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Question 1

Which of the following procedures would a CPA most likely perform during the planning stage of the audit?
A.
Evaluate the reasonableness of management’s allowance for doubtful accounts.
B.
Evaluate the significance of uncorrected misstatements.
C.
Determine areas where there is a higher risk of material misstatement.
D.
Confirm a sample of accounts receivable.

Answer 1

Choice “C” is correct. During the planning stage of the audit, the auditor will determine the areas where there is a higher risk of material misstatement.
Choice “A” is incorrect. Evaluating the reasonableness of management’s allowance for doubtful accounts is a substantive procedure, which is performed after the planning stages of the audit.
Choice “B” is incorrect. The auditor evaluates the significance of uncorrected misstatements in the final stages of the audit. This is performed after planning and after substantive testing procedures have been performed.
Choice “D” is incorrect. Confirmation procedures are performed after the planning stage of the audit.

Question 2

The overall attitude and awareness of those charged with governance (i.e., an entity’s board of directors) concerning the importance of internal control usually is reflected in its:
A.
Safeguards over access to assets.
B.
System of segregation of duties.
C.
Control environment.
D.
Computer-based controls.

Answer 2

Choice “C” is correct. The control environment reflects the overall attitude, awareness and actions of those charged with governance (i.e., the board of directors, management, owners, and others) concerning the importance of control and its emphasis in the entity.

Question 3

Which of the following conditions most likely would pose the greatest risk in accepting a new audit engagement?
A.
The client’s financial reporting system has been in place for 10 years.
B.
There will be a client-imposed scope limitation.
C.
The firm will have to hire a specialist in one audit area.
D.
Staff will need to be rescheduled to cover this new client.

Answer 3

Choice “B” is correct. A client-imposed scope limitation indicates that the client might be hiding errors or irregularities that could result in a material misstatement of the financial statements.

Choice “D” is incorrect. Rescheduling staff in response to acceptance of a new audit engagement is a normal activity for CPA firms and does not impact audit risk.

Question 4

The existence of audit risk is recognized by the statement in the auditor’s standard report that the:
A.
Auditor is responsible for expressing an opinion on the financial statements, which are the responsibility of management.
B.
Financial statements are presented fairly, in all material respects, in conformity with GAAP.
C.
Audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.
D.
Auditor obtains reasonable assurance about whether the financial statements are free of material misstatement.

Answer 4

Choice “D” is correct. The existence of audit risk is recognized by the statement in the standard report that the auditor obtained reasonable assurance about whether the financial statements are free of material misstatement. Audit risk is the risk that the auditor may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated.

Question 5

In a financial statement audit of a nonissuer, an auditor would consider a judgmental misstatement to be a misstatement that:
A.
Arises from a flaw in the accounting system.
B.
Exists because of nonstatistical sampling performed by the auditor.
C.
Involves an estimate.
D.
Arises from a routine calculation.

Answer 5

Choice “C” is correct. A misstatement that involves an estimate is considered a judgmental misstatement.
Choice “A” is incorrect. A misstatement that arises from a flaw in the accounting system generally would not be considered a judgmental misstatement. Judgmental misstatements involve subjective decisions, such as misstatements related to accounting estimates or inappropriate application of accounting policies.

Question 6

An audit supervisor reviewed the work performed by the staff to determine if the audit was adequately performed. The supervisor accomplished this by primarily reviewing which of the following?
A.
Financial statements.
B.
Analytical procedures.
C.
Working papers.
D.
Checklists.

Answer 6

Choice “C” is correct. Audit documentation, or working papers, comprises the principal record of audit procedures performed, evidence obtained, and conclusions reached. Reviewing the working papers allows a supervisor to understand the work performed and the evidence obtained, and to evaluate whether the audit was adequately performed.

Question 7

Which of the following characteristics most likely would heighten an auditor’s concern about the risk of intentional manipulation of financial 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 7

Choice “C” is correct. Excessive pressure on management to meet financial targets is a fraud risk factor that would heighten an auditor’s concern about the risk of intentional manipulation of financial statements.

Question 8

What is the definition of fraud in an audit of financial statements?
A.
An intentional act that results in a material misstatement in financial statements that are the subject of an audit.
B.
An intentional act that results in a material weakness in financial statements that are the subject of an audit.
C.
The unintentional misapplication of accounting principles relating to amounts, classification, manner of presentation, or disclosure.
D.
Management’s inability to design and implement programs and controls to prevent, deter, and detect material misstatements.

Answer 8

Choice “A” is correct. The definition of fraud is an intentional act that results in a material misstatement in financial statements that are the subject of an audit.

Question 9

A company has an internal audit function and is in a regulated industry. Which of the following groups should the auditor approach to inquire about the risks of fraud within the entity?
A.
Internal audit, suppliers, and management
B.
Management, internal audit, and audit committee
C.
Internal audit, regulators, and management
D.
Management, sales department head, and audit committee

Answer 9

Choice “B” is correct. An external auditor should inquire of management, internal audit, and the audit committee regarding the risks of fraud within the entity.

Question 10

Under PCAOB standards, which one of the following factors would indicate that a company has less complex operations?
A.
Lack of involvement by senior management in day-to-day operations.
B.
Several levels of management.
C.
Multiple business lines.
D.
A centralized accounting function.

Answer 10

Choice “D” is correct. According to PCAOB standards, a centralized accounting function is indicative of less complex operations.
Choice “A” is incorrect. Lack of involvement by senior management in day-to-day operations would indicate that a company has more complex operations.

Question 11

Which of the following factors most likely would lead a CPA to conclude that a potential audit engagement should be rejected?
A.
The details of most recorded transactions are not available after a specified period of time.
B.
Internal control activities requiring the segregation of duties are subject to management override.
C.
Management has a reputation for consulting with several accounting firms about significant accounting issues.
D.
It is unlikely that sufficient appropriate evidence is available to support an opinion on the financial statements.

Answer 11

Choice “D” is correct. A CPA cannot render an opinion on financial statements unless he or she has obtained sufficient appropriate audit evidence supporting that opinion. If such evidence were unlikely to be available, the CPA would most likely reject the potential audit engagement

Question 12

Which of the following is a requirement for an audit of both an issuer’s and a nonissuer’s financial statements?
A.
The auditor is required to express an opinion on the effectiveness of the company’s internal control over financial reporting.
B.
The auditor is required to refer to a recognized control framework in performing the audit of internal control over financial reporting.
C.
The auditor is required to assess the risk of fraud.
D.
The auditor is required to assess the effectiveness of management’s assessment of the company’s internal control over financial reporting.

Answer 12

Choice “C” is correct. The auditor is required to assess the risk of fraud in an audit of both an issuer’s and a nonissuer’s financial statements.

Question 13

Which of the following decisions would a CPA likely make during the planning stage of the audit?
I.
Whether to perform tests at an interim date or wait until the start of the audit.
II.
Whether to rely on the work of internal auditors.
A.
I only.
B.
II only.
C.
Neither I nor II.
D.
Both I and II.

Answer 13

Choice “D” is correct. During the planning stage of the audit, a CPA would determine the nature, extent, and timing of audit procedures. The timing would include whether to perform tests at interim or year end. Furthermore, part of the planning process would involve a decision whether to use specialists and whether to rely on the work of internal auditors.

Question 14

Which of the following decisions would a CPA likely make during the planning stage of the audit?
I.
Whether to perform tests at an interim date or wait until the start of the audit.
II.
Whether to rely on the work of internal auditors.
A.
I only.
B.
II only.
C.
Neither I nor II.
D.
Both I and II.

Answer 14

Choice “D” is correct. During the planning stage of the audit, a CPA would determine the nature, extent, and timing of audit procedures. The timing would include whether to perform tests at interim or year end. Furthermore, part of the planning process would involve a decision whether to use specialists and whether to rely on the work of internal auditors.

Question 15

The engagement partner is currently assessing how to use the client’s internal audit staff on the upcoming audit. If the competence of the internal audit manager is first being assessed, all of the following may be considered, except for which criteria?
A.
Number of internal auditors under supervision.
B.
Performance evaluations.
C.
Number of years of experience in profession.
D.
Quality of internal audit documentation

Answer 15

Choice “A” is correct. This would not be a criterion used by the engagement partner to assess the internal audit manager’s competence. The number of internal auditors that the internal audit manager supervises is a function of the size and structure of the client’s organization, not the competence of the internal audit manager.

Question 16

Which of the following statements regarding the risk of material misstatement is correct?
A.
Only factual misstatements should be considered when making the assessment of risk and the determination of any adjustments that may need to be made.
B.
Detection risk is the risk that a material misstatement will not be detected by the entity’s controls.
C.
The risk of material misstatement includes the auditor’s assessment of inherent risk as well as control risk.
D.
The risk that a material misstatement may occur due to complex calculations, faulty estimates, or high volume transactions is known as control risk.

Answer 16

Choice “C” is correct. Inherent and control risk are both components of the risk of material misstatement.

Question 17

The auditor with final responsibility for an engagement and one of the assistants have a difference of opinion about the results of an auditing procedure. If the assistant believes it is necessary to be disassociated from the matter’s resolution, the CPA firm’s procedures should enable the assistant to:
A.
Discuss the disagreement with the entity’s management or its audit committee.
B.
Refer the disagreement to the AICPA’s Quality Review Committee.
C.
Document the details of the disagreement with the conclusion reached.
D.
Report the disagreement to an impartial peer review monitoring team.

Answer 17

Choice “C” is correct. Each assistant has a professional responsibility to bring to the attention of the audit supervisor, disagreements or concerns the assistant might have with respect to accounting and auditing issues that he or she believes are of significance to the financial statements or auditor’s report. In addition, each assistant should have a right to document his or her disagreement if he or she believes it is necessary to be disassociated from the resolution of the matter.

Question 18

Which of the following risks may be assessed in nonquantitative terms?
Control
risk
Detection
risk
Inherent
risk
A.
Yes
Yes
Yes
B.
Yes
Yes
No
C.
Yes
No
Yes
D.
No
Yes
Yes

Answer 18

Choice “A” is correct. Both the risk of material misstatement (including control risk and inherent risk) and detection risk may be assessed in quantitative terms such as percentages or in nonquantitative terms that range, for example, from a minimum to a maximum.

Question 19

Proper segregation of duties reduces the opportunities to allow persons to be in positions to both:
A.
Record cash receipts and cash disbursements.
B.
Perpetrate and conceal errors and fraud.
C.
Establish controls and authorize transactions.
D.
Journalize entries and prepare financial statements.

Answer 19

Choice “B” is correct. Segregation of duties reduces the opportunity to allow any person to be in a position to both perpetrate and conceal errors and fraud in the normal course of duties.
Choice “A” is incorrect. Recording cash disbursements and cash receipts are both recording functions and are not incompatible for adequate segregation of duties.

Question 20

Which of the following statements regarding the risk of material misstatement is correct?
A.
The risk that a material misstatement may occur due to complex calculations, faulty estimates, or high volume transactions is known as control risk.
B.
Only factual misstatements should be considered when making the assessment of risk and the determination of any adjustments that may need to be made.
C.
Detection risk is the risk that a material misstatement will not be detected by the entity’s controls.
D.
The risk of material misstatement includes the auditor’s assessment of inherent risk as well as control risk.

Answer 20

Choice “D” is correct. Inherent and control risk are both components of the risk of material misstatement.

Choice “C” is incorrect. The risk described in this statement is control risk.

Question 21

When assessing an internal auditor’s objectivity, the independent auditor should:
A.
Examine workpapers of the internal auditor to verify evidence of supervision and review.
B.
Review the internal auditor’s current audit plan, including the nature, timing, and extent of audit work.
C.
Ascertain the organization level to which the internal audit function reports.
D.
Determine the educational level and the professional experience of the internal auditor.

Answer 21

Choice “C” is correct. When assessing an internal auditor’s objectivity, the independent auditor should ascertain the organization level to which the internal audit function reports.

Choice “D” is incorrect. The independent auditor should determine the educational level and the professional experience of the internal auditor when evaluating the competence, not objectivity, of the internal auditor.

Question 22

A successor auditor should make specific and reasonable inquiries of the predecessor auditor regarding the predecessor’s:
A.
Perception of the competency and reliance on the client’s internal audit function.
B.
Understanding of the reasons for the change in auditors.
C.
Methodology used in applying sampling techniques.
D.
Opinion on subsequent events that have occurred since the balance sheet date.

Answer 22

Choice “B” is correct. The successor auditor is required to make inquiries of the predecessor auditor before accepting an engagement. These inquiries should include the predecessor’s understanding as to the reasons for the change in auditors.

Question 23

Which of the following procedures would an auditor most likely include in the initial planning of a financial statement audit?
A.
Obtaining a written representation letter from the client’s management.
B.
Examining documents to detect any noncompliance with laws and regulations having a material effect on the financial statements.
C.
Considering whether the client’s accounting estimates are reasonable in the circumstances.
D.
Determining the extent of involvement of the client’s internal auditors.

Answer 23

Choice “D” is correct. The auditor considers several factors in planning the nature, timing and extent of auditing procedures. One of these factors is the extent of involvement of the client’s internal auditors.

Question 24

Hill, CPA, has been retained to audit the financial statements of Monday Co. Monday’s predecessor auditor was Post, CPA, who has been notified by Monday that Post’s services have been terminated. Under these circumstances, which party should initiate the communications between Hill and Post?
A.
The chairman of Monday’s board of directors.
B.
Monday’s controller or CFO.
C.
Hill, the successor auditor.
D.
Post, the predecessor auditor.

Answer 24

Choice “C” is correct. The initiative to communicate with the predecessor auditor rests with the successor auditor. Note, however, that the successor auditor must first receive permission from the client.

Question 25

A successor auditor’s inquiries of the predecessor auditor should include questions regarding:
A.
Communications to management and those charged with governance regarding significant deficiencies in internal control.
B.
The assessment of the objectivity of the client’s internal audit function.
C.
The response rate for confirmations of accounts receivable.
D.
The number of engagement personnel the predecessor assigned to the engagement.

Answer 25

Choice “A” is correct. A successor auditor’s inquiries of the predecessor auditor should include questions regarding communications to management and those charged with governance regarding significant deficiencies (and material weaknesses) in internal control.

Question 26

Which of the following is not assessed by the auditor as part of the decision regarding the acceptance of a new client?
A.
The integrity of the audit firm.
B.
The independence of the audit firm.
C.
The audit firm’s ability to meet required reporting deadlines.
D.
The audit firm’s ability to adequately staff the engagement.

Answer 26

Choice “A” is correct. The auditor should assess the integrity of client management (and not its own integrity) when deciding whether to accept a new client.

Question 27

Which of the following statements is correct concerning an auditor’s use of the work of a specialist?
A.
The reasonableness of the specialist’s assumptions and their applications are strictly the auditor’s responsibility.
B.
The auditor need not obtain an understanding of the methods and assumptions used by the specialist.
C.
The work of a management specialist who has a contractual relationship with the client may be acceptable under certain circumstances.
D.
The auditor may not use the work of a specialist in matters material to the fair presentation of the financial statements.

Answer 27

Choice “C” is correct. The purpose of using the work of a specialist is to provide the auditor with specialized skill or knowledge the auditor may lack. The work of a management specialist who has a relationship with a client may be acceptable under certain circumstances. If the management specialist has a relationship with the client, the auditor should assess the risk that the specialist’s objectivity might be impaired. If the auditor believes that the relationship might impair the management specialist’s objectivity, the auditor should perform additional procedures with respect to the specialist’s assumptions, methods, or findings to determine that the findings are not unreasonable or should engage another specialist for that purpose.

Question 28

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 28

Choice “A” is correct. As the acceptable level of detection risk (the risk that an auditor will not detect a material misstatement that exists in an assertion) decreases, the assurance directly provided from substantive tests should increase. The level of detection risk will decline as the benefit of direct tests increases.

Choice “B” is incorrect. If the assurance directly provided from substantive tests decreased, detection risk would increase because the direct tests have become less beneficial.
Choices “C” and “D” are incorrect. Changing the extent of tests of controls does not affect the level of detection risk.

Question 29

On which of the following dates would it be appropriate for an auditor of a nonissuer to discard audit documentation if the engagement letter was signed on June 30, Year 1, the audit was substantially complete on September 1, Year 1, and the audit report was released on March 15, Year 2?
A.
June 30, Year 3
B.
June 30, Year 6
C.
March 30, Year 7
D.
September 1, Year 6

Answer 29

Choice “C” is correct. Auditing standards for nonissuers require that audit documentation be retained for at least five years from the report release date. With an audit report release date of March 15, Year 2, the earliest that the audit documentation may be discarded is March 15, Year 7. March 30, Year 7, is more than five years from the report release date.

Question 30

Detection risk differs from both control risk and inherent risk in that detection risk:
A.
Arises from risk factors relating to fraud.
B.
Exists independently of the financial statement audit.
C.
Can be changed at the auditor’s discretion.
D.
Should be assessed in nonquantitative terms.

Answer 30

Choice “C” is correct. Detection risk can be changed at the auditor’s discretion, whereas control risk and inherent risk exist independently of the financial statement audit, and cannot be changed by the auditor.

Choice “B” is incorrect. Detection risk is a function of the effectiveness of audit procedures and of the manner in which they are applied, so it does not exist independently of the financial statement audit.

Question 31

Which of the following circumstances most likely would cause an auditor to consider whether material misstatements exist in an entity’s financial statements?
A.
Differences are discovered during the client’s annual physical inventory count.
B.
Clerical errors are listed on a monthly computer-generated exception report.
C.
Significant deficiencies in internal control previously communicated have not been corrected.
D.
Supporting records that should be readily available are frequently not produced when requested.

Answer 31

Choice “D” is correct. Supporting records that should be readily available but are frequently not produced when requested would cause an auditor to consider whether material misstatements exist.

Choice “A” is incorrect. Differences being discovered during the client’s annual physical inventory count is a common occurrence at most companies and would not necessarily indicate that a material misstatement exists.

Question 32

Which of the following courses of action is the most appropriate if an auditor concludes that there is a high risk of material misstatement?
A.
Increase of tests of controls.
B.
Select more effective substantive tests.
C.
Perform substantive tests as of an interim date.
D.
Use smaller, rather than larger, sample sizes.

Answer 32

Choice “B” is correct. When the auditor determines that the overall risk of material misstatement is high, the acceptable level of detection risk decreases and the auditor must perform more effective substantive procedures.

Choice “D” is incorrect. Larger samples sizes should be used when the risk of material misstatement is high.

Question 33

A CPA firm evaluates its personnel advancement experience to ascertain whether individuals meeting stated criteria are assigned increased degrees of responsibility. This is evidence of the firm’s adherence to which of the following prescribed standards:
A.
Quality control.
B.
Supervision and review.
C.
Professional ethics.
D.
Accounting and review services.

Answer 33

Choice “A” is correct. The AICPA’s Statements on Quality Control Standards assert that professional development policies and procedures should be established by the firm in order to provide reasonable assurance that personnel will have the knowledge required to perform their work and progress within the firm.

Question 34

Which of the following factors most likely would influence an auditor’s determination of the auditability of an entity’s financial statements?
A.
The operating effectiveness of controls.
B.
The complexity of the information system relevant to financial reporting.
C.
The existence of related party transactions.
D.
The adequacy of the accounting records.

Answer 34

Choice “D” is correct. Inadequate financial records may preclude the auditor from obtaining sufficient appropriate audit evidence.

Choice “B” is incorrect. The complexity of the client’s information system generally would not influence an auditor’s determination of auditability, although it might indicate the need for an information technology expert.

Question 35

An auditor who uses the work of a specialist may refer to the specialist in the auditor’s report if the:
A.
Auditor believes that the specialist’s findings are reasonable in the circumstances.
B.
Specialist’s findings provide the auditor with greater assurance of reliability about management’s representations.
C.
Auditor modifies the report because of the difference between the client’s and the specialist’s valuations of an asset.
D.
Specialist’s findings support the related assertions in the financial statements.

Answer 35

Choice “C” is correct. An auditor who uses the work of a specialist may refer to the specialist in the auditor’s report if, as a result of the work performed by the specialist, the auditor adds explanatory language to or departs from an unmodified opinion.

Question 36

An auditor who uses the work of a specialist may refer to the specialist in the auditor’s report if the:
A.
Auditor believes that the specialist’s findings are reasonable in the circumstances.
B.
Specialist’s findings provide the auditor with greater assurance of reliability about management’s representations.
C.
Auditor modifies the report because of the difference between the client’s and the specialist’s valuations of an asset.
D.
Specialist’s findings support the related assertions in the financial statements.

Answer 36

Choice “C” is correct. An auditor who uses the work of a specialist may refer to the specialist in the auditor’s report if, as a result of the work performed by the specialist, the auditor adds explanatory language to or departs from an unmodified opinion.

Question 37

Which of the following situations most likely represents the highest risk of a material misstatement arising from misappropriations of assets?
A.
A large number of transactions processed using cash.
B.
A large number of inventory items with low sales prices.
C.
A large number of transactions processed in a short period of time.
D.
A large number of fixed assets with easily identifiable serial numbers.

Answer 37

Choice “A” is correct. Transactions processed using cash have a higher risk of material misstatement related to misappropriation of assets. This is because cash is easier for an employee to take without recording the transaction or receipt in the books and records. A strong system of internal control, including proper segregation of duties and the use of a bank lock box for deposits, can reduce the risk of misappropriation of assets related to receipts.

Question 38

Joe Smith has been promoted to audit supervisor prior to an upcoming audit of a large existing client. Assuming that Smith is assigned five assistants for the client audit, his supervisory duties may include all of the following, except for:
A.
Reviewing the work performed by his assistants to determine adequacy and whether the audit objectives were met.
B.
Assuming primary responsibility for all phases of the client audit.
C.
Staying informed with his assistants regarding audit issues or difficulties encountered with the client.
D.
Communicating to his assistants the susceptibility of the client’s financial statements to material misstatement due to error or fraud.

Answer 38

Choice “B” is correct. The engagement partner (not the audit supervisor) has the primary responsibility for the client audit.

Question 39

Strand Inc.’s auditors have identified a major deficiency in regard to its controls. As a result of the deficiency, Strand:
A.
Cannot achieve any of its established objectives.
B.
Must restate its financial statements.
C.
Cannot claim compliance with the requirements of an effective system of internal control.
D.
Must reestablish its operating and compliance objectives.

Answer 39

Choice “C” is correct. A major control deficiency implies that an entity cannot claim that it has met the requirements of an effective system of internal control.

Question 40

During an audit an internal auditor may provide direct assistance to an independent CPA in:
Obtaining an
understanding of
internal control
Performing
tests of
controls
Performing
substantive
tests
A.
Yes
No
No
B.
Yes
Yes
Yes
C.
Yes
Yes
No
D.
No
No
No

Answer 40

Choice “B” is correct. Internal auditors may assist the auditor in obtaining an understanding of internal control and in performing tests of controls and substantive tests.

Question 41

Which of the following is true?
A.
If the assessed level of fraud risk is high, the auditor should attempt to reduce detection risk.
B.
If fraud risk is assessed at a minimum level, audit risk will also be minimal.
C.
Fraud risk is comprised of the risk of material misstatement and detection risk.
D.
Audit risk and fraud risk are synonymous terms.

Answer 41

Choice “A” is correct. As part of planning, the auditor should assess overall fraud risk, and design audit procedures in light of this assessment. The auditor should also respond to specifically identified fraud risks by altering the nature, timing, or extent of audit procedures. If the assessed level of fraud risk is high, audit procedures would be appropriately designed to minimize detection risk. This helps ensure that the auditor will obtain reasonable assurance about whether the financial statements are free of material misstatement caused by fraud.

Question 42

An auditor prepares an unmodified opinion on financial statements that are materially misstated due to fraud. Which of the following is true?
A.
The auditor will be considered to have met his or her responsibility provided the audit was planned and performed appropriately, including a specific assessment of the risk of material misstatement due to fraud.
B.
If all three fraud risk factors were observed during the audit, the auditor should not have issued an unmodified opinion.
C.
The auditor will be considered to have met his or her responsibility provided none of the three fraud risk factors were observed during the audit.
D.
If the client deliberately concealed the fraud from the auditor, the auditor will not be responsible for the erroneous opinion.

Answer 42

Choice “A” is correct. The auditor’s responsibility is to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. This includes a specific assessment of the risk of material misstatement due to fraud.

Question 43

Which of the following factors would a CPA ordinarily consider in the planning stage of an audit engagement?
I.
Financial statement accounts likely to contain a misstatement.
II.
Conditions that require extension of audit tests.
A.
I only.
B.
Neither I nor II.
C.
Both I and II.
D.
II only.

Answer 43

Choice “C” is correct. During the planning stage, the auditor assesses the risk of material misstatement in financial statement accounts. Based on this assessment, the auditor plans the audit procedures to provide reasonable assurance that material misstatements in the financial statements will be detected. Additionally, during the planning stage, conditions may come to the auditor’s attention that indicate a necessary extension of audit tests. The auditor would need to consider this factor in determining the time budget and staffing needs for the engagement.

Question 44

As the acceptable level of detection risk increases, an auditor may:
A.
Change the nature of substantive tests from a less effective to a more effective procedure.
B.
Select a smaller sample size.
C.
Postpone the planned timing of substantive tests from interim dates to year-end.
D.
Lower the assessed level of inherent risk.

Answer 44

Choice “B” is correct.
As the acceptable level of detection risk increases, the assurance that must be provided by substantive tests can decrease. Therefore, the auditor may reduce the sample size.
Choice “A” is incorrect. As the acceptable level of detection risk increases, the level of assurance required from substantive tests decreases. Changing the nature of substantive tests from a less effective to a more effective procedure provides more assurance and is more likely to result from a decrease (not increase) in detection risk.

Question 45

Which of the following statements is true regarding the communication with a predecessor auditor?
A.
Contact with the predecessor auditor before client acceptance is mandatory, but client permission is required.
B.
Contact with the predecessor auditor should not take place prior to engagement acceptance, but such communications may take place after testwork has begun.
C.
Contact with the predecessor auditor before client acceptance is mandatory and based on this requirement, client permission is not required prior to communication.
D.
Contact with the predecessor auditor before client acceptance is not mandatory, but encouraged, and client permission is required.

Answer 45

Choice “A” is correct. Prior to accepting a new client, the auditor must communicate with the predecessor auditor, but the client is required to grant permission before such communications take place. If the client will not grant such permission, the client should not accept the engagement.

Question 46

The ultimate purpose of assessing control risk is to contribute to the auditor’s evaluation of the:
A.
Risk that material misstatements exist in the financial statements.
B.
Operating effectiveness of control activities.
C.
Possibility that the nature and extent of substantive tests may be reduced.
D.
Factors that raise doubts about the auditability of the financial statements.

Answer 46

Choice “A” is correct. The ultimate purpose of assessing control risk is to contribute to the auditor’s evaluation of the risk that material misstatements exist in the financial statements.

Question 47

When determining the nature, extent, and timing of supervision for an audit, the audit supervisor may consider all of the following, except for which factor?
A.
The nature of the audit work assigned to an assistant.
B.
Size and complexity of the client.
C.
Assessed risk of material misstatement pertaining to the current audit.
D.
The assistant’s familiarity with the client’s industry.

Answer 47

Choice “D” is correct. Although having a familiarity with the client’s industry is a plus for the assistant, it would not be considered a primary factor used by the audit supervisor to determine the nature, extent, and timing of supervision for an assistant. Knowledge of a particular industry does not directly equate to an assistant requiring minimal supervision.

Question 48

Which of the following situations represents a risk factor that relates to misstatements arising from misappropriation of assets?
A.
A high turnover of senior management.
B.
A strained relationship between management and the predecessor auditor.
C.
An inability to generate cash flow from operations.
D.
A lack of independent checks.

Answer 48

Choice “D” is correct. A lack of independent checks is a fraud risk factor that provides an opportunity for misappropriation of assets.

Question 49

Which one of the below factors is not included in the PCAOB auditing standards as one that should influence the nature and extent of necessary planning activities?
A.
The size of the auditing firm and the number of auditors assigned to the audit.
B.
Changes in circumstances that occur during the audit.
C.
The size and complexity of the client company.
D.
The auditor’s previous experience with the company.

Answer 49

Choice “A” is correct. The size of the auditing firm and the number of auditors assigned to the audit should not influence the nature and extent of necessary planning activities.

Question 50

A successor auditor ordinarily should request to review the predecessor’s audit documentation relating to:
Contingencies
Internal control
A.
No
Yes
B.
Yes
Yes
C.
Yes
No
D.
No
No

Answer 50

Choice “B” is correct. A review of the predecessor’s audit documentation related to matters of continuing accounting and auditing significance would be permitted. This would include documentation concerning contingencies and internal controls.

Question 51

Davis, CPA, accepted an engagement to audit the financial statements of Tech Resources, a nonissuer. Before the completion of the audit, Tech requested Davis to change the engagement to a compilation of financial statements. Before Davis agrees to change the engagement, Davis is required to consider the:
Additional audit
effort necessary to
complete the audit
Reason given
for Tech’s request
A.
Yes
No
B.
No
Yes
C.
Yes
Yes
D.
No
No

Answer 51

Choice “C” is correct. When an auditor is requested to change the engagement from an audit to a compilation, the auditor must consider the effort needed to complete the audit, the cost of completing the audit, and the reasons for the client’s request. If the audit is substantially complete or an insignificant effort is needed to complete the audit, the auditor should consider the propriety of agreeing to the request.
In addition, if the reason for the request is to limit the scope of the auditor’s examination, the auditor must consider whether the information affected by the scope limitation is incorrect, incomplete, or otherwise unsatisfactory.
A change in circumstance (e.g., an audit is no longer necessary) or a misunderstanding as to the nature of an audit would, on the other hand, be considered a reasonable basis for the change.

Question 52

The auditor should obtain sufficient knowledge of the client’s information and communication system relevant to financial reporting to understand all of the following, except:
A.
The financial reporting process, including development of significant accounting estimates and inclusion of appropriate disclosures.
B.
The means the entity uses to communicate roles, responsibilities, and significant matters relating to financial reporting.
C.
Control activities related to each account balance, transaction class, and disclosure component in the financial statements or to every assertion relevant to them.
D.
Classes of transactions in the entity’s operations that are significant to the financial statements, and how those transactions are processed, from initiation to inclusion in the financial statements.

Answer 52

Choice “C” is correct. Ordinarily, audit planning does not require an understanding of the control activities related to each account balance, transaction class, and disclosure component in the FS or to every assertion relevant to them.
Choice “A” is incorrect. The auditor is required to understand the financial reporting process.

Question 53

Which of the following auditor concerns most likely could be so serious that the auditor concludes that a financial statement audit cannot be performed?
A.
There is a substantial risk of intentional misapplication of accounting principles.
B.
Management is dominated by one person who is also the majority stockholder.
C.
Internal control activities requiring segregation of duties are rarely monitored by management.
D.
Management fails to modify prescribed internal controls for changes in information technology.

Answer 53

Choice “A” is correct. Intentional misapplication of accounting principles would indicate that management lacks integrity and as a result, the auditor might conclude that a financial statement audit cannot be performed.

Choice “B” is incorrect. If management is dominated by one person who is also the majority stockholder, the risk of fraudulent financial reporting is increased, but this would not preclude the auditor from performing a financial statement audit.

Question 54

In designing a written audit plan, an auditor should establish specific audit objectives that relate primarily to the:
A.
Selected audit techniques.
B.
Cost-benefit of gathering evidence.
C.
Financial statement assertions.
D.
Timing of audit procedures.

Answer 54

Choice “C” is correct. In designing a written audit plan, an auditor should establish specific audit objectives that relate primarily to the financial statement assertions.

Question 55

An auditor uses the assessed level of control risk to:
A.
Indicate whether materiality thresholds for planning and evaluation purposes are sufficiently high.
B.
Identify transactions and account balances where inherent risk is at the maximum.
C.
Evaluate the effectiveness of the entity’s system of internal control.
D.
Determine the acceptable level of detection risk for financial statement assertions.

Answer 55

Choice “D” is correct. An auditor uses the assessed level of control risk to determine the risk of material misstatement, which in turn determines the acceptable level of detection risk for financial statement assertions. Detection risk should bear an inverse relationship to control risk. For example, the less control risk an auditor believes exists, the greater the level of detection risk he or she can accept.

Choice “C” is incorrect. The auditor’s evaluation of the effectiveness of the entity’s system of internal control is what the auditor uses to assess control risk, not vice versa.

Question 56

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

Answer 56

Choice “A” is correct. The control environment is the foundation for all other components of internal control. Management’s disregard of its responsibility to maintain an adequate internal control environment therefore compromises its ability to provide reasonable assurance regarding reliable financial reporting. The auditor may conclude that the risk that the financial framework used by the client may be unacceptable is great enough that an audit should not be conducted.

Question 57

An auditor has identified a risk of material misstatement due to fraud related to the inventory function. Which is least likely to be an appropriate response?
A.
Requesting that management more closely monitor the inventory function.
B.
Assigning more experienced personnel to the engagement.
C.
Requesting that inventory be counted on a date close to the end of the reporting period.
D.
Observing inventory counts on an unannounced basis.

Answer 57

Choice “A” is correct. An auditor should respond to fraud risk by designing appropriate audit procedures. Requesting that management more closely monitor the inventory function does not improve the auditor’s likelihood of detecting fraud.

Choice “B” is incorrect. Assigning more experienced personnel to the engagement is an appropriate response to identified risk, since more experienced personnel may be less likely to overlook a condition indicative of fraud.

Question 58

Which of the following is an element of a CPA firm’s quality-control policies and procedures applicable to the firm’s auditing practice?
A.
Efficiency of organizational structures
B.
Computer information processing
C.
Professional skepticism of management
D.
Acceptance of a client relationship

Answer 58

Choice “D” is correct. Acceptance of a client relationship is an element of a CPA firm’s quality-control policies and procedures applicable to the firm’s auditing practice. The elements of a CPA firm’s quality control are human resources, engagement/client acceptance and continuance, leadership responsibilities, performance of the engagement, monitoring, and ethical requirements (HELP ME mnemonic).

Question 59

While auditing the financial statements of a nonissuer, a CPA was requested to change the engagement to a review in accordance with Statements on Standards for Accounting and Review Services (SSARS) because of a scope limitation. If the CPA believes the client’s request is reasonable, the CPA’s review report should:
I.
Refer to the scope limitation that caused the change.
II.
Describe the auditing procedures that have already been applied.
A.
Neither I nor II.
B.
Both I and II.
C.
II only.
D.
I only.

Answer 59

Choice “A” is correct. If the CPA believes the client’s request is reasonable, he/she must comply with the standards for a review and issue an appropriate report. The report should not refer to the original engagement, to any auditing procedures performed, or to the scope limitation.

Question 60

According to the Committee of Sponsoring Organizations (COSO) of the Treadway Commission, which of the following components of the internal control integrated framework addresses the dissemination of information regarding control objectives and responsibilities?
A.
Control activities.
B.
Information and communication.
C.
Control environment.
D.
Risk assessment.

Answer 60

Choice “B” is correct. The information and communication component of the internal control integrated framework includes principles such as internal and external communication as well as obtaining and using information.

Question 61

Each of the following principles relates to the risk assessment component of the Internal Control—Integrated Framework, except:
A.
Specification of objectives.
B.
Consideration for the potential of fraud.
C.
Change identification and assessment.
D.
Accountability for internal control responsibilities

Answer 61

Choice “D” is correct. The principle of accountability for internal control responsibilities is part of the control environment component of the Integrated Framework.

Question 62

Which of the following statements best describes how a detailed audit plan of a CPA who is engaged to audit the financial statements of a large publicly held company compares with the audit client’s comprehensive internal audit program?
A.
The comprehensive internal audit plan is more detailed although it covers fewer areas than would normally be covered by the CPA.
B.
The comprehensive internal audit plan is less detailed and covers fewer areas than would normally be covered by the CPA.
C.
The comprehensive internal audit plan is substantially identical to the audit plan used by the CPA because both cover substantially identical areas.
D.
The comprehensive internal audit plan is more detailed and covers areas that would normally not be covered by the CPA.

Answer 62

Choice “D” is correct. “Internal auditors” are part of the system of internal control. Their audits would cover more areas in greater depth than those of the “independent auditors,” whose concerns are limited to areas materially affecting the “financial statements taken as a whole.” For example, internal auditors would be more involved in analyzing and reporting on the actual operations of the entity of which they are a part

Question 63

All of the following fundamental concepts are reflected in the definition of internal control, except that controls are:
A.
Geared toward achieving strategic, operations, and compliance objectives.
B.
Established to provide reasonable (not absolute) assurance.
C.
Affected by people and their actions.
D.
Adaptable to the structure of the entity.

Answer 63

Choice “A” is correct. Internal controls are geared toward the achievement of operations, reporting, and compliance objectives. Strategic objectives are established as part of the enterprise risk management process.

Question 64

In assessing the competence of internal auditors, an independent CPA most likely would obtain information about the:
A.
Entity’s ability to continue as a going concern for a reasonable period of time.
B.
Influence of management on the scope of the internal auditors’ duties.
C.
Policies limiting internal auditors from communicating with the audit committee.
D.
Quality of the internal auditors’ working paper documentation.

Answer 64

Choice “D” is correct. Competence is reflected by education, professional certification, experience, performance evaluations, the audit plan, audit procedures, and the quality of audit documentation.

Question 65

Control activities over safeguarding of assets may include controls relating to:
Financial
Reporting
Objectives
Operations
Objectives
Compliance
Objectives
A.
No
No
Yes
B.
Yes
Yes
No
C.
Yes
No
No
D.
No
Yes
Yes

Answer 65

Choice “B” is correct. Yes - Yes - No.
Controls over safeguarding of assets may relate to both financial reporting and operations objectives. For example, controls related to financial reporting might include:
Use of a lockbox system for collecting cash, or
Passwords for limiting access to accounts receivable data files.
Controls related to operations might include controls to prevent the excess use of materials in production. Controls over safeguarding of assets generally would not relate to compliance objectives. (Note that the auditor generally would only be concerned with the controls relevant to financial reporting, but this question does not ask which controls are important to the auditor.)

Question 66

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 financial statements in conformity with GAAP, while other matters are not important.
B.
An auditor’s consideration of materiality is influenced by the auditor’s perception of the needs of a reasonable person who will rely on the financial statements.
C.
An auditor considers materiality for the financial statements as a whole in terms of the largest aggregate level of misstatements that could be material to any one of the financial statements.
D.
Materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and qualitative judgments.

Answer 66

Choice “C” is correct. Materiality levels include an overall level for each statement; however, because the statements are interrelated, and for reasons of efficiency, the auditor ordinarily considers materiality for planning purposes in terms of the smallest aggregate level of misstatements that could be considered material to any one of the financial statements.
Choice “A” is incorrect. The concept of materiality recognizes that some matters, either individually or in the aggregate, are important for the fair presentation of financial statements in conformity with GAAP, while other matters are not important.
Choice “B” is incorrect. The auditor’s consideration of materiality is influenced by his or her perception of the needs of a reasonable person relying on the financial statements.
Choice “D” is incorrect. Materiality judgments are made in light of the surrounding circumstances and necessarily involve both quantitative and qualitative considerations.

Question 67

Which of the following statements is correct with regard to the consideration of materiality when an auditor is planning and performing a financial statement audit of an issuer?
A.
When determining a tolerable misstatement threshold, an auditor should take into account the amount of misstatements that were accumulated in prior periods.
B.
An auditor should determine a tolerable misstatement threshold at the overall financial statement level, but not at the account or disclosure level.
C.
When the reevaluation of materiality results in a significantly lower amount than initially established, an auditor would generally not modify audit procedures.
D.
An auditor does not need to express materiality as a specified, quantitative amount.

Answer 67

Choice “A” is correct. Determining the tolerable misstatement is a matter of the auditor’s professional judgment. The identification of misstatements in the prior-period audit may result in the auditor needing to reduce the tolerable misstatement to reduce the probability that the aggregate uncorrected and undetected misstatements exceed the materiality for the financial statements to an acceptably low level.
Choice “B” is incorrect. In certain circumstances, it is necessary for the auditor to reduce the tolerable misstatement for certain classes of transactions, balances, or disclosures if the auditor determines that misstatements of a lesser amount than the overall financial statement materiality would influence the judgment of a reasonable financial statement user.
Choice “C” is incorrect. It is the responsibility of the auditor to consider whether the audit plan and the nature, timing, and extent of auditing procedures need to be revised when the revised assessment of materiality is significantly different.
Choice “D” is incorrect. Although both qualitative and quantitative factors impact the assessment of materiality, it must always be expressed as a specific quantitative amount.

Question 68

The Committee on Sponsoring Organizations prepared the Internal Control Integrated Framework:
A.
To compliment the overarching concepts of the enterprise risk management framework.
B.
To help businesses assess internal control.
C.
To respond to the internal control assessment requirements of the Sarbanes-Oxley Act of 2002.
D.
As part of the Congressional task force known as the Treadway Commission

Answer 68

Choice “B” is correct. In 1992, the Committee on Sponsoring Organizations (COSO) issued Internal Control – Integrated Framework (the Framework) to assist organizations in developing comprehensive assessments of internal control effectiveness. The Framework is widely regarded as an appropriate and comprehensive basis to document the assessment of internal controls over financial reporting

Question 69

When performing a substantive test of a random sample of cash disbursements, an auditor is supplied with a photocopy of vendor invoices supporting the disbursements for one particular vendor rather than the original invoices. The auditor is told that the vendor’s original invoices have been misplaced. What should the auditor do in response to this situation?
A.
Count the missing original documents as misstatements, and project the total amount of the error based on the size of the population and the dollar amount of the errors.
B.
Increase testing by agreeing more of the payments to this particular vendor to the photocopies of its invoices.
C.
Reevaluate the risk of fraud, and design alternate tests for the related transactions.
D.
Increase randomly the number of items in the substantive test to increase the reliance that may be placed on the overall test

Answer 69

Choice “C” is correct. The auditor should reevaluate the risk of fraud and design alternate tests for the related transactions as the evidence (photocopy of vendor invoices) is not reliable.

Question 70

Before applying principal substantive tests to an entity’s accounts receivable at an interim date, an auditor should:
A.
Project sampling risk at the maximum for tests covering the remaining period.
B.
Consider the likelihood of assessing the risk of incorrect rejection too low.
C.
Ascertain that accounts receivable are immaterial to the financial statements.
D.
Assess the difficulty in controlling the incremental audit risk.

Answer 70

Choice “D” is correct. When audit procedures are performed before year-end, the auditor must assess the incremental risk involved and determine whether sufficient alternative procedures exist to extend the interim conclusions to year-end.

Question 71

The Treadway Commission was established to study factors that lead to fraudulent financial reporting. The Treadway Commission was established by:
A.
Treadway Foundation.
B.
Private sponsoring organizations.
C.
Securities and Exchange Commission.
D.
Sarbanes-Oxley Act of 2002.

Answer 71

Choice “B” is correct. The Committee on Sponsoring Organizations (COSO), an independent private sector initiative,

Question 72

Which of the following is usually considered a monitoring activity?
A.
Analyzing new information systems.
B.
Processing entity transactions.
C.
Segregating duties of employees.
D.
Using information from customer complaints

Answer 72

Choice “D” is correct. Monitoring is the process that assesses the quality of control performance over time. Monitoring may include, among other things, the evaluation of communications from external parties such as customers, regulatory agencies, and external auditors.

Question 73

Which of the following statements regarding risk assessment is correct?
A.
The risk of material misstatement is a function of detection risk and control risk.
B.
A high assessment of detection risk will require a reduction in inherent risk.
C.
An auditor’s assessment of control risk at a low level can help to offset a higher level of inherent risk.
D.
An auditor is required to assess the inherent risk, control risk, and detection risk within the client before beginning the audit.

Answer 73

Choice “C” is correct. Control risk and inherent risk are multiplied together to determine the overall risk of material misstatement. Thus, an assessment of control risk at a low level will help to reduce the overall risk of material misstatement.

Question 74

When determining the nature, extent, and timing of supervision for an audit, the audit supervisor may consider all of the following, except for which factor?
A.
The nature of the audit work assigned to an assistant.
B.
Assessed risk of material misstatement pertaining to the current audit.
C.
Size and complexity of the client.
D.
The assistant’s familiarity with the client’s industry.

Answer 74

Choice “D” is correct. Although having a familiarity with the client’s industry is a plus for the assistant, it would not be considered a primary factor used by the audit supervisor to determine the nature, extent, and timing of supervision for an assistant. Knowledge of a particular industry does not directly equate to an assistant requiring minimal supervision

Question 75

If the predecessor auditor refuses to give the current auditor of a nonissuer access to the documentation, what should the current auditor do?
A.
Withdraw from the engagement.
B.
Review the risk assessment of the opening balances of the financial statements.
C.
Discuss the matter with the client’s legal counsel.
D.
Disclaim an opinion due to a scope limitation.

Answer 75

Choice “B” is correct. If the predecessor auditor refuses to give the current auditor of a nonissuer access to the documentation, the current auditor should review the risk assessment of the opening balances of the financial statements.

Question 76

A successor auditor’s inquiries of the predecessor auditor should include questions regarding:
A.
The response rate for confirmations of accounts receivable.
B.
Communications to management and those charged with governance regarding significant deficiencies in internal control.
C.
The assessment of the objectivity of the client’s internal audit function.
D.
The number of engagement personnel the predecessor assigned to the engagement.

Answer 76

Choice “B” is correct. A successor auditor’s inquiries of the predecessor auditor should include questions regarding communications to management and those charged with governance regarding significant deficiencies (and material weaknesses) in internal control.

Question 77

Strand Inc.’s auditors have identified a major deficiency in regard to its controls. As a result of the deficiency, Strand:
A.
Must reestablish its operating and compliance objectives.
B.
Cannot claim compliance with the requirements of an effective system of internal control.
C.
Cannot achieve any of its established objectives.
D.
Must restate its financial statements.

Answer 77

Choice “B” is correct. A major control deficiency implies that an entity cannot claim that it has met the requirements of an effective system of internal control.
Choice “A” is incorrect. A company will not have to reestablish its operating and compliance objectives just because of a major deficiency in its system of internal control.

Question 78

Which of the following types of documentation are typically provided by the predecessor auditor for review?
I. Results of the audit procedures
II. Prior period engagement letter
III. Risk assessment procedures
IV. Client’s significant accounting policies
A.
I, II, and III
B.
I, III, and IV
C.
I and III
D.
II and IV

Answer 78

Choice “C” is correct. Typically, the predecessor auditor will allow a review of audit documentation related to planning, risk assessment, audit procedures, audit results, and matters of continuing audit significance.

Question 79

In assessing the competence, objectivity, and application of a systematic and disciplined approach by the entity’s internal audit function, an independent auditor would least likely consider information obtained from:
A.
Discussions with management personnel.
B.
Previous experience with the internal auditor.
C.
The results of analytical procedures.
D.
External quality reviews of the internal auditor’s activities.

Answer 79

Choice “C” is correct. Analytical procedures may be used to enhance the auditor’s understanding of the client’s business or to evaluate financial statement assertions, but generally would not be helpful in assessing competence, objectivity, and application of a systematic and disciplined approach by the entity’s internal audit function.

Question 80

If an auditor is obtaining an understanding of an issuer’s information and communication component of internal control, which of the following factors should the auditor assess?
A.
The oversight responsibility over financial reporting and internal control by the board or audit committee.
B.
The classes of transactions in the issuer’s operations that are significant to the issuer’s financial statements.
C.
The integrity and ethical values of top management.
D.
The philosophy and operating style of management to promote effective internal control over financial reporting.

Answer 80

Choice “B” is correct. The classes of transactions in the issuer’s operations that are significant to the issuer’s financial statements are typically assessed when the auditor is obtaining an understanding of the information and communication component of internal control.

Question 81

An auditor should obtain knowledge of a client’s information and communication system in order to understand each of the following, except:
A.
The process used to prepare financial statements.
B.
How transactions are initiated, processed, and reported.
C.
The means used by an entity to communicate financial reporting roles to its staff.
D.
The means used by an entity to ensure that management directives are carried out.

Answer 81

Choice “D” is correct. Control activities (not the information and communication system) are the policies and procedures that help ensure that management directives are carried out.
Choice “A” is incorrect. The process used to prepare financial statements includes understanding how transactions are reported. This is a part of the auditor obtaining an understanding of a client’s information and communication system.

Question 82

Prior to commencing field work, an auditor usually discusses the general audit strategy with the client’s management. Which of the following details do management and the auditor usually agree upon at this time?
A.
The specific matters to be included in the communication with those charged with governance.
B.
The schedules and analyses that the client’s staff should prepare.
C.
The effects that inadequate controls may have over the safeguarding of assets.
D.
The minimum amount of misstatements that may be considered to be significant deficiencies in internal control.

Answer 82

Choice “B” is correct. Prior to commencing field work, the auditor would likely discuss with management any assistance desired from client staff. This is part of establishing an understanding with the client.

Question 83

Which of the following is not a required part of the understanding between the client and the auditor?
A.
Management’s responsibility to correct deficiencies in internal control identified by the auditor.
B.
The auditor’s responsibility to obtain reasonable assurance about whether the financial statements are free of material misstatement caused by deliberate fraud.
C.
The auditor’s responsibility to obtain reasonable assurance about whether the financial statements are free of material misstatement caused by unintentional error.
D.
Management’s responsibility to adjust the financial statements if the auditor identifies material misstatements.

Answer 83

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

Question 84

The ultimate purpose of assessing control risk is to contribute to the auditor’s evaluation of the:
A.
Operating effectiveness of control activities.
B.
Factors that raise doubts about the auditability of the financial statements.
C.
Risk that material misstatements exist in the financial statements.
D.
Possibility that the nature and extent of substantive tests may be reduced.

Answer 84

Choice “C” is correct. The ultimate purpose of assessing control risk is to contribute to the auditor’s evaluation of the risk that material misstatements exist in the financial statements.

Choice “A” is incorrect. The auditor is required to obtain knowledge about the operating effectiveness of controls, if his or her risk assessment is based on the effective operation of controls. Obtaining such knowledge, however, is not the ultimate purpose of assessing control risk.

Question 85

Before applying substantive tests to the details of asset accounts at an interim date, an auditor should assess:
A.
Materiality for the accounts tested as insignificant.
B.
Inherent risk at a high level.
C.
Control risk at a low level.
D.
The difficulty in controlling the incremental audit risk.

Answer 85

Choice “D” is correct. Before performing substantive tests at an interim date, the auditor must assess the difficulty in controlling the incremental audit risk from the interim date (on which the substantive procedures are performed) to the year-end date (on which an opinion is rendered)

Choice “B” is incorrect. Generally, inherent risk should be low in order to test substantively at interim.

Question 86

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.
After performing our preliminary analytical procedures we will discuss with you the other procedures we consider necessary to complete the engagement.
C.
Our engagement is subject to the risk that material errors or fraud, including defalcations, if they exist, will not be detected.
D.
Arrangements to be made with the predecessor auditor.

Answer 86

Choice “B” is correct. The auditor does not consult with the client about audit procedures that will be performed.

Question 87

Which of the following statements is correct with respect to fraud encountered during an audit engagement of a nonissuer?
A.
It is often difficult to detect fraudulent intent in matters involving accounting estimates and the application of accounting principles.
B.
An auditor who initially detects fraud ultimately makes the legal determination of whether fraud has actually occurred.
C.
The distinguishing factor between fraud and error is the materiality of the transaction involved.
D.
Fraudulent financial reporting can include the unintentional misstatement of amounts or disclosures in financial statements.

Answer 87

Choice “A” is correct. It is often difficult to detect fraudulent intent in matters involving accounting estimates and the application of accounting principles because there is a high degree of management judgment and subjectivity.

Question 88

Which of the following internal control procedures would prevent an employee from being paid an inappropriate hourly wage?
A.
Using real-time posting of payroll so there can be no after-the-fact data manipulation of the payroll register.
B.
Giving payroll data entry clerks the ability to change any suspicious hourly pay rates to a reasonable rate.
C.
Limiting access to employee master files to authorized employees in the personnel department.
D.
Having the supervisor of the data entry clerk verify that each employee’s hours worked are correctly entered into the system.

Answer 88

Choice “C” is correct. Limiting access to employee master files to authorized employees in the personnel department will minimize the entry of and thus the processing with an inappropriate hourly wage (rate). Master files should be under the control of a data librarian so that only authorized personnel have access to those files.
Choice “A” is incorrect. Real-time posting of payroll does nothing to eliminate any after-the-fact manipulation of the payroll register. If the payroll register can be manipulated after-the-fact, such manipulation can occur regardless of whether it is updated online or in batch.

Question 89

By obtaining an understanding of the client and its internal control environment, the auditor is directly assessing the client’s:
A.
Inherent risk.
B.
Inherent and control risk.
C.
Control risk.
D.
Detection risk.

Answer 89

Choice “B” is correct. The risk of material misstatement is driven by inherent risk and control risk. So if the auditor obtains an understanding of the client and its environment including its controls, the auditor is effectively assessing both the client’s inherent risk and control risk.

Question 90

The acceptable level of detection risk is inversely related to the:
A.
Risk of misapplying auditing procedures.
B.
Assurance provided by substantive tests.
C.
Risk of failing to discover material misstatements.
D.
Preliminary judgment about materiality levels.

Answer 90

Choice “B” is correct. The acceptable level of detection risk is inversely related to the assurance provided by substantive tests. For example, if the acceptable level of detection risk decreases, more assurance is required from substantive tests.

Question 91

Holding other planning considerations equal, a decrease in the amount of misstatements in a class of transactions that an auditor could tolerate most likely would cause the auditor to:
A.
Increase the assessed level of control risk for relevant financial statement assertions.
B.
Decrease the extent of auditing procedures to be applied to the class of transactions.
C.
Perform the planned auditing procedures closer to the balance sheet date.
D.
Apply the planned substantive tests prior to the balance sheet date.

Answer 91

Choice “C” is correct. A decrease in the amount of misstatements that the auditor can tolerate will cause the auditor to modify the nature, timing and/or extent of auditing procedures. Performing the planned procedures closer to the balance sheet date is a timing modification that addresses this change.

Question 92

Which of the following statements is correct concerning an auditor’s responsibility to report fraud?
A.
The disclosure of fraudulent activities to parties other than the client’s senior management and those charged with governance is not ordinarily part of the auditor’s responsibility.
B.
The disclosure of material management fraud to principal stockholders is required when both senior management and the board of directors fail to acknowledge the fraudulent activities.
C.
Fraudulent activities involving senior management of which the auditor becomes aware should be reported directly to the SEC.
D.
The auditor is required to communicate to those charged with governance all minor fraudulent acts perpetrated by low-level employees, even if the amounts involved are inconsequential.

Answer 92

Choice “A” is correct. The disclosure of fraudulent activities to parties other than the client’s senior management and those charged with governance is not ordinarily part of the auditor’s responsibility

Question 93

Which of the following should an auditor do when control risk is assessed at the maximum level?
A.
Perform fewer substantive tests of details.
B.
Document the assessment.
C.
Perform more tests of controls.
D.
Document the control structure more extensively.

Answer 93

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, more, not fewer substantive tests of details would be performed.

Question 94

Which of the following should an auditor do when control risk is assessed at the maximum level?
A.
Perform fewer substantive tests of details.
B.
Document the assessment.
C.
Perform more tests of controls.
D.
Document the control structure more extensively.

Answer 94

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, more, not fewer substantive tests of details would be performed.

Question 95

Obtaining a signed engagement letter would most likely help the auditor to avoid which of the following?
A.
Management needed to obtain an audit report in accordance with a special purpose framework other than U.S. GAAP, but the auditor does not have the appropriate training and knowledge to perform the required engagement.
B.
The auditor believed that management intended to correct an identified material misstatement, however, management determined that the misstatement should be left as uncorrected.
C.
The auditor assumed that all subsequent events had been disclosed by management, but management failed to communicate a transaction that closed just before the audit report was issued.
D.
A disagreement between management and the auditor on the terms of the contingent portion of the audit fee agreement

Answer 95

Choice “A” is correct. The main purpose of the engagement letter is to establish an agreement between the auditor and the client and to reduce the risk of misinterpretation. The engagement letter should include the identification of the applicable financial reporting framework to be used for the report.

Question 96

According to COSO, what is the first ongoing monitoring step in evaluating the effectiveness of an internal control system?
A.
Identifying changes in internal control that have taken place.
B.
Reevaluating the design and implementation to establish a new baseline.
C.
Establishing a control baseline.
D.
Periodically revalidating operations where no known change has occurred.

Answer 96

Choice “C” is correct. Establishing a control baseline needs to be the first monitoring step in evaluating the effectiveness of an internal control system. Without a baseline for comparison, there is nothing to compare against when the evaluation is performed.

Question 97

An auditor ordinarily uses a working trial balance resembling the financial statements without footnotes, but containing columns for:
A.
Cash flow increases and decreases.
B.
Reclassifications and adjustments.
C.
Reconciliations and tickmarks.
D.
Audit objectives and assertions.

Answer 97

Choice “B” is correct. The working trial balance generally contains a column for adjustments and reclassifications.

Question 98

Regardless of the assessed level of control risk, an auditor would perform some:
A.
Dual purpose tests to evaluate both the risk of material misstatement and preliminary control risk.
B.
Tests of controls to determine the effectiveness of internal control.
C.
Analytical procedures to verify the design of internal control.
D.
Substantive tests to restrict detection risk for significant transaction classes.

Answer 98

Choice “D” is correct. Regardless of the assessed level of control risk, an auditor would perform some level of substantive tests to restrict detection risk for significant transaction classes. Even with the lowest possible assessed level of control risk, substantive testing cannot be entirely eliminated for significant transaction classes or balances.

Question 99

In assessing the need for a stronger system of internal controls, management will most likely use the Internal Control—Integrated Framework to do all of the following, except:
A.
Define rules that must be followed throughout the organization.
B.
Apply controls throughout all levels of the organization.
C.
Identify and analyze risks and risk mitigation strategies.
D.
Eliminate inefficient and ineffective controls.

Answer 99

Choice “A” is correct. The Integrated Framework is built on a principles-based (rather than rules-based) approach, which allows management to use judgment and flexibility in applying internal controls

Question 100

The Internal Control—Integrated Framework contains objectives that cover each of the following, except:
A.
The transparency of internal and external financial reporting.
B.
High-level goals established by leadership to develop the entity’s mission.
C.
Ensuring all applicable laws and regulations are followed.
D.
The safeguarding of the entity’s assets against potential losses.

Answer 100

Choice “B” is correct. High-level goals established as part of the development of the entity’s mission are considered strategic objectives, which are a part of enterprise risk management rather than the Internal Control—Integrated Framework.

Question 101

Which of the following statements is correct regarding an independent auditor’s reliance on a client’s internal audit staff?
A.
An independent auditor should use internal audit workpapers when available.
B.
An independent auditor should assess the organizational status of the director of internal audit.
C.
An internal auditor should provide direct assistance to the independent auditor during preparation of audit workpapers.
D.
An independent auditor should not reduce the amount of audit testing based on the work of internal auditors.

Answer 101

Choice “B” is correct. An independent auditor should assess the organizational status of the director of internal audit. The auditor assesses the organizational status primarily to evaluate the objectivity of the internal auditor.

Question 102

A not-for-profit organization periodically conducts focus groups of employees, service beneficiaries and governance board members to reevaluate its mission vision and values to determine the accuracy of the strategic statements to refine them where necessary. This activity relates to which component of internal control?
A.
Information and communication.
B.
Risk assessment.
C.
Control activities.
D.
Monitoring.

Answer 102

Choice “D” is correct. Periodically comparing and updating the mission vision and values of a not-for-profit could best be classified as a monitoring activity.

Question 103

In addition to descriptions of the nature, timing, and extent of planned risk assessment procedures and planned further audit procedures, which of the following additional pieces of information should be documented in the audit plan?
A.
Procedures performed to assess independence and the ability to perform the engagement.
B.
The understanding of the terms of the engagement, including scope, fees, and resource allocation.
C.
Other audit procedures to be performed to comply with generally accepted auditing standards.
D.
Issues with management integrity that could affect the decision to continue the audit engagement.

Answer 103

Choice “C” is correct. The audit plan should include documentation of specific audit procedures (including other audit procedures) to be performed to comply with generally accepted auditing standards.

Question 104

The engagement partner is in the process of creating an audit plan, which includes outlining which audit procedures to be performed in the current audit. In order to detect material misstatements, the auditor would use which of the following audit procedures?
A.
Test of controls.
B.
Other GAAS-related audit procedures.
C.
Substantive procedures.
D.
Risk assessment procedures.

Answer 104

Choice “C” is correct. The auditor would use substantive procedures to detect material misstatements. Substantive procedures include test of details and analytical procedures.

Question 105

Which of the following correctly matches a factor with the related internal control component?
A.
The internal audit function is part of monitoring.
B.
Recording the proper monetary value of transactions is part of control activities.
C.
Human resource policies and practices are part of control activities.
D.
Participation of the audit committee is part of monitoring.

Answer 105

Choice “A” is correct. The internal audit function is part of monitoring.

Question 106

Which one of the below factors is not included in the PCAOB auditing standards as one that should influence the nature and extent of necessary planning activities?
A.
The size and complexity of the client company.
B.
The size of the auditing firm and the number of auditors assigned to the audit.
C.
The auditor’s previous experience with the company.
D.
Changes in circumstances that occur during the audit.

Answer 106

Choice “B” is correct. The size of the auditing firm and the number of auditors assigned to the audit should not influence the nature and extent of necessary planning activities.

Question 107

Which of the following is true?
A.
Audit risk and fraud risk are synonymous terms.
B.
If fraud risk is assessed at a minimum level, audit risk will also be minimal.
C.
If the assessed level of fraud risk is high, the auditor should attempt to reduce detection risk.
D.
Fraud risk is comprised of the risk of material misstatement and detection risk.

Answer 107

Choice “C” is correct. As part of planning, the auditor should assess overall fraud risk, and design audit procedures in light of this assessment. The auditor should also respond to specifically identified fraud risks by altering the nature, timing, or extent of audit procedures. If the assessed level of fraud risk is high, audit procedures would be appropriately designed to minimize detection risk. This helps ensure that the auditor will obtain reasonable assurance about whether the financial statements are free of material misstatement caused by fraud