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Flashcards in A3-2 Deck (64)
1

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.

Neither I nor II.

b.

I only.

c.

Both I and II.

d.

II only.

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.

Choices "b", "d", and "a" are incorrect. The auditor would need to consider both factors (financial statement accounts likely to contain a misstatement and conditions that require an extension of audit tests) in planning the audit.

2

In assessing the objectivity of internal auditors, the independent CPA who is auditing the entity's financial statements most likely would consider the:

a.

Internal auditing standards developed by The Institute of Internal Auditors.

b.

Tests of internal control activities that could detect errors and fraud.

c.

Results of the tests of transactions recently performed by the internal auditors.

d.

Materiality of the accounts recently inspected by the internal auditors.

Choice "a" is correct. Objectivity is reflected by the organizational level to which the internal auditor reports as well as by policies prohibiting audits of areas where the internal auditor lacks independence. In assessing the objectivity of internal auditors, the independent CPA who is auditing the entity's financial statements considers information obtained from previous experience, from discussions with management, from external quality reviews (if performed), and from professional internal auditing standards (such as those developed by The Institute of Internal Auditors).

Choice "b" is incorrect. Tests of internal control activities that could detect errors and fraud would not help the CPA assess the objectivity of the internal auditor.

Choice "d" is incorrect. The materiality of the accounts recently inspected by the internal auditors would not help the CPA assess the objectivity of the internal auditor.

Choice "c" is incorrect. Results of the tests of transactions recently performed by the internal auditor would aid the auditor in evaluating the internal auditor's competence rather than his or her objectivity.

3

A CPA wishes to determine how various publicly-held companies have complied with the disclosure requirements of a new financial accounting standard. Which of the following information sources would the CPA most likely consult for this information?

a.

SEC Statement 10-K Guide.

b.

AICPA Codification of Statements on Auditing Standards.

c.

AICPA Accounting Trends and Techniques.

d.

SEC Quality Control Review.

Choice "c" is correct. The AICPA's Accounting Trends & Techniques is an annual survey of accounting practices followed in 600 stockholders' annual reports.

Choices "b", "d", and "a" are incorrect. These sources do not provide comparative information about accounting practices.

4

The work of internal auditors may affect the independent auditor's:

I.

Procedures performed in obtaining an understanding of internal control.

II.

Procedures performed in assessing the risk of material misstatement.

III.

Substantive procedures performed in gathering direct evidence.

a.

I, II, and III.

b.

I and II only.

c.

I and III only.

d.

II and Ill only.

Choice "a" is correct. The internal auditors' work may affect the nature, timing, and extent of the audit, including procedures the auditor performs when obtaining an understanding of the entity's internal control, when assessing risk, and when performing substantive procedures.

Choice "b" is incorrect. It is likely that many procedures performed by internal auditors will affect the independent auditor's substantive testing, by providing direct evidence about material misstatements in assertions.

Choice "c" is incorrect. It is likely that the work of internal auditors will aid the independent auditor in assessing control risk, since so much of the internal auditors' function is involved with monitoring the control structure.

Choice "d" is incorrect. It is very likely that the work of internal auditors will affect the independent auditor's procedures for obtaining an understanding of internal control, because monitoring the control system is the primary responsibility of the internal auditors. Their flowcharts, narratives, and analyses of controls could be helpful to the independent auditor.

5

Which of the following statements is correct concerning an auditor's use of the work of a specialist?

a.

The auditor may not use the work of a specialist in matters material to the fair presentation of the financial statements.

b.

The work of a management specialist who has a contractual relationship with the client may be acceptable under certain circumstances.

c.

The reasonableness of the specialist's assumptions and their applications are strictly the auditor's responsibility.

d.

The auditor need not obtain an understanding of the methods and assumptions used by the specialist.

Choice "b" 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.

Choice "d" is incorrect. Although the appropriateness and reasonableness of methods or assumptions used and their application are the responsibility of the specialist, the auditor should obtain an understanding of the methods or assumptions used in order to determine whether the findings are suitable for corroborating the representations in the financial statements.

Choice "a" is incorrect. The auditor may use, and in fact is encouraged to use, the work of a specialist in matters material to the fair presentation of the financial statements.

Choice "c" is incorrect. The appropriateness and reasonableness of methods or assumptions used and their application are the responsibility of the specialist; the auditor should, however, obtain an understanding of the methods or assumptions used in order to determine whether the findings are suitable for corroborating the representations in the financial statements.

6

The in-charge auditor most likely would have a supervisory responsibility to explain to the staff assistants:

a.

How the results of various auditing procedures performed by the assistants should be evaluated.

b.

Why certain documents are being transferred from the current file to the permanent file.

c.

That fraud is not to be reported to those charged with governance.

d.

What benefits may be attained by the assistants' adherence to established time budgets.

Choice "a" is correct. Assistants should be informed of their responsibilities and the objectives of the procedures that they are to perform. Part of the assistant's responsibility is to properly evaluate audit results, and the in-charge auditor would likely discuss this with them.

Choice "c" is incorrect. Fraud that causes a material misstatement or involves senior management should be reported to those charged with governance.

Choice "d" is incorrect. Preparation and maintenance of the time budget is related to planning rather than supervision.

Choice "b" is incorrect. The reasons for transferring documents from the permanent file to the current file need not be explained to the staff assistants.

7

Which of the following would an auditor most likely use in determining the auditor's preliminary judgment about materiality?

a.

The results of the internal control questionnaire.

b.

The anticipated sample size of the planned substantive tests.

c.

The contents of the management representation letter.

d.

The entity's annualized interim financial statements.

Choice "d" is correct. The auditor's preliminary judgment about materiality is generally based on either annualized interim financial statements or annual financial statements from a prior period.

Choice "b" is incorrect. The anticipated sample size for substantive tests is irrelevant in making a preliminary judgment about materiality.

Choice "a" is incorrect. The results of the internal control questionnaire would be relevant for making a preliminary assessment of control risk; however, these results are irrelevant for determining a preliminary level of materiality.

Choice "c" is incorrect. The management representation letter is obtained at the end of the audit and would not be available when preliminary assessments of materiality are made during planning.

8

An internal auditor's work would most likely affect the nature, timing, and extent of an independent CPA's auditing procedures when the internal auditor's work relates to assertions about the:

a.

Existence of contingencies.

b.

Valuation of related party transactions.

c.

Existence of fixed asset additions.

d.

Valuation of intangible assets.

Choice "c" is correct. In making judgments about the extent of the effect of the internal auditor's work on the auditor's procedures, the auditor considers the materiality of financial statement amounts, the risk of material misstatement of the assertions related to these financial statement amounts, and the degree of subjectivity involved in the evaluation of the audit evidence gathered in support of the assertions. As the degree of subjectivity increases, the need for the auditor to perform tests of the assertions increases. Testing the existence of fixed asset additions involves very little subjectivity, and thus work performed by the internal auditor may reduce the auditor's testing in this area.

Choice "a" is incorrect. Testing the existence of contingencies involves much subjectivity, and should, therefore, be performed by the auditor.

Choice "d" is incorrect. Testing the valuation of intangible assets involves much subjectivity, and should, therefore, be performed by the auditor.

Choice "b" is incorrect. Testing the valuation of related party transactions involves much subjectivity, and should, therefore, be performed by the auditor.

9

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.

Timing of inventory observation procedures to be performed.

b.

Evidence to be gathered to provide a sufficient basis for the auditor's opinion.

c.

Pending legal matters to be included in the inquiry of the client's attorney.

d.

Procedures to be undertaken to discover litigation, claims, and assessments.

Choice "a" is correct. In order to observe the physical inventory count, the auditor would have to coordinate schedules with the client. This timing is usually agreed upon before implementation of the audit strategy.

Choice "b" is incorrect. It would not be appropriate for the client to be involved in determining the amount of evidence necessary to provide a basis for an opinion.

Choice "d" is incorrect. It would not be appropriate for the client to be involved in determining the procedures necessary to obtain evidence about litigation, claims and assessments.

Choice "c" is incorrect. Determination of the pending legal matters to be included in a letter to the client's attorney would not generally be made during the planning stage of the audit.

10

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.

No

No

No

b.

Yes

No

No

c.

Yes

Yes

No

d.

Yes

Yes

Yes

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

Choices "a", "b", and "c" are incorrect, based on the above explanation.

11

In using the work of a specialist, an auditor of a nonissuer may refer to the specialist in the auditor's report if, as a result of the specialist's findings, the auditor:

a.

Is able to corroborate another specialist's earlier findings that were consistent with management's representations.

b.

Desires to disclose the specialist's findings, which imply that a more thorough audit was performed.

c.

Discovers significant deficiencies in the design of the entity's internal control that management does not correct.

d.

Becomes aware of conditions causing substantial doubt about the entity's ability to continue as a going concern.

Choice "d" is correct. The auditor may, as a result of the report or findings of the specialist, decide to add explanatory language to the auditor's standard report or depart from an unmodified opinion. Reference to and identification of the specialist may be made in the auditor's report if the auditor believes such reference will facilitate an understanding of the reason for the explanatory paragraph or the departure from the unmodified opinion. The auditor may need to get permission from the auditor's specialist before making reference to the specialist in the report. 

Choice "b" is incorrect. The auditor should not refer to the work or findings of the specialist unless the specialist's work results in a change to the auditor's report.

Choice "a" is incorrect. The auditor should not refer to the work or findings of the specialist unless the specialist's work results in a change to the auditor's report.

Choice "c" is incorrect. The identification of significant deficiencies in the design of the client's internal control would not result in a change to the auditor's report. The auditor should not refer to the work or findings of the specialist unless the specialist's work results in a change to the auditor's report.

12

Which of the following procedures would an auditor most likely include in the initial planning of a financial statement audit?

a.

Considering whether the client's accounting estimates are reasonable in the circumstances.

b.

Determining the extent of involvement of the client's internal auditors.

c.

Examining documents to detect any noncompliance with laws and regulations having a material effect on the financial statements.

d.

Obtaining a written representation letter from the client's management.

Choice "b" 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.

Choice "d" is incorrect. Representation letters are obtained by the auditor at the end of the audit. The representation letter should not be dated earlier than the date of the auditor's report.

Choice "c" is incorrect. The auditor does not perform tests to detect noncompliance with laws and regulations during the planning process.

Choice "a" is incorrect. The auditor does obtain and evaluate evidence to support significant accounting estimates, but this occurs subsequent to initial planning.

13

The senior auditor responsible for coordinating the fieldwork usually schedules a pre-audit conference with the audit team primarily to:

a.

Discuss staff suggestions concerning the establishment and maintenance of time budgets.

b.

Provide an opportunity to document staff disagreements regarding technical issues.

c.

Give guidance to the staff regarding both technical and personnel aspects of the audit.

d.

Establish the need for using the work of specialists and internal auditors.

Choice "c" is correct. Pre-audit planning meetings are typically held to plan technical and personnel aspects of the audit. Assistants should be informed of their responsibilities and the objectives of the procedures that they are to perform.

Choice "a" is incorrect. While staff suggestions regarding time budgets may be discussed, this is not typically the primary reason for the meeting.

Choice "d" is incorrect. Establishing the need for specialists and internal auditors may be discussed, but this is not the primary reason for the meeting.

Choice "b" is incorrect. Disagreements about technical issues arise and are resolved after testing begins, not during the pre-audit conference.

14

To obtain an understanding of a continuing client's business in planning an audit, an auditor most likely would:

a.

Read specialized industry journals.

b.

Review prior-year audit documentation and the permanent file for the client.

c.

Perform tests of details of transactions and balances.

d.

Reevaluate the client's internal control environment.

Choice "b" is correct. Knowledge of an entity's business is ordinarily obtained through experience with the entity or its industry and inquiry of personnel of the entity. Audit documentation from prior years may contain useful information about the nature of the business, its organizational structure, its operating characteristics, and transactions that may require special consideration.

Choice "c" is incorrect. Tests of details of transactions and balances are not performed during the planning stage of an audit.

Choice "a" is incorrect. Reading industry journals would provide information about the industry in which the entity operates, but reviewing prior-year audit documentation and the permanent file would provide a more thorough understanding of the specific client's business.

Choice "d" is incorrect. The client's internal control is not reevaluated during the planning stage of an audit.

15

In planning an audit of a new client, an auditor most likely would consider the methods used to process accounting information because such methods:

a.

Determine the auditor's acceptable level of audit risk.

b.

Influence the design of internal control.

c.

Affect the auditor's preliminary judgment about materiality levels.

d.

Assist in evaluating the planned audit objectives.

Choice "b" is correct. The auditor should consider the methods the entity uses to process accounting information in planning the audit because such methods influence the design of internal control. The extent to which computer processing is used in significant accounting applications, as well as the complexity of the processing, may also influence the nature, timing, and extent of audit procedures.

Choice "c" is incorrect. Materiality is a matter of professional judgment and is influenced by the auditor's perceptions of the needs of a reasonable person. It would not be affected by the methods used to process accounting information.

Choice "d" is incorrect. The auditor develops specific audit objectives based on financial statement assertions. The methods used to process accounting information would not be relevant to the development of objectives.

Choice "a" is incorrect. Audit risk is the risk that the auditor may unknowingly fail to modify the opinion on financial statements that are materially misstated. The acceptable level of audit risk is a matter of auditor judgment, but it would not be affected by the methods used to process accounting information.

16

Which of the following statements is not correct about materiality?

a.

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.

b.

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.

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.

Choice "a" 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 "b" 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 "c" is incorrect. Materiality judgments are made in light of the surrounding circumstances and necessarily involve both quantitative and qualitative considerations.

Choice "d" 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.

17

Which of the following statements is correct about the auditor's use of the work of a specialist?

a.

The auditor is required to perform substantive procedures to verify the specialist's assumptions and findings.

b.

The specialist should not have an understanding of the auditor's corroborative use of the specialist's findings.

c.

The auditor should obtain an understanding of the methods and assumptions used by the specialist.

d.

The client should not have an understanding of the nature of the work to be performed by the specialist.

Choice "c" is correct. Although the appropriateness and reasonableness of methods or assumptions used and their application are the responsibility of the specialist, the auditor should obtain an understanding of the methods or assumptions used in order to determine whether the findings are suitable for corroborating the representations in the financial statements.

Choice "b" is incorrect. An understanding should exist among the auditor, the client, and the specialist as to the nature of the work to be performed.

Choice "a" is incorrect. The auditor may consider performing substantive procedures to verify the specialist's findings if the specialist is related to the client, but is not required to do so.

Choice "d" is incorrect. An understanding should exist among the auditor, the client, and the specialist as to the nature of the work to be performed.

18

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.

Previous experience with the internal auditor.

b.

The results of analytical procedures.

c.

Discussions with management personnel.

d.

External quality reviews of the internal auditor's activities.

Choice "b" 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.

Choice "c" is incorrect. In assessing competence, objectivity, and application of a systematic and disciplined approach by the entity's internal audit function, the auditor usually considers information obtained from discussions with management personnel.

Choice "d" is incorrect. In assessing competence, objectivity, and application of a systematic and disciplined approach by the entity's internal audit function, the auditor usually considers information obtained from external quality reviews of internal audit activities.

Choice "a" is incorrect. In assessing competence, objectivity, and application of a systematic and disciplined approach by the entity's internal audit function, the auditor usually considers information obtained from previous experience with the internal audit function.

19

For which of the following judgments may an independent auditor share responsibility with an entity's internal auditor who is assessed to be both competent and objective?

~Assessment of inherent risk
~Assessment of control risk
a.

Yes

No

b.

No

No

c.

No

Yes

d.

Yes

Yes

Choice "b" is correct. The independent auditor is solely responsible for reporting on the financial statements. Thus, while he or she may use the work of the entity's internal auditor (both work already performed and work performed as part of the audit), independent auditors may not share any responsibility involving judgments, including the assessment of inherent and control risk. This is true because the internal auditor, even if assessed to be both competent and objective, is not independent.

Choices "d", "a", and "c" are incorrect, based on the above explanation.

20

The audit work performed by each assistant should be reviewed to determine whether it was adequately performed and to evaluate whether the:

a.

Auditor's system of quality control has been maintained at a high level.

b.

Audit procedures performed are approved in the professional standards.

c.

Audit has been performed by persons having adequate technical training and proficiency as auditors.

d.

Results are consistent with the conclusions to be presented in the auditor's report.

Choice "d" is correct. Review of assistants' work is necessary to determine whether it was performed in a satisfactory manner and to determine whether the work supports the conclusions presented in the auditor's report.

Choice "a" is incorrect. The responsibility of a firm to establish review procedures (a system of quality control) is distinct from the auditor's responsibility to adequately plan and supervise the work on a particular engagement. Quality control standards relate to the conduct of the firm's audit practice as a whole; GAAS relates to the conduct of individual audits.

Choice "b" is incorrect. Specific audit procedures are performed based on the auditor's judgment and would not necessarily be approved in the professional standards.

Choice "c" is incorrect. Review of an assistant's work would not necessarily be indicative of that assistant's technical training and proficiency. The review process is to determine whether the audit is being performed in a satisfactory manner.

21

An auditor obtains knowledge about a new client's business and its industry to:

a.

Make constructive suggestions concerning improvements to the client's internal control.

b.

Understand the events and transactions that may have an effect on the client's financial statements.

c.

Evaluate whether the aggregation of identified misstatements causes the financial statements taken as a whole to be materially misstated.

d.

Develop an attitude of professional skepticism concerning management's financial statement assertions.

Choice "b" is correct. The auditor should obtain knowledge of the client's business and its industry in order to determine the effect of transactions, events, and practices on the client's financial statements.

Choice "a" is incorrect. Constructive suggestions concerning improvements in the new client's internal control are generally made after the study and evaluation of the client's internal control, performed subsequent to planning. Knowledge about the new client's business and its industry is generally obtained during planning.

Choice "d" is incorrect. The auditor should have an attitude of professional skepticism in conducting the engagement, but this attitude is not necessarily related to the auditor's knowledge of the new client's business and its industry.

Choice "c" is incorrect. The auditor should evaluate whether the aggregation of identified misstatements materially affects the financial statements, but this is done near the audit's conclusion. Knowledge about the new client's business and its industry is generally obtained during planning.

22

Which of the following is required documentation in an audit in accordance with generally accepted auditing standards?

a.

An audit plan setting forth in detail the procedures necessary to accomplish the engagement's objectives.

b.

A flowchart or narrative of the information system relevant to financial reporting describing the recording and classification of transactions for financial reporting.

c.

A planning memorandum establishing the timing of the audit procedures and coordinating the assistance of entity personnel.

d.

An internal control questionnaire identifying controls that assure specific objectives will be achieved.

Choice "a" is correct. In an audit conducted in accordance with GAAS, the auditor must document the audit plan, setting forth in detail the procedures necessary to accomplish the engagement's objectives.

Choice "b" is incorrect. Documentation of the auditor's understanding of the client's internal control is required, but may take different forms. A narrative, an internal control questionnaire, a flowchart, or simply a memorandum (for a small client) may be sufficient.

Choice "c" is incorrect. A planning memo, while recommended, is not required under GAAS.

Choice "d" is incorrect. Documentation of the auditor's understanding of the client's internal control is required, but may take different forms: narrative, internal control questionnaire, flowchart, or simply a memorandum (for a small client) may be sufficient. In addition, controls do not assure the achievement of objectives.

23

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.

Refer the disagreement to the AICPA's Quality Review Committee.

b.

Document the details of the disagreement with the conclusion reached.

c.

Report the disagreement to an impartial peer review monitoring team.

d.

Discuss the disagreement with the entity's management or its audit committee.

Choice "b" 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.

Choice "a" is incorrect. Quality control committees are primarily concerned with determining whether quality control policies and procedures are being effectively applied. Generally, they would not get involved with disagreements related to specific engagements.

Choice "d" is incorrect. Disagreements among an audit firm's staff would generally be handled internally. Discussion of such matters with the client would be inappropriate.

Choice "c" is incorrect. Impartial peer review teams are primarily concerned with determining whether quality control policies and procedures are being effectively applied. Generally, they would not get involved with disagreements related to specific engagements.

24

In considering materiality for planning purposes, an auditor believes that misstatements aggregating $10,000 would have a material effect on an entity's income statement, but that misstatements would have to aggregate $20,000 to materially affect the balance sheet. Ordinarily, it would be appropriate to design auditing procedures that would be expected to detect misstatements that aggregate:

a.

$10,000

b.

$20,000

c.

$30,000

d.

$15,000

Choice "a" is correct. Because the statements are interrelated, the auditor ordinarily considers materiality for planning purposes in terms of the smallest aggregate level of misstatement that could be considered material to any one of the financial statements.

Choices "d", "b", and "c" are incorrect, based on the above explanation.

25

For which of the following judgments may an independent auditor share responsibility with an entity's internal audit function, which is assessed to be competent, objective, and apply a systematic and disciplined approach?

~Materiality of misstatements
~Evaluation of accounting estimates
a.

No

No

b.

Yes

Yes

c.

Yes

No

d.

No

Yes

Choice "a" is correct. Because the auditor has the ultimate responsibility to express an opinion on the financial statements, judgments about assessments of risk, the materiality of misstatements, the sufficiency of tests performed, the evaluation of significant accounting estimates, and other matters affecting the auditor's report should always be those of the auditor.

Choices "c", "d", and "b" are incorrect, based on the above explanation.

26

Which of the following procedures would an auditor least likely perform in planning a financial statement audit?

a.

Coordinating the assistance of entity personnel in data preparation.

b.

Discussing matters that may affect the audit with firm personnel responsible for non-audit services to the entity.

c.

Selecting a sample of vendors' invoices for comparison to receiving reports.

d.

Reading the current year's interim financial statements.

Choice "c" is correct. Selecting a sample of vendors' invoices for comparison to receiving reports is performed during fieldwork. This is not part of the planning phase.

Choice "a" is incorrect. Coordinating the assistance of entity personnel in data preparation is usually performed during the planning phase.

Choice "b" is incorrect. During the planning phase, matters that may affect the audit should be discussed with firm personnel responsible for non-audit services to the entity.

Choice "d" is incorrect. During the planning phase, the auditor generally would read the current year's interim financial statements.

27

When assessing an internal auditor's competence, a CPA ordinarily obtains information about all of the following,except:

a.

Educational level and professional experience.

b.

Access to information about related parties.

c.

The audit plan and audit procedures.

d.

Quality of audit documentation.

Choice "b" is correct. The degree of access the independent auditor has to information about related parties provides no information regarding an internal auditor's competence.

Choice "d" is incorrect. In evaluating the work of internal auditors, the independent auditor should examine, on a test basis, documentary evidence of the work performed by internal auditors and should consider such factors as whether the scope of the work is appropriate, the audit plan is adequate, audit documentation adequately documents work performed, conclusions reached are appropriate in the circumstances, and any reports prepared are consistent with the results of the work performed.

Choice "a" is incorrect. When considering the competence of internal auditors, the independent auditor should inquire about the qualifications of the internal audit staff, including for example, consideration of the client's practices for hiring, training, and supervising internal audit staff. This includes inquiries as to the internal auditor's educational level and professional experience.

Choice "c" is incorrect. In evaluating the work of internal auditors, the independent auditor should examine, on a test basis, documentary evidence of the work performed by internal auditors and should consider such factors as whether the scope of the work is appropriate, the audit plan is adequate, audit documentation adequately documents work performed, conclusions reached are appropriate in the circumstances, and any reports prepared are consistent with the results of the work performed.

28

An auditor reviews a client's accounting policies and procedures when considering which of the following planning matters?

a.

Method of sampling to be used.

b.

Understanding the client's operations and business.

c.

Preliminary judgments about materiality levels.

d.

Nature of reports to be rendered.

Choice "b" is correct. An auditor would review the client's accounting policies and procedures as part of obtaining an understanding of the client's operations and business. This understanding is important because it affects the design of internal control, which in turn impacts planned auditing procedures.

Choice "a" is incorrect. Although the auditor might consider the client's accounting policies and procedures when designing a sampling plan, this is not the primary reason for the auditor's review of the client's policies and procedures.

Choice "c" is incorrect. The client's accounting policies and procedures would not affect preliminary judgments about materiality, which are generally based on either annualized interim financial statements or annual financial statements from a prior period.

Choice "d" is incorrect. The client's accounting policies and procedures would not affect the nature of reports to be rendered. The nature of reports to be rendered would be based on the type of engagement and the specific results of that engagement.

29

An auditor is required to obtain an understanding of the entity's business, including business cycles and reasons for business fluctuations. What is the audit purpose most directly served by obtaining this understanding?

a.

To enable the auditor to accurately identify significant deficiencies in internal control.

b.

To assist the auditor in accurately interpreting information obtained during an audit.

c.

To decide whether it will be necessary to perform analytical procedures.

d.

To allow the auditor to more accurately perform tests of controls.

Choice "b" is correct. As part of audit planning, the auditor should obtain an understanding of the entity's business. This understanding enables the auditor to better understand events, transactions, and practices that may affect the financial statements, to plan and perform appropriate audit tests, and to properly understand and evaluate the results of those tests.

Choice "a" is incorrect. Obtaining an understanding of the entity's business would not be particularly helpful in identifying significant deficiencies in internal control. Also, such deficiencies are typically identified during the fieldwork stage of the audit, while obtaining an understanding of the entity's business typically occurs during planning.

Choice "d" is incorrect. Obtaining an understanding of the entity's business would not result in a more accurate performance of tests of controls. Accurate performance of audit tests is dependent upon factors such as existence of an appropriate audit trail, client cooperation, training and supervision of audit staff, etc.

Choice "c" is incorrect. Analytical procedures are always required in an audit, during the planning and overall review stages.

30

A retail entity uses electronic data interchange (EDI) in executing and recording most of its purchase transactions. The entity's auditor recognizes that the documentation of the transactions will be retained for only a short period of time. To compensate for this limitation, the auditor most likely would:

a.

Increase the sample of EDI transactions to be selected for cutoff tests.

b.

Decrease the assessed level of control risk for the existence or occurrence assertions.

c.

Perform tests several times during the year, rather than only at year-end.

d.

Plan to make a 100% count of the entity's inventory at or near the year-end.

Choice "c" is correct. When an entity transmits, processes, maintains, or accesses significant information electronically, some accounting data and source documents may be available only in electronic form, or only at a certain point in time. The auditor would generally perform tests of controls several times during the year to compensate for this limitation.

Choice "a" is incorrect. Increasing the sample size related to cutoff testing will not provide evidence about transactions occurring throughout the period under audit, since cutoff testing relates to year-end.

Choice "d" is incorrect. Auditing 100% of the year-end inventory does not provide evidence about transactions occurring throughout the period under audit.

Choice "b" is incorrect. Failure to retain documentation for longer periods of time would not imply that control risk is reduced. If anything, this might lead to an increase in control risk, making it less likely that phony transactions would be detected after the fact.

31

Samples to test internal control are intended to provide a basis for an auditor to conclude whether:

a.

The risk of incorrect acceptance is too high.

b.

The control activities are operating effectively.

c.

Materiality for planning purposes is at a sufficiently low level.

d.

The financial statements are materially misstated.

Choice "b" is correct. Samples to test internal control are intended to provide a basis for an auditor to conclude whether the control activities are operating effectively.

Choice "d" is incorrect. Tests of controls may provide evidence regarding the likelihood of misstatement, but they do not provide a basis for concluding whether the financial statements are materially misstated.

Choice "a" is incorrect. The risk of incorrect acceptance is an aspect of sampling risk related to substantive tests, not tests of controls.

Choice "c" is incorrect. Samples to test controls do not provide evidence regarding materiality levels for planning purposes.

32

An auditor plans to apply substantive tests to the details of asset and liability accounts as of an interim date rather than as of the balance sheet date. The auditor should be aware that this practice:

a.

Presumes that the auditor will reperform the tests as of the balance sheet date.

b.

Eliminates the use of certain statistical sampling methods that would otherwise be available.

c.

Should be especially considered when there are rapidly changing economic conditions.

d.

Potentially increases the risk that errors that exist at the balance sheet date will not be detected.

Choice "d" is correct. Applying substantive tests to the details of asset and liability accounts as of an interim date increases risk, as it is possible that errors will occur between the date of interim testing and the balance sheet date. For this reason, the auditor generally selects for interim examination only accounts that are reasonably predictable with respect to amount, relative significance, and composition, and must also identify procedures sufficient to extend interim conclusions to year-end.

Choice "b" is incorrect. The use of statistical sampling methods is not affected by the timing of audit procedures.

Choice "a" is incorrect. Applying substantive tests to the details of asset and liability accounts as of an interim date increases risk, but it does not require all such tests to be reperformed. Instead, the auditor should perform procedures designed to extend the interim conclusions to year-end. Such procedures should be less in scope than the initial procedures performed at interim; otherwise, it would make more sense to have simply applied the more extensive tests at year-end in the first place.

Choice "c" is incorrect. Generally, accounts selected for interim examination should be reasonably predictable with respect to amount, relative significance, and composition. Rapidly changing economic conditions might affect the valuation, significance, or composition of certain assets or liabilities, and therefore would make testing at interim less likely.

33

In assessing the competence of a client's internal auditor, an independent auditor most likely would consider the:

a.

Results of ratio analysis that may identify unusual transactions and events.

b.

Internal auditor's compliance with professional internal auditing standards.

c.

Evidence supporting a low assessed level of control risk.

d.

Client's policies that limit the internal auditor's access to management salary data.

Choice "b" is correct. In assessing the competence of a client's internal auditor, an independent auditor would consider the internal auditor's compliance with professional auditing standards. Such compliance could be evaluated by reviewing the audit plan and auditing procedures used by the internal auditor, as well as by assessing the quality of audit documentation provided.

Choice "d" is incorrect. The internal auditor's access to management salary data has no bearing on his or her competency.

Choice "c" is incorrect. The external auditor's assessment of control risk might be based in part on the existence and effectiveness of an internal audit group, but such assessment would not provide information regarding the competency of the internal auditor.

Choice "a" is incorrect. Ratio analysis might be used to identify unusual transactions or events, but it would not provide information regarding the competency of the internal auditor.

34

Which of the following would an auditor most likely use in determining the auditor's preliminary judgment about materiality?

a.

The anticipated sample size for planned substantive tests.

b.

The results of the initial assessment of control risk.

c.

The entity's financial statements of the prior year.

d.

The assertions that are embodied in the financial statements.

Choice "c" is correct. The auditor would most likely use the entity's financial statements of the prior year in the preliminary determination of materiality. The prior year financial statements would be a good starting point in estimating the current year's expected results, especially for a continuing client.

Choice "b" is incorrect. The assessment of control risk affects the design of audit procedures but is not relevant in determining materiality.

Choice "a" is incorrect. The anticipated sample size for planned substantive tests is set after the preliminary materiality level is determined.

Choice "d" is incorrect. Management assertions embodied in the financial statements have little relationship to materiality.

35

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.

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.

Choice "d" is incorrect. The auditor would perform substantive procedures before year-end if the amount of misstatements the auditor could tolerate were increased. The earlier in the year that the auditor performs substantive testing, the greater the incremental risk the auditor accepts regarding the year-end financial statements.

Choice "a" is incorrect. A change in the level of tolerable misstatement does not have a direct effect on the assessed level of control risk.

Choice "b" is incorrect. A decrease in the amount of misstatements that can be tolerated would necessitate an increase in the extent of auditing procedures.

36

When issuing an unmodified opinion, the auditor who evaluates the audit findings should be satisfied that the:

a.

Amount of factual misstatements are acknowledged and recorded by the client.

b.

Amount of identified misstatements are documented in the management representation letter.

c.

Estimate of the total misstatement is less than a material amount.

d.

Estimate of the total misstatement includes the adjusting entries already recorded by the client.

Choice "c" is correct. An unmodified opinion states that the financial statements are presented fairly, in all material respects. Accordingly, if the auditor believes that total misstatement (includes factual, judgmental, and projected misstatements) is immaterial, an unmodified opinion is appropriate.

Choice "b" is incorrect. Documenting misstatements in the management representation letter is not required, nor would it eliminate the need to modify the opinion if the identified misstatements were material.

Choice "a" is incorrect. Even if the client adjusts the financial statements to correct factual misstatements, the auditor still must feel comfortable that any remaining misstatements would not be material to the financial statements before rendering an unmodified opinion.

Choice "d" is incorrect. An auditor is not concerned with misstatements already corrected by the client. It is the auditor's estimate of uncorrected--and perhaps unknown--errors that affects the type of opinion rendered.

37

Which of the following procedures would an auditor most likely include in the planning phase of a financial statement audit?

a.

Identify specific internal control activities designed to prevent fraud.

b.

Obtain an understanding of the entity's risk assessment process.

c.

Perform cutoff tests of the entity's sales and purchases.

d.

Evaluate the reasonableness of the entity's accounting estimates.

Choice "b" is correct. In all audits, the auditor should obtain a sufficient understanding of each of the five components of internal control in order to properly plan the audit. The entity's risk assessment process is one of the five components of internal control.

Choice "a" is incorrect. Identification and testing of specific control activities generally occurs during the performance of the audit. 

Choice "d" is incorrect. Evaluating the reasonableness of accounting estimates generally occurs during the performance of the audit.

Choice "c" is incorrect. Cutoff testing of sales and purchases generally occurs during the performance of the audit.

38

In designing a written audit plan, an auditor should establish specific audit objectives that relate primarily to the:

a.

Financial statement assertions.

b.

Timing of audit procedures.

c.

Selected audit techniques.

d.

Cost-benefit of gathering evidence.

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

Choice "b" is incorrect. Although the timing of audit procedures is an important consideration in designing a written audit plan, obtaining audit evidence relating to the financial statement assertions is the primary objective.

Choice "d" is incorrect. The cost-benefit of gathering evidence is an important consideration in establishing a written audit plan, but audit objectives are not based on such considerations.

Choice "c" is incorrect. The specific audit objectives should relate primarily to financial statement assertions. Selected audit techniques are then developed in order to meet the identified objectives.

39

Which of the following is not a type of financial statement assertion?

a.

Understandability and classification.

b.

Fairness and accuracy.

c.

Valuation and allocation.

d.

Rights and obligations.

Choice "b" is correct. "Fairness and accuracy" is not a type of financial statement assertion.

Choices "d", "c", and "a" are incorrect. The assertions include:

d.

Rights and obligations

c.

Valuation and allocation

a.

Understandability and classification

 

40

In developing an overall audit strategy, an auditor should consider:

a.

Whether the inquiry of the client's attorney identifies any litigation, claims, or assessments not disclosed in the financial statements.

b.

Preliminary evaluations of materiality, audit risk, and internal control.

c.

Whether the allowance for sampling risk exceeds the achieved upper precision limit.

d.

Findings from substantive tests performed at interim dates.

Choice "b" is correct. In developing an overall audit strategy, an auditor should consider preliminary evaluations of materiality, audit risk, and internal control.

Choice "c" is incorrect. Evaluation of results from sampling applications would be performed during fieldwork, after the planning process has been completed.

Choice "d" is incorrect. Findings from interim audit testing would be considered during fieldwork, after the planning process has been completed.

Choice "a" is incorrect. Inquiry of a client's attorney and evaluation of the attorney's response is performed during fieldwork, after the planning process has been completed.

41

A retailing entity uses the Internet to execute and record its purchase transactions. The entity's auditor recognizes that the documentation of details of transactions will be retained for only a short period of time. To compensate for this limitation, the auditor most likely would:

a.

Increase the sample of transactions to be selected for cutoff tests.

b.

Plan for a large measure of tolerable misstatement in substantive tests.

c.

Compare a sample of paid vendors' invoices to the receiving records at year-end.

d.

Perform tests several times during the year, rather than only at year-end.

Choice "d" is correct. When an entity transmits, processes, maintains, or accesses significant information electronically, some accounting data and source documents may be available only in electronic form, or only at a certain point in time. The auditor would generally perform tests of controls several times during the year to compensate for this limitation.

Choice "c" is incorrect. Comparing a sample of paid vendors' invoices to receiving records provides evidence that the company received the goods for which it paid, but only if records are available in sufficient detail to make such a comparison. If detailed records are retained for only a short period of time, such comparisons would need to be performed throughout the year, not just at year-end.

Choice "b" is incorrect. The auditor's judgment as to an appropriate level of tolerable misstatement is based on considerations of materiality and audit risk. Increasing this level implies that the auditor is willing to accept a larger error, which would not be an appropriate response to the limitation described.

Choice "a" is incorrect. Increasing the sample size related to cutoff testing will not provide evidence about transactions occurring throughout the period under audit, since cutoff testing relates to year-end.

42

Which of the following statements is correct concerning materiality in a financial statement audit?

a.

Analytical procedures performed during an audit's review stage usually decrease materiality levels.

b.

Materiality levels are generally considered in terms of the smallest aggregate level of misstatement that could be considered material to any one of the financial statements.

c.

The auditor's materiality judgments generally involve quantitative, but not qualitative, considerations.

d.

If the materiality amount used in evaluating audit findings increases from the amount used in planning, the auditor should apply additional substantive tests.

Choice "b" is correct. Because the financial statements are interrelated, materiality levels are generally considered in terms of the smallest level of misstatement that could be material to any one of the financial statements.

Choice "a" is incorrect. Analytical procedures are performed during an audit's review stage to evaluate the overall financial statement presentation and to assess the conclusions reached. They generally would not result in a change in materiality levels.

Choice "d" is incorrect. If the materiality amount used in evaluating audit findings increases from the amount used in planning, the auditor should consider whether the audit plan needs to be modified. Typically, an increase in materiality levels would result in a decrease in audit risk, which would result in less substantive testing, not more.

Choice "c" is incorrect. Qualitative considerations may lead to situations in which misstatements that do not exceed materiality limits are still likely to influence the economic decisions of users. In such cases, an otherwise immaterial misstatement is deemed to be material.

43

Before applying principal substantive tests to an entity's accounts receivable at an interim date, an auditor should:

a.

Ascertain that accounts receivable are immaterial to the financial statements.

b.

Project sampling risk at the maximum for tests covering the remaining period.

c.

Consider the likelihood of assessing the risk of incorrect rejection too low.

d.

Assess the difficulty in controlling the incremental audit risk.

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.

Choice "c" is incorrect. The risk of incorrect rejection relates to the efficiency of audit testing, since an item that is initially (and erroneously) rejected will be subject to additional audit testing that should correct the error. The likelihood of assessing this risk lower than it should be does not affect the auditor's decision regarding the appropriate timing of audit work.

Choice "b" is incorrect. When audit procedures are performed before year-end, the auditor must assess the incremental risk involved, but this risk would not necessarily be assessed at the maximum level.

Choice "a" is incorrect. Interim testing may be performed on material accounts, as long as the auditor assesses the incremental risk involved and determines whether sufficient alternative procedures exist to extend the interim conclusions to year-end. Immaterial accounts would not need to be tested.

44

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.

Auditor modifies the report because of the difference between the client's and the specialist's valuations of an asset.

c.

Specialist's findings support the related assertions in the financial statements.

d.

Specialist's findings provide the auditor with greater assurance of reliability about management's representations.

Choice "b" 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. 

Choices "a", "c", and "d" are incorrect. If the auditor expresses a standard unmodified opinion, the auditor's report should not include any reference to the work of the specialist.

45

Which of the following statements is correct concerning an auditor's use of the work of an actuary in assessing a client's pension obligations?

a.

The reasonableness of the actuary's assumptions is strictly the auditor's responsibility.

b.

The client is required to consent to the auditor's use of the actuary's work.

c.

If the actuary has a relationship with the client, the auditor may not use the actuary's work.

d.

The auditor is required to understand the objectives and scope of the actuary's work.

Choice "d" is correct. The auditor should obtain an understanding of the nature of the actuary's work, including its objectives and scope.

Choice "a" is incorrect. The reasonableness of the actuary's assumptions is the responsibility of the actuary, not the auditor.

Choice "b" is incorrect. There is no requirement that the client consent to the auditor's use of the actuary's work.

Choice "c" is incorrect. If the actuary has a relationship with the client, the auditor may still use the actuary's work, but may need to perform additional procedures to verify objectivity.

46

Which of the following factors most likely would assist an independent auditor in assessing the objectivity of the internal auditor?

a.

The consistency of the internal audit reports with the results of work performed.

b.

The professional certifications of the internal audit staff.

c.

The appropriateness of internal audit conclusions in the circumstances.

d.

The organizational status of the director of internal audit.

Choice "d" is correct. Objectivity is reflected by the organizational level to which the internal auditor reports.

Choice "b" is incorrect. Competency, not objectivity, is reflected by the professional certifications of the internal audit staff.

Choice "a" is incorrect. Competency, not objectivity, is reflected by the consistency of the internal audit reports with the results of work performed.

Choice "c" is incorrect. Competency, not objectivity, is reflected by the appropriateness of internal audit conclusions in the circumstances.

47

In using the work of a specialist, an auditor may refer to the specialist in the auditor's report if, as a result of the specialist's findings, the auditor:

a.

Adds an explanatory paragraph to the auditor's modified opinion to emphasize an unusually important subsequent event in the audit report.

b.

Makes suggestions to management that are likely to improve the entity's internal control.

c.

Desires to disclose the specialist's findings, which imply that a more thorough audit was performed.

d.

Corroborates another specialist's findings that were consistent with management's assertions.

Choice "a" is correct. If, as a result of the work performed by the specialist, the auditor decides to add explanatory language, the auditor may refer to the specialist in the modified auditor's report. The auditor may need to get the permission from the auditor's specialist before making reference to the specialist in the modified audit report. 

Choice "c" is incorrect. As long as the auditor is expressing a standard unmodified opinion, no reference should be made to the work of the specialist.

Choice "b" is incorrect. As long as the auditor is expressing a standard unmodified opinion, no reference should be made to the work of the specialist.

Choice "d" is incorrect. As long as the auditor is expressing a standard unmodified opinion, no reference should be made to the work of the specialist.

48

In assessing the competence of internal auditors, an independent CPA most likely would obtain information about the:

a.

Policies limiting internal auditors from communicating with the audit committee.

b.

Influence of management on the scope of the internal auditors' duties.

c.

Entity's ability to continue as a going concern for a reasonable period of time.

d.

Quality of the internal auditors' working paper documentation.

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. 

Choice "b" is incorrect. Objectivity, not competency, is reflected by the influence of management on the scope of the internal auditors' duties.

Choice "a" is incorrect. Objectivity, not competency, is reflected by limitations placed on communications between the internal auditor and the audit committee.

Choice "c" is incorrect. Obtaining information about the entity's ability to continue as a going concern would not provide any information about the competence of internal auditors.

49

During the initial planning phase of an audit, the auditor most likely would:

a.

Discuss the timing of the audit procedures with the client's management.

b.

Identify specific internal control activities that are likely to prevent fraud.

c.

Inquire of the client's attorney as to whether any unrecorded claims are probable of assertion.

d.

Evaluate the reasonableness of the client's accounting estimates.

Choice "a" is correct. Procedures that an auditor may consider in planning the audit include discussing the type, scope, and timing of the audit with the client's management.

Choice "b" is incorrect. Identifying specific internal control activities that are likely to prevent fraud is an audit procedure, but not an initial planning activity.

Choice "d" is incorrect. Evaluating the reasonableness of the client's accounting estimates is not a planning activity. It is part of the evidence gathered later in the audit process.

Choice "c" is incorrect. Inquiring of the client's attorney is not a planning activity. It is part of the evidence gathered later in the audit process.

50

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.

Changes in circumstances that occur during the audit.

b.

The auditor’s previous experience with the company.

c.

The size and complexity of the client company.

d.

The size of the auditing firm and the number of auditors assigned to the audit.

Choice "d" 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. 

Choice "c" is incorrect. The size and complexity of the client company is listed in the PCAOB standard as a factor that should influence the nature and extent of necessary planning activities.

Choice "b" is incorrect. The auditor’s previous experience with the company is listed in the PCAOB standard as a factor that should influence the nature and extent of necessary planning activities.

Choice "a" is incorrect. A change in circumstances that occurs during the audit is listed in the PCAOB standard as a factor that should influence the nature and extent of necessary planning activities.

51

Under PCAOB standards, which one of the following factors would indicate that a company has less complex operations?

a.

A centralized accounting function.

b.

Multiple business lines.

c.

Lack of involvement by senior management in day-to-day operations.

d.

Several levels of management.

Choice "a" is correct. According to PCAOB standards, a centralized accounting function is indicative of less complex operations.

Choice "b" is incorrect. Multiple business lines would indicate that the company has more complex operations.

Choice "c" is incorrect. Lack of involvement by senior management in day-to-day operations would indicate that a company has more complex operations. 

Choice "d" is incorrect. Several levels of management in a company is indicative of more complex operations.

52

Which of the following factors would generally not be taken into account when determining the extent of supervision needed for the staff?

a.

The size and complexity of the company.

b.

The knowledge, skill, and ability of each engagement team member.

c.

The fee to be paid by the client.

d.

The risk of material misstatement in the audit.

Choice "c" is correct. The fee to be paid by the client should not be taken into consideration when determining the extent of supervision needed for the staff. The extent of supervision should be determined after taking into account the nature of the company, the nature of the work assigned to each engagement team member, the risk of material misstatement, and the knowledge, skill, and ability of each engagement team member.

Choice "b" is incorrect. The knowledge, skill, and ability of each engagement member should be taken into consideration when determining the extent of supervision needed for the staff. 

Choice "d" is incorrect. The risk of material misstatement in the audit should be taken into consideration when determining the extent of supervision needed for the staff. 

Choice "a" is incorrect. The size and complexity of the company should be taken into consideration when determining the extent of supervision needed for the staff.

53

Which one of the below statements best describes the concept of materiality?

a.

Information that meets strict quantitative thresholds.

b.

Information that directly impacts the income statement.

c.

Information that is not likely to influence the decisions of a reasonable investor.

d.

Information that is likely to be viewed by a reasonable investor as altering the mix of available information.

Choice "d" is correct. According to the U.S. Supreme Court, information is material if there is a substantial likelihood that the information would be viewed by a reasonable investor as having significantly altered the total mix of available information. 

Choice "c" is incorrect. Information is material if it is likely to influence the decisions of a reasonable investor.

Choice "a" is incorrect. Materiality is not determined by the use of strict quantitative thresholds. The determination of materiality may differ from client to client. Materiality must be determined using both quantitative and qualitative factors. 

Choice "b" is incorrect. Information can be material if it influences the user’s decision about any of the financial statements.

54

According to PCAOB standards, when would a company be least likely to reevaluate established materiality levels or tolerable misstatements?

a.

Changes that occurred after the materiality levels were originally set are likely to affect investor’s perceptions about the company’s financial statements.

b.

The client has stated that it will not be able to respond to the auditor’s request for evidence within the prescribed timeframe.

c.

Materiality levels and tolerable misstatement were originally based on estimated or preliminary financial statement amounts that differ significantly from actual amounts.

d.

There is a substantial likelihood that misstatements of amounts less than the materiality level established for the financial statements as a whole would influence the judgment of a reasonable investor.

Choice "b" is correct. The client’s request for an extension to submit documentation generally would not have an impact on established materiality levels or tolerable misstatements. 

Choice "d" is incorrect. If there is a belief that misstatements of an amount below the current materiality level would influence the judgment of a reasonable investor, then by definition, materiality is not at its correct level. Materiality is defined in part by the level at which information begins to influence the judgment of a reasonable person. 

Choice "c" is incorrect. If materiality levels were based on preliminary or estimated data, they should be revised when the actual amounts are known. 

Choice "a" is incorrect. If changes have occurred that will likely affect the investor’s perception about the financial information, the materiality level should be revised accordingly.

55

When assessing internal auditors' objectivity, an independent auditor should:

a.

Review the internal auditors' reports to determine that their conclusions are consistent with the work performed.

b.

Verify that the internal auditors' assessment of control risk is comparable to the independent auditor's assessment.

c.

Evaluate the quality of the internal auditors' working paper documentation and their recent audit recommendations.

d.

Consider the policies that prohibit the internal auditors from auditing areas where they were recently assigned.

Choice "d" is correct. Objectivity is reflected by the organizational level to which an internal auditor reports, as well as by policies prohibiting audits of areas where the internal auditor lacks independence.

Choice "a" is incorrect. Reviewing the internal auditor's conclusions may help the external auditor assess the internal auditor's competence, not objectivity.

Choice "b" is incorrect. The fact that the internal auditor's assessment of control risk matches the external auditor's assessment is not relevant to the decision of whether they are objective.

Choice "c" is incorrect. Quality of work does not guarantee the objectivity of an internal auditor.

56

During a financial statement audit an internal auditor may provide direct assistance to the independent CPA in performing:

~Tests of controls
~Substantive tests
a.

No

No

b.

Yes

No

c.

Yes

Yes

d.

No

Yes

Choice "c" is correct. The work of an internal auditor may aid the external auditor in obtaining an understanding of internal control, assessing risk, and performing substantive tests, including tests of controls.

Choices "b", "d", and "a" are incorrect per above explanation.

57

The company being audited has an internal auditor that is both competent and objective. The independent auditor wants to assign tasks for the internal auditor to perform. Under these circumstances, the independent auditor may:

a.

Allow the internal auditor to audit a major subsidiary of the company.

b.

Not assign any task to the internal auditor because of the internal auditor's lack of independence.

c.

Allow the internal auditor to perform tests of internal controls.

d.

Allow the internal auditor to perform analytical procedures, but not be involved with any tests of details.

Choice "c" is correct. When planning the audit, the auditor should consider the extent of involvement of the client's internal auditors in the performance of the audit. Although they can be involved with tests of controls and of details (i.e., substantive tests), their involvement should generally be limited.

Choice "a" is incorrect. When planning the audit, the auditor should consider the extent of involvement of the client's internal auditors in the performance of the audit. Although they can be involved with tests of controls and of details (i.e., substantive tests), their involvement should generally be limited.

Choice "b" is incorrect. Independence is not required, nor can it be obtained by an internal auditor.

Choice "d" is incorrect. When planning the audit, the auditor should consider the extent of involvement of the client's internal auditors in the performance of the audit. Although they can be involved with tests of controls and of details (i.e., substantive tests), their involvement should generally be limited.

58

Which of the following is true about the auditor's use of an internal auditor and a specialist?

a.

The auditor may share responsibility for the audit report with an internal auditor who is deemed to be both objective and competent, but may not share such responsibility with a specialist.

b.

A specialist may be related to the client, but an internal auditor may not.

c.

The auditor must assess the competency of both the internal auditor and the specialist.

d.

The auditor may share responsibility for the audit report with a specialist who is deemed to be both objective and competent, but may not share such responsibility with an internal auditor.

Choice "c" is correct. The auditor must assess the competency of both the internal auditor and the specialist.

Choice "b" is incorrect. As an employee of the client, the internal auditor is always related to the client.

Choices "a" and "d" are incorrect. The auditor may never share responsibility for the audit report with either a specialist or an internal auditor, regardless of whether either of those parties are competent and objective.

59

Proper supervision of assistants is required for all of the following reasons, except:

a.

To ensure that the work performed by assistants is adequate to accomplish the objectives of the engagement.

b.

To ensure that the work performed by assistants provides the professional development they will need to advance within the firm.

c.

To stay informed regarding significant accounting and auditing questions, new developments, and material problems.

d.

To ensure that the work performed by assistants is consistent with the conclusions presented in the report.

Choice "b" is correct. Although it is beneficial when assistants receive the experience they need for professional development, this is not the purpose of supervision.

Choice "a" is incorrect. Proper supervision of assistants is required to ensure that the work performed by assistants is adequate to accomplish the objectives of the engagement.

Choice "d" is incorrect. Proper supervision of assistants is required to ensure that the work performed by assistants is consistent with the conclusions presented in the report.

Choice "c" is incorrect. Proper supervision of assistants is required so that the senior auditors can stay informed regarding significant accounting and auditing questions, new developments, and material problems.

60

Which of the following procedures would an auditor most likely perform in the planning stage of an audit?

a.

Obtain written representations from management that there are no unrecorded transactions.

b.

Communicate management's initial selection of accounting policies to the audit committee.

c.

Make a preliminary judgment about materiality.

d.

Confirm a sample of the entity's accounts payable with known creditors.

Choice "c" is correct.  During the planning stage of an audit, the auditor should make a preliminary assessment of materiality.

Choice "d" is incorrect. Confirmation procedures are substantive procedures and are not performed during the planning stage of the audit. Also, note that accounts payable are not typically tested through confirmations.

Choice "a" is incorrect. Written representations from management in the form of a representation letter are obtained at the end of the audit and not during the planning stage.

Choice "b" is incorrect. Audit committee communications can take place throughout the audit and not necessarily during the planning stage.

61

Which of the following factors should an external auditor obtain updated information about when assessing an internal auditor's competence?

a.

Whether the board of directors, audit committee, or owner-manager oversees employment decisions related to the internal auditor.

b.

The educational level and professional experiences of the internal auditor.

c.

Whether policies prohibit the internal auditor from auditing areas where relatives are employed.

d.

The reporting status of the internal auditor within the organization

Choice "b" is correct. The educational level and professional experiences of the internal auditor help the external auditor assess an internal auditor's competence.

Choice "d" is incorrect. The reporting status of the internal auditor within the organization helps the external auditor assess an internal auditor's objectivity.

Choice "c" is incorrect. Objectivity is reflected by policies prohibiting the internal auditor from auditing areas where relatives are employed.

Choice "a" is incorrect. Objectivity is reflected by the organization level to which the internal auditor reports, which includes who oversees the employment decisions related to the internal auditor.

62

Which of the following matters does an auditor usually include in the engagement letter?

a.

Arrangements regarding fees and billing.

b.

Identification of working capital deficiencies.

c.

Indications of negative cash flows from operating activities.

d.

Analytical procedures that the auditor plans to perform.

Choice "a" is correct. An engagement letter typically includes information regarding fees and billing.

Choice "d" is incorrect. An engagement letter may include overall audit strategy, but typically would not include specific audit procedures.

Choice "c" is incorrect. Indications of negative cash flows from operating activities would be included in the audit workpapers, but typically would not be included in the engagement letter.

Choice "b" is incorrect. Identification of working capital deficiencies would be included in the audit workpapers, but typically would not be included in the engagement letter.

63

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 not reduce the amount of audit testing based on the work of internal auditors.

b.

An independent auditor should use internal audit workpapers when available.

c.

An internal auditor should provide direct assistance to the independent auditor during preparation of audit workpapers.

d.

An independent auditor should assess the organizational status of the director of internal audit

Choice "d" 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.

Choice "a" is incorrect. The independent auditor may use the work of the internal audit function to reduce the amount of audit testing.

Choice "c" is incorrect. An independent auditor is not required to use the internal auditors to provide direct assistance on the audit. However, an internal auditor may provide direct assistance to the independent auditor, as long as the independent auditor is satisfied with the internal auditor's objectivity and competence.

Choice "b" is incorrect. An independent auditor is not required to use the internal audit workpapers. However, an independent auditor may use the work of the client's internal audit staff based on the independent auditor's evaluation of the competency, objectivity, and application of a systematic and disciplined approach by the internal audit function.

64

For which of the following judgments may an independent auditor share responsibility with an entity's internal audit function, which is assessed to be competent, objective, and apply a systematic and disciplined approach?

~Evaluation of significant accounting estimates
~Materiality of misstatements
a.

Yes

No

b.

Yes

Yes

c.

Yes

Yes

d.

No

No

Choice "d" is correct. An independent auditor may not share responsibility with an entity's internal auditor for audit decisions, judgments, or assessments made as part of the audit. This includes evaluation of significant accounting estimates and materiality of misstatements.

Choices "c", "a", and "b" are incorrect, based on the above explanation.