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Flashcards in A4-4 Deck (15)
1

Which of the following circumstances most likely would cause an auditor to suspect that there are material misstatements in an entity's financial statements?

a.

The entity's management places no emphasis on meeting publicized earnings projections.

b.

Significant differences between the physical inventory count and the accounting records are not investigated.

c.

Cash transactions are electronically processed and recorded, leaving no paper audit trail.

d.

Monthly bank reconciliations ordinarily include several large outstanding checks.

Choice "b" is correct. Inadequate recordkeeping with respect to assets, such as failing to reconcile the physical inventory count and the accounting records, provides an opportunity for fraud or error to occur.

Choice "a" is incorrect. An auditor might suspect misstatement when management commits to aggressive or unrealistic earning projections, not when management doesnot emphasize meeting such projections.

Choice "d" is incorrect. The inclusion of several large, outstanding checks in the monthly bank reconciliation may be a normal occurrence and is not necessarily indicative of material misstatement.

Choice "c" is incorrect. Electronic processing and recording of transactions without a paper audit trail may be acceptable as long as a satisfactory electronic audit trail exists.

2

To be effective, analytical procedures in the overall review stage of an audit engagement should be performed by:

a.

A manager or partner who has a comprehensive knowledge of the client's business and industry.

b.

The staff accountant who performed the substantive auditing procedures.

c.

The managing partner who has responsibility for all audit engagements at that practice office.

d.

The CPA firm's quality control manager or partner who has responsibility for the firm's peer review program.

Choice "a" is correct. The manager and partner on a specific job generally bear a great deal of responsibility for the audit and the report. Typically they would perform analytical procedures during the final review stage, to evaluate overall financial statement presentation and to assess the conclusions reached. In order to evaluate the results of the analysis and to perform an effective review, the manager or partner should have a comprehensive knowledge of the client's business and the industry.

Choice "b" is incorrect. It is more effective to have a manager or partner perform this review rather than a staff accountant, because the manager or partner is generally more experienced and knowledgeable, and because it provides a double check on the work of the staff accountant.

Choices "c" and "d" are incorrect. The managing partner and the quality control manager or partner might not have a comprehensive knowledge of the client's business and industry.

3

Analytical procedures performed in the overall review stage of an audit suggest that several accounts have unexpected relationships. The results of these procedures most likely would indicate that:

a.

Additional tests of details are required.

b.

Internal control activities are not operating effectively.

c.

Irregularities exist among the relevant account balances.

d.

The communication with those charged with governance should be revised.


Explanation

Choice "a" is correct. If analytical procedures suggest unexpected relationships, the auditor would perform additional tests of details of the accounts involved.

Choice "c" is incorrect. The identification of unexpected relationships as a result of analytical procedures does not necessarily mean that irregularities exist in the relevant account balances, although this is a possible explanation.

Choice "b" is incorrect. The identification of unexpected relationships as a result of analytical procedures does not necessarily mean that internal control activities are not operating effectively, although this is a possible explanation.

Choice "d" is incorrect. The identification of unexpected relationships as a result of analytical procedures does not necessarily mean that communication with those charged with governance should be revised, although this is a possible consequence

4

Analytical procedures used in the overall review stage of an audit generally include:

a.

Retesting control activities that appeared to be ineffective during the assessment of control risk.

b.

Considering unusual or unexpected account balances that were not previously identified.

c.

Performing tests of transactions to corroborate management's financial statement assertions.

d.

Gathering evidence concerning account balances that have not changed from the prior year.

Choice "b" is correct. The objective of analytical procedures used in the overall review stage of the audit is to assist the auditor in assessing conclusions reached and in the evaluation of the overall financial statement presentation. Analytical procedures applied in the overall review stage are used to consider the adequacy of evidence gathered in response to unusual or unexpected balances identified in planning the audit, and to identify unusual or unexpected balances or relationships that were not previously identified.

Choice "d" is incorrect. If analytical procedures are used to gather evidence about account balances that have not changed from last year, they are functioning as a substantive test rather than as a final review procedure.

Choice "a" is incorrect. Analytical procedures are not used to test controls.

Choice "c" is incorrect. If analytical procedures are used as a test of transactions, they are functioning as a substantive test rather than as a final review procedure.

5

Which of the following ratios would an engagement partner most likely calculate when reviewing the balance sheet in the overall review stage of an audit?

a.

Quick assets/current assets.

b.

Interest payable/interest receivable.

c.

Total debt/total assets.

d.

Accounts receivable/inventory.

Choice "c" is correct. During the final review stage of an audit, the auditor focuses on the overall presentation of the financial statements. Total debt/total assets indicates the portion of assets financed by creditors, which is a meaningful ratio to calculate during the final audit review.

Choice "a" is incorrect. Quick assets/current assets simply indicates the percentage of current assets that are also "quick" assets. It is not a particularly meaningful ratio.

Choice "d" is incorrect. Accounts receivable/inventory is not a meaningful ratio because it compares a figure based on retail dollars with a cost-based figure.

Choice "b" is incorrect. Interest payable/interest receivable is not a meaningful ratio because these two amounts are not related.

6

Analytical procedures performed in the final review stage of an audit generally would include:

a.

Considering the adequacy of the evidence gathered in response to unexpected balances identified in planning.

b.

Calculating projected uncorrected misstatements estimated through audit sampling techniques.

c.

Reassessing the factors that assisted the auditor in deciding on preliminary materiality levels and audit risk.

d.

Summarizing uncorrected misstatements specifically identified through tests of details of transactions and balances.

Choice "a" is correct. Analytical procedures applied during the final review stage should be used to determine whether adequate evidence has been gathered in response to unusual or unexpected balances identified during the audit.

Choice "c" is incorrect. Analytical procedures generally involve comparison of recorded amounts to auditor expectations. Reassessing the factors used to establish materiality levels and audit risk would not involve such comparisons.

Choice "d" is incorrect. Analytical procedures generally involve comparison of recorded amounts to auditor expectations. Summarizing uncorrected misstatements would not involve such comparisons.

Choice "b" is incorrect. Analytical procedures generally involve comparison of recorded amounts to auditor expectations. Calculating projected uncorrected misstatements would not involve such comparisons.

7

An auditor most likely would apply analytical procedures in the overall review stage of an audit to:

a.

Enhance the auditor's understanding of subsequent events.

b.

Evaluate the effectiveness of the internal control activities.

c.

Determine whether additional audit evidence may be needed.

d.

Identify auditing procedures omitted by the staff accountants.

Choice "c" is correct. In performing analytical procedures as an overall review, the auditor determines whether adequate evidence has been gathered in response to unusual or unexpected balances identified during the audit, and may decide that additional audit procedures are warranted. In addition, the auditor may identify unusual or unexpected balances not already noted during the audit, which would also require the application of further auditing procedures.

Choice "a" is incorrect. Analytical procedures applied during the overall review stage of the audit are meant to evaluate the overall financial statement presentation, and to assess the conclusions reached by the auditor. This is a high-level review, and one that focuses on the financial statements. As such, it would not be likely to enhance the auditor's understanding of subsequent events.

Choice "d" is incorrect. Analytical procedures applied during the overall review stage of the audit are meant to evaluate the overall financial statement presentation, and to assess the conclusions reached by the auditor. This is a high-level review, and one that focuses on the financial statements. As such, it would not be likely to identify omitted auditing procedures.

Choice "b" is incorrect. Analytical procedures applied during the overall review stage of the audit are meant to evaluate the overall financial statement presentation, and to assess the conclusions reached by the auditor. This is a high-level review, and one that focuses on the financial statements. As such, it would not be useful in evaluating the effectiveness of the client's internal control activities.

8

Which of the following is an analytical procedure that an auditor most likely would perform during the final review stage of an audit?

a.

Testing the effectiveness of internal control procedures that appear to be suitably designed to prevent or detect material misstatements.

b.

Comparing each individual expense account balance with the relevant budgeted amounts and investigating any significant variations.

c.

Reading the financial statements and considering whether there are any unusual or unexpected balances that were not previously identified.

d.

Calculating each individual expense account balance as a percentage of total entity expenses and comparing the results with industry averages.

Choice "c" is correct. During the final review stage of an audit, an auditor evaluates the overall financial statement presentation and assesses the conclusions reached. As part of this evaluation, the auditor would likely read the financial statements and consider whether there are any unusual or unexpected balances that were not previously identified.

Choices "b" and "d" are incorrect. During the final review stage of an audit, the auditor focuses on the overall financial statement presentation rather than testing details. In addition, even during the audit, the auditor generally would not look at every individual expense account balance, but rather would look at some sample of balances. 

Choice "a" is incorrect. Analytical procedures involve comparison of recorded amounts to independent expectations developed by the auditor. Tests of controls are not part of this process.

9

An auditor's analytical procedures performed during the overall review stage indicated that the client's accounts receivable had doubled since the end of the prior year. However, the allowance for doubtful accounts as a percentage of accounts receivable remained about the same. Which of the following client explanations most likely would satisfy the auditor?

a.

Twice as many accounts receivable were written off in the prior year than in the current year.

b.

A greater percentage of accounts receivable were currently listed in the "more than 90 days overdue" category than in the prior year.

c.

The client opened a second retail outlet in the current year and its credit sales approximately equaled the older, established outlet.

d.

The client liberalized its credit standards in the current year and sold much more merchandise to customers with poor credit ratings.


Explanation

Choice "c" is correct. If a second, similar retail outlet were opened, one would expect sales and accounts receivable to double. As long as the collection rates for the new outlet's receivables were expected to be similar to those of the original outlet, however, the allowance for doubtful accounts as a percentage of accounts receivable would remain the same.

Choice "d" is incorrect. If the client sold more merchandise to customers with poor credit ratings, the allowance for doubtful accounts as a percentage of receivables should increase to reflect the greater level of estimated bad debts.

Choice "a" is incorrect. Write off of a specific account receivable reduces both the allowance and the receivable by the amount written off. If there were twice as many write-offs in the previous year than in the current year (and this were the only difference), the allowance for doubtful accounts as a percentage of receivables would not stay the same.

Choice "b" is incorrect. If more receivables are potentially uncollectible in the current year (as opposed to the prior year), the allowance for doubtful accounts as a percentage of receivables should increase to reflect the greater level of estimated bad debts.

10

An auditor finds several errors in the financial statements that the client prefers not to correct. The auditor determines that the errors are not material in the aggregate. Which of the following actions by the auditor is most appropriate?

a.

Document the conclusion that the errors do not cause the financial statements to be misstated, but do not summarize uncorrected errors in the working papers.

b.

Do not summarize the uncorrected errors in the working papers, and do notdocument a conclusion about whether the uncorrected errors cause the financial statements to be misstated.

c.

Document the errors in the summary of uncorrected errors, and document the conclusion that the errors do not cause the financial statements to be misstated.

d.

Summarize the uncorrected errors in the working papers, but do not document whether the errors cause the financial statements to be misstated.

Choice "c" is correct. The auditor should document the errors in the summary of uncorrected errors, and document the conclusion that the errors do not cause the financial statements to be misstated. 

Choice "a" is incorrect. The auditor is required to document both his/her conclusion and summarize uncorrected errors in the working papers.

Choice "d" is incorrect. The auditor is required to summarize the uncorrected errors in the working papers and document whether the errors cause the financial statements to be misstated.

Choice "b" is incorrect. The auditor is required to perform both of these procedures.

11

If not already performed during the overall review stage of the audit, the auditor should perform analytical procedures relating to which of the following transaction cycles?

a.

Purchasing.

b.

Revenue.

c.

Payroll.

d.

Inventory.

Choice "b" is correct. If not already performed during the overall review stage of the audit, the auditor should perform analytical review procedures relating to the revenue cycle because there is the presumption of revenue fraud in all audits.

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

12

According to PCAOB standards which one of the following statements does not reflect a qualitative standard that should be considered when evaluating the materiality of an uncorrected misstatement?

a.

The effects of misclassifications, for example, between operating and nonoperating.

b.

The dollar amount of the error.

c.

The significance of the misstatement relative to the needs of users.

d.

The cost of the correction.

Choice "b" is correct. The dollar amount of the error is a quantitative standard, not a qualitative standard. 

Choice "a" is incorrect. The effect of misclassifications is a qualitative standard that should be considered when evaluating the materiality of an uncorrected misstatement.

Choice "c" is incorrect. The significance of the misstatement relative to the needs of users is a qualitative standard that should be considered when evaluating the materiality of an uncorrected misstatement.

Choice "d" is incorrect. The cost of the correction is a qualitative standard that should be considered when evaluating the materiality of an uncorrected misstatement.

13

According to PCAOB standards, which of the following does not represent an example of management bias?

a.

Selective correction of misstatements brought to management's attention during the audit.

b.

Management decreasing the allowance for doubtful accounts when there has been no change in the level of write-offs during the period.

c.

Management reporting all insurance purchases initially as an expense and then adjusting the unexpired portion into prepaid insurance at the end of the period.

d.

The identification by management of additional adjusting entries that offset misstatements accumulated by the auditor.

Choice "c" is correct. This is not an example of management bias because at the end of the period the financial statements are fairly presented. Unexpired insurance should be reported as prepaid insurance. This is a correct application of the matching principle.

Choice "d" is incorrect. The identification by management of additional adjusting entries that offset the misstatements accumulated by the auditor is an example of management bias.

Choice "a" is incorrect. Selective correction of misstatements brought to management’s attention during the audit is an example of management bias. 

Choice "b" is incorrect. Management decreasing the allowance for doubtful accounts when there has been no change in the level of write-offs during the period is an example of management bias in accounting estimates.

14

Which of the following circumstances most likely would cause an auditor to suspect that material misstatements exist in a client's financial statements?

a.

The assumptions used in developing the prior year's accounting estimates have changed.

b.

Management consults with another CPA firm about complex accounting matters.

c.

Negative confirmation requests yield fewer responses than in the prior year's audit.

d.

Differences between reconciliations of control accounts and subsidiary records are not investigated.

Choice "d" is correct. If control accounts in the general ledger do not reconcile to the subsidiary ledgers, there may be a problem in the way transactions were recorded and posted. Failure to investigate such differences implies that, if such a problem exists, it has not been identified and corrected. The auditor would therefore suspect that material misstatements exist in the client's financial statements.

Choice "a" is incorrect. The assumptions used in developing accounting estimates generally do change as new information becomes available or as situations or conditions change. This would not necessarily indicate that a material misstatement exists.

Choice "c" is incorrect. Since responses to negative confirmations are only received when there are discrepancies, a lower response rate likely would be indicative of fewer problems with accounts receivable. This corresponds to a reduced likelihood of material misstatement.

Choice "b" is incorrect. Management's consultation with another CPA firm about complex accounting matters indicates proactive steps on the part of management to accurately address those matters. Material misstatements with respect to the complex accounting matters therefore would be less likely to exist.

15

A primary objective of analytical procedures used in the final review stage of an audit is to:

a.

Identify account balances that represent specific risks relevant to the audit.

b.

Gather evidence from tests of details to corroborate financial statement assertions.

c.

Detect fraud that may cause the financial statements to be misstated.

d.

Assist the auditor in evaluating the overall financial statement presentation.

Choice "d" is correct. The purpose of applying analytical procedures during the overall review stage of an audit is to evaluate the overall financial statement presentation, to assess the conclusions reached, and to assist in forming an opinion on whether the financial statements as a whole are free of material misstatement.

Choice "a" is incorrect. This description would represent analytical procedures used during the planning stages of the audit.

Choice "b" is incorrect. This description would represent analytical procedures used as substantive procedures.

Choice "c" is incorrect. This description would represent analytical procedures used as substantive procedures. Also, it is difficult to detect fraud using analytical procedures.