Chapter 4

Question 1

Information is considered material if it

Answer 1

affects a user’s decision-making process. This may be due to factors other than the magnitude of misstatements.

Question 2

information that exceeds an auditor’s preliminary materiality assessment

Answer 2

Quantitatively material

Question 3

an amount less than materiality, which is set to reduce the likelihood that a misstatement in a particular class of transactions, account balances, or disclosures, in aggregate, do not exceed materiality for the financial statements as a whole

Answer 3

Performance materiality

Question 4

information that is relevant when some areas of the financial statements are expected to influence the economic decisions made by users of the financial statements

Answer 4

Specific materiality

Question 5

strategy that sets the scope, timing, and direction of the audit and provides the basis for developing a detailed audit plan

Answer 5

Audit strategy

Question 6

strategy used when the auditor does not plan to rely on the client’s controls and increases the reliance on detailed substantive procedures that involve intensive testing of year-end account balances and transactions from throughout the year

Answer 6

Substantive audit strategy

Question 7

strategy used when the auditor obtains a detailed understanding of their client’s system of internal controls and plans to rely on that system to identify, prevent, and detect material misstatements

Answer 7

Combined audit strategy

Question 8

measurements, agreed to beforehand, that can be quantified and reflect the success factors of an organization

Answer 8

Key performance indicators (KPIs)

Question 9

the ability of a company to earn a profit

Answer 9

Profitability

Question 10

market price per share to earnings per share

Answer 10

Price-earnings (PE) ratio

Question 11

profit to weighted average ordinary shares issued

Answer 11

Earnings per share (EPS)

Question 12

the ability of a company to pay its debts when they fall due

Answer 12

Liquidity

Question 13

an evaluation of financial information by studying plausible relationships among both financial and non-financial data

Answer 13

Analytical procedures

Question 14

detailed testing of controls and substantive testing of transactions and accounts

Answer 14

Execution stage

Question 15

Analytical procedures are conducted at the planning stage of the audit to:

Answer 15

• highlight unusual fluctuations in accounts
• aid in the identification of risk
• enhance the understanding of a client
• identify the accounts at risk of material misstatement
• reduce audit risk by concentrating audit effort where the risk of material misstatement is greatest.

Question 16

_______ are made between account balances for the current year and the previous year and for the current year and the budget.

Answer 16

Simple comparisons

Question 17

a comparison of account balances over time

Answer 17

Trend analysis

Question 18

a comparison of account balances to a single line item

Answer 18

Common-size analysis

Question 19

conducted by an auditor to assess the relationship between various financial statement account balances. An auditor will calculate profitability, liquidity, and solvency ratios.

Answer 19

Ratio analysis

Question 20

reflect a company’s ability to generate earnings and ultimately the cash flow required to pay debts, meet other obligations, and fund future expansion.

Answer 20

Profitability ratios

Question 21

gross profit to net sales

Answer 21

Gross profit margin

Question 22

reflect a company’s ability to meet its short-term debt obligations. If a company is unable to pay its debts when they fall due, the company may lose key employees, suppliers may refuse to supply goods, and lenders may recall funds borrowed.

Answer 22

Liquidity ratios

Question 23

In conducting analytical procedures, the following information sources are generally considered to be reliable:

Answer 23

• information generated by an accounting system that has effective internal controls
• information generated by an independent reputable external source
• audited information
• information generated using consistent accounting methods
• information from a source internal to the client that has proven to be accurate in the past (for example, information used to prepare budgets).

Question 24

A predominantly substantive audit strategy:

Answer 24

means that the auditor will gain the minimum necessary knowledge of the client’s system of internal controls.

Question 25

A combined audit strategy:

Answer 25

requires the auditor to conduct extensive control testing.

Question 26

Profitability ratios are used to assess performance and:

Answer 26

companies will be interested in trends in the ratios.

Question 27

Common uses of analytical procedures include:

Answer 27

risk identification during the audit planning stage.
estimation of account balances during the audit execution stage.
overall assessment of the financial statements at the final review stage of the audit.

Question 28

An auditor is interested in the client’s inventory turnover ratio because it helps the auditor understand:

Answer 28

if the client is as competitive and has as high a turnover as the industry average.

Question 29

Analytical procedures:

Answer 29

must take into account seasonal variation in the client’s business.

Question 30

An auditor will identify accounts and related assertions at risk of material misstatement:

Answer 30

in order to plan the audit to focus on those accounts.

Question 31

For an audit, the auditor can control:

Answer 31

detection risk.

Question 32

An example of an item that is material is:

Answer 32

a theft of $100.
an undisclosed lawsuit for $1 million.
an undisclosed related party.

Question 33

Testing controls means that:

Answer 33

the auditor can plan to reduce their reliance on detailed substantive testing of transactions and account balances.