Auditing part 2

Question 1

Which of the following information discovered during an audit most likely would raise a question concerning possible illegal acts?

Answer 1

The entity prepared several large checks payable to cash during the year.

Large checks payable to cash would be most likely to raise questions regarding possible illegal acts. Valid company disbursements are typically made by check and controlled through accounts payable. Cash payments are unusual and difficult to control. As a result, large checks payable to cash would present a red flag during the audit.

Question 2

Which of the following factors most likely would cause a CPA to not accept a new audit engagement?

Answer 2

The prospective client is unwilling to make all financial records available to the CPA.

A CPA would not accept a client who was unwilling to make all financial records available.
Access to all financial records would be a minimum requirement for the audit, and management is required to state in the management representation letter that all financial records and data have been made available to the auditors.

Question 3

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

Answer 3

If the specialist is related to the client, the auditor is still permitted to use the specialist’s findings as corroborative evidence.

The specialist is not required to be independent. The auditor, however, must evaluate the nature of the relationship of the specialist to the client and assess the specialist’s ability to be objective.

Question 4

Disclosure of irregularities to parties other than a client’s senior management and its audit committee or board of directors ordinarily is not part of an auditor’s responsibility.

However, to which of the following outside parties may a duty to disclose irregularities exist?

Answer 4

YES to all 3
To the SEC when the client reports an auditor change

To a successor auditor when the successor makes appropriate inquiries

To a government funding agency from which the client receives financial assistance

Question 5

In a financial statement audit, inherent risk is evaluated to help an auditor assess which of the following?

Answer 5

The susceptibility of a financial statement assertion to a material misstatement assuming there are no related controls.

AICPA Professional Standards define inherent risk as “…the susceptibility of an assertion about a class of transactions, account balance, or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.

Question 6

herent risk and control risk differ from detection risk in that inherent risk and control risk are

Answer 6

Functions of the client and its environment while detection risk is not.

Inherent risk and control risk (also called environmental risks) are functions of the client and its environment, while detection risk is not. As a result, inherent risk and control risk can only be assessed by the auditor, while detection risk is controlled by the auditor.

Question 7

Which of the following information that comes to an auditor’s attention would be most likely to raise a question about the occurrence of illegal acts?

Answer 7

The discovery of unexplained payments made to government employees.

Doesn’t this immediately raise questions??!! Why would payments be made to government employees, especially unexplained payments? They sound like bribes.

Question 8

Which of the following factors most likely would cause an auditor not to accept a new audit engagement?

Answer 8

Concluding that the entity’s management probably lacks integrity.

Management integrity via the control environment sets the tone of an organization and provides the foundation for all other components of internal control. An inherent limitation of an internal control structure is the possibility of management override. Thus, the lack of management integrity can impact the audit in terms of the occurrence of both employee and management errors and irregularities. If the auditor believes that management lacks integrity, the risk that material misstatements might not be discovered becomes unacceptably high. As a result, the auditor would probably decide not to accept the engagement.

Question 9

An auditor who discovers that a client’s employees have paid small bribes to public officials most likely would withdraw from the engagement if the

Answer 9

Employees’ actions affect the auditor’s ability to rely on management’s representations.

An auditor may withdraw from an engagement when he/she believes that there is such a significant risk of fraud that it is not practicable to modify the procedures that are planned for the audit sufficiently to address the risk. If management fails to respond appropriately to the auditor’s discovery of the payment of bribes to public officials, it may indicate a more pervasive problem, even though the amounts involved were small. This failure may impact the auditor’s ability to rely on management’s representations and result in withdrawal from the engagement.

Question 10

Which of the following conditions most likely would pose the greatest risk in accepting a new audit engagement?

Answer 10

There will be a client-imposed scope limitation.

ANY client-imposed scope limitation is a problem. When you add that problem to the greater risk arising from a new client, you have greatly increased the risk related to the new engagement. A new client, by definition, is a client that will require more time to study and understand in order to perform the audit. If the client is also telling the auditors that certain audit procedures will not be allowed, the risk of missing a material misstatement becomes very high.

Question 11

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

Answer 11

The entity’s annualized interim financial statements.

The auditor’s preliminary judgment about materiality is a judgment about the amount of a misstatement in the financial statements under audit, which would be considered material (one that could influence the decision of a reasonable person relying on the financial statements). It is appropriate and likely, therefore, for the auditor to consider the entity’s annualized interim financial statements in developing such a judgment.

Question 12

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

Answer 12

Becomes aware of circumstances that cause the auditor to express a modified opinion.

An auditor may refer to the specialist in the auditor’s report if, as a result of the specialist’s findings, the auditor modifies the report and believes that the reference will enable readers to better understand why the modification was made.

Question 13

Should an auditor communicate the following matters to an audit committee (or those charged with governance) of a public entity?

Answer 13

YES
Significant audit adjustments recorded by the entity
Management’s consultation with other accountants about significant accounting matters

The auditor is required to communicate both significant audit adjustments recorded by the entity and management's consultations with other accountants about significant accounting matters to the audit committee (or those charged with governance).

Question 14

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

Answer 14

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.

The auditor is required to determine materiality for the financial statements as a whole. As a result, 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.

Question 15

Which of the following comparisons would be most useful to an auditor in evaluating the results of an entity’s operations?

Answer 15

Current year revenue to budgeted current year revenue.

A comparison of current year revenue to budgeted revenue would be very useful to an auditor in evaluating the results of operations. It would tell the auditor how well the entity did compared to the plan. The comparison would also enable the auditor to predict the effects on other income statement accounts, such as related expense accounts.

Question 16

Which of the following statements is correct concerning an auditor’s required communication with an entity’s audit committee?

Answer 16

This communication should include disagreements with management about significant audit adjustments, whether satisfactorily resolved or unresolved.

The auditor is required to communicate with the audit committee about the following: the auditor’s responsibilities under GAAS, significant accounting policies, management judgments and accounting estimates, significant audit adjustments (resolved and unresolved, other information in documents containing audited financial statements, disagreements with management, consultation with other accountants, and difficulties encountered in performing the audit.

Question 17

Which of the following statements is correct concerning analytical procedures?

Answer 17

Analytical procedures used in planning an audit generally use data aggregated at a high level.

Analytical procedures used for planning purposes aid the auditor in identifying the auditing procedures that will be used. The data used for this type of analytical procedure is generally highly aggregated.

Question 18

Which of the following circumstances most likely would cause an auditor to consider whether material misstatements exist in an entity’s financial statements?

Answer 18

Supporting records that should be readily available are frequently not produced when requested.

An auditor would consider whether material misstatements exist if supporting records that should be readily available are frequently not produced when requested. This could indicate a lack of internal control and the possibility of management misrepresentation which, in turn, could indicate an opportunity for material misstatements to be present.

Question 19

Which of the following circumstances is most likely to cause an auditor to consider whether a material misstatement exists?

Answer 19

Transactions selected for testing are not supported by proper documentation.

Lack of proper documentation for transactions selected for testing would most likely cause an auditor to consider whether a material misstatement exists. This is a direct and specific indication that a material misstatement might exist, whereas the other choices given generally relate to internal control considerations.

Question 20

Ordinarily, the predecessor auditor permits the successor auditor to review the predecessor’s working paper analyses relating to

Answer 20

Contingencies
Balance sheet

The successor auditor normally reviews the predecessor’s audit documentation relating to planning, internal control, audit results, balance sheet accounts, and contingencies. Thus, this is the correct answer. The successor auditor would request a review of contingency and balance sheet documentation.

Question 21

A successor auditor’s inquiries of the predecessor auditor should include questions regarding

Answer 21

The predecessor’s understanding as to the reasons for the change in auditors.

AICPA Professional Standards state that the successor auditor should inquire of the predecessor about 5 specific matters: (1) information that might bear on the integrity of management; (2) disagreements with management as to accounting principles, auditing procedures, or other similarly significant matters; (3) communications to those charged with governance regarding fraud and illegal acts by clients; (4) communications to management and those charged with governance regarding significant deficiencies and material weaknesses in internal control; and (5) the predecessor auditor’s understanding as to the reasons for the change of auditors.

Question 22

An auditor’s engagement letter most likely would include a statement that

Answer 22

Limits the auditor’s responsibility to detect errors and fraud.

The detection of errors and fraud is an area commonly misunderstood by clients. As a result, the auditor’s responsibility related to errors and fraud is clearly laid out in the engagement letter. The letter would note that the auditor is responsible for obtaining reasonable rather than absolute assurance about whether the financial statements are free of material misstatements caused by error or fraud. As a result, a material misstatement may remain undetected. Further, an audit is not designed to detect error or fraud that is immaterial to the financial statements.

Question 23

In assessing whether to accept a client for an audit engagement, a CPA should consider the

Answer 23

Client’s business risk
CPA’s business risk

The client’s business risk is the risk that the client will fail to meet its objectives, particularly with regard to survival and profitability. The CPA’s business risk is the risk that the CPA’s business will suffer due to association with the client. The CPA should consider both risks in determining whether to accept a client for an audit engagement.

Question 24

Which of the following factors most likely would cause a CPA to not accept a new audit engagement?

Answer 24

The prospective client is unwilling to make all financial records available to the CPA.

A CPA would not accept a client who was unwilling to make all financial records available.
Access to all financial records would be a minimum requirement for the audit, and management is required to state in the management representation letter that all financial records and data have been made available to the auditors.

Question 25

A successor auditor ordinarily should request to review the predecessor’s audit documentation relating to

Answer 25

Contingencies
Internal control

The successor auditor normally reviews the predecessor’s audit documentation relating to planning, internal control, audit results, balance sheet accounts, and contingencies. The successor auditor would request a review of contingency and internal control documentation.

Question 26

Which of the following statements most likely would be included in an engagement letter from an auditor to a client?

Answer 26

The CPA firm will involve information technology specialists in the performance of the audit.

Although the determination of matters to be addressed in the engagement letter involves professional judgment, it would be appropriate to document in an engagement letter any planned audit involvement of “specialists” regarding information technology or other matters.

Question 27

Before accepting an engagement to audit a new client, an auditor is required to

Answer 27

Make inquiries of the predecessor auditor after obtaining the consent of the prospective client.

Before accepting an engagement to audit a new client, an auditor is required to make inquiries of the predecessor auditor after obtaining the consent of the prospective client. The communication may be either written or oral.

Question 28

An auditor is required to establish an understanding with a client regarding the services to be performed for each engagement. This understanding generally includes

Answer 28

The auditor’s responsibility for ensuring that the audit committee is aware of any significant deficiencies in internal control that come to the auditor’s attention.

Professional standards require that the auditor establish an understanding with the client regarding the services to be performed. The understanding would generally include:
1 the objective of the audit;
2 management’s responsibilities with regard to the financial statements, internal control, compliance with laws and regulations, availability of records, and the management representation letter;
3 the auditor’s responsibilities for GAAS and reportable conditions;
4 a description of an audit; and
5 management’s responsibilities regarding correction of material misstatements and evaluation of immaterial adjustments.

Question 29

Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding the predecessor’s

Answer 29

Understanding as to the reasons for the change of auditors.

A successor auditor should communicate with the predecessor auditor about matters that will assist the successor auditor in deciding whether to accept the engagement. These would include the integrity of management, disagreements with management, and the predecessor’s understanding of the reason for the change in auditors.

Question 30

The scope and nature of an auditor’s contractual obligation to a client ordinarily is set forth in the

Answer 30

Engagement letter.

The engagement letter is the contract between the auditor and the client. It sets forth the nature of the engagement, timing, anticipated completion dates, and client assistance to be rendered.

Question 31

A ________ letter is issued at the completion of the engagement. It offers suggestions and recommendations as to internal controls and company operations based on observations made during the audit.

Answer 31

Management letter.

Question 32

Which of the following factors most likely would cause an auditor not to accept a new audit engagement?

Answer 32

Concluding that the entity’s management probably lacks integrity.

Question 33

Hill, CPA, has been retained to audit the financial statements of Monday Co. Monday’s predecessor auditor was Post, CPA, who has been notified by Monday that Post’s services have been terminated.

Under these circumstances, which party should initiate the communications between Hill and Post?

Answer 33

Hill, the successor auditor.

The initiative belongs to Hill, the successor auditor. When an auditor has been retained to audit the financial statements of an entity, the auditor contacts the predecessor auditor to obtain information about matters that may affect the conduct of the audit and to review the prior year audit documentation. The successor auditor should contact the predecessor auditor prior to final acceptance of the engagement.

Question 34

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

Answer 34

Arrangements regarding fees and billing.

The engagement letter identifies the respective responsibilities of the entity and the auditor, and essentially constitutes the contract between the parties. It is customary for the engagement letter to address fee-related issues.

Question 35

A successor auditor most likely would make specific inquiries of the predecessor auditor regarding

Answer 35

Disagreements with management as to auditing procedures.

Auditors are required by professional standards to make inquiries pertaining to the integrity of management, disagreements with management regarding accounting principles and auditing procedures, and the predecessor’s understanding of the reason for the change in auditors.

Question 36

The understanding with the client regarding a financial statement audit generally includes which of the following matters?

Answer 36

The responsibilities of the auditor.

An engagement letter, which documents the agreed upon terms of the audit engagement, specifically addresses the respective responsibilities of management and the auditor, among other matters.

Question 37

An auditor’s engagement letter most likely would include

Answer 37

Management’s acknowledgment of its responsibility for maintaining effective internal control.

The engagement letter would typically refer to:
1 the objective of the audit;
2 management's responsibilities for the financial statements, for internal control over financial reporting, and for compliance with laws and regulations;
3 availability of financial records;
4 representation letter;
5 auditor's responsibilities;
6 components of an audit; and
7 correction of misstatements.

The engagement letter would include management’s acknowledgment of its responsibility for maintaining effective internal control over financial reporting.

Question 38

Before accepting an engagement to audit a new client, a CPA is required to obtain

Answer 38

The prospective client’s consent to make inquiries of the predecessor, if any.

AICPA standards addressing required communications between successor and predecessor auditors state that an auditor should not accept an engagement until the successor auditor’s required communications with the predecessor auditor have been evaluated.