Chapter 8 Auditing Theory

Chapter 8 Auditing Theory

Multiple-Choice Questions

1.
easy / Which of the following is not one of the three main reasons why the auditor should properly plan engagements?
a / a.To enable proper on-the-job training of employees.
b.To enable the auditor to obtain sufficient appropriate evidence.
c.To avoid misunderstandings with the client.
d.To help keep audit costs reasonable.
2. / Avoiding misunderstandings with the client is important for:
easy
a / Good client relations / Facilitating high-quality work at a reasonable cost
a.
b.
c.
d. / Yes
No
Yes
No / Yes
No
No
Yes
3.
easy / A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued is the:
b / a.inherent risk.
b.acceptable audit risk.
c.statistical risk.
d.financial risk.
4.
easy / A measure of the auditor’s assessment of the likelihood that there are material misstatements in an account before considering the effectiveness of the client’s internal control is called:
d / a.control risk.
b.acceptable audit risk.
c.statistical risk.
d.inherent risk.
5. / When inherent risk is high, there will need to be:
Easy
d / A lower assessment of audit risk / More evidence accumulated by the auditor
a.
b.
c.
d. / Yes
No
Yes
No / Yes
No
No
Yes
6. / The auditor is likely to accumulate more evidence when the audit is for a company:
easy
a / Which has large amounts of debt / Which is to be sold in the near future
a.
b.
c.
d. / Yes
No
Yes
No / Yes
No
No
Yes
7. / Which of the following is not typically included in initial audit planning?
easy / a.Client acceptance/continuation decisions.
d / b.Determination of the purpose of the audit.
c.Obtain an understanding with the client.
d.Perform analytical procedures as substantive tests.
8. / Initial audit planning involves four matters. Which of the following is not one of these?
easy / a.Develop an overall audit strategy.
b / b.Request that bank balances be confirmed.
c.Schedule engagement staff and audit specialists.
d.Identify the client’s reason for the audit.
9.
easy / Most auditors assess inherent risk as high for related parties and related-party transactions because:
b / a.of the unique classification of related-party transactions required on the balance sheet.
b.of the lack of independence between the parties.
c.of the unique classification of related-party transactions required on the income statement.
d.it is required by generally accepted accounting principles.
10.
easy / Which of the following is not correct regarding the communications between successor and predecessor auditors?
a / a.The burden of initiating the communication rests with the predecessor auditor.
b.The burden of initiating the communication rests with the successor auditor.
c.The predecessor auditor must receive their former client’s permission prior to divulging information to the successor auditor
d.The predecessor auditor may choose to provide a limited response to a successor auditor.
11. / A successor auditor may perform which of the following for a new audit client?
easy
a / Speak to local attorneys, banks and other businesses regarding the company’s reputation / Speak to the predecessor auditors about disagreements they had with management
a. / Yes / Yes
b. / No / No
c. / Yes / No
d. / No / Yes
12.
medium / Which of the following is not a potential effect of an auditor’s decision that a lower acceptable audit risk is appropriate?
b / a.More evidence is accumulated.
b.Less evidence is accumulated.
c.Special care is required in assigning experienced staff.
d.Review of audit documentation is performed by personnel not assigned to the engagement.
13.
medium / It is easier and more common to implement increased evidence accumulation for inherent risk than for acceptable audit risk because:
a / a.inherent risk can usually be isolated to specific accounts.
b.inherent risk applies to the entire audit.
c.acceptable audit risk and sample sizes are set statistically.
d.acceptable audit risk does not impact on the amount of evidence which must be accumulated.
14. (SOX)
medium / If an auditor is requested to perform nonaudit services for a public company audit client, who is responsible for agreeing to those services with the audit firm?
d / a.The client’s management.
b.The client’s chief executive officer.
c.The client’s chief financial officer.
d.The client’s audit committee.
15.
medium / Which of the following statements is true regarding communications between predecessor and successor auditors?
b / a.The burden of initiating the communication rests with the predecessor.
b.The predecessor’s response can be limited to stating that no information will be provided.
c.The predecessor should communicate with the successor only if the client is public.
d.There must be communication between the predecessor and successor if the successor is to accept the engagement.
16.
medium / Investigating new clients with a focus on assessing the auditor’s potential relationship with that new client is a critical element in determining:
b / a.inherent risk.
b.acceptable audit risk.
c.statistical risk.
d.financial risk.
17. / The purpose of an engagement letter is to:
medium
b / a.document the CPA firm’s responsibility to external users of the audited financial statements.
b.document the terms of the engagement in writing to minimize misunderstandings.
c.notify the audit staff of an upcoming engagement so that personnel scheduling can be facilitated.
d.emphasize management’s responsibility for approving the audit program.
18.
medium / One means of informing the client that the auditor is not responsible for the discovery of all acts of fraud is the:
a / a.engagement letter.
b.representation letter.
c.responsibility letter.
d.client letter.
19. / Which of the following normally signs the engagement letter for an audit of a public company?
medium / a.Corporate treasurer.
d / b.Chief financial officer.
c.Chairman of the board of directors.
d.Audit committee.
20. / Which of the following normally signs the engagement letter for an audit of a private company?
medium / a.Management.
a / b.Board of directors representative.
c.Audit committee representative.
d.Corporate treasurer.
21.
medium
d / An understanding of a client’s business and industry and knowledge about operations are essential for performing an adequate audit. For a new client, most of this information is obtained:
a.from the predecessor auditor.
b.from the Securities and Exchange Commission.
c.from the permanent file.
d.at the client’s premises.
22. / The least effective method of identifying related parties for a public company would be a(n):
medium / a.inquiry of management.
c / b.review of SEC filings.
c.distribution of the engagement letter to all stockholders.
d.examination of stockholders’ listings to identify principal stockholders.
23.
medium / An official record of meetings of the board of directors and stockholders is included in the corporate:
c / a.bylaws.
b.charter.
c.minutes.
d.license.
24. / Which of the following is not likely to be a related party?
medium / a.Affiliated companies.
c / b.A major stockholder of the company.
c.A warehouse employee.
d.The chief executive officer.
25. / Which of the following is most likely to occur at the beginning of an initial audit engagement?
medium / a.Prepare a rough draft of the financial statements and of the auditor’s report.
c / b.Study and evaluate the system of internal administrative control.
c.Determine the client’s reason for an audit.
d.Consult with and review the work of the predecessor auditor prior to discussing the engagement with the client management.
26. / An auditor should examine minutes of the board of directors’ meetings:
medium / a.through the date of the financial statements.
b / b.through the date of the audit report.
c.only at the beginning of the audit.
d.on a test basis.
27.
medium / The first standard of field work, which states that the work is to be adequately planned and that assistants, if any, are to be properly supervised, recognizes that:
a / a.early appointment of the auditor is advantageous to the auditor and the client.
b.acceptance of an audit engagement after the close of the client’s fiscal year is generally not permissible.
c.appointment of the auditor subsequent to the physical count of inventories requires a disclaimer of opinion.
d.performance of substantial parts of the examination is necessary at interim dates.
28.
medium / The corporate minutes are the official record of the meetings of the board of directors and stockholders. The minutes typically include authorizations related to:
d
The CPA’s use of outside specialists / Management compensation
a.
b.
c.
d. / Yes
No
Yes
No / Yes
No
No
Yes
29. / An engagement letter sent to an audit client usually would not include a(n):
medium / a.reference to the auditor’s responsibility for the detection of errors or irregularities.
c / b.estimation of the time to be spent on the audit work by audit staff and management.
c.statement that management advisory services would be made available upon request.
d.reference to management’s responsibility for the financial statements.
30. / Which of the following is correct with respect to a company’s corporate charter?
medium
c / a.The corporate charter is granted by the federal government and is required to recognize the corporation as a separate entity.
b.The corporate charter includes the rules and procedures used to operate a corporation.
c.The corporate charter includes the exact name of the corporation, the date of incorporation, and the types of business the corporation is authorized to conduct.
d.The corporate charter must be annually reviewed by the PCAOB.
31. / Corporate bylaws include:
Medium
d / The types and amounts of capital stock the corporation is authorized to issue / The rules and procedures used to operate the corporation
a.
b.
c.
d. / Yes
No
Yes
No / Yes
No
No
Yes
32.
medium
b / In what order should the following steps occur?
A. Assess client business risk
B. Understand the client’s business and industry
C. Perform preliminary analytical procedures
D. Assess acceptable audit risk
a.D, B, C, A.
b.B, A, D, C.
c.B, D, A, C.
d.D, C, B, A.
33. / Which of the following statements is not correct with respect to analytical procedures?
medium / a.Auditing standards emphasize the need for auditors to develop and use expectations.
b / b.Analytical procedures must be performed throughout the audit.
c.Analytical procedures may be performed at any time during the audit.
d.Analytical procedures use comparisons and relationships to assess whether account balances appear reasonable.
34. / The most widely used profitability ratio is the:
medium / a.quick ratio.
d / b.profit margin.
c.return on assets.
d.earnings per share.
35.
challenging / The purpose of the requirement in SAS No. 84 of having communication between the predecessor and successor auditor is to:
b / a.allow the predecessor to disclose information which would otherwise be confidential.
b.help the successor auditor to evaluate whether to accept the engagement.
c.help the client by facilitating the change of auditors.
d.ensure the predecessor collects all unpaid fees prior to a change in auditor.
36.
challenging / The predecessor auditor is required to respond to the request of the successor auditor for information, but the response can be limited to stating that no information will be provided when:
c / a.the predecessor auditor has poor relations with the successor auditor.
b.the client is dissatisfied with the predecessor’s work.
c.there are actual or potential legal problems between the client and the predecessor.
d.the predecessor believes that the client lacks integrity.
37. / Which of the following is correct with respect to the use of analytical procedures?
challenging
d / a.Analytical procedures may be used in evaluating balances in the testing phase as long as the auditor also uses them in assessing the going concern assumption.
b.Analytical procedures must be used throughout the audit.
c.Analytical procedures used in the testing phase of the audit are primarily used to direct an auditor’s attention so that the auditor’s understanding of the business is improved.
d.Analytical procedures are performed by studying plausible relationships between financial and nonfinancial data.
38.
challenging / Which of the following ratios is best used to assess a company’s ability to meet its long-term debt obligations?
c / a.Quick ratio.
b.Return on common equity.
c.Debt to equity.
d.Current ratio.
39. / Which of the following statements is not correct?
challenging
b / a.Analytical procedures used in the planning phase of the audit are primarily directed at understanding the client’s business and directing the auditor’s attention to areas that may contain possible misstatements.
b.Analytical procedures used in the completion phase are primarily aimed at assessing going concern and secondarily aimed at directing the auditor’s attention to areas that may contain possible misstatements.
c.Analytical procedures must be used in the planning and completion phases of the audit, and are optional in the testing phase.
d.Analytical procedures used in the completion phase are primarily aimed at directing the auditor’s attention to areas that may contain possible misstatements and secondarily aimed at assessing going concern.
40. / Which of the following would not likely be classified as a related-party transaction?
medium / a.An advance of one week’s salary to an employee.
a / b.Sales of merchandise between affiliated companies.
c.Loans or credit sales to the principal owner of the client company.
d.Exchanges of equipment between two companies owned by the same person.
41. / Which of the following would not be found in the corporate charter?
challenging / a.The kinds and amount of capital stock authorized.
d / b.The date of incorporation.
c.The types of business activity that the corporation is allowed to conduct.
d.The rules and procedures adopted by the stockholders.
42. / Which of the following would not usually be included in the minutes of the board of directors?
challenging / a.The duties and powers of the corporate officers.
a / b.Declaration of dividends.
c.Authorization of long-term loans.
d.Approval of executive bonuses.
43. / When are auditors likely to encounter judgment problems in the use of analytical procedures?
challenging
d / a.Whenever the auditor places reliance on management’s explanations for unusual fluctuations in account balances without first developing independent expectations.
b.Whenever the auditor allows unaudited balances to unduly influence his/her expectations of current balances.
c.Whenever the auditor fails to consider the pattern reflected by several unusual fluctuations when trying to explain what caused them.
d.The auditor is likely to encounter judgment problems in each of the above instances.
44. / The major concern when using nonfinancial data in analytical procedures is the:
challenging / a.accuracy of the nonfinancial data.
a / b.source of the nonfinancial data.
c.type of nonfinancial data.
d.presence of multiple sources of nonfinancial data.
45.
challenging / An auditor searching for related party transactions should obtain an understanding of each subsidiary’s relationship to the total entity because:
b / a.the business structure may be deliberately designed to obscure related party transactions.
b.this may reveal whether transactions would have taken place if the parties had been unrelated.
c.transactions may have been consummated on terms equivalent to arm’s-length transactions.
d.this may permit the audit of intercompany account balances to be performed as of concurrent dates.
46.
challenging / The first standard of fieldwork requires, in part, that audit work be properly planned. Proper planning as intended by the first standard of fieldwork would occur when the auditor:
a / a.physically observes the movement of securities already counted to guard against the substitution of such securities for others that are not actually on hand.
b.uses negative accounts receivable confirmations instead of positive confirmations because the latter require mailing of second requests and review of subsequent cash collections.
c.compares all cash as of a particular date to avoid performing time-consuming cash cutoff procedures.
d.eliminates the possibility of counting inventory items more than once by arranging to make extensive test counts.
47. / Early appointment of the independent auditor will enable:
challenging / a.a more thorough examination to be performed.
d / b.a proper study and evaluation of internal control to be performed.
c.sufficient competent evidential matter to be obtained.
d.a more efficient examination to be planned.
48.
medium / Whenever an auditor compares client data to client-prepared budgets, there are two special concerns. Indicate if the two items below are concerns.
a
Assessing whether the budgets were realistic plans / Client data may have been altered to conform to the budget
a. / A concern / A concern
b. / Not a concern / Not a concern
c. / A concern / Not a concern
d. / Not a concern / A concern
49.
challenging / An auditor who accepts an audit engagement and does not possess the industry expertise of the business entity should:
b / a.engage financial experts familiar with the nature of the business entity.
b.obtain a knowledge of matters that relate to the nature of the entity’s business.
c.refer a substantial portion of the audit to another CPA who will act as the principal auditor.
d.first inform management that an unqualified opinion cannot be issued.
50. / Which is a liquidity activity ratio?
medium / a.Profit margin
b / b.Inventory turnover
c.Return on assets
d.Times interest earned
51. / Which is usually included in an engagement letter?
medium / Estimate of hours required to complete audit / Dollar estimate of fees to be billed to the client
d / a.
b.
c.
d. / Yes
No
Yes
No / Yes
No
No
Yes
52. / Which is usually included in an engagement letter?
medium
a / A reference to GAAP / A reference to GAAS
a.Yes
b.No
c.Yes
d.No / Yes
No
No
Yes
53. / Which is usually included in an engagement letter?
medium
c / The financial statements are the responsibility of the company’s management / Ratios to be used by the auditor in the planning phase
a.
b.
c.
d / Yes
No
Yes
No / Yes
No
No
Yes
54. / When may the auditor refer to a specialist in the audit report?
medium
c / Only if the specialist’s report results in a modification of the audit opinion / Only if the specialist assisted in the audit of an account material to the financial statements
a.
b.
c.
d / Yes
No
Yes
No / Yes
No
No
Yes
55. / Which is usually included in the engagement letter?
medium
b / The projected type of opinion on the financials statement to be audited / Name(s) of the client personnel responsible for supplying the auditor with information
a.
b.
c.
d / Yes
No
Yes
No / Yes
No
No
Yes
56. / Which is usually included in the engagement letter?
medium
b / List of audit procedures to be used in inventory observation / The auditors’ assessment of Audit Risk
a.
b.
c.
d / Yes
No
Yes
No / Yes
No
No
Yes

Essay Questions

57.
easy / Discuss the factors an auditor should consider before accepting a company as an audit client.
Answer:
The auditor should investigate and consider the prospective client’s standing in the business community, financial stability, management’s integrity, and relations with its bankers, attorneys, and previous CPA firm. The auditor should also determine whether he or she possesses the required competence and independence to do the audit.