Q&A Hero

Q: An auditor knows that an audit client operating in an industry in which common stock is valued based on the price-earnings ratio will soon make an initial public offering. All of the following are true except: A. Materiality should be reduced. B. Risk of material misstatement should increase. C. Detection risk should decrease. D. Audit risk should increase.

Q: The achieved (actual) level of audit risk A. Can always be accurately assessed by the auditor. B. Should be greater than or equal to acceptable audit risk. C. Can never be known with certainty. D. Is the same for all audit engagements.

Q: Engagement risk can be eliminated by A. Establishing policies for client acceptance and continuance. B. Lowering audit risk. C. Lowering materiality. D. Engagement risk cannot be eliminated.

Q: Which of the following is a factual misstatement? A. A management estimate that is outside the range of reasonable outcomes determined by the auditor. B. A fixed asset being recorded at the incorrect cost. C. A projected misstatement resulting from errors found during sampling. D. Difference in judgment between the auditor and management.

Q: 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.

Q: When assessing the risk of material misstatement, auditors evaluate the reasonableness of an entity's accounting estimates. An auditor normally would be concerned about assumptions that are A. Susceptible to bias. B. Consistent with prior periods. C. Insensitive to variations. D. Similar to industry guidelines.

Q: Under Statements on Auditing Standards, which of the following would be classified as an error? A. Misappropriation of assets for the benefit of management. B. Misinterpretation by management of facts that existed when the financial statements were prepared. C. Preparation of records by employees to cover a fraudulent scheme. D. Intentional omission of the recording of a transaction to benefit a third party.

Q: Client risk as defined in the text is A. The auditor's risk of loss from events arising in connection with financial statements audited and reported upon. B. The overall risk of material misstatement. C. The risk that audit procedures will fail to detect material misstatements. D. The risk of the entity's financial failure.

Q: Engagement risk is A. The risk of issuing an incorrect audit opinion. B. The auditor's risk of loss from events arising in connection with financial statements audited and reported upon. C. The overall risk of material misstatement. D. The risk of the entity's financial failure.

Q: Inherent risk includes sampling risk and detection risk.

Q: The combination of inherent risk and control risk is referred to as client risk.

Q: The risk of a material misstatement includes inherent risk and sampling risk.

Q: Professional judgment must be used when evaluating business risk.

Q: Inherent risk is the susceptibility of an assertion to material misstatement, assuming no related controls.

Q: The components of the audit risk model include inherent risk, control risk, and detection risk.

Q: Engagement risk is the auditor's exposure to loss or injury of his or her reputation from events arising in connection with financial statements audited.

Q: Audit risk is the auditor's exposure to loss or injury of his or her reputation from events arising in connection with financial statements audited.

Q: Assume that you are the new audit senior on the LV Drug Corporation (LVD) engagement. LVD is a pharmaceutical company that has three successful drugs and a number of drugs in progress in its research and development pipeline. You are considering your audit plan and it is important to identify the inherent risks that LVD has and how they relate to the planning process. Required: For each of the following factors, indicate whether it will tend to increase, decrease, or have no effect on inherent risk, and the reasoning for your answer. a. Dr. Jones is the major shareholder of LVD and its CEO. b. Your firm has audited LVD for the last four years. c. There has been high turnover of key accounting personnel during the last two years. d. The internal audit function reports to the audit committee. e. LVD has been the subject of lawsuits by users of Framadon who claim that the drug affects their liver functions. LVD is confident that there are no such side effects from the use of Framadon.

Q: DATRIX, Inc., a Fortune 500 company, has been experiencing poor performance. Industry analysts have been issuing negative reports and the company's stock price has been steadily declining. As an auditor, what would concern you about the audit engagement of DATRIX, Inc.

Q: In one sentence each, define misstatements arising from fraudulent financial reporting and misstatements arising from misappropriation of assets.

Q: Your classmate asserts, "Accountants shouldn't need to take business courses besides accounting, because they are only interested in the financial statements of a company." Defend or refute this statement. The classmate is misguided. Auditors need to develop a comprehensive understanding of business. Most business concepts and risks have the potential to affect the financial statements either immediately or in the long run. In addition, a thorough understanding of business risks increases the likelihood of identifying material misstatements in the financial statements. Therefore, an auditor should be familiar with an entity's business environment for numerous reasons, including evaluating the going concern assertion.

Q: You are teaching a class of new hires at your international accounting firm. Explain the audit risk model using a mathematical formula.

Q: In the planning stages of an audit, what information does an auditor gain through analytical procedures?

Q: Name three Sarbanes-Oxley Act requirements of the members and duties of the audit committee of a public company.

Q: Define the engagement letter and discuss its importance.

Q: 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 considers materiality for the aggregate level of misstatements that could be material to any one of the financial statements individually. C. Materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and qualitative judgments. D. An auditor's consideration of materiality is influenced by the auditor's perception of the needs of a reasonable person who will rely on the financial statements.

Q: Which element(s) is/are pervasive to the application of generally accepted auditing standards, particularly the standards of fieldwork and reporting? A. The elements of materiality and audit risk. B. The element of internal control. C. The element of corroborating evidence. D. The element of reasonable assurance.

Q: Which of the following is the most important qualitative factor that auditors should consider when making materiality judgments? A. A misstatement exceeded five percent of net income. B. The auditor also provides consulting services to the audit client. C. The misstatement will cause the client to fail to meet an earnings forecast. D. The audit committee is not well-educated about the accounting principle in question.

Q: Which of the following relatively small misstatements most likely would have a material effect on an entity's financial statements? A. An illegal payment to a foreign official that was not recorded. B. A piece of obsolete office equipment that was not retired. C. A petty cash fund disbursement that was not properly authorized. D. An uncollectible account receivable that was not written-off.

Q: Which of the following arranges the general types of audit tests in the order they are normally performed in an audit? A. Substantive procedures, tests of controls, and risk assessment procedures. B. Substantive procedures, risk assessment procedures, and tests of controls. C. Risk assessment procedures, tests of controls, and substantive procedures. D. Risk assessment procedures, substantive procedures, and tests of controls.

Q: Which of the following is a general audit test? A. Fee assessment procedures. B. Tests of controls. C. Preparation of corporate tax returns. D. Active testing procedures.

Q: Under the Sarbanes-Oxley Act, the audit committee of a public company has the following requirement(s): A. Each member of the committee must be a board member and shall be independent. B. The audit committee must preapprove all audit and nonaudit services. C. The audit committee must establish and maintain procedures to handle all issues that relate to accounting, internal control, and auditing. D. All of these.

Q: An entity's financial statements were misstated over a period of years due to large amounts of revenue being recorded in journal entries that involved debits and credits to an illogical combination of accounts. The auditor could most likely have been alerted to this fraud by A. Scanning the general journal for unusual entries. B. Performing a revenue cutoff test at year-end. C. Tracing a sample of journal entries to the general ledger. D. Examining documentary evidence of sales returns and allowances recorded after year-end.

Q: Which of the following procedures would an auditor most likely include in the initial planning of an examination of financial statements? A. Assess the need for the use of specialists in the audit. B. Inquiring of the client's attorney as to any claims that are likely to be asserted. C. Perform detailed testing of the individual financial statement accounts. D. Determining whether necessary internal controls procedures are being applied as prescribed.

Q: The audit client's board of directors and audit committee refused to take any action with respect to an immaterial illegal act which was brought to their attention by the auditor. Because of their failure to act, the auditor withdrew from the engagement. The auditor's decision to withdraw was primarily due to doubts concerning A. Adequate financial statement disclosures. B. Compliance with the statutory laws and regulations. C. Scope limitations resulting from their inaction. D. The integrity of management.

Q: The element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the A. Methods of statistical sampling to be used in confirming accounts receivable. B. Pending legal matters to be included in the inquiry of the client's attorney. C. Evidence to be gathered to provide a sufficient basis for the auditor's opinion. D. Timing of the audit.

Q: A dual-purpose test A. Simultaneously tests debits and credits. B. Is a procedure completed by both the internal and external auditors. C. Is useful to both the entity and the auditor. D. Is both a substantive test of transactions and a test of controls.

Q: Which of the following audit procedures would be least likely to disclose the existence of related party transactions of a client during the period under audit? A. Reading "conflict-of-interest" statements obtained by the client from its management. B. Scanning accounting records for large transactions at or just prior to the end of the period under audit. C. Reading minutes of the Board of Directors meetings for authorization or discussion of material transactions. D. Confirming purchases and sales transactions with the vendors and/or customers involved.

Q: The in-charge auditor most likely would have a supervisory responsibility to explain to the staff assistants A. That immaterial fraud is not to be reported to the client's audit committee. B. How the results of various auditing procedures performed by the assistants should be evaluated. C. How the overall audit strategy will allow the firm to reach a sufficiently low level of audit risk. D. How overall materiality was selected.

Q: Which of the following procedures would an auditor most likely include in the initial planning of a financial statement audit? A. Perform detailed testing of the individual balance sheet accounts. B. Examining documents to detect illegal acts 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 audit function.

Q: In assessing the competence of the internal audit function, an independent CPA most likely would obtain information about the A. Quality of the work of the internal audit function. B. Organization's commitment to integrity and ethical values. C. Influence of management on the scope of the internal audit function duties. D. Organizational levels to which the internal audit function reports.

Q: Which of the following is not a concern as to whether a misstatement is qualitatively material? A. The misstatement hides a failure to meet analysts' expectations. B. The misstatement is less than 5% of pretax income. C. The misstatement increases management's compensation. D. The misstatement changes a small amount of profit to a small reported loss.

Q: Which of the following is not a qualitative factor that may affect an auditor's establishment of materiality? A. Potential for fraud. B. The company is close to violating loan covenants. C. Firm policy sets materiality at 4% of pretax income. D. A small misstatement would interrupt an earnings trend.

Q: Which of the following would an auditor most likely use in determining the auditor's overall materiality? A. The anticipated sample size for planned substantive procedures. B. The entity's annualized interim (i.e. quarterly) financial statements. C. The results of the internal control questionnaire. D. The contents of the management representation letter.

Q: Tolerable misstatement is A. Materiality allocated to an assertion. B. Materiality for the balance sheet as a whole. C. Materiality for the income statement as a whole. D. Materiality allocated to a specific account.

Q: Which of the following is not an audit procedure that is commonly used in performing tests of controls? A. Inquiring. B. Observing. C. Confirming. D. Inspecting.

Q: In the context of an audit of financial statements, substantive procedures are audit procedures that A. May be eliminated under certain conditions. B. Are primarily designed to discover significant subsequent events. C. May be either tests of details of transactions, tests of details of account balances, or analytical procedures. D. Will increase proportionately with an increase in the auditor's reliance on internal control.

Q: The existence of a related party transaction may be indicated when another entity A. Sells real estate to the corporation at a price that is comparable to its appraised value. B. Absorbs expenses of the corporation under audit. C. Borrows from the corporation at a rate of interest which equals the current market rate. D. Lends to the corporation at a rate of interest which equals the current market rate.

Q: Which of the following would not necessarily be a related party transaction? A. Sales to another corporation with a similar name. B. Purchases from another corporation that is controlled by the corporation's chief stockholder. C. Loan from the corporation to a major stockholder. D. Sale of land to the corporation by the spouse of a director.

Q: An independent auditor finds that Holdaway Corporation occupies office space, at no charge, in an office building owned by a shareholder. This finding likely indicates the existence of A. Management fraud. B. Related party transactions. C. Window dressing. D. Weak internal control.

Q: Which of the following is an example of a related party transaction? A. An action is taken by the directors of Company A to provide additional compensation for vice presidents in charge of the principal business functions of Company A. B. A long-term agreement is made by Company A to provide merchandise or services to Company B, a long-time, friendly competitor. C. A short-term loan is granted to Company A by a bank that has a depositor who is a member of the board of directors of Company A. D. A nonmonetary exchange occurs whereby Company A exchanges property for similar property owned by Company B, an unconsolidated subsidiary of Company A.

Q: An auditor obtains knowledge about a new client's business and its industry in order to A. Make constructive suggestions concerning improvements to the client's internal control. B. Develop an attitude of professional skepticism concerning management's financial statement assertions. C. Evaluate whether the aggregation of known misstatements causes the financial statements taken as a whole to be materially misstated. D. Understand the events and transactions that may have an effect on the client's financial statements.

Q: To emphasize auditor independence from management, publicly traded corporations are required to A. Appoint a partner of the CPA firm conducting the examination to the corporation's audit committee. B. Establish a policy of discouraging social contact between employees of the corporation and the independent auditors. C. Request that a representative of the independent auditor be on hand at the annual stockholders' meeting. D. Have the independent auditor report to an audit committee of independent members of the board of directors.

Q: As generally conceived, the audit committee of a publicly held company should be made up of A. Representatives of the major equity interests (preferred stock, common stock). B. The audit partner, the chief financial officer, the legal counsel, and at least one outsider. C. Representatives from the client's management, investors, suppliers, and customers. D. Members of the board of directors who are not officers or employees.

Q: An independent auditor might consider the procedures performed by the internal audit function because A. They are employees whose work must be reviewed during substantive testing. B. They are employees whose work might be relied upon. C. Their work impacts the cost/benefit tradeoff in evaluating inherent limitations. D. Their degree of independence may be inferred by the nature of their work.

Q: All of the following refer to the competence of the internal audit function except: A. The party in the entity to which the internal audit function reports. B. The quality of internal audit documents and reports. C. Professional certification. D. Supervision and review of internal audit activities.

Q: To provide for the greatest degree of independence in performing internal audit activities, the internal audit function most likely should report to the A. Vice-President - Finance. B. Corporate controller. C. Audit committee of the board of directors. D. Corporate stockholders.

Q: Which of the following matters generally is included in an auditor's engagement letter? A. Management's responsibility for the entity's compliance with laws and regulations. B. The factors to be considered in setting preliminary judgments about materiality. C. Management's liability for illegal acts committed by its employees. D. The auditor's responsibility to guarantee accuracy of the financial statements.

Q: Engagement letters include all of the following except: A. A list of additional services that will be provided. B. A list of adjusting journal entries. C. Information about the audit fee. D. Arrangements involving the use of specialists.

Q: A written understanding between the auditor and the client concerning the auditor's responsibility for the discovery of illegal acts is usually set forth in a(n) A. Client representation letter. B. Letter of audit inquiry. C. Management letter. D. Engagement letter.

Q: An auditor is required to establish an understanding with a client regarding the responsibilities for each engagement. This understanding generally includes A. Management's responsibility to guarantee that there are no material misstatements due to fraud. B. The auditor's responsibility to plan and perform the audit to provide reasonable, but not absolute, assurance of detecting material errors or fraud. C. Management's responsibility for providing the auditor with an assessment of the risk of material misstatement due to fraud. D. The auditor's responsibility for the fairness of the financial statements.

Q: During the initial planning phase of an audit, a CPA most likely would A. Identify specific internal control activities that are likely to prevent fraud. B. Evaluate the reasonableness of the client's accounting estimates. C. Discuss the timing of the audit procedures with the client's management. D. Inquire of the client's attorney as to any unrecorded claims.

Q: Which of the following situations would most likely require special audit planning? A. Some items of factory and office equipment do not bear identification numbers. B. Depreciation methods used on the client's tax return differ from those used on the books. C. Assets costing less than $500 are expensed even though the expected life exceeds one year. D. Inventory is comprised of precious stones.

Q: Before accepting an engagement to audit a new client, a CPA is required to obtain A. An understanding of the prospective client's industry and business. B. The prospective client's signature on the engagement letter. C. A preliminary understanding of the prospective client's control environment. D. The prospective client's consent to make inquiries of the predecessor auditor.

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

Q: 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 segregation of duties are subject to management override. C. It is unlikely that sufficient appropriate evidence is available to support an opinion on the financial statements. D. Management has a reputation for consulting with several accounting firms about significant accounting issues.

Q: Evaluating a prospective client requires which of the following steps? A. Communicate with the SEC. B. Preplan the audit. C. Determine if the firm is independent of the client. D. Communicate with the AICPA.

Q: A successor auditor should request the new client to authorize the predecessor auditor to allow a review of the predecessor's A. Engagement letter. B. Audit working papers. C. Engagement letter and audit working papers. D. It would not be typical to allow a review of either the engagement letter or the audit working papers.

Q: An auditor who discovers that a client's employees paid small bribes to municipal officials most likely would withdraw from the engagement if A. The payments violated the client's policies regarding the prevention of illegal acts. B. The client receives financial assistance from a federal government agency. C. Documentation that is necessary to prove that the bribes were paid does not exist. D. Management fails to take the appropriate remedial action.

Q: Which of the following factors most likely would cause a CPA not to accept a new audit engagement? A. The prospective client's unwillingness to permit inquiry of its legal counsel. B. The inability to review the predecessor auditor's documentation. C. The CPA's lack of understanding of the prospective client's operations and industry. D. Indications that management has not investigated employees in key positions before hiring them.

Q: Which of the following should an auditor obtain from the predecessor auditor prior to accepting an audit engagement? A. Analysis of balance sheet accounts. B. Analysis of income statement accounts. C. All matters of continuing accounting significance. D. Facts that might bear on management integrity.

Q: When a CPA is approached to perform an audit for the first time, the CPA should make inquiries of the predecessor auditor. This is a necessary procedure because the predecessor may be able to provide the successor with information that will assist the successor in determining A. Whether the predecessor's work should be utilized. B. Whether, in the predecessor's opinion, the financial statements are materially correct. C. Whether, in the predecessor's opinion, the company's internal controls have been satisfactory. D. Whether the engagement should be accepted.

Q: An auditor has withdrawn from an audit engagement of a publicly held company after finding fraud that may materially affect the financial statements. The auditor should set forth the reasons and findings in correspondence with the A. Securities and Exchange Commission. B. Client's legal counsel. C. Stock exchanges where the company's stock is traded. D. Audit committee of the board of directors.

Q: Evaluating a prospective client requires which of the following steps? A. Communicate with the predecessor auditor. B. Preplan the audit. C. Establish the terms of the engagement. D. None of these.

Q: In assessing whether to accept a client for an audit engagement, a CPA should consider A. The current financial health of the prospective client. B. The integrity of management. C. The CPA's overall engagement risk. D. All of these should be considered.

Q: Hawkins requested permission to communicate with the predecessor auditor and review certain portions of the predecessor auditor's working papers. The prospective client's refusal to permit this will bear directly on Hawkins' decision concerning the A. Adequacy of the preplanned audit program. B. Ability to establish consistency in application of accounting principles between years. C. Apparent scope limitation. D. Integrity of management.

Q: Materiality is based only on a quantitative analysis of the financial statements.

Q: Materiality significantly impacts the auditor's decisions about how much and what kind of evidence to gather.

Q: There are five general types of audit tests.

Q: The engagement partner is typically responsible for doing the detailed audit testing.