditor’s understanding of internal
controls
d. Tests of details of balances focus on comparisons of recorded amounts to
expectations developed by the auditor

Answer 56

a. Tests of details of balances focus on the ending general ledger balances
for both balance sheet and income statement accounts

Question 57

A procedure designed to test for monetary misstatements directly affecting the
correctness of financial statement balances is a
a. Test of controls
b. Substantive test
c. Test of attributes
d. Monetary unit sampling test

Answer 57

b. Substantive test

Question 58

In order to promote audit efficiency the auditor considers cost in selecting audit tests to

perform. Which of the following audit tests would be most costly?
a. Substantive analytical procedures
b. Risk assessment procedures
c. Tests of controls
d. Tests of details of balances

Answer 58

d. Tests of details of balances

Question 59

Which of the following audit tests is usually the least costly to perform?

a. Substantive analytical procedures
b. Tests of controls
c. Tests of balances
d. Substantive tests of transactions

Answer 59

a. Substantive analytical procedures

Question 60

The ____ is the combination of the types of tests to obtain sufficient appropriate
evidence for a cycle. There are likely to be variations in the mix from cycle to cycle
depending on the circumstances of the audit.
a. Testing mix
b. Evidence mix
c. Audit process mix
d. Procedures mix

Answer 60

b. Evidence mix

Question 61

If the auditor find extensive control test deviations and significant misstatements while
performing substantive tests of transactions and substantive analytical procedures
a. The cost of the audit should decrease
b. The auditor will conclude that internal controls are effective
c. Extensive tests of details of balances will need to be performed
d. All of the above

Answer 61

c. Extensive tests of details of balances will need to be performed

Question 62

The document that details the specific audit procedures for each type of test is the

a. Audit strategy
b. Audit program
c. Audit procedure
d. Audit risk model

Answer 62

b. Audit program

Question 63

Presentation and disclosure related audit objectives would be performed in which phase
of the audit process?
a. Plan and design audit approach
b. Perform audit tests for controls and transactions
c. Perform analytical procedures and tests of balances
d. Complete the audit and issue the audit report

Answer 63

d. Complete the audit and issue the audit report

Question 64

Transaction-related audit objectives would most likely be performed in which phase of
the audit process?
a. Plan and design audit approach
b. Perform tests of controls and substantive tests of transactions
c. Perform substantive analytical procedure and tests of details of balances
d. Complete the audit and issue the audit report

Answer 64

b. Perform tests of controls and substantive tests of transactions

Question 65

Which of the following is not completed during phase IV of the audit?
a. Obtain a client representation letter
b. Read information in the annual report to make sure that it is consistent with the
financial statements
c. Perform substantive tests of transactions
d. Perform final analytical procedures

Answer 65

c. Perform substantive tests of transactions