FINAL REVIEW WRONG ANSWERS JUNE 24 Flashcards
_ _ _ _ _ _ _ _ _ _ _ _ _ is the statistical sampling method used when testing controls.
Attributes sampling
_ _ _ _ _ _ _ _ _ _ _ is used in conjunction with variables sampling, and is therefore used in substantive testing, not in tests of controls.
Ratio estimation
_ _ _ _ _ _ _ _ _ _ is used in substantive testing, not in tests of controls.
Variables sampling
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ is used in conjunction with variables sampling, and is therefore used in substantive testing, not in tests of controls.
Stratified sampling
Dan, CPA, has been engaged to audit Modern Home, a manufacturing company that specializes in furniture. Which of the following matters related to the year under audit would most likely result in an increase of inherent risk?
A. The furniture industry has experienced an overall increase in demand. B. Modern Home recently engaged in a complex derivative transaction. C. Modern Home purchased expensive new equipment in the current year. D. Modern Home experienced an increase in working capital.
Choice “B” is correct. Transactions that are complex, such as derivatives, typically result in an increase in inherent risk. (Complex transactions are more likely to be recorded incorrectly than simple transactions.)
Choice “A” is incorrect. A decrease (not increase) in overall industry demand would lead to an increase in inherent risk.
Choice “C” is incorrect. The purchase of equipment is a relatively simple transaction and would not likely increase inherent risk.
Choice “D” is incorrect. A decrease (not increase) in working capital would lead to an increase in inherent risk.
In every audit when assessing risks due to fraud, there is a presumption that which of the following risks exist?
A. Improper revenue recognition and management override of controls B. Pressures, opportunities, and rationalizations C. Errors and weak internal control environment D. Fraudulent financial reporting and misappropriation of assets
Choice “A” is correct. In every audit, there is a presumption that there is risk of both improper revenue recognition and management override of controls. Both risks should be addressed by the auditor in evaluating the overall fraud risk.
Choice “B” is incorrect. Pressures, opportunities, and rationalization represent conditions generally present when fraud occurs rather than fraud risks presumed to exist in every audit.
Choice “C” is incorrect. Errors are an unintentional misstatement or omission (rather than a fraud risk), and a client’s control environment must be assessed through control testing rather than a presumption that the environment is weak.
Choice “D” is incorrect. Fraudulent financial reporting and misappropriation of assets represent the two categories of fraud rather than fraud risks presumed to exist in every audit.
Henry, CPA, is auditing Tafco Industries. Alice is the staff person assigned to the job, Sam is an internal audit professional from Tafco who will be providing assistance in the audit of payroll, and Justin is a specialist who will aid in the valuation of inventory. Which of the following statements is true about Henry’s responsibility with respect to the three professionals assisting on this engagement?
A. Henry must ensure that all three professionals are independent of Tafco. B. Henry must clearly state in the auditor's report that Sam and Justin assisted in the audit, since they are outside professionals, but need not mention Alice's involvement. C. Henry must evaluate the qualifications of all three professionals. D. If the work performed by any of the three professionals results in a modified opinion, Henry may refer to that professional in the auditor's report.
Choice “C” is correct.
If Henry wishes to make use of the internal auditor’s work, he must asses her competency, objectivity, and whether the internal audit function utilizes a systematic and disciplined approach. Henry must be satisfied regarding the specialist’s professional competence, capabilities, and objectivity, if he wishes to use the work of the specialist. Finally, Henry must evaluate his staff’s qualifications in order to determine the appropriate extent of supervision required.
Choice “A” is incorrect. A specialist who is related to the client may be acceptable in certain circumstances, although the auditor may choose to perform additional procedures in those cases. Also, an internal auditor, as an employee of the client, lacks independence by definition.
Choice “B” is incorrect. Typically none of the three professionals would be mentioned in the auditor’s report, although the auditor may refer to the specialist’s work if, as a result of such work, the auditor expresses a modified opinion.
Choice “D” is incorrect. It is true that Henry may refer to the specialist if the specialist’s work results in a modified opinion. However, when the work performed by an internal auditor or a staff member results in a modified opinion, generally there would be no mention of this particular person in the auditor’s report.
A client requests to change an engagement from an audit to a review of financial statements. Which of the following is most likely to be considered by the auditor as an acceptable reason for the change?
A. The bank the client is obtaining a loan from has changed the assurance required on the financial statements from positive to negative assurance. B. Management is unwilling to sign the representation letter because management was not present for the entire period covered by the engagement. C. Management does not want the auditor to correspond with legal counsel. D. Audit procedures might discover that land is materially overstated.
Choice “A” is correct.
A change in client requirements represents an acceptable reason for a change in engagement.
Choice “B” is incorrect. Generally, refusal to provide a signed representation letter is considered an unacceptable reason for the change. In addition, the auditor would not be able to issue a review report without a representation letter.
Choice “C” is incorrect. The client’s refusal to allow correspondence with legal counsel is not an acceptable reason for the change.
Choice “D” is incorrect. The client’s attempt to create deceptive financial statements is not an acceptable reason for the change.
The function of an audit committee includes all the following except:
A. Helping to resolve any disagreements between the auditor and management. B. Appointing the independent auditor. C. Approving the audit conclusions. D. Reviewing the scope of the audit.
Choice “C” is correct. The audit committee is not responsible for approving the conclusions reached by the audit engagement team. This would be the responsibility of the engagement partner. The audit committee would be responsible for reviewing the quality of the auditor’s work to ensure the work performed was done so in an appropriate manner.
Choice “A” is incorrect. The audit committee is responsible for helping to resolve any disagreements related to the accounting treatment of significant items and to provide a bridge between the board of directors and the auditor.
Choice “B” is incorrect. The audit committee is responsible for selecting and appointing the independent auditor.
Choice “D” is incorrect. The audit committee is responsible for reviewing the scope of the audit to ensure that the audit report and the related conclusions will meet the needs of the specific engagement.
Regardless of the industry in which a firm operates, the firm will maximize profits by producing where:
A. Average total cost equals average revenue. B. Marginal cost equals average revenue. C. Average total cost equals marginal revenue. D. Marginal cost equals marginal revenue.
Choice “D” is correct.
Regardless of the industry in which a firm operates, a firm will maximize profits by producing where marginal revenue equals marginal cost (MR = MC).
Choice “A” is incorrect. If average total costs equals average revenue, then economic profits are zero.
Choice “B” is incorrect. This would be a profit maximizing position for a competitive firm only, as competitive firms operate where P = AR = MR = MC (because the firm faces a horizontal demand curve).
Choice “C” is incorrect. This is a zero profit condition for a competitive firm.
A CFO and budget director are working together to create the sales budget for the upcoming fiscal year. In developing the sales forecasts for their main products, they want to get a read on where they think the economy is headed over the next year. Which of the following indicators are they most likely to consider in their forecast?
A. Bond yield curve. B. Industrial production as measured by GDP. C. The prime rate charged by banks. D. The average duration of unemployment.
Choice “A” is correct. To forecast sales for the coming year, the CFO and budget director will look at leading indicators that are used to predict economic activity. The bond yield curve is the only option above that represents a leading indicator, as the others are either coincident indicators (which change at the same time as the economy overall) or lagging indicators (which change after a given economic trend has already begun).
Choice “B” is incorrect. Industrial production as measured by GDP (gross domestic product) is a coincident indicator.
Choice “C” is incorrect. The prime rate charged by banks is a lagging indicator.
Choice “D” is incorrect. The average duration of unemployment is a lagging indicator, while average new unemployment claims (which was not an option given) is a leading indicator.
Which of the following situations is not an example of an inherent limitation of internal control?
A. A programming error in the design of an automated control allows an employee to give himself an unauthorized pay increase. B. Management's failure to enforce control policies surrounding access to inventory allows employees to steal assets. C. A lack of physical controls over the safeguarding of assets allows an employee to steal company assets. D. A fraud scheme whereby an employee orders personal goods and his supervisor, who is in on the scheme, signs the checks to pay for those goods.
Choice “C” is correct.
A lack of physical controls over the safeguarding of assets implies that internal controls are inadequate. Inherent limitations do not relate to controls that are missing or nonexistent, but rather to reasons why internal controls cannot provide absolute assurance.
Choice “A” is incorrect. A programming error in the design of an automated control is a human error. The fact that we cannot completely eliminate human error is one of the inherent limitations of internal control.
Choice “B” is incorrect. Management override of internal control is an inherent limitation of internal control.
Choice “D” is incorrect. Deliberate circumvention of controls by collusion among two or more people is an inherent limitation of internal control.
Which of the following would most likely not be considered a specific IT risk?
A. Unauthorized access to confidential data B. Insufficient data storage C. Security and identity management D. High turnover
Choice “D” is correct.
High turnover can be a risk to a business; however, it is most likely not to be considered a specific IT risk.
Choice “A” is incorrect. Unauthorized access to confidential data is an IT risk.
Choice “B” is incorrect. Insufficient data storage is an IT risk.
Choice “C” is incorrect. Security and identity management is an IT risk.
The Fredrix Corp. has a generous bonus program for senior executives that is based on achievement of stock values in excess of target values. The company’s chief financial officer correlates consistent revenue growth with increasing stock prices and insists that the controller change the classification of financing agreements properly accounted for as failed sales to sales with right of return in an effort to increase sales. The chief financial officer reviews the controller’s compliance with his instructions and makes changes in those instances where the controller did not follow the directive. The chief financial officer’s behavior is best described as:
A. Collusion. B. Management intervention. C. Management override. D. Material omission.
Choice “C” is correct. Management override refers to actions taken by management to override control for personal gain. The chief financial officer’s actions to change accounting and reporting for transactions appropriately classified as financing agreements to sales to increase stock prices and collect bonuses is an example of management override of controls.
Choice “A” is incorrect. The chief financial officer’s actions to change accounting and reporting for transactions appropriately classified as financing agreements to sales to increase stock prices and collect bonuses is an example of management override of controls, not collusion. Collusion represents a cooperative effort to circumvent controls for mutual gain. The chief financial officer, not the controller, benefits from the changes in classification.
Choice “B” is incorrect. The chief financial officer’s actions to change accounting and reporting for transactions appropriately classified as financing agreements to sales to increase stock prices and collect bonuses is an example of management override of controls, not management intervention. Management intervention involves the fully appropriate involvement of management in unusual transaction.
Choice “D” is incorrect. The chief financial officer’s actions to change accounting and reporting for transactions appropriately classified as financing agreements to sales to increase stock prices and collect bonuses is an example of management override of controls, not material omission. The chief financial officer is overriding controls to materially misstate sales.
Which of the following represents an appropriate overall response to an increase in financial statement level risk?
A. Changing the general approach of the audit to ensure control testing of all significant accounts. B. Increasing the level of supervision. C. Shifting substantive procedures to interim. D. Providing management with more specific details about audit sampling procedures.
Choice “B” is correct.
An increase in level of supervision represents an appropriate overall response to an increase in financial statement level risk.
Choice “A” is incorrect. Testing of controls in a financial statement audit is performed when the auditor’s risk assessment is based on the assumption that the controls are operating effectively or when substantive procedures alone are insufficient.
Choice “C” is incorrect. An auditor most likely would perform tests at period end, rather than interim, because it provides greater assurance.
Choice “D” is incorrect. An appropriate overall response to an increase in financial statement level risk is to incorporate a greater level of unpredictability into the audit. Informing management of the specific details of substantive procedures would make the audit more predictable.
Using a combined approach most likely would involve:
A. Reducing inherent risk for most of the assertions relevant to significant account balances. B. Identifying specific controls relevant to specific assertions. C. Changing the timing of substantive tests by omitting interim-date testing and performing the tests at year-end. D. Performing more extensive substantive tests with larger sample sizes than originally planned.
Choice “B” is correct
Using a combined approach involves identifying specific controls relevant to specific assertions that are likely to prevent or detect material misstatements in those assertions. If those controls are found to be operating effectively, substantive testing can be reduced.
Choice “A” is incorrect. A combined approach is based on the relationship between the operating effectiveness of controls and the required level of substantive testing. The level of inherent risk is not part of this evaluation.
Choice “C” is incorrect. Substantive tests performed at year-end would be more consistent with a substantive approach, which would require more competent substantive testing to be performed.
Choice “D” is incorrect. Using a combined approach would most likely lead to less extensive substantive tests with smaller sample sizes.
Which of the following statements is true regarding management’s responsibility for fair value measurements?
A. Management performs independent testing over fair value measurements and disclosures to provide reasonable assurance that they are in conformity with GAAP. B. Management is responsible for making fair value measurements and disclosures in accordance with GAAP. C. Management is not responsible for fair value measurements because they are estimates. D. Management should obtain sufficient, appropriate audit evidence to support the reasonableness of the fair value measurement.
Choice “B” is correct. It is management’s responsibility for making fair value measurements and disclosures in accordance with GAAP.
Choice “A” is incorrect. The auditor is the one who tests fair value measurements and disclosures to provide reasonable assurance that they are in conformity with GAAP, not management.
Choice “C” is incorrect. Management is responsible for ensuring that all fair value measurements are reasonable and calculated and disclosed in accordance with GAAP.
Choice “D” is incorrect. The auditor is the one responsible for obtaining sufficient appropriate audit evidence.
An auditor suspects that the entity may be making illegal cash payments to local government officials. Which of the following procedures would least likely result in the discovery of possible noncompliance with laws and regulations?
A. Performing a test of details of transactions. B. Observing the cash disbursement process. C. Inspecting correspondence from regulatory agencies to the client. D. Inquiring of management regarding the entity’s compliance with laws and regulations.
Choice “B” is correct. Observation of the cash disbursement process provides information about the disbursement of cash at that point in time. It is unlikely that a client that is making illegal payments to local government officials would decide to make the payment during the observation.
Choice “A” is incorrect. Performing a test of details of transactions may provide information indicative of acts of noncompliance, such as discovery of payment of unusual fines or payments for unspecified services.
Choice “C” is incorrect. The auditor is required to inspect correspondence from regulatory agencies in order to assist the auditor in identifying instances of noncompliance with laws and regulations.
Choice “D” is incorrect. The auditor is required to inquire specifically of management regarding the entity’s compliance with laws and regulations in order to assist the auditor in identifying instances of noncompliance with laws and regulations.
Bell, CPA is auditing BPJ Inc., a manufacturing company. Legal Team, LLC is the external council for BPJ Inc. and represents them on any major legal disputes throughout the year. Bell CPA’s audit procedures should include:
A. Confirmation approval by Legal Team, LLC, obtained in writing, that BPJ Inc. has made all appropriate financial statement disclosures regarding potential litigation, claims, and assessment. B. A letter prepared by Bell, CPA and sent to BPJ Inc. requiring them to disclose all potential litigation, claims, and assessments. Direct correspondence with the client's attorney is prohibited. C. A letter prepared by BPJ Inc. and sent to Legal Team, LLC regarding confirmation of information disclosed to Bell, CPA with respect to legal matters in which Legal Team, LLC was directly engaged. D. A letter prepared by Bell, CPA and sent to Legal Team, LLC regarding confirmation of information obtained by Bell related to legal matters in which Legal Team, LLC was directly engaged.
Choice “C” is correct. An attorney letter should be prepared by the client and sent by the auditor to the client’s legal counsel (both external and internal counsel).
Choice “A” is incorrect. The client’s attorney would not approve of the client’s financial statement disclosures. This is the responsibility of the auditor to conclude on the adequacy of the disclosures based upon the information obtained from both management and the client’s legal counsel.
Choice “B” is incorrect. The attorney letter is not prepared by the auditor and send to the client, but rather prepared by the client and sent to the client’s internal or external legal counsel. Direct communication with the client’s attorney is not prohibited.
Choice “D” is incorrect. The attorney letter is not prepared by the auditor, but rather by the client. The auditor does send the letter directly to the client’s attorney.
The risk of incorrect acceptance:
A. Relates to substantive tests and affects audit efficiency. B. Relates to tests of controls and affects audit efficiency. C. Relates to tests of controls and affects audit effectiveness. D. Relates to substantive tests and affects audit effectiveness.
Choice “D” is correct.
The risk of incorrect acceptance relates to substantive tests and affects audit effectiveness.
Choice “A” is incorrect. The risk of incorrect rejection relates to substantive tests and affects audit efficiency.
Choice “B” is incorrect. The risk of assessing control risk too high relates to tests of controls and affects audit efficiency.
Choice “C” is incorrect. The risk of assessing control risk too low relates to tests of controls and affects audit effectiveness.
Which of the following procedures would not provide an auditor with evidence regarding a client’s actual or potential litigation, claims, and assessments?
A. Obtaining a letter from the client's attorney. B. Inquiring with management regarding litigation. C. Review minutes from meetings of the board of directors. D. Confirming key details of pending litigation with the opposing party.
Choice “D” is correct. The auditor would not have any correspondence with the opposing party in pending litigation with the client.
Choice “A” is incorrect. The auditor would obtain a letter from the client’s attorney regarding the nature and status of any pending litigation, claims, or assessments.
Choice “B” is incorrect. The auditor should inquire with management regarding any pending litigation and obtain a signed management representation letter that indicates that management has disclosed all relevant information with respect to litigation, claims, and assessments to the auditor.
Choice “C” is incorrect. Reviewing the minutes from meetings with the client’s board of directors would provide evidence of any discussion of pending litigation.
Which of the following procedures would a CPA most likely perform in the planning stage of a financial statement audit?
A. Make inquiries of the client's attorney regarding pending and threatened litigation and assessments. B. Communicate with those charged with governance concerning the prior year's audit adjustments. C. Compare recorded financial information with anticipated results from budgets and forecasts. D. Obtain representations from management regarding the availability of all financial records.
Choice “C” is correct. The planning process should include application of analytical procedures, such as comparison of the financial statements with budgeted or anticipated results.
Choice “A” is incorrect. Inquiries are typically made of the client’s attorney during the fieldwork stage of the audit, not during the planning stage.
Choice “B” is incorrect. Assuming all of those charged with governance are not also involved with managing the entity, the auditor is required to communicate with those charged with governance concerning adjustments arising from the current year’s audit, not adjustments from the previous year.
Choice “D” is incorrect. Management representations are typically obtained at the end of the audit, not during the planning stage.
Which of the following should an auditor do when control risk is assessed at the maximum level?
A. Perform more tests of controls. B. Document the assessment. C. Document the control structure more extensively. D. Perform fewer substantive tests of details.
Choice “B” is correct. When an auditor assesses control risk at the maximum level, the assessment should be documented and the auditor should make decisions to potentially perform more substantive procedures.
Choice “A” is incorrect. When control risk is assessed at the maximum level, then the testing of controls is typically not required.
Choice “C” is incorrect. All control structure documentation should have been performed prior to assessing the control risk at the maximum level.
Choice “D” is incorrect. When control risk is assessed at the maximum level, more, not fewer substantive tests of details would be performed.
According to U.S. GAAS, the date of the management representation letter should be:
A. As near as possible to, but not after, the date of the auditor’s report. B. The same as the date of the auditor’s report. C. The same as the date of the financial statements. D. As near as possible to, but not after, the date of the financial statements.
Choice “B” is correct.
U.S. GAAS require the date of the written representations to be the date of the auditor’s report.
Choice “A” is incorrect. According to ISAs, not U.S. GAAS, the management representation letter should be dated as near as possible to, but not after, the date of the auditor’s report.
Choice “C” is incorrect. U.S. GAAS require the date of the written representations to be the date of the auditor’s report. The auditor will complete the audit after the date of the financial statements.
Choice “D” is incorrect. U.S. GAAS require the date of the written representations to be the date of the auditor’s report. The auditor will complete the audit after the date of the financial statements.
