Audit 3 questions

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cpa

A successor auditor ordinarily should request to review the predecessor's audit documentation relating to:
1. Contingencies
2. Internal control

Choice "a" is correct. A review of the predecessor's audit documentation related to matters of continuing
accounting and auditing significance would be permitted. This would include documentation concerning contingencies and internal controls.

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

Choice "b" is correct. The control environment is the foundation for all other components of internal control. Management's disregard of its responsibility to maintain an adequate internal control environment therefore compromises its ability to provide reasonable assurance regarding reliable financial reporting. The auditor may conclude that the risk of misrepresentation in the financial statements is great enough that an audit
should not be conducted.

Which of the following matters generally is included in an auditor's engagement letter?
a. Management's responsibility for the entity's compliance with laws and regulations.
b. The factors to be considered in setting preliminary judgments about materiality.
c. Management's vicarious liability for illegal acts committed by its employees.
d. The auditor's responsibility to search for significant internal control deficiencies.

Choice "a" is correct. An understanding with the client should be established regarding management's
responsibilities, which include identifying and ensuring that the entity complies with applicable laws and
regulations. The understanding should be documented through a written communication, such as an
engagement letter.

Before accepting an engagement to audit a new client, a CPA is required to obtain:
a. An understanding of the prospective client's industry and business.
b. The prospective client's signature to the representation letter.
c. A preliminary understanding of the prospective client's control environment.
d. The prospective client's consent to make inquiries of the predecessor auditor, if any.

Choice "d" is correct. Inquiry of the predecessor auditor is a required pre-acceptance procedure. However,
consent of the prospective client must be obtained before a CPA can make such inquiries of the predecessor
auditor.

Which of the following auditor concerns most likely could be so serious that the auditor concludes that a
financial statement audit cannot be conducted?
a. The entity has no formal written code of conduct.
b. The integrity of the entity's management is suspect.
c. Procedures requiring segregation of duties are subject to management override.
d. Management fails to modify prescribed controls for changes in conditions.

Choice "b" is correct. Serious concerns about the integrity of management may indicate a risk of
management misrepresentation in the financial statements that is so great that an audit cannot be conducted.
If the integrity of management is suspect, there would be a presumption of dishonesty. The auditor would
then need to question the genuineness of all records and documents obtained from the client and would
require conclusive rather than persuasive evidence to corroborate all management representations. An audit
conducted on these terms would be unreasonably costly and impractical.

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. Evidence to be gathered to provide a sufficient basis for the auditor's opinion.
b. Procedures to be undertaken to discover litigation, claims, and assessments.
c. Pending legal matters to be included in the inquiry of the client's attorney.
d. Timing of inventory observation procedures to be performed.

Choice "d" 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.

Which of the following statements would least likely appear in an auditor's engagement letter?
a. Fees for our services are based on our regular per diem rates, plus travel and other out-of-pocket
expenses.
b. During the course of our audit we may observe opportunities for economy in , or improved controls over,
your operations.
c. Our engagement is subject to the risk that material errors or fraud , including defalcations, if they exist, will
not be detected.
d. After performing our preliminary analytical procedures we will discuss with you the other procedures we
consider necessary to complete the engagement.

Choice "d" is correct. The auditor does not consult with the client about audit procedures that will be
performed.

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?
a. Hill, the successor auditor.
b. Post, the predecessor auditor.
c. Monday's controller or CFO.
d. The chairman of Monday's board of directors.

Choice "a" is correct. The initiative to communicate with the predecessor auditor rests with the successor
auditor. Note, however, that the successor auditor must first receive permission from the client.

Prior to commencing field work, an auditor usually discusses the general audit strategy with the client's
management. Which of the following details do management and the auditor usually agree upon at this time?
a. The specific matters to be included in the communication with those charged with governance.
b. The minimum amount of misstatements that may be considered to be significant deficiencies in internal
control.
c. The schedules and analyses that the client's staff should prepare.
d. The effects that inadequate controls may have over the safeguarding of assets.

Choice "c" is correct. Prior to commencing field work, the auditor would likely discuss with management any
assistance desired from client staff. This is part of establishing an understanding with the client.

An auditor is required to establish an understanding with a client regarding the services to be performed for
each engagement. This understanding generally includes:
a. The auditor's responsibility for determining the preliminary judgments about materiality and audit risk
factors.
b. Management's responsibility for identifying mitigating factors when the auditor has doubt about the entity's
ability to continue as a going concern.
c. The auditor's responsibility for ensuring that those charged with governance are aware of any significant
deficiencies in internal control that come to the auditor's attention.
d. Management's responsibility for providing the auditor with an assessment of the risk of material
misstatement due to fraud .

Choice "c" is correct. An understanding between the auditor and the client generally includes the auditor's
responsibilities. One of the auditor's responsibilities is to ensure that those charged with governance (e.g.,
the audit committee) are aware of any significant deficiencies in internal control that come to the auditor's
attention.

Which of the following statements most likely would be included in an engagement letter from an auditor to a
client?
a. The CPA firm will provide absolute assurance about whether the financial statements are free of material
misstatement.
b. The CPA firm is responsible for ensuring that the client complies with applicable laws.
c. The CPA firm will involve information technology specialists in the performance of the audit.
d. The CPA firm will adjust the financial statements to correct misstatements before issuing a report.

Choice "c" is correct. The auditor's understanding with the client often includes discussion of any specialists
who will be involved in the engagement.

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. Materiality of the accounts recently inspected by the internal auditors.
d. Results of the tests of transactions recently performed 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).

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. AICPA Codification of Statements on Auditing Standards.
b. AICPA Accounting Trends and Techniques.
c. SEC Quality Control Review.
d. SEC Statement 1 O-K Guide.

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

In assessing the objectivity of internal auditors, an independent auditor should:
a. Evaluate the quality control program in effect for the internal auditors.
b. Examine documentary evidence of the work performed by the internal auditors.
c. Test a sample of the transactions and balances that the internal auditors examined.
d. Determine the organizational level to which the internal auditors report.

Choice "d" is correct. When assessing the internal auditors' objectivity, the auditor should obtain information
about whether the internal auditor reports to an officer of sufficient status to ensure broad audit coverage and
adequate consideration of, and action on, the findings and recommendations of the internal auditors.

Which of the following statements is correct concerning an auditor's use of the work of a specialist?
a. The auditor need not obtain an understanding of the methods and assumptions used by the specialist.
b. The auditor may not use the work of a specialist in matters material to the fair presentation of the financial
statements.
c. The reasonableness of the specialist's assumptions and their applications are strictly the auditor's
responsibility.
d. The work of a specialist who has a contractual relationship with the client may be acceptable under
certain circumstances.

Choice "d" 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 specialist who has a relationship with a client may be
acceptable under certain circumstances. If the 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 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.

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 intangible assets.
c. Existence of fixed asset additions.
d. Valuation of related party transactions

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

Which of the following statements is correct concerning an auditor's use of the work of a specialist?
a. The work of a specialist who is related to the client may be acceptable under certain circumstances.
b. If an auditor believes that the determinations made by a specialist are unreasonable, only a qualified
opinion may be issued.
c. If there is a material difference between a specialist's findings and the assertions in the financial
statements, only an adverse opinion may be issued.
d. An auditor may not use a specialist in the determination of physical characteristics relating to inventories.

Choice "a" is correct. The work of a specialist who has a relationship with a client may be acceptable under
certain circumstances. If the specialist is related to the client, the auditor should consider performing
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.

In using the work of a specialist, an auditor of a non issuer may refer to the specialist in the auditor's report if,
as a result of the specialist's findings , the auditor:
a. Becomes aware of conditions causing substantial doubt about the entity's ability to continue as a going
concern.
b. Desires to disclose the specialist's findings , which imply that a more thorough audit was performed .
c. Is able to corroborate another specialist's earlier findings that were consistent with management's
representations .
d. Discovers significant deficiencies in the design of the entity's internal control that management does not
correct.

Choice "a" 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 unqualified 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 unqualified
opinion.

To obtain an understanding of a continuing client's business in planning an audit, an auditor most likely would:
a. Perform tests of details of transactions and balances.
b. Review prior-year audit documentation and the permanent file for the client.
c. Read specialized industry journals.
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.

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. Influence the design of internal control.
b. Affect the auditor's preliminary judgment about materiality levels.
c. Assist in evaluating the planned audit objectives.
d. Determine the auditor's acceptable level of audit

Choice "a" 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.

Which of the following statements is correct about the auditor's use of the work of a specialist?
a. The specialist should not have an understanding of the auditor's corroborative use of the specialist's
findings.
b. The auditor is required to perform substantive procedures to verify the specialist's assumptions and
findings.
c. The client should not have an understanding of the nature of the work to be performed by the specialist.
d. The auditor should obtain an understanding of the methods and assumptions used by the specialist.

Choice "d" 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.

In assessing the competence and objectivity of an entity's internal auditor, an independent auditor least likely
would consider information obtained from :
a. Discussions with management personnel.
b. External quality reviews of the internal auditor's activities.
c. Previous experience with the internal auditor.
d. The results of analytical procedures.

Choice "d" 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
the competence and objectivity of an entity's internal auditor.

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. Results are consistent with the conclusions to be presented in the auditor's report.
c. Audit procedures performed are approved in the professional standards.
d. Audit has been performed by persons having adequate technical training and proficiency as auditors.

Choice "b" 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.

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.

When assessing an internal auditor's competence, a CPA ordinarily obtains information about all of the
following , except:
a. Quality of audit documentation.
b. Educational level and professional experience.
c. The audit plan and audit procedures.
d. Access to information about related parties.

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

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. Apply the planned substantive tests prior to the balance sheet date.
b. Perform the planned auditing procedures closer to the balance sheet date.
c. Increase the assessed level of control risk for relevant financial statement assertions.
d. Decrease the extent of auditing procedures to be applied to the class of transactions.

Choice "b" 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.

In designing a written audit plan, an auditor should establish specific audit objectives that relate primarily to
the:
a. Timing of audit procedures.
b. Cost-benefit of gathering evidence.
c. Selected audit techniques.
d. Financial statement assertions.

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

Which of the following is not a type of financial statement assertion?
a. Rights and obligations.
b. Fairness and accuracy.
c. Valuation and allocation.
d. Understandability and classification.

Choice "b" is correct. "Fairness and accuracy" is not a type of financial statement assertion.
Choices "a", "c", and "d" are incorrect. The assertions include:
Rights and obligations
Valuation and allocation
Understandability and classification

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 allow the auditor to more accurately perform tests of controls.
d. To decide whether it will be necessary to perform analytical procedures.

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.

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. Eliminates the use of certain statistical sampling methods that would otherwise be available.
b. Presumes that the auditor will reperform the tests as of the balance sheet date.
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.

An auditor intends to use the work of an actuary who has a relationship with the client. Under these
circumstances, the auditor:
a. Is required to disclose the contractual relationship in the auditor's report.
b. Should assess the risk that the actuary's objectivity might be impaired.
c. Is not permitted to rely on the actuary because of a lack of independence.
d. Should communicate this matter to those charged with governance as a significant deficiency in internal
control.

Choice "b" is correct. While a specialist who is unrelated to the client will provide the auditor with greater
assurance of reliability, a specialist who is related to the client may be acceptable in certain circumstances. In
such situations, the auditor would likely perform additional procedures to verify objectivity.

Before applying principal substantive tests to an entity's accounts receivable at an interim date, an auditor
should:
a. Consider the likelihood of assessing the risk of incorrect rejection too low.
b. Project sampling risk at the maximum for tests covering the remaining period .
c. Ascertain that accounts receivable are immaterial to the financial statements.
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.

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. Specialist's findings support the related assertions in the financial statements.
c. Auditor modifies the report because of the difference between the client's and the specialist's valuations
of an asset.
d. Specialist's findings provide the auditor with greater assurance of reliability about management's
representations

Choice "c" 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 unqualified opinion.

Which of the following factors most likely would assist an independent auditor in assessing the objectivity of
the internal auditor?
a. The organizational status of the director of internal audit.
b. The professional certifications of the internal audit staff.
c. The consistency of the internal audit reports with the results of work performed.
d. The appropriateness of internal audit conclusions in the circumstances.

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

In assessing the competence of internal auditors, an independent CPA most likely would obtain information
about the:
a. Influence of management on the scope of the internal auditors' duties.
b. Policies limiting internal auditors from communicating with the audit committee.
c. Quality of the internal auditors' working paper documentation .
d. Entity's ability to continue as a going concern for a reasonable period of time.

Choice "c" is correct. Competence is reflected by education, professional certification, experience,
performance evaluations, the audit plan, audit procedures, and the quality of audit documentation.

An auditor assesses control risk because it:
a. Is relevant to the auditor's understanding of the control environment.
b. Provides assurance that the auditor's materiality levels are appropriate.
c. Indicates to the auditor where inherent risk may be the greatest.
d. Affects the level of detection risk that the auditor may accept.

Choice "d" is correct. The auditor uses the assessed level of control risk (together with the assessed level of
inherent risk) to determine the assessed risk of material misstatement, which in turn affects the acceptable
level of detection risk for financial statement assertions.

the acceptable level of detection risk decreases, an auditor may:
a. Reduce substantive testing by relying on the assessments of inherent risk and control risk.
b. Postpone the planned timing of substantive tests from interim dates to the year-end.
c. Eliminate the assessed level of inherent risk from consideration as a planning factor.
d. Lower the assessed level of control risk

Choice "b" is correct. As the acceptable level of detection risk decreases, the assurance provided from
substantive tests should increase. Consequently, the auditor should do one or more of the following : 1)
change the nature of substantive tests from a less effective to a more effective procedure, 2) change the
timing of the substantive tests, such as performing them at year-end rather than at an interim date, or 3)
change the extent of substantive tests, such as using a larger sample size.

Control risk should be assessed in terms of:
a. Specific controls.
b. Types of potential irregularities.
c. Financial statement assertions.
d. Control environment factors .

Choice "c" is correct. The auditor identifies internal controls relevant to specific financial statement
assertions, and then performs tests of controls to evaluate their effectiveness in preventing material
misstatements in those assertions. Control risk should be assessed in terms of financial statement
assertions.

Which of the following may be assessed in non quantitative terms?
1. control risk
2. detection risk
3. inherent risk

Choice "c" is correct. Both the risk of material misstatement (including control risk and inherent risk) and
detection risk may be assessed in quantitative terms such as percentages or in nonquantitative terms that
range , for example, from a minimum to a maximum.

Inherent risk and control risk differ from detection risk in that they:
a. Arise from the misapplication of auditing procedures.
b. May be assessed in either quantitative or nonquantitative terms.
c. Exist independently of the financial statement audit.
d. Can be changed at the auditor's discretion.

Choice "c" is correct. Inherent risk and control risk differ from detection risk in that they exist independently of
the audit of financial statements, whereas detection risk is related to the auditor's procedures and can be
changed at the auditor's sole discretion.

On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed risk of
material misstatement from that originally planned. To achieve an overall audit risk level that is substantially
the same as the planned audit risk level , the auditor would:
a. Decrease substantive testing .
b. Decrease detection risk.
c. Increase inherent risk.
d. Increase materiality levels.

Choice "b" is correct. Detection risk is inversely related to the risk of material misstatement. Therefore, an
increase in the risk of material misstatement would cause a decrease in allowable detection risk.

The acceptable level of detection risk is inversely related to the:
a. Assurance provided by substantive tests.
b. Risk of misapplying auditing procedures.
c. Preliminary judgment about materiality levels.
d. Risk of failing to discover material misstatements.

Choice "a" is correct. The acceptable level of detection risk is inversely related to the assurance provided by
substantive tests. For example, if the acceptable level of detection risk decreases, more assurance is
required from substantive tests.

Regardless of the assessed level of control risk, an auditor would perform some:
a. Tests of controls to determine the effectiveness of internal control.
b. Analytical procedures to verify the design of internal control.
c. Substantive tests to restrict detection risk for significant transaction classes.
d. Dual purpose tests to evaluate both the risk of monetary misstatement and preliminary control risk.

Choice "c" is correct. Regardless of the assessed level of control risk, an auditor would perform some level of
substantive tests to restrict detection risk for significant transaction classes. Even with the lowest possible
assessed level of control risk, substantive testing cannot be entirely eliminated for significant transaction
classes or balances.

When an auditor increases the assessed level of control risk because certain control activities were
determined to be ineffective, the auditor would most likely increase the:
a. Extent of tests of controls.
b. Level of detection risk.
c. Extent of tests of details.
d. Level of inherent risk.

Choice "c" is correct. As the assessed level of control risk increases, the acceptable level of detection risk for
financial statement assertions decreases. To attain a decreased level of detection risk, greater assurance is
needed from substantive tests. Increasing the extent of tests will provide greater assurance.

An auditor uses the assessed level of control risk to:
a. Evaluate the effectiveness of the entity's internal control.
b. Identify transactions and account balances where inherent risk is at the maximum.
c. Indicate whether materiality thresholds for planning and evaluation purposes are sufficiently high.
d. Determine the acceptable level of detection risk for financial statement assertions.

Choice "d" is correct. An auditor uses the assessed level of control risk to determine the risk of material
misstatement, which in turn determines the acceptable level of detection risk for financial statement
assertions. Detection risk should bear an inverse relationship to control risk. For example, the less control
risk an auditor believes exists, the greater the level of detection risk he or she can accept.

As the acceptable level of detection risk decreases, the assurance directly provided from :
a. Substantive tests should increase.
b. Substantive tests should decrease.
c. Tests of controls should increase.
d. Tests of controls should decrease.

Choice "a" is correct. As the acceptable level of detection risk (the risk that an auditor will not detect a
material misstatement that exists in an assertion) decreases, the assurance directly provided from substantive
tests should increase. The level of detection risk will decline as the benefit of direct tests increases.

On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed level of
control risk , and therefore the risk of material misstatement, from that originally planned. To achieve an
overall audit risk level that is substantially the same as the planned audit risk level, the auditor would:
a. Increase inherent risk.
b. Increase materiality levels.
c. Decrease substantive testing .
d. Decrease detection risk.

Choice "d" is correct. Decrease "detection risk." Overall audit risk is made up of the risk of material
misstatement and detection risk. The risk of material misstatement is itself comprised of two separate risks,
inherent risk and control risk. When the assessed level of control risk is increased , the risk of material
misstatement also increases, and detection risk must be decreased to achieve an overall audit risk level that
is substantially the same as the planned audit risk level.

In a financial statement audit, inherent risk is evaluated to help an auditor assess which of the following?
a. The internal audit department's objectivity in reporting a material misstatement of a financial statement
assertion it detects to the audit committee.
b. The risk that the internal control system will not detect a material misstatement of a financial statement
assertion.
c. The risk that the audit procedures implemented will not detect a material misstatement of a financial
statement assertion.
d. The susceptibility of a financial statement assertion to a material misstatement assuming there are no
related controls.

Choice "d" is correct. Inherent risk is the susceptibility of a relevant assertion to a material misstatement,
assuming there are no related controls.

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

Choice "a" is correct. An illegal payment of an otherwise immaterial amount could be material if there is a
reasonable possibility that it could lead to a material contingent liability or a material loss of revenue.

Which of the following is not an inquiry the auditor should make to identify the risks of material misstatement
due to fraud?
a. How management communicates to employees its views on acceptable business practices.
b. Whether operating personnel have communicated to management regarding internal control and how it
functions to prevent, deter, or detect material misstatement due to fraud .
c. Whether there are any particular business segments for which a risk of fraud may be more likely to exist.
d. Whether management is aware of any allegations of fraud

Choice "b" is correct. The auditor should inquire whether management (not operating personnel) has
communicated to those charged with governance (not management) regarding internal control and how it
functions to prevent, deter, or detect material misstatement due to fraud .

Which of the following procedures would an auditor most likely perform during an audit engagement's overall
review stage in formulating an opinion on an entity's financial statements?
a. Obtain assurance from the entity's attorney that all material litigation has been disclosed in the financial
statements.
b. Verify the clerical accuracy of the entity's proof of cash and its bank cutoff statement.
c. Determine whether inadequate provisions for the safeguarding of assets have been corrected.
d. Consider whether the results of audit procedures affect the assessment of the risk of material
misstatement due to fraud .

Choice "d" is correct. During every stage of the audit, the auditor should consider the assessment of the risk
of material misstatement. During the overall review stage, the auditor should consider whether the results of
any of the audit procedures affect the assessment of the risk of material misstatement due to fraud.

Which of the following circumstances most likely would cause an auditor to consider whether material
misstatements exist in an entity's financial statements?
a. Management places little emphasis on meeting earnings projections.
b. The board of directors makes all major financing decisions.
c. Significant deficiencies in internal control previously communicated to management are not corrected.
d. Transactions selected for testing are not supported by proper documentation.

Choice "d" is correct. Vouching recorded transactions to supporting documentation provides support for the
occurrence assertion. The lack of supporting documentation calls into question the occurrence of the
transactions under examination.

What assurance can an auditor give a client concerning
1. "direct effect illegal acts"
2. "Indirect effect illegal acts"

1. limited
2. none
Choice "a" is correct. The auditor should design the audit to provide reasonable assurance that direct effect
illegal acts are detected. Because of the nature of illegalities having an indirect effect on the financial
statements, the auditor provides no assurance that such acts will be detected.

Which of the following procedures would least likely result in the discovery of possible illegal acts?
a. Reading the minutes of the board of directors' meetings.
b. Making inquiries of the client's management.
c. Performing tests of details of transactions.
d. Reviewing an internal control questionnaire.

Choice "d" is correct. Reviewing an internal control questionnaire provides information about control policies
and procedures, but does not provide information about actual transactions or events that have occurred.
Therefore, it is not likely to uncover any illegal acts.

Which of the following situations represents a risk factor that relates to misstatements arising from
misappropriation of assets?
a. A high turnover of senior management.
b. A lack of independent checks.
c. A strained relationship between management and the predecessor auditor.
d. An inability to generate cash flow from operations.

Choice "b" is correct. A lack of independent checks is a fraud risk factor that provides an opportunity for
misappropriation of assets.

When performing a substantive test of a random sample of cash disbursements, an auditor is supplied with a
photocopy of vendor invoices supporting the disbursements for one particular vendor rather than the original
invoices. The auditor is told that the vendor's original invoices have been misplaced. What should the auditor
do in response to this situation?
a. Increase randomly the number of items in the substantive test to increase the reliance that may be placed
on the overall test.
b. Reevaluate the risk of fraud , and design alternate tests for the related transactions.
c. Increase testing by agreeing more of the payments to this particular vendor to the photocopies of its
. .
inVOices.
d. Count the missing original documents as misstatements, and project the total amount of the error based
on the size of the population and the dollar amount of the errors.

Choice "b" is correct. The auditor should reevaluate the risk of fraud and design alternate tests for the related
transactions as the evidence (photocopy of vendor invoices) is not reliable.

Of the following non-financial information, what would an auditor most likely consider in performing analytical
procedures during the planning phase of an audit?
a. Turnover of personnel in the accounting department.
b. Objectivity of audit committee members.
c. Square footage of selling space.
d. Management's plans to repurchase stock.

Choice "c" is correct. When performing analytical procedures, the auditor considers relevant nonfinancial
information , which generally is related to financial data in some way. For example, a relationship might exist
between the square footage of selling space and the level of sales.

When performing analytical procedures in the planning stage, the auditor most likely would develop
expectations by reviewing which of the following sources of information?
a. Unaudited information from internal quarterly reports.
b. Various account assertions in the planning memorandum.
c. Comments in the prior-year's management letter.
d. The control risk assessment relating to specific financial assertions.

Choice "a" is correct. Analytical procedures involve comparison of recorded amounts to independent
expectations developed by the auditor. During the planning stage, analytical procedures generally use
financial data, such as unaudited information from internal quarterly reports.

Analytical procedures used in the planning phase of an audit should focus on:
a. Documenting the risk factors relating to the susceptibility of assets to misappropriation.
b. Identifying the internal control activities that could reduce the assessed level of control risk.
c. Discovering uncorrected misstatements that should be communicated to the audit committee.
d. Enhancing the auditor's understanding of the transactions and events that have occurred since the last
audit.

Choice "d" is correct. Analytical procedures used in the planning phase of an audit should focus on
enhancing the auditor's understanding of the transactions and events that have occurred since the last audit.

An auditor is required to document the auditor's understanding of the:
I. Entity's control activities that help ensure management directives are carried out.
II. Entity's control environment factors that help the auditor plan the engagement.

Choice "c" is correct. The auditor should document key elements of the understanding of the entity and its
environment, including each of the five components of internal control. The five components include the
entity's control activities and the entity's control environment.

Which of the following procedures most likely would provide an auditor with evidence about whether an
entity's internal control activities are suitably designed to prevent or detect material misstatements?
a. Reperforming the activities for a sample of transactions.
b. Performing analytical procedures using data aggregated at a high level.
c. Vouching a sample of transactions directly related to the activities.
d. Observing the entity's personnel applying the activities.

Choice "d" is correct. Observation and inspection may be used to evaluate the design of controls.
Observation of entity personnel applying control activities is a procedure that would likely provide evidence
about the design of the activities.

In planning an audit, the auditor's knowledge about the design of relevant internal controls should be used to:
a. Identify the types of potential misstatements that could occur.
b. Assess the operational efficiency of internal control.
c. Determine whether controls have been circumvented by collusion.
d. Document the assessed level of control risk.

Choice "a" is correct. Knowledge about the design and implementation of relevant internal controls should be
used to identify types of misstatements that could occur.

Which of the following types of evidence would an auditor most likely examine to determine whether internal
controls are operating as designed?
a. Gross margin information regarding the client's industry.
b. Confirmations of receivables verifying account balances.
c. Client records documenting the use of EDP programs.
d. Anticipated results documented in budgets or forecasts.

Choice "c" is correct. Client records documenting the use of EDP programs would be a relevant item for an
auditor to examine while determining if internal control is operating as designed.

Proper segregation of duties reduces the opportunities to allow persons to be in positions to both:
a. Journalize entries and prepare financial statements.
b. Record cash receipts and cash disbursements.
c. Establish internal controls and authorize transactions.
d. Perpetrate and conceal errors and fraud .

Choice "d" is correct. Segregation of duties reduces the opportunity to allow any person to be in a position to
both perpetrate and conceal errors and fraud in the normal course of duties.

In an audit of financial statements, an auditor's primary consideration regarding internal control is whether the
control:
a. Reflects management's philosophy and operating style.
b. Affects management's financial statement assertions.
c. Provides adequate safeguards over access to assets.
d. Enhances management's decision-making processes.

Choice "b" is correct. Assessing control risk is the process of evaluating the effectiveness of an entity's
internal control in preventing or detecting material misstatements in the financial statements.

Which of the following are considered control environment factors?
1. detection risk
2. Human resource policies and practices

1. no
2. yes
The control environment represents the collective effect of various factors on
establishing, enhancing, or mitigating the effectiveness of specific policies and procedures. Such factors
include management's philosophy and operating style, the entity's organizational structure, the participation of
those charged with governance, methods of assigning authority and responsibility, and human resource
policies and practices.

An auditor should obtain sufficient knowledge of an entity's information system relevant to financial reporting
to understand the:
a. Safeguards used to limit access to computer facilities.
b. Process used to prepare significant accounting estimates.
c. Procedures used to assure proper authorization of transactions.
d. Policies used to detect the concealment of fraud.

Choice "b" is correct. The auditor should obtain sufficient knowledge of the client's information system
relevant to financial reporting to understand the types of transactions processed, and how the transactions
are initiated , recorded and summarized. Included in the information system relevant to financial reporting is
the preparation of significant accounting estimates.

primary internal control planning objectives of an
auditor in a financial statement audit:

a. Identify types of potential material misstatements.
b. Consider factors that affect the risk of material misstatements.
d. Design effective substantive tests.

An auditor should obtain sufficient knowledge of an entity's information system relevant to financial reporting
to understand the:
a. Safeguards used to limit access to computer facilities.
b. Process used to prepare significant accounting estimates.
c. Procedures used to assure proper authorization of transactions.
d. Policies used to detect the concealment of irregularities.

Choice "b" is correct. An auditor is responsible for evaluating the reasonableness of significant accounting
estimates made by management. An entity's information system may affect the quality of such estimates and
therefore should be considered by the auditor.

Which of the following components (elements) of an entity's internal control includes the development of
personnel manuals documenting employee promotion and training policies?
a. Monitoring.
b. Control environment.
c. Information and communication system.
d. Quality control system.

Choice "b" is correct. The control environment element of an entity's internal control relates to the tone of the
organization, which includes human resource policies and practices.

In obtaining an understanding of an entity's internal control, an auditor is required to obtain knowledge about
the:
1. Operating effectiveness of
controls
2. Design of controls

Choice "b" is correct. No - Yes. In obtaining an understanding of an entity's internal control, an auditor is
required to obtain knowledge about the design of controls and whether they have been implemented. The
auditor is not required to obtain knowledge about the "operating effectiveness of controls" as part of obtaining
an understanding of internal control.

Which of the following controls is least likely to be relevant to a financial statement audit?
a. Procedures that prevent the excess use of materials in production.
b. Policies that relate to compliance with income tax regulations.
c. Use of computer passwords to limit access to data files.
d. Generation of production statistics used to evaluate variances.

Choice "a" is correct. Procedures to reduce inefficiency on the production line relate to operational objectives,
and not necessarily to financial reporting objectives.

In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an
auditor most likely would:
a. Review the entity's descriptions of inventory controls.
b. Perform test counts of inventory during the entity's physical count.
c. Analyze inventory turnover statistics to identify slow-moving and obsolete items.
d. Analyze monthly production reports to identify variances and unusual transactions.

Choice "a" is correct. In obtaining an understanding of a manufacturing entity's internal control concerning
inventory balances, an auditor would most likely review the entity's descriptions of inventory controls.

Which of the following services performed by another entity would not be considered to be part of the client's
information system?
a. Processing of the client's accounting transactions by an electronic data processing service center.
b. Preparation of the client's financial statements by an outside accounting organization.
c. Initiation of the client's weekly payroll transactions by a payroll processing organization.
d. Sale (specifically authorized by the client) of investment securities by an external broker.

Choice "d" is correct. Services performed by another organization are not considered to be part of the client's
information system if the services provided are limited to executing transactions that are specifically
authorized by the client.

An auditor is auditing a mutual fund company that uses a transfer agent to handle accounting for
shareholders. Which of the following actions by the auditor would be most efficient for obtaining information
about the transfer agent's internal controls?
a. Review reports on internal control placed in operation and its operating effectiveness produced by the
agent's own auditor.
b. Review prior-year workpapers to determine whether the number of transactions processed by the agent
has materially increased.
c. Perform an audit on the internal control function of the agent.
d. Perform tests of controls on a sample of the audited firm's transactions through the agent.

Choice "a" is correct. Reports on internal control placed in operation and its operating effectiveness produced
by the agent's own auditor would be an efficient means of obtaining information about the transfer agent's
internal controls.

Which of the following factors is most likely to affect the extent of the documentation of the auditor's
understanding of a client's system of internal controls?
a. The industry and the business and regulatory environments in which the client operates.
b. The degree to which information technology is used in the accounting function .
c. The relationship between management, the board of directors, and external stakeholders.
d. The degree to which the auditor intends to use internal audit personnel to perform substantive tests.

Choice "b" is correct. The more complex the IT system, the more extensive the documentation (such as
flowcharts , narratives, questionnaires, decision tables, etc.). The less complex the IT system, more limited
documentation , such as a memorandum, may be sufficient.

Which of the following statements is correct concerning an auditor's assessment of control risk?
a. Assessing control risk may be performed concurrently during an audit with obtaining an understanding of
the entity's internal control.
b. Evidence about the operation of controls in prior audits may not be considered during the current year's
assessment of control risk.
c. The basis for an auditor's conclusions about the assessed level of control risk need not be documented
unless the auditor's risk assessment is based on the effective operation of controls.
d. The lower the assessed level of control risk, the less assurance the evidence must provide that the
controls are operating effectively.

Choice "a" is correct. Some risk assessment procedures performed to obtain an understanding of internal
control may provide evidence about operating effectiveness, even if they were not intended for that purpose.
This is possible because the procedures performed to achieve one objective may also provide evidence
regarding the other.

When the auditor's risk assessment is based on the effective operation of controls, the audit will most likely
involve:
a. Performing more extensive substantive tests with larger sample sizes than originally planned.
b. Reducing inherent risk for most of the assertions relevant to significant account balances.
c. Changing the timing of substantive tests by omitting interim-date testing and performing the tests at yearend.
d. Identifying specific internal controls relevant to specific assertions.

Choice "d" is correct. When the auditor's risk assessment is based on the effective functioning of internal
control, the auditor should identify specific internal controls relevant to specific assertions that are likely to
prevent or detect material misstatements in those assertions.

To obtain audit evidence about control risk, an auditor selects tests from a variety of techniques including:
a. Inquiry.
b. Analytical procedures.
c. Calculation.
d. Confirmation.

Choice "a" is correct. Tests of controls include such procedures as inspecting documentation, inquiry,
observation, and reperformance .

If an auditor's risk assessment is based on the effective operation of controls, the auditor will likely:
a. Apply analytical procedures to both financial data and nonfinancial information to detect conditions that
may indicate weak controls.
b. Perform tests of details of transactions and account balances to identify potential errors and fraud.
c. Identify specific internal controls that are likely to detect or prevent material misstatements.
d. Document that the additional audit effort to perform tests of controls exceeds the potential reduction in
substantive testing.

Choice "c" is correct. Assessing risk based on the effective operation of controls involves (1) identifying
specific internal controls relevant to specific assertions that are likely to prevent or detect material
misstatements in those assertions, and (2) performing tests of such controls to evaluate their effectiveness.

The objective of tests of details of transactions performed as tests of controls is to:
a. Monitor the design and use of entity documents such as prenumbered shipping form s.
b. Determine whether internal controls have been implemented.
c. Detect material misstatements in the account balances of the financial statements.
d. Evaluate whether internal controls operated effectively.

Choice "d" is correct. The objective of tests of details used as tests of controls is to evaluate whether an
internal control operated effectively.

An auditor wishes to perform tests of controls on a client's cash disbursements procedures. If the controls
leave no audit trail of documentary evidence, the auditor most likely will test the procedures by:
a. Confirmation and observation.
b. Observation and inquiry.
c. Analytical procedures and confirmation.
d. Inquiry and analytical procedures.

Choice "b" is correct. For internal controls which leave no audit trail of documentary evidence (e.g.,
segregation of duties), the auditor must use inquiry and observation to test the procedures.

Which of the following statements about performing tests of controls to support a lower level of control risk is
not true?
a. Observation by the auditor provides more assurance than inquiry alone.
b. Inquiry alone generally will support a conclusion for a lower assessed level of control risk.
c. Prior audits may be considered by the auditor in assessing control risk in the current audit.
d. An audit of financial statements is a cumulative process.

Choice "b" is correct. Inquiry alone generally will not support a conclusion for a lower assessed level of
control risk.
Choices "a", "c", and "d" are incorrect, as the following are true:
a. Observation by the auditor provides more assurance than audit evidence obtained by inquiry alone.
c. Prior audits may be considered by the auditor in assessing control risk in the current audit.
d. An audit of financial statements is a cumulative process.

Which of the following audit techniques most likely would provide an auditor with the most assurance about
the effectiveness of the operation of internal control?
a. Inquiry of client personnel.
b. Recomputation of account balance amounts.
c. Observation of client personnel.
d. Confirmation with outside parties.

Choice "c" is correct. Observation of client personnel provides an auditor with the most assurance about the
effectiveness of the operation of an internal control.

To obtain audit evidence about control risk, an auditor ordinarily selects tests from a variety of techniques,
including:
a. Analysis.
b. Confirmation.
c. Reperformance.
d. Comparison.

Choice "c" is correct. Reperforming the application of relevant controls provides evidence regarding their
operating effectiveness.

Audit evidence concerning proper segregation of duties ordinarily is best obtained by:
a. Preparation of a flowchart of duties performed by available personnel.
b. Inquiring whether control activities operated consistently throughout the period.
c. Reviewing job descriptions prepared by the personnel department.
d. Direct personal observation of the employees who apply control activities.

Choice "d" is correct. Audit evidence concerning proper segregation of duties ordinarily is best obtained by
direct personal observation of the employees who apply control activities, especially if the control activities do
not leave an audit trail.

An auditor may decide not to test controls related to certain assertions because the auditor believes:
a. Sufficient appropriate evidence to support the assertions is likely to be available.
b. Evaluating the effectiveness of controls is inefficient.
c. More emphasis on tests of controls than substantive tests is warranted.
d. Considering the relationship of assertions to specific account balances is more efficient.

Choice "b" is correct. An auditor may decide to assess control risk at the maximum level for certain
assertions because the auditor believes evaluating the effectiveness of controls is inefficient (i.e., it would be
more efficient to test the assertions substantively).

After performing risk assessment procedures, an auditor decided not to perform tests of controls. The auditor
most likely decided that:
a. The available evidence obtained through tests of controls would not support an increased level of control
risk.
b. A reduction in the assessed level of control risk is justified for certain financial statement assertions.
c. It would be inefficient to perform tests of controls that would result in a reduction in planned substantive
tests.
d. The assessed level of inherent risk exceeded the assessed level of control risk.

Choice "c" is correct. After performing risk assessment procedures, an auditor might decide not to perform
tests of controls because it would be inefficient. In other words, the time required to perform tests of controls
would be greater than the reduction in time spent on substantive testing.

As part of understanding internal control, an auditor is not required to:
a. Consider factors that affect the risk of material misstatement.
b. Ascertain whether internal controls have been implemented.
c. Identify the types of potential misstatements that can occur.
d. Obtain knowledge about the operating effectiveness of internal control.

Choice "d" is correct. As part of understanding internal control, an auditor is not required to obtain knowledge
about the operating effectiveness of controls. Operating effectiveness is evaluated later, and only for those
controls on which the auditor plans to rely.

After obtaining an understanding of internal control and performing risk assessment procedures, an auditor
decided not to perform tests of controls. The auditor most likely concluded that the:
a. Additional evidence to support a reduction in control risk was not cost-beneficial to obtain.
b. Assessed level of inherent risk exceeded the assessed level of control risk.
c. Internal control was properly designed and justifiably may be relied on.
d. Evidence obtainable through tests of controls would not support an increased level of control ris

Choice "a" is correct. When an auditor decides not to perform tests of controls, the auditor most likely
concluded that the additional evidence to support a reduction in control risk was not cost-beneficial to obtain.
In other words, the additional costs that would be incurred to support a lower assessed level of control risk
would not be offset by the anticipated cost savings resulting from a lower level of substantive tests.

Which of the following is not part of obtaining an understanding of internal control?
a. Considering the types of misstatements that may occur in an entity's financial statements.
b. Determining whether internal controls are operating effectively.
c. Considering knowledge obtained from previous audits.
d. Determining the extent to which internal controls are computerized.

Choice "b" is correct. The auditor is not required to obtain knowledge about operating effectiveness as part of
the understanding of internal control. This knowledge is obtained later, for specific controls on which the
auditor plans to rely.

During the planning phase of the audit, the auditor obtains an
understanding of the internal control system by considering:

• The types of misstatements that may occur.
• The risk that misstatements may occur.
• Factors that influence the design of tests of controls and substantive tests.
• The assessment of inherent risk.
• Judgments about materiality.
• The complexity and sophistication of the entity's operations and systems.
• The use of manual vs. computerized control procedures.
Such knowledge may be obtained by appropriate inquiry, inspection, or observation. Knowledge may also be
obtained based on previous experience with the client and/or an understanding of the industry in which the
entity operates.

Which of the following audit techniques ordinarily would provide an auditor with the least assurance about the
operating effectiveness of an internal control activity?
a. Inquiry of client personnel.
b. Inspection of documents and reports.
c. Observation of client personnel.
d. Preparation of system flowcharts .

Choice "d" is correct. Preparation of system flowcharts may aid in the auditor's understanding of internal
control, but would not indicate whether controls were actually operating as designed.

In an environment that is highly automated, an auditor determines that it is not possible to reduce detection
risk solely by substantive tests of transactions. Under these circumstances, the auditor most likely would:
a. Perform tests of controls to support a lower level of assessed control risk.
b. Increase the sample size to reduce sampling risk and detection risk.
c. Adjust the materiality level and consider the effect on inherent risk.
d. Apply analytical procedures and consider the effect on control risk.

Choice "a" is correct. When an entity transmits, processes, maintains, or accesses significant information
electronically, factors unique to electronic processing may make it impractical or impossible to reduce
detection risk to an acceptable level through substantive testing alone. In such cases, tests of controls should
be performed .

Which of the following factors would least likely affect the extent of the auditor's consideration of the client's
internal controls?
a. The amount of time budgeted to complete the engagement.
b. How frequently the control is performed .
c. The expected deviation rate from the control.
d. The extent to which other tests provide evidence about the same assertion.

Choice "a" is correct. The extent of the auditor's consideration of the client's internal controls is affected by a
variety of factors , with the primary goal being to obtain a sufficient understanding the entity and its
environment, including its internal control. The amount of time budgeted to complete the audit should not be
a primary factor in determining the extent of consideration of the client's internal controls--if more time is
needed to adequately consider internal control, then the budget should be revised .

In which of the following circumstances is substantive testing of accounts receivable before the balance sheet
date most appropriate?
a. The client has a new sales incentive program in place.
b. Internal controls during the remaining period are effective.
c. There is a high turnover of senior management.
d. It is a first engagement of a new client.

Choice "b" is correct. The higher the auditor's risk assessment, the closer to period end substantive
procedures should be performed. Conversely, effective controls reduce control risk and reduce the risk of
material misstatement, allowing more interim testing to occur.

What is the most likely course of action that an auditor would take after determining that performing
substantive tests on inventory will take less time than performing tests of controls?
a. Assess control risk at a low level.
b.
c.
d.
Perform both tests of controls and substantive tests on inventory.
Perform only substantive tests on inventory.
Perform only tests of controls on inventory.

Choice "c" is correct. If it would take less time to perform substantive tests than it would to perform tests of
controls, and if there is no other reason to test controls (i.e. , if there is not a high degree of electronic
processing), the auditor would not be likely to test controls.

Which of the following is always necessary in a financial statement audit?
I. Tests of the operating effectiveness of controls.
II. Analytical procedures.
III. Risk assessment procedures.

II and III.
Choice "d" is correct. Risk assessment procedures must be performed to assess the risk of material
misstatement and to determine whether and to what extent further audit procedures are necessary. In
addition , the planning process and the overall review stage of the audit must include application of analytical
procedures. Tests of the operating effectiveness of controls, however, are only performed when the auditor's
risk assessment is based on the assumption that controls are operating effectively, or when substantive
procedures alone are insufficient.

Which of the following could be difficult to determine because electronic evidence may not be retrievable after
a specific period?
a. The acceptance level of detection risk.
b. The timing of control and substantive tests.
c. Whether to adopt substantive or reliance test strategies.
d. The assessed level of inherent risk.

Choice "b" is correct. When electronic data is not maintained indefinitely, the auditor must be careful to
consider the appropriate timing for audit tests, making sure that testing is performed while data is still
available.

An audit client failed to maintain copies of its procedures manuals and organizational flowcharts . What
should the auditor do in an audit of financial statements?
a. Issue a qualified opinion on the basis of a scope limitation.
b. Document the auditor's understanding of internal controls.
c. Assess control risk at the maximum level.
d. Restrict the auditor's responsibility to assess the effectiveness of controls in the audit engagement letter.

Choice "b" is correct. Although it is helpful when the auditor can review client procedures manuals and
organizational flowcharts , not having this documentation simply means that the auditor will need to put forth
more effort to obtain an understanding of internal control. As is always the case, the auditor should document
his or her understanding of internal control.

When an auditor increases the planned assessed level of control risk because certain control activities were
determined to be ineffective, the auditor would most likely increase the:
a. Extent of tests of details.
b. Level of inherent risk.
c. Extent of tests of controls.
d. Level of detection risk.

Choice "a" is correct. When an auditor increases the planned assessed level of control risk because certain
control activities were determined to be ineffective, detection risk must be reduced accordingly. This may be
accomplished by increasing the extent of tests of details.

Control environment factors include:

1. Communication and enforcement of integrity and ethical values.
2. Commitment to competence.
3. Participation of those charged with governance.
4. Management's philosophy and operating style.
5. Organizational structure.
6. Assignment of authority, responsibility, and accountability.
7. Human resource policies and practices.

The accountant may have a duty to disclose irregularities to all of the following outside
parties:

Yes - The SEC when the client reports an auditor change.
Yes - A successor auditor when the successor makes appropriate inquiries.
Yes - A government funding agency from which the client receives financial assistance

An auditor of a manufacturer would most likely question whether that client has committed illegal acts if the
client has:
a. Been forced to discontinue operations in a foreign country.
b. Been an annual donor to a local political candidate.
c. Failed to correct material weaknesses in internal accounting control that were reported after the prior
year's audit.
d. Disclosed several subsequent events involving foreign operations in the notes to the financial statements.

Choice "a" is correct. Being forced to discontinue operations in a foreign country would cause the auditor of
the manufacturer to question whether that client has committed an illegal act.

Information that may raise a question concerning possible illegal acts include unusually
large payments made to:

• Cash
• Bearer
• Purchase cashiers checks
• Transfer funds to numbered accounts

Which of the following is not a control environment factor?
a. Participation of those charged with governance.
b. Hiring and advancement policies.
c. Management's approach toward business risks.
d. Proper segregation of duties.

Choice "d" is correct. Policies and procedures involving segregation of duties are control activities, not control
environment factors.

Before applying principal substantive tests to the details of accounts at an interim date prior to the balance
sheet date, an auditor should:
a. Assess control risk at a low level for the assertions embodied in the accounts selected for interim testing .
b. Determine that the accounts selected for interim testing are not material to the financial statements taken
as a whole.
c. Consider whether the amounts of the year-end balances selected for interim testing are reasonably
predictable.
d. Obtain written representations from management that all financial records and related data will be made
available.

Choice "c" is correct. Before performing substantive tests at an interim date, an auditor should consider
whether the amounts of the year-end balances selected for interim testing are reasonably predictable with
respect to amount, relative significance and composition

Which of the following is not true with respect to the control activities of an entity?
a. Control activities are the policies and procedures that help ensure that management directives are carried
out.
b. Control activities are the policies and procedures that help ensure that the financial statements are fairly
presented in conformity with generally accepted accounting principles.
c. An understanding of control activities may be obtained while the auditor is obtaining an understanding of
the other components of internal control.
d. An understanding of control activities does not require an understanding of control activities related to
each account balance included in the financial statements.

Choice "b" is correct. Control activities are the policies and procedures that help ensure that management
directives are carried out. These policies and procedures may relate to any of the three objectives (financial
reporting, operations, and compliance), not strictly to the financial reporting objective.

Before applying substantive tests to the details of asset accounts at an interim date, an auditor should assess:
a. Control risk at a low level.
b. Inherent risk at a high level.
c. The difficulty in controlling the incremental audit risk.
d. Materiality for the accounts tested as insignificant.

Choice "c" is correct. Before performing substantive tests at an interim date, the auditor must assess the
difficulty in controlling the incremental audit risk from the interim date (on which the substantive procedures
are performed) to the year-end date (on which an opinion is rendered).

When assessing an internal auditor's objectivity, an independent auditor should:
a. Evaluate the adequacy of the internal auditor's audit plans.
b. Inquire about the internal auditor's educational background and professional certification.
c. Consider the organizational level to which the internal auditor reports.
d. Review the internal auditor's audit documentation.

Choice "c" is correct. When assessing an internal auditor's objectivity, an independent auditor should
consider the organizational level to which the internal auditor reports.

An auditor should obtain knowledge of a client's information and communication system in order to
understand each of the following , except:
a. How transactions are initiated , processed , and reported .
b. The process used to prepare financial statements.
c. The means used by an entity to communicate financial reporting roles to its staff.
d. The means used by an entity to ensure that management directives are carried out.

Choice "d" is correct. Control activities (not the information and communication system) are the policies and
procedures that help ensure that management directives are carried out.

The monitoring component of internal control excludes:
a. Assessing information derived from external parties.
b. Assessing the quality of internal control performance over time.
c. Improving controls that are not operating effectively.
d. Eliminating controls that are not operating effectively.

Choice "d" is correct. Monitoring is the process of assessing the quality of internal control performance over
time and taking necessary corrective actions. Eliminating a control that is not operating effectively would not
be an appropriate corrective action.

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. Influence the design of internal control.
b. Affect the auditor's preliminary judgment about materiality levels.
c. Assist in evaluating the planned audit objectives.
d. Determine the auditor's acceptable level of audit risk.

Choice "a" is correct. The auditor would consider the methods used to process accounting information in
planning an audit of a new client, because such methods influence the design of internal control. The auditor
is required to obtain an understanding of the design of internal control in order to plan the audit and determine
the nature, timing, and extent of tests to be performed.

Dunn, CPA, is auditing the financial statements of Taft Co. Taft uses Quick Service Center (QSC) to process
its payroll. Price, CPA, is expressing an opinion on a description of the controls placed in operation at QSC
regarding the processing of its customers' payroll transactions. Dunn expects to consider the effects of
Price's report on the Taft engagement. Price's report should contain a (an):
a. Description of the scope and nature of Price's procedures.
b. Statement that Dunn may assess control risk based on Price's report.
c. Assertion that Price assumes no responsibility to determine whether QSC's controls are suitably
designed.
d. Opinion on the operating effectiveness of QSC's internal controls.

Choice "a" is correct. Price, CPA (the "service auditor") should include in his or her report a description of the
scope and nature of the procedures performed.

Lake, CPA, is auditing the financial statements of Gill Co. Gill uses the EDP Service Center, Inc. to process
its payroll transactions. EDP's financial statements are audited by Cope, CPA, who recently issued a report
on EDP's internal control structure. Lake is considering Cope's report on EDP's internal control structure in
assessing control risk on the Gill engagement. What is Lake's responsibility concerning making reference to
Cope as a basis, in part, for Lake's own opinion?

The user auditor should not make reference to the report of the service auditor as a
basis, in part, for his or her own opinion on the user organization's financial statements. Since the service
auditor is not responsible for the examination of any part of the user organization's financial statements, a
division of responsibility would be inappropriate

A successor auditor should request the new client to authorize the predecessor auditor to allow a review of
the predecessor's:
1. engagement letter
2. audit documentation

It is not appropriate for the successor auditor to request a review of the predecessor
auditor's engagement letter. This is a business matter between the client and the predecessor auditor that
has no impact on the successor's audit. Conversely, review of the predecessor auditor's audit documentation
is appropriate and customary to facilitate the successor's audit.

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